In our last Podcast, I had a conversation with Steve Crandall, Vice President in charge of Implementation Services here at Technomic Asia.  We talked about how important people are to a winning China strategy … how to look for them, recruit them, train them and keep them.  After we were done recording it, I asked Steve if he thought that maybe we were being too “basic” … that this was stuff that people already know.  He said, “People might know this stuff, but its always good to be reminded of it … knowing and doing are two different things.”

Well, it turns out that Steve was right … because since we posted that Podcast, we have had LOTS of comments on how useful the information was and how important it was to revisit the basics.  So to that end, we are going to go “back to the basics” again in terms of thinking about China and building your China strategy.  This is particularly critical during these times in the corporate business planning cycle … the silly season where bold strategies are considered and aggressive plans developed.  And China – given its centrality to most global business plans – is susceptible to such ridiculous hopes, dreams and schemes.  So let’s go “back to the future”, if you will, and think about our China strategies from the beginning.

Click on the links to listen to today’s Podcast …

I am going to start this post out with a warning: in the world of global economic intrigue and gamesmanship, the following ranks rather low on the excitement scale … but on June 22nd, China announced that it would scrap the export tax rebate it gives to China producers of 406 categories of export products.  These products include steel, non-ferrous metals, fertilizers, chemicals, plastics, rubber, and glass.  This was the first adjustment in the export tax rebate since July 2009, when it was increased as part of China’s stimulus program.

Now I know that, for most of you, the phrase “export tax rebate” doesn’t send a thrilling chill down your spine … and if it DOES, then maybe you need to get out more.  But we think that there is something deeper here that is worth exploring just a bit further.

This policy announcement is coming at an interesting time.  The communication between the U.S. and China on the global economy and the RMB valuation has had more passive-aggressive subtext than a Midwestern family Thanksgiving – “PLEASE pass the SALT, DEAR!!” – so one rather hoped that any move by China would be attempt to alleviate some of the stress … as in “Please ADJUST your RMB rate, DEAR!!”.  However, at first blush, there is not a huge material impact to the trade imbalance as the policy change is not expected to make a major dent in exports, since it affects only $11 billion in exports, or about 1% of the total.

However, we think that the importance of this policy change goes beyond any material impact.  We think that China is trying to telegraph some very specific messages to two constituencies: the international community and its own people.

First of all, the Chinese government is signaling to its own domestic manufacturers that it wants them to curb overcapacity, move up the value chain, and turn away from the export-driven model of growth.  In this new policy, the government has focused on the environmental benefits of discouraging the production and export of these 406 products, which are highly energy-intensive and polluting, thereby scoring a point with the Greens, both domestic and international.  Lower production will save energy and reduce greenhouse emissions, in line with China’s stated promise of reducing energy consumption per unit of GDP by 20% from 2005 to 2010.  Again, this move is not going to get China all the way to environmentally friendly heaven, but it’s a step in the right direction.

At the same time, this move is a response to recent global pressures on the RMB and non-tariff trade barriers, trying to get China to be an engine of global recovery, rather than continuing its export-driven model.  Europe and the US are trying to export their way to recovery, so someone’s exports have got to go down.  By partially eliminating the export rebate, in line with RMB revaluation, China can better claim that it’s pulling its weight globally.  Given that this is a partial rollback of the stimulus package, China can also claim that it’s dealing with stimulus-induced preferences for domestic industry, further reducing what some say is over-investment by the Chinese government in their own infrastructure which has led to an over-inflation of China’s GDP growth.  So that’s quieting 4 squawking birds of international conscience with one stone of administrative action … not bad at all.  The tortured metaphor of that last sentence does not give enough Kudos to China for this move … China is definitely starting to understand that, for its policy changes to have impact, symbolism – properly spun – can have more power than substance in the world of international diplomacy.

However, of the two possible audiences for this move – internal and external – we fall on the side of this being a stronger message to its own domestic producers, an encouragement to move up the value-chain and pursue domestic innovation, not just be the manufacturer for the world.  Steel is a good example.  48 of the 406 affected products are made, at least in part, from steel that, until this action, had enjoyed a 9 percent rebate.  Steel exports from China have grown 127% year-on-year, and 266% alone just this past May.  However, along with this growth have been the installation of new steel-making facilities in China … despite a general ban on adding more capacity, Chinese companies found a way to build 40 new steel plants in this past year.  This has resulted in the overproduction of low value-added steel which means that China’s steel industry profits have come almost entirely from the 9% rebate.

