The China syndrome

Posted on 13 Aug 2008 by The Manufacturer

China has evolved at breakneck speed from a source of low-cost components and products to one of the world’s fastest-growing and most important markets. Ruari McCallion tracks the changing landscape of opportunities and challenges

As little as two years ago, the focus of this article would have been on China as a low-cost manufacturing economy and the concern would have been purely how British manufacturers could compete. China has changed, is changing and will continue to change. It’s one of the fastest-growing economies in the world; by 2020, it’s expected to have passed Japan and will probably pass the US five years later – or even sooner. Growth is estimated to have been around 11 per cent in 2007 – a level that the world’s advanced economies can only dream of – although purchasers of metals and commodities may wish they’d ease off a bit.

But nothing is straightforward. Companies that outsourced production to China, especially a few years ago, found that all was not as advantageous as it immediately seemed. It took a while before Waterford Wedgwood’s venture in Han Dan was successful without qualification. The company’s manufacturing and supply director recommended that companies considering a strategic move should exercise the greatest possible care in calculating their first year costs, and then double them. Goods inwards inspections, extra inventory (a significant proportion of it on board ships), port handling costs, storage, quota impacts, customs and cross-border bureaucracy and additional working capital to finance it all add up to a hefty total. Bombardier Aerospace’s
director of procurement observed that low-cost countries are low-cost for several reasons, which could include poor infrastructure and lack of appropriate skills, all of which require additional support – which costs money.

But China is moving rapidly beyond the low-cost model. Companies like BMW and GM haven’t established car plants in the PRC in order to supply their home markets; they’re located close to the growing economies the companies wish to penetrate. The same applies to Airbus and Boeing, who need to provide local economic benefit if they want airlines in the Far East to buy their products.

China’s GDP in 2007 is estimated at $3,249 billion, 50 per cent greater than the UK’s – but although the government has allowed the renminbi to accumulate in value against the US dollar by 15 per cent, there’s still a huge gap between the official exchange rate and purchasing parity. On the latter measure, Chinese GDP is equivalent to $7,043 billion – twice the ‘official’ level.

Industry/manufacturing makes up 49.2 per cent of the Chinese economy, and services 39.1; that leaves 11.7 in agriculture. 2006 estimates had 25 per cent of the workforce in industry, 32 per cent in services and a massive 43 per cent in agriculture; that’s about the same as the UK in the 1850s. China’s industrial revolution is only gathering pace at the moment, it’s nowhere near full steam. However – there’s always a ‘however’ – the reservoir of labour doesn’t mean the country has an ongoing pool of low-wage workers to call on.

“We are seeing wage inf lation across the board,” said Jeremy Waller, of The Consultancy Company. He first went to China with Inchcape in 1982 and has had direct and indirect involvement there ever since. He now advises companies on doing business with and in the country. “It depends on where you are; there’s more on the coast than in the interior, and more in the south than in the north; and conditions are changing, too.” The old days of extensive exploitation and working conditions that embarrassed a number of western corporations when they became known are being put firmly into the past.

“The government is imposing better terms and conditions on employers to control exploitation and to end the 10-hour days, seven days a week,” he said. “Some factories that you come across could be in Wigan or Hemel Hempstead; go round the corner and you could find something Victorian. The level of disorganisation can be horrendous and safety varies hugely, from truly third world to the best of western standards. But the government realises that health and safety, worker safety and so on, are real issues.”
If standards and working conditions are being raised, then costs will inevitably rise, also. But direct labour is a very small element; wage costs could double and still have very little impact. Raw material costs are still more important.

If China is to maintain its growth and development into a world-leading manufacturing economy, it has to address efficiency. Hitherto, the solution to increasing velocity through the factory has been to throw people at the problem. That is wasteful and ultimately self-defeating. It’s only by attacking root causes that delays and inefficiencies are permanently overcome.

“There is a need to add lean and six sigma in a structured way,” he said. He believes it will happen, and very quickly when it does. “China leapfrogs whole stages in developments. For example, it never had chequebooks; it went straight to debit cards and electronic payments. It will go from the equivalent of the 1930s to the 21st century in one go. One of the big benefits that will come will be the quality improvements that come with six sigma.” But ‘quality’ is supposed to be present already, with ISO9000 series accreditation pretty widespread. “Unfortunately, people buy their ISO9000 accreditation; they hire a consultant for a couple of days, who goes through their paperwork and they issue the certificate.” As the auto industry – particularly western implants – grows, real quality will spread.

Any country’s skills base will be an issue of great interest to anyone intending to invest or work in it. China is turning out a colossal number of graduates each year, as Japan did in the 1980s – and look how it transformed from a ‘copier’ to an innovator, across the board. China is a country that values the best of the rest of the world, also, and it holds western education in very high regard, British and American in particular. Chinese students are far from unknown at British schools, both in the private and state sectors.

Some of the problems that have induced hesitation in western companies remain, but the government seems to have taken notice and is addressing them. In a centralised political system, what Beijing says truly goes – regional officials and factory managers who go against the Party line can find themselves sentenced to death, not just fired from their posts. But IP protection, fair treatment from the courts and supply chain quality remain as issues to be wary of.

“There are a number of ways to head off IP concerns,” said Waller. “First is working with people you’ve had a previous relationship with, people you know and trust.” But that’s a bit chicken-and-egg; you have to work with people to gain experience. “So, second, sit the people down and tell them you take IP very seriously and that there are laws in China about unlawfully taking designs. They’ll nod and say yes, so you suggest they’ll have no problem signing a document that will allow you to sell their wife and children into slavery if they breach your IP. Nine times out of 10, they’ll go ahead. If you take them to a court of law you might not win, but you get their attention.” And if you become a large enough client, you have leverage – so it’s important to deal with the right size of company, not one that will dominate you or vice versa, but one that can become a strategic partner. Don’t abandon the normal quality controls and assurances that would be common sense in the west, and pay attention to how the country is evolving.

“China in the 1980s was going through a formative stage and there was a lot of mess, including deep-rooted problems with the local culture and with foreign joint ventures. There was huge misunderstanding,” he said. During the 1990s,
both sides began to understand each other better.
The problems of growth – inflation, in particular – seem to be under control, because of the centralised government structure; it keeps a very firm hand on money supply. China is a huge exporter but its local economy is bigger and growing. Higher value-added content is rising. The transport infrastructure is improving – the picture of green fields being transformed into industrial complexes served by motorways in just a matter of months is fact, not fiction. The opening of the Trans-Siberian railhead on the coast means that containers can now be shipped all the way to Europe by land, which could help with shipping costs and time.

“In 10 years’ time, China will probably have moved on again, with higher value-added goods – and consumers buy imported products. I keep coming across examples of companies in the UK making things you’d have thought had long gone overseas. But they make particular products in a particular way and sell them to high-end retailers. There’s a cachet appeal, which it is important to nurture,” said Waller.
“There are lots of opportunities for British manufacturers in China.” Both operating inside and exporting to it.