The China Analyst April 2012


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The China Analyst April 2012

  1. 1. April 2012 І The China Analyst 中国分析家 A knowledge tool by The Beijing Axis for executives with a China agendaFeaturesState of Change: Assessing China’s CompetitivenessHow to Engage: The Rise of New Chinese ManufacturersChinese OFDI: Bolder, Wiser and More Strategic
  2. 2. Chinese companies in the Fortune 500 juxtaposedwith the development of Beijing’s subway systemThis infographic illustrates the progression of Chinese companies in the Fortune 500 from 1994 (when the first Chinese companyjoined the list) with a visual reference to the expansion of the Beijing subway system from 1971. All but two of Beijing’s current15 lines were opened in the last decade; in the same period, 47 of the current total of 58 mainland Chinese companies joined theFortune 500.The circles around each company visually portrays the expansion in revenue of the companies at time of joining the Fortune 500 vs.2010. Note the subway map is not exhaustive of Beijing’s current subway system of 15 lines. Line 5 Opened in 2007 Bank of Communications Line 13 Opened in 2002 China Ocean China National China Shipping Offshore Oil Minmetals Lenovo Group China National Building China Railway Line 4 Materials Group Engineering Zhejiang Materials Jiangsu Opened Industry Group Shagang in 2009 Group China Metallurgical Group China China South Railway Industries Construction Group Chemchina Peoples  Aluminum China Datang  Huawei  Ping An  Insurance Co. of  Corp. of China China  Wuhan Iron &  Technologies Insurance China Shenhua Group Guodian Group Steel Line 10 Opened in 2008 China State Aviation Industry Construction Corp. of China China China Pacific China National Comunications Insurance Group Petroleum Corp. Construction China Mobile China Mobile Communications Communications Jizhong Energy Group Henan Coal Shanghai China Automotive China North  Shipbuilding & Chemical Industries Group Industry Shanghai State Power Baosteel Group (company reorganised Line 1 Line 2Opened Opened China and reformed) Huanengin 1981 in 1981 Sinomach Group Cofco Group China Construction Agricultrual China Bank Bank of China Telecommunications State Power Sinochem Bank of China Industrial & Sinopec Group Commercial Bank of China China National China China First State Grid Dongfeng Motor Aviation Fuel Southern Automotive Group Power Grid Works China Railway Materials China United Commercoal Telecommunications  Citic GroupLegend China Electronics Companies that joined the Fortune 500 before 2000 (Line 1) Companies that joined the Fortune 500 in 2000-04 (Line 2) Companies that joined the Fortune 500 in 2005-07 (Line 13) Hebei Iron & Steel Group China Post Companies that joined the Fortune 500 in 2008 (Line 5) Group Companies that joined the Fortune 500 in 2009 (Line 10) Companies that joined the Fortune 500 in 2010 (Line 4) Sinosteel Inside circle: Company revenue in year of joining Fortune Shougang Group 500 Outside circle: Company revenue in 2010
  3. 3. The China AnalystAt the Highest Level The ChinaThe China of 2012 is a China that is priming itself for a new era. Change anddevelopment have been ubiquitous in China for over three decades now— Analystduring all this time China has been changing itself and the world in many April 2012ways. But what is about to happen is a Chinese evolution on a different level.It is imperative for every company in the world to change their perception of Published byChina. The Beijing Axis 3806 Central Plaza 18 Harbour Road Wanchai Hong Kong, PRC China is changing. Chinese companies, involving years of imitation, Tel: +86 (0)10 6440 2106 While this simple alteration, adaptation, and innovation. Yet it is Fax: +86 (0)10 6440 2672 statement could have a process that is very much underway in China, been uttered at any progressively impacting various markets around time in the last three the world. Executive Editor decades, in 2012, it is beginning to take Thus, it is essential not to underestimate the Kobus van der Wath on a new meaning. change that China is still capable of. Hence, Although China has in this edition of The China Analyst, we have become the second- undertaken the task of assessing China’s current Editor largest economy in level of competitiveness and to consider the Barry van Wyk the world, it has now future implications of a more competitive China. reached the point We have highlighted China’s leading companies Assistant Editor where its ambitions are that are approaching the ‘technological frontier’no longer satisfied with being second-best, with in their respective industries, and have assessed Daniel Galvez danielgalvez@thebeijingaxis.combeing merely an imitator, a follower, and a user of the options that are available to foreign firms inforeign technology. It is now aiming to be a leader the face of a more competitive China. Design Specialistin its own right, an industrial giant renowned notonly for its scale but also for its pioneering spirit. Hattie Peng What is required is for foreign companies and observers to start changing their perspectivesTo some companies around the world this may on China. A more competitive China will bringsound odd. Many would still not mention ‘China’ new challenges as well as new opportunities. It is To view the contents of previousand ‘innovation’ in the same sentence. There are editions of The China Analyst, see imperative that companies be informed, the first Previous Editions on page 39. Toindeed various reasons why the type of innovation steps towards being able to act preemptively. subscribe free of charge to The Chinathat has taken root in China in the last few Analyst, please visit www.thebeijingaxis.decades has in large part relied on imitation and I trust our readers will enjoy this edition of The com or But to maintain this