Inadequacy in China’s intellectual property rights (IPR) protection regime is one of the key challenges faced by foreign firms operating in and considering entry into China’s market. The world’s second-largest economy has a “first to file” system and is notorious for protecting local firms over foreign ones in disputes.
However, recent developments - such as a deal with the Motion Picture Association of America (MPAA), the central government’s creation of a slew of IPR courts, and the emergence of intellectual property (IP) financing techniques - demonstrate China’s intentions to foster the innovation-oriented business environment it sees as leading future economic growth.
The MPAA, the key enforcer of film copyright issues in the US, signed a deal with Shenzhen Xunlei Networking Technologies, a Chinese video hosting website to “prevent unauthorized access” to MPAA member copyrighted works.
The two groups have a history of involvement. In 2008, MPAA sued Xunlei for supposedly providing illegal access to its members’ works. The CNY 7-million suit was later dropped.
This deal comes shortly after Chinese authorities cracked down on Xunlei competitor, QVOD, for copyright issues and after Xunlei applied to go public in the US for the second time. Its initial IPO application in 2011 was revoked due to copyright issues.
This unique deal represents an innovative response to the Chinese authorities’ recent crackdown on instances of copyright infringement. Chinese authorities have identified bolstering IPR protection as a priority issue in 2014. In fact, Chinese Premier Li Keqiang recently stated that, "protecting IPR is protecting innovation."
To provide for greater protection of IPR in China, Beijing is establishing new IPR courts. At a recent press conference, Tao Kaiyuan, Vice President of the Supreme People's Court, announced that China’s highest judicial body is currently reviewing IPR courts abroad. Following this research tour, judicial authorities will embark on the creation of China’s new IPR courts.
Analysts assert that other judicial reforms, from increasing the courts’ capacity to grant preliminary injunctions (a vital tool for the protection of trade secrets from defendants) to awarding larger damage awards and bringing simultaneous actions against infringers, are also helping plaintiffs protect their IP in China.
One reason Beijing is pushing for greater IPR protection is in the hopes of fostering the technological innovation seen propelling other economies with leading IPR protection regimes. The Party’s recent policy toward “indigenous innovation” has become one of the key drivers of the economy.
Beijing also aims to increase the perceived value of IPR through the country’s IP financing initiative. Earlier this year, Shandong-based Quanlin Paper reported to the State Intellectual Property Office that it had secured a $1.3-billion loan against a portfolio of 110 patents and 34 trademarks, most of which are based in China. This is one of the largest sums produced from an IP portfolio and may demonstrate confidence in China’s IPR regime.
China’s leaders have recognized that China’s future economic growth will be driven, not solely by heavy industry or manufacturing, but with private technology companies leading the way.
Beijing seeks to support these Chinese technology companies, which are heavily reliant on IPR protection and who have become increasingly relevant to China’s economic growth.
China is rapidly catching up to international high-tech leaders. Proper IPR protection is a prerequisite for attaining greater growth and not losing future competitiveness in this key area of the economy. Foreign firms will benefit from this development by minimizing the risk of losing their intellectual property to their competitors in this crucial market.
This editorial was produced by The Beijing Axis for Business Day by Kobus Van Der Wath.
In recent weeks, global automakers have announced their intentions to increase their focus on China. For example, General Motors stated that it would invest USD 12 billion from 2014 to 2017, and VW recently announced plans to invest USD 25 billion from 2014 to 2018. These statements are unsurprising when one looks at the progress China’s auto market has made up to now, and the room it still has to grow into.
Since 2000, when 1.8 million automobiles were sold in China, until 2013, when 21.98 million units were sold, sales growth reached a compound annual growth rate of over 20 percent. China’s auto market exceeded 25 percent of the global automobile market by 2013 and is expected to become nearly a third of the world’s total auto sales by 2020 with roughly 34.7 million units. Furthermore, taking into account the fact that China’s projected car ownership rate (number of cars owned per 100 of the driving population) of 16% in 2020 will be well below that of the US at 99%, the potential for automakers is difficult to overestimate.
However, due to the size of the opportunity, competition among foreign and local automakers will continue to be high. Additionally, with some import tariffs as high as 25%, it is easy to see why so many of the foreign automakers are looking to undergo a very aggressive and rapid localization strategy. Without tariffs and with less expensive locally-made parts, Chinese consumers can expect better priced vehicles. In addition, due to the wide variety in tastes throughout China, automakers are looking to expand their portfolio of models. In 2008, there were less than a dozen luxury car models sold in China under five brands, while today, there are ninety models offered by twenty five brands according to research firm TNS.
One segment of the market to look out for is the hybrid vehicle. Because of China’s air pollution crisis and increasing manufacturing capabilities, it may not be long before China represents the world’s largest market for hybrids. The government is planning to have 5 million hybrids on the road by 2020 and has already begun a subsidy program to help achieve this goal. Depending on the city, individuals who purchase hybrids will receive benefits ranging from a USD 19,500 handout and a free license plate (which costs a minimum of USD 1,600 in large cities) to exemption from travel restrictions that owners of petrol-driven cars face.
