This editorial was produced by The Beijing Axis for Business Day by Kobus Van Der Wath.

JD.com, China’s answer to the American online retailer, Amazon, released their initial public offering (IPO) on the Nasdaq Exchange in New York in late May. Based out of Zhongguancun (China’s technology centre in northwest Beijing and answer to California’s Silicon Valley), the Chinese e-commerce platform peaked at a market capitalisation of US$28 billion by the close of the first day’s trading, 2.4 times last year’s sale of US$11.5 billion and almost twice as large as Amazon’s market capitalisation. 

This offering, the largest of a Chinese web company ever, exceeded expectations and demonstrated faith that the level of Chinese economic activity online will boom, even as China’s GDP growth rate stabilizes around 7.5%.

Though JD has yet to record a profit, investors remain confident that this simply reflects investment in growth. In recent years, JD has, for instance, expanded it logistical capabilities across Western China, which has allowed the company to replicate the success of its same day shipping model in China’s less-developed provinces. However, this strategy has been very expensive. The IPO will allow the company to recoup some of their investments and advance their ability to expand their distribution infrastructure. 

The JD IPO demonstrates widespread interest in Chinese web companies and the potential for its larger competitor, Hangzhou-based Alibaba, which leverages a different business model. Instead of JD’s more direct management of the logistics of its orders, Alibaba primarily serves as an online retail platform for both consumer-to-consumer (Taobao) and business-to-consumer (T-mall) transactions. Alibaba is essentially the Chinese equivalent of eBay. 

Alibaba recently filed initial paperwork for its IPO, which will take place later this summer, and has received a valuation in the extremely wide, but nevertheless high range of US$115 to US$245 billion. This is due to the firm’s uniquely high value of goods sold through its marketplaces—roughly US$250 billion in 2013—and its high operating margins—roughly 50% of revenues in the first nine months of 2013. 

Similar to Shenzhen’s Tencent and unlike JD, Alibaba has purchased and developed several verticals beyond its central ecommerce platforms, such as Alipay, a Paypal equivalent; Aliyun, an Amazon web services equivalent; and Intime, a department store operator, which will allow for “online-to-offline” shopping. 

With their high valuations and current estimations for growth rates, Chinese web companies represent one of the strongest areas of the economy. Online shopping was recently forecasted to grow at 27% in coming years. 

Moreover, the Chinese government has consistently demonstrated its commitment to reorienting China’s economy around more efficient growth, such as that seen in the technology of web companies. 
 
With their IPOs in New York stock exchanges, not only are these Chinese web companies gaining access to capital to enable further expansion, but they are also advancing their corporate governance. Chinese companies on foreign exchanges are subjected to greater scrutiny, as they are required to open their books and corporate structure up to the public for shareholder critique. 

At the same time, Chinese technology firms have been expanding their international reach. Alibaba, for example, recently established its Southeast Asia headquarters in Singapore and has been on a mission to purchase several foreign start-ups, ranging from a ride-sharing app to several web-based shopping start-ups. Shenzhen-based Tencent has been aggressively rolling out its mobile messaging app, WeChat, across South Africa in the past few months. 

Well-positioned foreign firms will benefit from the internationalization of these firms in many ways. For example, because JD and Alibaba arguably represent the largest marketplaces in the world, the sourcing opportunities as these companies internationalise will be tremendous. 

These IPOs represent a pivotal moment in the transformation of the Chinese economy toward greater consumption and integration with foreign enterprises. Meanwhile, greater transparency in Chinese companies due to their listing on foreign stock exchanges is raising the standard of corporate governance in China. 

Van der Wath is group MD of The Beijing Axis. He can be reached at kobus@thebeijingaxis.com

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 kobus@thebeijingaxis.com

Growth Stabilizes in China

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Thumbnail image for f04da234c5db14f558be45.png This article was originally produced for the ChinAfrica magazine. 

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.

Prices flatten

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.

This post is the second in a series presenting the current status of CSR sourcing in China. Read part one, A Primer on CSR Standards and Sourcing in China.

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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.  

The most commonly observed CSR infractions fall into the following categories: unsatisfactory workplace safety arrangements, overworking employees, and poor compensation and record keeping practices.  

Safety 

Audited factories faced many challenges related to: failing to plan for emergencies, and risky treatment of hazardous chemicals and other dangerous supplies. The most common safety infraction that our team witnessed was the lack of an evacuation plan. Our team also noticed that several of the audited plants had not installed smoke detectors, did not have access to fire hoses, and had locked or otherwise obstructed emergency exits. In addition to poor physical infrastructure for potential emergencies, many factories do not communicate evacuation procedures adequately. Together, these infractions indicate that these facilities are unprepared that is unprepared for an emergency situation. Secondly, many factories were using hazardous chemicals without adequate safety labeling and had not provided their staff with sufficient safety training.  

