Investment : Business Management

• Japan
• The ASEANIEs
• Backyard operators
• Service expectations
• Marketing Electromagnetic Flowmeters in China
• COMPANY BACKGROUND
• THE MARKET Product
• Customers
• Design institutes

Design institutes were typically responsible for the technical design of all new plants in China. They specified the technical specifications of the equipment to be installed. Historically, design institutes had been part of state-owned enterprises. However, with industrial reform starting in the mid-I 980s, they were gradually separated. By 1991, most of them had become 'engin

bureaus' no longer dependent on nor directly supervised by either the industrial ministry

enterprise to which they had belonged. Finding overnight that they had to fend for thenr

had drastically changed the way they operated. Understanding the critical role the

institutes played, enterprises and industrial ministries had recently begun to rebuild their rej

with them.

SHAIC understood the critical role the design institutes played in their business. If the institute included electromagnetic flowmeters in the technical drawings and specified Sl-l the preferred supplier, the likelihood of clinching the order was greatly improved. Giver flowmeters were relatively new and Krugers advanced technology was unfamiliar to Cl customers, they typically followed the design institute's recommendations in building production facilities.

SHAIC paid particular attention to the design institutes. Understanding the critical importar guanxi6 it had spent a lot of time and effort to cultivate good relationships with the institutes (as well as with the industrial ministries and enterprises themselves where stron or influence existed). SHAIC had developed a system where it hired as 'advisors' key de makers in the design institutes (and other influential government units). It negotiated an a contract with those advisors, and if they turned out to be useful and helpful, the contrac extended. A fixed advisory fee was provided; advisors working for design institutes recei' 1 - 1.5% commission on clinched orders.

In greenfleld operations involving foreign direct investment, the Chinese design institutes p an insignificant role. Big multinationals making plant investments in China had in-I engineering bureaus which executed the plant design. These bureaus were familiar flowmeters and flowmeter technology and typically specified equipment they used in their elsewhere in the world. European multinationals such as Bayer, BASE, and Ciba-Geigy woul Kruger technology US multinationals such as Coca-Cola and johnson and Johnson and v use US technology Japanese multinationals such as Marubeni and Itochu would use Jap technology. In this area, SHAIC was often quoted by Kruger as a reliable and quality don supplier but conflicts had occurred as Kruger sales reps in Beijing preferred to import equip from outside China for US dollars. In general, however, if plant investments were pa financed in (RMB), then SHAIC stood a chance of getting orders.

Another 30% of SHAIC's orders came from instrument companies which functioned as either distributors or original equipment manufacturers (OEMs). In 1995, the average order size was four flowmeters with orders ranging from l 0,000 to 200,000. The average list price for a flowmeter was about 20,000. To help customers in their budget proposals and design institutes in cost estimates, specific list prices for all equipment had been developed. Competitors had relied on these list prices as reference points for the domestic market

The domestic order cycle was highly seasonal. Typically, no orders came in until late February or early March; in subsequent months orders picked up and would peak in July, August. or September. As of October, orders fell rapidly up to the end of the year.

The steel industry in China was dominated by very large SOlEs such as Shougang (also known as Capital Iron and Steel), Magang and Baogang, some of which had ministerial status. Steel was considered a backbone industry and was tightly controlled by the central government Because of their historical heritage, many of the steel giants suffered from a 'planned economy' mentality which came to haunt them in 1993. With their huge production capacities, they had found themselves going for wider and wider geographic penetration to get rid of their steel output. This pressure pushed them into markets where they had no contacts (or guanxi, which they relied upon primarily to develop orders) and which were dominated by smaller competitors who were more aggressive and flexible, and controlled a strong local guanxi network. With the central government's economic retrenchment programme (which primarily eyed the rapid expansion of capital construction projects by SOEs) shaking the market and steel imports driving prices down, the steel giants ended up in the doldrums short of cash and highly indebted. By 1995, for example Shougang was SHAIC's largest customer but also its largest debtor. With a continued tght monetary policy to control inflation, the central government had not allocated any funds to the steel sector.