Toyota is already on schedule to manufacture the entire hybrid version of the Corolla and Levin sedans in China by the end of 2015. Daimler is also looking to dramatically increase sales of its DENZA brand through its joint venture with Chinese partner BYD. Even Tesla, the Silicon Valley manufacturer of electric vehicles, is looking to manufacture them in China within four years. However, while the future may look promising, large capital expenditure on charging infrastructure will have to be made to make owning an electrical car convenient for drivers in China’s cities.
In the meantime, there is little stopping the overall positive growth in demand for petrol-driven cars. Although China’s major cities currently offer the largest demand currently, the competition there is also at its highest. Certain automakers are already seeking to get ahead of this trend and looking to frontier markets where competition is lower but growth prospects are still high. VW and General Motors, the two most successful foreign automakers in China by sales, are such examples. VW opened factories in Chengdu (central China) and Urumqi (northwest China) in 2013 to tap these inland opportunities, while GM has announced that it will also open five plants across inland China and less developed cities in eastern China. Expect other foreign automakers to follow suit.
These developments will no doubt please government officials looking to boost consumption and wean the country off its dependence on exports for growth. Similarly, the larger the role China plays in the global auto market, the more technological expertise will likely emerge and develop in China. In the near future, we might see vehicles that are fully designed in China become global best sellers and play a role towards lowering global greenhouse gas emissions.
Kobus Van der Wath is group MD of The Beijing Axis. He can be reached at email@example.com
Despite continued distortion in trade data evaluation due to the propensity for fraudulent “over-invoicing” in the first half of last year, trade figures surprised analysts by rising in April.
Trade growth focused on the U.S. and EU
Largely as a result of trade with developed markets, both exports and imports increased in April. Exports increased from $170 billion in March to $188 billion in April, a 9-percent year-on-year increase. Imports, on the other hand, experienced 8-percent growth from $162 to $170 billion.
Much of the growth in exports was directed toward developed countries. Exports registered to the United States, for example, jumped 12 percent in April from the previous year, a significant development considering the 11.3-percent decrease year-on-year in February and the 1.2-percent increase in February. An impressive 15.1-percent increase in shipments to the European Union occurred in April, compared to the same period in 2013. Exports to ASEAN, on the other hand, fell to 3.8-percent growth from double-digit growth earlier in the year. Some analysts contend that the lackluster demand in emerging economies suggests that this trade growth does not mean that exports are necessarily en route to recovery.
The simultaneous decrease of CPI and PPI over April is a sign of weak demand for consumption and investment and slowing economic growth. Food prices, a key contributor to the decrease in consumer and producer prices, increased by only 2.3 percent in April, falling under the 4.1-percent increase in March. The price of pork and fresh vegetables, for example, fell by 7.2 percent and 7.9 percent, respectively. Analysts suggest that there is downward pressure on property prices, and that there will be room for policy intervention, such as cutting the reserve-requirement ratio, if real estate prices continue to fall.
Sign of stabilization in future growth
Some analysts suggest that trade figures will continue to increase in May and that this sustained growth will encourage Chinese policymakers to reverse the recent depreciation of the yuan. Over the first four months of 2014, fixed-asset investment growth had fallen to 17.3 percent, which demonstrates a potential for lower future economic growth, despite the encouraging signs from trade data.
In our sourcing projects, TBA has come across repeating infractions of corporate social responsibility (CSR) standards in Asian factories. TBA recently conducted a series of audits at factories in Southern China and Southeast Asia.
- Safety issues
- Do factories post emergency evacuation plans in the correct locations?
- Do factories put warning labels on chemical containers?
- Do factories conduct trainings with relevant employees for the handling of toxic substances?
- Are secondary containers used for chemicals stored in the chemical material warehouse and transfer area?
- Do factories keep the emergency doors unlocked all the time?
- Are smoke detectors located throughout the factory?
- Health and hygiene
- Is there an accident and injury log available for reference?
- Is there emergency equipment, such as first aid kits, available in the factory?
- Does the factory have access to medical services? (It is recommended that the factory sign a medical service contract with the nearest hospital.)
- Working hours
- Do employees exceed the daily (60 hours per week) and weekly (six days per week) limits for working time?
- Child labour, forced and compulsory labour
- In China, it is illegal to employ workers under the age of 16.
- Any form of forced labour, such as forced prison labour, is also forbidden.
- Remuneration and compensation
- Do employees’ wages meet local requirements?
- Labour unions, discrimination and disciplinary practices
- Are employees free to join labour unions and participate in collective bargaining?
- Do the managers engage in any kind of workplace discrimination?
- Photo credit: psit (Flickr)
The Beijing Axis has extensive experience in servicing the procurement needs of multinational companies and established platform and networks in China and Asia. CIPS expertise lies in developing the procurement and supply management profession through specially-designed training, qualifications, products and services. The combined team will have the ability to better serve the mainland China and Hong Kong markets through a focused programme that synthesises global best practices with local delivery.
Established in 1932, CIPS is the dynamic champion driving the global procurement and supply management profession and promotes licensing the profession, which encourages the advancement of best practice in the profession. As the world’s largest institute of its kind, CIPS was awarded a Royal Charter in 1992 and is a not-for-profit body with offices in the UK, Africa, Australia, Middle East and North Africa (MENA), and Singapore, while expanding its presence in China. CIPS clients include China Light & Power (CLP), Caterpillar and American Express.
