China's rise has already left its mark on businesses throughout the world. If you are in a labor-intensive industry, such as textiles, apparel, shoes, and man-made luggage, Chinese competition may have driven you out of business. If you occupy the higher end of the market, you may have gotten there as a defensive move against low-cost Chinese imports only to find out that this segment, too, is susceptible to competition from China and from other countries escaping the low margin zone. If you are a producer of durable household goods, such as appliances, you may still be in business courtesy of Chinese manufacturing or outsourcing; perhaps you are already not doing much more than slapping your brand label on a Made in China product. If you currently have no connection to China, you may be thinking of establishing one as you read these pages. As a supplier, you may be asking yourself whether you will be replaced by a Chinese competitor, and if you're a buyer, you may wonder if you should retain some of your domestic or third-country sources as a hedge against interruption in Chinese supplies.
The “first impact” of China's rise has been more apparent in some countries than in others (for example, more in the U.S., less in the European Union, or EU) and has been felt more in labor-intensive and low or intermediate technology areas than in technology-intensive areas. In the United States, China leads in such categories as footwear, toys, and household wooden furniture, among others, and, with the expiration of the Multifiber Arrangement and China's World Trade Organization (WTO) ascension, is about to take over textile and apparel. Three years earlier, when quotas on manmade fiber luggage were eliminated, unit price dropped by half and China's share of the global market rose fivefold. During the same period, U.S. luggage imports from Mexico declined by half, prompting the closing of several factories. Exports from Thailand and the Philippines also took a plunge.[1]
China's advance in the labor-intensive categories will not make many waves in the United States, which exited many such product lines long ago. For instance, a survey conducted by the American Rubber & Plastics Footwear Manufacturers Association (RPFMA) found that only 17 types or rubber/fabric and plastic/protective footwear, representing merely 5 percent of the footwear sold in the United States, are still produced here. The impact will be felt, however, in industrialized countries that have shielded their producers via a combination of subsidies and trade protection, and especially in developing nations that have relied on lower pay and proximity to market to stay the course. The travails of those developing economies will come back to haunt the industrialized nations who supply much of the value added in their production chain, provide aid to their struggling economies, and are host to their immigrants. As the radius of affected industries and product lines expands to cover a broader product array, industrialized nations will be further drawn into “the China debate” on its social and political ramifications.
In business, the rise of China will challenge basic assumptions regarding the nature of national and firm competitiveness, the value of geographic proximity, and the cost of market entry and exit. Location advantages that have underpinned company survival and prosperity for decades—and sometimes for centuries—will be questioned, and the global mobility of production factors will accelerate under a global supply chain. As on prior occasions of dramatic economic shift, the coming changes will test both external and internal alliances. Players will be playing by new rules, with new winners and losers created.
How should businesses prepare for the Chinese century? Preparation begins by understanding the nature of the coming change and assessing its impact on one's industry, firm, and individual employees. Preparation continues with a willingness to re-evaluate the very raison-d'être of the organization, questioning not only practices and routines but also the fundamental assumptions on which the business model rests. The re-evaluation will often call into question the adequacy of responses that have worked well in the past but may not hold this time. For instance, an opinion prepared for the Department of Commerce and the U.S. Trade Representative notes that the few leather tanneries that survived in the United States did so by focusing on the high-end automotive and furniture upholstery market; however, the Chinese move up-market is occurring at such a pace that this strategy is now called into question. As a whole, “business as usual” solutions will no longer work. Firms must rethink their entire value chain, which will likely lead to a new business model or to an outright exit.
In the 1840s, a British author wished, “If we could only persuade every person in China to lengthen his shirt-tail by a foot, we could keep the mills of Lancashire working around the clock.[2] Some 160 years later, this assessment of the Chinese impact on the textile and clothing trade is about to come true, except that the mills doing the overtime will not be in Lancashire or North Carolina but in Zhejiang and Jiangsu. As for the customers, they will be all over the globe. Between 1989 and 1999, China's share of the G-7 apparel market doubled, reaching 20 percent, according to OECD figures. China's clothing exports have continued to rise since 1999, passing the $70 billion mark in 2002. China is now the number one foreign source for the clothing sold in the U.S. Its 12 percent share is surely understated, because it does not count Hong Kong's 4-plus percent (which is at least partially mainland made) or the $160 million worth of smuggled clothing seized by U.S. Customs.[3] China, says the International Trade Commission (ITC), “is expected to become the 'supplier of choice' for most U.S. importers.” The American Textile Manufacturers Institute (ATMI) estimates that by 2006, China will control more than 70 percent of the U.S. import market (see Exhibit 6-1). The Institute bases its predictions on 29 apparel categories, for which quotas were abolished on January 1, 2002, resulting in China's share of the American market rising from 9 percent in 2001 to 45 percent by the end of the first quarter of 2003. The only thing that might prevent China from cornering the entire market, according to the ITC and U.S. manufacturers and retailers, is the reluctance of buyers to be completely dependent on a single source.
