China has often been characterized as a country of contradictions. Its economy has thrived on market forces, helped by the heavy hand of Beijing; it has opened itself up to the world, but doing business there is sometimes akin to operating in the dark; its export muscles have been the envy of manufacturers all over, yet they have not been able to work miracles in auto manufacturing like they have in electronics and textiles. PricewaterhouseCoopers consultant Ken DeWoskin has had a front row seat to China's transformation since he first began working in the country in 1977. A former Professor of International Business and Asian Languages and Cultures at the University of Michigan, he has advised in the fields of auto manufacturing, energy, telecommunications, entertainment and financial services. Excerpts of the conversation:
Q: Given China's economic success, do you think the idea of a socialist market economy is starting to get some respect in the world?
A: China is certainly getting some respect in the world. There's hardly an area of the Chinese economy that has not far exceeded what experts were predicting even a decade ago. There's no question that the economy as a whole and the leaders of China have gained a tremendous amount of respect. At the same time, I would say that people who look at China professionally are all asking single question: does China's socialist market economy really work, and is it really creating tremendous value? Or is it a massive, massive case of borrowing against the future?
Q: In what ways is it borrowing against the future?
A: Let's look at the bad asset situation which has been created in China – upwards of US$800 billion in nonperforming assets which are really redirected bank deposits from Chinese citizens that had been invested in infrastructure and companies. We certainly know a great deal of it is not recoverable. Then there's the whole issue of social obligations. Right now, 11% of China's population is over 60. But in another 20 years, that population in China will be approaching 20%, and by 2040, it's going to be something in the region of 23-26%. China has little systematic provision in terms of pension funds and reserves to take care of that population. A third issue would be the physical environment. The power sector is reliant on a coal industry that creates a tremendous amount of pollution. Carbon emissions are huge, there are very serious water problems and a lack of industrial reliability and security, which leads to the kind of situation we've had in Harbin. The Chinese are not paying the environmental costs of the growth they're enjoying; they're deferring those costs for the future and those costs are enormous.
Q: Shifting gears, can you talk generally about some projects you're involved in?
A: Right now, a major focus is automotives and automotive sourcing. One of the areas in which China's export drive has not been particularly successful is in playing a role in larger global supply chains. China has the basic technologies and the quality to export, but hasn't developed the processes needed to be suppliers to aircraft or automotive assemblers. And even though there's tremendous potential synergy between Chinese component makers and assemblers of automobiles, aircraft and industrial equipment all around the world, this is an area that's just beginning to take off.
Q: Why haven't Chinese auto makers been able to find an export market?
A: I think there are a lot of reasons for that. It is a very complex industry that requires a lot of systems, a lot of processes and a lot of large-scale project management. China has only been at it for 25 years so these competencies are only now developing. But they are competing against players who have hundred-year histories. The second issue is the way that auto companies are now consolidating all around the world. You have American Motors being absorbed by Chrysler, GM buying Daewoo, Ford and Honda becoming ever more closely integrated. The idea of a single country being able to develop a whole new viable, global automotive brand is becoming ever more improbable. I think that either the Chinese auto industry is going to become a purely domestic industry, like Malaysia's auto industry has become, or we're going to see a different kind of integration where large players like SAIC, Dongfeng and First Auto stop worrying so much about being completely Chinese companies and start merging into major networks.
Q: The opportunities to fail in China are equally available, if not more so, than the opportunities to strike gold there. What are some common mistakes made by foreign operators in China?
A: It's failing to learn the lessons of the past, which are that China as an operating environment for businesses is different from anything else they've seen. It's a radically different environment from Japan, and it's certainly radically different from the US and Europe. Foreign companies often don't understand their potential partners and what I call their associates – their suppliers, their customers, the regulators, the whole social ecosystem that they need to deal with when they come to China. I think it was Deng Xiaoping who coined the expression "We cross by feeling for stones." That doesn't work well for foreigners coming into China: they may get across the river but they don't know where they're going to come out. Every company coming into China, whether they're doing a joint venture or a wholly foreign-owned enterprise, is going to have to rely on a set of people – suppliers, customers, joint venture partners.
Q: What about the competitive threat of local companies to the multinationals? Can you assess the degree of threat that domestic companies pose to them?
A: I think the threat they pose is very high and generally underestimated. China's overall growth has exceeded the expectations of experts and global industry players – and the same could be said of Chinese companies. Television maker TCL successfully took over RCA's television business through the Thomson deal, and Lenovo has bought IBM's PC business. If someone told you 10 years ago that a Chinese computer maker was going to buy IBM's PC business, you would have thought they were crazy. Chinese companies are emerging now with significant advantages. They have enough cash to be able to go out into the world and buy capabilities they have trouble developing domestically, they're internationalizing their management and they're becoming very intense competitors. There are two ways in which Chinese companies offer a potential threat to existing industry players. One is when, like a Lenovo or a Huawei, they go out and compete for global market share, offering very competitive pricing. The second way, which is not so well understood, is when Chinese companies develop so much capacity they can do a lot of damage to global pricing structures.
Q: What is it about Chinese operations that fuels this excess capacity?
A: Part of it is the hybrid nature of the economy. In the automotive business, utilization is probably 55-60% of capacity and that's because you have provincial governments pouring money into companies like Chery, banks pouring money into companies like Geely and cities supporting companies that lose money like Nanjing Auto. China's steel industry is bringing on 20-25% new capacity every year now, a result of planning that was done during a period when global steel prices were very high. The result of this overcapacity is that steel makers can't pay energy and iron ore costs to keep the furnaces going. Look at the low prices of small appliances like microwave ovens and dormitory refrigerators. Think of the pressure that puts on someone like Maytag, GE or Whirlpool, or anyone else in the appliances business.
Q: One of your specialty areas is technology. What is your advice to Intellectual Property-intensive companies operating in China?
A: China is going to present IP challenges which are unprecedented. It's not just a question of piracy, it's a question of China's general IP strategy, which is really focused on driving down the cost of IP as a component of manufactured goods. In the same way that Chinese manufacturing tends to depress world prices of goods it manufactures in large volumes, the next decade of growth in China is going to be driven by low-cost IP. My advice is you can't really approach this next decade as a period in which you primarily focus on protecting IP through legal or technological means, as in the past. You need to approach your IP with a value-management strategy and recognize that new factors are going to have an impact on the value created through R&D, innovation and investments. IP protection at major corporations is no longer just the job of lawyers. It's the job of the business development people, the mergers and acquisition people and the human resources people. It has to be more holistic, more integrated and more focused on the broader strategy of value management than the strategy of protection.