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.

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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.

The China Analyst - October 2012

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China's hand-picked next generation of leaders will be tasked with solving deep-rooted problems formed during China's 30 years of socio-economic development. A growing (and increasingly visible) disconnect between top wage earners and the working class, frustrated factory owners, and a rapidly-ageing population are just some of the key issues facing modern China.

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.

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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:

  1. China's Economy: Heading for a Firm Landing?
  2. China's SOEs: Stalled Reforms or Agents of Change?
  3. 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.

The China Compass - August 2012

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The China Compass - August 2012, published by The Beijing Axis, combines basic country data of China, as well as other major world economies, with more detailed analysis of a wide range of macroeconomic and social data; presents a comprehensive picture of the ever-changing and evolving Chinese landscape; contains up-to-date statistics, topical themes and insights; and is presented in a reader-friendly format as a useful desk reference for executives with a China agenda.

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Click here to download the August 2012 edition

Since our last edition, the developed world has been unable to escape from a self-induced sovereign debt crisis, which has fuelled speculation as to whether China's economy is headed for a 'soft' or 'hard' landing. While China's GDP growth has subsequently slowed to 9.2% in 2011 and 7.8% year-on-year in the first half of 2012, fears of 'hard' landing seem overblown. Even growth of 7.6% in the second quarter fits with our core view that China's annual growth rate for 2012 is still expected to be around 8%.

As China attempts to rebalance its economy towards a more sustainable growth pattern that puts a greater emphasis on domestic consumption while sheltering the economy from the global slowdown, we expect many cyclical and structural changes and increased volatility. However, we still do not foresee a hard landing.

Our focus and theme of this edition is 'China Moves Towards Growth Moderation and Sustainability', featuring sections on:

  • Selected Macroeconomic Indicators
  • Domestic Consumption and Foreign Trade
  • Domestic and Foreign Investment
  • Financial Indicators
  • Social Indicators

We trust that this edition of The China Compass will continue to shed light on past developments, current issues and future prospects of the Chinese economy, making this fascinating and complex story slightly more comprehensible.

As always, we welcome and appreciate all feedback. 


The China Compass is published by The Beijing Axis, a China-focused international advisory and procurement firm. 

For more publications by The Beijing Axis, including past editions of The China Compass, please visit the 'News & Media' section of The Beijing Axis website.

Here's a little mental leap. In the last few years Beijing's subway has expanded substantially, especially after a building blitz before the 2008 Olympics. At the time, Chinese companies have entered the Fortune 500 in increasing numbers. What if you would literally put these two completely disparate phenomena together?


The result is this infographic. It illustrates the progression of Chinese companies in the Fortune 500 from 1994 (when the first Chinese company joined the list) with a visual reference to the expansion of the Beijing subway system from 1971. All but two of Beijing’s current 15 lines were opened in the last decade; in the same period, 47 of the current total of 58 mainland Chinese companies joined the Fortune 500. The circles around each company portrays visually the expansion in revenue of the companies at time of joining the Fortune 500 vs. currently. Note the subway map is not exhaustive of Beijing’s current subway system of 15 lines.

Click for a closer view.
Note: This infographic appeared on page 3 of the April edition of The China Analyst

The China Analyst - April 2012.jpgThis is the new edition of The China Analyst - April 2012. In this edition we ask you to prepare for a more competitive China. We ask you to change your perspective on China. 

How competitive is China really? It has changed a lot in the last three decades, yet now it is aiming to transition to innovation-driven competitiveness. If you apply a little imagination and envision where current trends are heading, you might be induced to change your opinion on China. This process has started happening in a number of industries, such as heavy and construction equipment, where Chinese companies have begun to shake up the competitive landscape, especially in emerging economies. Yet in various other industries as well a number of Chinese companies are approaching the 'technological frontier.' It is a process that is occurring in gradual steps, as Chinese companies adapt, improve and innovate, but it is a process that all companies in the world should be aware of and prepare for. 

In other usual sections we also look for example at how companies procuring from China are using the Product Positioning Matrix (China Sourcing Strategy), and we look at China in the context of the global debt landscape (China Strategy). In addition, we look as usual at the trade and investment landscape in four key geographies: China-Africa, China-Australia, China-LatAm, and China-Russia. 

