The China syndrome

The global economy is changing at a rapid rate and even though a large amount of equipment used by the trucking industry is still built here in Australia, or sourced from North America, Japan or Europe, a large proportion of the components used in their manufacture are sourced in places like China. More and more manufacturing is relocating there.

Many of the suppliers the trucking industry deals with on a day-to-day basis will be engaging with China more deeply in the coming years. This engagement will be changing the way they do business, the way products are developed and, hopefully, keep equipment prices down but quality at its current level or above.

A better understanding of how the Chinese do business and the way they interact with their western partners is a good way to get a handle on the character of the relationship between the products the industry buys and how they are going to be made in the future. Speaking at a recent industry forum, Martin Toomey, General Manager of Eaton Vehicle Group Australia/New Zealand, talked about his experience in setting up a business in China and running through the kinds of issues western manufacturers need to be prepared for when dealing with this massive economic machine.

“I have experience of entering China as a multinational company making heavy duty truck components,” says Martin. “I spent four years establishing a wholly-owned foreign enterprise, a ‘WOFE’, and a couple of joint ventures. There are 4257 small and medium sized businesses in Australia doing business and actively involved in China. That’s a lot of organisations that have some skin in the game, where they have invested in developing their relationship or even set up their own entity in China. Many of those businesses will be facing the stark realities of doing business in China.

“If you’re going to do business in China, you really have to understand more than just the demographic numbers. You need to understand the issues facing the leadership in China at every level within their domestic economy. It’s essential to understand the goals of the leaders, who will be your partners in any enterprise, it doesn’t matter what kind of entity you have, they will be involved.

“The political economy in China is one of the most important factors in their success, but it’s also very much a hindrance to the way China can transform in the future. There are three main drivers and constraints in China today, urbanisation, the emerging middle classes and the political economy.”

Urbanisation is going on at a massive scale in China. It is the largest migration ever in history, millions of people are leaving rural towns and heading into the cities. In order to get an idea of the scale of this, the agricultural area of the United States is around the same size as that of China, in the US the area has 7 million people working in it, in China there is 450 million. They are leaving the land and looking for employment.

In most mature economies the middle classes tend to be an ageing demographic. China’s development didn’t really start until 1992 so the new middle-classes come from the younger generation. Their newfound wealth is driving a lot of demand for items like cars and white goods. It is also influencing the older generation who will remain happy with the system as long as their children are progressing with an improved lifestyle.

It is difficult for us here in Australia to comprehend the sheer scale of China and what is going on there. In fact, there are 96 cities in China which are bigger than Sydney. The Chinese government makes every important decision, there is no entity that can function without the government say-so. There are five layers within the political economic system. Starting with the national government at the top, there are 31 provinces, below this there are over 650 municipalities, these are broken down into counties and, at the bottom, around 41,000 townships.

Businesses going into China start their negotiations at the municipality level. There are a number of incentives they are looking for. These can range from smoothing the process to gain a business license to offering land for free or at a token price. They can also offer loans and tax advantages. The provinces are all competing against each other. Although business tax goes directly to the central government, GST is paid to the province and is an important part of provincial revenue.

Every person in the structure has been appointed by someone above them. Workers in the municipality are dependent upon superiors in the province and so on. This is the way central government influence is passed down through the pyramid – everyone’s job is dependent upon the opinion of someone in the next tier above.

“The more time you spend in China, the more you realise they are at a crossroads,” says Martin. “In order to get innovation into an organisation you have to have a tolerance for failure. Nine out of ten innovative ideas fail. In the western world innovation comes out of deep scientific and technical research followed by testing and validation, until finally you launch something that is almost perfect.

“In China, you won’t see technical innovation, but more likely commercial innovation. They have recently been launching electric cars. The first launch was an absolute failure, a complete flop, you could hardly drive these cars out of your driveway. Why on earth would anyone want a car which didn’t work? They don’t have our innovative concepts, they expect the market to give them feedback about how the product performs and how it can be improved.

“It will often take them four or five launch iterations before the product is anywhere near usable. Given the way the political economy is structured, if you are heading a municipality and within your state there is an electric car maker, you will use your own population as a test pool. Often these vehicles will be put into public use, taxis, shuttles etc. But the scale is there, they could use 30,000 vehicles tomorrow. It wouldn’t be tolerated in most countries, but in China you can do it.”

Historically, China has skipped a number of important stages in the development of science. 500 years ago they were technically advanced but since then there has been very little progress with no depth of scientific scholarship. China sees itself as being a leader in global manufacturing in the future and not much more.

It is important for westerners to realise the customer is in fact the state and they have to treat the market in a different way and need to find out what the state’s requirements are. This can then open the door for a company and the state will give them market share. There are only five major truck manufacturers in China, because the state controls the market.

The Chinese heavy duty truck market has a large array of vehicles available. They range from some very modern looking vehicles to some primitive models. There is now a lot of European influence on the more modern vehicles. Around 950,000 heavy duty trucks will be built in 2012 in China.

If these major players in the Chinese truck market want to continue to extend their growth they will have to look overseas. Southeast Asia and Australia is very attractive to them as it is close and relatively easy for them to service.

MAN has signed a technology agreement with CNHTC, Sinotruck. It has given the company the entire TGA truck platform technology. So it now has access to one of the best selling trucks in Europe. Cummins has got agreements and joint ventures in just about every sector of the truck engine market. It is already starting to export its Dong Feng Cummins engines to be fitted in Kamaz trucks in Russia.

“Often what you find, as a foreign investor in China, is that when you have set up your business it is quite easy to win the first bit of business,” says Martin. “It’s like a hook, they want to bring you in, they want to partner with you, they want to learn about your technology. The research and development team are very interested and will ask you a lot of questions about how stuff works. Most organisations are very happy to tell them. Then they can create a truck which they can take to any truck show in the world and it will have disc brakes, ABS etc. It looks good, very sexy, but those vehicles don’t sell, not in China and they’re not suitable for export.

“Phase 2, after the vehicle has been launched, sees negotiations between the foreign investor and Chinese manufacturer. They want you to sign contracts and your organisation would normally stay away from unlimited consequential losses or payment terms at 180 days, warranty you can’t dispute and many more. At this point business starts to get very ugly.

“Then you get into phase 3, thinking you have got through the worst of it, you haven’t. While you were arguing about all of the contract terms in phase 2 they have moved on. They now introduce supplier number two and supplier number three, local suppliers using your drawings and design, taking your specifications and all the information the R&D department has given to them. They are now using everything they learned about you in phase 1 in phase 3. It’s a familiar pattern, I’ve been through it and I am seeing other foreign investors going through it today.”

The solution, according to Martin, is to go into the initial phases of the relationship with a product developed specifically with China in mind. By relaxing tolerances and material quality the overall costs are lower from the start. This produces components which will work well but only last three years on the truck, this is what the Chinese market expects. A company can’t try and sell a component designed in Europe to last at least 12 years on a truck. The components have to be fit for purpose, designed to suit the local market.

A large proportion of the suppliers to the trucking industry in Australia are somewhere on this steep learning curve. How they handle the situation and how well their organisation and product comes out of it will depend on the way they learn to work the system. Sourcing most manufactured goods from China is inevitable, we have no choice. Good old Aussie ingenuity will not be needed to make the component, but instead will be used to get the Chinese to make it to the standard and at the price we require.

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