China Business Blog and Podcast

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Those who have been doing business in China for awhile are quite familiar with the differences between the State-Owned Enterprises (SOEs) and the Privately-Owned Enterprises (POEs).  For those of you not familiar with this distinction, let me break it down for you.  The POEs are just that, companies owned privately with little or no government involvement – they are often run by business-savvy executives with global business experience.  The SOEs, to put it succinctly, are seen as hulking, unprofitable behemoths chocked full of aging assets and run by 55 year old Party hacks in moth-eaten Mao suits and greasy comb-overs.  OK … maybe I am being a bit too hard on them, but the term “SOE” has been used as a pejorative descriptor more often that not.

After Liberation in 1949, the Chinese Communist Party brought all businesses under their control and POEs were, for all intents and purposes, completely eliminated in China (as was nearly all foreign investment when they were unceremoniously kicked out of China).  Through a series of disastrous events in the 50s through the 70s (the Great Leap Forward, the Cultural Revolution, etc.), the government proved that, not unlike their Soviet cousins, they were terrible CEOs – factories were inefficient, poorly run and churned out bad-quality junk that had no relationship to any market demands whatsoever.  That wasn’t as bad as it seemed because China retail and commercial trade was not yet standardized so bad products were also hard to purchase.  Go figure.

One of the many reforms that the Deng Xiao-ping administration started in the early 80s was captured under the Party phrase 民进国退 (min2 jin4 guo3 tui4): “POEs will advance; SOEs will retreat.”  What this meant, in effect, was that the Party wanted to get out of the business of being in business and started the long, mind-numbing, ulcer-inducing process of unwinding the complicated SOE culture … which included, for many people, guaranteed housing, education and healthcare.

Fast forward to the mid-2000s and you begin to see private Chinese companies really moving the market.  Thanks to China’s joining the WTO in the early part of this century, various sectors in the China market were opened to foreign investment, particularly retail and distribution/logistics.  This led to further (and more rapid) modernization of China’s business environment and it looked as if the SOEs were going to go the way of the dinosaur, only to be studied by business anthropologists who dug up their jerry-rigged balance sheets and padded expense accounts.

But don’t count the SOEs down for good … we see that there might be life in these old war horses yet, in part because the Chinese government and the Party (one in the same thing here) sees some advantages to keeping their fingers in the business world, particularly in areas that have remained the jurisdiction of the government such as automotive, oil & gas, media, etc.  Not to over-simplify things but these SOEs have two unique competitive advantages over their foreign competitors: first, the SOEs are not held to strict growth and profitability metrics and are encouraged by the State to get as big as possible, regardless of margin targets; and second, the government makes available an almost unlimited stock of growth capital through forced lending from the State-controlled banks.  Imagine if you, as a business executive, were told by your shareholders, “OK … here is the deal – we want you to grow this company.  Don’t worry about profits, just bring in the revenue … we have ways of dealing with the P&L.  And when you need money, just ask.  We’ve got plenty.”  Sounds like a dream scenario, right?

Well, it seems to be working and we are seeing a surge in some of these SOEs – in automotive, the so-called “Big Four” (First Auto Works, Shanghai Automotive, Dongfeng and Changan) are on a consolidation tear, encouraged by the government to acquire smaller, regional automotive companies, much like GM, Chrysler and Ford did in the early days of the U.S. auto industry.  The Chinese oil, gas and mining giants are actively looking outside of China for investment and, though they have been rebuffed by some foreign governments, are slowing expanding their global footprint.  Several of the larger SOE construction equipment companies are aggressively expanding, both inside and outside of China (as a side note, some say that this is why Carlyle’s acquisition attempt of construction giant XCMG did not go through last year … that the government wanted to maintain control in what they saw as a very strategic industry).  All of these SOEs – and many more besides – benefit from very easy capital lending requirements from State-run banks.

