China's growth as both a leading consumer and manufacturer of goods and services represents a huge opportunity for Canadian companies. But to effectively capitalize on this opportunity, firms need to move quickly to develop a comprehensive strategy that focuses on the key forces that drive advantage in China.
The imperative to take China seriously centres around five key forces: the growing size of the market; workforce and investment cost advantages; the threat of competitors in other low-cost jurisdictions; an expanding educated talent pool; and the relocation of customers.
These forces are also interconnected. Expanding your operations to take advantage of low-cost manufacturing and sourcing in China gives you better access to–and advantages in–the local market. Increasingly, however, to maximize growth and the low-cost supply base, you need some form of R&D to customize products for the local market and to work with suppliers to enable them to produce higher value-added components and products.
Failure to seize opportunities in China can leave companies on the outside looking in, as their competitors take advantage of new relationships–including supplying North American customers who have set up shop in China. Understanding and effectively leveraging these forces is critical for Canadian companies that are looking to take advantage of the huge market opportunity in China.
A new and expanding market
Economic growth in China has been dramatic in the past decade. Rapid efforts to modernize its economy have resulted in high GDP increases. With a population of more than one billion hungry for better infrastructure and more consumer goods, China is the biggest single business opportunity that exists today. It is a market too important for most Canadian businesses to ignore. In fact, China is already among the largest markets globally in a wide range of industrial and consumer categories. With this growth not expected to slow down any time soon, the list should continue to grow.
Canadian companies need to figure out what this means. They either need a strategy to operate in the world's largest market or to be convinced that their sector and customers are isolated from the forces at play. While companies have traditionally relocated manufacturing operations to rapidly industrializing economies (RIEs) like China primarily to take advantage of lower costs, once they are established in those countries they are naturally positioned to serve the growing local market.
Many of the companies that were early entrants into China have been able to take advantage of the opportunities presented by the rapid development of the domestic marketplace. GE Medical Systems is a clear example. When it set up shop in China, it transferred technology to local Chinese R&D centres, which then designed “Chinese” versions of GE's products. These met the local needs so well that GE quickly became a market leader in China. In addition, some of the Chinese products have proven to be a hit in other countries. By focusing on the local market, GE has created both a new market in China and a new worldwide segment.
As China's overall economy continues to mature, new segments of its domestic marketplace will likely develop very quickly. Companies that use China to source parts and products can take advantage of these local market opportunities.
The migration of sourcing, manufacturing, R&D, and service operations from high-cost countries (HCCs) like Canada to rapidly industrializing economies like China is well underway and accelerating fast. The labour-cost advantage will not diminish significantly in the near term.
China has more than 800 million people still living in rural areas. The migration of China's rural labour force to manufacturing jobs should mitigate any steep increase in the wages of the nation's low-skilled workers–for at least the rest of this decade.
Low cost no longer means low quality. Canadian companies can now source virtually anything on the other side of the globe for far lower costs and get equivalent quality.
But China offers much more than just savings on the labour side. Like other RIEs, it offers lower capital-investment costs, larger economies of scale and government incentives aimed at attracting foreign investment. Along with this, under the World Trade Organization, China is becoming a more corporate-friendly place to conduct business.
To support this push for new investment, China has been adopting favourable economic policies and making sustained investments in infrastructure, education and training. In addition, it has absorbed an extensive knowledge transfer from multinational companies that are already operating there. While overall it may have far less automation in its manufacturing compared to a country like Canada, modern management techniques, rigorously applied, are ensuring equivalent levels of quality.
Given these factors, the importance of China and other RIEs in the global economy will continue to grow at a rapid pace over the next decade. Globalization is affecting all major industrial categories and redrawing the playing field. This is putting pressure on Canadian companies to make the move to global operations. However, many firms continue to struggle with the seemingly daunting barriers to realizing this opportunity. The reality is that many companies will lose their traditional sources of competitive advantage in the face of the forces at play.
Access to growing talent pools
One of the early concerns about relocating manufacturing operations to China and other RIEs was the lack of skilled labour. The reality today is that most of these countries have vast numbers of talented, trainable and loyal workers, eager to move up the skill ladder. A heavy investment by the Chinese government to educate and train its workers means that the labour pool is available and ready.
Our research has found that the perceived productivity gap between western countries and China is often unfounded. Chinese operations tend to use far less automation and rely more on low-cost manual labour. The result is that while productivity on a per capita basis is often lower, capital productivity is much higher.
Concerns about quality from RIEs are equally unfounded. Once the initial bugs in the supply chain are worked out, quality levels are generally on par with those of HCCs. In service industries, quality levels actually tend to be much higher in RIEs than in HCCs. For instance, in RIEs many call-centre agents are university graduates, whereas in Canada these positions are often filled by staff with lower levels of education.