The Beijing Axis is a leading, China-focused global procurement house that offers a comprehensive range of intelligent global sourcing solutions across the supply chain that balances total cost, delivery time and quality, while minimising risk. With more than 11 years of delivering procurement solutions for international companies, TBA’s clients include global mining, energy, manufacturing, construction, engineering, technology, insurance, FMCG, and retail companies.
CIPS has worked in the region for over 10 years with its education partner, China Communications and Transportation Association (CCTA), and has recently signed a new contract for five years, delivering its own qualifications in English and Mandarin. CIPS has also developed two degree programmes in conjunction with the National Education Examinations Authority (NEAA) and CCTA which are available entirely in Mandarin across China.
David Noble, Group CEO, CIPS, said of the partnership: “China and Hong Kong play a significant role in the development of the global economy, and China is a prominent power in the East.”
“We have already developed strong relationships with CIPS members in the region and with the education authority but would like to do more. This partnership will cement the goodwill and activity already undertaken by CIPS and strengthen procurement and supply management throughout the business community.”
“The partnership with CIPS comes at an opportune time when training and certification in the procurement and supply sector is gaining ground in mainland China and Hong Kong,” explains Kobus van der Wath, Founder and Group Managing Director of The Beijing Axis. “CIPS high-level training and certification offerings complement our comprehensive and practical global procurement and supply chain outsourced services.”
TBA will initially offer CIPS corporate award and certification targeting businesses and public sector organisations, and will be present at a number of events in the next few months. David Noble will be visiting China in July 2014 to formally launch the partnership and jointly meet branch members, partners and industry players with The Beijing Axis.
For more information, please visit the CIPS China website.
The Chartered Institute of Purchasing & Supply (CIPS) is the world’s largest procurement and supply professional organisation. It is the worldwide centre of excellence on purchasing and supply management issues. CIPS has a global community of over 106,000 in 150 different countries, including senior business people, high-ranking civil servants and leading academics. The activities of purchasing and supply chain professionals have a major impact on the profitability and efficiency of all types of organisation and CIPS offers corporate solutions packages to improve business profitability.
About The Beijing Axis
The Beijing Axis (TBA) is an international advisory and procurement firm. Combining extensive experience and comprehensive capabilities, we collaborate with clients across their value chain through strategy and management consulting, outsourced procurement services, commodity trading, and capital advisory to raise their performance and profitability. With more than eleven years of delivering international advisory and procurement solutions, we have offices in Beijing, Singapore, Perth and Johannesburg, with Mumbai and Latin America currently being rolled out.
For more information, please contact:
Barbie H. Co
- Feeding a Billion: China’s Transforming Agricultural Sector
- Chinese Mining Firms in the Year of the Horse: a Trot, a Canter or a Gallop?
- Chinese Super Majors: Tilting the Global Oil and Gas Playing Field
The world that witnessed a decade of impressive growth is now a distant memory. The global financial crisis intervened and put a halt to it. Demand in developed markets plummeted before levelling out and the knock-on effects have been felt around the world. China, along with a few other countries, temporarily bucked the trend but most are seeing relatively slower growth and it seems as if this pace is set to remain in place for the foreseeable future.
Unfortunately, not only are growth prospects bleak, but for numerous countries and sectors, costs are rising faster than revenues. This is not only the case for some developed economies, such as Australia, where labour costs have grown at twice the pace of other OECD countries over the past decade, but also that of a number of so-called low cost countries (LCCs).
Of the numerous ways to counter the effects of slowing revenues and rising costs, companies are attempting to increase their productivity and efficiency as well as run cost-cutting initiatives. By targeting one’s cost base, companies are searching for innovative ways to deliver the same products and services as before from a more cost-effective position.
A changing competitive landscape
Globalisation has created opportunities for companies to exploit cost arbitrage between geographies, with the so-called LCC phenomenon enabling constant shifts of foreign direct investment flows in manufacturing and export activities from developed to developing countries that possess a more favourable manufacturing cost profile. None is this more evident than in China, the world’s largest exporter and a preferred sourcing destination for procurement managers across the globe.
However, China’s rising factors of production is leading companies to identify alternative sources of supply, especially in the case of some apparel and other low-value products, where the location of factories has partially moved from China to Thailand, Indonesia, Vietnam, Bangladesh and Myanmar. There has been literature published that deals exclusively with which countries will be able to, and are challenging, China’s dominance as the world’s factory. In George Friedman’s work “The CP16: Identifying China’s Successors”, he explains how several countries are already manufacturing certain categories (typically low-value and labour-intensive) more competitively than China.
This has raised some pertinent questions: Will China’s higher cost profile threaten its competitive position as a low-cost sourcing destination? Is it time for global manufacturing to go somewhere else?
Assessing China’s competitiveness
As reflected in the chart above, China is moving away from its position as simply a LCC into a sourcing destination which enjoys the same world-class infrastructure facilities, access to highly skilled labour force and technological innovation capabilities as the most advanced economies in the world. While labour costs are definitely lower in many other destinations, a wider set of factors must be considered when choosing an alternative location. Ease of doing business, availability of raw materials, reliability of supply, good quality products and scale are some of the competitive advantages China still enjoys that ‘cheaper’ alternatives do not. Companies considering alternative sources of supply may face infrastructure challenges, shortages of skills or political instability. China will continue to hold certain key advantages – robust infrastructure, advanced technology/R&D and a skilled labour force – compared to its manufacturing competitors. While China is becoming a more expensive sourcing destination, it is also more comprehensive, flexible, and more reliable than many of its counterparts. The quality/cost ratio is also rising for many manufacturers. In the meantime, smaller supply bases in LCCs may eat a part of the cake (e.g. countries specialising in one single product).