To download this edition, please click on the link below, or see The China Analyst website at www.thebeijingaxis.com/tca


The shipbuilding industry has been the scene for a major uptick in Chinese export market share in the period 2007-10. 

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The OECD countries that China captured market share from were in this case Japan and South Korea. These two, in their turn, were responsible for capturing the market from Europe as early as the 1970s, but it was only in 2010 that South Korea was surpassed by China as the world's leading shipbuilder. The chart above illustrates how rapidly this occurred in the period 2007-10. 

According to the global shipping services provider Clarksons, in 2011 China accounted for around 41% of the global shipbuilding share in dead weight tonnes, while South Korea had 33%, Japan 20%, and Europe only 2%. China's ascent in the industry was complicated, however, by the global financial crisis. With sluggish demand for new ships and rising costs for labour and steel, the volume of new orders in 2011 fell 52%, according to the China Association of the National Shipbuilding Industry (CANSI). 

China's smaller shipyards are bearing the brunt of the downturn, and more than 30% of them could go bankrupt this year, according to some observers. The current dearth of orders is not a new phenomenon, moreover, as Clarksons have pointed out that the numbers of orders for local Chinese yards have been declining all the way since 2007.     

Early in 2012, the dire situation facing China's smaller shipyards seems to have contributed to China's Transport Ministry banning from its ports any ships larger than 300,000 dead weight tons. For more on this somewhat controversial issue, see this Reuters report.   
Its always tempting to compare economic aspects of China and India, as we have done before. Exports is one area that is commonly compared; the chart below summarises briefly China and India's performance over the last decade. There are some striking observations. 

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Firstly, the scale indicates that India's exports are dwarfed by China's, yet both Chinese and Indian exports have increased substantially in the last decade. China's advance in exports was mainly situated in the Machinery and Electrical Equipment category, in which it has gained market share all over the world (i.e. in Australia, as we have outlined before) and which reflect the strategic evolving of its economy from the 1990s.  

India, however, have not focused on equipment as China has, but instead the bulge has occurred in the 'Other' category. The bulk of this 'Other' category includes Manufactured Goods, of which Engineering Goods in 2010 constituted about 65%. Petroleum Oil Products (or POL products) constituted a significant share of about 15% of India's total exports by 2010, and was the fastest-growing Indian export over the decade. Gems and Jewelry constituted another 16.2%. For some more info on India's recent export performance, see here
This is the first in a new series of posts looking at certain trade and industrial 'hotspots' in China.

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If you look at trade statistics for Chinese provinces in 2011, it is clear that something is happening in Henan, an emerging central province, and particularly in its provincial capital of Zhengzhou, one of China's 20 fastest growing cities. Zhengzhou is what some might call a typical second-tier Chinese city (Bentley and Louis Vuitton have just set up shop there). Provincial Value Added of Industry growth was a solid 19.6% in the first eleven months of 2011, yet what sets the province apart is the huge jump in foreign trade achieved in 2011. In August 2011, Xinhua picked up on Henan's trade bounty when it reported that Henan had registered total foreign trade of USD 11.7 billion for H1 2011 (this is perhaps an underestimate), with the European Union serving as the main trade partner. The province's main exports were silver, aluminium, vegetables, porcelain, and fur, while main imports were iron ore, lead ore, machinery, and wood pulp. 

According to China's National Bureau of Statistics, in the first eleven months of 2011, the y-o-y growth in the province's foreign trade was 78.5%, the second-highest rate of growth (Chongqing registered a full 143%). This rapid growth was from a relatively low base, it now stands at USD 28.4 billion (light years away from the likes of Jiangsu with USD 490 billion and Guangdong with USD 830 billion). Henan still also has a very low GDP per capita as well as average household consumption expenditure of only RMB 7837, the ninth lowest of all China's provinces, and the lowest average wages of all China's provinces (RMB 22,552). Yet the province's rapid growth in trade in 2011 points to the fact that something is stirring in Henan. 