Source: The American Textile Manufacturers Institute, 2003.
Figure 6-1. China's Projected Control of the U.S. Textile and Apparel Import Market.
The U.S. market will not be the only one affected. World Bank forecasts that China will increase its share of the global clothing market, currently at roughly 17 percent, to 45 percent in the second half of the decade. A Chinese study estimates that as a result of WTO accession, China's apparel output will increase by almost 40 percent, while its textile output will grow by about 25 percent.[4] Chinese firms are gearing for the challenge. Data from the International Textile Manufacturers Federation shows that China accounts for 57.5 percent of all new shuttleless looms ordered during the 2000–2001 period. Further, 9.9 percent were ordered from Taiwan and Hong Kong. The U.S., the EU, and Canada combined account for 13.6 percent of the orders.
China's winning formula rests not only on low wages. As the ITC notes, China does not have the lowest wages in this sector, but it has the lowest per-unit costs due to higher productivity and scale economies. The country has the supporting industries that facilitate production; for instance, it is the largest manufacturer of man-made fibers. Vertical integration of large manufacturers permits rapid response and keeps outsiders away from the value chain. Chinese apparel makers are also better capitalized than developing country makers, permitting the introduction of the newest technology. The result is a one-stop shop unavailable anywhere else. China will become the supplier of choice, offers the ITC report, “because of its ability to make almost any type of textile and apparel product at any quality level at a competitive price.” Where the Chinese still lack is in the creative aspects—in particular product design—but they can make up for that by knocking off foreign designs, a difficult thing to detect in any environment, let alone that of China.
China's advance will come at the expense of other industry players. An IMF report estimates that all other clothing exporters will suffer a significant drop, ranging from 14.4 percent for industrial nations, 32.2 for Latin America, and 32.4 for Africa.[5] The hardest hit will not be the developed nations who can redeploy their resources into sectors where they are more competitive and can obtain higher margins, but the developing and especially the least-developed economies that will be hard pressed to find alternative venues for growth and employment. ITC data shows that textile and apparel constitute 86 percent of Bangladesh's merchandise exports, 83 percent of Haiti's exports, and 63 percent of Honduras' exports. For Lesotho, in sub-Saharan Africa, the textile and apparel category accounts for 94 percent of all merchandise exports. The sub-Saharan region has already seen a dramatic decline in nightwear exports (a category where they compete with China in the U.S. market), from 98,000 dozens in 2001 to less than 30,000 in 2003. Lacking prospects for substitution, nations such as Lesotho are faced with grim prospects that will worsen an already bad economic situation, with political and social ramifications to come.
Even though developing economies will be on the firing line, developed countries will share the pain. Nations that have protected themselves from earlier entrants such as Taiwan and Korea by retrenching into the high-end, exclusive sides of the market will not be immune this time. ATMI projects losses of about $2.5 billion for EU exports to the U.S. Italy is forecasted to lose over $1.2 billion worth of exports in the American market, and even its top-of-the-line firms that have been in business for centuries are now threatened.[6] Canada is also projected to lose close to $2 billion of U.S.-destined apparel exports. Regions that are reliant on textile and apparel (such as North Carolina) will lose much of their domestic market, as well as the foreign markets they still dominate as exporters and as suppliers of fabric or yarn (such as the Caribbean). ATMI projects the closure of 1,300 U.S. textile plants in a three-year period—roughly a plant a day—although the enactment of the Central American Free Trade Agreement has served to stave off such a collapse for both U.S. and Central American firms. The United States and other rich nations will have to find a substitute for the lost export revenues of Haiti and Honduras. France will do the same for its former colonies in North and West Africa, extending regional interdependencies. Joining them will be a more assertive China, which will leverage its position to score political points with America's and the EU's closest neighbors by offering them bits and pieces in what will become a global supply chain whose “heart” (design, logistics, finance, and so on) resides in China.
