Adapting to the China Challenge
←
→
Page content transcription
If your browser does not render page correctly, please read the page content below
executive briefing Adapting to the China Challenge Lessons from experienced multinationals Written by: Professor Simon Collinson, Lead Ghoshal Fellow, AIM, Warwick Business School Dr Bridgette Sullivan-Taylor, AIM Associate, Warwick Business School Dr Jung-Li (Rowena) Wang, AIM Associate, Warwick Business School
AIM – the UK’s research initiative on management
The Advanced Institute of Management Research
(AIM) develops UK-based world-class management
research. AIM seeks to identify ways to enhance
the competitiveness of the UK economy and its
infrastructure through research into management
and organisational performance in both the private
and public sectors.
Written by:
Professor Simon Collinson, Lead Ghoshal Fellow, AIM, Warwick Business School
Dr Bridgette Sullivan-Taylor, AIM Associate, Warwick Business School
Dr Jung-Li (Rowena) Wang, AIM Associate, Warwick Business School
2
about AIM
AIM consists of:
■ Over 250 AIM Fellows and Scholars – all leading academics in their fields…
■ Working in cooperation with leading international academics and specialists
as well as UK policymakers and business leaders…
■ Undertaking a wide range of collaborative research projects on management…
■ Disseminating ideas and shared learning through publications, reports,
workshops and events…
■ Fostering new ways of working more effectively with managers and policymakers…
■ To enhance UK competitiveness and productivity.
AIM’s Objectives
Our mission is to significantly increase the contribution of and future capacity
for world class UK management research.
Our more specific objectives are to:
■ Conduct research that will identify actions to enhance the UK’s international
competitiveness
■ Raise the quality and international standing of UK research on management
■ Expand the size and capacity of the active UK research base on management
■ Engage with practitioners and other users of research within and beyond the
UK as co-producers of knowledge about management
contents AIM – the UK’s research initiative on management 2
About AIM 3
AIM research themes 4
Executive review 5
Introduction: China – the next economic superpower 6
The big picture 8
Western multinational investment in China 15
Getting into China 20
The benefits of collaboration 30
Management and policy implications – the long view 39
Conclusions 42
3
AIM research themes
Current AIM research projects focus on:
UK productivity and performance for the 21st century.
How can UK policymakers evaluate and address concerns surrounding the UK’s
performance in relation to other countries?
National productivity has been the concern of economists, government policymakers,
and corporate decision-makers for some time. Further research by scholars from a
range of disciplines is bringing new voices to the debates about how the productivity
gap can be measured, and what the UK can do to improve the effectiveness of UK
industry and its supporting public services.
Sustaining innovation to achieve competitive advantage
and high quality public services.
How can UK managers capture the benefits of innovation while meeting other
demands of a competitive and social environment?
Innovation is a key source of competitive advantage and public value through new
strategies, products, services and organisational processes. The UK has outstanding
exemplars of innovative private and public sector organisations and is investing
significantly in its science and skills base to underpin future innovative capacity.
Adapting promising practices to enhance performance
across varied organisational contexts.
How can UK managers disseminate their experience whilst learning from others?
Improved management practices are identified as important for enhancing
productivity and performance. The main focus is on how evidence behind good or
promising practices can be systematically assessed, creatively adapted, successfully
implemented and knowledge diffused to other organisations that will benefit.
4
executive review
■ Inflows of foreign direct investment (FDI) into China represent the most
significant flows, not only of capital but also of technology and managerial
capabilities, into an emerging economy, ever witnessed.
■ The scale, scope and speed of economic growth in China overall, and specific
improvements in the innovative capabilities and competitive advantages of
particular Chinese firms, are connected to these FDI inflows.
■ Both Western multinational firms and local Chinese firms are benefiting from Both Western
joint-ventures, alliances and partnerships that arise from FDI. Each side is multinational
learning, accessing complementary assets, capabilities and knowledge. firms and local
■ Different forms of partnership, complementarities and learning exist depending Chinese firms
on the firm, industry and operational context. Coping strategies and successful are benefiting
management practices also differ according to these specifics. from joint-
ventures
■ These opportunities, and related threats, are evolving for Western firms currently
alliances and
invested in China or looking to invest (as well as firms elsewhere, as Chinese
partnerships…
firms increase exports and expand outward FDI).
■ The most successful firms are the most dynamic. They are clear about how
current collaborators are learning and changing, and are adapting. They are
proactively identifying future niche businesses and repositioning themselves
within global value chains in response to the future competitive advantages
of Chinese firms.
■ A central principle of the Chinese Government’s National Development Plan is
to improve domestic scientific and technological capabilities and boost China’s
competitiveness in high-technology based industries.
■ More research is required to map the rate of change more comprehensively
across a range of industry sectors, so as to better-inform UK policymakers
about the opportunities and threats for British businesses.
5
introduction: China – the next economic superpower
The fact that China is an increasingly attractive market and a magnet for foreign
direct investment is not news. The unprecedented rise of foreign direct investment
into China – now running at over $60 billion a year – has created the largest array of
international mergers and acquisitions, alliances, joint ventures and partnerships ever
witnessed. These are clearly a major source of complementary assets, resources
and capabilities for the Western multinationals and the local companies involved,
who engage in a reciprocal give-and-take as part of the process of market entry.
The research reported here examined British, European and US firms operating in
China. There are numerous success stories and examples of how these multinational
firms have overcome the challenges to establish profitable businesses producing and
selling in the world’s fastest-growing market. Many of these firms are also learning
from this experience in ways that benefit their business operations elsewhere.
However, against the current opportunities presented by Chinese firms Western
managers must also balance longer-term competitive threats. Chinese firms are not
just managing to imitate Western brands and transfer technology (either legally or
illegally) but are developing the kinds of innovative capabilities needed to continually
produce new and better products and services.
So while Western firms are learning about China, Chinese firms are learning how
to innovate. This raises two crucial questions: which industries will Chinese firms
eventually come to dominate; and how long will it take?
