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How To Research & Evaluate Outsourcing Opportunities In China Part 1 of 4

Part 1 of a new white paper written by B2B International’s associate consultant Dr Daniel Park. You can catch part 2 on Friday 30th March. For more information on researching Chinese markets visit the webpage of B2B International China.

First thoughts

Imagine you are the CEO of a medium-sized manufacturing company operating in Europe. Recently you have lost a major piece of business to a competitor that has offered equivalent quality product to yours at a price well below the level that your company can meet, and this competitor is bringing in the product from China. Just the other day you were reading something about the acceleration in migration of manufacturing into Asian countries to serve not only established Western markets but also the growing markets of Asia as they advance at world-leading growth rates. Is outsourcing from China becoming a necessity for your company in order to survive, let alone develop? Is it possible to research a “buy/importâ€? opportunity in a similar way to a “sell/exportâ€? opportunity? What are the opportunities and pitfalls? What are the risks in entrusting a part of your product range – either a critical component or a wholly finished product – to a distant source in a very different culture? What do you have to find out? How do you find it out?

Let us step back and start by considering China and the way in which this vast country and diverse society are moving in the 21st century. We need to look at both the economic and business dimensions.

The economic dimension – China’s performance and potential

China existed in a relatively impoverished and near-isolated state from the end of the Second World War up till the late 1970s, maintaining a cold-war hostile stance to all but a few small fundamentalist Marxist states. What has happened in the past 25+ years, since the then leader of the Communist Party, Deng Xiaoping, introduced the “Open Door� policy in 1978, has been nothing less than a true cultural revolution that has propelled China into the 21st century, with the prospect of becoming a leading (as well as a large) economy within the next 20 years.

Consider what has been achieved from a start-point as a backward agrarian economy with a heavy burden of military expenditure in changing into an increasingly diverse and globally active economy. Here are the main significant issues.

* China is the world’s fastest-growing major economy – around 9% per year sustained over the past few years.

* China is the world’s third-largest trading economy – US$ 1000 billion per year in foreign trade value.

* The technological level of the Chinese economy is rising rapidly – Chinese growth is NOT based exclusively on utilization of cheap labour.

* China’s foreign exchange reserves exceed US$ 500 billion.

* China is fully accustomed to trading in world currencies – this is one reason why its dollar (and other hard currency) reserves are healthy.

* China is a member of the World Trade Organization.

* China’s population of 1.3 billion is becoming increasingly affluent.

* China has put a man in space; is a significant nuclear power; and some parts of its manufacturing industry compare favourably with the best in the world.

* China is the biggest spender on research and development after the United States and Japan.

* New foreign direct investment is running at about US$ 50 billion per year and is growing.

* Chinese expenditure on overseas mergers and acquisitions topped US$ 2 billion in 2003 and looks set to reach US$ 4 billion in 2007.

* China is taking steps to end the fixed relationship with the dollar and to allow exchange rates and interest rates to become market-determined.

Let us look at this economic background in a little more detail.

There is plenty of theoretical debate as to when China will join the top 3 or 4 economies in the world and how this is measured. Leaving this theory aside for the moment, there is near-unanimity amongst economists that it looks set to happen during the next 20 years or so. A more important point is the remaining potential of China after this position is reached. When China reaches the same economic size as the USA, its GDP per capita will still be much lower. Assuming that Chinese economic policy-makers succeed in avoiding the excessive debt at national, corporate and individual levels that now plagues several major economies in the developed world, this growth can continue further as (a) the technological sophistication of the economy rises, driving demand for industrial products and systems, and (b) a greater proportion of the huge population gets more affluent and is in a position to afford more sophisticated goods and services, driving up demand in the consumer sector. Note how much significance has been given in the recent (February-March 2007) full parliamentary session to questions of raising the consumption component of GDP and introducing more modern mechanisms of consumer finance and credit into the Chinese economy.

Because the Chinese currency (renminbi) is at the moment pegged to the US dollar, Chinese exports have become cheaper as the dollar has declined. This position will change as part of the financial transition agreement in China’s accession to the World Trade Organization, and the renminbi will relate to an international basket of currencies. A convertible currency and market exchange/interest rates will change China into as much of an opportunity as a threat.

Somewhat differently from the earlier experience of other high-growth Asian countries, China is not building an export-led economy based on cheap labour coupled with high import tariffs and quotas. China recognizes that it requires raw materials, technology and know-how from the rest of the world and therefore takes the long view on the desirability of an open economy.

There is still a widespread view that Western organizations can concentrate on higher-value products and leave China to concentrate on low-specification, price-sensitive goods. This is an extremely dangerous and self-deluding view. China is developing an increasing number of companies – both indigenous and also in collaboration with Western partners – that can compete at the highest standards in any sector anywhere in the world.

The way ahead has, however, some problems.

The majority of the rapid growth in the economy comes from the coastal cities and Special Economic Zones and this has created an economic imbalance. Though much of the former state-owned sector has now been privatized, it is seriously inefficient and is increasingly a drag on the aspirations of Chinese economic managers. Major programmes for upgrading technology and systems are being introduced, along with Western management techniques, in order to increase the efficiency of this vast sector and to create new, smaller businesses in the supply chain as the inevitable re-structuring comes. China is consuming vast quantities of raw materials, particularly energy, steel and other basic inputs, contributing to the recent hardening of world prices for these vital commodities. There are programmes of conservation and improvement in material conversion efficiencies that address this major issue.

Perhaps most importantly, working with and through the Hong Kong financial and industrial community, Deng Xiaoping’s successors through to Zhu Rongji and Hu Jintao, have continued the process of privatization and technological upgrading of Chinese industry.

Understanding the economic dimension is the first part. Let us now turn to the business dimension.

This entry was posted on Wednesday, March 28th, 2007 at 10:16 am and is filed under Industrial Research, International Market Research, Market Assesment, Market Research, Market Research China, White Papers. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.