The Second Wave of Opportunity In China

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By:  James Waite, Managing Director Ops-Asia                           17 July 2013

Dramatic Growth of China

 

When I arrived in China in January of 1997, the country was the seventh largest economy in the world. Today it ranks second, lagging only the United States in economic clout. Much has changed in China over those sixteen years. I’m reminded of a newly-constructed two-lane highway we frequently traveled from Shanghai to Suzhou in 1997. That highway passed through picturesque landscape, lined with farms that in autumn were darkened by the dense smoke of burning rice stalks. Today, a four lane expressway,

Shanghai shopping district, weekday evening.

lined with the factories of companies from all over the world, links Shanghai to Suzhou.
 

In 2009 China reached number #1 in annual automobile sales and, in 2010, China sold over 17.2 million vehicles, compared with US sales of 11.5 million. Equally spectacular is the growth in its road system – with the first expressway built in 1988 and now, at year-end 2011, China has over 53,000 miles of expressways – second only to the United States’ 57,000 mile system.
 

Chinese GDP growth is projected at 7.7% and 8% in 2013 and 2014, compared to projections of U.S. growth under 3% for the same time period. As foreign companies continue to recognize the growth opportunities in China the amount of direct investment in China grew from an average of about 12.5% annual growth from 2001 through 2010.  In 2011 the direct investment continued grow and exceeded 2010 investment by 9.7%.
 

Young Chinese consumers are moving toward a more Western-oriented lifestyle and want their own apartments, cars, and the latest phone or other electronic gadget. Latest projections put the Chinese middle class at over 640 million by 2025, roughly double the current total U. S. population.
 

Dramatic growth, across all economic facets of China, indicates opportunity unmatched globally.

 

Changes in the Business Environment

 

Prior to my arrival in China, most foreign companies partnered with Chinese entities to create joint ventures in China. This was due, primarily, to government regulations and access to the Chinese market. Now, the most popular business structure is a wholly-owned foreign subsidiary with no Chinese partner. In 2001, when China joined the World Trade Organization, I began to see the gradual reduction of import tariffs and, about 2005, foreign businesses were allowed to engage in buying and exporting Chinese-manufactured items when, in the past, they had been required to pay a formal trading company to conduct this type of business.
 
There has also been significant change in labor mobility and cost. In the late 1990’s, employees were primarily found in the local community. In the 2000’s, professional and skilled employees come from all over China and factory labor, typically from the poorer parts of the country. With a more mobile work force, comes higher employee turnover,

Typical Chinese Factory product packing line.

which grew to as high as 25% in recent years. The minimum wage has increased over 10% per year in the last few years and many economists expect wages to double over the next five years.  Other costs, such as raw material, have also increased in line with global price growth.
 
With the east coast of China the first geographic location that western companies focused on when starting their Chinese operations, the cost structure is now higher than that of the central and western parts of China. Many companies already in China, or new entrants to the Chinese market, are looking across a spectrum of locations, attempting to balance the cost elements and access to good transportation and skilled labor.

 

Change in China Leads to Business Model Review

 

With opportunities in China changing dramatically, companies currently operating there are re-evaluating their strategies, relationships and operations to enhance their Chinese operations’ return on investment. Companies that came to China to set up low-cost manufacturing for exporting products to U.S. markets have seen profits erode, as costs have increased. China’s economic situation today indicates that it’s time to re-evaluate strategies and strengthen implementation plans.
 
My team has seen, firsthand, how American companies are dealing with change in China. Here are two approaches used by companies that have developed successful strategies.
 

Business Model #1: Upgrading Operations & Management
 
In 2006, an American company first formed a joint venture with a Chinese company to manufacture auto components for their global customers, who had factories in China. The manufacturing facility was located in the central part of China, which has one of the lowest minimum wage levels in the country. By 2008, the joint venture faced increasing customer orders and delivery requirements. To meet the needs of their customers, the joint venture installed modern equipment with a higher finished-product yield, developed a preventative maintenance program for the entire factory, established metrics to track progress and tracked the performance of each work cell. They also hired new department heads, which had strong leadership skills, experience working in a modern manufacturing company and were good communicators.
 
Two years after beginning this strategic initiative, the joint venture is performing to expectations and their customers are satisfied with timely, high-quality delivery.  Because managing a joint venture can be very different from an American company’s traditional business model, it requires a management team – in both the corporate home office and at the joint venture site – that understands Chinese business practices and is effective at communicating with all parties: Chinese and American management as well as the factory staff.