But this new ruling makes a fine distinction between the two types of steel products. The rebate on the commodity steel goes away but the higher value-added steel products such as cold-rolled and galvanized steel – which many US buyers are more interested in anyway – still enjoy a 13% export rebate.  So, by getting rid of only the rebates on low-valued added products, the government is sending a signal to the domestic industry: “Start moving up the value chain, and stop building so bloody much capacity.  Move away from the low-cost export model and start innovating.”

After over 20 years of concerted effort on building their economy through exports, China is going to take awhile to turn this ship around.  In other words, China is not going to becoming a domestically-driven (and particularly a consumer-driven) economy any time soon … I don’t even think the next 20 years is going to get them there.  But bit by bit, they are moving that direction … and this recent policy change is one of those bits.  And keep your eyes and ears open for future policy announcements … more and more you are going to see the double purposes behind policy changes as China navigates the dangerous waters between both the internal and external constituencies most impacted by such changes.

OK… I am just going to put it out there: these last 10 years have kind of sucked.  Years from now, we are going to look back on the first decade of the new millennium and only the very strong among us are going to be able to avoid using a variety of four-letter words to describe it.  From the rise of terrorism to the meltdown in the global economy, these have been tough times.

Things didn’t start well, of course, with the futuristic “Y2K” problem. It was, for the most part, just IT consultants crying wolf.  But to so completely lack faith in our own technology so as to doubt its ability to handle a digit change in the thousands column does not speak well of our confidence or our technology.

But, for me, what started things off on the wrong foot was our inability to agree with simply what to call this decade.  The “Aughts”? The “O’s”?  The “Naughts”?  Given the current state of the average American’s bank account, “the Nils” sounds like it’s the most appropriate.  But c’mon, folks … if we can’t even name the stinking decade, how are we supposed to handle the real issues.  Frankly, I am a bit ashamed that we Americans couldn’t come up with the marketing slogan that we could all hold hands around.  We are a country that brought you such ditties as Hooters, Cabbage Patch Kids and the Pet Rock.  And we can’t name a decade?  How embarrassing!

However, contrary to the desperation much of the rest of the world is facing, China had a pretty good decade.  From a GDP of about $2,000 per person when 2000 started, China is projected to be over $6,500 per person heading into 2010.   And unlike other changing economies such as the former Soviet Union, China’s political infrastructure didn’t go through a meltdown in the face of such growth.  Certainly, there were many doomsayers predicting the imminent collapse of China, but so far, these people with their Nostradamus For Dummies guidebooks have been, thankfully, quite wrong.

The Chinese authorities are, certainly, giving themselves a big Attaboy for their performance in this past decade.  Not only has their growth been the best in the world, but they’ve landed some pretty big gigs to show it off including the Olympics and the Shanghai Expo.  Fair enough, let’s give China their due … but let’s also look forward to the next decade and make some guesses ourselves as to what we might expect.

Here at Technomic Asia, we are celebrating our 25^th year in China … that is, if I might say so, pretty impressive for a boutique consulting firm where many of our peer firms have burned out long ago.  However, if you would have asked any one of us when we first started in China in 1985 to predict what China would look like in 2010, there is NO WAY that any of us would have come close to envisioning what I can see out my window right now.  Back then, I had to bring in coffee from Hong Kong and now I have three Starbuck’s stores and seven knock-offs of the same within a 10 minute walk of my office.  So predicting the future in China is not a science; heck, its not even an art.  I would liken it to a pin-the-tail-on-the-donkey game played by at a birthday party of some cargo cult voodoo priestesses.   Yea, its that much of a crapshoot.

But what the heck … its only my job to assess the China market and plan growth strategies for my clients, so I am going to go out on a limb here and introduce 5 themes for 2010 that I think will become even more important as the decade continues.   They are, in no particular order because they ALL are important and impact each other:

1. Growth

2. Distribution

3. Consolidation

4. Mergers & acquisitions

5. The emergence of China as a global power

As a year-end wrap up, I want to introduce each of these themes today and then we will re-visit them throughout 2010 and explore their progress (or lack thereof).  So let’s get to them …

The last decade has seen China grow in importance in companies’ global strategies … from just a blip on their radar screen at the turn of the century, China is now a major – if not THE major – strategic initiative for many companies.  And the reason?  Growth!  And its not just because, in 2009, China was the only market in the world to grow more than 8%.  The rumor perpetuated by politicians and angry journalists that China is ONLY a source of low-cost labor and a way for evil capitalists to export jobs from the U.S. is dead-wrong: China is a source of good-old top-line growth. In the midst of all the management theory bouncing around boardroom walls, it turns out that customers are important.  As a former sales manager of mine once told me, tongue firmly planted in-cheek, “Kent, I’ve done some research and have determined that 100% of our revenue comes from customers.  We better focus on them.”  And you know what?  China can be a great source of new customers for many companies.