In 1993, imports represented about a quarter of the household wooden furniture sold in the United States; by 2002, they amounted to almost half. The difference can be easily accounted for: Between 1996 and 2002, U.S. imports of Chinese household furniture rose more than sixfold from $741 million to $4.8 billion. U.S. imports from China, by then the world's leading maker and exporter of wooden furniture, rose 75 percent between 2000 and 2002.[7] During the same period, production of all wooden furniture in the United States, including that made with imported components, declined from $12.12 billion to $10.67 billion.[8] The industry has been on a downward employment trend for years, having shed some 50 percent of its 150,000 strong workforce in the 1980s and 1990s, a result of automation and productivity improvements more than foreign competition. China's resurgence has greatly accelerated the pace, however, with the industry losing a further 28 percent (roughly 30,000 jobs) in just three years (2000–2002) according to the U.S. Department of Labor.
Edward M. Tashjian, vice president of marketing for Century Furniture of North Carolina, noted in a testimony before the House Committee on Small Business in June 2003 that a Chinese bedroom set comparable to his company's $22,755 offering was priced at $7,070, or 69 percent lower. Even if the quality of the Chinese product were lower (which is not necessarily the case), price advantage of that magnitude would be hard to pass over even by discerning consumers. The pressure on revenues and margins is evident: In a petition filed on October 31, 2003, a group of 28 U.S. furniture makers argued that between 2000 and 2002, sales by group members fell by 23 percent, and operating income declined by 75 percent. The petition stated, “It is no exaggeration to say that the imports from China have singlehandedly forced the industry into a tailspin so swift and so deep that it may soon become irreversible.” The group accused their Chinese competitors of unfair pricing in the American market while benefiting from Chinese government subsidies and currency manipulation.
The U.S. industry, on its part, seems to have been caught unprepared. Dave Dyer, senior vice president of operations for Henredon Furniture Industries, Inc., told the Subcommittee on Commerce, Justice, State, and the Judiciary Appropriations House Committee on Appropriations on May 22, 2003, “Had someone suggested to me five years ago that we would be vulnerable to an onslaught of low-cost furniture products originating offshore, I would not have believed it.” The common wisdom that the upper-end market was immune to low-cost competition was proven wrong as the Chinese manufacturers increasingly eyed the upper market on its fatter margins and sought to expand into other product categories. Tashjian projected that cheap imports—especially from China—would soon spread to upholstered products, such as sofas; Mr. Dyer observed that imports in the upholstery segment rose from $20.4 million in 1996 to $313 million in 2002, a fifteenfold increase. Local manufacturers in this segment were buffered in the past by the need for customization, but improved communications and logistics are bringing down the response time of Chinese makers—and with it the advantage of locally based production.
The wooden furniture tale reveals the depth of emotions that now surround the China debate (“Is God an American?” asked an importer of Chinese furniture[9]) and the difficulty of building an effective coalition to put obstacles in the way of Chinese imports. Major U.S. furniture retailers, many of whom import from China, offer little support for American manufacturers, and the major producers, like Missouri-based Furniture Brands and Virginia-based Hooker, are increasingly dependent on Chinese outsourcing and are reluctant to take a stand against imports.[10] In the political arena, the elected representatives of regions that are reliant on the furniture industry, such as North Carolina, find it difficult to solicit the support of their colleagues from Virginia, Mississippi, Ohio, Tennessee, New York, Indiana, Michigan, and Illinois, where furniture manufacturing represents a smaller part of the economy, not to mention California and Oregon, which have negligible participation in the industry.
China's business impact comes in many colors, from price pressures on domestic and third-market producers to competition for foreign investment dollars. Among industrialized nations, the United States has so far been the hardest hit: It takes the bulk of China's imports but has been relatively unsuccessful in exporting into China's burgeoning market. In the meantime, the EU and Japan are feeling the pressure of a rising China, which coincides with the internal restructuring of their economies. Nonetheless, China weighs more heavily on other developing nations, especially those who lack the resources and capabilities to redeploy into areas not threatened by Chinese competition. Some of those nations will view China's rise as an opportunity to engage in overdue reforms, whereas others will appeal to their developed brethren for help in the form of preferential trade agreements and outright handouts. The result may be even greater dependence on outside patrons (China including), with its attendant economic, political, and social correlates.