impression of China Analyst, and as always we welcome your For advertising opportunities, pleaseChina would be a costly error of judgement. feedback. contact Barbie Co at barbieco@, the best way to look at China is to use alittle imagination, to project current trends into Kobus van der Waththe future and to imagine what such a world Founder & Group Managing Directormight be like. Farsighted individuals will do this The Beijing Axisnow, not in two, five or ten years down the road. kobus@thebeijingaxis.comThose who delay this assessment indefinitely willat some point in the future find, to their dismay,that Chinese competitors have approached ahigher level of competitiveness.In 2012, as China transitions to new political DISCLAIMER This document is issued by The Beijing Axis Ltd. While all reasonable care has been taken in preparing this document, no re-leadership, this process is starting to go into a sponsibility or liability is accepted for errors or omissions of fact or for any opinions expressed herein. Opinions, projections andhigher gear. The main battleground for market estimates are subject to change without notice. This document is for information purposes only, and solely for private circula-share in value-added industries is currently tion. The information presented here has been compiled from sources believed to be reliable. While every effort has been made ensure that the information is correct and that the views are accurate, The Beijing Axis cannot be held responsible for any loss,ongoing in developing markets. In countries irrespective of how it may arise. In addition, this document does not constitute any offer, recommendation or solicitation to anylike Brazil, South Africa and India, Chinese heavy person to enter into any transaction or to adopt any investment strategy, nor does it constitute any prediction of likely future movements or events in any form. Some investments discussed here may not be suitable for all investors. Past performance isand construction machinery manufacturers have not necessarily indicative of future performance; the value, price or income from investments may fall as well as rise. The Beijingmade substantial gains in recent years. While Axis, and/or a connected company may have a position in any of the investments mentioned in this document. All readers are advised to make their own independent judgement with respect to any matter contained in this document.competitively-priced product offerings havelong been a core element of China’s competitive Copyright notice: Copyright of all materials, text, articles and information contained herein resides in and may only be repro-advantage, Chinese manufacturers are now duced with permission of an authorised signatory of The Beijing Axis. Copyright in materials created by third parties and the rights under copyright of such parties is hereby acknowledged. Copyright in all other materials not belonging to third partiesprogressively fabricating products that compete and copyright in these materials as a compilation vests in and shall remain copyright of The Beijing Axis and should not benot only on price but also on quality and after reproduced or used except for business purposes on behalf of The Beijing Axis or save with the express prior written consent of an authorised signatory of The Beijing Axis. All rights reserved. © The Beijing Axis 2012.sales services. It is an extended process for4 І The Beijing Axis
  4. 4. Table of Contents April 2012 6 FEATURES State of Change: Assessing China’s Competitiveness 22 STRATEGY Mapping China in the Global Debt LandscapeForeign companies are facing the prospect of a competitive In this edition we illustrate China in the global debt outlook.landscape significantly altered by emerging Chinese competi- 24tors. STRATEGY China in Europe: Cash, Debt and M&As 9 FEATURES How to Engage: The Rise of New Chi- Is Europe’s crisis becoming China’s opportunity? nese ManufacturersChinese machinery suppliers are producing increasingly sophis-ticated goods, but are still struggling to increase their efficiency 27 REGIONS Regional Overview: BRIICS A macro overview of the leading developing economies: Brazil,and adequacy of internal support processes. Russia, India, Indonesia, China and South Africa.11 FEATURES Chinese OFDI: Bolder, Wiser and More 28 REGIONS Regional Focus: CHINA-AFRICA China-Africa trade and investment analysis, and a focus on Strategic China’s relations with the East African community. 30The current Chinese OFDI wave is emerging as a key enabler ofconsolidation, growth, market positioning and the acquisition REGIONSof strategic assets and expertise for Chinese companies. Regional Focus: CHINA-AUSTRALIA China-Australia trade and investment analysis, and the series Australia State Watch, featuring Tasmania.14 MACROECONOMY China in 2012 - Soft Landing? 32 REGIONS Regional Focus: CHINA-LATIN AMERICA China-Latin America trade and investment analysis, and a spe-This year marks the beginning of a trying period for China’s cial focus on China’s relations with Ecuador.economy. As it aims for a soft landing, it will find itself in themidst of a fundamental transition, and the economic indicatorshave already begun to reflect these new trends. 34 REGIONS Regional Focus: CHINA-RUSSIA16 China-Russia trade and investment analysis, including the series PROCUREMENT China-Russia Resources Watch. China Sourcing Strategy: The Purchase 36 Positioning Matrix The Beijing Axis News - September 2011–Understanding the Purchase Positioning Matrix can help companies March 2012determine the most suitable procurement structure to set up in China. The latest The Beijing Axis Group news.19 INVESTMENT China Capital: Inbound/Outbound FDI & Financial Markets 40 About The Beijing Axis Company profile and contact information.Analysis on the latest on FDI in China and OFDI by Chinesefirms.