Business Model #2: Utilizing American Advisors to Improve Chinese Vendors’ Operations
 
An American market leader in the manufacture and sale of outdoor cooking equipment established a component and finished-product sourcing operation in China with 20-25 different vendors. In the period from 2000 through 2010, material and labor costs increased causing the price paid by the American company to increase as well.
 
To address these issues, the company hired its own staff in China, who acted as consultants, working in the vendor’s factories. They helped vendors improve processes and upgrade equipment and quality systems, along with assisting in the required employee training. This resulted in almost 100% on-time deliveries and a significant reduction in the number of customer quality complaints. It also helped to stabilize purchase prices for the American company. The end result was a win-win situation — the vendors reduced their cost and the American company had less volatility in pricing – leading to happy customers and increased sales.
 
Whether currently operating in China or looking at China for the first time, American companies have a wide range of business strategy options and alternative business models for creating a successful business in China, including:

  • Export products or services from the United States to China  
  • Source products or components from China to the United States or other global        destinations
  • Manufacture in China and export to the US or other markets
  • Manufacture in China for the Chinese and/or Asian market
  • Asian partner for your US-based operation
  • A combination of the above

 Opportunity Linked to Strong Planning

 

Today, China offers American companies an extremely appealing global growth opportunity. Chinese government policy and economic activity is aligning to shift its position from the “world’s export factory” to increased domestic consumption. In March of 2011, the Chinese government passed the Twelfth Five-Year Plan with goals supporting a rebalancing of its economy, shifting emphasis from investment toward consumption and from urban and coastal growth toward rural and inland development. These goals encourage foreign investment in modern agriculture, high-tech and environmental-protection industries.
 
American companies of all sizes – no matter their current relationship with the Chinese market – can find new or additional opportunity in China and Chinese companies eager to discuss and evaluate alternatives for long-term cooperation. Whether updating your plans or evaluating a new business, you should: assess your current situation, collect market intelligence, prepare feasibility plans, develop your strategy and business plan, and implement.
 
There’s a well-evolved economic revolution occurring in China that offers real and dynamic opportunity to companies willing to take the time and invest the resources in understanding how to do business there.  It’s not easy to get accurate information or be culturally attuned to doing business in China. The Chinese will present all the reasons why you should invest in their country, but you need subtle and nuanced insights to be able to sift through the data to make informed business decisions. Your company can study the Chinese market itself, through a potentially arduous networking process, or it can shorten the learning curve by utilizing the expertise and advantages of strategic partners who know China and have strong relationships already in place, avoiding the risks of moving in a sub-optimal business direction.

Setting up factories and growing businesses in China

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Interview with James L. Waite, who set-up factories and grew American businesses in China

Interviewed by: Tim Mojonnier                                                     23 January 2012

Tim Mojonnier writes about operations management best practices at BusinessTheory.  In 1990, he started Mojonnier & Associates, a management education & consulting company. In addition, he teaches MBA and executive education courses at several Chicago universities. 
James L. Waite is President of Ops-Asia, which has offices in Northbrook, IL and Shanghai, China and can be contacted at: jwaite@ops-asia.com

You lived in China for 13 years. When did you live there?
I arrived in January 1997 and returned to the U.S. in November 2010, with occasional trips back to the U.S. During my time in China, I spent 9 years in the Shanghai area, and the balance in the south, Guangdong area.

What was it like living in China for all those years? What were the biggest challenges in adapting to the local culture?
Initially, my wife and I felt uncomfortable going into the streets, and shopping by ourselves. Because we were foreigners, the prices were higher and the Chinese way is to negotiate for everything. We also had to acclimatize ourselves to being long term expatriates (expats). Most expats typically live in a country for 2-3 year assignments. Since we lived in China for over a decade, we always had to make new friends. In addition, dealing with a translator was a challenge, because the translator would just translate the words, but not the meaning. Furthermore, the Chinese do not always speak their mind, and they do not speak directly. After being there several years we were able to understand the meaning of Chinese conversations. We also learned how to communicate basic things and feel comfortable shopping in local open air markets and moving with the flow in the crowded streets. In conclusion, once we got over the initial shock of living in a different culture, we realized that the Chinese are a warm people, who enjoyed being around Americans, in part because it provides them with an opportunity to practice their English. Chinese business people are all educated and very smart. It was a pleasure working with them, and we have developed many friends who visit us when they pass through Chicago.

