Global Sourcing - Procurement in China

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Contents

1  Introduction  1

1.1  Problems and Objectives  1

1.2  Structure  2

2  Procurement Market China  4

2.1  Basic Information  4

2.1.1  Geographical Data  4

2.1.2  Economic Data  5

2.2  The Significance of China as a Procurement Market  7

2.3  Procurement Regions  12

2.3.1  Pearl River Delta  12

2.3.2  Yangtze River Delta  13

2.3.3  Beijing-Tainjin Bohai Bay Triangle  14

2.3.4  North-Eastern Lowlands Liaoning Region  15

2.3.5  The Inner Regions  17

2.4  Chinese Companies  18

2.4.1  A Division of 6 Classes  18

2.4.1.1  National Champions  18

2.4.1.2  Dedicated Exporters  20

2.4.1.3  Competitive Networks  21

2.4.1.4  Technology Upstarts  23

2.4.1.5  Emerging Companies  24

2.4.1.6  Scrap Companies  25

2.4.2  Forms of Ownership of Chinese Companies  26

2.5  Products Suitable for Industrial Procurement in China  29

3  First Contact to Potential Suppliers  33

3.1  Possibilities of Contact Initiation  33

3.1.1  Trade Promotion Office in the Embassies  33

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3.1.2  Chinese Representative Offices in Germany  34

3.1.3  Chinese National Foreign Trade Companies  34

3.1.4  Industry and Commercial Companies in China  35

3.1.5  Fairs  35

3.1.6  Seminars and Symposiums  36

3.1.7  International Procurement Offices  36

3.1.8  Internet  37

3.1.9  Magazines and Technical Periodicals  38

3.1.10  Business Partners Acquaintances and Friends  38

3.2  Exhibition Market China  39

3.2.1  Trade Fair Visit within the Context of a Purchasing  

  Strategy in China  39

3.2.2  Trade Fairs in the Consciousness of Chinese Companies  40

3.2.3  Trade Fair Industry and Trade Fair Centres  41

3.2.4  Successful Trade Fair Visit for Purchasers  45

3.3  Initiating Business from First Contact to Business Relations  51

4  Quality Management  54

4.1  Quality Management in International Procurement  54

4.2  Quality Consciousness in China  57

4.2.1  Development of Quality Management in the PR China  57

4.2.2  Quality Consciousness Today  58

4.3  Practical Quality Assurance Measures  61

4.3.1  Supplier Certification  61

4.3.2  Assessment of the Supplier by Audit  62

4.3.3  Quality Agreement  63

4.3.4  Quality Support  67

5  Transportation Logistics  68

5.1  Introduction  68

5.2  Logistics Companies in China  70

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5.3  Traffic Carriers in China  72