Endemic of the mentality plaguing the steel giants was the reaction to SHAIC's 1995 request to Shougang to settle its outstanding debt By the end of 1993, accounts receivable from Shougang stood at 6.7 million. Orders continued to come in but Shougang did not pay and SHAIC stopped devering. It was at about that time (and as the triangular debt problem worsened with the tight monetary policy) that SHAIC instigated a policy of cash on delivery, unheard of in the industry at that time. To avoid having to write off the debt (which eventually happened in 1995., SHAIC approached Shougang to settle the outstanding debt with a steel delivery. However, Shougang's production and sales department could not agree on the payment in part because the size of the delivery was rather small relative to the orders Shougang was traditionally used to.

As deliveries to the steel sector dropped, drinking water became a new and promising area of application. Under the administrative control of the Ministry of Water Resources (MWR), local water supply companies had been traditionally quite independent and essentially operated local (regional) monopolies in water supply. Recently, as the central government (and MWR) became concerned about drinking water, a process of re-centralization had been taking place with the objective to bring the water supply companies under central coordination and control. Water supply companies were now meeting three times a year to exchange infomiation and discuss development plans (including infrastructure investments). Recognizing opportunities in this sector, SHAIC had bought 'speaking time' at those meetings, and had recently engaged two 'advisors' from the MWR.

SHAIC's actual and potential customers were primarily SOEs. With a growth in the number of wholly foreign-owned enterprises (WFOEs), it was possible that in the future some of the customers would fall outside of the direct administrative control of the Chinese government For the immediate future, however, understanding the administrative control mechanism operating at different government levels and identifing the important actors and gatekeepers in it remained paramount to successful marketing and selling to the state-owned sector in China.

Under the old system of a planned economy which was in place in China until the late 1970's, all enterprises belonged administratively to a central government ministry and/or a more local (provincial or municipal) government bureau. The central government link often involved administrative reporting to, and control by, a central ministry, provincial authorities, and local representative organizations or administrative bureaus. Given that SOEs were essentially manufacturing sites responsible for production output and the social welfare of all employees, the decision-making authority on many important managerial decisions (e.g. distribution) fell outside of the SOE and rested (or was shared) with one or more administrative units in this complex government control mechanism.

With industrial reform starting in 1984, the Chinese government's objective was to separate ownership from management Afthough progress had been- made, the objective had not been fully reached by 1995. More importantly, with the plight of many SOEs (two-thirds of them were reportedly loosing money in 1995. and the central government's concern about social stability (and the state-owned sector remaining the largest industrial employer), there was often a sense of a reversal of that policy and a tightening of government control. With government decentralization and reorganization (including restructuring of ministries) started in 1984 and partially (and to varying degrees in different sectors) achieved by 1995, expatriate managers - and often Chinese colleagues - were often at a total loss to identify the logic of the decision- making authority in this complex and evolving government control mechanism.

In 995, SOEs (and hence JV partners) continued to report to local, provincial, and central government authorities. Such reporting and supervision had often created the impression among foreign JV managers that a shadow management structure was operating and influencing jV operations. For companies such as SHAIC selling to SOEs, it remained difficult to identify where the decision-making authority rested and with whom. The latter was important as bureaucratic control was often exercised at the discretion of government officials within the context of vague regulations (often without clear implementation rules or publicly unknown - the so-called neibu regulations). Cultivating personal relations with such officials at various levels was critical to develop an understanding of the system and to potentially influence it Mr Broekers, as some of his foreign colleagues in other jVs, had come to realize that China 'was governed by men, not by laws'. In this context, Mr. Broekers understood the critical importance of design institutes and their engineers to SHAIC's business.

Electromagnetic (or magnetic inductive) flowmeters measure mass flow in pipes. They installed and used as process control instruments in a wide range of industrial applicat including water cooling systems in the steel industry, drinking water supply, mining, chen industry, power industry, beverage industry, etc. SHAIC manufactures flowmeters for p ranging in diameter from 10 mm to 3 m. The design and compactness of the flowmeters adapted for different applications. For example in the dairy industry, the flowmeters are desif with sanitation in mind; for installation in hazardous areas, other design adaptations have tc made.

