This post seeks to provide you with a possible context in which to view and better understand our trip to China.

I recently touched based with one of our graduates working for a US firm that manufactures its product in China and exports the product back to the US and Europe. His firm is finding that establishing and managing the supply chain in an emerging market like China can be a challenge.  I asked him, “What are you now seeing happening on the ground in China?  And its pros and cons?” and he noted the below:

>Dear Professor Carr,

Good to hear from you. I hope the school year is going well and the students are preparing themselves for the incredible experience that is China. I am still loving the hustle and bustle of China. There is so just much more energy here compared to the US, and opportunities are in abundance.

There are some major changes on the ground here that I have seen in recent months.

One change is the shortage of raw materials, not just in our [XX] industry but in the [YY] industry as well. These are the two industries I have direct contact with but I suspect this change is across the board.

[One of my Orfalea College classmates also in China] has also been telling me how there was a massive shortage of parts for the OEM electronics business and only the big companies who have the buying power were getting what they needed. The smaller firms had to sit and wait for parts. (His company at the time was having one of their bigger customers place the parts orders that other smaller companies needed.) In my industry costs have gone up due to demand, and finding specific lesser-used materials has become difficult. Unless you are a big company and can meet the high order requirements of most factories to run a specific material, you can sometimes be out of luck.

Also, when the downturn in the economy started a year or two back, raw material vendors cut back production in all industries, as they were scared that they would be sitting on piles of stock. But it turns out global production didn’t dip a much as expected thereby causing shortages all over.

Also, the banking crisis and the troubles that small to medium size companies were having in accessing capital, caused many of those factories to go out of business. And China’s growing domestic consumption helped add to this shortage. It is unbelievable how fast this place is growing and changing.

Some companies are moving their manufacturing from the coastal cities to the more central provinces of China. One example I am sure you are aware of is Fox Conn, one of the world largest OEM electronic manufacturers. It has started moving its Shenzhen offices more inland to save on labor costs and to take advantage of some of the tax breaks the local governments are offering there to attract business.  Many other companies are doing the same, or at the least opening second facilities in more remote areas of China, and moving what they can to those areas.

Both at the national and local level (Shenzhen and other already developed cities) the minimum wage has been raised. I have seen the minimum wage increase three times in the two years I have been here, between the national and local increases. This, along with the shortages of raw materials, has caused prices to significantly increase in manufacturing.

The Yuan (RMB) is also going up in value against the US dollar. This, of course, gives us less bang for our buck. This in and of itself is very interesting, as a change in currency value either way will have huge effect on the economy here and abroad. The Chinese don’t want to move the value of the RMB much. However, inflation in China is a huge issue and fear, and keeping the RMB pegged doesn’t help deal with that. But moving it can force many foreign companies to start looking elsewhere for cheaper manufacturing. So this is a catch-22 situation we all face.

Further, I believe, along with other Chinese I know and work with, that China’s real estate is over priced and in danger of a crash. The central government is doing all it can to try and prevent this at the national level, but local governments continue to ignore Beijing’s mandate on this and fund huge development projects, hoping to cash in on what have been super lucrative opportunities so far. This issue continues to have a down stream impact on firms like mine, and our supply chains.

Chinese companies are also now giving preference to domestic consumption and charging many export-based companies premium prices for their goods.  As touched on above the buying power of the middle and even lower class is rapidly growing. The Chinese government wants to make sure that this growth continues and will give priority to domestic growth over the other issues it faces (and there are many).

In this changing environment, some firms will pull some of their manufacturing back to the States or Europe. Others will stay and move a second facility inland. Others will focus less on export and now that they have their China legs under them turn their attention to manufacturing in China and selling mainly to the Chinese domestic market — if you are manufacturing in China you MUST look at China as a market to sell to as well. But challenges will come with focusing on the domestic market as well. Any foreign product that is designed and used as an export product by foreign companies, if sold to the local market, will still be taxed as an import product. This gives Chinese companies the advantage as they can under price the competition. For example, Sony TVs are more expensive to buy in China than in the US, even though they are made there. That goes for computers, clothes, accessories, and everything else.