While China dominates a number of product categories in the EU market (such as microwave ovens), Europe's deficit with the country is about one third that of the U.S.—not a lot for a bloc that as a whole maintains a trade surplus. According to Dr. Thomas Boam, minister counselor for commercial affairs at the U.S. Embassy in Ottawa, Canada, who formerly held the same position in the Beijing embassy, there are good reasons for the EU's superior trade performance in the China market.
First, Boam says, Europeans trust their governments and Non-Government Organizations (NGOs) more than Americans and utilize their help to reduce error rate. Second, Europeans heavily subsidize sales using a mixture of credits and outright gifts. (The Europeans assert that the U.S. provides its own subsidies.) Boam recalls the case of Cummins Diesel, which lost a bus engine deal to Iveco after the Italian firm came in with government subsidies that amounted to 70% of the purchase price. U.S firms lack access to subsidized credits such as U.S. AID, which has been on hold since the Tiananmen massacre. Third, European firms are conscious of exports, while America's smaller enterprises see the international market as a temporary stop gap to help ride domestic downturns. Fourth, European firms have no qualms about paying bribes (Europeans differ, but until recently, bribe paying abroad was legal—even tax deductible—under the laws of Germany, for instance).
Fifth, European political leaders intervene on behalf of their firms, while U.S. political leaders bash China on human rights. “Our leaders may be right, but the Europeans get the contracts,” notes Boam. Sixth, American firms are burdened by the U.S. superpower status. Chinese officials worry about the U.S. imposing sanctions to make a political point and hence will buy U.S. equipment but not systems; however, they know that the Europeans “will have nothing stand in the way of a deal.” Seventh, the Europeans protect their domestic markets from Chinese imports, but the U.S. does not. Finally, because of the U.S. deficit, the Chinese have huge reserves of U.S. dollars that they are unable to spend in the U.S., so it goes toward buying Japanese and European goods. In other words, the Chinese have the capacity to balance their trade with Europe because of the U.S. trade deficit.
There are a couple of other explanations: The EU has Eastern Europe as a lower-cost base in its own backyard; the U.S. has Mexico, but that environment does not offer the same advantages. European markets are more closed and fragmented, making it more difficult for China's newcomer firms to penetrate the market. Structural rigidities in the EU increase the cost of shutting down operations and moving them offshore. Finally, Europe does not have the U.S. cold war “baggage” and friction surrounding sensitive issues such as visa issuance. The EU has also been less restrictive in terms of technology transfer, although this may come back to haunt it as Chinese recipients become direct competitors. So far, the EU has tried to act in tandem regarding China affairs, but this masks the divergent interests of those members that have a substantial trade deficit with China (such as the United Kingdom and the Netherlands) vis-à-vis those who have only a small deficit (such as Germany).
In the Japanese market, the impact of a rising China was held back by price insensitivity, high brand consciousness, and a fragmented, multilayered, and nepotistic retail and distribution network. With the introduction of fundamental changes in the Japanese business and retail environment (such as the growth of large discounters) and the rising cost pressures of a deflationary economy, Chinese products have started to penetrate the market. The first wave was led by Made in China Japanese name brands such as National/Panasonic (brand names of Matsushita Corporation) and Toshiba, but Japanese consumers can now find Haier appliances and other branded Chinese goods priced substantially lower than domestic makes. Apparel imports have risen by half over the past five years and are projected to continue their expansion. China is now the largest exporter of goods to Japan, having surpassed the United States, which held the lead for half a century. Chinese imports have been blamed for Japanese deflation (in fairness, they were at most a contributing factor, and, possibly even a driver of market demand) and for “hollowing out” Japan's manufacturing core, a criticism that is now echoed in the United States.
Some Japanese firms were caught off guard. Sanyo's appliance division, for instance, is suffering serious losses. Others have been busy moving operations to China, where they find what they lack in Japan: low wages and benefits (whereas the aging Japanese society forces ever-growing pension contributions), a stable currency (the yen is appreciating), and reasonable real estate costs (for manufacturing sites). China also provides Japanese manufacturers with the opportunity to build state-of-the-art facilities unencumbered by obsolete design and outdated machinery, serve a high-growth market, and tap a future innovation source. Japanese firms have come to the realization that China can be a vital part in their bid to remain competitive. They are preparing for the Chinese century by sharpening R&D competencies and building the supply chain necessary for China-based manufacturing, including a new international airport near Nagoya that will handle mostly China flights.
