‘Margin squeeze’ warning for Beijing

“For years China has been the world’s cheap assembly shop. Now, it is laying the groundwork to become a global power in more sophisticated, technology-intensive industries.”
Zhang Jun
China Centre for Economic Studies

That’s the general idea anyway, but China remains wholly unprepared and unequipped for such a smooth move up the value chain. China is starting from a very narrow base and its financial share of the entire manufacturing process is growing smaller. The SCMP’s Jake Van Der Camp recently turned his eye to the problem of China’s manufacturing squeeze:

About 150 years ago England went through an industrial revolution and you probably still recognise names associated with that period – Watt, Brunel, Stephenson, Wedgwood for instance. Just over 100 years ago it was the turn of the United States and you know the brand names – Ford, Westinghouse, Standard Oil and so on. You also know the brand names from Japan’s industrial emergence – Sony, Toyota, JVC. Even the recent ones from South Korea are recognised round the world – Hyundai, Samsung, LG.

Can you give me a brand name from China recognised round the world? Haier, you say? Sorry, not in Dogdung, Nebraska or Chienmerde, France.

China has so far been the world’s cheap assembly shop, using foreign technology, foreign components, foreign know-how and foreign brandnames. Exports from foreign invested enterprises as a percentage of China’s total exports stood at just over 20% in 1993 (source CEIC), that figure hit 50% around 2000 and now stands at over 60% and rising. After all, if a large country is willing to allow its people to be an underpaid manufacturing slave-labour force, well, the rest of the world will naturally take advantage of it.

The rest of the manufacturing process, i.e. product design, brand ownership, sources of required components, marketing, finance, insurance etc. is largely based overseas. Unfortunately for China, these stages are where most of the money is made.

Also, unfortunately for China, it’s already small slice of that earnings pie is growing smaller. As the prices of China raw materials have shot up in the last couple of years, the prices of Asian imports into the U.S. have gone down at a similar rate (U.S Import Index, China). This is termed ‘margin squeeze’. Companies like Wal-Mart, for instance, demand lower prices every year for consumer goods that it sources from Asia.

Professor Zhang Jun warns China, reform before it’s too late: “The country first needs domestic structural reform that encompasses the gross inefficiencies of the financial system, massive misallocation of capital and the dead weight of state enterprises“. If Beijing wants to make the next step up, they should take a few lessons from how Henry Ford did it with Ford Motor and Akio Morita with Sony. They will never get their sophisticated brands with a short-term focus on headlong growth.

The Discussion: 17 Comments

Richard, you are mistaken. Haier and other chinese name brands are victims of US aggression and Japanese cunning.

Hongxing, Jr.

I say this only half in jest. I think Haier would do well on the white-goods market outside china and that US protectionism is ridiculous, but I also think China should be forced to allow private companies from outside the middle kingdom to buy up chinese companies.

December 5, 2005 @ 8:03 am | Comment

Fair enough, but that still doesn’t account for China’s over-reliance on foreign technology, management know-how and, most important of all, cash. Especially, since FDI is starting to drop and massive China-investors like Japan and Taiwan are increasingly investing in places like Vietnam.

Vietnam (due for WTO membership in mid-2006) now allows visa-free travel for Japan nationals and the country has zero anti-Japanese sentiment. Taiwanese investment in China also dropped 18% this year.

China’s policy of using existing foreign technology and foreign investment has worked well but it’s time to move on, China looks ill-equipped to make that move forward.

Mind you, Japan also disallowed foreign investment and its closed markets were the subject of many an row with the U.S. and Europe in the 80s. However, they did spend an awful lot on R&D which China, so far, is reluctant to spend money on.

December 5, 2005 @ 8:45 am | Comment

Sorry, the above was in answer to Laowai.

December 5, 2005 @ 8:53 am | Comment

Good points. I really think China’s anti-Japanese sentiments are going to be more costly than most Chinese suspect. Seems to me that few Chinese are aware of the level of Japanese participation in China’s economy.

China’s business culture is also going to start working against it, if new rivals have functioning legal systems, complete with rule of law and respect for contracts.

I’m afraid the “copycat” mentality is also going to start offering diminishing returns if foreign firms start moving to places with less risk of intellectual property theft.

Lots of very big challenges for China in the near future.

Hey Martyn, have you been brushing up on your Vietnamese lately? ๐Ÿ™‚

December 5, 2005 @ 10:00 am | Comment

Good article. I’ve been trying to talk up branding, consistency, value added, and quality in my little corner of the world for two years now, but it’s not registering. I suspect that there’s no real cultural basis for even understanding what I’m talking about.

The single advantage–cheap labor–can’t last much longer if the other cheap labor nations discover systematic quality and innovation.

December 5, 2005 @ 10:26 am | Comment

Haier isn’t a household name yet, but their appliances are creeping into kitchens and living rooms in the US. If Korean companies, which used to rely on Japanese technology, can now compete with Japanese products on the world market, I think Chinese companies can become internationally competitive.

In China, my Haier appliances worked fine, and I would buy one here. If I buy a so-called American brand, it’s probably made in China anyway. I’d rather put money in the pocket of self-made CEO Zhang Ruimin than reward overpaid US execs for outsourcing.