Having said all of the above, I still think any established brand that is not focusing on selling IN China or getting into the game here is really missing out and needs to find a way to get their foot in the door. However, if they don’t partner with a Chinese partner when they do so this will be extremely difficult and the more their brand grows in popularity the more it will be counterfeited and sold on the black markets. But that is just a cost of doing business in China. I feel that in time this situation will improve as China continues to develop and modernize.

The above, of course, doesn’t even take into consideration the vast cultural differences that still exist between Western and Chinese ways of thinking and doing business. The reality is that in doing business in China you are still a foreigner and the locals will always have an advantage over you. Everyday I am in China I am reminded that I am a foreigner, which presents difficulties in some areas but also some opportunities in others.

In summary, there is a lot going on here and in the ever-complex world of China. The opportunities are just huge here and the buying power is too great to ignore this market. I am thrilled to hear you continue to bring students to China. The place continues to blow me away.

I hope to make it back to SLO in the future so we can talk some more and catch up.

XXXX

Question: Your thoughts to this alumni’s view, experience and touch base?

And to build off this post and alumni feedback re: this shift now taking place in China as China continues to develop and ‘modernize’, see these two interesting related posts and perspectives from Dan Harris over at the always good China Law Blog, China Manufacturing:  ‘We’re Bringing It Back Home’ and Where To Locate Your Business In China. This Download Will Tell You.

May 5, 2011 addendum:  Today’s Wall Street Journal had two excellent article that echo and build on this blog post and alumni observation, Will Costs Abroad Drive Firms Home? and Candle Maker Feels Burned: Compamy, With Plants in Asia, Struggles to Open in U.S.

A hat tip to Gary Chou for sending me the below link. I am a National Geographic subscriber, remember the below issue coming out and reading it, but I forgot to put up a post and the issue had since disappeared into the mess on my office desk at home.

Click HERE to check out these great pics on China’s Instant Cities (the photo gallery link is on the right side of the page; the commentary by Peter Hessler is top notch, as is all of his work - e.g., Two Years on the Yangtze). And reading this very good Wall Street Journal article, On the Move: Chinese Officials Want More Farmers to Migrate to the City; But They Are Also Aware That Migration Brings Problems, will put these photos into a good big picture context for you.

Finally, last month, April 2008, National Geographic published a special issue only on China called, China: Inside the Dragon. Check it out. Again, some great short pieces by Peter Hessler and the usual amazing pictures. You can also click HERE to listen to the China Business Network’s recent podcast interview of the Editor-in-Chief of National Geographic Magazine, Chris Johns, about this issue on China. I also had no idea National Geographic is read by 40 to 45 million people each month. Cha-ching. And talk about a company that has put on a clinic for others re: how to manage and build its brand ….

Enjoy.

Prof. Carr June 13, 2008 addendum: see also this related post on instant city Shenzhen I just made (Shenzhen is located in southern China).

Submitted By: Simone Michel

South China was once known as the world’s factory floor. Plants used to spring up like mushrooms and seas of workers would wait in front of the gates in hope of being the lucky one to get a job. Lately, this picture has started to change. Many of the big gates remain closed due to rising costs and shifts in Chinese government policy, knocking hundreds of smaller factories out of business. Some of the factories that are still in Guangdong province, watching how their profit margins disappear, are considering moving to lower-cost countries such as Vietnam. According to this 1,000 shoe factories closed in 2007.

Many reasons come together: Companies are losing money because of the rising value of China’s currency, making it more expensive compared to the US Dollar. Furthermore, raw material prices ballooned and not the full percentage of this price increase could be passed on to customers. Tax shields for foreign companies were abolished. Inflation returned to China last year as well, letting cost of labor rise faster than productivity. As a rule of thumb, foreign managers in Shanghai have to raise wages by 10 percent every year, otherwise their employees give notice.

