An intricate alliance

Jan. 1, 2020
The days of ?Made in the USA? are practically over. Pick an item from a retail shelf and it has likely been through China, had components made in China or was subsidized in some way by this massive economic power in the East. The second in a two-part

The days of “Made in the USA” are practically over. Pick an item from a retail shelf and it has likely been through China, had components made in China or was subsidized in some way by this massive economic power in the East.

One entity to thank is the ubiquitous Wal-Mart, which imports more goods from China than many entire countries: More than 10 percent of what China ships to the U.S. ends up on Wal-Mart’s shelves. But it would be unfair to blame one company for the mass migration of manufacturing jobs from our factories and our waning economic influence overseas. 

The dilemma we face — including a crippling trade deficit, the loss of millions of jobs, a price spike in raw material costs and diminished clout in the global business community — is the result of multiple factors, not to be solved with one sweeping solution, as some may believe.

As strange as it sounds, an answer to this dilemma could be to do even more business with China, taking advantage of a competitive marketplace and playing the game by their rules as we learn and understand just what contributed to this country’s rapid rise.

On the positive side, China’s influence and investments are expected to create U.S. jobs and opportunities that hearken to industries of old; China has also changed the business landscape through innovation, something upon which the U.S. once prided itself.

Moreover, China is responsible for the “China price” — the end result of low wages, thin profit margins and the utmost efficiency, offering a mixed benefit for consumers. Unfortunately, a typical U.S. resident who needs this China price most is someone who’s likely lost a job because his company cut costs to compete with the China price, an insight explained in Ted C. Fishman’s book “China, Inc.”

Illustrating China’s dominance in price-setting, Fishman writes, “General Motors, which buys more than $80 billion worth of parts a year, now has a clause in its supply contracts that gives its supplier 30 days to meet the best price a company can find worldwide or risk immediate termination.”

China exported $6.5 billion in auto parts in 2003, more than double what it did the previous year, according to Fishman.

Another effect of China’s growth is a spike in raw material costs. Copper, aluminum, zinc and oil prices have all increased due to China’s demand. (Recent gas price increases can also be attributed, in part, to a hefty demand from China’s factories.) The result of a massive construction boom, China bought 40 percent of the world’s cement in 2003, according to a Morgan Stanley economist. 

And China’s influence on the U.S. is more than economic. A mass of smog known as the Asian Brown Cloud has traveled over the Pacific via the jet stream to the West Coast, a grimy reminder of China’s proclivity for using unwashed coal in its factories. Fishman writes that the Brown Cloud may also be responsible for altering weather patterns — reducing rain in Washington, Oregon and sections of the Midwest.

Last month, we looked at China’s emerging automotive aftermarket and nascent system of parts distribution, as well as the dire ecological effects of China’s boom. This month, we’ll explore just how the U.S. can regain its global footing, and we’ll provide advice for those who want to take advantage of China’s influential automotive marketplace by seeking Chinese business partners.

Swimming against the currency

On top of being responsible for a record $160 billion U.S. trade deficit, China’s currency poses a pervasive problem for the U.S.

The country is accused of undervaluing its currency, the yuan, to increase exports, as well as pegging the yuan to the U.S. dollar. U.S. legislators plan to respond with a proposal that threatens a 27-percent tariff on imports from China if the country does not revaluate its currency.

However, aside from possible World Trade Organization violations, this plan may be a mistake for more than one reason, according to economists and writers.

The currencies of the U.S. and China are inextricably linked, and radical change in any direction could negatively affect the entire global community.

Were the yuan to be revaluated, or floated, China’s imports would become cheaper for its domestic market, but the large amounts of foreign investment flowing into China would dry up, causing risk to its banks, writes Gerard Baker, an editor for The Times of London, who adds, “Mountains of bad loans will emerge from the banks’ balance sheets like submerged icebergs.”

Also at play is the fact that China has almost $200 billion in U.S. Securities, a significant piece of the approximately $2 trillion in holdings by foreign countries.

If the U.S. decreases its deficit too quickly, the global economy could easily falter, adds Baker. On the other hand, should China or a number of other countries decide to “cash in” their U.S. holdings, the dollar’s value would drastically plunge and U.S. interest rates would spike.

Besides, if the yuan is adjusted, it would have little actual impact on the U.S. trade deficit, according to a recent article in The Economist, which argues that the only valid way to counteract the deficit is for Americans to save more money and buy less.

China accounts for only 10 percent of the total U.S. trade, and a 10-percent revaluation would reduce the dollar’s “trade-weighted value” by only 1 percent, the article adds.

It is said that China should instead establish a flexible exchange rate and peg its yuan to a number of currencies rather than to the dollar.