5.3.1  Road Traffic  72

5.3.2  Rail Traffic  74

5.3.3  Aviation  75

5.3.4  Inland Waterway Transportation  76

5.3.5  Sea-going Vessel Transportation  77

5.4  Checklist for the Selection of a Logistics Service Provider  79

6  Chinese Negotiations  80

6.1  Roots of Chinese Culture  80

6.2  Basic Values  82

6.2.1  Personal Connections Guanxi  83

6.2.2  Face (Lien and Mien-tzu)  84

6.2.3  Hierarchy  85

6.3  Further Important Aspects  87

6.3.1  Patience  87

6.3.2  Significance of Business Cards  87

6.3.3  Different Contractual Understanding  88

6.3.4  Minutes of Meeting  89

6.3.5  Translator  89

6.3.6  Gifts  90

6.3.7  Business Meals  90

7  C o n c l u s i o n 9  2

  B i b l i o g r a h y 9  4

  List of Lectures  102

  Internet Links  103

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List of Figures

  Figure 1: Map of China  4

  Figure 2: Sourcing regions of Asian and European countries  7

  Figure 3: Comparison of hourly compensation for production workers  10

  Figure 4: Pearl River Delta  12

  Figure 5: Yangtze River Delta  13

  Figure 6: Beijing-Tianjin Bohai Bay Triangle  14

  Figure 7: North-Eastern Lowlands Liaoning Region  15

  Figure 8: Inland  17

  Figure 9: Scrap company  25

  Figure 10: Servopiston unmachined  31

  Figure 11: Servocyclinder unmachined  31

  Figure 12: China International Exhibiton Centre  42

  Figure 13: Shanghai New International Exhibition Centre  43

  Figure 14: Guangzhou International Convention Exhibition Centre  44

  Figure 15: Initiating Business  52

  Figure 16: Traffic Infrastructure  72

  Figure 17: Road Transportation  73

  List of Tables  

Table 1:  General Data on China  5

Table 2:  National Champions  19

Table 3:  Dedicated Exporters  21

Table 4:  Competitive Networks  22

Table 5:  Technology Upstarts  24

Table 6:  Forms of Ownership of Chinese Companies  28

Table 7:  Basic Values in China  82

Table 8:  Basic Values in Germany  82

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1 Introduction

1.1 Problems and Objectives

The significance of global purchasing activities is becoming ever more important for German companies. The high salaries – and non-wage labour costs – and the high production costs in the German economic region associated with them are reflected in the prices of products. A way out of this cost trap for many companies is offered by international procurement and production. They see in global procurement a possibility to purchase parts of products cheaply. Thus, an orientation towards international procurement and supply is both understandable and necessary.

For Germany, China is the most important trading partner in Asia. The most striking feature in the last few years has been the change in the structure of procurement from China: whilst in the past it was mainly textiles, shoes and toys that were sourced there, the focus is now shifting to more high-tech product categories, such as metal products, pressure die-cast components, electronic components and hardware, for example. This increasing provision is drawing production companies to China, companies which are on the outlook for potential savings. In addition to China’s cost advantage, the quality level and the reliability of suppliers in China have increased in the last few years.

Despite all the options available, China is, however, not a simple and transparent procurement market and should not be tackled with undue haste under any circumstances. All buyers who would like to get involved in this new business in China are subject to a series of problems. The geographical distance, the foreign culture and language as well as the lack of market knowledge all play an important role. This is why the China’s potential as a base for procurement is still being used too little, especially by German companies. Proceeding in a systematic way and carrying out thorough preparations reduce risks and help to ensure success in the Chinese procurement market.

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The objective of this thesis is the creation of a guide to industrial procurement in China. It is aimed at purchasing employees in German production companies who have not yet had experience of dealing with or in China and who would like to start. The guide is to give an initial general orientation towards that which purchasers expect and how they can best carry out their sourcing project. The reader is given insight into the Chinese procurement market. Problem areas and hurdles regarding procurement in China are observed; practical tips are given to get round such problems.

Due to the size of the subject matter, it is not concerned with developing a complete compendium of industrial procurement in China. Some questions which have been discussed in other publications will inevitably remain open. Thus, e.g. taxation and legal aspects are not dealt with. The reader who is interested in further information is directed to the literature list as an aid.

1.2 Structure

The thesis is divided into seven chapters.

After the introduction in Chapter 1, Chapter 2 focuses on the “where” (procurement regions in China), on the “from whom” (classification of Chinese suppliers) and on the “what” (procurement products) of the involvement of a production company in China.

The focus of Chapter 3 is the initial contact with possible Chinese suppliers. The different possibilities of establishing contact are shown, dealing in particular with the Chinese trade fair market and the behaviour of German buyers at Chinese fairs.

For German companies which have already gained buying experience in China the quality of the products supplied is a great problem. Thus, Chapter 4, after describing the quality consciousness of the Chinese, presents practical measures for quality control with regard to procurement in China.

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Chapter 5 deals with transport logistics. It describes the different types of logistics service providers and the potential carriers for inland and export logistics with their opportunities and risks. At the end of the chapter, a checklist gives assistance in choosing a logistics service provider.

Chapter 6 is concerned with “Negotiations in China”. Some basic values which still determine the course of negotiations today can be found in the roots of Chinese culture. The reader is also given practical tips for successful negotiations in China.

The concluding remarks are presented in Chapter 7.

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2 Procurement Market China

2.1 Basic Information

This section presents a short overview of the most important geographical and economic data on China.