6
Most managers we interviewed see the rise of China in particular industries
and industry niches as inevitable. Early signs suggest that consumer electronics,
computer hardware, mobile telecoms, autos and certain kinds of IT services and
software may be destined for Chinese domination. Certain capabilities, like high-
quality manufacturing, design and incremental product development are beginning
to appear. But more complex, customer-led service capabilities and radical product
innovation, and truly high-tech entrepreneurship will take much longer, regardless
of the ambitions of the Chinese Government.
The most dynamic Western firms are responding by adapting. Whilst reaping the
advantages of cheap labour and growing disposable incomes, they are learning, by
being on the ground in China, about future threats and opportunities that will come
from Chinese firms. This means operational changes to safeguard certain core assets
and competences, and strategic changes, including re-positioning across global value
chains to complement, rather than compete head-on with China’s future strengths.
Certain
capabilities, like
high-quality
manufacturing,
design and
incremental
product
development
are beginning
to appear.
7
the big picture
1 Scale, scope and speed of growth
In the 1950s China’s economy was the size of Sudan’s. It is now the fourth biggest
economy in the world. By 2015 it is predicted to be the second largest economy,
and some see it overtaking the USA by 2040-50 to become the world’s largest.
In the past 25 years, with GDP growth averaging 9 percent per year, it has evolved
from a closed, centrally planned system towards an open, market-oriented economy.
Reforms started in the late 1970s with the phasing out of collectivised agriculture,
and expanded to include the gradual liberalisation of prices, fiscal decentralisation,
increased autonomy for state enterprises, the foundation of a diversified banking
system, the development of stock markets, the rapid growth of the non-state sector,
and the opening to foreign trade and investment.
Table 1: Economic growth in China; past and future
2003 2004 2005 2006 2007 2008
Nominal GDP USD bn 1,641 1,932 2,247 2,632 3,131 3,673
GDP per capita USD 1,270 1,486 1,719 2,001 2,366 2,759
GDP growth (real) percent 10 10.1 10.2 10.7 10.7 10.0
Source: Deutsche Bank Research
(www.dbresearch.com/servlet/reweb2.ReWEB?rwkey=u6025395)
The restructuring of the economy and resulting efficiency gains have contributed to
a more than tenfold increase in GDP since 1978. Despite the impressive growth rate,
however, in per capita terms the country is still lower-middle income and 130 million
Chinese fall below international poverty lines.
Increased trade, and foreign direct investment (FDI), both inward and outward,
have accompanied this economic growth as China has become integrated into the
global economy.
Trade in goods as a percentage of GDP doubled between 1990 and 2002, reaching
a level well above that of the Triad economies. The largest contribution to this
expansion was made by high-technology manufacturing. In 2006, China’s international
trade volume reached 2.22 trillion U.S. dollars, with an increase of 24 percent.
It now ranks third in the world in terms of total import and export volume. A growing
share of China’s economic growth has been generated in the private sector as
the government has opened up industries to domestic and foreign competition,
though the role of the state in ownership and planning remains extensive.
8
Table 2: China trade data
Major exports 2006 Percent Major imports 2006 Percent
of total of total
Electrical machinery 10.5 Electrical machinery 22.1
and equipment
Clothing and garments 9.8 Petroleum and petroleum 10.6
products
Yarn and textiles 5.0 Industrial machinery 3.5
Petroleum and products 1.1 Textiles 2.1
Main destinations Percent Main origins Percent
of export 2006 of total of imports 2006 of total
US 21.0 Japan 14.6
Hong Kong 16.0 South Korea 11.3
Japan 9.5 Taiwan 11.0
South Korea 4.6 US 7.5
Germany 4.2 Germany 4.8
Netherlands 3.2 Malaysia 3.0
UK 2.5 Australia 2.4
Singapore 2.4 Thailand 2.3
Source: The Economist Country profiles
www.economist.com/countries/China/profile.cfm?folder=Profile-FactSheet
Comparisons with Japan, during its rapid growth are interesting. Despite its large
and growing domestic market China exports a great deal more and across a wider
range of industries than Japan did in its heyday. Although the country only opened its
borders to trade and investment during the early 1980s by 2005 China had surpassed
Japan to become the third-largest trading nation in the world after the United States
and Germany. In 2006 China’s trade surplus more than tripled to boost foreign
currency reserves to a point where they also exceeded those of Japan to become
the largest in the world. Outward FDI from China is also relatively higher, partly as
a result of the strong Government push for international expansion (the ‘going global’
strategy pursued by MOFCOM) and the active use of mergers-and-acquisitions (M&A)
by Chinese firms to access Western markets, technologies and brands.
9
Export figures are an indication of competitive advantage and in the case of China
the size of the market, economy and wide range of industries involved in exporting
differed vastly from Japan. Japan enjoyed export success in a few core sectors:
consumer electronics, automotive and engineering. In China exports of goods and
services now account for 40 percent of GDP. In 2006 merchandise exports from
China grew 27 percent from 2005 to US$969bn. Once again, export growth
outpaced the 20 percent growth in imports. Also a familiar pattern, Asia accounted
for the largest proportion of exports (47 percent). China’s surplus with its two most
important trade partners reached US$144bn and US$92bn respectively in 2006.
This accounts for the $180 billion current account surplus, the largest in the world.
The scale, scope and speed of growth in China suggest that Chinese firms are
‘learning’ faster than ‘latecomer firms’ in emerging markets. One of the major drivers
of both ‘imitation’ and learning for Chinese industries has been the presence of
foreign multinational companies in China’s growing economy. The scale of their
involvement is shown by the sheer volume of FDI inflows over the past 20 years.
In 2005 China recorded over $72 billion of FDI inflows (compared to less than
$3 billion for Japan which has always attracted relatively low amounts of direct
investment). China’s total stock of FDI is more than three-times that for Japan,
again despite its relatively recent economic liberalisation.