  5. 5. The China Analyst State of Change: Assessing China’s Competitiveness China has become very competitive in a relatively short space of time, and now it is aiming to transition to the next development stage, namely innovation-driven competitiveness. China’s general trajectory in this regard is clear, and foreign companies are facing the prospect of a competitive landscape significantly altered by emerging Chinese competitors. By Barry van Wyk C hina in 2012 is on the verge of transitioning to a third The Global Competitiveness Report (GCR), an annual generation of national leadership that is seeking publication by the World Economic Forum, is the most to make China’s economy more competitive in the comprehensive assessment of national competitiveness. It global economy. After three decades of sustained economic defines competitiveness as the set of institutions, policies, and growth, China has ambitions not only of being competitive, factors that determine the level of productivity of a country, but of being a leader in innovation and industry. To reach where productivity leads to economic growth and prosperity. these objectives, China’s leadership is considering initiatives The report measures a wide range of factors grouped into and reforms for making China a more developed, more 12 pillars1, and it evaluates the importance of these pillars to prosperous and more creative country. China’s economy and individual countries by dividing the latter into three stages of its competitive standing in the world is in a state of change, development: and in various industries, this is presenting different types of • Factor-driven, for countries still competing based on opportunities and challenges for foreign companies. factor endowments such as unskilled labour and natural resources; Measuring China’s success • Efficiency-driven, for countries developing more efficient production processes and increasing product Companies and countries are inevitably drawn into greater quality to account for rising wages; competition over finite markets. To gain a greater share of those markets, a company must provide products that are • Innovation-driven, for countries where wages have in some way superior to those of its competitors, so it can risen so much that businesses can only compete by ultimately increase profit. For a country, the ultimate objective producing new and unique products of gaining greater share of global markets is to increase the standards of living of its citizens. In the latest edition of the report (2011-12), China, which has improved its ranking each year since 2005 and is now ranked China’s rising competitiveness after 1978 was the result of a 26th overall2, is categorised in the Efficiency-driven stage. The mobilisation of the factor endowments that the country had report notes that China has improved its performance in most in abundance, especially cheap, unskilled labour. Opening of the pillars, yet notable ones where its standing is much parts of the economy to foreign investors drew in technology lower than its overall position are Institutions (due mostly to and allowed China to integrate itself into occurrences of corruption), Financial market development global value chains. China systematically and Technological readiness. became a supplier of labour-intensiveOver the period products and components, combining To benchmark national industrial performance for evaluating inward FDI with a policy to develop the competitiveness of companies, the United Nations2001-08, China’s competitive local companies. The rise in Industrial Development Organisation (UNIDO) developedmanufacturing China’s competitiveness was conditioned the Competitive Industrial Performance (CIP) index, whichexports grew by a by the concurrence of several factors: a measures an economy’s competitiveness for producing andstaggering 27.9% favourable exchange rate, low wages and exporting manufactured goods. Measuring a set of eight large labour supplies, the inflow of FDI, the key indicators using manufacturing value add (MVA) datay-o-y. huge potential of the Chinese domestic as well as population and trade data from 2005 and 2009 for market, and the opening of world markets 118 economies, the 2011 CIP index ranked China in 5th place to Chinese manufacturers. overall, rising from 6th in 2005, and trailing only Singapore (1st overall), the US, Japan and Germany. In analysing the China has come to occupy a unique position in studies of data used for the CIP index, the UNIDO report found that competitiveness. Its rapid growth in the last three decades has seen Chinese exports gaining global market share in an 1 The 12 pillars are Institutions, Infrastructure, Macroeconomic expanding range of industries along with China’s progression environment, Health and primary education, Higher education and up the value chain. The living standards of Chinese nationals training, Goods market efficiency, Labour market efficiency, Financial have also clearly improved, so that China’s competitiveness market development, Technological readiness, Market size, Business has increased at both the national and company levels. sophistication, and Innovation. 2 China leads the BRICS in the rankings; South Africa is next in line in 50th place. 6 І The Beijing Axis
