Where is China’s Innovation Coming from?

In a previous article, we spoke about how China was rapidly becoming one of the world’s leading innovators, filing more international patents than any other country in 2010. Now, questions remain as to the value of quantity over the quality of innovation and just how that reflects on China’s move up the value chain. This also begs the question: what is China doing to “out-innovate” traditional innovation strongholds like the U.S., EU and Japan, even if that innovation is not matched in technological prowess?

There are several factors that have led to China’s rise up the value chain, beginning with the disruption of traditional supply chains; whereby companies began outsourcing their manufacturing capabilities to China to decrease the assets on their books while increasing productivity and margins; mandated technology transfers, where foreign companies, intent on bidding on government tenders in China were required to contribute their proprietary technology to secure the tender, the chance to get access to China’s growing middle class and the fear that not doing so, would result in significant long-term disadvantages, and finally, China’s nascent engines of innovation, companies that have at first built their businesses as Original Equipment Manufacturers that have since added research and development to their business models in order to compete with competitors, both domestically and abroad in increasingly commoditized industries.

As brands began to outsource their manufacturing capabilities to Chinese manufacturers in the ‘80s and those OEMs became increasingly adept at producing low-end components, the win-win arrangement progressed, with many manufacturers rising up the value chain to take on an increasingly large portion of their partner brand’s manufacturing capabilities. This trend is by no means China specific, but had it not occurred, as with other Asian manufacturing hubs, further steps would have been impossible.

Now armed with a more technically skilled workforce and rapidly improving industrial capabilities, China was set to come of age and invest in what is now some of the world’s most impressive infrastructure, specifically the world’s largest high-speed rail network. Determined to win government tenders, company’s like Kawasaki were encouraged to partner with local Chinese companies, with proprietary technology being part of their contribution to those Joint Ventures. While this won companies like Kawasaki market share in the short term, their Chinese partners would ultimately become their competitors, producing their own trains using Kawasaki’s technology ready for export. This, once more, is not a China-only trend, but akin to the vast majority of developing countries, whereby emerging economies “disrupt” traditional industries with what is often a cheaper labor force, allowing developed countries to adapt and further innovate new products and industries.

While technology transfers are no longer required to bid on Chinese tenders, many companies choose to partner with Chinese companies in order to improve their chances at access to the Chinese market, reasoning perhaps, that the lost opportunity is not worth the technology parted with to secure that access.

An exciting trend is now emerging that is seeing domestic Chinese companies truly out-innovating global competitors. While their numbers remain small, the government has incentivized companies that invest in innovation, ensuring that, while the quality of the gross number of patents filed to date may not yet stand up to global competitors, the future is truly bright for innovation in general, as well as for China.

What Happens When China Becomes the World’s Largest Importer?

China’s economy has grown largely on the crest of a wave of exports fueled by foreign direct investment over the past 30 years, but as the global market changes and China adapts to new realities, what are some potential opportunities that arise from companies with an existing presence in the export industry in China and how might they leverage that experience to benefit from the changing domestic economy?

China’s export industry is indeed changing, while it is by no means going away, physically or metaphorically, there are certainly some challenges that will present themselves over the coming years. But like any challenge, there also comes opportunities; as China’s imports rapidly increase, despite the ebb and flow effect of global markets, the trend is clear, China will become both the world’s largest importer and largest economy in the world in the not-too-distant future.

In a previous article, we spoke of about how China, in an effort to maintain economic growth and offset the effects of a decrease in exports, while at the same time attempting to close what has been an increasingly larger wealth gap and create a more robust (and happy) middle class. In so doing, we may be seeing a shift in the China model, one that is increasingly more consumption, and therefore import-oriented than only foreign direct investment and export-oriented.

Businesses currently exporting from China are in a marvelous position to take advantage of this trend. In the process of offsetting rising costs as a result of the changing global economy and China’s pivot to adapt to it, these companies can use their existing production capacity, experience on the ground and/or human capital to make sales on the mainland and capture a part of what will be the world’s largest consumer market.

While traditional imports, often components ready for tertiary production and future export, as well as luxury goods and status symbols such as wine will remain, there is nary an industry that will not be touched by this development, while some more readily or imminently accessible markets exist such as those that cater to China’s aging populous, professional services, design and medical products, a nascent middle class will ensure that the market for quality goods will only grow for the foreseeable future.

While, as with any pivot, timing is essential to ensure that these products come to a market that is ready for them, the future is bright for forward looking enterprises that see the opportunity when it presents itself.

China’s Industrial Base – Moving Inland?

In one of last month’s articles, we cited China’s rapidly increasing labor costs, one of the lynchpins of the country’s economic growth of the past 30 years. One of the many reasons that labor is becoming increasingly difficult to find, is often tied to China’s migrant workers, by far the globe’s largest migratory workforce, leaving for home during Chinese New Year, with increasingly fewer returning to their positions at factories along the coasts.

This begs a couple of questions, the first: why (perhaps how), in a country of 1.4 billion people is there a labor shortage? And the second and perhaps more important going forward: How will this affect China’s manufacturing and export industries?

The reality is that both the labor shortage and the resulting solutions are related. Over the past 30 years, as coastal cities have rapidly developed and been the primary beneficiaries of foreign direct investment and government assistance, they attracted massive numbers of migrant workers from elsewhere in the country. The best example of the scale of this migration is perhaps, Shenzhen, formerly a fishing village just 30 years ago, is now home to some 14 million people and is one of China’s primary economic hubs. Migrant workers will traditionally leave for home, bringing with them the majority of their savings to provide for family back home. As this trend has continued in tandem with increase government investment into China’s interior, the infrastructure required to facilitate industry has developed.