We just completed the annual business survey for the American Chamber of Commerce in Shanghai and determined that over 60% of American companies were in China primarily to serve the China market … they were looking for growth!  As U.S. and European companies are emerging from the dark depths of economic depression in the past couple of months, I have increasingly had serious discussions with CEOs about ways to grow in China.  They have all said that they feel they have just scratched the surface of what they could – and should – do in China and they need to do more.

A sub-topic under our “Growth” theme for this year will be companies’ expansion into China’s Tier 2, 3 and 4 cities – its not only important to be in China but you have to expand across markets here as well.  Remember that a Tier 2 city in China can still have nearly 8 million people in it so we are not yet talking about selling into rural areas … this is still urban marketing.  But gone are the days when  company could just set up a sales office in Shanghai, Beijing or Guangzhou and hope to do enough throughout the country.  We see many companies today making significant efforts to expand their China footprints and throughout this year we’ll talk with some of these company leaders to find out what they are doing and how they are doing it.

Closely associated with the “Growth” theme is our second theme, “Distribution” … I guess this is overstating it but if you want to grow, you’ve got to actually get your products to market.  Companies who are already in China need to find a better way to get more products to more markets.   Companies are discovering that China is a VERY large and fragmented market and your route-to-customer in one region will not be the same as in another region.  We’ve said it before in these Podcasts but you will never – repeat, NEVER – find one distributor to represent you all over China.  I don’t care what industry you are in, it ain’t gonna happen.  Sure, your distributor will TELL you that they can do it, but they cannot, at least not as well as you need it done to realize the growth that you need.  You will need to take over that responsibility yourself, to find the right combination of distributors to reach the right markets.

In 2009, we did a lot of work for clients to assess the strength of their own distribution, typically benchmarking their operation against their competitions’ (both local and foreign).  And more often than not, we found huge gaps … geographies not covered, certain sectors totally missed and important customers under-served.  These clients are using 2010 to rebuild their distribution.  Sometimes they need to tear things down and then rebuild them … but more often than not, they just need to identify the gaps and start to fill them.

Not only do we need to address the people part of the distribution equation but we also need to consider the supply chain infrastructure.  From sourcing to manufacturing to transportation to warehousing and, finally, to distribution, foreign companies in China are reassessing how they handle their entire operation.  Growth without a firm distribution and supply chain foundation is impossible so 2010 will be the year when companies will start to get very serious about improving both.

The third theme that I think will be important in 2010 and beyond is “Consolidation”.  As I just said, China is a large and fragmented market and a key contributor to that fragmentation is purely the number of players involved in any particular sector.  For example, China has over 100 automotive OEMs … not just 100 brands but 100 distinct auto manufacturers (a long way from what we used to call the “Big Three” in the U.S. which is now, depending on how you count it, probably more accurately described as the “Big One-and-a-Half”).  In pharmaceuticals, there are over 3,000 manufacturers in China and over 10,000 pharma distributors.  Most of these are what China calls “sub-scale” which is a polite way of saying, in effect, that they are too small to survive very long on their own and really have no opportunity to grow very much.

The Chinese government is strongly supporting consolidation and are, in many cases, selecting key companies (often State-owned) to move to the top of the food chain in this Darwinian, survival-of-the-fittest process.  I did a Podcast recently on the Big Four automotive companies (including First Auto Works, Shanghai Automotive, Dongfeng and Changan) and how they are looking to acquire companies inside and outside of China to bring under their rapidly expanding umbrellas.  Look for some major automotive moves in 2010.  In pharma, the government is forcing the smaller distribution companies to merge with the larger ones, so much so that the rumor on the street is that there will be only one distributor per province in the end.  Personally, I don’t see how this can happen, at least in my lifetime, so while the end state is unknown, it is absolutely certain that consolidation will be the trend.

Foreign companies playing in China will want to play close attention to consolidation trends in their own industrial sectors.  The competitive landscape will change greatly as consolidation takes place … your competitors will be stronger, wealthier and have a larger geographical footprint.  In many cases, consolidation will result in a broader product portfolio, making it more difficult for you to compete with them toe-to-toe.

