January 2008 Archives

Xinhua reported on Thursday that China's first market credit index has been launched in Yiwu. The index, to be published monthly, includes eight sub-indices: credit management, entrepreneur quality, business performance, financial credit, fair competition, commodity quality, intellectual property rights and consumer rights protection - all aimed at reflecting the "development, changes and trends of the credit situation in the Yiwu market."

Located in Jinhua city in Zhejiang province, with a total population of 1.6 million people (including one million non-native residents, a fact supposedly indicative of Yiwu's success as a trading city), Yiwu was an impoverished rural area in the 1970s, but the city has now been hailed as the world's largest platform for the transaction of Christmas presents and a paradise for foreign traders from all over the world; the city's commodity wholesale market, Yiwu China Commodity City has been called The Great Mall of China.

With a trading heritage dating back to the early Qing dynasty when a peddler's organization developed from peasants trading brown sugar for rooster feathers (used in compost), the Yiwu of today originated during the 1970s when vendors spontaneously established two periodic markets. From small-scale family crafts production, capital accumulation in the 1990s led to the establishment of modern mass-producing factories which by 2004 were made up of eight large clusters: socks, shirts, wool, accessories, zippers, toys, key sticks and printing.

With Yiwu trade fairs reaching a total trade value of 9.45 billion Yuan in 2006 and attracting product displays from 110,000 business people in 2007, the success of Yiwu is also derived from local government reform policies since 1982, when restrictions on business were eased and the informal periodic market became the regular Yiwu Commodity Market, utilizing extensive local linkages and distribution systems. As business expanded and constraints appeared, new generations of markets developed in succession to the original. Thus while Yiwu has become a massive marketplace and sourcing platform, it is a product of a long-standing Chinese business heritage as well as a modernizing element of China's modern business network.

Yet with its emphasis on providing cheap, low-end products for global sourcing networks, Yiwu's potential in moving up the value chain is as yet not entirely defined, and Clay Chandler, Fortune magazine's Asia editor, recently wrote that he found
little at Yiwu to suggest Zhejiang's small producers are making the shift from quantity to quality... my visit to Yiwu left me questioning whether Zhejiang's vaunted entrepreneurs have what it takes to climb the global value chain. Part of the trouble, cearly, is that China's financial system - rigged in favour of state-owned giants and foreign multinationals - deprives small, homegrown companies of the capital they need to invest in new technologies and marketing and move beyond commodities to unique, high-value brands.
At least U.S. Secretary of Commerce Carlos Gutierrez, when recently visiting China, was impressed with the gift of an electronic dog he received from Li Changjiang, director of the General Administration of Quality Supervision, Inspection and Quarantine (GAQSIQ). China Daily reported Gutierrez describing the gift as "very lovely, very interesting."

Additional sources:

DING, K, Distribution System of China's Industrial Clusters: Case Study of Yiwu China Commodity City, Institute of Developing Economies Discussion Paper No. 75. LINK

Shanghai Business Review, Volume 3, Issue 6, July 2006. LINK
Three cases in the news this week highlight the precarious nature of Intellectual Property (IP) regulation in China.

The Financial Times (see also TIME) reported Tuesday of the ongoing saga involving Chinese glue-making company Magpow and its chairman Yuan Hongwei, who stands accused in the U.S. of trying to register more than 221 trademarks in China, most of them well-known brands such as UTT, Castell, Araldite and Super Glue. U.S.-based industrial adhesive manufacturer Abro has been engaged in a global campaign against Magpow's blatant display of corporate identity theft since 2001, yet the day before he was due to appear in a London court facing extradition to the U.S. earlier this month, Yuan Hongwei published an open letter on the internet thanking the people and government of China, who had just assisted him in returning home to the 'embrace of the motherland' after he was apparently 'tricked' into flying to the U.K.

In somewhat contrasting news, The New York Times reported Friday of Zhongyi Electronic Ltd., a small Chinese high-tech firm, who are suing Microsoft who they say have been using its Chinese language input technology and fonts in Windows operating systems without commercial agreement for over a decade. Microsoft has refuted the claims, saying it fully performed its obligations and that earlier license agreements had given it the right to use the technology. The China Business Law Blog (blocked on the mainland) recently also did a posting on the developing story of how Microsoft this month was dealt another blow when the China Trademark and Patent Office (CTPO) rejected its opposition of the registration of the trademark "Windows" by a Ningbo eye glass company.

While this illustrates the difficulties foreign enterprises could often face in protecting their intellectual property in China, a September 2007 World Intellectual Property Organization (WIPO) study on the economic impact of IP systems in China (available here) cast some light on the interplay of factors complicating IP in China. From 1992 to 2003, the report states, Chinese imports of high-tech products far exceeded exports, and local companies' high-tech imports were less than a quarter of those of foreign funded enterprises. Hence local companies, in lack of essential patents, find it harder to break out of low value-added processing trades.