Table 3: Inward and outward direct investment flows
US$ billions
2003 2004 2005
Inward Outward Inward Outward Inward Outward
China Mainland 47.08 -0.15 54.94 1.81 79.13 11.31
France 42.50 53.15 38.71 76.65 70.69 133.60
Germany 29.20 6.17 -15.11 1.88 32.66 45.63
Hong Kong 13.62 5.49 34.03 45.72 33.62 27.20
India 4.59 1.33 5.47 2.02 6.60 1.36
Italy 16.41 9.07 16.81 19.26 19.97 39.67
Japan 6.24 28.77 7.80 30.96 3.21 45.44
Russia 7.96 9.73 15.44 13.78 14.60 13.13
Taiwan 0.45 5.68 1.90 7.15 1.63 6.03
United Kingdom 16.78 62.19 56.21 94.86 164.53 101.10
USA 53.15 129.35 122.40 222.44 99.44 -12.71
Source: UN World Investment Report 2006 National sources
10The presence of multinational firms and the high rate of labour mobility in China
combine to increase the rate at which Chinese firms learn. This partly drives their
rate of internationalisation. Chinese firms are also apparently internationalising faster,
and across a broader range of industries than comparable counterparts elsewhere.
Figure 1 shows the growth of outward FDI from China in recent years.
Figure 1: Chinese outbound FDI in $ million 2000-2005
6920
5498
2701 2855
785
551
2000 2001 2002 2003 2004 2005
Compound annual growth rate
Excludes FDI in Hong Kong and British Virgin Islands
Source: Hirt and Orr, McKinsey Quarterly (2006)
2 Government initiatives
Government industrial policy is directed at growing Chinese overseas direct
investment under the epithet of ‘Going Global’. In 2006 Premier Wen Jiabao
strengthened this approach, building on the initial impetus by Premier Zhu Rongji
in 2001, as part of the government push for the development of national industry
champions and the procurement of natural resources abroad. Both underpin a broader
agenda of economic nationalism including energy security, geopolitical positioning
and national competitiveness.
Another major policy objective in China is to boost high technology industry sectors.
This is led by the National Development and Reform Commission as part of the
country’s 11th Five-year Plan, launched in June 2006. Key industries, including
information technology, biotechnology, aerospace, new materials, high-tech services,
new energies, and marine science and technology are the focus of this initiative.
The Government is also facilitating both local technology-based start-ups firms and
encouraging high-tech FDI by upgrading the R&D infrastructure to develop innovative,
patentable technologies. There has been a huge expansion in the number of researchers
in China since 1999. China counts now more researchers than Japan, and is on its way
to potentially overtake the EU in this regard. The country is already second only to the
US in terms of advanced technology exports, and it will overtake Japan this year to
become the second largest investor in R&D. It spent around half of the UK budget on
R&D in 1994 and now spends well over three times as much as the UK each year.
11In the coming years China plans to reduce its external imbalances; boost domestic
demand, particularly consumer demand, and rebalance investment and consumption;
further promote balanced external sector development; speed up financial reform;
and further improve the exchange regime ‘in a gradual and controllable manner.’
There are, however, a range of on-going problems, including:
■ Large disparities in per capita income between regions.
■ Unemployment, particularly affecting previous employees of state-owned
enterprises (SOEs), and migrants.
■ Corruption and other economic crimes.
■ Environmental damage and social problems related to the economy’s
rapid transformation.
■ A rapidly aging population, due to the one-child policy.
In the coming
years China
plans to reduce
its external
imbalances;
boost domestic
demand…
and rebalance
investment and
consumption…
12China’s aerospace industry
“Within the next 15 years there will be three major commercial aerospace
corporations; Boeing, Airbus and a Chinese firm. Soon after there may well be two;
one of which will be the Chinese firm.”(Quote from a British executive in the
Aerospace industry with over 35 years’ experience in China).
Passenger volumes in China’s air transportation industry are expected to grow
annually by 11 percent over the next 20 years. This will make it the world’s second
largest aviation market, requiring an additional 1,790 aircraft to cope with the
increased volume. 49 new airports and 701 airport expansion projects are also
expected under China’s current five-year plan, which began in 2006.
The Chinese Government maintains a strong degree of control over the civil aviation
industry. Respective agencies aim to improve the reliability and efficiency of the
transport infrastructure and promote competitiveness amongst domestic firms.
The General Administration of Civil Aviation of China (CAAC) is the Government
agency responsible for the non-military aviation industry. It has recently rationalised
the country’s airlines, completing mergers with the ‘Big 3’ – Air China, China Eastern
and China Southern – and some of the smaller airlines.
CAAC and other agencies are also central to the expressed aim of the Chinese
Government to develop an indigenous ‘Made-in-China’ aircraft to rival Boeing and
Airbus. There is no doubt this can be done and the economic rationale is not so
relevant, given that the Government has begun funding this as a prestige project
and will continue to do so until it succeeds. There are questions, however, as to how
long it will take and how reliable, safe and therefore saleable the final product will be.
One senior British executive in China described the ‘Stairway to Heaven’.
Three stages towards local technological maturity in aerospace manufacturing:
Stage 1 ‘Made-to-print’: local manufacturers follow simple designs for low-end
(and later, high-end) manufacturing.
Stage 2 Local firms take on responsibility for product modules or ‘build-kits’,
including some re-design and process innovation.
Stage 3 Full engineering partnerships with Western firms, with shared design and
development, local responsibility for technology, quality etc., and risk and
revenue-sharing (suppliers as shareholders in on-going development processes).
Foreign firms in China, including Airbus and Boeing, Rolls-Royce and General Electric
are part of this plan. In order to gain access to the growing domestic market, estimated
to be worth $289 billion over the next 20 years, they have had to establish partnerships
with local Chinese manufacturers. These involve sub-contracting, technology transfer
and training with an expressed aim of increasing the local content of aircraft.
AVIC1 (Aviation Industry China) and AVIC2 are responsible for all aerospace
manufacturing in China. AVIC1 concentrates on large aircraft and is the main organisation
charged with developing a complete Chinese-made aircraft. However, rather than
one unified ‘China’ interest group there are local rivalries and factions competing with
each other to become the lead player, not a simple ‘them-and-us’ situation. As in other
industries in China local competition drives learning. There is ‘collaborative competition’
guided, more-or-less by the Government, depending on the industry.
