Posted on 03/10/2004 8:46:43 PM PST by maui_hawaii
Reflections on 2003 and Some Thoughts on the Opportunities and Challenges of the Coming Five to Ten Years*
EXECUTIVE SUMMARY
In 2003, I traveled to China five times. Without a doubt, I would have made more trips if there was no SARS. During my five trips, I traveled with the executives of 11 US companies in total, met with hundreds of Chinese businessmen and government officials, visited over 100 companies primarily in the manufacturing sectors. As I have observed in the last 12 months, the changes in China and the urgency of US companies to respond to the ever-changing world, i.e., competition from the world’s largest emerging manufacturing center, are unprecedented. The following is a summary of what I saw in 2003 and what I believe both US and Chinese companies will face in the near future.
OBSERVATIONS:
• China today remains the world’s largest construction site, a massive center of infrastructure development and investment opportunity.
• China continues to experience excess manufacturing capacity, as well as excess labor and an acute unemployment problem as it scrambles to find jobs for a population of 1.3 billion people. Factories, particularly private enterprises owned by Chinese nationals, continue to expand on a very large scale (some of them will double or even triple their capacities in the coming year). They aggressively make investment in equipment and facility, and many of them are buying capital equipment both domestically and internationally, notably, from Japan, Taiwan, Germany, and Switzerland. Excess capacity should persist, and certain industries such as textiles, light manufacturing, furniture, home appliances and
consumer electronics will see capacities in excess of total global demand in the coming few years.
• Many more foreign companies are investing in China. However, once initial investments are made, they tend to remain at that level. One seldom sees significant new investment in the subsequent few years.
• In most areas, both geographically and by product, deflation remains prevalent. Nevertheless, economists are growing concerned about the prospect of inflation in the rapidly growing Chinese economy. A shortage of raw materials could lead to inflation. Steel prices, for instance, increased several times in December 2003. However, given the huge and inexpensive labor pool and continuing expansion, any inflation in China should prove short-lived and limited to specific areas.
• The supply of raw materials continues to restrain China’s growth, particularly when coupled with trade disputes. Steel, for instance, is now being imported from Taiwan, Japan, Korea and even the US to meet demand. As a result, Chinese manufacturers in certain industries are now not much more competitive than their counterparts in the US after taking transportation costs into consideration. Chinese manufacturers, especially the private companies, are growing more conscious of this, and are apprehensive about further escalations in the prices of raw materials.
• Despite its rapid economic growth, China is still very much a developing country. Outside the coastal regions, inland areas remain quite poor and largely underdeveloped. Labor costs there are very low, and labor is chiefly engaged in the agricultural sectors. The imbalance between wealth in the coastal regions and the inland areas will pose an increasing challenge to the Chinese government. In the coming years it will have to be addressed with greater urgency than before. On the positive side, the huge untapped pool of unskilled inland labor will almost certainly guarantee China an envious labor-cost advantage over many other countries for several years to come.
• China’s State-Owned Enterprises (SOEs) fall into a number of tiers. The top tier, consisting of the “backbone” or core enterprises, continues to receive support from the Central Government, and companies in this tier still enjoy an oligopolistic position. It will be surprising if they are privatized in the next five to ten years, if ever. They possess abundant resources and strive to internationalize and corporatize their operations. Many of them are making acquisitions internationally, sending their employees overseas for training, and rapidly modernizing their operations. Their size, however, is problematic. They are simply too big and too complex to be “nimble.” Furthermore, “corporatization” does not necessarily render them, as many people believe, more independent than
they are today. The other tiers of SOEs are comprised of non-core companies (apart from certain large enterprises) and presently stand in various stages of transition. For some, the privatization process has begun or is about to begin, while others are waiting to be relocated from residential areas to industrial parks. The sheer complexity of the transition, however, effectively keeps many suspended in limbo. There is a general feeling that they all will be privatized or re-organized within the next two to three years. But there seems to be little capital investment in these tiers, and as time goes by, they will likely become much less competitive.
• As mentioned above, private companies are aggressively expanding in China. Most Chinese companies are still in their infancy with respect to being able to compete head-to-head with US companies, particularly in product development and the establishment of their own distribution networks in the US marketplace. They are, however, becoming better managed, more modernized and better equipped. They show little or no interest in yesterday’s technologies; they are more focused on quality, more willing to venture outside of China, more willing to invest in research and development, and more willing to make direct investment in the US in order to bypass traditional middlemen. Unlike only a few years ago, Chinese companies are now demonstrating a willingness to retain outside professional help. For instance, a China-based telecommunications hardware company has recently put aside US$5 million to retain a foreign law firm to handle a legal dispute with a US company.
• China is becoming more sharply focused on city planning. Factories are moving out of the big cities such as Shanghai, Beijing and Guangzhou. Companies in the same industries are clustering together in the same geographical areas. These factors intensify competition among Chinese companies themselves as they vie for a share of both export and domestic markets.
