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China's competitiveness in a strong-yuan world
By George Zhibin Gu
SHANGHAI - China's surprise July 21 revaluation of the yuan will probably prove
to be the most important business story of 2005. As a result, both inside and
outside of China, there has been a great deal of commentary on how different
sectors of China's economy stand to gain, or lose, from the policy change.
But the most important question is, how will the stronger yuan affect China's
competitiveness over the long term? In fact, when the question is seriously
analyzed, the answer is that the revaluation could boost China's general
competitiveness. What is more, the entire world may benefit from a more
competitive Chinese economy. China's most basic economic challenge, for the
next generation, will be to move from a low value-added, investment-driven
economy to a high value-added, efficiency-driven one. The stronger yuan, and
the outside world, will both play a significant role in causing this shift.
Business chains: China's hidden strength
China's vast, underpaid labor force is widely regarded as the foundation of its
competitiveness. But cheap labor is not the key ingredient in the recipe. True,
the average manufacturing job in China pays only $115 per month. But many other
developing nations, such as India and Indonesia, have a large supply of
inexpensive labor - yet China has pulled ahead of them, and other developing
nations, as a top business and investment center. Why?
What has made the biggest difference is that China has successfully built a set
of complete business chains, especially in the manufacturing sector. The term
"business chain" encompasses all the phases a product goes through before it
reaches the customer, from raw material, to parts manufacturing, to assembly,
marketing, the provision of technology and capital, and so on. To a far greater
extent than competing countries, China has successfully achieved critical mass
for its business chains: increasingly, all the required elements are present
within the country. China's business chains increasingly directly connect final
products with global markets and buyers: In 2004 alone, Wal-Mart purchased
about $18 billion worth of products made in China. General Electric (GE) aims
to reach $5 billion in outsourcing in China in 2005, and Philips did $9 billion
of business in China in 2004.
A major reason for the localization of business chains in China is that the
country has become the number one global consumption market. In 2004 alone,
China manufactured nearly 180 million mobile phones, 80 million of which were
sold to Chinese customers, helping to make China the world's biggest mobile
phone market with 360 million subscribers. International telecom players have
little choice but to compete in China if they intend to win in the world
marketplace. Nokia's global leadership in 2004 was helped in no small measure
by its $6.9 billion in business from China.
The great advantage complete business chains offer is that all manufacturers,
Chinese or domestic, can make all sorts of products in one place - China. In
one extreme case, Geely Group, a private, fast-growing Chinese firm which has
been manufacturing cars since 1998, has been able to sell nearly 100,000 cars
to 27 developing nations in Southeast Asia, Eastern Europe and Africa. Its
quick growth comes from the fact that there are already thousands of auto parts
makers inside China. Geely Group is no more than an assembler of parts made by
these Chinese manufacturers. However, it has been able to produce the cheapest
cars in the world: Geelys sell for as low as US$3,800, a price point which has
created a market not only in China, but in many developing nations as well.
Improbably, the company is even planning to team up with the Hong Kong
government for a new plant in Hong Kong, which aims to sell sedans to the
international market.
Foreign MNCs and the business chains
China's complete business chains have helped the country's enterprises to
exhibit the international economy's key virtues: efficiency, convenience,
competitiveness and low cost. A small increase in the value of the yuan
exchange rate can hardly harm these ever-growing business chains. The latest
trend is for foreign multinationals to set up research and development centers
within China; IBM, Sony, Philips, Microsoft, Siemens, Intel and LG have set up
more than 600 R&D centers in the country. These centers are not only
responsible for producing products localized to cater to Chinese demand, but in
many cases, next-generation products for the global markets. Countless
businesses from the developing world have also rushed into China, developing
the business chains even further.
The business chains are bound to expand further because all their participants,
whether foreign or Chinese, have a vested interests in their continued
progress. As long as China continues to be politically stable with fast-growing
consumption as well as a friendly business environment, foreign investors and
multinationals will continue to treat China as a priority.
Different nations are now trying to take advantage of the opportunities China
offers to boost their own long-term development. But some are doing better than
others. Japan, in spite of recent Japan-China tensions that have somewhat
cooled Japan Inc's ardor for China, is arguably doing better than US Inc. The
auto industry is an example. Both Japanese and American automakers have sought
to reduce costs by shifting production to lower-cost countries; US firms have
mostly gone to Mexico, while Japanese firms have used China. But the scale of
Japan's investment in China is greater, and partly because of the greater scale
of the market in China as compared to Mexico, the potential gains to Japanese
firms are greater. Japanese automakers are now considering selling their
Chinese-made cars to international markets.