13Airbus subcontracts around $60 million per year to five Chinese firms and this is
expected to double over the next 5 years. Components made in China include A32p
wing parts, passenger doors and landing gear bay. Two major joint ventures are at the
centre of Airbus operations in China, in the towns of Xian (Xian Aircraft Corporation
with 28,000 employees) and Shenyang (Shenyang Aircraft Corporation with 20,000
employees). Both the local firms are state-owned enterprises (SOEs) operating
under the AVIC1 umbrella organisation. The Head of the Xian plant is also the local
town mayor.
Rolls-Royce has supplied engines to many Chinese airlines and also has a number
of key joint ventures, one of which is also in Xian. XR Aerocomponents Ltd (XRA)
is a high-tech joint venture with the Xian Aero Engine Company that began in 1997
to cast and machine turbine nozzle guide vanes (NGV) and turbine blades. In 2002,
XAE also became an approved classified parts supplier to Rolls-Royce. Other local
suppliers include Sichuan ChengFa Aero Science and Technology Ltd (rings, sheet
metal and fabrications), Beijing Aero Lever Precision Limited (VSV levers) and
Shenyang Liming Aero-Engine Group Corporation (heat shield rings).
Companies like Airbus and Rolls Royce have transferred manufacturing technology
and put in place a range of training programmes to develop the local capabilities at
these plants, and amongst local components suppliers. Whilst improved productivity
is important the quality and reliability of the components produced here are far more
important, given the safety-critical nature of the final product.
Process improvement and innovation at the plant level are monitored or measured
by a number of indicators. These include output and productivity measures, which
show improvements in scrap yield, for example, and in ‘concessions’ (buyer’s
rejection of component because of minor faults – such as inaccurately cut wing parts)
and ‘rework’ (more substantial returns, accompanied by quality notes as feedback
to supplier). The increased use of quality circles, ‘lean’ management systems, and
techniques such as the use of ‘visibility boards’ which map out operations on the
plant floor and monitor process changes, all indicate improvements in managerial
and process-related capabilities. Other advances, such as a move from the use of 2-D
to 3-D design drawings, demonstrate engineering, design and product development
innovations. All of which shows how local Chinese managers, engineers and plant-
level personnel are learning through their interaction with Western counterparts.
Formal training takes place alongside informal on-the-job learning. Rolls Royce has
a joint facility with CAAC in Tianjin, opened in 1997 for the training of technicians,
engineers and managers. It has signed six training protocols with CAAC since 1990,
including the CAAC Senior Executive Development Programme.
Moreover, a number of research programmes with Chinese universities and research
institutes have been developed, focusing on aero engine technology. The Joint
Engineering Team (JET) programme is one of these running with AVIC I/II.
14western multinational investment in China
Foreign direct investment into China in the first six months of 2007, totalled $31.89
billion, an increase of 12.2 percent from a year earlier. Hong Kong and the British
Virgin Islands, where many Chinese companies register for tax purposes, were
the top two sources of foreign direct investment, followed by Korea, Japan and
Singapore. China has attracted the dominant share of FDI into any single country,
with over $60billion per year in recent years.
Most investments are in the form of equity joint-ventures or wholly-owned foreign
enterprises, as shown in the table below. Around 70 percent of FDI each year is in
manufacturing industries, but service-related FDI is growing.
Table 4: FDI in China (2006)
Approved foreign investment this year
Number of projects Realised FDI value
The mode of utilising This year The same Change from This year The same Change from
foreign investment period last previous period last previous
year year% year year%
Total 41485 44019 -5.76 735.23 758.86 -3.11
I Foreign Direct 41485 44019 -5.76 694.68 724.06 -4.06
Investment
Equity Joint Venture 10223 10480 -2.45 143.78 146.14 -1.62
Contractual Joint 1036 1166 -11.15 19.40 18.31 5.92
Venture
Wholly Foreign Owned 30164 32308 -6.64 462.81 429.61 7.73
Enterprise
Share Company with 50 47 6.38 4.22 9.18 -54.00
Foreign Investment
Joint Exploration 0 0 – 0 0 –
Others 12 18 -33.33 64.47 120.81 -46.64
II Others Foreign 0 0 – 40.55 34.80 16.52
Investment
Stock Issuance 0 0 – 13.55 1.60 747.00
International Leasing 0 0 – 0.36 1.08 -66.67
Compensation Trade 0 0 – 0.21 0.16 32.01
Processing and 0 0 – 26.43 31.96 -17.32
Assembling
Sources: Invest in China
15Ten Asian locations; Hong Kong, Macau, Taiwan province, Japan, Philippines,
Thailand, Malaysia, Singapore, Indonesia and South Korea, account for around
Whilst the 60 percent of FDI inflows. Japan, USA and the EU invest roughly similar proportions.
majority are in Cumulative FDI in China’s high-tech industry has topped $70 billion, with more than
the banking, 700 foreign-affiliated high-tech companies operating R&D facilities in China. In 2005
consultancy and the country’s exports of high-tech products totalled Rmb218 billion, up sixfold
trading sectors, from 2000.
more companies
are now 1 UK-China trade and investment
looking at the The UKTI, the British trade and industry agency, considers China a ‘high-growth
UK’s R&D market and not an emerging economy’ (Cahn, UKTI CEO, 2007). According to Foreign
capabilities and and Commonwealth figures the UK is the largest EU investor in China in cumulative
service sector. terms with over 5000 British-invested projects. Major UK companies in China include
Arup, BP, Shell, P&O, Rolls Royce, B&Q and Tesco. The greatest potential for UK
companies lies in the aerospace, energy, environment, education and training,
financial services, healthcare, ICT, oil & gas and water industries.
Against this, more than 300 companies have invested in the UK from mainland China.
Whilst the majority are in the banking, consultancy and trading sectors, more
companies are now looking at the UK’s R&D capabilities and service sector.
Total bilateral trade, including trade in goods and services between the UK and China
increased by 111 percent between 2001 and 2005.