  6. 6. Features Features 专题 The China AnalystLeading Producers in the Five Fastest Growing Industry both in the national as well as company spheres. Yet whileSectors (%, 2000 and 2009) China’s exports have indeed expanded enormously after its Average World Five Leading Economies accession to the World Trade Organisation (WTO) in 2001, Annual (Share in World MVA) the processing trade accounts for around half of its exports. Growth According to a WTO trade policy review on China published in Rate Economy 2000 Economy 2009 2010, foreign-invested enterprises (FIEs) accounted for 84.1% US 53 US 53 of China’s total processed exports in 2009. As export dataOffice, Japan 15 China 11 reflect the gross value of products leaving a country’s ports,accounting UK 6 Japan 9 the very high share of imported inputs in Chinese exports& computing 9.8machinery China 4 Germany 7 means that export data do not adequately measure the value(ISIC 30) Korea actually produced in China. The competitiveness of Chinese Germany 4 6 exports is thus in large part fuelled by foreign multinational Rep. US 61 US 62 plants in China’s coastal regions, and not necessarily by world-Radio, Japan 15 China 12 class Chinese companies.television and China 5 Japan 10communication 9.4 Taiwan, Korea Furthermore, since 1996, foreign firmsequipment 3 5 have accounted for around 85% of China Rep.(ISIC 32) Korea Taiwan, China’s high-technology exports. 4 Since 1996, foreign 3 4 Rep. China The technological spillovers that firms have accounted Japan 23 China 33 were expected to accrue from the for around 85%Electrical US 21 Japan 20 FIEs and many MNCs operating inmachinery and 7.9 Germany 13 Germany 10 China, moreover, have largely failed of China’s high-apparatus(ISIC 31) China 8 US 10 to materialise. For all its export growth technology exports. Italy 4 India 5 and the increasing competitiveness of US 31 US 22 its industry, and despite the fact that Japan 9 China 15 58 mainland Chinese companies wereOther transportequipment 7.3 UK 8 Brazil 14 included in the Fortune 500 in 2011 (the third-most after the(ISIC 35) Brazil 6 Japan 7 US and Japan), China has not as yet been able to produce a Korea France 5 6 truly global brand:5 the latest edition of Interbrand’s 100 Best Rep. Global Brands in 2011 is still missing the first Chinese entry. In Japan 23 China 48 terms of the living standards of Chinese people, the ultimate US 14 Japan 14 objective of national competitiveness, China is still far inBasic Metals China 12 US 5 5.7 arrears. With a GDP per capita of USD 4,382 in 2010, the figure(ISIC 27) Germany 6 Germany 4 for China is not yet half that of Brazil or Russia’s, countries that Korea 4 India 3 rank below China in comparisons of national and industrial Rep.Source: Industrial Development Report 2011, UNIDO competitiveness.China had increased its share in overall global MVA from 6.7% Transitionsin 2000 to 15.4% in 2010, when global MVA amounted toUSD 7.39 billion. Reflecting the shifting landscape of global China can theoretically only reach the innovation-drivenmanufacturing towards Asia, in 2010, developing economies threshold by raising the skills of its workers and upgrading itsaccounted for 35.6% of global MVA (up from 20.7% in 1990), domestic technology and institutions to be able to produceand China accounted for almost 75% of the latter total. innovative products and pioneering technology. The drive for increasing China’s competitiveness is currently envelopedGlobal manufactured exports are dominated by medium- and in a broad transition of China’s economy seeking to develophigh-technology products, which have never dropped below better paid, more skillful and more competitive workers and60% of world manufactured exports since 1992. The UNIDO industries. In 2012, this is occurring on the backdrop of areport found that the five fastest-growing sectors globally national leadership transition.over 2005-093 were all (except for Basic Metals) in medium-and high-technology manufacturing. In all of these sectors, A vision for a competitive and innovative China was presentedin fact in 21 out of the total 22 industrial sectors, China has in February 2012 in a voluminous study jointly developedbecome the first or second leading manufacturer in the world by the World Bank, the Chinese Ministry of Finance and the(see table above). In this process, over the period 2001-08, Development Research Centre of China’s State Council. TheChina’s total manufacturing exports grew by a staggering resultant China in 20306 document outlined six key strategic27.9% annually. Developed countries still account for around aspects for China to consider in order to become a high-60% of global medium- and high-technology exports, yet here income country by 2030. These focus in part on rethinkingalso China has made inroads, with the share of medium- and the role of the state and the private sector in China’s economyhigh-technology products of its total exports increasing from to encourage increased competition, innovation, and China’s45.5% in 2000 to almost 60% in 2009. continued integration with global markets.Caveats 4 ‘Foreign’ here refers to foreign firms and joint ventures. In 2009, for example, the share of foreign firms in this case was 83.2%. See http://China has clearly dynamically improved its competitiveness, for more details. 5 Although Lenovo and Huawei have been suggested as possible3 Office, accounting and computing machinery; Radio, television candidates.and communication equipment; Electrical machinery and apparatus; 6 With the subtitle Building a Modern, Harmonious, andOther transport equipment; and Basic metals. Creative High-Income Society. 7 І The Beijing Axis
  7. 7. The China Analyst As the Global Competitiveness Report outlined, rising wages State of change: The implications of a more have been instrumental in inducing companies to innovate competitive China to remain competitive. Wages in China have been rising rapidly since the mid-2000s. All urban wage growth has The current transitions in China’s economy and society have been high, yet that of low-skilled workers has been highest broad implications for the new type of competition as well among all wage earners, more or less doubling in real terms opportunity that a more competitive China can hold. Foreign from 2001 to 2010. China’s labour force is expected to peak companies in various industries are increasingly presented at around 1 billion workers in 2015, and China may already with a competitive landscape significantly altered by these have passed or is about to pass the Lewisian turning point.7 transitions in China. Rising wages in urban areas in China are also regarded as an important means for decreasing the urban-rural income gap For lower value-added products in industries where China has and increasing urbanisation in China, thereby stimulating the long been dominant as a Low Cost Country (LCC) producer, services industry. China is still to a large extent an attractive option. Yet whereas procurement managers could previously focus their attention China’s competitiveness will decline, solely on China, they are now increasingly considering China however, if rising wages occur without as only one of a few options. Foreign companies sourcingA small number of concomitant increases in labour productivity textiles and clothes from China, for example, will now findChinese companies and innovation. With this in mind, China’s it attractive to source only some products from China, as ithave reached or government has identified improving the still holds comparative advantage in areas such as industrial quality of China’s human capital as a key variety and infrastructure, while increasingly sourcing selectedare approaching objective. The core policy framework to items from other Asian countries like India and Sri Lanka.the technological this end is the 12th Five-Year Plan (FYP) forfrontier. 