The Closing Window of Opportunity for Small & Medium Manufacturers in China
By Kenneth J. McGuire, MEAC
One thing that pretty much everybody can agree on about China is that the economic scene in China is changing at unprecedented speed. So this is a timely report on a May/June 2006 trip that will likely be quickly outdated.
Starting with the usual, I can report about the breathtaking economic pace in Shanghai, the incredible Olympic 2008 clean-up going on in Beijing, and the white hot build-up of every industrial sector in almost every part of China. Brand-spanking new hardware is being put in place for continued economic expansion. Unfortunately, the ‘operating software’ for running all this new hardware is still mostly a disappointing work in progress. There are still many deficient quality processes and poor customer service practices surrounding the new hardware. Much of this ‘software’ is either fragmented with important parts missing or just incomplete. Depending on the Chinese people’s time and experience working with the new hardware and discerning customers, other processes work quite well to a western standard.
Closing Window for Partnerships On this trip I also detected what appeared to be a great opportunity for Small and Medium Enterprises that is slipping away. The window for manufacturing companies seeking to collaborate with willing Chinese manufacturing companies seems to be closing. On previous trips, there has been a surprising push to attract American Small and Medium Enterprises to establish a presence in China. At ceremonial business gatherings there was strong expressed sentiment encouraging foreigners to find a suitable Chinese business partner to team up and grow together. This was especially in evidence by officials of Economic Development Zones seeking new foreign tenants. But there were also many Chinese business owners and managers who attended matchmaking sessions and reinforced this welcoming invitation. China’s business people were eagerly seeking an audience with US business people. China’s business owners and managers were seeking to learn of western ideas and eager to find products or prospects for partnering opportunities.
Development Zones offer economic incentives to come to China. Tax-free periods offered in the development zones promote company partnering and encourage manufacturing investments. In the past, every China manufacturer you would meet was looking to find a US partner with which to build a future.
That open solicitation for partnering seemed to be missing on this trip. Perhaps because of the effort by the central government to cool the overheated economy, or possibly because that original effort hadn’t produced the desired effect. But it was evident that most of that enthusiastic energy was missing on this trip.
US Turns to China as Low Cost Source To be sure, there is evidence that there are still plenty of US companies heading to China to find low cost sources. The continuing trade deficits confirm that much outsourcing is still taking place with China. And in the first half of 2006, foreign direct investment was still huge at $60 billion USD. But there is evidence that it is slowing. The Wall Street Journal suggests that most of the manufacturing that can be profitably moved to China, probably already has been and now some of the low end manufacturing is beginning to move out of China to even lower cost nations. But low cost sourcing is not partnering. Partnering needs to be something more
The ‘low cost source’ Chinese company is also beginning to discover that while they may find success for a while as the low cost producer, longer term they run the risk of being ‘outsourced’ for an even lower cost alternative. Too often, the win/win of being a low cost source means that the foreign company wins twice (low price and with no obligations).
Maturity Brings Higher Costs Many emerging Chinese enterprises, especially those in the inflationary coastal areas are now are facing an exodus of their customers who continue to seek low costs and find it elsewhere. Many China producers, who got their start being the ‘low cost source,’ invested their early experience wisely and matured into capable organizations. Maturity also brought higher costs. Companies operating in China today must find competitive advantages that go beyond cheap labor. Relying on capabilities focused on ‘cheap’ are one-dimensional. Too many of these companies were operating under the impression that a manufacturer who was willing to work hard, study the rules of quality, and abide by the customer’s demands would eventually do pretty well. Unfortunately, knowing how to make a product and knowing how to find a reliable market for that same product are not the same thing. So, these companies are now looking to find continued growth by leveraging that early manufacturing experience only to find that they lack critical skills.
Longer-term success requires skills that many Chinese entrepreneurs have not had the time or the inclination to develop. Marketing skills and knowledge of market applications are two crucial value-adding components modern customers seek. Skills that are missing, such as marketing intelligence, modern supply and demand management skills, experience in developing sustainable quality producing processes, and managing a long complex supply chain, are increasingly important. These are ‘knowledges’ that are required to attract and retain customers.
Additionally, world-class competitors need to learn how to develop and/or adapt products that can stand the test of demanding customers in volatile global markets. Being the low cost producer does not develop those traits. For many of these companies it’s a case of not knowing what they don’t know.
Too Few US SME’s in China This is where American SME’s (Small and Medium Manufacturing Enterprises) have a lot to share. It is also where there is a huge opportunity being missed. SME’s, some 22.9 million of them in the US, produce 14 times the number of patents as large companies. And these SME’s are twice as likely to successfully commercialize new innovations. In the US economy, SME’s produce half the GDP, generate 75% of the new jobs, and account for nearly half the country’s payroll. The innovation and supply chain agility of US SME companies is a tremendous competitive knowledge pool. Combining and blending those traits with unbeatable cost advantage is a genuine win/win ‘world-beater’ opportunity.