• Southern China remains the nation’s export engine in light manufacturing. All other factors equal, products from the South tend to be of higher quality that those from other parts of the country. However, we have seen that the North is beginning to catch up as the result of comparatively higher costs and aggressive investment in the Yangtze River Delta area.
• Most, if not all, US companies have become more conscious of China. Many have incorporated China into their strategies regardless of their level of direct experience with China. While some are attracted to China by its enormous potential consumer market, most go to China in order to better manage production costs. An increasing number of US companies
are compelled to go to China by the dynamics of domestic consumer demand. Such demand is not only just for manufactured products but also for services such as software development, back office processing, designs, and other. Investors, also, have begun to ask the corporations in which they invest how they are dealing with China. Several buyout firms in the US, for example, have approached us for assistance because their investors, particularly institutional investors, are questioning their existing or planned investment strategies in China.
• Despite the increasing sophistication of both US and Chinese companies in dealing with each other, misunderstanding and poor communication (not just language) between the two parties continue. Reliable information on Chinese companies continues lacking. The problem is further expounded by the unlimited supply of self-proclaimed “wellconnected, expert” China consultants. US companies continue to have a hard time in connecting with the right Chinese partners, and likewise, Chinese companies continue to have a difficulty in finding the appropriate partner in the US.
CONCLUSIONS
• Unless something changes dramatically, US companies will face continuing pressure from an increasingly internationalized economy, particularly in those manufacturing areas where products are generic or commodity in nature, involve high labor content and low transportation costs. Even US companies, buyout funds, and venture capitalists without any international experience have come to recognize the need to explore China and the dynamics of competing in a global market influenced by the growing sophistication of Chinese manufacturers. In certain industries, such as furniture, home appliances, housewares, textiles, footwear and consumer electronics, we should see excess capacity, cheaper prices and better quality. Under pressure, companies are attempting to by-pass middlemen and sourcing agents and trying to establish their own sourcing capability despite some of the frustration that they have experienced. Consumers will be the ultimate winner; however, manufacturers in both the US and China will continue to face very keen competition.
• Outsourcing in the service industry is expected to be the next wave of globalization. The industry is highly labor intensive, almost no material contents, very little capital investment, very little or no transportation cost, and trade barrier is almost non-existent. This is further enhanced by the
advanced technology, decreasing cost of communication, and improving language skills of the Chinese.
• China’s unemployment problem and expanding capacity should mean that inflation due to a shortage of raw materials will pose a challenge only in certain industries driven by cost-push factors.
• The two main factors that will bottleneck progress in the Chinese manufacturing sector currently are: (1) the shortage of raw materials; and (2) trade disputes. The shortage of raw materials, however, should ease up in two to three years, largely as the result of massive investment in steel mills, resin factories, etc., in China. Trade disputes will likely intensify among all nations around the world.
• China’s long-term challenge will be its ability to continue operating a “market economy with Chinese characteristics,” that is to say, a marketoriented economy in which the Chinese government remains significantly involved. The questions this raises for China are: (a) What level of government involvement in the economy is necessary at present? (b) Should the core SOEs be privatized and, if so, how? (c) How should other SOEs be privatized when its ownership is largely local but its debt is held by the Central Government? (d) How should the inland and western regions of China be developed? (e) How can China reduce its reliance on exports?
• As factories in the same industries have clustered together geographically in China, consumer power has become concentrated in a few cities, transportation and communications have improved exponentially in these areas, and information has become more readily available. For these reasons, doing business in China is now much less costly than it was many years ago. This trend will continue, and few companies will remain immune from its effects.
* The opinions expressed herein are those of the authors alone and do not necessarily reflect the views of the United States of America-China Chamber of Commerce.
Demand in China is just that, demand that happens to be in China. Much of the 'internal demand' we are seeing is driven by multinational corporations or those companies servicing those multinationals.
...(b) Should the core SOEs be privatized and, if so, how?...
We don't even privatize everything here in the United States so no everything is feasible, I guess I'd like to see a specific list of industries before that question can be answered. Then it would have to be determined who would get to own the industry if privatized. How do you even do something like that? Hold an auction and sell the state's assets to the highest bidder(s)?
What we have is nothing. Yet with regards to China people talk about the 'invisible hand'. Invisible my ass..
How do they sell them off? Auctions do happen. What they look for is sometimes foreign partners who are willing to buy said factory and include it in their operations...
They also look for some locals who often get loans (aka banking crisis) and buy what are deemed non critical companies and try to hence manage them to profitability.
I haven't seen such an analysis up to this point. This is troubling since once businesses finish setting up their operations and move more into a 'maintenance' of facilities etc. mode, this false consumer demand will effectively cease. What then...investors are left hanging? It seems that know one has summed up the true consumer demand potential in the PRC. If someone would be able to credibly (somehow find reliable stats out of the PRC etc) do this, investors and industries would have a better idea of their future prospects in China.
I guess the question is: are there any reliable PRC statistics/data to attempt to make such an analysis?...
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