Typically, the authors (both from the Law School of Peking University) concluded, Chinese companies use IP and "seek protection for defensive purposes," yet even successful companies "have not yet grown strong enough to bear the cost and risk inherent in R&D in China." Although "expanded sale" can induce R&D investment,
With limited net income and limited experience in managing R&D activity, concern is raised as to whether domestic companies could successfully make and commercialize innovation before being thrown out of the market or simply being absorbed by foreign companies.
This analysis would suggest that while both sides can appreciate the value of IP, Chinese companies can easily view the status quo of IP as a barrier and unfair disadvantage in the face of rising costs, which is just one more issue complicating IP protection in China.
Considering the immense significance of special economic 'boom' zones in China's path of industrialization, the Binhai New Coastal Area in the eastern part of Tianjin is set to follow the Pearl River Delta and the Yangtze River Delta in becoming China's third major industrial heartland. Covering over 2,200 square kilometres and with a population of 1.3 million, Binhai New Area's claim to be China's next economic powerhouse after Shenzhen and Shanghai's Pudong was greatly enhanced when it was mentioned in Hu Jintao's speech at the 17th National Congress in 2007 as an emerging economic zone that would play a major role in reform, opening up and independent innovation. Hailed for its modern manufacturing, research and development, and shipping and logistics capabilities, by 2010 half of Binhai's industrial output is expected to come from high-tech industries.

In an interview with Leaders managazine in 2005, Pi Qiansheng, Director of the Binhai Administrative Committee, identified four directions for the general development of the Binhai region:
The modern manufacturing, researching and transforming base; the international material-circulation center; the symbolic region of the modern international city; and a new seaside city that is suitable for living.
Advocating a 'brand-new vision to perceive the development of the Binhai New Coastal Region,' Director Pi expected Binhai not only to provide services to the Bohai Rim but to
exert influence over northeastern, northwestern, and northern China. It should construct transportation advantages, technology-research advantages, information-service advantages, and also human-resource advantages.
The President of Rohm Semiconductor Co Ltd, investing in Tianjin since 2000, in an interview with China Daily in December felt that the government's official endorsement of the Binhai New Area would see the city's financial and logistics services and sourcing environments vastly improve, and while
cheap labour used to be the top attraction for us... now we are also looking at Tianjin's financial and logistics services and local sourcing. We may shift some logistics and sourcing functions to local service providers.
The Ministry of Commerce and Tianjin Economic-Technological Development Area (TEDA) agreed to establish a 'China Training Center for Outsourced Services' to support the development of the Binhai New Area and to  provide a 'new mode and mechanism for training of talents for outsourced services.' Recently the Binhai area has also emerged as an incubator for industries that adapt military products for civilian use, with potential projects involving aviation, aerospace, shipbuilding, electronics, and new materials and new energy.

Hong Kong's The Standard on Tuesday proclaimed Tianjin as being in 'pole position' to lead China's next wave of financial reform and to deliver the same spur to the national economy as did the development of Shenzhen and the Pudong area of Shanghai in the 1980s and 1990s.

Additional links and sources:
Binhai singled out as country's next economic engine, China Daily 11/08/07

Tianjin Binhai to attract foreign investment, China Daily 29/12/07

First training center for outsourced services in China set up in TEDA, Xinhua Newswire, 02/08/07

Tianjin becomes new base for military-to-civilian technology transfer, Xinhua 29/12/07
When it comes to product quality in China, it is "still too easy to break the law." Reuters on Wednesday reported Chinese Vice Premier Wu Yi adding a cautionary tone to recent claims of success in a four-month government campaign against 'shoddy goods':
"...in a country with as many people as ours and an industry whose technical and management skills are uneven, you cannot expect to nurture good production and consumer habits in the space of a few months... (A)lthough this campaign has solved some outstanding problems, the results achieved have only been initial ones.
The Vice Premier outlined a long list of issues still confronting the country, including (quoting the Reuters report) "the plethora of small factories in remote areas which often fall beneath the radar and lack of awareness of quality problems among the Chinese public."

Silk Road International Blog recently profiled a factory in Jiangsu province with 20 years of international experience manufacturing two products "over and over" for a couple of large clients. Each employee does the same thing every day and there is little if any appreciation of quality control. And they are growing so quickly that,
while intentions are good, they are falling short in quality because of the inability of the 'family business' model to keep up with the new international level business they are attracting. They are going after bigger fish... appear(ing) bigger and more capable than they really are... The international standards/testing requirements are not even on their radar.
Unregulated factories in remote areas form part of the rural-urban disparity affecting the building of a harmonious society in China. Yet ultimately the responsibility of sourcing quality products from China lies as much with suppliers as with importers. China Sourcing News on Thursday reported the American Society for Quality conceding that much of the responsibility for quality problems resulting in Chinese product recalls lies with 'inadequate oversight' by U.S. importers:
...importing companies need to take more responsibility for their inadequate assessment of risks in dealing with foreign suppliers, insufficient supplier development activity and a lack of discipline applying quality basics with suppliers
who, in the case of China, include a plethora of largely unregulated factories who have little problem in breaking the rules.