■ UK exports of goods to China increased by 16 percent over 2005.
■ UK exports of services increased by 54 percent between 2003 and 2005.
■ UK-China bilateral trade exhibited the highest rate of growth for any major market
between 2001 and 2005.
■ Overall trade in goods and services reached $33 billion in 2005.
■ UK’s exports to China amounted to £3.28 billion in 2006. The main exports are
iron and steel, electrical/mechanical equipment, precision instruments, plastics.
chemicals and pharmaceuticals.
■ UK’s imports from China also rose and amounted to £15.9 billion in 2006,
up 18 percent on 2005. Main imports are IT equipment, clothing and footwear,
toys and furniture and plastics.
16Figure 2: UK-China trade (1997-2006)
20,000
18,000
UK exports to China UK exports from China
16,000
Via Hong Kong Via Hong Kong
14,000 Direct Direct
12,000
10,000
8,000
6,000
4,000
2,000
0
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Years
The UK firms in the top-500 firms in China are: BP, Shell, Aviva, HSBC, Vodafone,
Tesco, RBS, HBOS, Prudential, GSK, BT, Barclays, Centrica, J.Sainsbury, Lloyds TSB,
Standard Life, BAT, Royal Sun Alliance, AstraZeneca, Anglo American, Compass
Group, Old Mutual, Legal & General, National Grid Transco, Royal Mail Group, Hilton
Group, Kingfisher, Alliance Unichem, Marks and Spencer, BAE Systems, Wolseley,
Corus Group, British Airways, GUS, Diageo, Abbey National.
17About the research: the largest survey of its kind
Who is learning what in corporate alliances between foreign firms in China
and their local partners – and what are the implications for future strategy and
competitive advantage?
This research examined the evolving relationships between foreign multinational
firms and their local counterparts in China. It focused on how these firms collaborate
to innovate. Producing new products or improved processes through technology-
sharing, training and joint-learning activities within alliances, joint-ventures or
contracted buyer-supplier relationships. The approach specifically examined transfers
of assets, resources and capabilities which improved the recipients’ capacity to
innovate. A central aim was to compare the benefits gained by Western multinational
firms from being in China, against the potential that they are breeding their future
competitors there.
Key questions were, for example: what kinds of assets, resources, capabilities and
knowledge were exchanged in the partnership? Were the strategic trade-offs planned
or emergent? What did each side learn that contributed to specific aspects of
innovation performance? What aspects of this learning were seen as reciprocal
or non-reciprocal and intended or unintended? Related to this evolving process of
exchange and learning was there a distinctive change in the relative specialisation
of the two partners (and did this amount to a move along or between industry
value chains)?
A series of company case studies were developed through interviews with managers,
engineers, scientists and plant-level personnel. These focused on specific joint-
ventures, alliances and contractual partnerships in the China-based businesses
of these firms, with local firms. Over 100 interviews were held both in the home-
country location of the firm (UK, Mainland Europe or the USA) and in China. Many
of the largest UK investors in China are included in the sample which covers more
than 30 joint-projects in 20 multinational firms in the pharmaceuticals, telecoms,
aerospace, automotive, industrial manufacturing, FMCG manufacturing and research
and high-tech manufacturing sectors.
Whilst compiling the company case studies the research team interviewed a range
of policymakers, consultants and representatives from Government agencies based in
the UK and China. These included the DTI, UKTI, CBI, British Chamber of Commerce
in China and China-Britain Business Council (CBBC).
18The largest questionnaire-based survey ever on this topic was also conducted, using
two different company samples. For one sample a China-based survey firm was
commissioned and produced responses from 320 firms. The other questionnaire
was sent out to UK corporate members of the CBBC and other UK and China-based
corporate membership organisations. This survey allowed us to compare the
experiences of 51 British firms with those of 181 American firms and 88 from mainland
Europe. Over half (62 percent) had been established in China for over 10 years.
Most of them are manufacturing firms, and almost two-thirds are in the machinery
and equipment, electrical and optical equipment, and chemicals-related sectors.
In terms of sales revenue, 67 percent of the firms surveyed had more than doubled
their operations in China since establishing a presence and over a quarter had grown
their sales more than 6-fold. Moreover, 66 percent had grown their market share
in China by over 5 percent since entering the market and 15 percent of the sample
had succeeded in expanding their market share by more than 30 percent.
The findings help us understand more about the challenges multinational firms face
in the Chinese market and how they are responding to these challenges. They
also complement aggregate, industry-level and national-level, surveys of shifting
competitiveness with a better understanding of processes, practices and mechanisms
of transfer and learning at the micro-level.
19getting into China
China began to open-up to investors following Deng Xiaoping’s ‘Open Door’ policy in
the late 1970s. China holds the double attraction for MNEs of a growing consumer
market and as an increasingly cost-effective source of ‘inputs’, particularly cheap
labour. At the same time the rapid growth of the economy and the country’s growing
purchasing power is channelling investment into transportation, energy, utilities,
communication systems and other aspects of its infrastructure. In response to
these attractions, MNEs have made a large number of investments in China.
China has long-been a target market for exporters and investors. Only Government
liberalisation made it possible to do business here and both central and local
Government still maintain a strong influence on the local rules of the game. There
is a priority list of desired investments and ventures involving advanced technology,
exports, or the generation of foreign exchange are preferred.
It is more common in China for multinationals to use intermediaries in the market-
entry process than elsewhere in the Pacific Rim. However, FDI trends for foreign-
invested enterprises (FIEs) show a distinctive shift away from joint-ventures toward
wholly-owned foreign enterprises (WOFEs), driven primarily by the changing market-
entry regulations.
For firms in some industries, where the central Government has strong development
ambitions particular forms of investment (or associated activities such as local R&D or
training) may be necessary to get access to local procurement networks and markets.
There are examples in industries such as aerospace (see the case study above),
telecoms, energy and utilities, where investments may not appear economically
viable in their own right, but need to be assessed over the longer-term.