2011-15, which aims to engineer competitive One industry that can serve as an illustration of China’s advantages for China based on science, increasing competitiveness is heavy industry. In this industry, technology and innovation and to make China has over the last few years begun to provide new options China an industrial leader in certain strategic for buyers of construction and mining machinery, challenging industries. During the previous FYP of 2007-11, China’s the established industry leaders. In the period 2000-10, China’s expenditure on R&D increased by 22% annually, and in 2011, exports of heavy machinery grew by a CAGR of around 30%. R&D spending is estimated to reach 1.85% of GDP.8 Chinese companies have been most successful in this regard in developing markets, and have gained a small degree of China’s output in academic publications has soared in the market share in countries like Brazil and South Africa, as our last decade, reaching 112,000 in 2008 (8.5% of the global next article How to Engage outlines. output), and Chinese research publications have become leaders in the fields of materials science, physics, chemistry This process is still at an early stage, and while China’s and mathematics. Chinese patent applications to the World construction equipment manufacturers, for example, are Intellectual Property Office (WIPO) increased from 23,000 in now able to manufacture a bulldozer or a motor grader by 1996 to 290,000 in 2008. Yet in terms of academic papers, industry standards and make gains in market share on price, Chinese contributions are reportedly still lacking so-called these machines do not yet compete with the leading brands in high-impact articles, and the quality of its patents have not the market. Yet Chinese companies are making investments in been matched by its quantity as incentives for filing patent these countries and are systematically upgrading the quality applications have produced a large number of minor design of their machines as well as their parts and after sales services and utility patents. to become more competitive, following the example of the likes of South Korea. The logical conclusion of this process A small but growing number of Chinese companies have will be a Chinese bulldozer that is cheaper and basically just actually reached or are approaching the ‘technological as good as a Caterpillar bulldozer, providing an attractive frontier’ in their respective industries. These include ZTE alternative for mining and construction companies. This and Huawei in the ICT industry, Suntech Power in the solar gound-breaking development may still be a few years away, industry and Dalian Machine Tool Group in engineering. yet it is inevitable.10 Huawei, for example, has developed the world’s first ‘100G’ technology capable of delivering large amounts of data The globally competitive and pioneering Chinese company wirelessly over long distances. Chinese companies – both and brand are still under development, but the outlines have state-owned and private – are excelling in areas such as PVCs, started to take shape. biopharmaceuticals, nanotechnology, stem cell therapeutics, high density power batteries, supercomputers, and shipping Barry van Wyk, Senior Consultant containers. Chinese companies have also achieved results with other forms of innovation, for example developing creative business models to suit existing products.9 7 As China in 2030 points out, “Although the precise timing remains disputed, most researchers accept that China is at or nearing the Lewis turning point of exhaustion of the rural labour surplus, and the remaining rural working age population may be too old, sick, or disinclined due to family obligations to migrate to urban areas.” 8 The 12th FYP aims to raise expenditure on R&D to 2.2% of GDP by 2015. Some countries have achieved a science & technology ‘takeoff ’ when this percentage approached 2%. 9 Broad Air Conditioning, for example, has developed a way to 10 In South Africa, the Chinese company Shantui recently opened a commercialise gas-powered air conditioning systems for large large new facility and has launched an advertising campaign as ‘the buildings. world’s leading maker of bulldozers’. 8 І The Beijing Axis
  8. 8. Features Features 专题 The China AnalystHow to Engage: The Rise of NewChinese ManufacturersSqueezed from different angles by the strengthening of the renminbi, rising costs for labour andraw materials, more stringent environmental regulations, push towards industry consolidation,and slack capacity in developed countries, Chinese machinery suppliers have no choice butto move up the value chain. They are producing increasingly sophisticated goods, but are stillstruggling to increase their efficiency and adequacy of internal support processes. Buyers mustbe patient and invest more time in building relationships with suppliers to ensure that they cancapture the benefits of China procurement while reducing its risks. By Lilian LucaG one are the days when the West had the luxury of worrying about low-end textiles and shoe exports from China. The future of exports from China will be led by equipmentmanufacturers, and although they may not yet be penetratingWestern markets, competition in third markets is intensifying.