For years, Mexico enjoyed a double advantage over its developing country competitors vying to serve the U.S. market: geographical proximity and NAFTA-generated tariff-free access. The value of proximity has gradually eroded (although it remains vital for certain product lines). Ricardo Haneine, director of the A.T. Kearny Mexican office, calculated that proximity yields no more than five cents on the dollar for Mexican manufacturers compared to their Chinese competitors.[11] In some categories, such as apparel, where Mexico competes with China head on, operations are located deep in the Mexican hinterland, lowering proximity advantages. And, with China about to enjoy much-improved access to the U.S. market, the NAFTA advantage is dissipating as well. Mexico remains competitive in areas such as automotive, where proximity and close integration are especially important and where local facilities have made strides in quality and productivity, and in computer equipment, where labor represents a relatively modest portion of product cost. Mexico is losing ground, however, in telephone equipment, household appliances, and electrical assemblies, such as transformers.[12] The result has been disturbing: Between 1980–1999, according to IMF data, Mexico racked up an export gain of $121 billion compared to China's $177 billion; in the 1999–2002 period, China's gain edged up to $188 billion, while Mexico's plunged to a mere $13 billion.[13]
In textile and apparel, which account for 6 percent of Mexico's merchandise exports, the impact has been devastating. For years, Mexican garment exports rose in tandem with those of China. In 1978, Mexico had a 0.6 percent share of the global market in clothing and textile; by 1999, the share rose to 4.5 percent. During the same time period, China's share rose from 2.4 to 15.4 percent.[14] As recently as 2000, per Department of Commerce figures, the U.S. volume of textile and apparel imports from Mexico was more than double that from China, but by 2002, the Chinese were in the lead. In the categories where China competes directly with Mexico, such as integrated products, the growth was more than threefold just from 2001 to 2002, according to the ITC. It is going to get worse: According to ATMI, the U.S. market share of brassieres made in Mexico is projected to fall from 47 percent in 2001 to 6 percent in 2004; China's share is expected to rise from 5 to 67 percent. According to the Wall Street Journal, 325 of the 1,122 clothing maquiladoras have closed down since January 2001.[15] All in all, projects ATMI, Mexico's clothing industry will lose $5.4 billion as a direct result of China's entry. An ITC investigation notes that U.S. apparel companies and retailers have already reduced their sourcing in the country, and more plan to do so when the quota regime expires. Interviewees cited rising labor costs, inconsistent quality, low reliability, intratransit merchandise loss, limited availability of full-package service, and the inability of suppliers to diversify into fashion denim jeans, a higher margin product.
According to U.S. Census Bureau figures, in August 2002, overall U.S. imports from China surpassed those from Mexico for the first time ever. The two countries then alternated for several months as America's second and third largest import sources (after Canada), but by May 2003, China pulled away and did not look back. While the numbers for Mexico may temporarily rebound to reflect higher oil prices, the overall trend is unlikely to reverse. This does not mean that all of Mexico's troubles are China's fault. The country's dependence on the U.S. market means that its economic fate is closely tied to the ups and downs of the American economy. For instance, the bulk of the decline in Mexico's U.S.-destined machinery exports in 2001 can be explained by the 10 percent decline in the output of the American motor vehicle industry that year, which reduced its purchases of Mexican wiring harnesses by the same ratio. The same is true for household appliances, where U.S. imports from both China and Mexico have been on the increase.[16]
Other problems are of Mexico's own making but have been exposed in the glare of competition. Cofose, a Mexican organization for foreign trade promotion, organized a trip to China to compare the national competitiveness of the two locales. The Mexican visitors found China to be superior on all counts: China had, they observed, stronger national vision, sound long-term planning, a more favorable investment climate (clear regulations, tax incentives, order, and security), cheaper but more productive labor, and a lower raw material cost.[17] A GE study offers a more positive assessment, noting that while Mexico ranks lower than China on labor costs, electricity costs, and a supplier base, it does better (not surprisingly) on transportation costs and free trade agreements, but also on productivity, international telecommunications cost, technology transfer requirements, intellectual property rights (IPR) protection, management flexibility, and regulatory transparency.[18] The Mexican government has taken measures to lower the cost of manufacturing, reducing corporate taxes and offering cheap land and other subsidies, but it remains to be seen whether this will be enough to stop the tide of firms relocating to China and whether Mexican companies will be able to leverage China as a market or as a complementary producer.