A recent article in the New York Times highlighted the pressures that Chinese banks are under to insure that they keep their lending capital accounts well-stocked and rumors are flying around China that the government is requiring China banks to raise their capital adequacy ratios.  Some might see this as a slowing down of lending.  However, I interpret it as just the opposite: the government wants the Chinese banks to keep good reserves of dry powder to be able to lend to those, predominantly, SOE companies that need growth capital.  It’s a “go slow to go fast” strategy if there ever was one.

All of this has led to private chats over dinners and drinks all over China that the government is trying to reverse their dictum of the 80s and say, rather, 国进民退 (guo3 jin4 min2 tui4): “SOEs will advance and POEs will retreat.”  While I seriously doubt we will ever see this in an official government document, the government’s practices are certainly encouraging this.  The SOEs are no longer run by Party hacks … their CEOs are often Western-business educated and understand very well both international commerce and the unique requirements of doing business in China.  They are dressed in Armani suits, have their hair styled and show up at the right parties, all the while maintaining their status in the Party-with-a-capital-P!

Just this past year, we’ve been involved in more competitive intelligence programs with our clients, helping them understand the ever-changing landscape around them.   It used to be that they were just interested in understanding their foreign competitors; however, more and more we see Chinese companies – and particularly SOEs – coming to the forefront of our clients’ concerns.  And given the competitive advantages these SOEs bring with them, everyone is very smart to be concerned about them.

So the question you need to answer is this – do you know your SOE competition?  Do you know who is backing them?  Who is running them?  Do you know what their growth strategies are and what their plans are to grow in the market?  Do you know what they think of you?!?  I can almost guarantee that they are no longer the lazy competitors you once knew.  You better understand them because they are a big threat, whether you know it or not.

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We are in the middle of a discussion with Bill Powell, senior writer for Time and Fortune magazines.  In the first part, we talked about China and the rest of the world, how we try to make comparisons to what is happening in China with what we have seen in the past.  In this Podcast, I wanted to start off by getting Bill’s take on the challenges of covering China.  I prefaced my question by saying that, in our consulting practice at Technomic Asia, we are very careful not to talk about “THE” China market … there are, in fact, MANY China “markets” taking into account big cities, small cities, northern cultures, southern cultures, urban and rural, etc.  I asked him to talk about the practicalities over covering such a vast subject and the challenges he finds in trying to do so …

An article in CNN Money a couple of days ago was headlined “Mexico overtakes China as the number one location for manufacturing goods destined for the American market.” A survey was done among U.S. manufacturers who said that, on average, fully landed manufacturing costs on products manufactured in Mexico were cheaper than those from China.  OK … interesting so far as it goes.  But that is also like saying: “News Flash: Mexico is Geographically Closer to the U.S. than is China!!”

Maybe I am being unfairly smarmy, but smarmy is sometimes the only club I have in my bag.  However, there is a potential flaw here in that, in the interest of coming up with the Index That Explains All, we are missing a TON of subtlety.  And trust me, I do the same thing … it is very human to want to find a Unified Theory.  Oh … and I am usually not very subtle.

But I think there are a couple of things we should be thinking of here …

First of all, a single manufacturing index is potentially misleading because there is not a single manufacturing environment in the world.  Sure, saying that “in general” Mexico is cheaper than China is OK, but you start breaking this down by manufacturing sector and you’d start to see a lot of differences.  The article says that Mexico makes a lot of sense for things like automotive components being shipped to the U.S. … well, auto manufacturing in the U.S. just got the rug pulled out from under them and they DRASTICALLY cut all sourcing.  And it would make sense that the first cut sourcing from China because, for landed cost to the U.S., it is not as competitive.  Look at individual sectors: alternative energy; wafer fabrication; food and beverage.  We might find the same thing but we might not.