(EIU, 2011, ‘Heavy Duty: China’s next wave of exports’)While China has steadily grown its manufacturing and exportbase over the past 20 years to become the world’s largestexporter, a status that has now become firmly entrenchedin the minds of procurement managers worldwide, a fewworrisome trends emerged last year that depict alterationsto the old China sourcing equation. Labour and raw materialscosts in China have seen a steady increase to a point wheremany commodity-type goods such as textiles, toys andsimple carbon steel products can no longer be competitively XEMC’s 220t haul truck. (Source: XEMC)sourced from China, with China losing market share toother Low-Cost Country (LCC) producers. Moreover, as we by reduced export rebates affecting the export pricenoted in the September 2011 issue of The China Analyst, competitiveness, more stringent energy and pollutionthe competitiveness of simple, labour- or raw-material- regulations leading to increasing costs, rising labour andintensive goods made in China has been further eroded by a raw materials costs, and currency appreciation. For a fewstrengthening Chinese currency, government-imposed export years, Chinese manufacturers in these sectors were able toduties and quotas, the closure of old, polluting facilities, and maintain profit margins by investing in new, more efficienta reduction in subsidies which provide access to cheap land manufacturing processes, but this game isand electricity. becoming increasingly difficult to play due to rising costs of building new capacity inSo, since China is becoming more expensive, all one can do is China, including the rising cost of capital, Facing increasedprepare for a lengthy trip to discover new suppliers in exotic land and environmental compliance. Thus, competition,Asian locations, right? Wrong. The big picture tells a different facing increased competition at home from Chinesestory altogether. both existing producers with outdated capacity and nimbler, more innovative manufacturers areThe global, long term trend at work here is of course China’s startups, Chinese manufacturers are turning to producttransformation into a middle-income country, one that is turning to product innovation and exports innovation andindustrialised, modern and aspires to become a leading as avenues for growth.producer of high value-added manufactured goods. The exports as avenuesgovernment has been promoting this for years, with every five An article by the Economist Intelligence for growth.year plan shifting resources to support knowledge-intensive Unit 1 cites the evidence of Westernindustries, encouraging investment in science and technology manufacturers losing market share in keyeducation, and discouraging the exports of low-value added, industries where they still dominate globalresource- or labour-intensive goods via various policies. As exports as evidence that Chinese producers are climbingan example of such policies, the 12th Five-Year Plan’s list of up the value chain. In centrifuges and filtering/purifyingpriority industries includes high-end machinery, energy machinery, for example, a USD 45 billion global exportsconservation and clean technology (included among the market, China doubled its market share from 3.5% to 7.1%seven ‘Strategic Emerging Industries’). from 2007 to 2010, while OECD countries lost market shareOn the other hand, ’discouraged’ industries get penalised 1 See quotation and reference at the beginning of this article. 9 І The Beijing Axis
  9. 9. The China Analyst Increase in China’s Market Share of Select Product Categories (%, 2007-10) 18 Cruise ships, cargo ships, barges Bubble size: 2010 Global Transmission shafts/cranks, gears 16 export value (USD bn) 14 124 Air, vacuum pumps; hoods incorp a fan Heating/cooling equip for plant/lab use Market Share Increase 12 Centrifuges, filtering/purifying machinery Chemicals in 15 Taps, cocks, valves for pipes 10 wafer form Lifting/handling/loading machinery Motorcycles, Electrical switching apparatus 8 17 side-cars Derricks, cranes Bearings Harvesting/threshing machinery 6 12 19 Refrigerators, freezers 31 4 Tube or pipe fittings, of iron or steel Fork-lift trucks, trucks with 76 45 43 15 36 handling equip Aluminium bars, rods and profiles 15 29 60 15 10 14 26 60 2 65 36 51 Pumps for liquids; liquid elevators Optical fibre, cables Self-propelled bulldozers, excavators 0 55 60 65 80 Electrical ignition/starting equip 95 Construction/mining machinery parts Moving/grading/boring machinery for earth OECD Countries Global Market Share (2010) Source: Economist Intelligence Unit; The Beijing Axis Analysis in the same period, from 82.7% to 80.9%. The same trend is from OECD countries, quality variability, lack of service and visible in transmissions, gears, bearings, handling machinery limited spare parts supply networks, and lack of flexibility in and other sectors (see chart above). commercial terms remain the biggest challenges when dealing with Chinese manufacturers. As the sophistication of buyers in Most of these exports from China are, however, not going to emerging markets gradually increases, so will their demands OECD markets, but rather to non-OECD countries, an example on Chinese products: availability of customised designs and of the so-called South-South trade relationship. Brazil, Russia, features, higher specifications and tolerances, availability of and India are the major importers of machinery from China. credit terms and financing options, transparent tendering Incidentally, with growth stagnating in the developed world processes and pricing, and improvements in customer service in the aftermath of the global financial are some of the features they will demand in the coming years. crisis, China’s exports are going to markets that are currently driving world economic Chinese manufacturers will thus have to upgrade not onlyWith growth growth. They successfully compete in these their manufacturing capacities and product design andstagnating in the markets against established Western brands, R&D capabilities, but also their supply chain systems (ability offering more affordable products with to monitor inputs for quality and timeliness), the interfacedeveloped world, simpler features and specification sets while between their engineering departments and manufacturingChina’s exports are more sophisticated, feature-laden Western