From backwater to transportation and manufacturing hub
Although it is often regarded as somewhat of a rural backwater, Henan has a lot going for it. Consider the following. As a province of China, in 2010 Henan: 
  • had the third-largest population of 94 million people (Shandong had 96 million; Guangdong had 104 million)
  • had the second-largest cultivated land area of 7.9 million hectares Heilongjiang had 11.8 million)
  • had the second-longest total length of highways at 245,089 km (Sichuan had 266,082 km), and the fourth-longest length of railways in operation at 4,282 km
  • had the second-largest freight traffic at 20.0 billion tonnes (Anhui had 22.8 billion tonnes)

In 2011, moreover, Henan very much lived up to its reputation as China's breadbasket: it was China's leading province for Output Value of Agriculture, Forestry, Animal Husbandry and Fishery, with RMB 560 billion. Yet with a large albeit low-earning workforce, good transportation networks and a suitable geographic location close to the eastern seaboard, Henan is well-placed to take advantage of the large-scale relocation of manufacturing to cheaper central provinces. 
  
It comes as no surprise, then, that Foxconn, the original equipment manufacturer for Apple products, plans to hire an additional 100,000 workers at its plant in Henan, doubling its workforce there. Foxconn's Henan factory is itself brand new, only opening in August 2011. 

In appreciation of the province's attractive set of advantages for its business, Kerry Logistics in January 2012 announced plans to build a new logistics centre in Henan that will be targeting the electronics and technology, automobile, industrial and material science sectors. Kerry's managing director in mainland China put it well: "China’s coastal provinces have refocused to attract manufacturers of higher value-added products and there has been a migration of production to the central and western regions due to lower land and labour costs, we see the potential to transform Zhengzhou into one of China’s manufacturing and processing hubs."

Foxconn and Kerry are both setting up in Zhengzhou, the provincial capital and rising star of Henan. The city has been included in 29th place in the Top 50 Chinese Cities by Investment Potential list, and Zhengzhou’s imports and exports last year reached USD 13.5 billion, up 196% from 2010. Exports jumped 166% to USD 5.3 billion, while exports increased by 258% to USD 5.3 billion. Another prominent city in Henan is Luoyang, where CITIC HIC, one of the world's leading manufacturers of mining equipment, is located. 

The next China
Although its people are still relatively poor, Henan is on the cusp of the next development wave in China. It has a strong agricultural reputation, yet it also has a number of advantages that positions it to become a manufacturing hub in central China, ideally placed in central China close to the eastern provinces. 

It all means that you should probably get used to hearing the name 'Zhengzhou.' 


Note: All data is from China National Bureau of Statistics, unless otherwise stated. 
China Procurement Roundtable: Assessing China as a Supply Chain Partner for the African Mining, Industrial and Retail Sectors  

Venue: Radisson Blu Hotel Sandton (close to Hilton) Cnr Rivonia & Daisy, Sandton, Johannesburg, South Africa 
Date: 16 February 2012, 07:00 - 09:00 
Organiser: The Beijing Axis
Tel: +27 (0) 11 201 2453 

Briefing: From resource extraction and investments to consumer products and services, China’s presence in Africa and its role in the continent’s development can be observed in various facets of the economy. With China’s continued role as a key supply chain partner in the mining, industrial and retail sectors, supply chain managers of companies engaging with or planning to engage with China need to understand the realities and inherent complexities of dealing with the country and, specifi cally, the individual suppliers. The lure of eff ectively dealing with capacity constraints and minimising costs are strong incentives for reaching out to a low-cost country solution; however, this must be tempered with a robust understanding of the market, proper supply chain and logistics management, as well as developing a solid relationship with your supplier. This session will include an examination of actual procurement case studies that were inherently complex or that experienced difficulties in the process of execution. 

Please send confirmations to rsvp@thebeijingaxis.com before 10 February 2012. For any further enquiries please contact Dirk Kotze at +27 (0) 11 201 2453 or send an email to dirk@thebeijingaxis.com.
Global textile and apparel sourcing is currently in a state of change. In China, the textile industry is not a major focus for industrial development, and lower value added manufacturing is progressively moving into South East Asian countries. For this reason, textile and apparel sourcing has to become more diversified. Yet this does not mean that China is no longer one of the leading players in this field, but emerging countries in South East Asia are increasingly challenging China's dominance. 