Most members of the Association of Southeast Asian Nations (ASEAN) have a trade surplus with China, supplying anything from food to raw materials and intermediate inputs. China, at the same time, has been encroaching on ASEAN's traditional territory of electronic assembly: As China's share of the global electronics market went up from 9.5 percent in 1992 to 21.8 percent in 1999, Singapore's share declined from 21.8 to 13.4. As China's personal computer production expanded from 4 percent of global output in 1996 to 21 percent in 2000, ASEAN's share dropped from 17 to 6 percent.[19] The ASEAN trade surplus has so far cushioned the pressure, but it is not clear it will be maintained. China's WTO accession is widely viewed as providing more opportunities to the developed nations that negotiated concessions for their favorite concerns (such as services for the United States) than to developing nations. ASEAN nations that provide intermediary inputs to China's rapidly expanding industry will fare better than developing countries in Latin America and Africa who are dependent on the labor-intensive sector that China now dominates. As China progresses, it will have a lesser need to import mid-technology components for which Chinese producers are emerging. In the meantime, ASEAN firms that are pushed out from lucrative end-product markets in the industrialized nations will lose not only revenues but also the learning and reputation that come with such presence. They will be increasingly dependent on China—a dependence they are already seeking to reduce by establishing alliances with other nations and by retaining alternative supply sources.
Beyond ASEAN, countries in Latin America, the Indian subcontinent, Eastern Europe and the former Soviet Republics, Africa, the Middle East, and Central Asia are importing large amounts of Chinese products. Some can offer something in return—in particular, oil and minerals for the growing Chinese economy (such as Russia and the Middle East) or, in some instances, technology (such as Israel and India). As the IMF report suggests, commodity imports explain China's high and balanced trade with many of “the 48 club”—the world's least developed economies. Less developed nations with no tradable commodities that the Chinese desire will have little to offer except perhaps a UN vote; they will, however, help China reposition itself as a Third World champion at the same time it seeks to attain a superpower status.
As Exhibit 6-2 shows, the Chinese industry has been moving from primary goods and basic manufactures toward the more sophisticated segments of the manufacturing sector. In 2002, according to the Chinese Ministry of Commerce, electronics and machinery constituted about half of the country's total export. China's share of the global electronic market has more than doubled in a decade and now exceeds 20 percent. Its share of the personal computer market has quintupled in five years. Most of the TV sets, video recorders, DVD players, and cell phones today are either made in China or include Chinese components. China's cost advantage is increasingly associated with high productivity, scale economies, supporting industries, and advanced manufacturing technologies rather than merely with low wages.
In the automotive industry, China is fast becoming an outsourcing hub for components, and it's emerging as a viable exporter. Volkswagen (VW) has already begun to export its China-made cars and is projecting substantial volume increases in the coming years. Honda has built the first export-only plant and is getting ready to start operations. Once the Chinese automotive market slows its rapid growth (admittedly years from now), the pressure to export will rise as manufacturers—both foreign firms and “national champions”—worry about utilizing the enormous capacity they have built up. Given the general overcapacity in the industry and the technological edge of the newer China plants, it is difficult to see how automotive manufacturing in developed markets such as the United States and Europe will not be affected.
A new crop of national champions leads China's charge in the technology-intensive sector. TCL is completing a merger with a unit of French Thomson that will make it the world's largest TV manufacturer. Haier has 6 percent of the global refrigerator market and manufactures also in the United States; Haier's competitor, Kelon, is not far behind. Lenovo (formerly Legend) in computers, servers, and cell phones (and increasingly in services); Huawei Technologies in telecommunications; China Netcom in phone service; and Pearl River in pianos are taking first steps in building global brands. Having endured stiff competition at home from both domestic and foreign players (most Chinese industries have low concentration rates, meaning the leading manufacturers control only a small share of the market), those firms have built competitive capabilities, among them the ability to respond quickly to changing demand. Firms that have worked as Original Equipment Manufacturers (OEMs) or part suppliers to Western companies have learned the importance of shaving another minute from a production process or another cent in material cost. What they lack in technology, marketing, and logistic capabilities they make up by hiring staff—mostly locals who have worked previously for foreign multinationals—but also returnees and expatriates. They are also on the lookout for cross-border acquisition opportunities. Two Chinese firms, one of them completely lacking automotive technology, have been the frontrunners to purchase Sanyong Motors, a unit of the Korean chaebol, which will give the buyer immediate access to advanced technology and a global supply chain.