From a China Daily report on Thursday, China's auto production and sales are both likely to hit a record 10 million units in 2008. In 2006 China surpassed Japan to become the world's second largest car market, trailing only the U.S., and is currently the world's third largest vehicle producer after Japan and the United States. Set to play an integral role in China's burgeoning consumer spending, vehicle sales jumped to 7.95 million units in the first 11 months of 2007, a 23.3% year-on-year increase. (Even in the Tibet Autonomous region, where according to a Xinhua report 1 in 20 people now own an automobile, due to soaring car ownership vehicle tax has been introduced for the first time.) Reflecting China's expanding industrial prowess in the automotive sector, these developments are part of China's high-tech industry growth which, according to Wu Zhongze, vice-minister of science and technology, has averaged 27% each year for the last five years. While allowing domestic products to substitute imports, innovative homegrown technologies have given domestic car makers a 17% share of China's total auto sales in 2007.

According to a Deloitte Special Report entitled Future Drivers of the China automotive industry, in 2005 the total value of automotive products and export volume of vehicles from China for the first time surpassed the corresponding imports into China. International demand for Chinese vehicles have been steadily increasing, especially for light weight trucks, and a few ambitious Chinese automotive companies are planning to export to mainstream markets in Europe and North America. Yet despite a savings potential of 10-40% or more on landed cost for simple components with high labour content, sourcing from low cost automotive suppliers in China is a risky undertaking complicated by immature suppliers lacking reliable information and compliance controls and who are often unable to meet the demands of international procurement.    

An IBM Business Consulting Services report on 'how the Chinese view their automotive future' found evidence of 'euphoria' about the development of China's automotive industry, yet also 'uncertainty' about the 'significant gaps and challenges for both domestic and foreign companies relating to a host of issues including poor quality, unknown/uncertain supply, lack of a clear export strategy and intellectual property concerns limiting the introduction of new technology.

Our study results pinpoint a number of serious challenges...including defaults on auto loans, uncertain relationships with joint venture partners, higher demand for oil, higher pollution levels, and severe traffic problems in the cities. (Yet) Chinese manufacturers and suppliers realize the need for research and development capability and are taking steps to close the gap between themselves and their world-class competitors.

Ultimately, as the Deloitte report concluded, automotive sourcing from China 

is a strategy, not a tactic. Give it the commitment and attention it deserves and you will gain both short-term wins and long-term sustainable improvements.

The China Economic Review today mentions an article in the South China Morning Post reporting on Liu Yupu, a protege of Hu Jintao, who has been named as party secretary in Shenzhen. Liu is said to confront three major issues facing the Pearl River Delta: upgrading the electronics industry, attracting new talent and maintaining industrial advantages despite rising costs. 

Yet despite facing higher labour costs and intense pressure to keep prices low, Chinese industrial companies' profits rose 36.7% in the first eleven months of 2007. According to a report on Bloomberg on Saturday, combined net income climbed to 2.3 trillion yuan, while sales jumped 27.6% to 35.5 trillion yuan. As the government tries to decrease investment in factories to curb environmental damage and prevent the risk of industrial overcapacity, spending on properties and factories in urban areas climbed 26.8% in January through November from a year earlier. The government has ordered state-owned companies to pay as much as 10% of profit as dividends to soak up more of the money that could fuel investment.

In an extended and very insightful assessment of manufacturing in Shenzhen and the state of Chinese manufacturing generally, James Fallows in the July/August edition of Atlantic Monthly describes China's factories as the country's backbone:

Most of what has been good about China over the past generation has come directly or indirectly from its factories. The country has public money with which to build roads, houses, and schools - especially roads. The vast population in the countryside has what their forebears acutely lacked, and peasants elsewhere today still do: a chance at paying jobs... Americans complain about cheap junk pouring out of Chinese mills, but they rely on China for a lot that is not junk, and whose cheap price is important to American industrial and domestic life. 

Indeed, Liu Yupu in Shenzhen would probably be heartened by Global Sources' 2007 China Design Capabilities Survey, which indicated that 66% of mainland China's electronics design engineers are looking to extend design functionality, while 56% are concentrating on designing products with more reliable performance.

Yet in sourcing products from China, Supply&Demand-Chain Executive cautioned in a commentary yesterday, 'all that glitters may not be gold.'  

There is money to be saved and quality products to be had in China. You can save up to 40 percent of your manufacturing costs, but only if you can avoid the potential margin-eating pitfalls. The caveat being that the management time and learning curve dollars are a burden that few companies want to absorb. Unless you work through experienced domestic suppliers to manage the risks for you, be ready for late nights, early mornings, frustrating phone calls, confusing e-mails, and some long and grueling trips... 

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