Work time 

Chinese law stipulates that employees must not work more than 6 days per week or more than 60 hours per week. At one factory in Southern China, however, we found company records indicating that employees had worked 23 consecutive days; another Chinese factory reported an employee had worked 84 hours in one week. 

Wages and record keeping 

Some factories do not maintain sufficient records and have been accused of not compensating their employees in full and/or falsifying the wage records. At one factory, we were unable to ascertain whether employees were being compensated adequately due to poor record keeping. This problem persists across Asia and must be improved to meet international standards of social responsibility. 

Comparing the conclusion of our audits with the situation across Asia demonstrates that the infractions seen at our potential suppliers’ factories are representative of the Asian procurement landscape as a whole. While these particular infractions did not result in any of the factories failing the social audit, they did reveal a clear path to improving social responsibility practices.

Photo credit: Kevin Buehler (Flickr)
This post is the first in a series presenting the current status of CSR sourcing in China. Part two will follow next week.

factory girl.jpgRecognizing the large scale of the social implications of actions taken by large firms, many firms began implementing Corporate Social Responsibility (CSR) policies in the mid-twentieth century. Today, producing a CSR report is a common marketing tool that allows organizations to demonstrate their support of social principles. Studies show a correlation between CSR activities, consumer activity, and appetite for high-quality goods and services. 

Because many factories in China have labelled themselves as SA8000 certified (an international social auditing standard), we use SA8000 as the foundation of our social audits. The following checklist forms the backbone of our social auditing activities in the Chinese and Southeast Asian markets. 

Also, the auditor should require factory managers to present all relevant documents for each requirement. In many cases, Chinese factory managers claim that while they adhere to CSR standards, they are will not share their records. The following provides an outline of a CSR audit with which managers can customise to meet their particular needs.

Guiding Social Audit Principles
    • 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)
Thumbnail image for CIPS_CN_RGB.pngBEIJING – 9 June 2014 – The Chartered Institute of Purchasing & Supply (CIPS) has partnered with The Beijing Axis (TBA) to strengthen and support the procurement and supply profession in mainland China and Hong Kong.

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.

 

About CIPS

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:

CIPS

The Beijing Axis

Trudy Salandiak
Public Relations Manager
T: +44 (0) 1780 761575/07917 64856
E: trudy.salandiak@cips.org

Barbie H. Co
Senior Manager: Marketing and Sales Planning
T: +86 10 6440 2106 ext. 202
E: barbieco@thebeijingaxis.com

CIPS_CN_RGB.png 北京——201469日,英国皇家采购和供应学会(CIPS)与北京中外商桥投资咨询有限公司(TBA)强强联合以加强和支持中国大陆和香港地区的采购和供应业务实力。 

中外商桥公司借助其在中国和其他亚洲地区的平台和关系网络,在为跨国公司针对其采购需求提供服务方面有着丰富的经验。CIPS专门为采购和供应管理领域的从业者提供定制化的培训、专业认证、产品和服务。强强联合的团队通过结合全球最佳实践方案和本地化交付的特色培训课程项目更好的服务于中国大陆和香港地区市场。 

CIPS成立于1932年,旨在通过其培训和资质认证促进采购领域最佳实践的发展,并源源不断地为全球的采购和供应管理领域注入活力。作为行业中最大的同类机构,CIPS这一非营利性组织于1992年获得英国皇家特许授权。其办事处遍布全球,包括英国、非洲、澳大利亚、中东和北非以及新加坡等地区,同时中国办事处也在筹建当中。CIPS的客户包括中华电力有限公司、卡特彼勒和美国运通等。 

北京中外商桥投资咨询有限公司是一家行业领先的,以中国为中心的全球采购服务商。中外商桥提供一系列横跨供应链的全球采购解决方案以平衡总成本、确保交付时间和产品质量的同时最小化风险。中外商桥的客户包括来自国际矿业、能源、制造、建设、工程、技术、保险、快消品和零售等行业的公司,有着超过11年为国际客户交付采购方案的经验。 CIPS与其合作伙伴中国交通运输协会在中国地区提供英语和普通话专业认证服务已超过10年,并于近日签订了为期5年的新合同。协同教育部考试中心和中国交通运输协会,CIPS在中国地区还开发了两个可以选择普通话教学的学位培训课程。 

CIPS的集团首席执行官David Noble这样看待合作关系:"中国和香港在全球经济发展中的地位举足轻重,而中国在东方的实力尤为突出。" 

