As China’s economy slows and local firms become more competitive, many foreign manufacturers are reassessing their operational and commercial business models, Jay Hoenig and Jon Anderson of East West Associates tell Insight
Adjusting to new economic conditions
Foreign companies in China have always faced a multi-tude of business challenges. These include, but certainly are not limited to, growing local competition, downward pricing pressure, a challenging regulatory environment and governance/ethics issues. But the impact of these factors was overshadowed by the robust growth in both the China domestic and export markets thus allowing even mediocre companies to remain profitable.
Now, after years of 10 percent or more GDP growth, China faces a severe slowdown across many market sectors. Caught off-guard, many foreign-invested enterprises (FIEs) in the manufacturing sector are under pressure to turnaround or in some cases close or consolidate factories. Slowing markets and increasing labor costs are endang-ering the unprepared.
While the slowdown was hard to predict, some companies had become complacent during the good times, say Jon Anderson and Jay Hoenig of East West Associates, a firm that helps foreign SMEs solve operational, commercial and risk management problems in their China manufacturing operations. Based on their experiences working with such companies, Anderson and Hoenig have identified several oversights these companies made – and the corrective actions they need to take to resolve the resulting issues at their China-based manufacturing plants.
At small companies in particular, the ‘Fly-in, Fly-out’ style of management has not worked. “It’s where company management visit the operation for a week, meet with the suppliers, review the top-level statistics to confirm that they’re okay, shake hands with the local management and go back home,” says Anderson. “As such, they never really develop a depth of under-standing of how to operate in China. They depend on the local general manager to tell them what’s going on and typically are told things are fine.” But the financials don’t lie.
If the local manager is exp-erienced, professional and understands market realities, the fly-in, fly-out approach may work for a while, particularly if accompanied by strong company oversight, rigorous setting of metrics and alacrity in addressing performance issues. But in today’s evolving economic environment, management from a distance can be risky. If the wrong person is in charge, company executives may be too remote to notice until it’s too late.
Interaction with Chinese senior managers
While China’s economy has produced significant growth for so many years, many Western and Chinese executives now have to accept what has been termed the New Normal economy. As a result of this unprecedented growth, a number of Chinese general managers and team members have never experienced a prolonged economic downturn in their professional careers. Anderson noted that for many people in their early 50s, this current economy is the first time they have experienced slower growth. As a result, many general managers and executives lack the experience of developing and executing turnaround and restructuring strategies at their factories in China. They do not have these skills because they have never been called for.
Many managers need support in determining and activating the right tactics and remedial actions to minimize the financial risk to the company. “Can they look at their operation and say, ‘we are running three shifts, can we cut back to one; how can we reduce overhead and inventory, can we expand our client base, etc.,’” he asks.
Local managers also need to have the experience, judgement and professional confidence to com-municate with U.S. management and describe the new challenges he or she is facing in this new evolving marketplace. Having the confidence to set realistic financial goals based on the market realities is essential for a long term view. Establishing unattainable goals to please headquarters management is a short solution with long consequences, say the East West team.
Containing costs is elemental to any company’s profitability, but especially in a downturn. The acquisition or building of non-core internal resources has saddled many companies with high costs. Capacity that was built to meet double digit annual growth is now a burden. A common example is expanding in areas outside the company’s core competencies. Tough “make or buy” decisions need to be addressed to find areas of cost reduction.
As companies overextend their operations, even well intentioned managers can get buried in growing internal expenses. “The ‘fat’ forms when you start expanding your operation to internalize things. This is when you’re building internal resources to do what outsourcing can do a lot more efficiently and cost effectively,” says Hoenig.
In good times, many companies get bigger and bloated and less efficient at activities outside their core competency. “That’s what gets them into trouble,” says Hoenig. “A company may be an expert in assembling cars, but not in producing transmissions, lights, tires and other components.”
For companies seeking to decrease the scope of their production, there is still hope. East West executives say that cost reduction opportunities are plenty: limiting travel, renegotiating supply contracts, rationalizing fixed assets, reducing inventory, curtailing the number of production shifts, etc. But they also stress the need to boost revenues, whether through improving sales performance, improving product design or listening to customer feedback.
Sales & marketing
According to East West, many foreign firms in China use business models designed five, 10 or 15 years ago, and unsuited to today’s economic conditions. This thinking also infects sales and marketing, where many local companies now outperform their foreign competitors.
“Foreign firms initially ‘pulled’ to China to support a few OEMs need to expand sales outside the traditional base of foreign customers. Organizational assessments and sales and marketing assessments are really critical,” says Anderson, who adds that few companies have assessed their own sales team to understand the sales process or surveyed their customers for feedback on their wants.
Among the questions that East West encourages companies to ask themselves are: Do they have the right sales people? Is the organi-zational structure of the sales department correct? Is the com-petition using distributors or are they selling directly?
Strategic & tactical complacency and the sales proposition
Executives at East West argue that for a long time the culture of “good enough” was sufficient to ensure profits for foreign companies operating in China, even when selling in ways similar to those in Europe and the U.S. Today, good enough is no longer profitable in China.
One common fault that East West has identified is what it terms “strategic and tactical complacency.” “They’re not asking ‘Where else can we sell our product? How can we better localize our product? How can we explore new geographical areas?’” says Anderson. “But if you’re not growing while your competition is, your competition is going to overtake you. If you’re not expanding your operation, product wise, geography wise, customer wise, or industry wise, one day your competitor will.” And, local competition is producing better product with lower price expectations.
Facing the future
With their large human and financial capital resources, many multinationals have the time, in-house skills and resources to adjust to the winds of economic change. That luxury is rarely available to smaller FIEs, which East West says are more susceptible and sensitive to indifferent performance.