China still has a lot going for it. It has well-established supply chains, as well as good infrastructure and expertise in making apparel and textile products; no single emerging country in South East Asia can yet hope to match China in all of these capabilities. Hence China will likely remain the leading textile and apparel sourcing country in the region over the near to medium-term. But the basic point here is that sourcing can (and should) now utilise the increased number of sourcing options in the region, and not focus solely on China. 

Old and emerging players: The global landscape
The World Bank has identified four basic types of apparel exporting countries in the world, with the largest share of production occurring in Asia:
  • Steady Growth Suppliers: China, Bangladesh, India, Vietnam, and Cambodia (Pakistan and Egypt can also be included on this list, but with smaller market shares)
  • Split Market Suppliers: Indonesia (which is increasing its market share in the US and Japan, and decreasing its share in the EU), Sri Lanka (which is increasing its market share in the EU and decreasing in the US)
  • MFA-era Suppliers*: Canada, Mexico, the Central America Free Trade Agreement, (commonly known as DR-CAFTA, a free trade agreement including the US and the Central American countries of Costa Rica, El Salvador, Guatemala, Honduras, Dominican Republic and Nicaragua), EU-12, Tunisia, Morocco and Thailand (all of which have all registered sharp declines in textile and apparel exports after the MFA quotas were abolished in 2005)
  • Past-prime Suppliers: Hong Kong, South Korea, Malaysia and other countries with decreasing market shares since the 1990s such as the Philippines and Singapore

The map below illustrates the new challengers to China's dominance for textile and apparel sourcing, highlighting the emerging sourcing potential of South and South East Asia:

Textile and Apparel Sourcing Landscape.png
New opportunities in the Asian landscape
China is no longer the only option for textile and apparel sourcing, and it certainly is no longer the cheapest option. So taking advantage of this new landscape means being able to exercise a range of sourcing options focusing on a number of emerging Asian countries. Some of these opportunities are outlined very briefly below: 

  • With low cost domestic supply of cotton and low labour costs, Pakistan has a good track record for pure cotton apparel production for items such as male T-shirts and cotton jerseys
  • Bangladesh still has an underdeveloped apparel and fabric manufacturing industry, although it also has very low labour costs and cotton prices. Thus Bangladesh can be targeted for sourcing of cotton garments of basic design and standard quality
  • Sri Lanka has similar cost advantages as Pakistan and Bangladesh (although the cotton price and labour costs are slightly higher), but operating and capital costs are higher, and a lot more machinery needs to be imported. As a result, Sri Lanka could potentially only be a sourcing target for certain niche products such as women's underwear
  • Cambodia's textile industry is still highly underdeveloped, but low costs and government support for the industry makes it attractive likewise for niche products such as basic design T-shirts
  • Indonesia's cotton price is the lowest in the region, but operating costs are higher than most countries in the region and much of the machinery in the industry is largely outdated. Indonesia does, however, have substantial installed capacity across a range of textile segments, and hence can be targeted for a number of products such as synthetic fabrics, synthetic apparel, and high-end cotton shirts
  • Vietnam has a lower cost base than China and India, although higher than Bangladesh and Pakistan. The textiles and apparel industry is actively supported by the government, and relatively significant currency depreciation makes the country's exports competitive. The local workforce is still largely of a low-end skill base, however, meaning that Vietnam's best sourcing opportunities are still in basic designs and standard types such as woven garments and children's products
  • India has a diverse and integrated fabric and apparel industry, and it now has lower labour costs and cheaper cotton prices than China. These and other trends mean that India will likely gain a comprehensive competitive edge over China in the future. India can be targeted for sourcing fabrics and textiles across virtually all product categories


This very brief outline illustrates that China is no longer the only game in town for textile and apparel sourcing. It is still the dominant player, and will likely still account for the largest share of global textile and apparel sourcing for some time to come, but other countries in South and South East Asia are now attractive for specific products, and China's position will be further assailed in the years to come by these emerging Asian countries. The trick is to exercise the right sourcing options.   


* The Multi Fiber Arrangement (MFB), implemented as a short term measure to allow developed countries to adjust to imports from the developing world, governed world trade in textiles from 1974 to 2004 and imposed quotas on exports from developing countries to developed ones.  

Also see this report on the CEIBS website: China's Role in the Global Textile Industry