A second factor to consider when assessing China’s overall competitiveness is the attractiveness of inland China. While average wages have almost doubled in China since 2007, those in central and western China are still comparable to other LCCs. Land costs show a similar picture. Hewlett-Packard for instance, recently set up factories in central and western China due to its costs advantages for exporting to Europe on express freight trains via the ancient Silk Road. They can now deliver goods to Western Europe in around three weeks (slower but cheaper than ship and air) which will also lower inventory costs and lead times. Many other companies have followed. The Chinese government is currently upgrading existing infrastructure networks to counterbalance increased inbound logistics costs. It has also announced the creation of a fourth economic hub (as it did in coastal China in the 1980s) in central China to foster further investment in manufacturing. If this initiative proves successful, China will simply become its own alternative to low cost manufacturing, or at least part of it. This advantage will not last forever but provide a solid enough case for many to make the move inland and compete.
Thirdly, as China’s labour costs have increased over the last decade, so has its investment in R&D. Today, more than half of the world’s Fortune 500 companies are operating factories and R&D centres in China and many aspire their China operations to become new global centres of excellence. High-tech zones with IP-designated courts in cities such as Chengdu are creating an investment environment suitable for more technologically-advanced manufacturing.
Therefore, while China might be losing a competitive edge in labour-intensive products, it is gaining new competitive advantages in high value-added products. This has huge implications for companies looking to outsource not only the manufacturing process, but also the engineering and design elements of a product or project.
China’s competitive edge is not coming to an end, it is just transforming. China’s higher cost profile is accelerating the pace of a transformation characterised by greater levels of value added and innovation. China has taken a new direction towards quality rather than quantity at the cheap, margins rather than volumes, and productivity rather than low labour costs.
Implications for global supply chains
How companies react to this changing competitive environment is of critical importance. While this is not an easy task, there are some aspects supply chain executives must consider when facing these
challenges, such as:
- Fine-tune China procurement. For most procurement managers, China will remain central to their strategies for reasons such as scale, variety and reliability among others. However, its transformation requires a re-thinking of current category strategies. What capacity is moving out and what capabilities are being built? How are our existing suppliers adapting? In China, there are increasingly sophisticated production capabilities across mature product categories; a move towards the manufacturing of very complex components with solid in-house product design; and an emerging set of engineering capabilities serving international markets among other trends. Partnering or establishing strategic long-term relationships with large-scale, service-oriented and design-capable Chinese suppliers are some of the initiatives foreign companies are taking in order to take advantage of the increase in Chinese companies’ capabilities. However, Chinese companies still have certain gaps in skills and capabilities, but what is important is how to bridge those gaps, manage the risks and play the game well.
- Follow a portfolio approach. Most strategic and prudent sourcing executives are adopting a portfolio approach. This does not imply moving away from China but rather building capabilities in emerging sourcing destinations that can complement an existing Chinese supplier base. China dominates in most but not all categories. Understanding the manufacturing competitiveness and associated risks of low cost countries on a relative basis becomes essential. Specific factors such as poor infrastructure, social non-compliance or political risks may negate an otherwise appropriate portfolio. Sourcing executives are strategically matching countries with the categories and even sub categories that they are competitive in. While the right mix can increase a supply chain’s complexity, it can also lower its overall cost structure and diversify its potential risks. However, with the world constantly changing, executives should try to anticipate the future direction of their chosen portfolio and be prepared for numerous possibilities.
- Revisit risk management. As companies become more dependent on cost-cutting initiatives to maintain or increase their margins, managing supply chain risks becomes critical. This is especially important when those initiatives involve new (and usually riskier) sources of supply. Extended supply chains add complexity to the work of procurement managers. Enlarging one’s pool of pre-qualified vendors requires more visibility. Depending on volumes and associated risks, some sort of local risk management thinking and presence is required. More frequent travelling, strategically partnering with service providers who are on the ground, making better use of technology and establishing a local presence (or a combination of the above) are some of the available options.
Cutting costs while compromising quality is not an option Finding alternatives to China is possible, but you will have to manage the risks better and probably work harder.
- Develop innovative strategies. Supply chain managers are realising that exploiting cost arbitrage opportunities between geographies is becoming increasingly difficult. The fast shifting landscape of LCCs means that finding a one-stop sourcing solution is unlikely. Although China is as close as one can achieve to a one-stop sourcing location, more and more supply chains are involving a larger number of geographies. It is within this context that other costs such as inbound logistics, outbound logistics and storage are playing a greater role in the cost cutting strategies of procurement managers. This reality requires innovative supply chain organisational structures, strategies, skills and technologies in order to facilitate cost reductions and improve efficiencies across the entire supply chain.