What did you do before you lived in China?
After graduating from the university, I worked in the Chicago area for 7 years in construction and design engineering. Later, I held manufacturing management positions such as V.P. Manufacturing and General Manager. I was employed in industries that produced air pollution control equipment, pumps, industrial testing equipment, laboratory testing equipment, etc.

What did you do during your stay there?
I had three primary engagements. First, I managed a joint venture between an American ball valve manufacturer and a Chinese company. The assignment entailed overseeing the relationship between the two organizations as well as running the business. Second, for Sloan Valve Co., a global manufacturer and distributor of flush valves and faucets for high end commercial buildings, I developed a business plan that described a strategy to enter the Chinese market selling American products in the China market. The plan was funded, and I started up the operation in China, where I worked for 6 years. Third, I worked for Weber-Stephens, establishing a supply chain management company. The focus was on finding suppliers, qualifying suppliers, and monitoring their performance. I traveled to many places in China for all 3 companies, and gained an understanding of what products are made in various locations and the Chinese customs to do business.

Given ever increasing levels of inflation and local labor rates as well as the appreciation of the Renminbi, is China still an attractive country to outsource production to? If so, why?
$1.90 per hour is the highest Provence minimum wage (Guangdong Providence), which includes all of the employer costs to put an employee on board. However, the City of Shenzhen recently announced increases for the minimum wage effective starting Feb. 2012 = $2.17/hour including burden. Skilled Chinese workers can command more. Still, outsourcing work to China provides a manufacturer with significant labor savings, but you need to have the correct strategy for why you are doing business in China. Companies trying to penetrate the local market have the best opportunity. The Chinese like western products; they desire the things and life style we have. Look at Apple’s phones; they had a sale on their latest model and the demand was so great that they cancelled the sale, and shut shops down. Demand for these types of products is unbelievable. But outsourcing labor-intensive work to China—while developing channels to enter the local Chinese market—is not an easy thing to do. However, the return can be great. Finally, if you are only focused on reducing labor costs, then outsourcing work to places like Viet Nam may be a better option. However, this strategy involves chasing a few cents savings and moving to new factories or new vendors every few years.

What are the main challenges associated with running a business in China?
That’s a big question. It depends on whether you are just sourcing components from China or making product for the local Chinese market. If you are only manufacturing and exporting, then quality is especially important. Also, retaining good employees is always a challenge, especially given wage inflation. Pirating good employees is an issue. You need to have cultural sensitivity, understanding what people expect from an employer. Having a first-rate Human Resources policy and activity is important in order to retain good employees. Also, it is very difficult for small manufacturers. The Chinese think that bigger is better. They believe that it is better to work for a big company, which is especially an issue when dealing with the government. The larger the company, the greater the likelihood that officials will work with you. If you are a small guy, it is difficult to attract their attention.

What are the main opportunities associated with running a business in China?
For the years 2007, 2008, and 2009, the American Chamber of Commerce in Shanghai and Booz & Co. conducted a survey of about 1,000 manufacturers to understand why they came to China. The following is a list of the major reasons, ranked from most important to least important:
1. 83%: Access to the local Chinese market
2. 66%: Labor cost savings
3. 51%: Access to the broader Asian market—having a business in China provides you with
the ability to export to other Asian countries without import duties
4. 44%: Material savings
5. 41%: Strategic move against key global competitors

In November 2011, you returned to China for a month. How have things changed since you were last there?
Previously, China put a lot of effort in infrastructure projects, but at the time I left, there was a downturn in this activity. I was surprised to see a great amount of construction still going on. Housing prices are finally coming down, enabling the middle class to buy their own apartments. Business in general is just booming; people are busy, hustling, you can just feel the energy in the streets. You don’t feel that here [in the U.S.] at all. Nevertheless, the Chinese business people are concerned. Previously, the economy was growing at a 10 % clip, but it has slowed to 7% projected GDP growth in 2012. However, the government is committed and will make the 7% growth happen. Inflation has increased, and there is concern about an anticipated leadership change in the highest levels of government.

What does your firm do?
Ops-Asia helps businesses to be successful in Asia and/or the U.S. We focus on small to mid-sized companies that don’t have the resources to do this type of activity. The primary market segments served are industrial products, building materials, household appliances & automotive components. We assist firms in 4 areas: business development, operations competitiveness, project management, and supply chain management.♦