Our “Consolidation” theme leads us nicely to the fourth trend, “Mergers and Acquisitions”.  Not only will local companies grow through M&A but foreign companies are increasingly looking at growth by acquisition, particularly those who have been in China for awhile.  There are multinational companies who came into China through a joint venture many years ago but who are now, for all intents and purposes, operating as a wholly foreign-owned enterprise (or WOFE).  Once they did the deal, they started growing organically, adding products and distribution territories so that, over time, they have built quite a good presence.

However, they have gone about as far as they can go organically and, to speed up time-to-market and increase depth of market penetration, they are looking at acquisitions.  In the past couple of months, we have done some Podcasts on China M&A and will continue that again in the New Year.

Our fifth and final theme is a bit trickier and I put it under the heading of “China as a growing global power” … however, this requires some unpacking.  Here on the China Business Blog and Podcast, we tend to avoid so-called “macro views” and, instead, dig deep into the specific strategies and tactics that companies are using to succeed in China.  We don’t talk much about the goings-on in Beijing, the ins and outs of political leadership.  Its that not this is NOT important – it is – but such palace intrigue can often be quite far away from the day-to-day issues that company management faces in China and, for most of us anyways, we have very little direct influence on the seats of power.  Besides, our daily experience is in the trench warfare of markets, not hanging out in the rare air of the Zhongnanhai leadership.  And my momma always told me to talk about what you know…

However, I think we are seeing an emerging power and even “attitude” from Beijing that warrants mentioning and awareness.  Basically put, the Beijing leadership has been making more unilateral decisions lately and is doing so quite confidently that the rest of the world will not punish or even censure them all that much.  Just a few days ago it was announced that China executed a British citizen for drug trafficking, despite the VERY loud protests from the West that China should take some time and think about it.  The view from Beijing since the execution is that this is an issue of their “judicial sovereignty” and that the rest of the world should butt-out.  In the many articles I have read on this, the journalist inevitably mentions that Britain is China’s third largest trading partner and hints that British authorities are trying to “keep lines of communication open”.  Which means that, although they will whine a bit, nothing is going to happen to China because of their actions.

I mention this, not to criticize either side for their behavior – and I am sure there is lots of criticism to go around – but rather to highlight that we are moving into some new territory here.  2009 was a heady year for China … the Olympics, the fastest growing economy in the world, huge cash reserves, significant investments in U.S. t-bills all added up to an administration that, frankly, thinks they are pretty bullet-proof.  You can be sure that, increasingly, the Chinese government will be making more unilateral decisions and will be less and less sensitive to the opinions of other international players.  How it plays out is anyone’s guess … but suffice it to say that this will be a factor, starting in 2010.

One word of caution here – just because things are happening in Beijing does not necessarily mean that there will be a direct impact on what you are doing in your local area.   All governments move along their own timelines … and some would say their own dimensions of reality … and these timelines are often best measured using carbon-dating methods, things move so slowly.  So please don’t assume that I am prophesying doom and gloom … this is just another data point you will need to include in the algorithms you use to understand what is happening in China.

So there you have it … my predictions for the future.  Radical and cutting edge?  Probably not, but I am very certain that we will see these themes come into play and interact with each other this coming year.  As for each of you and your companies – include these themes in your strategic planning.  Assume that your competition is moving in these directions and challenge yourself and your China management to be able to articulate, in detail, how you are going to handle all of these, both defensively and offensively.

One of my favorite quotes about the future is from Alan Kay, the American computer scientist, researcher and visionary, who said “The best way to predict the future is to invent it.”  It has been true for the past quarter century I have been in China and will be so for the next 25 years – China is a unique environment where you can, literally, create your own future.  And this is what we at Technomic Asia hope for you in 2010 and beyond which is why we end every Podcast with our motto: “In China, everything is possible but nothing is easy.”  We wish you all a very Happy New Year and we’ll see you next time on the China Business Blog and Podcast.

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.

No question the economy is down in China, but unlike the Unites States, the China economy is above break even. In 2008 China’s economy grew 9%, a whopping number to Americans, however, it is the lowest growth rate to the Chinese in the last 8 years.

As the world economies contract, the whipsaw effect is stinging China, especially in South China. This export mecca of Asia has many companies shutting down, consolidating, and fighting to stay alive.

We all know it is difficult to undertake new programs during an uncertain economic downturn, but for those with the wherewithal and the will, there is opportunity in chaos.

Taking a new look at your sourcing can have the following benefits:

1. Immediate cost reduction
2. Improved sourcing performance in quality, consistency and speed
3. A more robust but leaner organization to ensure longer term stability
4. And stronger and more effective supplier relationships

Let’s keep the COST acronym as a road map to taking action. The landscape for sourcing product is changing dramatically. Here are a few mile markers.