But rising cost is not the only reason factories have gone bankrupt. On one hand, workers can now find more jobs elsewhere than ever before and South China is experiencing a labor shortage. Furthermore, the workers that can be found are unskilled. On the other hand, China’s government is making it harder on these factories. After encouraging cheap manufacturing for more than a decade, the regime wants to push investment toward high-tech. The goal is to have more sophisticated factories with higher-wage jobs. China is following Japan and Taiwan, countries who have both started out at the low-end and climbed up the manufacturing ladder to the high-tech end.

Furthermore, the government changed labor policies at the beginning of this year. Chinese workers are starting to get aware of the working conditions and are now demanding higher wages, overtime pay and improved safety. The second broadcast of NPR’s China series highlights nicely how the new law is requiring businesses to give workers written contracts and pay compensation if they’re fired.

With more and more workers pressing their rights against their employers, a supplier’s market of labor and rising costs, the factories are forced to come up with new ideas. Do you think the factories in Guangdong province have to shut down because of all these external influences or do you think it’s their own responsibility because the concept of lean production has never played a role in China’s past?

Submitted By: Naomi Guy

The air is hot, sticky, and dirty. Your throat becomes itchy and a bad taste arises. What do you do? Well, in China you better not spit. Renmin University in China has created a Civic Index to measure the “civility” of their cities and gauge progress as the Olympics draw near. The index analyzes behaviors such as spitting, littering, and line forming from over a quarter million observations and surveys. According to this article, Beijing has been decreasing this behavior, but not as drastically as required before the Olympics. In 2007, Beijing scored 73.4 points, up from 69.06 in 2006 and 65.21 in 2005, but not up to the 80 point target. Changes were brought about using both positive and negative reinforcements ranging from flowers to fines. An example of an interesting (yet somewhat derogatory) program is one to promote the peaceful forming of lines. On the 11th of each month (standing for 1 after 1), uniformed officials swarm upon bus stops and subway stations waving flags at everyone to ensure they line up. The program was created by Zhang Huiguang, director of Beijing’s Capital Ethics Development Office. She is now better known as “Ms. Manners”, and claims that changing these bad habits before the Olympics is “crucial in providing a cultural and historical legacy to China and the world as a whole”.

So what’s the big deal? It seems obvious that any country would want to look as good as possible for the hundreds of thousands of tourists expected for the Olympics. Well, we all remember back a few short years ago when SARS was a major health threat. During that time, officials tried to stop spitting in public to help stop the spread of the disease. Sadly, more effort has been directed into putting on a clean image for the Olympics than protecting the health of the country, and the world, just three short years ago (article). A fairly drastic change in behavior has occurred in the past year to create a new image, three years ago, when lives were at stake, it was hardly a difference.

So why is this? Did the government not care as much about health, or were people too stubborn to believe the threat of SARS? Is an external image more important than internal wellbeing? Would you expect this behavior to be true outside of China? Do you agree with Ms. Manners that these changes are crucial to providing a legacy?

I’d like to leave you with this statement by, Zhang Faqiang, vice chairman of the China Olympic Committee, “Ultimately, China’s modernization rests on the quality of its citizens.” Do manners truly make a quality citizen? and can that lead to modernization? I’ve know some key American inventors with little to zero etiquette…

A hat tip to Dan Harris and the China Law Blog for this lead ….

Here is a really, really interesting power point presentation by advertising giant Ogilvy on consumers in China’s Tier II and III cities. Some great stuff in here that will relate to what you are studying or will study in your MBA marketing class this winter quarter (e.g., branding, market segmentation, packaging, impulse buying, distribution channels, price sensitivity, who makes the family buying decisions, etc. anyone?). This material also highlights why so many foreign firms are trying to get into the market there — the consumer class and their spending power in these lower tier cities are on the upswing. This presentation is worth spending a few minutes to click through and study. Doing so, via this compare and contrast measure, also helped me better understand the marketing of products here in the US. Once in China, as you walk in and out of stores, and as you bus from A to B and look out the window, you need to think back to this material and connect some of the dots as related to your coursework ….