We are entering an era where the ability of managing complexity and volatility across different stages of the supply chain and sourcing destinations will become a differentiator. New competitive forces are appearing and supply chains are being adapted to capture the advantages on offer. While companies with an existing LCC agenda are revisiting and optimising their strategies with a portfolio approach, companies with minimal exposure to LCCs will feel the pressure of rising costs more than ever and have little alternative but to begin incorporating low cost sourcing strategies.
Although China is not necessarily the right answer for all companies or product categories, it is still a focal point for most global supply chain strategies. China has preserved and is continuously creating a set of competitive sourcing factors that attract companies seeking to compete on scale, quality, technological innovation and even service delivery. Facing tight cost pressures, Chinese companies are learning the value of optimising management and processes to boost productivity, further boosting China’s gradual move up the value chain.
The speed and manner in which China transforms itself will directly affect the sourcing potential of numerous countries around the world. China will not only prove to be more attractive than other countries for certain products higher up the value chain, but it will also continue to lose competitiveness to countries in lower value products. Supply chain managers able to anticipate such shifts will cope with the complexities that emerge and adapt quickly enough to create unique competitive advantages.
This article is an abbreviated version of a forthcoming white paper by The Beijing Axis, to be released in mid-October 2013. For a copy of the white paper, please contact Barbie Co at firstname.lastname@example.org.
One of the dynamic issues to watch against this backdrop will be the success (or failure) of Chinese firms in being able to crack into developed markets. The fruits of globalisation will no longer accrue solely to rich-world businesses as increasingly competitive emerging-market products and services win over consumers in the West.
In the coming years, Chinese car manufacturers will continue their efforts to break into European markets, Chinese real estate firms will be looking to diversify their asset portfolios into more stable but still revenue-generating economies, and Chinese construction and IT firms will continue searching for new growth opportunities outside their home markets, all of which will redefine competitive lines across industries and borders.
This edition includes the following lead articles:
- China’s Increased Presence in the Developed World
- The Growing Global Influence of Chinese Consumers
- China's Transformation: Implications for Global Supply Chains
Our Macroeconomic Monitor section focuses on the challenges China must overcome to ensure the country’s path towards more moderate and sustainable growth, while our Strategy section illustrates global trading patterns between China and its leading commodity suppliers and also includes a profile of MCC, China’s leading metallurgical engineering and construction contractor. These complement other regular sections such as: Investment, where we analyse China's overseas resource investments; BRIICS, a macroeconomic comparison of the world's six major emerging economies; and four Regional Focus sections with analyses of the latest China-related trade and investment activities in Africa, Australia, Latin America and Russia.
The China Analyst is published by The Beijing Axis, an international advisory and procurement firm.
To view the current and past editions of The China Analyst online, please visit our website.
Has China reached the point of no return? (aka the Lewis turning point)
Those that argue that China has already reached the Lewis turning point cite the fact that starting from2006, wages for Chinese migrant workers have skyrocketed. Based on data from the China Household Income Project, in 2006 and 2007, migrant wages increased by 11.5% and 11.2% in nominal terms, and 10% and 6.4% in real terms. Wage growth slowed in 2008, but resumed in 2009 when migrant wages increased by 16.6% in nominal terms and 17.3% in real terms. In 2011, China’s migrant workers got an average pay increase of around 21% according to data from the National Bureau of Statistics.
However, to conclude that China has already reached the Lewis turning point by looking only at migrant worker salary data ignores certain demographic realities and other broader forces at play in China. For example, in 2011, the agricultural sector accounted for only 9% of China’s total GDP but employed 40% of its labour force. This is an unusually high workforce percentage committed to a sector that accounts for less than 10% of the economy. In comparison, agriculture accounts for 3% of GDP and employs 7% of the workforce in neighbouring South Korea, while in the US, agriculture is only 1% of the economy and employees 2% of the US labour force (see chart
below). This implies that the productivity of China’s agricultural sector is much lower than that of the US or South Korea, which is understandable given that both countries have highly industrialised agricultural sectors and are more developed than China. As China’s economy modernises, so too will its agricultural sector, and in the process, become more productive and mechanised.
Assuming that the modernisation of China’s agricultural sector can reduce the agricultural labour force by 50%, an additional 160 million rural workers will be made available to participate in other sectors of the economy (China’s total workforce in 2011 was estimated to be around 800 million). All this serves to highlight that China has yet to reach the Lewis turning point and is unlikely to anytime soon.
Explanations for rising migrant wages
So if China has yet to reach the Lewis turning point, why have Chinese migrant wages risen so quickly? In theory, the surplus of rural labour in China combined with a fairly underdeveloped agricultural sector should work to suppress migrant wages from going up. To understand why this is happening, one needs to have a broad understanding of China’s socio-political context. Like most central governments around the word, the Chinese Communist Party (CCP) has a mandate to create more jobs for its citizens. However for the CCP, job creation is not just an economic issue, but also a political one; in a one party state like China, high unemployment would undermine the ruling party’s legitimacy to govern and can lead to social unrest. This can partly explain why China remains addicted to infrastructure spending; large infrastructure projects not only stimulate economic growth but also employ thousands of workers over a several year period. This also explains why China has been slow to modernise its agricultural sector. If China were to rapidly adopt a modernised agricultural sector, hundreds of millions of the rural Chinese population would be left without work. This large unemployed workforce would be difficult for the secondary and tertiary sectors to absorb all at once, since the vast majority of these rural workers lack the necessary education and training.