workshops, capabilities in the tendering departmentsgoing to markets gear gradually lose their appeal to budget- (sophisticated English-language commercial and legal support,that are currently conscious emerging market buyers. In these fast design change implementation and cost modeling), and markets, where secure sources of capital of course will have to put more solid internal quality assurancedriving world remain scarce and costly, upfront cost processes in place which should become the norm rather thaneconomic growth. considerations often trump lifetime costs the exception. of ownership at which OECD machinery exports perform better. In the meantime, global procurement managers can already actively investigate and engage with Chinese suppliers Chinese producers utilise a number of different ways to offering more sophisticated machinery, high-tech spares climb the technology ladder. Many have successfully reverse- and consumables. This entails investing upfront time on engineered (and often improved upon) Western designs; researching and traveling to production facilities, establishing others are beginning to see the fruits of massive R&D good working relations to open ongoing dialogues over spending; and still others are trying their hand at acquiring features and pricing, discussing service support options, and new technologies through M&A as evidenced by the shopping working with suppliers to ensure a rock-solid quality control spree being undertaken at the moment by Chinese firms in process. In these unchartered territories, local support in Europe’s mid-size industrial sector. The heavy equipment the form of procurement service providers experienced in industry has some shining examples of leading Chinese commercial and technical China procurement issues is often innovators moving up the value chain and making inroads indispensible and the key to achieving LCC procurement into the export markets: XEMC is introducing increasingly targets within a manageable time frame. sophisticated haul trucks (see picture on previous page), Taiyuan Heavy (TZ) is becoming a world leader in open-pit Lilian Luca, MD: Beijing Axis Procurement mine excavators, while ZPMC is the world’s top container crane and gantry crane producer. As machinery exports from China penetrate more markets, the reality is that many Chinese suppliers are still unprepared to adequately service foreign sales. Even though their machinery is often simpler to maintain and less complex than that 10 І The Beijing Axis
  10. 10. Features Features 专题 The China AnalystChinese OFDI:Bolder, Wiser and More StrategicUnlike the initial wave of overseas investment led by China’s dominant state sector in theirpurchases of mining and energy companies in resource-rich regions, the current M&A activityis emerging as a key enabler of consolidation, growth, market positioning and the acquisitionof strategic assets and expertise for Chinese companies. Forward-looking Chinese companiesnow consider overseas investment as a viable approach towards moving up the value chain bygaining access to foreign brands and technology. By Daniel GalvezW ith China’s rapid economic ascent and subsequent attention being placed on advanced manufacturing, transformation into a market-based economy, technology and science-based industries. Unlike the initial Chinese companies are now expanding abroad and wave of overseas investment led by China’s dominate stategoing global not only per the government’s mandate, but sector in their purchases of mining and energy companiesalso to reduce their reliance on China’s economic growth by in resource-rich regions, current M&A activity is emerging asexpanding into new markets. At the same time, market forces a key enabler of consolidation, growth, market positioningare inducing them to acquire or gain access to sophisticated and the acquisition of strategic assets and expertise.technologies through strategic mergers and acquisitions Forward-looking Chinese companies now consider overseas(M&A), at increasingly favourable prices, to raise their level investment as a viable approach towardsof competitiveness. China’s overseas acquisitions in the moving up the value chain by gainingnon-financial sector, which reached a record USD 60.1 billion access to foreign brands and 2011, will continue as increasingly sophisticated Chinese Likewise, while global leaders in the heavy The mostbuyers seek bargains amid the downturn among developed machinery sectors have a significant competitive Chineseeconomies, especially in Europe (see chart below). presence all around the world, they mostly firms realise size come from developed countries. However,Over the short term, the ongoing euro zone debt crisis will leading Chinese construction equipment alone will notcreate multiple opportunities for active Chinese investors, makers such as Sany Heavy Industry are guarantee long-giving them easier access to technologies they have long quickly catching up, displacing previous term success in thecoveted in the European and other developed markets. Our industry leaders from the top 10 in termsarticle in this issue, China in Europe: Cash, Debt and M&As, domestic market. of sales through both organic growth anddives further into this trend. But what are the new driving strategic acquisitions (on next page).forces behind the current wave of Chinese OFDI? And whatare the strategies being employed by Chinese companies to Chinese companies have also shown a bigger appetitesuccessfully close deals in the natural resources and industrial for relatively riskier assets compared to their peers fromsectors, which continue to comprise the bulk of Chinese OFDI developed countries. In other words, Chinese companiesdeals? (see chart below) are beginning to realise the intangible benefits from making purchases overseas. But why exactly are Chinese becomingShifting focus bolder, looking for acquisitions outside their own borders? It is becoming increasingly well-known that Chinese companiesAs China’s economy moves into a new phase, the focus of are not only concerned about becoming bigger and increasingChinese investment abroad is also shifting, with greater their market share in the short term, Chinese companies areChina’s Outbound M&A by Region (USD bn, 2010-11) China’s Outbound M&A by Sector (%, 2010-11) 2010 2011 1% Automotive 15% 12% Europe Industry 7% 14% Asia 14% Services Chemicals 3% 22% North AmericaAustralia & New Zealand Resources 61% South America 51% Africa 0 3 6 9 12 15 2010 2011Source: A Capital; The Beijing Axis Analysis Source: A Capital; The Beijing Axis Analysis 11 І The Beijing Axis