Rather than travel to far flung factories on the coast leaving their family behind in search of work, many former migrant workers are opting to find work closer to home; and industry has begun to follow.

This has resulted in massive competition for workers between factories along the coasts resulting in increasing wages both instituted by the factories themselves, as well as the municipalities in which they are located, with regional manufacturing hubs such as Beijing, Shanghai and Guangdong looking to attract migrant labor to their regions with mandatory minimum wage increases. So, while some of China’s industry has begun its own migration, other, higher value manufacturing remains near the coast due to intricate supply chains and more advanced infrastructure. This has not, however prevented some advanced manufacturing from moving.

Foxconn, with its massive workforce and plethora of clients has the ability to support much of its own supply chain, and while this has allowed them to move some manufacturing into the hinterland, to cities such as Zhengzhou, Chengdu and Wuhan, they have also added nearly one million robots to supplement their labor force in Shenzhen, to mitigate the increased cost of labor.

So what does this mean for businesses in the export industry? It will largely depend on what is being exported; while lower labor costs further inland may be attractive to manufacturers whose products lie lower on the value chain may move to benefit from these savings, those higher up the value chain in IT and more specialized industries derive much of their competitiveness from a robust supply chain, fueled by an experienced and skilled labor force currently beyond the reach of smaller inland cities.

China Racing to Become the World’s Largest Innovator – What could this mean for your business?

China is quickly becoming the world’s largest patent holder, filing more patents than any nation in 2011, to surpass the United States. What could China, with an existing manufacturing base and an impressive commitment to R&D mean for your business?

In one of our previous posts we spoke about how China is investing in its middle class in order to build a consumer-based domestic economy to contribute to its GDP. We also spoke about how China’s infrastructure has risen above other Southeast Asian economies to become a more robust manufacturing base that is difficult for other nations to compete with, given the sheer size and breadth of China’s supply chain and infrastructure. In this post we examine how this trend will be accentuated by China’s drive toward a more innovation-based economy in an attempt to capture a larger percentage of the global GDP and to ensure growth for the future in the face of rising costs.

While China has become renowned as the world’s manufacturing hub, the country is intent on rising up the value chain in order to capture a larger percentage of revenue from products sold abroad instead of simply relying on manufacturing for export. In so doing, the Chinese government has mandated in recent years that patent applications should rise to 2 million by 2015.

The significance of this has not gone unnoticed, with United States patent filings reaching just 480,000 in 2010 and surpassed by China in 2011. While the innovative nature of these patents filed in China is still largely lagging the United States, the number of inventive patent filings by China is rapidly increasing.

Further still, China now spends the second most of any nation on research and development, having surpassed Japan in 2006, though spending just under half of what theU.S. has committed. At the same time, the country and Asia as a whole is gaining on Western economies with shares of global R&D expenditures growing in favor of the likes of China, South Korea and Taiwan while those of the EU and the U.S. decline.

China’s increasing influence in research and development is perhaps most clear in those patent filings filed overseas. China’s patent filings in the United States have also been rapidly increasing, focused primarily in the new energy field with wind and solar technologies being the most prominent but also including telecommunications, battery and automobile manufacturing technologies.

Businesses can now take advantage of China’s increasing R&D expertise, particularly in the new energy sectors such as wind and solar. This gives businesses the ability to research and develop, test and finally manufacture a product for a specific market, while spending capital and resources on marketing and selling that product in its destination market, while benefiting from cost savings still intrinsic toChina and comparatively reduced lead time.

What Does an Appreciating RMB and Rising Labor Costs Mean for China’s Export Industry?

There has been a great deal of doom and gloom in recent years, asserting that China’s export industry, the mainstay of its rapid economic growth for the past three decades, was coming to an end. Much has been said for a move of manufacturers and supply chains to more cost-effective regions such as Vietnam, Indonesia and now even Myanmar. To look at rising labor costs and the appreciating Renminbi by themselves would leave one feeling like a dramatic change was coming to the role which China currently plays in the world, there are several reasons why this is not so, at least not yet.

Contrary to political rhetoric in the West, the Renminbi has actually risen dramatically over the past year, diminishing China’s current account surplus, with Chinese produced products becoming more expensive while Western products have been made cheaper for Chinese consumers. At the same time, rising labor costs have further taken a bite out of margins, rising at an average of 22% in 2011 across 21 of China’s 31 provinces. This is largely a calculated move by China to develop a more robust middle class, able to not just earn an income making products that the rest of the world consumes, but to be able to afford those products themselves, thereby giving China an economic driver that does not rely exclusively on export driven growth and foreign direct investment.

So, does a rising RMB and wage hikes translate into an exit from China? No. The reality is, that while other South East Asian countries like Bangladesh, India or Pakistan may offer cheaper labor pools, they lack the basic infrastructure required to facilitate a cost-effective move for the vast majority of products currently being manufactured in China, including roads, power and crucially, expertise. Having developed themselves into the world’s factory over the past thirty years, China possesses the expertise to facilitate a robust supply chain that is both rapid and reliable, saving critical lead times and cost. While neighboring countries such as Vietnam have often been touted as the next Asian Tiger, soon to become a rival to China’s manufacturing prowess, the reality is starkly different. With rapid inflation and crumbling roads,Vietnam has fundamental issues that prevent it from becoming a viable alternative to China.

While China edges its way up the value chain, the intrinsic advantages that are fueling this growth will continue to rise, while forward thinking businesses will take advantage of the rise of the Chinese consumer and, like many are already doing, find a place for sales in China in their business plans, thereby offsetting the increased costs with higher margin domestic sales.