These developments will further increase the radius of China's influence. China's emerging national champions, already battling established multinationals in their home market, have their eyes set on international markets. Within a few years, Chinese consumer product maker (such as Nice, which outsells Unilever and P&G in the detergent category locally) will start their overseas push, opening a new competitive front. And while Chinese service providers are decades behind, they can leverage the financial capabilities of Taiwan, Hong Kong, and the Chinese Diaspora to solidify their position in shipping (where China is already a major player) and aviation, engineering services, and down the road, research and development.
Business reaction to the China challenge has been mixed so far. Many industries and firms have been caught unprepared, failing to realize the threat to their current business model or the sudden acceleration of structural shifts that in the past took decades to consummate. Some have been blindsided by the promise of the China market to the point of neglecting the challenge in their own backyard; others have given up all too easily on the burgeoning Chinese economy, forfeiting opportunities to more aggressive players. Still others have been sidetracked by the tired and by now obsolete responses of U.S. unions that have been focusing on China's admittedly dismal human rights record while failing to offer much in a way of solutions besides veiled protectionism.
Some industry groups pin their hopes on political pressure, buoyed by the interest politicians have taken of late in the job issue, but they will be, at best, buying time. (Textile and apparel makers have already won some quota relief, but as safeguards expire at the end of 2008, this tactic, too, will have been exhausted.) Others believe that currency adjustment will take care of the problem, but they need to look no further than the mid 1980s, when the appreciation of the yen in the aftermath of the Plaza accord brought, at best, a temporary halt in the growth of the deficit. Even under a radical scenario of a 30–40% increase in the value of the yuan, China's labor-intensive products would continue to enjoy an enormous price advantage, although some categories, such as chip making, may see a difference. In short, businesses should not count on the government to bail them out but prepare for the new reality that is about to dawn.
For firms that operate in labor-intensive industries, the writing is on the wall. For many developed country firms, especially those lacking the pricing power of brand or specialized capabilities, the best option is simply to exit the market. This is a harsh remedy with ominous consequences for employees and communities, but one that may be preferable to slow bleeding because it avails capital and human resources to be redeployed rather than exhausted. Developing country firms stand a better chance because the improvements they need to make in the labor-intensive sector are more modest than those demanded of industrialized country competitors, but they still need to obtain the necessary know-how. Indeed, an alliance between a developed nation manufacturer with the requisite technology and process and a third country producer with a lower cost base is one way to meet the China challenge.
If a business does not wish to exit, it had better come up with a new game plan showing how it is planning to avoid being the “plant of the day” closure. It might want to explore product lines where it has specialized capabilities and labor constitutes a relatively minor part of total cost. In and of itself, automation may not do the trick. The Chinese are automating, too, when it makes sense, and their labor cost advantage may often compensate for lower automation. In a high-cost environment, reaching the point where productivity improvements outweigh wage cost advantage requires a high magnitude change, like that achieved by American Axle, which reduced the number of hours it needed to generate $1,000 in revenue from 10 in 1994 to 3.8 in 2003, while enhancing quality.[20]
One solution is to extend technological capabilities into related areas not only in manufacturing but also in higher growth services. SRC Holdings, for one, diversified into the higher margin areas of logistics and commercial software, publishing, banking, and the spa business to support its core manufacturing operations. Malden Industries went as far as utilizing some of its land in Lawrence, Massachusetts for real estate development while counting on research and technological advance to hold its own against Chinese competitors.[21] Customization, a traditional survival tool for many U.S. small and mid-size enterprises, can be a viable strategy where the product in question is small-batch, expensive, or difficult to transport, or requires lead time that is shorter than the Chinese production and shipping (typically three weeks) cycle.