20According to folklore in China, ‘the mightiest dragon cannot crush the local snake’;
i.e. local advantage can help a great deal in fending off larger and wealthier
‘predators’. Mutually-beneficial, collaborative partnerships and joint-ventures are
the norm, however. In a joint venture the local partner is typically responsible for
providing the land and buildings and for carrying out local marketing. The MNE is
expected to contribute the equipment, technology, and capital and to be responsible
for export marketing. In those cases where the multinational is manufacturing for
sales in China, high quality products, excellent service, and good promotional efforts
are critical to success.
1 Forms of foreign investment
Firms can invest via direct investment mechanisms (FDI), including Sino-foreign joint
ventures, joint exploitation and exclusively foreign-owned enterprises, foreign-funded
share-holding companies and joint development. The other means of investment
include compensation trade and processing and assembling.
(i) Sino-foreign joint ventures, also known as joint share-holding corporations.
In general, according to Chinese regulations, the capital from foreign party should
not be lower than 25 percent.
(ii) Cooperative businesses, also called contractual cooperation businesses, where the
rights and obligations of different parties are embedded in the contract. The foreign
partner generally supplies all or most of the capital while Chinese party supplies land,
factory buildings, and other facilities.
(iii) Exclusively foreign-owned enterprises. These take the form of limited liability
companies and regulations formally call for these to either ‘adopt international
advanced technology and facilities’ or ‘all or most of the products must be
export-oriented’.
(iv) Joint exploitation, development and production enterprises relate to maritime
and overland oil exploitation.
(v) Foreign-funded share-holding companies, where Chinese and foreign shareholders
hold the shares of the company and accept liability according to proportional
ownership. The shares held by foreign investors must account for more than
25 percent of the total registered capital.
(vi) New types of foreign investment. China is increasingly open to new types of
foreign investment such as BOT, investment companies and, increasingly, merger
and acquisition (M&A).
212 Challenges for foreign firms
The annual business climate survey conducted by the American Chamber of
Commerce in China found, in 2006, that 64 percent of its member companies were
Respect and reporting ‘profitable’ or ‘very profitable’ businesses in China. One out of three said
credibility often that their China operations had higher margins than their worldwide organisations did
comes from and another third reported margins that were on a par with the global average. Firms
asserting one’s reported the biggest problems to be, in order of importance:
own practices
and ‘rules of ■ Transparency of laws and regulations
the game’. ■ Cost of doing business
■ Recruitment and personnel management
■ Customs procedures/ export procedures
■ Foreign exchange regulations/ exchange rate risk.
Some key issues for foreign entrants are:
■ Market-access rights from equity holdings to taxation levels vary by industry and
are changing rapidly. At least three, often more, levels of government, including
local, regional and central government agencies have a direct and strong influence
over the ‘local rules of the game’ and give preferential treatment to local firms
and to particular kinds of foreign investors.
■ Chinese tax laws and other regulations governing business practices are complex.
Despite the expense it is necessary to use attorneys, accountants and
consultants familiar with Chinese requirements.
■ Contracting tends to based around relationships and connections (guanxi) rather
than formal, legal documents. These are the basis of mutual trust, with ‘
due-diligence’ on potential business partners performed by checking their
network ‘connections’, as opposed to formal ‘market’ mechanisms. Relationships
with the right connections are critical. Developing guanxi connections with the
wrong partners creates obligations that may act as a trap. Contracts on their own
are just the starting point, not the end.
■ Intellectual property rights (IPR) are not well-protected, legally or via any local
business ethics. Investors need to carefully consider the implications of this,
including the possibility of local firms getting and using key ‘assets’ such as
brands, patents and business systems.
■ Keeping face, building a reputation and being respectful is important.
Group-orientation and steeper hierarchies characterise Chinese organisations.
■ Learning the language may be important, to provide insights into the local
business culture. Too much of a willingness to ‘do things the local way’ can be
seen as a sign of compromise and ultimately weakness. Respect and credibility
often comes from asserting one’s own practices and ‘rules of the game’.
22■ The role of the Chinese partner in the success or failure of a joint venture or
alliance cannot be over-emphasised. Good partners will have the connections
to overcome obstructive red-tape and enable success; bad partners may have
no power or knowledge to deal with obstructive bureaucrats, may violate
confidentialities and/or establish competing businesses.
■ Although there is a large, cheap general labour pool, skilled managers, particularly
those with marketing expertise, are difficult to find and keep. Engineers and
technicians are similarly difficult to hold on to.
China has a reputation as a cheap manufacturing hub so cost advantages are still the
primary motivator for many companies. The positives of sourcing in China include:
■ Lower labour costs
■ Large manufacturing capacity
■ Lower capital costs
■ Improvements in quality
■ Low cost product design and R&D.
The negatives:
■ Communication
■ Product quality
■ Initial start up time
■ Intellectual property theft
■ Increased management complexity
■ Operation and supply chain challenges.
3 Pros and cons of joint-ventures
A clear benefit of majority-owned JVs is the element of control combined with the
benefits of gaining immediate access to experienced managers and their local
relationship networks and experienced personnel.
Major reasons for forming a joint-venture or local partnership (in approximate order
of importance):
■ Accessing local business knowledge, including customer and supplier connections
■ Assistance with local officials and regulations
■ Financial input from partner
■ To limit investment risk
■ Access to local management skills
■ Access to local materials of sources of inputs
■ Access to distribution channels
■ It is a requirement for PRC in my sector.
23Key criteria for partner selection for British managers (in approximate order of
importance) are:
■ Relationship between senior management (trust, respect, strategic synergies etc.)
■ Reputation of Chinese partner
■ Partner’s links and connections to officials, key institutions and firms (suppliers,
customers etc.)
■ Products or services of partner
■ Location of partner
■ Complementary resources, assets and technology
■ Size of partner
■ Access to local capital/currency.
Precisely how competent or well-connected Chinese managers are is difficult to
assess before entering into the relationship. Partner selection is obviously critical
but doing any kind of due diligence on the assets or integrity of potential partners
is difficult in China. As Chinese firms very often put forward land and other assets
in place of capital this can be a major issue. Experienced consultants and old-hands
with good knowledge and connections can help with this process.