The meters are typically included in new plant designs. With the major overhaul and upgradir existing production facilities in many industries together with the construction of many production operations (often involving foreign direct investment) in China, the market pot for electromagnetic flowmeters was believed to be very large.

Under Chinese government regulations, representative offices are not entitled to do business in China and, cannot solicit orders (i.e. they have no business license).

As a high-tech company. SHAIC had preferential status with an income tax rate of I 0% relative to the in 33% corporate tax rate.

SHAIC is a Sino-German JV located in the Minhang ETDZ, southwest of Shanghai (see Exhibit CS 10.1 ).3 After two years of negotiation with the central government in Beijing, the jv was established in 1986 between Honggong Instrument Works (Shanghai) and Kruger (Germany). Honggong Instrument Works is a centrally-controlled state-owned enterprise (SOE) based in Shanghai which administratively belongs to the Ministry of Nuclear Energy (MNE), one of China's smaller industrial ministries.

Kruger is a family-owned German company headquartered in Duisburg, Germany. It was established more than 70 years ago and has grown to become an international force in the field of measurement technology. In the field of flowmeters, Kruger had become synonymous with quality and reliability. In 1994, worldwide turnover was about 500 million DM. In the early I 980s, as China opened its door for foreign direct investment, Kruger saw enormous opportunities in the China market Afthough electromagnetic flowmeters were new to China, many of its overseas clients (e.g. Bayer, BASF, Ciba-Geigy), required flowmeters installed in their Chinese production facilities. To enable broader penetration in the local market and to educate potential customers in its advanced technology, Kruger decided to set up an equity JV and transfer flowmeter product and production technology to China. Initial contacts were made with the central government in 1984, and the jv contract with Honggong Instrument Works was formally signed in 1986.

Under the JV agreement Kruger contributed technology and an equity investment of 11.7 million DM. In return, it obtained a 40% equity stake in SHAIC. The majority stake of 60% was with Honggong Instrument Works. Where Kruger took the responsibility for production, HIW took responsibility for marketing and sales. By September 1995, SHAIC occupied two production sites in the Minhang ETDZ of Shanghai and a sales office in the centre of Shanghai. One of the tciIities in Minhang was equipped with a large flow calibration rig capable of handling a wide range of flowmeters up to 3 m diameter - the only flow calibration system in China. In 1995, a total of 122 people were employed at the three sites. Mr Broekers and the production manager were the only expatnate managers in the jV. The organizational structure of the joint venture is depicted in Exhibit CS 0.2.

In terms of administrative structure, SH,JC - through fts Chinese partner HIW - belonged the Ministry of Nuclear Energy (MNE). Being located in Shanghai and working in the field instrumentation, ft also had to report to the Shanghai Measurement Instrument Bureau (SMlB) the Shanghai Municipal Government In essence, SHAIC was required to periodically rep performance statistics to MNE in Beijing (the central government link) and to the SMlg- Shanghai (the municipal government link). The latter link had increasingly become a concern ai was well known that SMIB had recently established fts own jVs (at the local, Shanghai Munici Government level) wfth Iwo of Kruger's international competftors.

In addftion to The iv, Kruger continued to import electromagnetic fiowmeters from abroad and occupied a representative office in Beijing.4 Afthough KrOg&s products were typically of a mo advanced design than the flowmeters manufactured by SHAIC, the jV had been known compete with them on orders originating from outside China.

In 1994, SHAIC attained a turnover of 48 million. With a cost of goods sold of 67%, net pit on turnover was 17%, 2% higher than the average for the 112 foreign-funded enterpd operating in Minhang at the end of I 9945 The 17% net profit figure represented a 3% drop fit the previous year. By September 1995, Broekers believed that 60% of the installed flowmeten China were SHAIC products. The remaining 40% were imported products, as SHAIC was i only producer in China at that time. Of the imported products, about 8% were Kr01 flowmeters.

In September 1995, Kruger was negotiating wfth MNE and HIW to increase its equity stake over 50% and to transfer more advanced technology to SHAIC.

