MANY US and European companies have a strategy to increase their market share significantly in China due to the size of the market, as well as the current and future opportunities it presents. I would even say: companies that are not setting up in China and looking to grow their businesses in the country will lose out to their global competitors.
To support growth – both in China and globally – it is important to set up a manufacturing base in-country, paying local labour rates and using qualified Chinese or Asian suppliers to achieve competitive local manufacturing costs. Without local manufacturing facilities, businesses will often struggle.
It is also essential for corporate procurement functions to have a presence in China so they are nearer to this important, cost-competitive market, where they can gain supplier innovations and support the organisation’s overall procurement strategies with qualified in-country suppliers – both for domestic plants and exports to sites in other countries.
I moved to China 20 years ago as part of Danfoss Group’s strategy to develop China as its second market – a key driver to setting up successful and fast-growing, greenfield manufacturing and sales companies. Adapting has been a learning curve – as many other businesses have, no doubt, experienced – but the pace of the market and the scale of activity means there is still huge value in teams learning about doing business in China.
Opportunity and risk
The country’s growth and its continuing appeal to both investors and procurement organisations can be explained in many ways. However, time and again, companies have seen the risks attached to investing resources in a China strategy materialise. Some foreign organisations failed in their due diligence; paying the price of learning lessons the hard way and were left either struggling with their manufacturing set-ups or were forced to close their Chinese operations for the following reasons:
- Market size – Some firms overestimated the size of the Chinese market. Although the country has a population of around 1.4 billion people, not all of them have lots of disposable income.
- Competition – There is tough competition – not only between foreign companies but with local businesses, too.
- Market and distribution channels – Some firms failed to understand how to approach China and set up the right distribution channels. The Chinese market is heterogeneous – not homogeneous – with large differences between north, south, east and west in terms of language, culture, professionalism, costs and development. China is larger than Europe, a similarly heterogeneous region.
- People – Some companies struggled to attract and retain top-quality local talent to support growth.
Culture – Many cultural misunderstandings and conflicts affected foreign businesses, especially those involved in joint ventures. Today, the preferred legal structure is to set up a wholly foreign-owned company in China. Chinese culture still differs from the west in terms of language, culture and the business norm: China has a planned economy, while the west is more open. One key thing that westerners often misunderstand is that there are occasions when a Chinese supplier says yes, but it doesn’t mean it and actually won’t be able to deliver.
How has Chinese procurement developed?
When I first moved to China, the country was very different. It was hard to find skilled, English-speaking employees and export-oriented suppliers, and many foreign businesses were in the process of setting up new companies to catch a share of a market that was expected to grow quickly. Firms did not know what to procure from China nor the total cost-savings they could achieve.
Setting up procurement in China has to be seen as a strategic change-management project, one in which good interfaces to internal stakeholders, suppliers and the corporate procurement function are vital.
To succeed, it is important to employ the right person to lead the regional procurement function – one with a strong background in change management, who can adapt to the culture and act as a bridge to the company’s head office. For this, most companies employ a procurement chief with a strong track record and international experience in Asia or China. Young or inexperienced managers will often encounter difficulties as age and experience are held in high regard.
Top factors to successful procurement in China
- Align strategy – To set up a corporate in China, the procurement function must be part of the group strategy and be aligned with group and business unit plans.
- Empowerment – Not only is it important to ensure there is a clear procurement governance structure and roadmap for the regional function, but the in-country procurement organisation should be both trained and clearly empowered.
- Find, train and retain the right people – Competition between businesses trying to attract talent is huge, making recruitment difficult, but the challenge is integrating and retaining staff. According to McKinsey: "People matter most – capabilities and culture have the biggest impact on purchasing performance."
- The relationship between head office and China – It is important to have strategies and best practices that are well synchronised and based on a clear governance structure and hold regular meetings to ensure they are aligned. It is equally important to have a highly competent and motivated team.