Secondly, the business press tends to gloss over a key point of international business by focusing on EITHER cost savings OR growth, but never in combination.  The simple fact remains that, while China might be getting more expensive on a bill of material line-item basis, the pull of its growing markets is enough for companies to ignore one-sided thinking about costs and, instead, consider their entire businesses.  If I am an auto parts manufacturer and am thinking about the sales from a factory, I am going to look at my global sales opportunities … and if I am located in China where the auto market is still growing at double digits, I might be willing to trade a few points of manufacturing cost over a plant in Mexico where the markets in their sphere are receding faster than my hairline.  As we’ve said before in these pages, cost cutting will only get you to business heaven … all companies need to find a way to GROW!  And China is leading on the growth index in almost every sector, far greater than anything in North America.  I’d rather see an index on manufacturing costs to products shipped to China … this is where the growth is and where our eyes should be also.

Third, I don’t think we should be looking at this as a competition, a horse-race between nations where we identify winners and runners-up.  Some very grave errors have been made over the last 30 years by companies swinging on the Manufacturing Pendulum — first we move everything to Taiwan (and close down the U.S.), then we move it to China (and close down Taiwan) and finally back to Mexico (where we close down everything else and start all over again).  A mature global business thinks in terms of “and”, not “or”.  We should ALWAYS be thinking “China and Mexico” (and Poland and Russia and Brazil and…).

Fourth, I am very hesitant to base any view of global business on a survey done this year.  We are in the Twilight Zone in terms of our understanding of the puts and takes of the global economy … the floor has dropped out and we are suspended in mid-air, Wiley Coyote-like with an “Acme” anvil in our hands an a panicked look on our face.  Any survey of ANYTHING this year should have a big ‘ol asterisk on it making a disclaimer that the results may not have any relationship to a future reality.  Based on points 1-3 noted above, I think we are going to be seeing a lot of changes in these numbers in the very near future.

In no way do I want to minimize the findings here … it is very true that manufacturing costs have been on the rise in China for a number of years.  It is a fact of life.  But as those costs have risen, the world in and around China has changed drastically and companies should not only look at raw manufacturing costs to plan their global strategies.  First ask the question “How can we grow?” and then (and only then) decide where to put your operations.

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Unless you have been living in a hole or the dark side of the moon for the past year, your life has somehow been impacted by the global economic slowdown.  You, a friend or a family member have lost a job; your municipal budgets are being cut; heck, your OWN budget is being slashed.  It has not been a fun year, even here in China where things are still moving along at a pretty good clip.

Though there are signs that things are getting better, I am not convinced we are totally out of the woods yet.  But just because we have no guarantee of where things might be going, that doesn’t mean we can crawl back into our hole or retreat to the backside of the moon … no, we need to keep moving forward.

And at Technomic Asia, that is exactly what we are doing.  For many years, our consulting practice has been involved with foreign companies doing all kinds of alliances in China: from joint ventures to licensing to distribution to acquisitions, we have helped our clients put their alliance strategy together and then execute it.  Up until about a year ago, we had been seeing a real upturn in acquisitions in China: the government rules for acquiring companies were loosening up and foreign companies were looking to China for new growth opportunities.  Then the bottom fell out of the economy and companies put all that activity on hold.

However, as things settle around the globe, multinational companies are looking for ways to grow and China seems a very good place to look for that growth.  And one of the methods they are returning to is growth through acquisition.

To capture this wave, we have brought in a new team member to Technomic Asia: Dr. Kim Woodard.  Kim has had over 30 years of experience in China, first coming here in the 70s in the earliest stages of China’s opening to the West following Nixon’s “Ping Pong Diplomacy”.  Armed with a Ph.D. from Stanford, Kim was soon a respected leader of foreign companies’ earliest advances into China.  Kim helped establish A.T. Kearney’s China practice and then went on to help big names such as John Deere and AMP establish their China operations.

Most recently, Kim had his own firm, Javelin Investments, to assist Western multinationals with acquisitions in China.  We wanted to bring Kim in to Technomic Asia to give us the ability to provide a complete M&A advisory practice – from initial strategy development all the way through to negotiation, closing and integration.

Given the returning importance of M&A in China, I wanted to have a series of conversations with Kim about M&A and, in his experience, what makes for a successful acquisition in China.  Attached is the first in a series that we will roll out in the coming weeks.  I hope you enjoy it!