C – Now is the time to assess changes in Countries in Asia for sourcing. There was a brief moment in recent memory when oil costs were at all time high other Asia counties may have looked attractive, now the pendulum has swung back, so considering the right countries to prepare for demand when it returns is critical to reducing costs.

O – The Organization with the right skills in place will be better positioned to control costs. We have seen general discontent with 3PL performance that is leading management teams to explore doing more themselves in China, such as putting in their own warehouse or consolidation center. 

S – Just as you need the right mix of organizational Skills, the same is true for suppliers. The opportunity in the chaos is reassessing your suppliers and whether their suppliers are handling the economic downturn. How will downstream suppliers align is a question that should be answered now, and not in the middle of the future accelerated demand that may seem distant today.

T – There is no time like the present to review Terms of traditional vendor relationships and consider other strategic sourcing arrangements. The time to reduce costs is at hand. It is an opportunity that may lead to both short term cash and long-term relationships that are mutually beneficial.

Listen to more of this discussion with Jim Tompkins CEO of Tompkins Associates and me in this podcast called Asian Sourcing Cost Reduction

He writes:

[T]he most significant part of Supplier Relationship Management (SRM) — the actual Relationship — has either not been fully developed or has been insufficiently nourished in order to thrive. SRM goes to the heart of successful Supply Chain Partnerships, and in China, Guanxi is at the heart of any business, government or personal relationship.

…With suppliers, Guanxi is a general and deep type of understanding between two entities in which both are aware of the other’s needs and always take them into account. It’s an ongoing process and often flows on a more personal level than Westerners would consider a typical business relationship.

Read the full post here.

For more on guanxi, watch this 3:30 video put together by the creators of “On the Frontlines: Doing Business in China,” a DVD series Technomic Asia has helped produce. For more info on that, see here.

He talks about the importance of “MH 101,” referring to the fundamentals of materials handling. Andel quotes Technomic Asia’s Steve Ganster on the state of materials handling in China:

Ganster told me there’s a wide spectrum of warehousing in China, from dirt floors to state of the art. In fact China represents what the U.S. was like at several stages between World War II and up to the 90s.

“They need to take it to the next level of technology with equipment, process and strategy,” he said. “The government will ensure there’s a good 8% GDP growth one way or the other this year. There’s huge investment in infrastructure. The difference is they have the cash in their bank account.”

Read the full article here.

The article looks back at the trouble facing China and the rest of the world during 2008 and analyzes how those challenges might affect 2009. Some suspect China to see a bit of a business exodus, but others disagree.

As for competition from other low-cost Asian contenders, Steve Ganster, senior vice president, Asia, for Tompkins Associates, a Raleigh, N.C., firm that advises mostly U.S.-based Fortune 500 and mid-size companies, has analyzed the costs of sourcing in nearby Vietnam and found that with the exception of savings in the value-added tax regimes, there is no appreciable benefit. India, he says, is hampered by an inferior infrastructure and a multilayered bureaucracy that makes it virtually impossible to develop and implement projects in a timely fashion.

“China is unparalleled in its economic scale and size for both exports and domestic demand,” says Ganster. “None of the countries we’ve looked at will be able to match China’s will and ability” to continue to make offshoring an attractive sourcing option.

Ganster advises companies now in China but mulling a shift in their sourcing plans to first examine ways to optimize their existing distribution networks. He says that might include more effective consolidation practices at origin or streamlined transportation strategies such as shipping direct to customers and bypassing warehouses and distribution centers in the United States.

Read the full article here.

In other news, the December/January issue of Supply & Demand Chain Executive magazine contains an article written by Steve, titled “The China-ready Supply Chain.” Here’s the intro:

For a successful supply chain in which China is a main source of your raw materials or destination for finished goods, you need to operate in a high state of readiness. The combination of stark differences in business systems with the West, long travel distances, and constant and sometimes turbulent change make it imperative that you have a “China-ready supply chain.” This article first describes why your supply chain needs to be “ready” and then discusses the key attributes that indicate a high degree of readiness for doing business well with China and getting excellent performance from your supply chain.

Read the full article here.

Today’s podcast features Steve Ganster, managing director of Technomic Asia. Kent’s not gone — just sharing the spotlight.

Download this podcast
Download audio file (20081215_china_matters_2.mp3)

A full transcript:

I wanted to take a few minutes to lift our thinking out of the chaos and calamitous scenarios bombarding us in the news today to revisit and expand on one of our earlier podcasts by my cohort Kent Kedl on the topic “Why China Matters.”