- Execute the right commodities and projects – This is where significant cost savings can be achieved. Not all commodities and parts make good procurement sense in China. Start with high-spend, low-complexity projects to achieve breakthrough success stories and attractive savings. Analyse the whole group spend both by business unit commodity, and outline the best fit for China sourcing and the total cost savings that can be achieved.
- Select the right suppliers – To avoid surprises and too many trial-and-error cases and delays, develop a thorough supplier selection process, including audits. Build up the right supplier relationships and ensure trust with the supplier’s owner or top management. Always have a qualified backup supplier and avoid a single-supplier strategy – healthy competition reaps better rewards.
- Supplier development – A supplier development team is a crucial part of any procurement function in China, particularly if a supplier needs help or opens audit gaps that need to be closed. In some cases, technical experts should be incorporated into the supplier selection process, such as with steel plants or special processes.
- Secure zero defects and on-time delivery from suppliers – A qualified supplier development team can not only play a role in the supplier development process, it can also help to ensure suppliers establish zero-defect processes. For on-time delivery, a clear supplier logistic agreement clarifies the logistics processes, inventories, lead-times, multiple-order quality and freight process. In the start-up phase of a new Chinese supplier, it can make sense to follow up on their outgoing inspection to ensure parts arriving in Europe or the US do so in perfect condition.
- Lean and efficient export logistics – Set up freight consolidation hubs at your international freight forwarder warehouse for exports from China to Europe or the US. The freight forwarder must be able to handle both sea- and air- freight, in case the route by which the goods are transported needs to change. Any contracted freight forwarder must provide a range of logistical export services, such as the tracking of goods.
- Overcome internal barriers – This is important to tackle issues such as quality, which is particularly relevant while developing and phasing-in new suppliers or logistics teams, which will experience long lead times and, in some instances, increased inventories, when sourcing from China. These functions need to work collaboratively to secure what can be significant cost savings.
- Market intelligence – Part of a strategic procurement function’s role is to catch suppliers’ latest innovations and follow the lead of competitors in terms of what you are purchasing and where you are sourcing it from. An international business’s China procurement function plays an important role in this by providing vital market intelligence from this key growth market.
Where is procurement in China heading?
Global sourcing and procurement professionals face a number of difficulties due to increasing costs in China. Many have struggled to identify other low-cost options, either in-China or elsewhere in Asia, that can replicate the opportunity.
- China’s GDP will continue to grow impressively at more than 5% per annum.
- Labour costs will increase more in China than in other countries in the region, but these expenses can be partly or fully offset by automation, as well as making productivity and efficiency improvements through suppliers.
- China offers attractive steel prices – a commodity that is valuable in many industries – exports of the metal to Europe have doubled over the past three years. As a result, the European Union is also looking into anti-dumping measures for some steel grades.
- For high-volume industrial or automotive products, China will remain competitive and further increase both productivity and quality to meet international standards. For the foreseeable future, it will retain its position as the top exporting country in the world.
- For low-volume, labour-intensive consumer products, some manufacturing will move to other low-cost countries in the Asia-Pacific region – this trend has affected the clothing and footwear industries over the past ten years.
- China will continue to have a large domestic market and will become a stronger force in the global economy.
A key role for procurement in China is to work with suppliers on efficiency and lean manufacturing projects to compensate for labour and other cost increases. Risk management, zero-defect and on-time delivery are areas in which improvements must be made in order to avoid hidden costs.
It is also imperative that businesses have a strong supplier relationship management programme, which not only improves the cost base but focuses on innovations and process improvements. It is key to align long-term growth plans and investments in this area.
If companies fail to implement a best-cost country procurement strategy, they will lose competitiveness and, in the long-term, will lose market share. For the next few years, however, China will remain a very competitive sourcing market and a best-cost country, particularly for industrial and automotive companies.
Nis-Peter Iwersen is a former vice president for Asia, and head of procurement for industrial and automotive companies, with experience building up qualified procurement organisations in Asia and China.
This contributed article has been written by a guest writer at the invitation of Procurement Leaders. Procurement Leaders received no payment directly connected with the publishing of this content.