No More Vacations For Me

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Sheesh … can’t a guy get away for holiday without the world falling apart??  I go for 10 days of sun, sand and minimal Internet and come back to find the world upside down.  AIG needs more money (to fund bonuses? foreign banks? Liddy’s baseball card collection?) and President Obama is firing CEOs (not that many others have wanted to do the same in the past but lacked the political will and cajones).  China dope-slapping Coke in its attempted acquisition of Huiyuan is counter-slapped by Australia for Minmetals attempted investment in OZ Minerals.  An apt description from Dr. Venkman in Ghostbusters: “Cats and dogs living together!  Real wrath-of-God stuff!!”

Not that the situation would be any different if I would have been on the frontlines last week, bravely Podcasting and blogging about the world from my 5th floor Shanghai office … but I do have a bit of a Rip VanWinkle feeling about it all.  To have so much happen in the space of just over a week makes my head spin (causing the too-small brain inside my rather large cranial capacity sound like some Cinco de Mayo maraca jam session).

The suddenness of all this – and too much free time on a beach – has led me to think of three deep thoughts:

Deep Thought Number One: the age of dominance of the western multinational company (MNC) is over. Actually, I think this dominance has been over for some time but we’ve been so busy kicking the body and yelling “Look!  Its moving!” that we’ve not realized its dead.  Certainly this is true in manufacturing … that happened some time ago when we started worshiping at the alter of the god Wal-Mart to receive the deity’s blessings that came from cheap products manufactured in low-cost countries.  I am not saying we would/could/should have done anything differently, but we are where we are.

So maybe the proper way to say this is that we Westerners need to lose the illusion that we are in total control of the world.  We are not.  And the last stand where at least Americans could claim dominance – the financial sector – has completely lost its mojo (and most of its money).  The title “Bank Manager” has become the new oxymoron replacing “student-athlete” and “country-music”.

Practically speaking, this means that Western companies will now be the seller as often (or even MORE often) than they are the buyer.  For every Coke-Huiyuan situation we will find Chinese companies buying medical companies (ala Mindray), mining rights (ala Minmetals) or car companies (ala a billion rumors in the market about various GM divisions being schlepped to the Chinese ).  Certainly, there are massive financial and cultural hurdles to overcome for Chinese companies and institutions to become major buyers, but there is definitely the motivation here and there are certainly enough Western assets – distressed and otherwise – for them to pursue.

Deep Thought Number Two: China WILL become a stronger global player in several sectors. This is a natural result of the first … if there is a leadership vacuum created by the decline of Western firms, someone will step into their place.  And the Chinese seem to be the most likely to come off the bench and make the winning basket.  I see three sectors to keep our eyes on – two are no-brainers and one might be a long-shot.

The first sector where China will begin to gain global leadership is, obviously, automotive.  Already the second-largest auto market in the world, China is also the leading supplier of auto parts and components to the world.  China will begin to leverage this supply chain dominance into actually creating cars to sell into other markets.  It is already happening in southeast Asia where a number of Chinese suppliers are exporting cars.  And Chery attempted a distribution agreement for small cars with Chrysler in the U.S. before the U.S. auto world turned upside down.  Finally, China has declared that they WILL be the global leaders in electric cars and technology – in the next three years.  That is very aggressive but it seems the entire economic and political system is focused on doing this.  Look for the leading China auto companies – SAIC, FAW, Dongfang, Changan, Chery and the cheeky BYD – to flex their muscles internationally.

The second sector is medical device.  Again, China is a leading player in the supply chain of components to the global medical industry but strict regulatory requirements have kept them largely from being very strong in Western medical markets.  The Mindray acquisition of Datascope last year was their attempt to change that – Mindray is the biggest Chinese medical device company, competing against the big boys of GE, Philips, Toshiba and Siemens.  Their acquisition of Datascope, a mid-sized U.S. player in the patient monitoring device sector, was Mindray’s first entry point into the U.S. market.  Look for them and others to follow. But look particularly at China becoming an even stronger growth market for medical companies of all kinds.  China will be investing a big chunk of their economic stimulus package in their medical sector in an attempt to rapidly upgrade the penetration and quality level of medical care for their 1.3 billion population.  As they do this, there is going to be a lot of money out there to purchase medical devices, pharmaceuticals, lab equipment and even healthcare management solutions.  Any medical company of any size should be looking at China as their key growth market in the mid-term.