"我们已经和区域内CIPS会员公司以及有关教育部门建立了稳固的关系,但我们想做得更多。此次与中外商桥结成的合作关系不仅将巩固CIPS已有的信誉和已经付出的行动,而且能够强化整个商界的采购和供应管理。" 

"我们在最合适的时机与CIPS结成了合作伙伴关系,可以看到中国大陆和香港的采购和供应类培训和专业认证领域正在快速发展。"中外商桥的创始人及总裁古柏先生说道。"CIPS的培训和专业认证服务,是对我们全球采购和供应链外包服务的一个补充。" 

初期,中外商桥将会推出一系列针对特定行业和公共领域的企业定制化培训和企业认证服务,且会在接下来的几个月举办和参加一系列的活动。David Noble将于2014年7月来华,正式签署与中外商桥的合作关系并一同会见分公司成员、合作伙伴和业内企业。 

了解更多,请访问CIPS 中国网站


关于CIPS 

英国皇家采购与供应学会(CIPS)是全球领先的采购与供应领域专业服务机构。它是全球采购和供应管理问题的优化中心。CIPS拥有一个遍布150个国家且超过10万6千人的"CIPS社区",包括资深商务人员、高级公务人员和知名学者。采购和供应链专业人士的业务活动对所有类型的机构或组织的盈利水平效能都有明显的影响,为了提高企业的盈利能力,CIPS为您提供企业一站式解决方案。 

关于北京中外商桥公司 

北京中外商桥咨询服务公司成立于2002年,是一家经验丰富的专门为客户提供跨国咨询及采购服务的外资公司。我们的服务包括两个方面:帮助外国公司进入中国和中国公司走向海外。我们的业务涉及四个领域:第一,跨国战略和管理咨询;第二,跨国采购服务;第三,跨国大宗商品交易;第四,跨国投资咨询。在跨国采购和跨国咨询方面,中外商桥拥有超过11年的丰富经验。我们已经在北京、新加坡、珀斯和约翰内斯堡成立了机构,同时孟买和拉丁美洲办公室也正在紧锣密鼓的筹建中。


需要更多信息请联系:

英国皇家采购与供应学会

北京中外商桥

Trudy Salandiak
公共关系经理
电话: +44 (0) 1780 761575/07917 64856
邮箱: trudy.salandiak@cips.org

许菁桐
市场拓展和销售规划高级经理
电话: +86 10 6440 2106 ext. 202
邮箱: barbieco@thebeijingaxis.com

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China has recently opened a remarkable number of industrial development zones such as high-tech parks. These parks represent tools Chinese policymakers use in their attempt to encourage hubs of high-tech development, innovation and entrepreneurship. The Chinese government seeks greater high-tech development to accelerate the economy’s transition from a resource and capital-intensive economic model to a more advanced, service-oriented model. These zones represent the government’s attempt to reach its goals of both directing more foreign direct investment (FDI) and foreign technology to China.
 
These parks also present one prong of Beijing’s “Go West” campaign, in which the government aims to develop China’s inland provinces. Today, there are roughly the same number of industrial development zones, the larger category into which the high-tech parks fit in, in coastal provinces as there are across both China’s central and western provinces.
 
Chengdu, for example, aims to position one of its neighbourhoods as a tech hub that rivals Beijing’s Zhongguancun, China’s so-called Silicon Valley. With international firms such as Dell, Siemens and Philips basing their Western Chinese operations there, the Chengdu Hi-Tech Zone in the south-western city recently announced that the number of enterprises registered in the zone increased by nearly 50% to over 1,600 in Q1 2014.
 
However, recent studies have suggested that the zones themselves have provided limited impact on their two primary goals—increasing both the level of FDI and rate at which foreign technology is acquired—and that any perceived achievement of these goals would have occurred regardless of the park’s establishment. More than one study has suggested that without development zones, these enterprises would still be in the same region, just not as concentrated.

While it is unclear whether these parks will successfully achieve their goal of bringing greater FDI and advanced foreign technology to China, the scale and speed of their growth is remarkable and their presence will continue to make a strong impact of the development of China’s economy, especially inland China, for the foreseeable future.

The China Analyst - April 2014

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The Beijing Axis released the most recent issue of its in-house publication, The China Analyst. The April issue outlines the implications of China’s continued quest for natural resources as the country redefines itself once more through the implementation of key economic reforms. 