Looking out of his office window, Mr E.j. Broekers, general manager of Shanghai Honggc Advanced Instrument Co., Ltd. (SHAIC),' a Sino-Gemian joint venture (JV) in the Minh. Economic and Technological Development Zone (ETDZ) of Shanghai, noticed the I smokestacks of the main Shanghai electric power station. His eyes followed the large clouds smoke that shot out of the smokestacks into the hot summer air. Despite continued growtl revenue and profits, some clouds have appeared on SHAIC's horizon as well', he thought himself.

SHAIC was established in 1986 as an equity jV between the Shanghai-based Hongg Instrument Works (HIW) with 60% equity and the German company Knger with 40% eq Since its establishment, the jV had developed a profitable business in China. Se] electromagnetic or magnetic inductive fiowmeters of various sizes, turnover in 1994 had read 48 million2 (including VAT) with a 17% net profit. But market development had bee rollercoaster. Since 1993, orders had come increasingly from the southern part of C (primarily Guangdong Province) and from sectors other than steel which had represented bulk of business in the early years. With this shift, the role of the Ministry of Nuclear En (MNE) (to which HIW belonged administratively) in opening up markets had waned. As opportunities found themselves outside of the ministerial sphere of MNE, Broekers felt that Chinese partner would face increasing difficulty in executing its sales and marke responsibilities. A more aggressive market development approach was needed.

However, due to (a) lack of liquidity in the economy because of the central government's tight monetary policy since August 1993, (b) complex differences in the industrial ministries to which clients reported (particularly the extent of central control and information exchange), and (c) the general lack of experience with electromagnetic flowmeters among potential Chinese customers, questions arose on where to focus next Broekers specifically wondered how to access and develop virgin application areas, how to secure an efficient entry, and how to pre-empt foreign competitors who were in the process of getting their own jV operations off the ground. With 60% of the installed flowmeters being from SHAIC, Broekers also questioned how to maintain the motivation among the Chinese employees. The enthusiasm and aggressiveness they had shown dunng the initial years of the JV would have to be maintained, if not increased, to successfully tackle the new market opportunities.

Over the years Asian managers have developed technical expertise in buying indus products. Despite comparatively low labour costs, they often select capital-intens rather than labour-intensive, processes. Often-cited reasons are a search for quality, fact that machines are easier to manage than workers, and fears of higher labour r or impending labour shortages. The desire to impress customers and suppliers is al factor.

In many industrial sectors, the services provided are at least as crucial as price and payment terms: many Asians see service as a strong indicator of commitmi and expect suppliers to provide sufficient information and show a willingness to ad products. This requires extensive local representation, local warehousing for delivery, and after-sales service on the spot.

Manufacturers in the ASEANIEs are at different technological and developmei stages, each requiring different marketing strategies:

• Implementors, at the first phase of the learning process, assemble a limi product range. They are looking for new product and product opportunities and generally prefer a complete package that includes i materials, components and capital equipment. (A typical example would Sumatra Tobacco, a medium-sized cigarette manufacturer in Indonesia, wli diversified into instant coffee.) Western firms must learn to bundle their 0:

and emphasize marketing technology rather than products.

• Assimilators are assemblers who have learned fast, and moved tow producing first components. They expect quality and specific technical knc how, and require advice on products and processes that need upgrading.

These local companies, with little technical expertise and purchasing power, represent a challenge for the Western firm. They play a useful role in the dom< economy, manufacturing simple consumer goods aimed at the traditional segment small scale. While overall they form a major economic factor, they must be targ individually, which is difficult and expensive - especially since many operate out major cities. This segment is an attractive market for sellers of second-hand machi1 or suppliers of commodity products from Taiwan and Korea; it is less relevant for 11 selling sophisticated or expensive product lines.