The third sector to keep your eyes on – and I know I am out on a limb here – is the financial sector.  What?, you say.  A centrally-controlled, socialist system with a partially convertible currency is going to become a leader in global finance??  Yes, that is exactly what I am saying.  I am not saying “tomorrow” or even “in the next 20 years”, but all you have to do is follow the money and the motivation.  China certainly has the money – both in cash and U.S. T-bills – and their motivation is repeatedly being articulated – the latest has China’s leadership saying that they hope to build Shanghai into a major financial sector by 2020 and that “the Chinese Yuan will become a new world-favored currency by then”.  Gutsy?  Sure.  Possible?  Maybe.  But are they going to work on it?  You can bet on it!

This all leads us to my Third Deep Thought:  When it comes to the future, we don’t know JACK!! I know … as the proprietor of a leading market strategy consulting company in China whose very JOB it is to predict market futures for our clients, it is counter productive to admit this.  But c’mon … consider the situation.  If, 18 months ago, you would have told anyone with half a brain and a cable TV subscription that Lehman Brothers, Bear Sterns and AIG would be toast at the start of 2009, we would have assumed you had only a quarter of a brain.  Two years ago – even in the midst of big changes already happening in the automotive market – if you would have said that the U.S. Big Three would be on the edge of global collapse and that BYD (hitherto known as a battery maker) would make the biggest splash at the Detroit Auto Show, we would have taken away the last 25% and made you ride the little bus.

The truth of the matter is that we – meaning pundits, consultants, politicians, TV news anchors, banking regulators (if there are any left) – have NO idea what is going to happen next.  Sure, we know that “down” is still the trend and that “flat” is the new “growth”, but the details of which movers and shakers will actually be the ones shaking and moving is a complete mystery.  So let’s give up trying to predict where things are going and start act like they are going to go somewhere.

This means that we – and by “we” I mean “we Westerners” – get it through our neatly coiffed (but thick) skulls that we are not going to be returning to “normal”.  This economic crisis is not just a speed bump on the journey that we’ve been on since the dawn of the industrial age … it is a fork in the road with a car-swallowing pothole in it, at the bottom of which is a pack of very hungry lions who have been subsisting only on lettuce and Fruit Roll-ups.  OK … that metaphor needs a bit more work, but the bottom line is that EVERYTHING has changed!  The products, pricing, distribution, supply chain, competitors and even regulatory environments of your business are changing radically.  New players – many of them Chinese – are not just playing in the shallow end of the business pool; they are swimming in the deep end and, frankly, many of them look pretty good.

What has not changed is the advice for Western companies regarding China – we have been saying this for a LONG time and, in fact, we can maybe put a sharper point on that advice which is: your company’s future WILL be involved somehow with China so find out what it is now and start working on it.  In the midst of the global economic meltdown, China is still one of the best places for pure growth in most sectors.  You are probably not going to find growth in your home markets in the U.S. or Europe so why keep banging your head against that wall?  Net-net: if China is not at the top of your list of “Ways to save your corporate ass and position yourself for the future”, then you are missing the boat.  That is a fact that I feel 100% confident in predicting.

I just heard from a friend of mine that I worked with back in the ‘good old days’ of the late 80s, teaching in China.  Roger was (and still is) one of these rare people who combines an upbeat, optimistic personality with an IQ in the mid triple digits (we all know the opposite type: Mensa members with sandpaper personalities bookended by happy-snappy people who couldn’t think their way out of a paper bag).  Roger is a scientist – he is, in fact, Dr. Roger – and approaches life as only a scientist can.  In China in the 80s, EVERYTHING seemed to be falling apart, stopping up or breaking.  Roger was the only one in captivity who had a set of tools and knew how to use them – and he actually LOVED doing it!  I don’t know how to plug in a hammer so I am pretty worthless in such situations … but Roger could (and did) fix everything.