In and of itself, moving up-market no longer ensures survival. As Henredon Industries found, Chinese firms are encroaching on this segment, joined by competitors from other countries, all trying to escape the same low margin fate. Branding is a critical component in this strategy, but with more developed country manufacturers exiting the market, Chinese firms have been able to buy established brand names, thus nullifying the effect. This leaves technological development and innovation, China's Achilles' heel, as a solution—as long as a company is in a position to protect it. A company's starting point should be that its technology and know-how are vulnerable, whether it has a China presence or not; as Boam says, “If it can be copied, it will.” Being physically present in China will expose a company's production process on all its intricacies, but it will have more leverage with the Chinese authorities to crack down on violators, among other advantages. There are certain obvious steps a company can take to reduce the risk, from technological solutions (such as using a smart chip) to operational procedures (a company should think like an intelligence organization, sharing technology and know-how only to the extent necessary) and governance (a company should opt for a wholly owned foreign subsidiary, except where a Chinese partner can make vital and exclusive contributions unavailable from anyone else, and, when it has firm grounds to believe that the partner is unlikely to either copy the company's technology or forward it to a third party).
With cost pressures likely to intensify in all but the most exclusive segments of the market, outsourcing can be a vital ingredient in a company's survival plan. Furniture Brands, the largest residential furniture company in the U.S., closed down 17 U.S. plants as part of a move to shift production to China. Henredon Furniture sources almost a third of its product line in low-cost economies, including China. GE is planning to do the same with its refrigerator line, while Maytag is importing Chinese components to lower the price of its dishwashers. Outsourcing permits the lowering of costs without sacrificing market presence and, with proper quality control, brand image. The strategy also has drawbacks, however, among them the grooming of future competitors, which can be offset partially by retaining core capabilities. Some firms, like Cutting Edge, a small Ohio division of CB Manufacturing, try to leverage their China outsourcing capabilities by offering third-party outsourcing services to small and mid-size firms.[22]
Outsourcing may not always be enough, even when accompanied by other measures. The Wall Street Journal reported the struggle of a remaining Furniture Brands plant in North Carolina to stay afloat by improving productivity, adjusting layout, tuning in to employee suggestions, and using some Chinese input, yet it is not clear that this will stave off eventual closure.[23] Or, take the case of Ohio-based Nippert, a tertiary supplier of copper rod and wire to the U.S. auto industry that came under intense pressure to cut costs by as much as 5 percent annually to compete with foreign sources. Having to meet requirements for ISO (International Organization for Standardization) certification and pollution control that its Asian competitors did not have to worry about and with no control over metal pricing (a major cost component), Nippert squeezed whatever efficiencies it could and then started outsourcing in Taiwan, saving as much as 70 percent in tooling costs. Yet, Chinese competition continued to erode its customer base. Faced with the loss of its biggest customer, who could no longer compete with a competitor who had moved production to China earlier, Nippert sold off its assembly business to focus on its core competency: the manufacture of copper shapes. (Final assembly is now in China.) With China cornering the market for scrap metal, prices for domestic producers rose, further weakening its position. The company started to shed staff, quality suffered, and with less capital available for R&D and equipment upgrades, chances for a rebound dimmed.[24]
While China's rise accelerates the plight of manufacturers like Nippert, it also opens new doors. China's outsourcing is not only a strategy for survival in a cutthroat business, but it's also an unprecedented opportunity for new entrants. Take the case of Dan Zubic, recently covered in the Wall Street Journal. An American who was laid off from his job at NEC's television making division, Dan contracted with one of the Taiwanese TV manufacturers (most of whom manufacture on the mainland) to form a new company,[25] something that could not even have been contemplated when GE, RCA, Motorola, and later Sony, Matsushita, and Samsung ruled the market.
Finally, China's almost balanced trade flow proves that it is not impossible to sell in that market, the fastest growing in the world. With many of the world largest companies, such as Goodyear, Toshiba, and Nestlé, expanding their China operations, they will be looking for partners and suppliers with whom they can work globally. If a company will not consider this option of servicing the Chinese market, another supplier—possibly from China—will. Success is by no means assured. To cite Dr. Boam, “There are only two kinds of foreign companies in China: those that are making huge amounts of money and those that are losing their shirts. The latter group is not only sizable, but growing.” To be counted among the first group, a company must do its homework, understand how the Chinese environment works, and determine how to develop and protect a competitive advantage under different game rules. The same formula applies to the China game as a whole.