2.1.1 Geographical Data

¹ http://www.lib.utexas.edu/maps/middle_east_and_asia/china_pol01.jpg

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2.1.2 Economic Data

Despite some doubts as to the accuracy of its statistics, the People’s Republic of China is undoubtedly one of the countries with the strongest economic growth. Gross Domestic Product (GDP) in 2004 reached a value of $1650.7 billion . After 9.1% (2003) GDP rose by 9.5% and reached its highest growth level since 1996. China has since become the sixth biggest economy in the world. GDP more than doubled in the 10 years between 1994 and 2004 (+128%). In the same time frame, its export trade volume rose almost six-fold from 198 million to 1.155 billion dollars. This gives it 3 ^rd place among the trading nations, behind the USA and Germany.

In contrast, on the international welfare scale China is in the last third. GDP per capita passed the 1000 dollar threshold for the first time in 2003. If one takes into

² http://www.auswaertiges-amt.de/www/de/laenderinfos/laender/laender_ausgabe_html?type_id=

2&land_id=32; http://www.cia.gov/cia/publications/factbook/geos/ch.html

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account the different levels of prices in the countries, GDP per capita based on purchasing power can be calculated at approximately 4700 dollars. The slight level of development can be seen by the fact that almost 15% of GDP is still produced in the primary sector, which employs almost half of all gainfully employed. The tertiary sector of industry, also called the service sector, contributes just 32% to the production of GDP – compared to 60 to 70% in industrialised nations. Unemployment among the 745 million employees is around 10% in the cites, somewhat higher in rural areas. 3

³ Cf. Schüller (2005), lecture;

http://www.auswaertiges-amt.de/www/de/infoservice/download/pdf/wirtschaftsberichte/ 32_wb2.pdf, http://www.cia.gov/cia/publications/factbook/geos/ch.html.

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2.2 The Significance of China as a Procurement Market

From a German point of view, the Chinese procurement market has increased considerably in significance in the last fifteen years. This is shown by the very dynamic growth in the German imports from China, which more than quadrupled from 8 billion in 1995 to 32.5 billion Euro in 2004. ⁴ The share of technological products also increased in the same period. In 2004, China was Germany’s sixth most-important trading partner for imports. In the mid term, it is assumed that by 2010 bilateral trade will have doubled. ⁵ The growing significance of the Asian supply market is also shown in a study carried out by the University of Applied Sciences in Berlin.

Fig. 2: Sourcing regions of Asian and European countries 6

⁴ Cf. Statistisches Bundesamt (2005a), press release.

⁵ Cf. Schüller (2005), lecture.

⁶ Cf. Baumgarten/ Krokowski (2003), p. 13.

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According to this, the European companies questioned will increase their procurement volume in the Far East from 10% to 15%. Whereas Europe will continue to increase its worldwide imports from an average of 40% to 49%, the procurement departments in Asia will reduce their share of global sourcing from 60% to 46% (see Fig. 2). 7

The Chinese procurement market is observed by international companies from many different perspectives: on the one hand, as a so-called sourcing market against the background of the realisation of price advantages and cost reduction or to expand the supply spectrum within the framework of global sourcing, and on the other hand as a local procurement market for raw materials, prefabricated products, accessories, and machine and plant equipment for production in China.

There are many reasons why China has become one of the world’s most significant export countries within a relatively short time: ⁸ N Cheap production due to a comparatively cheap but increasing highly qualified workforce. Chinese universities currently supply the job market with approximately 3 million highly qualified engineers and natural scientists annually. The average monthly salary for a young academic is currently at approx. 250 Euro in the cities.

N Extensive capital investments: in 2004, Foreign Direct Investment (FDI) in China reached a volume of US$ 60.6 billion. ⁹ China is the largest receiver of FDI.

N Improvements in product quality and production efficiency due to advances in technological developments as well as restructuring of the economy. There are even Chinese companies certified by the TÜV-ISO.

⁷ Cf. Baumgarten/ Krokowski (2003), p. 13.

⁸ Cf. Song, G. (2004), p. 75.

⁹ Cf. Asia Bridge (2005), p. 25.

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N Continually improved infrastructure and efficiency of the logistics system: as a rule, goods from China can reach European ports via sea within approx. 4 weeks. ¹⁰ N Expanding Chinese internal market: strong competition within the internal market, the continual inflow of foreign investment and new technologies ensures market adjustment in all areas and increases the international competitiveness of Chinese industry.