I give this background because today’s topic is “Engineering in China” and it was prompted by an email I received from Roger this morning.  He sent me a link to an article that says that China is now the global leader in indexed engineering publications – in other words, more words about engineering are coming out of China than anywhere else in the world.  I sent Roger a note back on the topic and, not seeing any shame in being lazy and re-purposing content, I thought I would riff on it a bit more here.

It would make sense, with all the manufacturing in China and the number of schools graduating HUGE numbers of engineering students here, that the total volume of engineering publications coming out of China would be quite large.  Heck, China is the number one exporter of engineered products … why shouldn’t it also be the leader in exports of articles about engineering?  However, as we often see in China, “volume” does not connote “quality” and that would be my primary concern in this case – just because there are a lot of engineering articles coming out of China does not mean that China is a leader in engineering best practices.

I think we have talked before in these pages about some of the challenges in engineering in China, particularly the differences we see between engineering education in the West and here in China.  In the West, students are trained in “engineer-to-solution” methods where they are taught how to provide a total solution using various principles of engineering.  Sketch a challenge out on the back of a napkin and a Western engineering student should, theoretically, be able to give you several ways of solving it (it seems like U.S. engineering students are always participating in some invention competition or another).

In China, the training is more “engineer-to-print” where students are taught how to “read” a problem (a blueprint, data output, etc.) and then solve that particular problem.  Foreign friends and clients here who run engineering departments are constantly challenged by their local staff who want to be given a problem to which they can apply their standard toolbox of formulas to come out with the “right answer” (I still remember our English students bringing us the TOEFL test and wanting to know which of the two choices was “right” … when actually, BOTH of them were “right”, given the situation!  Very frustrating for them as well, I’m sure!).  They have to work very hard to get their local staff to stop applying solutions until they fully understand what the problem is.

A British friend of mine runs an engineering department at one of the biggest Chinese car makers.  He said that the greatest frustration he has is working with local engineers who understand engineering theory…but don’t drive!!  He told me of a time that they were designing a car seat that kept rattling once the vehicle reached a certain speed.  The engineers said, “That’s OK, my bicycle seat rattles too when I go fast!”  My friend could NOT seem to get them to understand that this was a TOTALLY different situation that required a different solution!!

Roger embodies the Western approach to problem solving.  The small teachers college where we worked had a flat roof over the dining hall and, after heavy rains, the pipes would clog up and would not be able to drain the water, leaving a VERY heavy and dangerous weight over our heads (it did not promote good digestion, to have the Wading Pool of Damocles suspended above you over dinner!).  The engineers at the school did their best to unplug the drains, but it just didn’t work – so they threw up their hands and said, 没有办法 (mei you ban fa “nothing we can do about it”).  Roger, being Roger, did not agree with this assessment, nor did he agree with the basic problem.  The issue, said Roger, was NOT that the drains did not work … the issue was that the water was still there!  Just because the drains didn’t work did NOT mean that you could not get rid of the water.  After another nerve-wracking dinner one evening, Roger went down to the local store and purchased a long section of rubber tubing.  He then went up to the roof, put one end of the hose in the water and tossed the other end over the side of the building.  Using some magical principle of physics that I think he called “gravity”, he started the flow of water out of the hose and, after some time, the roof was completely drained.  The school’s engineers were VERY impressed and proceeded to go buy more sets of tubing to deal with other buildings on campus (I think the local store ran out of supplies and purchased a truckload of tubing the next week, wrongly thinking there was a bull run on the rubber tubing market … and that stuff is probably still there, 20 years later!).