Companies in the survey also cited problems with other legacy issues related to
joint-ventures, including:
■ Built-in obligations to retain certain individual employees and/or high levels
of staffing which undermined efficient operations
■ Long-standing ties to local or (less often) central politicians who may have
formal roles in the firm, ownership claims or other means of influence
■ Other obligations for payments to certain parties
■ Technology transfer and training agreements
■ Obligations to certain suppliers, contractors or customers.
Firms that have joint-ventures with SOEs can be tied into a number of Government
regulations, particularly as regards employment and wages. Formally wage rises in
SOEs are strictly regulated. One interviewee said their JV was limited to a three
percent wage rise per year across the entire workforce. This presented a challenge
in terms of retaining staff and competing for talent with other firms (see below),
and they had been forced to find ways around this restriction.
By comparison, wholly-owned foreign enterprises (WOFEs) and subsidiaries offer
most control, and are on the increase as the preferred form of foreign establishment.
WOFEs however do not provide the local knowledge and contact networks offered
by local partners. There is an even greater premium on recruiting experienced and
knowledgeable Chinese staff to fill senior positions.
24In general, firms that have experience of joint-ventures in China report that access to
local labour and support in recruiting, managing and developing local labour are
important benefits of the partnership.
In general foreign firms take responsibility for production and R&D functions in the
joint-venture and the Chinese partner tends to contribute more to the distribution and
marketing side of operations. Although there is shared responsibility for finance and A large number
personnel functions, foreign and local managers tend to take on distinctive sets of of British
tasks. Chinese managers deal more with local financial and personnel issues, managers
including tax regulations, payment systems and wages, recruitment and routine also cited
personnel management. Partly because of the long-term need to reduce expatriate differences in
management involvement, foreign managers are involved in training activities and the definition
managing links with head-office. or perception
of ‘quality’
Many of the problems experienced by firms in joint-ventures and partnerships reflect between
the challenges listed above. Recruiting, managing and motivating personnel rank very themselves and
high amongst key difficulties faced by foreign managers, even when working with local managers
local partners (see Labour Issues’ section below). Skill shortages and weaknesses in and personnel.
Chinese management, and the resulting low levels of labour productivity also
presented significant problems. But there are indications from our case studies that
show this to be partly a failure on the part of British managers to differentiate
between labour costs and productivity. The former are simpler to estimate than the
latter, leading to high expectations of cost-savings which are not realised on the
ground in China.
A large number of British managers also cited differences in the definition or
perception of ‘quality’ between themselves and local managers and personnel.
The Chinese were seen to accept low levels of quality and/or be unclear about the
need for high quality or other customer-led product attributes. This is linked to a more
general difference in mind-set which stems from China’s pre-liberalised past when
market incentives and individual motivations of managers and employees were very
different. This influences management and employee attitudes to all basic aspects
of business practice such as the need to measure and monitor performance, or the
impetus for continuous improvement.
Other problems and risks cited by managers include:
■ Losing control to local managers
■ Damaging reputation effects of specific partnerships
■ Dangers of creating a new competitor
■ Repatriation of profits and transfer pricing
■ Local sourcing difficulties
■ Infrastructure and communications
■ Government restrictions
■ Corruption and bureaucratic uncertainties.
25Case study: Oxford instruments in China1
The Oxford of ancient spires and ivory-towers is well-known amongst the Chinese.
The successful, high-tech spin-off Oxford Instruments (OI) is less well known, but the
company is working to change this. Having sold a range of its products in China for
over 10 years and experienced a 30-40 percent growth in sales year-on-year, senior
managers at OI decided it was time to invest more heavily. The company opened
representative offices in Beijing and Shanghai between during the last decade and
employed 20 people (including two expatriates). Then, between April 2003 and
August 2004 they registered as a wholly foreign-owned enterprise (WFOE) and
established a manufacturing facility. This was a major investment for a firm with
a turnover of $330 million and 1500 staff around the world. But it was a necessary
step given that over 90 percent of OI’s sales were from outside of the UK with
approximately 5 percent in China. Moreover, its managers learned a number of
important lessons along the way.
A key reason for investing directly in
the China market, moving to a higher
level of both commitment and risk,
was to get closer to the growing
number of Chinese customers.
OI chose to build on the strong
platform of Rep offices through the
establishment of a repair and service
centre for supporting its microanalysis detector customers in China. It also wanted
to provide a platform for the assembly of top-level products. To establish a business
entity capable of delivering these kinds of activities it needed some outside help.
One way to reduce the risks of FDI is to hire local specialists knowledgeable about
the local ‘rules of the game’ with the relationships and connections to help smooth
the way. Another route is to hire experts who understand the international legal and
regulatory conditions relating to a Foreign Direct Investment (FDI) project. In fact,
when initiating its investment plans in China, OI did both. An international law firm
was hired to ensure that global regulatory standards were followed. A local sponsor
was also brought in (at a significantly lower cost) to help with the submission of the
investment application to government authorities.
The establishment process itself was relatively straightforward. Step one was to
register the company name. Step two was the submission of a feasibility report and
articles of association to show the firm would be profitable and (most important)
produce good tax returns. The WFOE, Oxford Instruments (Shanghai) Co. Ltd., was
then given Government approval and granted a trading license around three months
after the start of the process. Post-registration procedures, including securing the
company ‘chop’ (an official company seal or signature stamp) took a little longer.
1
Sources: This case has been compiled by the author from a presentation by and discussions with Daniel Ayres, Project Manager for
the establishment of the Manufacturing WFOE in Shanghai; www.oxford-instruments.com. Adapted from: Rugman A.M., Collinson,
S. and Hodgetts, R. (2006) International Business, FT Pearson Prentice Hall, Fourth Edition.
26Further development of an effective and efficient HQ-subsidiary organisation structure
and good working relationships between head-office management and local
managers in China were seen to be key priorities in the early stages of the China
venture. The UK side defined a common internal financial reporting structure and
shared the group business strategy, which the senior management in China was then
allowed to revise and tailor to the local context and culture. The existing OI China
Chief Representative, a Chinese national employed by OI for 5 years, was named as
the General Manager of the new organisation. The leadership of this existing member
of the OI team, with experience of working both in a related industry and in an
English-speaking environment to head-up the China operation was important for
creating the necessary HQ-subsidiary relationships. As with any international
expansion, an overarching question for OI was (and continues to be): what business
processes and decision-making responsibilities do we move to China and what do we
keep in the UK?