Significant R&D investments have also been made in China in recent years. As a result, the country is rapidly becoming a leading centre for R&D. Last September, the Economist Intelligence Unit released a report on the globalization of R&D. It asked companies where, outside of their home country, they plan to spend their R&D capital. China ranked No. 1, with 39% of firms indicating they will put R&D investment there.
Research costs tend to be much cheaper in China for many of the same reasons that labour is cheaper. In addition, in R&D, speed is as important as cost. With less automation and tooling requirements, testing and changes can be implemented more swiftly than in commercial production, negating many advantages HCCs have through automation in manufacturing.
New competitors based in China
Early entrants into China are creating competitive advantage by locking up sources of supply, building relationships, developing organizational capabilities and learning. Leading companies are pulling even further in front of the pack by exploiting the powerful synergies arising from lower costs, better efficiencies, and pioneering access to large and fast-growing markets.
Our experience has found that many companies are not thinking about China in terms of both risks and opportunities for improving competitive positions. Therefore, they are not preparing both offensive and defensive strategies. As a result, they are either unprepared for their traditional competitors gaining significant cost advantages through low-cost sourcing, or they miss opportunities for growth.
Chinese-owned companies are also quickly becoming powerful forces at home and globally as they leverage their low-cost position and heavy investment in R&D. In many cases, these firms are owned by the government and supported by heavy military purchases. Companies like Huawei, Johnson Electric and Techtronic are assuming dominant global positions. Huawei–which means “Chinese made”–puts a premium on R&D. Of the company's 23,000 employees, 46% are in R&D. Huawei's products are now sold in 70 countries around the world.
Relocation of existing customer bases
Canadian firms need to understand the China strategies of their customers. For instance, companies in the automotive sector are making investments in China not only to take advantage of cost savings but to supply a hugely underdeveloped but high-potential marketplace. Automotive suppliers need to anticipate and respond to the global migration of original-equipment manufacturers, to China.
We have found that many companies are taken by surprise when their customers relocate to China or another RIE.
A call to action
The convergence of these five forces means Canadian companies need to take China seriously. Significant opportunities exist for firms that take a strategic approach to the cost and market opportunities.
While some of the institutional and cultural barriers to doing business may seem daunting, these five driving forces are powerful reasons why Canadian businesses cannot afford to ignore the realities of an emerging China. Too few Canadian firms are carefully thinking through how their cost structures, business models and competitive positions could change as globalization rewrites the established rules of competition in their industries. Fewer still are taking strategic action now to create long-term advantage for their stakeholders. They have not taken the threat and potential of China seriously enough. Some are hesitating because they are: (a) misjudging the speed of change in the infrastructure of business; (b) postponing tough decisions around legacy assets and liabilities; (c) taking a static versus a dynamic view of the cost structure; (d) operating from old perspectives gained in '90s experiments; (e) underestimating competitors and overestimating the defensibility of historical advantage.
What companies need to do
Canadian companies need to take the threats and opportunities from China seriously and need to assess these along the “five forces.” Management needs to continually examine the dynamics of globalization. At a minimum, they should perform an initial assessment of the opportunities for China and other RIEs, as well as potential threats. We have been surprised to find that very few companies–Canadian or otherwise–understand the inroads globalization is making into their businesses. Fewer still take a systematic approach to evaluate their business portfolios for these threats and opportunities.
Companies need to ask some fundamental questions:
Which products are in motion? Determine how fast your industry is moving offshore–and what product lines are leading the way. Understand who your competitors are and how much share RIE-based operations have of the market. Then analyze the economics and efficiencies driving the trend and how fast it is likely to accelerate.
Which customers are in motion? Determine which of your customers are moving offshore–to what extent and how fast. You need to know if your customers are winning or losing the globalization drive. You need to know how you can improve your value proposition so they continue to choose you as a supplier. You need to know how you would supply any customers that may decide to move.
Which assets will become liabilities? In light of likely migration patterns, you need to understand the physical assets, investments and people that might be affected by migration.
Thinking systematically about your business portfolio in terms of China will give you a baseline to assess product, customer and asset portfolios, and determine which are best suited to remain in Canada, those to divest and those that should be relocated to China or another RIE.
With this information in place, companies can imagine a “what's best” global business built on lowest global cost, best global capabilities, largest and fastest-growing markets and most promising customer connections. You can then reset your company's priorities to face the inevitable gaps, address the interdependencies, reset your priorities, strategies and organization, and then build the execution platforms and manage the risks.
Peter Stanger is a vice-president and director of the Boston Consulting Group and manages its Canadian practice from Toronto. Jim Hemerling, formerly of Toronto, is now Boston Consulting's managing director for Greater China and is based in Shanghai.