“Clearly, there are some triggers at some point that China is going to pull to revalue the yuan upwards,” says Merrill Weingrod, principal for Providence, R.I. business consultant China Strategies. He adds that any attempt at predicting a sure outcome is pure speculation. “For sure, no one has a clear insight as to what the effect will be.”

Weingrod, who assists U.S. and European companies looking to move manufacturing to China or set up stateside sales networks, insists that trade barriers are not necessarily the way to control deficits.

He points to a quota system once in place for importing textiles from China, to which China responded by becoming more efficient at production. When trade barriers are lifted, this usually leads to even more imports. 

Fishman notes that when 29 categories were removed from this textile trade quota in 2002, China’s goods imported into the U.S. nearly tripled, while imports from the rest of the world dropped 14 percent.

Creating your own competition

So you want to do business with China? As we pointed out last month, China offers unprecedented opportunity in both manufacturing and distribution for the aftermarket. But playing by their rules places you in an entirely different business game.

The country’s aftermarket is still developing, and as the distribution channels mature, millions of Chinese automotive consumers find themselves in need of sophistication with which the U.S. aftermarket is all too familiar.

Whether it’s moving manufacturing to China, importing goods for distribution in the U.S. or distributing Chinese-made goods throughout China, there are a number of things one must learn. Chief among them is you may end up creating your own competitors.

In order to do business in China, some companies are required to share intellectual property with the government (a key player in automotive joint-venture partnerships), essentially creating their own homegrown competition. And, unlike the foreign company, which must recoup its development costs, the Chinese manufacturer that appropriates the proprietary information can earn back its money almost immediately, giving a competitive advantage to China, points out Fishman.

“The auto sector is one of the few in which the Chinese government still twists arms to get foreigners to enter joint-venture relationships with the state,” he writes. “And yet, the state companies are not all hindered in their relationships.”

For example, adds Fishman, a company’s Chinese partners can enter into multiple business partnerships and share the technology with whomever they please.

“IP rights is a big problem (in China),” says Lance Ealey, auto analyst for the Freedonia Group. “You have a deal with a certain company and six months down the line you find a company has appropriated your product. What’s your recourse?”

Unfortunately, not much, because this is one of several routes the Chinese government seeks to “level” its playing field.

Another thing to know about China is many companies will “root for the home team,” says Ealey. “China’s interesting in that it is a bunch of different provinces and cities that tend to look out for their own. (The) biggest mistake people can make is looking at China as monolithic.”

This concept of looking out for one’s own is embodied in a term called guanxi, a social network that supersedes rules and conventions. Within the network, people promote the interests of the personal connections, even if it means using pirated software to run a business. Fishman quotes political scientist Andrew Mertha as saying guanxi was injected into Chinese society to create social order and trust after the Cultural Revolution.

“China today is still and will remain forever a highly relationship-driven culture,” says Weingrod, who’s affiliated with Kurt Salmon Associates.

This cultural tendency can be traced back to Confucianism, which centers around a highly structured autocratic system. “It’s really important for a person in Chinese culture to figure out how they fit in the system,” adds Weingrod. “China is more impacted by the relationships that people have with each other than the West is. We’re more strategic and abstract thinkers.”

To fully understand China’s difference from the U.S. in its relationships may take years, he adds, though, “It should be part of your strategy before entering.”

Good or bad, guanxi is a fact of life in doing business in China. Frank Ordoñez, president of Delphi Product & Service Solutions and vice president of Delphi Corp., says he sees the importance of guanxi in the company’s business relationships.

For example, “Delphi’s top person in China is Chinese...Make sure you’ve got Chinese people who understand Chinese customs and culture.”

Ordoñez also recommends getting trading licenses that transcend provinces due to the fact that each province usually has its own set of rules.

China offers a complex tax advantage with its various foreign enterprise zones, says Weingrod, but the logistics of moving a company around can be expensive and antiquated.

In researching China’s business landscape, Weingrod warns that this information must be augmented with research obtained “from the ground.” In China, there isn’t the wealth of research information that’s found in the West, he adds.

But before any of these points are considered, it’s advised that you do your homework thoroughly when creating business plans and seeking the Chinese business partner.

About face

Countries with cheaper manufacturing potential than China can be found, says Weingrod, but Chinese workers are “culturally programmed” to be incredibly efficient.

He describes an issue of “face,” where it’s embarrassing to be wrong in public. This produces an internal drive in employees not likely found anywhere else.

“The issue of face in China compels the worker to do a really good job on the production line,” he offers, adding the ratio of production managers to employees in China is lower than anywhere else.

There’s no way to train a work force to gain the inherent motivation of the Chinese  worker, surmises Weingrod. 