Except for Haier and Hisense, I don’t know any other Chinese brands sold in the States.

December 5, 2005 @ 4:24 pm | Comment

I got alot of students interested in talking about branding, product design and marketing by spending a couple of weeks on this Wired magazine article. The hook was that Samsung looked to traditional Korean values to find marketing and design ideas instead of just making cheap appliances. Considering the Korean Wave has continued to grow since then, Sam_S, you oughta be able to get the students talking about it. If necessary, appeal to their patriotism/nationalism a little bit e.g. How is China going to beat Sony like Samsung did?. All that anti-Japanese sentiment, when there, might as well go towards something positive and creative.

Martyn, it’s true China relies on alot of foreign money and ideas, more than historical British, Japanese or U.S. counterparts. But as for China having a manufacturing slave labor force, well, Britain and the U.S. did that too. People quickly forget how brutal it was in early twentieth century America. The difference, you might say, is at the top. Where in China is a guy like J.P. Morgan to invest money in an eccentric Serbian engineer like Nikolai Tesla?

December 5, 2005 @ 4:29 pm | Comment

I see PKD is being comment spammed as much as I am. The word g*eneric was blacklisted.

December 5, 2005 @ 4:30 pm | Comment

Heh. Dave, I’ll soon have a grandchild named Nikolai because my son is a dedicated engineer-nerd.

December 5, 2005 @ 5:15 pm | Comment

Daily linklets 6th Dec

A super brief linklets today… China's gender imbalance and one child policy. Rules for Hong Kong demonstrations. The news Hong Kong's English media doesn't print. An interview with a Chinese businessman saying Western companies push for c…

December 5, 2005 @ 9:01 pm | Comment

I’ve been teaching English for the past few months to some of the engineers and office staff of a very large Chinese company (consumer electronics). They are currently poised to enter the world market, and they are paying the utmost attention to product design, brand ownership, components, marketing etc etc. This company has in the past participated in joint ventures with foreign companies, but they’ve used that time to learn and to grow rather than to be exploited.
I really think they’ve got a chance to succeed as they’re focusing on all the right things, and really just need the time.

December 6, 2005 @ 12:50 am | Comment

While it is true that Japanese investors are slowing their investments in China, it is largely NOT because of anti-Japanese sentiment.

Most Japanese kind of ignore anti-Japanese sentiment in China in the same way that most Americans ignore white hate groups who jump up and down and say that black people are inferior to them.

The actual reason for the investment shift (to India and other Asian countries) is that Japanese investors are moving away from ‘Cheap’ and towards ‘advanced’. They want to invest in high tech design and product generation rather than just manufacturing.

There are also concerns among investors over the reliability of China’s electricity and water infrastructure and its low level of protection on IPR.

Saying this, during the summer there were some strong fears as to whether Beijing would protect Japanese investment in the case of more anti-Japanese riots. However these fears have subsided somewhat.

It’s a real shame, even if Tokyo and Beijing don’t get along, I’d been given real hope that the business relationship between China and Japan might have been able to help China and Japan to come closer together so that Chinese could realize that Japanese are people too.

December 6, 2005 @ 1:41 am | Comment

Slim muses:

China’s business culture is also going to start working against it, if new rivals have functioning legal systems, complete with rule of law and respect for contracts.

I’m afraid the “copycat” mentality is also going to start offering diminishing returns if foreign firms start moving to places with less risk of intellectual property theft.

Lots of very big challenges for China in the near future.

That’s a great summation. “Copycat culture” – love it. I’m going to start shamelessly using the term as my own.

I’ve been brushing up on my Cantonese as it happens. Listening is no problem but the speaking bit is pretty bad.

December 6, 2005 @ 7:10 am | Comment

ACB’s above point about anti-Japanese sentiment not being a deciding factor is credible as the Japanese ‘China-plus-one’ investment policy (and interest in Vietnam) predates the April anti-Japan riots by about 2 years.

Japanese firms seem to take a lateral or big picture view and, like the the cost-conscious Taiwanese, are investing in India and Vietnam due to general worries about China (unrest, health issues etc.) and matters of cost (inc quotas, IP theft etc) in addition to what ACB mentions.

December 6, 2005 @ 7:14 am | Comment

Even the Chinese themselves are moving production to Vietnam. There was a story today either in WaPo or the NYT about Chinese businessmen moving their operations to Vietnam owing to cheap labor, scant environmental production, and better water and energy supplies.

December 6, 2005 @ 5:45 pm | Comment

Heh. Dave, I’ll soon have a grandchild named Nikolai because my son is a dedicated engineer-nerd.

Sam, you might want to mention to your son that if he’s naming the kid after Tesla, the first name should be “Nikola” (no “i” on the end).

Might save the kid a lifetime of misspellings. ๐Ÿ™‚

December 7, 2005 @ 1:46 am | Comment

Slim, I probably got it wrong. My son would know better. Maybe I should warn him anyway, since our last name is always misspelled, too.

December 8, 2005 @ 4:27 am | Comment

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