In that podcast, Kent encouraged us to keep our eye on the ball with respect to China — in terms of what it can contribute to both our top and bottom lines. He also warned us to keep our attention on China’s ability and increasing interest to invest in the West.

As many of you no doubt have heard, there are a range of scenarios being bantered around about a Chinese auto company buying GM. While I think there are many hurdles to this scenario, even its possibility should grab our attention. China will continue to increase its standing in the world economy and thus affect our business, negatively or positively, whether we like it or not. Therefore, it has to remain on our strategic radar.

In this podcast I wanted to give you some perspective on the “talk on the streets” from companies and observers actively playing in China’s market in order to get a read on their views of the opportunities and challenges facing western firms doing business there. I’ll also touch on the tactics and initiatives being considered as a response. These insights are assimilated from a range of sources, including our own Technomic team, our many clients (who comprise both large and small/medium sized firms both sourcing and selling in China), from local Chinese businessmen, as well as from our friends at AmCham-Shanghai.

First let me acknowledge that all is not rosy in China either. Most firms are planning for lower growth (though you will note they do use the term “growth”) and, as you would expect, they see recession in Europe and the U.S. Credit is tight and the market for public offering of equity is very difficult. China’s stock market has also tumbled. Competition is becoming even fiercer with resultant price/margin pressure.

This margin pressure extends throughout the whole supply chain. So local management see as the keys to success a major focus on cash and cutting costs while trying to maintain and even develop their human capital, attempting to keep morale up. They are looking to be more innovative and to excel in their supply chains. We continually hear the buzz words, “get lean,” “best practice” and “China is the best place to be.”

Digging deeper

Let’s probe a couple of these areas a little more deeply and identify some specific measures and initiatives being implemented by those companies taking a more proactive position in these tough times.

Supply chain excellence remains a central theme with a focus on inventory reduction, scrap/waste elimination, capacity rationalization and better/smarter purchasing. As mentioned, credit risk management is a high priority as is the preservation of cash. One thing the Chinese businessman has taught me over the years is that “cash is king,” or emperor as the case may be.

Importantly, and a central point I want to get across, is the continued emphasis on growth. China, despite some slowdown, still offers attractive possibilities to expand the top line, even in this world recession. To achieve this, companies are trying to get smarter in their commercial strategies, selecting high value/high margin projects, targeting higher growth industries and especially import substitution (perhaps a warning here for those of you feeling comfortable with your export channels into China’s marketplace). Additionally, they are maximizing access to global and regional accounts, trying to exert as much account leverage and influence as they can.

The central theme here is proactivity. In these turbulent market conditions, disruptive strategies can be very effective, especially if your competition is distracted by such mundane things as survival.

Let me also address a question that I hear constantly these days: Is manufacturing leaving China? I know how to say the word “no” in about 10 languages, so consider it said. Now, is China’s manufacturing profile changing? Absolutely! We see some attrition where manufacturing is very people intensive, has low margin and is highly polluting. The government seems content to let this type of manufacturing either survive on its own, or migrate to other Asian countries like Vietnam. We are seeing little abatement in manufacturing FDI coming into China.

Look what at China offers manufacturers:

1. A strong and deepening supply chain and infrastructure
2. A major and continually growing domestic market in addition to export potential
3. Large volume scale and its benefits to cost competitiveness
4. An ample workforce that can be trained and empowered
5. Significant latent productivity to be gained by further process improvements
6. A very supportive pro-business government

Talk to Westerners who have dealt with government, employees and unions in Vietnam, India or other developing southeast Asian nations. This may open your eyes to the positive things China offers.

As we have repeated over the past year, China remains a strategic market for a dual-strategy approach: tapping the local market while developing secure and competitive sourcing for both domestic and international markets. And to quell the rumors of China’s impending demise that I see reported in the U.S. media, note the following:

• According to the “2009 Economic Blue Paper” released Dec. 2 by the Chinese Academy of Social Science, a central government think tank, China’s GDP is expected to grow 9.8 percent or so this year and should be able to be maintained at a growth rate of some 9.3 percent in 2009. The minimum GDP growth rate for 2009 as set by the government is 8 percent. Anything lower than this is not acceptable to the government, whose top priority is to maintain social stability. So I can imagine that the Chinese government will do whatever is possible to accomplish this “break-even” growth rate for 2009. The government has both the will and the means to make this happen, and we have seen no hesitation in the past for them to take action.
• If you like mind boggling numbers, note this one: Pledged investment by the central government for 2009/2010 is RMB 4 trillion! My calculator doesn’t have so many decimal places, but I reckon that’s almost $580 billion. Local governments are committing substantial funds, as well, which could significantly increase or even exceed this already massive figure. The central government even earmarked almost $15 billion for investment projects for the 4th quarter of 2008 to pad GDP a bit. As the Summer Olympics this year showed us, China can do things on a mind-boggling scale.
• The EIU forecasts that by 2030 China will have over one billion middle- or upper-class consumers and be second only to the U.S. in economic output.