Fishman describes lines of clean-cut uniformed employees at a Wanfeng automotive factory who begin their day doing calisthenics to music played over a PA system: employees who likely were subject to “company boot camps run by People’s Liberation Army drillmasters, who inculcate the twin virtues of patriotism and hard work.”

Weingrod experienced this worker efficiency firsthand when he was in the leather business. He recalls visiting a hut in rural Wenzhou where barefoot men in leather production sat on the floor staring at pieces of leather that would have been thrown out in any other workshop. The men studied the irregular leather patches, marked with holes, and proceeded to fill in those holes by gluing in scrap leather pieces one by one. 

Weingrod’s first thought was that this was not cost-efficient. Then he realized: “This guy is making 60 cents an hour; the leather costs $4 a sq. foot.” So if the worker takes an extra hour filling in holes, money will still be saved in the long run for the company.

This story is illustrative of the level of productivity embedded in the Chinese workforce, believes Weingrod.

Often times, the Chinese will opt for labor-intensive solutions rather than technical solutions, he adds. Aside from increased profits with manual labor, many Chinese companies do not want to rely on outside technical assistance if a complicated machine breaks down.

Again describing the Wanfeng automotive factory, Fishman writes that workers man the assembly lines with hand tools and move items past each station by hand and hand truck: Not a single robot or conveyor belt is in sight.

“The Chinese are very practical and concrete so they solve problems in a very practical way,” says Weingrod. “They’re focused on the immediate flow of cash.”

To highlight his point, Weingrod continues: “In the West we consider inventory an asset; the Chinese consider inventory a liability.”

It’s not all negative

Many are already familiar with the numbers. Millions of manufacturing jobs have been relocated to China as companies are squeezed from pressure to meet the China price.

Automotive suppliers move to be closer to the assembly plants they serve, and the companies all work together to participate in a growing economy and lower the overall cost of parts and vehicles for worldwide consumers, including Americans.

The U.S. automotive industry has been hit especially hard as China is transforming itself into a global leader in auto parts and vehicle production.

In the Chicago area alone, which has lost more factory jobs than any other urban center in 2003, 100,000 such positions packed up and left between 2000 and 2003, reports Fishman in “China, Inc.”

But there is an upside for the U.S. economy as a whole, and maybe peripherally for the aftermarket: agriculture.

Three trends have taken root in China that are set to boost the U.S. agriculture market, according to Fishman. First, millions of Chinese are improving their diets.

Second, the migration of Chinese residents from rural areas to urban centers — expected to be hundreds of millions over the next decade — is turning more Chinese citizens from food growers into grocery buyers. Additionally, China’s urban sprawl is depleting the country’s fertile land.

A fall in China’s grain harvest last summer led to the country becoming a net importer of food for the first time ever.

Agriculture, cites Fishman, is the largest U.S. employer, with 21 million jobs tied into farming. It may not be too much of a stretch to suggest that aftermarket farm equipment is an avenue that distributors may want to consider in tandem with this bountiful sector.

Fishman points out that even this good news has its share of resistance. Brazil plans to beat the U.S. to the punch in the global grain trade; also, after China joined the WTO in 2001, American farmers encountered artificial trade barriers imposed by the Chinese, which, Fishman adds, “come and go without warning.”

China’s influence has ultimately paved the way for low interest rates and lower-priced products in the U.S. marketplace — a scenario that should be taken advantage of because it will not last forever. This has the potential to open doors for new businesses to form and new jobs to be created if innovation and perseverance lead the way.

What next?

Rather than disparage the effects of China and accuse an entire culture of causing such disruption in the stateside economy, the U.S. must continue to innovate and set itself apart from all competitors, especially China.

Offering some perspective, Consultant Merrill Weingrod says China represents 23 percent of the world’s population. “China is trying to uplift 23 percent of the world’s population,” he adds. “We have to understand as much as we’d like to dominate everything, we’d rather live in a world where 23 percent has a good life.”

The way parts are imported in China is likely to change shape as the country’s government recently closed tax loopholes for companies that import automotive parts. A policy that took effect April 1 levies a 30-percent tax rate for cars made with imported parts, double the existing 15-percent tax rate, reports Automotive News. Before this point, companies usually imported “kits” to avoid the higher rate imposed on importing vehicles — also 30 percent. This could easily change the manner or location in which automobiles are assembled in China. 

Fishman believes the U.S. must convince its leadership to view China’s rise as worthy of national attention as “political hot spots” like the Middle East.

Though the importance of China is well known in the automotive aftermarket and other segments of business, it appears that not enough political attention is drawn to what could be (and what many consider already is) a worldwide crisis.

“For America to stay productively employed, its skills, sophistication and imaginative power must remain world-class, every day better than ever before,” Fishman writes. “America must itself become a new place.”