  11. 11. The China Analyst Ten Leading Global Construction Equipment Makers China National Offshore Oil Corporation (CNOOC), China’s (Annual Sales USD mn, 2007 vs. 2011) largest offshore oil and gas producer, has shown a particular 30 2007 2011 interest in Chesapeake Energy’s assets, investing USD 3.43 billion since October 2011 in two separate deals. In these Market Share by Country (2011) 25 deals, Chesapeake (the second-largest US natural gas supplier Others and most active American natural gas driller) gets a cash boost 12.0% 20 Germany US to help pay back its USD 10.3 billion debt load and remains the 7.5% 28.3% operator of these projects, lessening the likelihood the deals Sweden 15 11.4% will face regulatory opposition. In exchange, CNOOC gains China Japan exposure to the complicated shale gas extraction technology it 24.9% 10 16.0% lacks. In other words, China is forgoing ‘big splash’ investments and opting for smaller, more strategic assets under the radar. 5 So what’s driving this quest for shale gas technology? Chinese 0 energy companies are racing to meet China’s aggressive Caterpillar Komatsu Hitachi Volvo Liebherr Sandvik XCMG Zoomlion Sany Terex production growth forecasts to power the country’s fast- growing economy. In fact, Beijing recently announced it *Note: XCMG, Zoomlion and Sany were not ranked among the top 10 in 2007 would invest USD 13 billion to switch the city’s coal-fired Source: China Construction Manufacturing Online; The Beijing Axis Analysis power plants and heating facilities to natural gas in a move aimed at addressing public concern over the city’s poor air quality, with other cities sure to follow. Likewise, according to seeking to invest in assets abroad that will better position the Energy Information Administration (EIA), China is believed them at home, relative to their domestic rivals, as well gain to have vast reserves (36 trillion cubic metres) of natural gas a foothold in new markets over the long term. The most trapped in shale rocks, a quantity roughly 12 times the size competitive firms realise size alone will not guarantee long- of China’s conventional natural gas deposits. In June 2011, term global success; technological know-how enhances long- China National Petroleum Corp (CNPC), the country’s largest term competitiveness, and puts them in a better position to energy producer and PetroChina’s parent, formed a joint compete against western rivals in their own home markets. venture with Shell to improve its own shale-gas well drilling For example, aforementioned Sany recently opened a USD 60 efficiency. Subsequently, in March 2012, the firms announced million office and assembly plant in the south-eastern US in their partnership had reached new heights with the signing 2011, its largest such facility outside China, to help realise it’s of a production sharing contract to develop a shale gas long term goal of eventually manufacturing excavators in the block in China, the first such deal in the country. Increased US to directly compete against industry-leading Caterpillar domestic demand along with untapped shale gas reserves is on its home turf. So while industry consolidation is still being strengthening the competitive rivalry among China’s energy encouraged to facilitate the development of China’s own giants, forcing them to buy strategic assets overseas from ‘global champions’, China’s fast-rising global competitors are their existing partners in order to become more competitive now letting their global ambitions drive their strategies rather in China. than relying on government policy alone. China’s construction equipment manufacturers have also New trends shown a keen interest in acquiring new technologies through foreign acquisitions (see chart below). At the beginning of It’s widely known that China’s energy policy has increased 2012, Sany announced that it would acquire Putzmeister, a its focus on commercial ties with countries rich in natural German Mittelstand company and also the world’s largest resources and related technologies, and more specifically manufacturer of high-tech concrete pumps. Together with those that can help China unlock its huge Citic PE Advisors, a Chinese private equity company, Sany reserves of unconventional (shale) natural will acquire all of Putzmeister for USD 473 million, with Citic gas. Of the roughly USD 18 billion that retaining a minority shareholding. This follows Zoomlion’sChina is forgoing Chinese state-owned enterprises spent‘big splash’ buying oil and gas companies in 2011,investments and nearly one-third (USD 5 billion) was invested China’s Construction Machinery Industry Outbound M&A in Canada’s resource sector. In October (2005-12*)opting for smaller, 2011, Sinopec acquired the Canadian firm 350 3.5more strategic Daylight Energy Ltd. for USD 2.2 billion in 300 % of China Overall Outbound M&A (%) (rhs) 3.0assets under the order to gain access to Canadian shale-gas Value of Deals (USD mn) (lhs)radar. reserves which marked Sinopec’s largest 250 2.5 foreign acquisition of the year. In 2012, PetroChina completed its acquisition of a 200 2.0 minority (20%) stake in a Royal Dutch Shell shale-gas project in Canada, which will allow the company to 150 1.5 use any advanced technology to which it gains access to for 100 1.0 its own exploration and development purposes back in China. Major Chinese energy firms have also shown a strong interest 50 0.5 in the US, whose firms, along with those in Canada, lie at the forefront of shale gas technology and are gradually warming 0 0.0 2005 2006 2007 2008 2009 2010 2011 2012 to Chinese investment partly because of cash shortages and the potential for future exploration opportunities in China. *Note: As of 6 March 2012 Source: Thomson Reuters; The Beijing Axis Analysis 12 І The Beijing Axis