To keep this large rural population employed in agriculture and not flood the cities in search of higher paying jobs, the Chinese government has implemented various direct subsidies to indirectly boost their income. The most drastic measure was taken in 2004, when the government both increased cash subsidies to farmers and abolished agricultural taxes nationwide. These two government actions have created incentives for farmers to increase farm outputs, further adding to their income and applying upward pressure on migrant pay.
Furthermore, while cheap labour has been a key factor in generating high economic growth over the past three decades, it has also contributed to profound income disparities between rural and urban households. If left unchecked, such persistent, widening inequality could lead to social crises that could interrupt growth and damage competitiveness. To alleviate social tension, the Chinese government has begun to intervene by enforcing higher minimum wages along with investing in a social safety net for the poor. As part of the government’s plans to increase minimum wages by 13% annually through 2015, many provinces and municipalities, including Guangdong, Beijing and Shanghai, have raised their minimum wages by double digits in 2011. While many of these minimum wage increases are occurring in China’s affluent eastern areas, it is clear that the main beneficiaries are the migrant workers who flock to these areas in search of work. Such a re-alignment of rural–urban income, as a result of wage increases for unskilled migrant workers, will reduce overall income inequality over time.
The changing nature of China’s cost competitiveness
Regardless of when China will reach the Lewis turning point, the indisputable fact is that Chinese migrant wages are rising and this in turn is also driving up general labour costs in China. The rise in Chinese wages means that China will no longer be the cheapest supplier of low-end manufactured goods. This will benefit countries such as Vietnam, Indonesia, Pakistan and other developing nations who can expect to see more manufacturing outsourced to their countries instead of China. However in reality, only a portion of total manufacturing will shift from China. Smaller low-cost countries simply lack the supply chain, infrastructure, and labour skills to absorb all of China’s current production volume.
Furthermore, China’s vast landmass and regional differences allows for the country’s central and western provinces to carry on labour-intensive industries, which coastal regions have outgrown. China’s spatial and regional diversity means that China can avoid the common ‘flying geese’ pattern of labour-intensive industries’ moving to less-developed economies by allowing labour-intensive industries to continue growing in the less-developed inland regions. In fact, this trend is already clear. In 2011, employment growth for migrant workers in the western and central regions stood at 8.1% and 9.6%, respectively. In contrast, employment growth in the Yangtze and Pearl River Delta regions was relatively stagnant, increasing by only 0.3% and 1%, respectively. Such a development is possible because China’s capacity for industrial development in the central and western regions has substantially improved as a result of the central government’s implementation of the ‘going-west’ strategy.
It should also be noted that while Chinese wages may be going up, Chinese exports are also moving up the value chain. In 1985, China had a GDP per capita of just USD 290 at current prices and had almost no high-tech exports. By 2011, China’s GDP per capita had increased to USD 5,414 with high-tech exports now accounting for roughly 30% of total exports. In contrast, the average GDP per capita of the countries which China then competed with was USD 8,318 in 1985. By 2011, the GDP per capita of these countries had increased to USD 37,291. This means that while wages in China may be going up, the wages of China’s competitors on a product-by-product basis have been rising even faster along with the sophistication of their exports. China might have become expensive for many low-end manufactured goods such as T-shirts and footwear, but it is still comparatively priced for semiconductors, cars and software development. In fact, recent hikes in minimum wages all across China are aligned with the government’s initiatives to accelerate the country’s process of industrial restructuring, since higher labour costs will force enterprises to move up the value chain into more technologically-advanced industries. In other words, various higher-end products currently being produced by South Korea, Japan, Taiwan, Singapore, and the US will face stiffer Chinese competition.
China still has a large untapped pool of migrant workers, but fewer will be working in low-end, labour intensive industries; instead, more will be employed in high-end value-added industries as China continues to move up the value chain, posing a greater challenge to middle- and high-income economies, as it moves towards head-to-head
competition across various product categories.
This article originally appeared in the October 2012 issue of The China Analyst. To download the entire issue, please click here.
The joint venture brings together The Beijing Axis’ strength in analytics, strategy formulation and implementation, transaction support, and outsourced procurement and managed services, with IMPERIAL Logistics’ extensive resource base of transportation, warehousing and distribution operations in Africa and Europe, as well as best-of-breed integrative process and technology solutions. The combined team will have the ability to build a seamless distribution channel from China – and other Asian, low-cost manufacturing countries – to Africa, as well as from Africa to Asia.
“Partnership with a global company such as IMPERIAL is the logical next step in our growth plan,” said Kobus van der Wath, Founder and Group Managing Director of The Beijing Axis. “It enhances our current position as an international advisory and procurement firm, which counts the provision of a comprehensive range of procurement and supply chain managed services as one of our key service offerings to the market.”
With on-the-ground presence and extensive networks in Asia and Africa, the partnership will also provide strong support to companies that are looking to expand into these high-growth regions by offering a strategic and operational ‘soft landing’ to companies that are aiming to grow exports or establish a presence in these dynamic markets.
With over 35 years’ experience and operations spanning 14 countries on the African continent, IMPERIAL Logistics has extensive experience in logistics and supply chain management, and has achieved annual growth of over 15 per cent over the past decade.