By NO means do I intend to belittle Chinese engineers … the market is making quantum leaps every day and, to be honest, the quality of “engineering to print” can be phenomenal and much better than the West (the copy-market benefits from this!).  But there is still some way to go, as the editor of the Chinese Journal of Construction Machinery is quoted as saying about the engineering articles coming out of China, “… their quality is still an issue. Many of China’s EI papers are less than satisfactory.”  That’s OK … give it some time and there will be millions of engineers embodying the Spirit of Roger solving more problems than you can shake a rubber hose at!

Mary Teagarden, Ph.D., is professor of global strategy at Thunderbird School of Global Management and editor of Thunderbird International Business Review. In her October “China Insider” column, she writes about China as the “workshop of the world“:

The concept of global supply chain nodes becomes important when setting up plants in this new workshop of the world. Blue jeans companies, for example, might choose to produce denim in China but manufacture the apparel elsewhere.

Retailers also can form partnerships with local manufacturers to gain an edge in China. Haier, one of China’s largest appliance manufacturers, introduced its products to the United States through Wal-Mart. Today, Wal-Mart imports account for more than 1 percent of China’s gross domestic product.

Despite the potential cost savings, manufacturers must pay close attention to supply chain control if they want to thrive in China. This means manufacturers must buy from reliable vendors and monitor processes closely.

In her previous column, Teagarden wrote about China as a market base. Next month, she’ll discuss China as a research base. You can follow her “China Insider” series of columns here.

Technomic Asia’s Steve Ganster earned his MBA from Thunderbird and has participated in various China seminars at the school over the years.

Technomic Asia’s Kent Kedl, host of the China Business Podcast, is featured in an article on Chinese product safety in “Insight,” the magazine of the American Chamber of Commerce in Shanghai.

To read the full article, hit the PDF link at the end of this summary. Here’s a quick overview, borrowed from AmCham Shanghai’s site:

The August 2007 Mattel recall was arguably the most damaging for China this year. Mattel shook already weak consumer confidence in Chinese product quality and safety when they recalled 1.5 million Chinese-manufactured Fisher Price toys.

Despite Mattel’s apology that design flaws and poor specifications were largely to blame, confidence in Chinese product quality remains low. More recently, Australian-sold Bindeez beads (Aqua Dots in the U.S.) were recalled after being found to contain a chemical that metabolized into gamma hydroxybutyrate (GHB), better known as the “date rape” drug, when ingested.

Questions surrounding toy safety are at the forefront of American minds this holiday season, which begs the question: how did we get into such a quality crisis?

Don Lee and Abigail Goldman of the Los Angeles Times wrote yesterday about the steps that will likely be taken to improve the quality and safety of products manufactured in China. Bottom line, they report: Higher quality will result in higher prices.

For years, American consumers have enjoyed falling prices for goods made in China thanks to relentless cost cutting by retailers such as Wal-Mart and Target.

But the spate of product recalls in recent months — Mattel announced another last week — has exposed deep fault lines in Chinese manufacturing. Manufacturers and analysts say some of the quality breakdowns are a result of financially strapped factories substituting materials or taking other shortcuts to cover higher operating costs.

Among the China consultants and other experts quoted is Technomic Asia’s own Kent Kedl. Read the full article from the LA Times.

Time magazine’s Austin Ramzy writes today about the suicide of one of Lee Der Industrial’s co-owners after his company was identified as one of the manufacturers of toys recalled by Mattel. He goes on to write about the impact the greater product-safety issue is having on China’s manufacturing market:

With its export-driven economic growth on the line, the Chinese government has taken aggressive steps to safeguard the reputation of its goods. [...] The measures are “a combination of window dressing and substance,” says Steve Ganster, the managing director of Technomic Asia, a Shanghai-based consultancy.

“The window dressing is important politically, but I think there will be true substance that, like anything in China, will trickle down and have an effect in the bigger market.” But until that effect takes place, the drumbeat of product recalls looks set to continue: on Tuesday, reports emerged that Mattel would announce another toy recall, over lead-based paint traced to a different Chinese manufacturer.

Read the full article on Time’s Web site.