By Steven H. Ganster
For a successful supply chain in which China is a main source of your raw materials or destination for finished goods, you need to operate in a high state of readiness. The combination of stark differences in business systems with the West, long travel distances, and constant and sometimes turbulent change make it imperative that you have a "China-ready supply chain." This article first describes why your supply chain needs to be "ready" and then discusses the key attributes that indicate a high degree of readiness for doing business well with China and getting excellent performance from your supply chain.
Whether China is "here to stay" as a market is no longer a debate. Depending on which economist you believe, China will be the world's largest economy in about 15 to 20 years. Further, China is so inextricably intertwined with the global marketplace that, like it or not, China will affect you, your customers and your supply chain. China is not just another emerging market that will move from a sunrise to a sunset state, politely giving way to the next "hot market." China is a locomotive economy. The group of G8 countries now patronizingly reaches out to emerging countries like China to be unofficial members of its elite group (what is now known as the G8+5). In reality, China has economically blown by most of the G8 markets, like Russia, France and Canada, to name a few.
In short, we must proactively deal with China. Any global strategic plan without China as an integral part needs a reality check. Despite its rising costs, China can still be considered the workshop of the world, boasting exports approaching $1.5 trillion in 2008. At the same time, China's 1.3 billion consumers present an almost unimaginable latent market potential for a broad range of goods and services. As a result, our supply chains are umbilically connected to China's economic womb.
In preparing your supply chain to be China-ready, a number of key challenges must be addressed:
- China's vast and complex market landscape. China crams its 1.3 billion citizens (estimates of China's population range from 1.2 to 1.5 billion, the margin of error being the size of the United States) into a space the size of the continental United States, and it boasts more than 170 cities with a population exceeding 1 million residents. Almost 70 percent of economic, trade and investment activity is focused in a small group of provinces along the east coast, yet China's domestic infrastructure is very inefficient. As a result, moving goods within China takes time and costs a lot of money. Transport costs can be 40-50 percent higher than comparable figures in the West. There is a shortage of railway and river transport capacity, internal toll rates can be obscenely high, and the technology of the freight movers and handlers is pathetically low.
- Opaque financial and legal systems. Those active in China know that things are often "gray." Many Chinese firms will have two or more sets of books, with the real numbers in the head of the owner. While many new laws are being promulgated, their interpretation (not to mention enforcement) leaves much to be desired. China is still a country of "rule by man" versus "rule by law." This lack of transparency makes it difficult to know what your real costs are and certainly makes it hard to know with whom to do business and, of course, whom to trust. As a result, financial planning must be done with an uncomfortable level of uncertainty.
- Huge cultural and business system differences with the West. In the scale of human development, China's economy would be barely out of adolescence. Business systems are immature, and Western-style management experience is hard to find. This is coupled with sharp cultural differences with the West in terms of values, communication style, organizational hierarchy and even life experience. Understanding and appreciating the differences in business culture in China is one of the most underestimated challenges faced by Western management. Intertwined with these business and cultural differences is a pervasive level of corruption, either outright graft or more subtle gray tactics in business practices that often depend heavily upon relationships (guanxi). Progress in this area is taking place, such as in intellectual property protection, but it will take generations to fully eradicate the old ways of doing business.
- Rapid pace of change. The constant dynamism in all aspects of China's economy only aggravates the above challenges. For example, within the last two years alone, China's currency has appreciated by 20 percent, the VAT rebate on exports was reduced to almost nothing, oil reached $150 a barrel before falling back again, and a new labor law has gone into effect. The combination of these changes has cost many Chinese exporters about 30 percent of margin. (Interestingly, as this article is being written, China is again raising the VAT rebate for a number of products in response to the duress of many Chinese exporters.) The ripple effect to Western companies' sourcing strategies has been equally disruptive as costs have gone up, suppliers have abandoned ship and transport costs from China to the West make current sourcing patterns questionable. Planning for China is like shooting at a moving target.
In sum, China presents some formidable and even unique challenges, which make it imperative that our supply chains are ready in order to perform competitively and stay in tune with the shifting landscape.
In my work with many Western companies, both sourcing from and doing business in China, I have observed a number of attributes that indicate a company's supply chain readiness. While not all inclusive, the items below tend to be important factors that many companies typically overlook. As you consider your own supply chain structure, process, organization and people, determining how you rate on these attributes can be a good index of your readiness level.