Due to these aspects, in particular the unrivalled low wage costs, China is developing into one of the most lucrative procurement markets. According to the study “Capturing Global Advantage“ by the Boston Consulting Group, China’s cost advantage will not change in the next few years. The cost gap is not only unlikely to close within the next 20 years but in some cases may actually increase. Mainly there are 2 reasons for this: 11

First, the growth of wages in China will be limited because of the enormous reservoir of under- and unemployed people. China still has more than 800 million people living in the countryside. They are expected to exert very strong downward pressure on wages for low-skilled positions over the next few decades. Although there will be more pressure on higher-skilled positions, the supply of candidates for such positions is also very large.

Second, the current differential in labour rates is so great that the gap between them will remain substantial for the foreseeable future, even if there are double digit differences in the rates at which they grow (see Fig. 3).

¹⁰ See Chapter 5 for Transport Logistics.

¹¹ Cf. Boston Consulting Group (2004), p. 18-20.

Fig. 3: Comparison of hourly compensation for production workers 12

In fact, the gap in real wages will actually increase in absolute value, at least for

the next few years, because the bases are so widely different. A U.S. or Western

European factory worker costs an employer $15 to $30 per hour. A Chinese

¹² Boston Consulting Group (2004), p. 19.

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factory worker earns less than $1 per hour – a gap of $14 to $29. If wages increase at an annual rate of 8 percent in China, while in the United States and Germany they increase at annual rates of 2.5 percent and 2 percent, respectively, in 2009 the average hourly wage will be approximately $1.30 in China, $25.30 in the United States and $34.50 in Germany. So despite the disparity in growth rates, the gap will have expanded by up to $4 (assuming that there is no significant change in the relative values of the countries).

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2.3 Procurement Regions

China’s 5 procurement regions are described below.

2.3.1 Pearl River Delta

Fig. 4: Pearl River Delta

The Pearl River Delta is not only one of China’s most dynamically developing economic regions but also one of most quickly emerging worldwide. In half a million manufacturing sites, it produces approx. 10% of all the People’s Republic’s goods and services, attracts almost 25% of all foreign direct investment and produces almost 40% of all the country’s exports. In the ports of the Pearl River Delta, almost as many containers are handled as in all of the USA. ¹³ Traditionally, Guangdong is a home to light industry, which makes up more than half of industrial output. The most important products are electrical devices such as televisions, audio equipment, copy machines, telephones and other consumer products such as textiles, cigarette lighters, watches, toys and shoes ¹⁴ . It is not surprising that numerous western retail companies have settled in the region (Wal-Mart, Metro, Otto, Carrefour, Ikea).

¹³ Cf. Song, L. (2005), lecture.

¹⁴ Cf. Song, G. (2004), p. 72.

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Increasing numbers of companies are now following the retail companies, for the focus of production in the region is shifting increasingly towards the high-tech fields of electronics and telecommunications.

The supply industry in also growing strongly since the density of factories has attracted an increasing number of competitive suppliers. The resulting growth in the range of electronic components and assemblies, plastic and metal parts, and pressure die-cast components on offer is also attracting an increasing number of European and American Small and Medium-sized Enterprises (SME) to the region, which are buying parts for their own manufacturing processes. ¹⁵ The area of the Pearl River Delta is highly recommended as an entrance into the Chinese supply market.

2.3.2 Yangtze River Delta

Fig. 5: Yangtze River Delta

The Yangtze River Delta (YRD) is the industrial heartland of China. Almost a quarter of the economic performance of the country is created here, whereby the region makes up only 1% of the territory and has less than 7% of the population. A third of China’s exports originates from the YRD. Exactly as in the Pearl River Delta, the region has a highly developed private sector and is home to more than 800000 private companies.

¹⁵ Cf. Kracht/ Kriegeskorte (2004a), p. 6.