So, yes, China will have its struggles, but it ain’t going anywhere.

Finally, let me leave you with a few take-aways in terms of actions you might consider with respect to China as you review your 2009 strategy:

• A clear theme among our client base is “smart growth.” This means being aggressive but more pointed in your projects and target markets/customers. To be effective, you must have current and accurate intelligence on your marketplace.
• Manufacturing efficiencies are there to be had. Explore lean strategies and bring your best practices to China. Even if you are working with third-party vendors, in the right buyer-supplier relationship, you can effectively transfer process knowledge to key partners to help them improve their competitiveness.
• Re-think your supply chain from start to finish. The recent dynamics in global markets have changed the landscape of sourcing costs and moving product around. Look at ways to optimize your supply chain and use it as an offensive weapon. You can exploit the strain your supply chain partners are feeling to develop a more efficient process and a more competitive supply structure. You may find, like the Detroit Three, as our auto companies are now called, that they are open to about any conditions in order to get “bailed out” of their present circumstances.
• Lastly, chaos is the breeding ground for disruptive strategies. Look at going forward or backward in your supply chain in order to add value and enhance control. Consider an aggressive acquisition. There are many cost-effective assets to be had in China if you know how to find and cultivate them. A strategic move here could alter the playing field in your market, both in China and internationally. With the lull in market demand and the difficulties in going IPO, you may find that there are more friendly targets out there among Chinese manufacturers than there have been in the last couple of years when many of these same companies were demanding 20-30 times earnings for a piece of the action.

I hope these insights from the front lines have been helpful and that you will consider some of the actions I suggested. It is interesting to note that when the Chinese use the word for crisis (wei ji), it is a joining together of two words: “danger” and “opportunity.” Let’s not forget the second part of this meaning for crisis as we battle this economic environment. Stay tuned for continued updates from our teams at Technomic Asia and Tompkins Associates.

That is, there needs to be something more, such as commitment and communication, for both types of relationships to survive. Stresses, including the current economic downturn, tend to reveal the cracks between supply chain links.

“The market turbulence we are now experiencing is putting significant strain on buyer-supplier relationships,” says Steve Ganster, podcast guest speaker and managing director of Technomic Asia. “Transparency, trust and open communication provide the needed ingredients to work through these difficult times.”

Along with ensuring that strong relationships remain intact, Ganster reminds listeners that their supply chains should be used as offensive weapons to differentiate themselves from the competition. He stresses the importance of strategic thinking when making the “buy” decision.

“As the first component in the supply chain, ‘buying’ is crucial to the other steps. If you get the ‘buy’ phase wrong in your supply chain strategy, then ‘make, move, store, and sell’ are going to be much tougher to execute well,” he says.

“Carefully think through options, work with real-time market intelligence, and consider the longer term. Don’t make decisions based on short-term spikes or overreact to changes,” Ganster adds.

The recent podcast is the second in a series focusing on “buy, make, move store and sell.” “Supply Chains in the Global Economic Downturn,” the first of the new series, explores the economic issues affecting businesses in every nation today. In this first episode, Gene Tyndall outlines what companies need to do to survive and prosper in a challenging climate.

Tompkins Associates features a new podcast on the first and third Tuesday of every month. Visit http://www.tompkinsinc.com/podcast to subscribe via iTunes or any podcast feed reader, or to sign up for email updates

As Jim says:

In fact, I have heard it said that Western companies and Asian companies spell SRM differently. In the West, SRM is spelled capital S, little r and capital M (SrM). For the West, it is all about Supplier Management. To the contrary, in Asia, SRM is spelled little s, capital R and little m (sRm). It is all about relationships.

Read a full transcript and listen to the podcast with Jim and Steve here.

On Sept. 24, Steve was in Wolfsburg, Germany, giving a talk at the Informationstechnologie für die Autoindustrie (Information Technology for the Auto Industry) conference. Steve’s presentation was about “Supply Chain Management in China’s Automotive Market.” Just prior to that conference, Technomic Asia’s released the most recent edition of its China automotive aftermarket research report.