A good supply chain begins with clear alignment to corporate strategy. In today's complex global marketplace, supply chain strategy is a core component of a company's financial success — maybe the core component. Too often, management puts structure before strategy, letting legacy systems, old ways of thinking or opportunistic business deals lead their strategy development. Those companies that religiously observe strategy before structure are the clear winners, always keeping supply chain structure subservient to the company's strategic goals. This approach involves forward thinking and often creative solutions, such as partnerships with unlikely players in your value chain, going up- or downstream in your business to capture more value-add or control of the supply chain, changing your organizational structure to incorporate more international management or redesigning reporting relationships and responsibilities. To identify these opportunities and achieve good alignment, supply chain issues must be elevated to the highest level within corporate management.
Given the opaque business environment in China, a lack of full transparency can be a huge liability. It opens the door to financial risk (leaving money on the table); intellectual property risk (stolen technology, piracy or corruption); and even legal risk (customs violations, lack of FTC compliance and, as we have recently experienced with toys, dog food and infant formula, health violations). In short, we require a high level of visibility from our supplier's supplier to our customer's customer. To achieve this level of transparency, we need on-the-ground market intelligence, rigorous information requirements and close cooperation with our supply chain participants. This task requires constant vigilance and is not cheap, but the rewards are significant.
One aspect of particular importance in the area of transparency is the need to understand total delivered cost. Too often, management's cost analysis is incomplete. Too many companies still buy "FOB China port," leaving on the table an unknown and not unsubstantial domestic freight cost. In determining a sourcing decision, management does not consider all the costs, such as management time and travel, legal and financial overheads, and more. A good starting point to achieving full transparency is to expose the total delivered cost. This exercise will force you deeper into the supply chain at all levels, which will also uncover important nonfinancial factors, such as raw material sources, compliance issues and the like.
Pursuit of Partnerships
As sourcing from China has become more difficult and more important to the livelihood of firms in the West, the way companies relate to each other is also changing. Partnerships with key participants in your supply chain can better enable you to streamline your processes and make them more secure while also enhancing transparency. Managers willing to consider new types of partnerships with key suppliers, customers or intermediaries are often more ready to face dynamic challenges in the global marketplace. The goal of partnership is to achieve a more intimate and cooperative relationship with key supply chain players. This closer relationship is designed to:
1. Further intertwine the companies' objectives, making them more interdependent and achieving strong organizational alignment.
2. Make possible a high level of transparency in all aspects of the relationship.
3. Establish a safe environment in which technology, process and best practices can be shared openly — further strengthening both parties through ongoing relationship building.
4. Enable more flexibility to adjust to unexpected market changes, promoting an attitude of working together to find effective and fair solutions.
5. Ensure a higher level of stability and predictability in a very turbulent and uncertain environment, providing sustainability and effective risk management.
Successfully establishing partnerships is not easy and requires a shift from the prevalent vendor management attitude held by many firms today. The structures of these partnerships can also be diverse, ranging from contractual supply agreements to shared equity. The common denominator will be the foundation of trust and integrity undergirding the relationship. Management needs to be ready to explore new types of relationships to address the many unique challenges of an increasingly complex global supply chain.
As China-oriented supply chains have expanded and matured, having the appropriate resources on the ground has become more critical. These resources include the right people in the right reporting relationships, supported by the right amount of technology and processes. Yet even with the right mix of resources, performance will suffer without effective relationships that seamlessly integrate these resources with corporate headquarters (and other geographic centers as appropriate). In my experience, companies tend to be too slow to invest in these resources due to cost concerns, operational complexity and the difficulty in finding quality people. Yet these resources are the key to ensuring strategic alignment, achieving full transparency and developing quality partnerships.
Typically, Western companies will establish only basic quality control and procurement functions in China but stop short of adding resources in other important areas, such as product development and design. China is rich in these resources. Though they may be a bit raw, they can, with proper guidance, provide very cost-effective and even creative support to corporate teams. Additionally, deploying a senior company manager to China can empower the local organization and ensure smooth communication with headquarters.
Too much reliance on third parties for market intelligence or operational control handicaps a company's supply chain readiness. Having your own hands, feet, eyes and ears on the ground significantly enhances your ability to optimize your supply chain's performance.
In conclusion, the stakes for getting things right with our China-based supply chains have been raised, with the cost of failure potentially fatal. We need to do all we can to ready our supply chain to deal with tough and ever-changing challenges. Applying old solutions to a new, flat global marketplace just won't work! As I like to say to those struggling to get things right in China: "Everything is possible, but nothing is easy."
About the Author: Steven H. Ganster is CEO of Technomic Asia, a strategic consultancy with more than 20 years of experience helping clients plan and execute Asian growth strategies. Technomic Asia is a division of supply chain consulting firm Tompkins Associates. Ganster is also the author of "The China Ready Company."