This lack of deep resources means that small and medium-sized enterprises in particular must be astutely aware of their company operations and performances. “Big companies can embed average performers and the organization will still grind forward,” says Hoenig. “At an SME if you have only two sales people and one quits, sales may drop 50 percent – so much depends on individuals so employee engagement is critical.”
SMEs then, need to be relentlessly assessing and questioning their operating methods and products. “Is it the product? Is it the organization? Is it the pricing? Is it the leadership? Is it the sourcing? Do we have noncompetitive suppliers? Do you need to re-compete all of your sourcing?” are just a few of the questions they should begin asking, says Hoenig.
Case Study: Interim general management of a U.S.-owned China WFOE manufacturing plant (Jon Anderson)
A Wholly Foreign Owned Enterprise (WFOE) specializing in the production of specialized equipment for mining, seaport bulk goods, and a variety of other logistics applications operated in China for eight years. After the WFOE was unprofitable for four years, experienced three years of flat sales and suffered surging expenses, its parent company dismissed the local general manager and asked East West Associates (EWA) to provide an interim general manager (IGM). The role of the IGM was to lead an operational and commercial assessment of the WFOE’s operation as well as fulfill the traditional functions of the general manager with profit and loss accountability.
With a goal to break even within a year, EWA first assessed the WFOE’s human resources department, looking to improve people utilization, boost employee morale and scale the organization to its current business climate. What EWA found was limited depth, high personnel turnover and minimal accountability, matched with an overall lack of teamwork and poor staff utilization. Due to earlier management’s poor communication to staff and lack of transparency, it also suffered from a largely mistrustful and cynical employee base.
Concurrently, EWA found significant complications in the company’s operating strategy. Its operator utilization was below 60 percent due to low sales and overstaffing, and employees had become used to a slower-paced work environment. To increase the WFOE’s efficiency, EWA focused internal resources on final assembly, testing and packaging in order to reduce production cycle time. This strategy, paired with an increase in outside purchases of higher order subassemblies, allowed EWA to increase assembly and packaging efficiency by 25 percent and reduce slow moving stock.
One severe obstruction to the WFOE’s success was its unrealistic commercial target. Despite negative signals in the marketplace, the company’s budget called for an unachievable 20 percent increase in sales. To re-focus the sales force, EWA modified the sales commission program to encourage year over year improvement and turned to OEM clients instead of maintenance, repair and overhaul (MRO) clients to ensure larger and steadier orders.
Additionally, EWA’s Voice of the Customer exercise, which posed questions on the company’s value proposition to many end users, indicated that some of the company’s value-add resonated with them. Importantly, the process also provided realistic ideas for improvement and validated the severe cost pressures in the marketplace.
Within a nine-month time frame, EWA identified over US$1 million in cost reduction opportunities, about 20 percent of which came from the SG&A budget. The expense line cost by about 12 percent, and discovery of “lost” items accounted for an additional two to three percent reduction in inventory value, while EWA’s elimination of aged raw materials and finished goods lead to a 23 percent decrease in finished goods costs.
After assessing a company’s operations and determining whether restructuring, reengineering, and functional process improvements are applicable or not, downsizing and plant closures may be the final option. Listed below are several key issues that East West Associates say should be addressed:
Follow the current labor laws for terminations, severance pay, retirement, enforced or unpaid leave and other provisions. The law currently requires at least one month’s notice per year of service. This should be regarded as the base level.
Notification to the local and municipal labor bureau and PSB is necessary; however, do not expect support unless you as a company have large operations in the area that will remain open.
Know how much “guanxi” you have. Do not put local officials in the positon of being surprised when they hear of your reduction in workforce or closure.
Review your company’s history with respect to labor unrest, labor bureau complaints and ensure current compliance with all regulations, especially taxes and social welfare requirements.
A local area risk assessment is strongly encouraged to better understand the community and the employee-company relationship history.
Successful closures share one common factor: the companies all established a multi-functional team to identify the impact on all stakeholders and created a crisis management plan to secure and protect the company’s staff, assets and IP.
The services of outside experts with experience handling the risk management and communications issues associated with closings may be extremely valuable if the internal resources are not experienced.
Local officials will likely stay away and may not intervene on either side. If you are able to enlist the support of local officials, however, this can help to keep emotions reasonably calm.
The PSB will not intervene or get involved until the law is broken. This means physical violence and injury.
JV partners, if any, tend to disappear when trouble starts and do not like to get involved. Do not expect much help from your JV partners.
Careful consideration should be given to who will make the termination or plant closure announcement. The announcement itself should explain the company’s reasons for termination or downsizing, termination packages and the termination process.
Typically 95 percent of the workforce will accept terms offered if treated fairly. It is the five percent that do cause trouble who often incite others.
Remember that if labor unrest suddenly develops, it’s too late to develop a crisis management plan to mitigate the risks to management, assets, IP and your brand.
A town hall-type meeting on company property on announcement day is not recommended.
Give laid off workers what they deserve and then some. Research local practice.
Jon Anderson currently holds the position of Vice President & Managing Director for East West China. He is responsible for oversight and execution of all EWA projects in greater China, business development and staff development. Jon has served in a variety of senior consulting and corporate executive roles in China since the mid-90s
Jay Hoenig is responsible for East West’s Asia Pacific and Middle East operations (Japan through ME), including business strategy, strategic planning, and all client projects and assignments. He is a former Chief Operating Officer Asia Pacific for Hill and Associates Group and Chairman of Hill & Associates (PRC). He was also previously Asia Pacifc VP at Bechtel.