Growing demand from the transition and traditional segments, coupled with ste foreign demand for manufactured exports, has caused sales of raw materials and se manufactured goods to grow rapidly. New plants and equipment are needed to replace existing equipment and to expand capacity (either because of import-substitution policies or because exports are increasing throughout the region). Large-scale turnkey projects in extractive industries and the processing of raw materials are further opportunities to sell capital goods. Road constmction equipment, power plants, telephone systems, port facilities are required to urgently develop and upgrade

• jfrastructure. Demand for industrial products is far greater in the ASEANTEs than in industrial countries of similar size.

Four market segments

Governments and state-owned enterprises

Governments play a major role in the purchasing of industrial products. either directly, or through state-owned enterprises. In most ASEANIEs the public seaor still dominates the industrial scene, despite some attempts to privatize political considerations often influence purchasing decisions, and as a rule preference goes to local suppliers, although competitive bidding also exists. Successful bids are often prepared by gathering extensive information well before a tender is officially announced. Consultants who determine the technical specifications of prOteCtS will play a major role.

Because Asian governments formulate policies, ser standards, grant licenses, provide foreign exchange and credit, they also have a major influence on purchasing decisions in the private sector. Industry associations and chambers of commerce can be of help to the foreign firm.

Leading local finns and non-Japanese multinationals

Leading local or regional firms, and the subsidiaries of Western multinationals, have similar purchasing processes: in both cases local technical staff. act as gatekeepers, specifiers and influencers. However, in local finns, important purchasing decisions are made by the chief executive (often the owner), while Western subsidiaries may have to refer to their headquarters or regional office; when expatriate staff are involved in the decision, they may introduce a slight bias toward suppliers of their own national origin, although not to the exclusion of others.

Japanese firms

Several thousand Japanese subsidiaries are actively operating in the region - an important but problematic segment for Western suppliers. By and large they prefer to deal with proven suppliers - usually Japanese. This is due to several reasons:

• close relationships with subcontractors at home, and the strong influence of headquarters on subsidiaries;

• the closed nature of Japanese communities abroad;

• most Japanese manufacturers in the region are joint ventures with local firms and with one of the large Japanese trading houses (sogo shosha), wi enormous product portfolio and geographic spread enables them to

practically anything that is not delivered by suppliers in Japan.

There is not much room left for non-Japanese suppliers except in n products, such as special chemicals. They should direct their marketing effort headquarters rather than at local units.

when Japan took steps to lower tariff and non-tariff barriers in resr to Western criticism, it became clear that there were other obstacles to We exports: networks of Japanese firms buying frop each other; subtle administj

guidance that favoured local firms; a c6mplex distributiori system; closed-door bic for construction contracts; bureaucratic and regulatory obstacles, espcial1y in technology sectors.

The Japanese government has gradually removed these obstructions. example the Japanese telecommunications company NIT has been persuade purchase part of its equipment abroad. Japanese science institutions have acquire supercomputers, and the Japanese electronics industry is buying a sizeable numb US semiconductors. Even US software suppliers have established viable operatioi Japan in the 1990s. Also, Japan can now claim to be the only country which offi< exhorts its citizens to buy imported goods, which provides special loans for imj and which has set up a government agency (JETRO) specifically to help foi exporters find a Japanese market for their goods.

To succeed in Japan, however, requires more than just exporting: foreign I must make substantial direct investments over a long period. In Japan, as a relationships matter more than a good price: transactions are carried out, aft relationship has been established, and price is only one ingredient in a mi expectations and interactions. This, of course, is also true in Europe, and, to a h degree, in the USA. But, by and large, in the West pricing has been and still is thej important ingredient in the conclusion of a business deal. In Japan, on the other h this rarely holds true, particularly when selling to industrial customers. Saying that the Japanese market is open, Japanese society remains closed, is still a description.

Keiretsu, or enterprise groups, are the best-known example of industrial cliq Understanding the links between the various members of these groups and the they grant preferential treatment to each other is vital for calculating an indivi foreign firm's chances of success in a given market. But close relationships do guarantee the conclusion of a contract, even within the keiretsu. Business links becoming looser, and selling to and buying from competitors is becoming n conunon, even on an OEM basis. But Japanese buyers will continue to define quality of relationships with existing suppliers, customers and other partners competitive advantage that matters more than an outsider's ability to offer the r product at the right price.