“We deliver excellence in end-to-end logistics and supply chain management, enabling customers to grow in an efficient, proactive and cost effective manner,” elaborates IMPERIAL Logistics Chief Integration Officer Cobus Rossouw. “Our joint venture with The Beijing Axis reflects IMPERIAL Logistics’ commitment to ensuring that our clients are positioned to take advantage of global megatrends like the shift of economic and political power from West to East, and from developed to developing markets. The Beijing Axis’ expertise in low cost country sourcing and emerging market entry strategies combined with the international supply chain management capabilities of IMPERIAL Logistics boosts our clients’ chances of success in ventures between China – the rest of Asia - and Africa.”
“As one of the first regions visited by Chinese President Xi Jinping, Africa obviously holds a very important place in the country’s agenda,” contends van der Wath. “Apart from providing the wealth of raw materials that China needs in order to support its domestic development, Africa provides untold opportunities for Chinese companies, many of which are actively reshaping the continent’s landscape as part of a complex partnership that has reignited and vastly expanded ties from a previous era.”
In 2012, China-Africa trade grew by a significant 19.3 per cent from 2011, reaching USD 198 bn. Some analysts expect this figure to reach USD 385 bn by 2015.
The matrix has two axes, an x-axis that measures the complexity of the procurement needs (low complexity would be sourcing simple commodities such as pumps; high either complexity would be missile systems), and a y-axis that measures the procurement value (which can be high because the purchase item is expensive, e.g. an aircraft, or because the purchase volume is large, e.g. USD 100 million’s worth of pumps). A procurement need is considered complex if there are no more than four suppliers that can meet the manufacturing requirements, otherwise it is regarded as simple. A procurement need is considered high value if the procurement value for a product group or from a country is more than 3% of the total procurement value.
Based on these two axes, the matrix can be divided into four quadrants with corresponding values of sourcing complexity and value: Bottleneck (high, low); Routine (low, low); Leverage (low, high); and Strategic (high, high).
The Bottleneck Position: Stuck in No Man’s Land
(Lower right quadrant – Low value, high complexity)
Procurement in this quadrant tends to focus on specialised products from unique suppliers that are not very expensive. Typically, OEM products belong to this quadrant. Avoid this position if possible. The best strategy is to look for standard substitutes that are widely available. International buyers in the Bottleneck position, however, do not have readily available and economically sensible options available to them in selecting a procurement structure in China. The complex procurement requires a more formal business structure in order to establish partnerships with suppliers. This makes establishing a rep office or outsourcing not the most suitable options, yet the low procurement values also do not justify the expense of a JV or WOFE structure.
To make matters worse, the supplier has all the power in this position as their product is of high complexity or rare, while the buyer cannot effectively leverage economies of scale. The lack of appealing options in establishing a procurement structure, combined with low buyer power means that buyers should avoid being placed in this position as much as possible and try to seek out substitute products. If, however, foreigner buyers find themselves unable to extract themselves from this position, perhaps the best way is to adopt a fly-in fly-out approach until they find a substitute product.
China example: China’s rare earth metals industry
Currently China has a near monopoly on the rare metals industry, supplying around 95% of global exports. However, due to the industry’s damaging impact on the environment, the Chinese government is consolidating the industry. A single government-controlled monopoly, Bao Gang Rare Earth, has been created to mine and process ore in northern China, the region that accounts for two-thirds of China’s output, while production from southern China will be consolidated into three companies in the near future. The government has already ordered 31 mostly private rare earth processing companies to shut down and is forcing four others to merge with Bao Gang. Along with industry consolidation, China is also tightening export quotas, which has sent the price of rare earth metals soaring, impacting a long list of industries. For example, the average price for fluorescent bulbs (using the rare element europium oxide), rose by 37% in 2011.
The Routine Position: Lather, Rinse and Repeat
(Lower left quadrant – Low value, low complexity)
Procurement in this quadrant usually focuses on more routine products which are easily available and cheap. Here, organisational costs can be more important than the invoiced costs. Suppliers should be selected on their ability and willingness to reduce the costs of logistics.
International buyers in the Routine position have the most options when choosing a procurement structure in China. If the procurement values are very low (less than 1% of the total input value) and the complexity is simple, it makes more economic sense to just outsource the entire procurement operation to a qualified service provider, such as a PSP or trading company. If the procurement value is closer to the 3% threshold, establishing a rep office (whether from headquarters or off shore) should be considered, since with higher procurement values, more extensive use of service providers will be needed. Thus, it makes sense to establish a permanent office to ensure the quality of service providers. WOFE or JV structures are not economically justifiable.
China example: Alibaba
As the ‘factory of the world’, its no surprise that China is home to the world’s largest online business-to-business trading platform for small businesses, Alibaba. Claiming to have more than 65 million registered users, Alibaba is a transaction-based wholesale platform that brings together importers and exporters from more than 240 countries and regions. For buyers with limited procurement needs in China, Alibaba provides another channel for them to source small quantities of goods at wholesale prices from China.
The Leverage Position: Maximising Economies of Scale
(Upper left quadrant – High value, low complexity)
Procurement needs in this quadrant are characterised by high volumes in monetary terms and the availability of ample suppliers for the same product. Because of the volume, various discounts become available. This further reduces other organisational costs, such as ease of ordering, lead-time, flexibility, and payment terms, among others. In this position, buyers have substantial power over suppliers.