The challenges of the strong yuan
At the same time, the yuan's appreciation will undeniably take a toll on
Chinese exporters, in particular textile and consumer product makers, whose
profit margins were already low, usually below 5%. Any punitive measures
imposed by foreign governments would have more adverse consequences on their
health.
Domestically, there are tough issues raised by the strong yuan. One of the most
pressing is overcapacity, especially in the manufacturing sector. This problem
is worsened by two factors: first, there are simply too many players in most
economic sectors. In air-conditioner manufacturing, for example, there are more
than 50 companies now, although this is actually an improvement from the 400
that existed in 2000. Though the market is still growing fast, many of these
companies are no longer profitable. Kelon, the Chinese market leader in making
cooling products, which trades on both the Hong Kong and Shenzhen stock
exchanges, has been making serious losses lately, chiefly due to the
overinvestment in the sector. But achieving a rational consolidation is
difficult, because most of these companies are still controlled by government
units. Consolidation is clearly necessary, and would be easier if political
interests could be separated from the business world. But this remains a tough
task for today's China.
Another difficult issue is that most Chinese manufacturers don't have
sufficient intellectual property and cutting-edge technology. Instead, they
must pay high prices to buy technology from the outside world. This problem is
a significant contributor to the poor profitability of many Chinese
manufacturers. For example, in 2004, China produced some 70 million TV sets;
but most Chinese TV makers lost money.
In general, to most Chinese manufacturers, the yuan's appreciation will produce
both good and bad effects. On the minus side, their already low profit margins
are further eroded by loss of the competitive advantage provided by the weak
yuan when selling to Wal-Mart and other international buyers. But on the plus
side, throwing away the undervalued-currency crutch could force them to become
more competitive. This means that China Inc would have no choice but to focus
more on innovation, intellectual development and rational consolidation, among
other beneficial measures. In the long term, this pressure should make China
Inc perform better.
Strategies: M&A or OEM?
One interesting development lately is that China Inc is increasingly interested
in expanding into foreign markets, to look for new markets, better technology,
established brands, distribution networks, new resources, or all of these. But
international expansion is risky for any multinational, let alone a Chinese
company, given that China Inc is the least experienced group in the
international marketplace.
This difficulty is made worse by the fact that nearly all members of China Inc
are financially weak, which forces them to target only financially troubled
assets when searching for merger and acquisition opportunities. Unfortunately,
making troubled assets perform can be extremely tough, as TCL, a top Chinese
consumer products manufacturer, found out when it recently acquired Thomson's
TV unit and Alcatel's mobile phone assets. Both units were unprofitable when
acquired and TCL has yet to turn them around. Lenovo's recent purchase of IBM's
troubled PC unit has run into similar troubles.
But there are other business models that have turned out to be more positive.
One highly successful case was Galanz, the Chinese leader in microwave ovens.
Galanz' key strengths are low costs and an original equipment manufacturer
(OEM) business model (OEMs manufacture products for other firms to sell under
their own brands). The same microwave that takes $90 for an European company to
produce, Galanz can make for $30. As a result, Galanz has attracted dozens of
OEM clients from all over the world, including GE and Philips. Most
interestingly, many of its clients have shipped their entire assembly lines to
Galanz's homebase in Guangdong. Galanz has used this model to become a global
leader with a global share of some 40%.
The company has expanded its product lines to include air conditioners
recently. In 2004 alone, it shipped 1.56 million air-conditioners to the
international market, making it the Chinese export leader in this category. At
the same time, Galanz remains a minor player in the domestic air-conditioner
market. For now, it is expanding its production and hopes to reach 6.5 million
air conditioners per year - mostly for export. Although the yuan revaluation
will reduce Galanz's price advantage, the magnitude of the change is too small
to alter its competitive advantage, and most export-oriented firms in China
remain in this category.
China has successfully integrated its economy with the global economy to a high
degree within the last three decades. Though there remain huge trade, political
and economic issues for China and the outside world to work on, the entire
world has directly benefited from the expanding Chinese pie. The small, but
decisive increase in the yuan's value shows, above all, that China is committed
to playing its part in the maintenance of a stable, growing global economy.
George Zhibin Gu, a business consultant based in China, is the author of
a new book, Made in China: Players and Challengers in the 21st Century (Portuguese
edition, www.CentroAtlantico.pt) and a forthcoming book, China's Global
Reach: Markets, Multinationals, and Globalization (English edition, Trafford,
Sept 2005). He can be reached at gzb678@yahoo.com.cn.
(Copyright 2005 George Zhibin Gu) |
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