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The YRD Region also has numerous companies from the steel industry (e.g. Boasteel Shanghai), machine building and the automotive industry (e.g. Shanghai Volkswagen, Shanghai General Motors and more than 180 international supply companies). Other pillars of the region are the textile and chemical industries (e.g. Bayer Shanghai, BASF Nanjing). There is a large number of industrial supply companies (e.g. tool makers, pressure die-cast companies, synthetics spraying companies, metal working companies), which ensure a large range of raw and basic materials, semi-finished goods and diverse investment goods and means of production. ¹⁶ Shanghai offers an international atmosphere, a high quality of life and a somewhat western lifestyle. Such “soft” factors should not be underestimated for expatriates from the west when choosing a procurement region, especially when installing one’s own procurement offices. 17

2.3.3 Beijing-Tainjin Bohai Bay Triangle

Fig. 6: Beijing-Tianjin Bohai Bay Triangle

Beijing as the capital of China possesses superior advantages since business and politics are still closely connected. Beijing thus plays an important role for foreign

¹⁶ Cf. Kracht/ Kriegeskorte (2004b), p. 7 f.

¹⁷ Cf. China Contact (2004a), p. 16.

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entrepreneurs in establishing and maintaining social relations with party functionaries and representatives of state institutions and ministries. ¹⁸ The Bohai Bay Region accounts for 9% of China’s economic performance and a fifth of its exports. As an industrial area the region is home to the country’s largest steel and oil industries. However, high-tech companies have also located in the region in the last 20 years. Experts are of the opinion that the region could become the dominant economic force of the whole of north-eastern Asia by 2010. It already dominates the steel, automotive, chemical and raw materials industries. The production of software, mobile telephones and electrical household appliances is centred mainly around Beijing and Tianjin. ¹⁹ For western buyers who would like to procure components for production at home, the Bohai Region offers only a very limited supply market.

2.3.4 North-Eastern Lowlands – Liaoning Region

Fig. 7: North-Eastern Lowlands – Liaoning Region

The three north-eastern provinces Liaoning, Jilin and Heilongjiang are China’s “Ruhr Region”. Heavy industry has been built up here intensively since 1949. The whole north-eastern lowlands lives from the iron and steel industry, automotive

¹⁸ Cf. Song, L. (2004), p. 242.

¹⁹ Cf. Song, G. (2004), p. 73.

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factories and chemical works. China’s first automobile factory was built in 1953, since 1990 it has been a joint venture with Volkswagen AG. ²⁰ Closures and redundancies in the outdated steel works and coal mines has lead to mass unemployment and mass protests in the last few years. A quarter of all Chinese unemployed live in the north-eastern provinces.

Until the end of the seventies the Liaoning province was China’s main production region. Together with Jilin and Heilongjiang the province accounted for 17% of GDP. Today, it is only 9%. In Liaoning alone in the last few years three million workers have been laid off and 500 firms closed. Many cities in the region arose because of state companies. When a state company is closed, the unemployment rate in the vicinity of the company quickly rises to 50%.

The private sector is only gaining ground slowly. 70% of the north-eastern Chinese economy consists of state-owned companies, in Shanghai’s neighboring province Zhejiang the share is only 30%.

Since 2003, the Chinese government has increasingly supported the structural change of this region. 7.4 billion US dollars have already been put into 100 industrial projects.

Foreign investors (e.g. Volkswagen 1 billion Euro, BMW 225 million Euro) and foreign know-how are also helping considerably to create new jobs. ²¹ In the course of the reform process a small but increasing number of local suppliers are setting up procurement bases near production centers.

²⁰ Cf. Song, L. (2004), p. 243.

²¹ Cf. Wirtschaftswoche (2004), p. 90 f.

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2.3.5 The Inner Regions

Fig. 8: Inland

In contrast to the booming coastal regions the Chinese heartland is defined by its slight economic power, weak foreign orientation and its reform deficit. Only a few well-qualified state-owned companies can be found. Since the end of the 90s the Chinese leadership has been following a “Go West” strategy. Economic development is to be boosted by state support and foreign investment. The expansion of the infrastructure in particular is being supported by the Chinese government’s development plan. Everywhere in western China large construction projects for highways, railroads, canals, dams, pipelines and electricity cables can be seen. With high levels of investment the government in Beijing is trying to ensure that the west can compensate its greatest disadvantage as soon as possible. In addition to the new infrastructure, the low wage costs – when compared to the coastal regions – and the attractive tax benefits represent further essential incentives for foreign investment. ²² An example of this is Intel’s announcement to build a semi-conductor factory for 200 million dollars in Chengdu, the capital of the province Sichuan. 23

²² Cf. Song, L. (2004), p. 246.

²³ Cf. Wirtschaftswoche (2003), p. 72.