This edition includes the following lead articles: 

  1. Feeding a Billion: China’s Transforming Agricultural Sector 
  2. Chinese Mining Firms in the Year of the Horse: a Trot, a Canter or a Gallop? 
  3. Chinese Super Majors: Tilting the Global Oil and Gas Playing Field 
Our Macroeconomic Monitor section focuses on China’s attempt to execute its boldest reforms in thirty years. Our Strategy section includes a profile of CNOOC, one of China’s top three oil and gas majors. These complement other regular sections such as: Investment, an analysis of China's overseas resource investments, Procurement, which describes installation and commissioning, a key component of The Beijing Axis’s services, and the Regional Focus sections, which provide analysis of the latest China-related trade and investment activities in Africa, Australia and Latin America. 

Please view The China Analyst here or download the full PDF version here.

While costs have become a focal point for companies seeking to grow their margins, China’s competitive position as a low-cost sourcing destination is being questioned. This article takes a closer look at the new competitive forces shaping China and other low cost countries’ competitiveness and the implications for global supply chain executives.

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?

Factors-Expected-to-Affect-China’s-Competitiveness-in-the-Short,-Medium-and-Long-Term.jpgAssessing 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.

Comparison-of-Sourcing-Capabilities-of-Selected-Economies-(2012).jpgImplications 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.
High-level-Overview-of-Selected-Countries’-Short,-Medium-and-Long-Term-Manufacturing-Capabilities.jpg

Final word

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 barbieco@thebeijingaxis.com.

While costs have become a focal point for companies seeking to grow their margins, China’s competitive position as a low-cost sourcing destination is being questioned. This article takes a closer look at the new competitive forces shaping China and other low cost countries’ competitiveness and the implications for global supply chain executives. - See more at: http://www.thebeijingaxis.com/tca/editions/the-china-analyst-sept-2013/203-chinas-transformation-implications-for-global-supply-chains#sthash.nr3DCGGI.dpuf
While costs have become a focal point for companies seeking to grow their margins, China’s competitive position as a low-cost sourcing destination is being questioned. This article takes a closer look at the new competitive forces shaping China and other low cost countries’ competitiveness and the implications for global supply chain executives. - See more at: http://www.thebeijingaxis.com/tca/editions/the-china-analyst-sept-2013/203-chinas-transformation-implications-for-global-supply-chains#sthash.nr3DCGGI.dpuf

The China Analyst - September 2013

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As China’s top leaders prepare to discuss major policies on the country’s reform agenda during the upcoming plenary session of the 18th Central Committee in November, China watchers are cautiously optimistic that President Xi Jinping and his leadership team will push through long anticipated reforms needed to ensure China continues on its long-term growth trajectory.

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.

TCA Sep 2013 Cover.jpg
Click here to download the September 2013 edition.

In the September 2013 edition of The China Analyst, we outline the implications of China’s growing footprint in the developed world as the country enters a new era in its on-going transformation.

This edition includes the following lead articles:

  1. China’s Increased Presence in the Developed World
  2. The Growing Global Influence of Chinese Consumers
  3. 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.

Recent developments in the Chinese economy have drawn renewed media attention to rising labour costs in China. More than 50 years ago, economist Arthur Lewis pointed out that with the expansion of the modern sector of a low-income country, the unlimited labour supply (from the rural sector’s labour surplus) would disappear and, as a result, the country will enter into a phase of faster real wage increases. Many countries, including South Korea and Japan, have experienced such a change. What about China—is it already at the Lewis turning point? If so, does this signal the end of cheap labour in China?

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.

Annual Per Capita Income of Urban and Rural Households China.jpgHowever, 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.

Size of Agricultural Sector for Select Countries.jpgFurthermore, 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.

IMPERIAL_Logistics logo.pngThe Beijing Axis has boosted its procurement and international supply chain offering by entering into a joint venture with global logistics and supply chain leader, IMPERIAL Logistics. The partnership will ensure that both companies and their clients are well-placed to reap the benefits of the thriving trade and development between the two fastest growing continents in the world – Asia and Africa.

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.  

Global purchasing managers sourcing from China face a myriad of options on setting up their Chinese procurement operations. Whether it be a direct structure such as a rep office, offshore structure, joint-venture, and WOFE; or to completely outsource operations to a trading company or third-party service providers, each option has its own pros and cons. Understanding the Purchase Positioning Matrix can help companies determine the most suitable procurement structure to set up in China.

The Purchase Positioning Matrix: A Tale of Two Axes 

Based on ‘The Portfolio Instrument’ developed by Dirk-Jan F. Kamann (which is itself based on Kraljic’s 1983 purchasing model), the Purchase Positioning Matrix is a framework for buyers to develop their supplier relations strategy by examining their sourcing needs in terms of sourcing value and sourcing complexity. The Matrix can be represented by the following illustration:

Purchase Positioning Matrix.jpg
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.

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