The very next day, Sept. 25, Steve was in Munich, Germany, discussing “Sourcing in China: Trends and Best Practices” at the ROI Annual Best Practices Event. Then, back in the United States, Steve headed to Denver yesterday to give a talk on “Building Supply Chain Partnerships in China” Council of Supply Chain Management Professionals’ Global Conference 2008.

If you’re interested in more information on any of these subjects, or perhaps having Steve speak at an upcoming event, please let us know.

The article explains that ” ‘relationship’ rules in ‘supplier relationship management’ with Asian sources.” From the article:

“Moving too quickly on sourcing decisions in low-cost countries may prove to be a short-term tactic,” notes Steven Ganster, managing director of Technomic Asia and author of The China Ready Company. “Businesses need a long-term strategy that focuses on relationships for effective sourcing in Asia, and the most successful sourcing companies have placed a premium on developing relationships with their suppliers. These relationships are the backbone of SRM,” he says.

Tompkins conducted a survey of companies that averaged nearly 10 years of experience in sourcing in China and more than 6 years of sourcing in all other Asian countries to gain further insights into trends and current practices in international sourcing and supplier relationship management.

Read more here.

The in-depth conference is subtitled “Emerging Trends and Best Next Practices.” It’s designed to help senior supply chain executives gain insights into hot topics, including reverse logistics and global supply chain capacity constraints, and understand how your current performance and operating practices compare to similar enterprises.

Technomic Asia’s Steve Ganster is one of the many presenters at the conference. He’s presenting “Global Sourcing Practices” of “top quartile companies,” helping attendees understand how their operations compare with those of industry leading companies.

For more information, visit the Supply Chain Leadership Forum site.

Tompkins Associates says its podcast series will “educate business executives on the advantages of adopting a global supply chain strategy, and any company that makes, buys, sells, or moves products will want to hear the series.” Here’s more info from the series description:

Your company needs a supply chain operations strategy that is responsive to a global market. The leading experts at Tompkins Associates explore the hot issues associated with global business today, including supplier relationship management, supply chain benchmarking and best practices, the facts versus fiction in globalization, and much more in this podcast series. Tompkins Associates designs and integrates global end-to-end solutions for companies that embrace supply chain excellence. In mp3 format and updated with a new podcast every first and third Tuesday of the month.

The first podcast in the series is called “Stop Debating Globalization: It’s a Reality.” Read the transcript or listen now.

You can check www.tompkinsinc.com/podcast for more or subscribe via the podcast’s RSS feed.

As companies are learning that what works at home won’t necessarily work abroad in the Chinese marketplace, they’re finding new ways to cater specifically to the needs and desires of Chinese people — rather than shoe-horning American products into a distinctly non-American set of tastes.

Watch the full segment, about 6 minutes long, here.

The article, written by Jim Tompkins of Tompkins Associates, Technomic Asia’s parent company, emphasizes the importance of relationship building for effective Supplier Relationship Management. A quick excerpt:

China has become North America’s preferred overseas destination for low-cost sourcing. It seems like the perfect strategy, right? The North American company gets what it needs at lower costs, and the Chinese manufacturer/distributor gets the business it needs. Everyone is happy.

But there are clear signs in the business world that the honeymoon is over. This is because the most significant part of Supplier Relationship Management (SRM)–the actual Relationship–has either not been fully developed or has been insufficiently nourished in order to thrive.

Read the full article here.

From the article’s introduction:

China’s burgeoning automotive market is having a significant and strategic effect on companies’ supply chains. Western parts and material suppliers have little choice but to respond proactively to China’s exploding automotive market or risk not only missing new demand opportunities in China but also opening the door for both international and Chinese companies to come after them in the West.

[...]

In the past few years, first-tier parts makers have turned to their supply base, passing on the pressure to localize to second- and third-tier suppliers. This cycle creates both opportunities and threats at all levels of the supply chain. As a result, many small- to mid-sized firms (SMEs) are now challenged to respond — or else.

Read the full article here.

Technomic Asia’s Kent Kedl reminds readers of the WSJ article of the need to take responsibility for vetting suppliers and sources in China (and elsewhere, of course):

Industry analysts say many U.S. companies save money by sourcing in China but are reluctant to spend on vetting supply chains. “You can’t just throw the [orders] over the Great Wall and hope it comes back good,” says Kent D. Kedl, general manager for Technomic Asia, a consulting firm in Shanghai that advises U.S. and European clients. He says companies “need people camped out” in China.

Another person quoted in the article, Clara Shih, president of Best Buy Produce International, adds: “People in this country don’t really care [about food quality] as long as it’s cheap.”