A rep office structure, whether from headquarters or off shore, is the most suitable one for international buyers in China in the Leverage position. The high value of procurement from China makes it economically worthwhile for the company to set up a rep office in China. The key to making this work is the frequent use of service providers. Although branch offices cannot directly import/export, it can chose from plenty of service providers in China that can provide this function. From a savings-to-cost ratio, this makes the branch office highly scalable since it is much easier to use or not use service providers than to hire or fire direct employees. Furthermore, since the purchase complexity is low, companies can comfortably outsource procurement operations in China without having to send their own personnel, leaving the branch office to take care of routine supervision duties.
China example: Walmart
Walmart is the world’s largest retailer and grocery chain by sales. In 2011, Walmart reported USD 422 billion’s worth of revenue, which is more than its five closest competitors combined, including Target and Tesco. Because of its mammoth size and buying power, Walmart can leverage economies of scale to pressure suppliers to accept lower margins in exchange for high purchase volumes. Many suppliers give in to Walmart’s pressure because they depend on the discount retailer for a majority of their sales. To keep its prices even lower, Walmart sources extensively from China, and has established its Global Merchandising Centre in Shenzhen. Walmart’s purchase volumes from China are so substantial that if Walmart were a country it would be China’s sixth largest export country.
The Strategic Position: Towards a Win-Win Relationship
(Upper right quadrant – High value, high complexity)
Procurement needs in this quadrant are characterised by high costs and unique suppliers. Here, co-operation and long-term relations that gradually grow deeper are typical features. Relations rather than contracts are an issue; usually, in regards to contracts, they last five years or the total production life cycle of a particular product.
International buyers in the Strategic position have complex procurement needs and high procurement values, which makes it worthwhile to set up a more formal business structure, such as a WOFE, in order to form strategic relationships with the limited number of suppliers. A company may even consider partnering with an existing supplier in China by forming a joint venture in order to obtain exclusive distribution rights or to be able to better manage the design/production process for the products produced by that supplier. Due to the highly strategic and sensitive nature of the buyer-supplier relationship in the Strategic position, relying on agents and trading houses for procurement needs is no longer suitable.
China example: Commercial Aircraft Corporation of China (COMAC)
COMAC, a Chinese state-owned corporation, is a new entrant in the larger passenger aircraft industry and has the potential to break the Boeing/Airbus duopoly. COMAC has already signed an agreement with Irish airline Ryanair, Europe’s largest discount airline, to cooperate in the development of China’s large passenger aircraft, the C919. According to the deal, the two companies will work together in research and development, airworthiness and customer services on the C919 project. The C919’s first test flight is planned for 2014.
Putting the pieces together
With an understanding of the Purchase Positioning Matrix, global procurement mangers can now identify where they belong on the matrix and hopefully avoid some costly mistakes, such as setting up a WOFE structure or expensive JV when they are in the Bottleneck or Routine position. As a general rule, starting from the ‘Bottleneck’ position, buyers should strive to move in a clockwise direction with the goal of ultimately ending up in the ‘Strategic’ quadrant. This will be a natural transition for international buyers in China to move towards anyway, especially as China moves further up the value chain, away from labour-intensive, low value-added
manufacturing into high-tech, R&D-intensive industries currently largely dominated by developed countries.
This article originally appeared in the April 2012 edition of The China Analyst. To download the entire issue, please click here.
Beijing needs to rebalance its economy away from excessive reliance on investment towards a more domestic consumption driven growth model. Beijing will only be able to accomplish this feat through targeted market-oriented reforms such as deepening reforms in the land, labour and financial markets. In the meantime, the vested interests of China's powerful SOEs, who have long enjoyed preferential government policies in an effort to breed global champions, will remain a major hurdle in pushing long-awaited reforms.
China is still on track to become the world's largest economy sometime during the new leadership's 10-year tenure. If China's policymakers fail to push much-needed reforms, foreign investors will look to other markets and marginalised sections of the population will grow even more restless. However, if China can stay on course - while battling increasingly visible signs of strain - it will herald yet another chapter in China's unrivalled growth story.
Click here to download the October 2012 edition
In the October 2012 edition of The China Analyst, we gauge China's progress in implementing these market-oriented reforms and highlight the opportunities that companies need to be aware of as China enters a new, more sustainable growth phase.
This edition includes the following lead articles:
- China's Economy: Heading for a Firm Landing?
- China's SOEs: Stalled Reforms or Agents of Change?
- FOCAC 2012: Sino-African Partnership Gains Momentum
A new Commodities section focusing on China's role in global commodities trade is included to complement other regular sections such as: Procurement, where we take a closer look into China's rising labour costs; Strategy, where we explore China's role in Africa's development as an investor and major trading partner; Investment, where we analyse China's overseas resource investments; BRIICS, a macro economic comparison of the world's six major emerging economies; and four Regional Focus sections with analyses of the latest China-related trade and investment activities in Africa, Australia, Latin America and Russia.
The China Analyst is published by The Beijing Axis, a China-focused international advisory and procurement firm.
To view the current and past editions of The China Analyst online, please visit our website.