The drivers behind the current transformation underway in Chinese manufacturing are much more complex than those that initially led the Middle Kingdom to become the world’s leading manufacturing nation. Over the past 30 years, Chinese manufacturing radically transformed global supply chains, up-ending established industry structures. In the next five to ten years, China’s new phase industrial growth is likely to have an even more rapid and profound impact on a range of industries that we often assume to be the birth-right of companies domiciled in the aging slow-growth economies of the US, Europe and Japan. This in turn will spark not only a new clutch of corporate “winners and losers”, but also unleash painful and complex trade and geopolitical frictions.
In contrast to the simplistic assumptions heralding the “end” of Chinese manufacturing competitiveness, consider four different sectorial drivers of China’s future growth, each with its own unique dynamics and regional/global impact:
- Building on Labor Intensive Positions.China will not withdraw from “labor intensive industries”, it will merely change its role in the value chain to a higher position. For example: In textiles, cut and sew for low-price garments moves offshore while fabric, dyestuffs and design remains in China. In electronics, assembly moves offshore or automates while chips and components expand rapidly. Moreover, China’s competitiveness is now based on the strength of industry clusters, not on low-cost labor.It now has a new league of well-established suppliers working across the value chain in the traditional industries. These companies have built a reputation through long-term cooperation with global buyers. This experience and trust has now become a key element in China’s competitive advantage in the “traditional” areas that Westerners (mistakenly) think of as the core of China’s manufacturing.
- Heavy Industry Now A Key Building Block. Past investment in heavy industry now becomes a key building block for China’s manufacturing future as it moves up the value added curve. Local steel companies originally met the need for construction rebar. Now they supply quality sheet for autos and white goods (refrigerators, washing machines) as well as specialty steel for heavy/transport equipment (cranes, excavators and ships). Integrated chemical clusters produce both commodities as well as higher value added specialty products. Continued consolidation across most of these basic industries – as occurred in the US and Europe at a similar stage of industrial development – is now underway, raising competitiveness.
- More Technology Content. Heavy machinery for such sectors as construction, power generation and general manufacturing are not particularly sophisticated but they definitely have more technology content than garments or furniture. China’s growth in these areas will cause some global price deflation as it introduces simpler technologies and avoids over-engineering. This will drive its market share gains for China-based manufacturers, pushing down global prices of heavy equipment as it drove DVD players from a $500 price point to $50.
The most interesting development is China’s entry into more sophisticated consumer and industrial goods driven in many cases by the growing scale and rising sophistication of Chinese domestic demand:
- Generic pharmaceuticals which are rising in quality to meet Chinese domestic demand (Corporate examples: Hisun, Huahai)
- Medical equipment and devices (Mindray, Microport, LePu)
- Telecom (Huawei, ZTE)
All of these are much more regulated (health, safety, security, environment), capital intensive, IP-rich and higher value-per-item product areas than China’s traditional manufacturing growth sectors. Thus the vested interests on the Chinese side as well as among Western competitors suggest a much higher level of risk and potential friction as China asserts its dominance.
- Industries of the Future.The area likely to generate the biggest surprises in the long run, however, will be industries of the future – those such as aerospace and biotechnology, where innovation is critical and in which Western firms as well as political leaders generally assume an Anglo-Saxon birthright. Disruptive innovation from China is likely to take multiple forms ranging from scientific breakthroughs to the application of scale and entirely new business models. For example nuclear power and alternatives such as solar and wind represent sectors where government policy aims to make China a leading manufacturer, requiring innovation. With the scale of China’s need for clean fuel and its heavy investment in it, China will continue up the technology curve in what will be the world’s largest nuclear and alternative energy equipment market.
Which Industries Are Next?
Our Need for New Assumptions
What are the implications for both companies and policy makers? China’s next phase of industrial growth trends seem likely drive five disruptive changes that challenge our current assumptions about the way the world works:
- Rapidly alter the map of global and Asian production. China will increasingly become the “hub” of global manufacturing, not just in labor-intensive industries, but also in those that increasingly depend on both scale and innovation. Its impact will ripple through the Asian region in the form of continued rapid integration in regional capital and trade flows.
- Redraw the rules of competition across a wide range of global industries. Some sectors will be “commoditized” and driven to radically new price points as production costs fall and new market segments thus become the driver of growth. Much of this growth will occur in countries where Western firms have a relatively weak presence and their premium products/services are misaligned to local customer needs.
- Generate new and infinitely more complex trade and geopolitical friction. As China enters the global market in more regulated industries (eg pharma) and those considered strategically sensitive (think of the barriers that have already emerged in telecom/IT equipment and energy), the West’s political and business resistance are likely to become much more vociferous than the ill-fated efforts to slow China’s dominance of the global garment trade.
- Drive China’s continued economic reforms and become a focal point of internal policy debate as well as political battles. In the 1990s, Premier Zhu Rongji astutely used China’s WTO entry as a catalyst for radical policy change. China’s new President appears equally decisive but faces entrenched vested interests, not unlike those Zhu battled. Leveraging the needs of the Chinese population as a political justification for painful change, we are certain to see growing range of policy choices that create rapid change in an increasingly complex domestic operating environment.
- Determine a new group of corporate “winners and losers” within China and globally. Given the pace at which Western corporations typically make the fundamental decisions that shape their product portfolios, business models and organization structures, the next five years are likely to yield a sharp division between those that successfully navigate this transition and those that do not. In the global industrial restructuring of the past three decades, many executives in textiles, consumer electronics and auto components failed to grasp fully the speed and the radical nature of the changes taking place in the needs and locations of customers or the competitive challenges they faced. Many of those who did accurately assess the threat were simply unable to alter their respective firms’ strategies fast enough or radically enough to survive.
Western executives in many of the “next wave” industries live today in the same terminal denial that characterized their counterparts across America’s “rust belt” two decades ago. Some will be able – for a time – to rely on traditional customers in slow-growth markets at home to reinforce their complacency. Many of these firms adopt “global” strategies focused on increasingly specialized market niches. In the 1990s, one US specialty chemical company convinced itself it could sustain its competitive position in ABS plastics because it “was the only firm capable of making all 14 shades of pink ABS required for Mary Kay bottle caps. Two years later – as Chinese customers dominated global demand for ABS – the company was forced to divest this business to a commodity chemical firm.
Within China, the shift is likely to have an even more dramatic corporate impact. As the balance shifts from preferential treatment of state enterprises to one that relies increasingly on market forces, a fresh shakeout will occur. This will be accompanied by a painful consolidation of industrial assets as subscale producers that account for much of China’s inefficiency are allowed to go bankrupt or are acquired by larger, better-managed firms.