Key constraints and challenges cited by OI include: time and resource-consuming
Chinese bureaucracy at various levels including central, regional, local governments
and individual firms (one customer required 11 different VAT invoices for a single
sale). It was important for OI to link the new Shanghai facility into their global IT
infrastructure but the instability of the local internet required the company to invest in
alternative (and more costly) connection methods. As OI continues to grow in China
the task of developing the necessary range of capable, experienced local managers in
the sales and marketing functions as well as in operations will continue to be a focus.
Oxford Instruments
(Shanghai) Co. Ltd.
is formally opened
by Charles Holroyd,
MD of OI Analytical Ltd.
(2nd from left).
Perhaps more significant than these problems have been OI’s concerns about
protecting its intellectual property rights (IPR) in China. OI’s R&D assets and
technological capabilities underpin its primary competitive advantage. It has had to
take steps to avoid losing these to local Chinese competitors. Some formal protection
and registration steps are available and these have been taken by OI but this provides
limited protection in China. More effective protection of IP is gained through placing
an emphasis on the careful recruitment of staff in China, the retention of the
development and some manufacturing of key technologies at home in the UK.
27Many people talk about the importance of relationships in China. One interpretation is
that in the process of developing relationships the Chinese are effectively performing
a ‘credit-check’. In the absence of stable or reliable formal contracting rules,
regulations, processes and institutions more emphasis is placed on inter-personal
trust as the reliable basis for doing business. What rules there are in China tend not
to be applied consistently. This leaves plenty of scope for influencing processes and
decisions which places even more of a premium on having the right connections.
At an early stage in the project the following light-hearted ‘rules’ for doing business in
China were presented by a speaker at a ‘Making it in China’ session at the University
of Cambridge:
(Rule 1) China is a highly regulated country, in which one needs to learn countless
regulations, understand and follow them.
(Rule 2) China presents a chaotic and unpredictable operating environment in which
anything is possible, in fact there are no rules.
(Rule 3) Rules 1 and 2 are simultaneously valid.
4 Labour dilemmas
Across all our survey firms foreign managers confirmed that one of the most
remarkable aspects of China is the sheer drive and motivation of its people. In general
they are very hard-working and ambitious. Local cultural values and China’s past
history do have a strong influence on work-place behaviour, underlying a reluctance to
Cheap labour is take the initiative and the need for detailed instructions, for example. But a massive
one of China’s appetite for learning, advancement and the rewards of capitalism amongst the people
major are central to China’s growth drive.
attractions,
however, Cheap labour is one of China’s major attractions, however, experienced labour is
experienced increasingly scarce and there is a talent war for particular kinds of employees
labour is as labour rates increase and firms put in place a range of strategies to retain
increasingly good employees.
scarce…
Despite its population of over 1.3 billion people, good labour, from experienced
managers to skilled manufacturing workers, is scarce, particularly in the Eastern urban
areas. Rises in wage costs since 2002 are beginning to run the risk of outpacing
improvements in the productivity of the country’s workforce, which could result in
lower export competitiveness.
28Wages in advanced coastal cities like Shenzhen, Guangzhou, Shanghai and Beijing are
among the highest in China. Wages in smaller cities in the east of China, such as
Suzhou, Nanjing, Wenzhou and Qingdao, are relatively low, averaging between $180
and $230 per month. Meanwhile, labour costs in inland cities like Hefei, Wuhan and
Weihai are the lowest in China, with monthly wage rates of between $120 and $160.
Chinese
Recruiting and keeping good staff is one of the most taxing issues facing Western employees
business in China, as companies compete to attract qualified people. Chinese recognise their
employees recognise their market value and are not afraid to bargain for better market value
opportunities. Professionally trained engineers and managers who are multi-lingual and are not
and can provide a ‘bridge’ to combine the advantages of West and East are in afraid to
particularly short supply. bargain for
better
Some kinds of skilled workers in Shanghai are moving jobs as often as every 6 to 15 opportunities.
months. The rapid rate of inflation of the standard of living in Shanghai is also driving
this job-hopping with skilled professionals moving jobs for as little as $10/month and,
for those with considerable experience, for a 20-50 percent increase in salary.
Our surveyed firms averaged 9 percent labour turnover per year, ranging from
0 percent to 70 percent overall. The interview-based case studies revealed more
detail and a fairly consistent pattern. They experience lower turnover amongst the
less-skilled or non-skilled plant-level workers (around 3-5 percent), compared to 10-15
percent on average but up to 20-25 percent in a number of cases for well-trained
employees. The pattern varies by location in China and industry sector. One firm cited
a 70 percent annual turnover rate for its good, English-speaking managers creating a
huge challenge to maintain both local production and consistent links with head-office
and local suppliers and customers. Poaching, particularly of these kinds of scarce
managers, is relatively commonplace, by Chinese firms and by multinationals
competing for the same talent.
For foreign firms in China who invest in training and who are concerned about
controlling their intellectual property this presents a major problem. When staff move
so quickly between organisations, investment in up-skilling and training can be lost.
Not only this, their new knowledge and expertise, for example in manufacturing
technologies, process engineering or new product development, may well end up
helping competitors. In some manufacturing industries there is a significant flow of
technologies, management practices and plant-level capabilities between foreign
firms and local Chinese firms.
In order to protect these human assets and maintain a level of sustainable
competitive advantage over a longer time frame, many Western firms in China are
developing innovative strategies to tie employees in for defined periods. Some
companies, for example, are tying employees in for one year for every month spent
abroad training. If they leave early employees are required to reimburse the company
for the costs of this training. A move recently supported by the Chinese government
by making compensation payments legally enforceable.
29You can also read