On this trip I was told more than once that there are surprisingly “too few” American SME’s actually willing to partner with Chinese counterparts. The “buy cheap in China and sell it at home” formula shortchanges the collaboration opportunities.
If SME’s don’t start a global collaboration with Chinese manufacturers now, where will their companies be in five years? What is the likelihood that a high cost SME could withstand the assault of a price competitor with a 25:1 resource cost advantage? And what if a few of their dominant customers discover the “China Price” first? How long will their niche protect them? Customers are fickle, especially when it comes to price. SME procrastination in seizing the China Opportunity is a ‘bet the company’ gamble.
Effects of the China Price By now the “China Price” has affected every manufacturer, either directly or indirectly. It has become the new competitive benchmark and is making it difficult to raise the revenue ‘top line,’ even after developing new or improved products. The same China Price phenomenon is also affecting every manufacturing company’s ability to grow its profit margins, even though these companies have adopted improved operating processes and invested in vastly improved advanced technologies.
One senior executive said, “If the Chinese can make it, we really can’t afford to be in the business.”
Such an opinion points to the hopelessness of engaging in price competition when one’s opponent has an overwhelming cost advantage. It seems to be saying that there simply is no good reason to invest resources in a losing competitive battle. Comments like this might be expected from a New England factory, but they came from a Japanese executive.
Combining Innovation & Low Cost In the face of these compounding difficulties, what seems to be holding some US companies back from adopting a China strategy? If the direct threat that Chinese manufacturing poses is so apparent, why don’t more companies see the opportunity to go global and join the 49,000 US businesses already in China? SME’s should be seeking a Chinese company to partner with, blending innovation and low cost before all the good ones are committed to a competitor.
China manufacturing is the new elephant in the room. One can see it as a threat or an opportunity. It depends on your tolerance for undertaking dramatic change. Going to China is risky. The difficulty of attempting to conduct business half a world away, in a vastly different culture, in a non-English language, makes for a daunting challenge. Any business could choose to postpone or shy away.
Surviving Economic Disruption from China Small and Medium Manufacturing Enterprises need to develop a new global vision if they are to survive the economic disruption that an emerging China has precipitated. And they can’t afford to wait. The window of opportunity is closing.
What should the value proposition be? Both partners need to give up doing what the other partner has a clear economic advantage in. That is the essence of the term Globalization.
China manufacturers are unbeatable on price because they have the lowest resource costs in the world, but they lack management and marketing skills that are second nature to most SME manufacturers in America. That is an obvious place to begin the search for a blending potential
Most Chinese exist in a manufacturing world of idle machines, late deliveries, piles of waiting inventory, production bottlenecks, and frequent rework quality problems.
SME’s must search for a blending of low cost, innovation, superior supply chain logistics, and market opportunities that make partnering a winning, two-way value proposition.
Blending Opportunities To survive in the American manufacturing world SME’s need to be strong, agile, fast moving, and fiercely competitive. These are precisely the innovations that can accelerate success for a budding Chinese company. When teamed up and pooled with the lowest cost modern manufacturing resources in the world, a well-suited partnership redefines the meaning of the term “world beater.”
In a global market, it is unaffordable to invest high wages in workers tending parts making machines. It is also illogical to think that low cost alone can offset cultural and language obstacles to ‘service’ a customer in the home market. Who better than the people who make the product can service it in their native language, and in accordance with their local circumstances?
For both Chinese and American manufacturers, it is absurd to think that the logistics of an ocean crossing shipment makes sense anywhere time delay is not protected by certain known need and a low obsolescence risk. This is another obvious blending opportunity.
To get started, an SME needs to study, explore, decide, plan, and then act swiftly. Figure 1 outlines a four phase – two year process that will serve as a good starting place. Each company’s China Entry will be situation specific, but any expectation that it will be a short, one trip event is a ‘lottery ticket’ hope. China entry requires the first string team on a dedicated basis. And the first string team needs coaching which accelerates realization to cash positive in 24 months for the SME business proposition.
Figure 1. China Entry Event Timeline
The first step is getting started. Senior management conviction to the decision to accept the China Challenge needs to be based on first -and discovery and exploration. Knowing your company strengths, priority business needs, and resource limits is step 1. A readiness assessment and opportunity profiling is good preparation. Then going to China to size, shape, and plan the opportunity is next. Moving forward is contingent on what the first steps reveal.
Phase II starts by reaffirming the ideas laid out in Phase I with data and informed research. The steps from there will be obvious. There will also be a murky transition through the next implementation and execution phases. The most important thing is to be flexible to the reality that unfolds. This is where good coaching is essential. But no amount of coaching or preparation will substitute for step 1 — getting started before the window closes.
For more information on doing business in China, contact Kenneth J. McGuire, MEAC, 23 White’s Path 2-A, South Yarmouth, MA 02664. Office 508.398.2010. Mobile 508.776.4028. E-mail:
