Emerging Markets Connect

In Case You Stopped Worrying: Quality Issues in China Are Back

Concerns around quality and risk exposure in China sourcing raised during the summer of 2007 have re-emerged, or if they haven't they should have, in light of revelations of tainted milk from a number of Chinese companies.  Although its impact has so far been largely limited to inside China, this is as good a time as any to revisit China sourcing and partner relationship management strategies. We'd encourage companies to avoid the trap of saying "we don't have anything to do with milk," and "this is limited to inside China," wiping their foreheads, and continuing as usual. Chances are most companies continue to be fine, but a few lenses on this to mull over, and questions to ask yourself:

1. Do I fully understand the pressures my Chinese partners are facing? Rising commodity costs and slower sales are not just squeezing you; your suppliers are likely feeling this too. This is the classic root cause of quality fade in China: partners seeking to maintain or increase margins in the face of new cost pressures. Don't discount this.
2. Does this matter to me if my presence is limited to joint ventures? You bet it does. The closest the current milk crisis has come so far to directly impacting an international company has been the joint venture relationship between Fonterra (a New Zealand company) and Sanlu, the Chinese dairy firm that was first to be identified with tainted milk. Control is just as much an issue in a JV as it is in a traditional sourcing relationship.
3. How well do I know what's going on with my suppliers' suppliers? Another Western company impacted by this is Starbucks and its China operations. One of its dairy suppliers, Mengniu is blaming its suppliers for its problems. Surveys of our members have found risk management to be virtually absent beyond the first tier of suppliers. This is something worth addressing.
4. When's the last time I reviewed my supplier monitoring practices? If it's been a year, that might be a little bit too long. At the very least, you might want to conduct a quick refresher and tightening of procedures and awareness internally.

Partnership management and quality assurance have been constant topics of concern and discussion among our members, and we've learned a few things from them over the past year that are worth remembering in light of these recent events:

1. Do the things you know to be effective. Surveys of our members (Link for Quality Executive Board members only) have found that many fail to use the supplier quality management methods they know to be effective. Instead they focus on what's familiar. For example, almost 94% report using periodic supplier audits, but only 52% find it to be highly effective. On the other end, almost all of our members emphasize putting staff on site at a supplier as a highly effective strategy, but only 17% actually do it.
2. Use real-time evaluation when entering partnerships. Our conversations with experienced executives working in China have taught us that the more successful companies enter into partnerships slowly. But they don't do this the way you'd expect, by extending due diligence. Instead, they shorten their up-front due diligence process, and instead extend their integration ramps with partners, using this period to identify and resolve quality issues before they become customer-identified problems. This may mean some wasted production, but it reduces the risk of wasted partnerships from production failures down the line.
3. Provide tools and support to first tier suppliers to manage risks among their partners. Our members describe emerging practices (Link for Procurement Strategy Council members only) to engage their first-tier suppliers in the risk assessment process by making cooperation a prerequisite for partnership, and sharing risk mitigation practices with key first-tier suppliers to extend assessment rigor to lower tiers.
4. Ensure your own staff understand product safety protocols. One of our members described a frightening situation when they realized, shortly after news broke last year about lead in children's toys, that many of their own staff could not describe their quality assurance protocols for a number of key products. They developed simple check sheets to make sure this information was widely available, and focused heavily on ensuring their staff could pass the "pop quiz" test at any time for any key products where they had responsibility.


Some useful additional resources:
- [Sept. 25 Update]: Wall Street Journal's China Journal has a good run-down of indications that this is spreading outside China, here.
- China Law Blog has covered issues around quality extensively, and is always a good resource. Their most recent post, along with links to past advice, is here.
- Silk Road International has also been all over this topic for some time. Their latest, and links to great earlier advice, is here. While it targets smaller enterprises in China, the advice holds for all companies and is well worth a read.
- For perspective on the public relations aspect of quality issues, Imagethief has a useful offering here.

Does Sustainability Mean Something Different in Emerging Markets?

We had an interesting conversation last week with a member in the telecommunications industry on the topic of sustainability. Two things in particular worth noting:
1. Although it's a global company with facilities around the world, sustainability initiatives are being led not in the West but in their two China locations. In fact after two years they're just now thinking about how they can expand these efforts to other global locations. The logic is certainly sound: the two China locations host about 80% of global employees, and all of their sourcing and production is there.
2. More importantly, the heightened attention to sustainability is a direct reaction to Chinese government policy and its heightened scrutiny of environmental impact. This member did not share the view that enforcement is or will be weak. What's more, and harder, they see the government holding large (mostly Western) companies more and more accountable for enforcing sustainable practices throughout their own supply chains. In other words, if your supplier is dumping chemicals into the local lake in the process of working for you, you're in just as much trouble, actually probably more, as they are.

The news here is this: Sustainability in China is not a joke. It should be a central aspect of your company's "green" strategy, and if you don't have a "green strategy" it should still be a central aspect of your China strategy.

Here's what our members are telling us they're doing:
1. Play to Stay: Companies in general anticipate a very long-term presence in China. What they're doing less often is matching that ambition with actions that support a long-term presence over short-term margin gains. Looking the other way on unsustainable operations might keep costs down, but it also displaces efforts to get ready for emerging demand for a clean and socially responsible presence globally. It wins you no fans in China, and it wins you no fans in your home market.
2. Apply a Three-Pronged Approach to Sustainability: Companies operating in China are organizing their approach to sustainable business more comprehensively than the "traditional" lens suggests, focusing on environmental, social, and economic aspects. This comprehensive view is particularly important in emerging markets, where companies can be exposed on a variety of fronts.

What does the "three-pronged" approach look like? On the environment, companies are doing the expected--reducing material and energy use, monitoring pollution--as well as the less expected--collaborating with local partners to encourage environmentally friendly practices. Social sustainability looks different in China, focused (in addition to labor, health, and safety practices) on building skills and helping Chinese businesses and employees become self-sufficient. Similarly, approaches to economic sustainability in China are slightly different, emphasizing improving the long-term economic environment there as well as long-term business viability by developing local skills, knowledge, and technology.

China might be different than other emerging markets in some ways here, particularly in the desire for companies to maintain a long-term presence there. But there are many places where the ambitions are, or will be, similar--Brazil, India, Russia, Indonesia, Philippines. companies will have to think hard about how the notion of a sustainable (read: self-sufficient, long-term, profitable) business presence fits into their environmental and social impact on emerging markets.

China Price Rising, So What?

Apart from events surrounding the torch relay, the China story in 2008 so far has been one around  rising costs. Raw material price increases, rapid inflation, steady currency revaluation, tax law changes, labor law changes, and more, all combining in what one of our members has called China's "Perfect Storm." Reporting on these trends suggests that China is finished as a long-term sourcing location: people are leaving, Vietnam and other Asian locations are the future, Chinese companies are themselves sourcing in the U.S. for cost advantage.

Not so fast. A conversation early last month among a number of our members sourcing in China demonstrated that, while cost in China is getting troubling, few have any plans to pack their bags. Two root causes here:
1. China's A Critical Market: If you're targeting China as a market, cost increases are still an issue, but largely off-set by reduced logistical burdens of producing elsewhere, market knowledge gained from an intensive local presence, and goodwill generated through job creation and value-added local production.
2. Few Better Options: Our members recognize that in many cases China remains a tough location to beat, and they wonder how likely other locations are to hold any advantages they currently demonstrate. One company has Vietnamese sourcing partners requesting 30% increases this year; others are closing facilities in Mexico to source products, for the U.S. market, in China because costs in Mexico were too high. Indeed, many of the raw materials and labor cost increases impacting companies in China are reflective of global trends (China's new labor law notwithstanding) rather than anything China-specific.

So what are companies doing? Our member conversations suggest three strategies that introduce some cushion to the impact of China's cost trends:
1. Adopt A China “Plus” Mentality: Companies are sticking around, but diversifying their sourcing strategies to scale back production in China while ramping up additional locations.
2. Build Production Agility with Added Locations: Members are using new partners in new locations to manage cost volatility by shifting production volumes geographically in response to cost trends.
3. Use New Partners for Leverage: Members emphasize the negotiation leverage that has emerged with additional partners both within and outside China.

This location leverage is of course not the only tactic: reconsidering product "recipes", general supplier improvements, stronger negotiation tactics, and looking to customers to off-set some increases were all mentioned, among others. Underlying all of this, though, is a long-term commitment to China. It's not going away; and leading companies are not leaving.

[CEB members who would like a copy of the full conversation summary from this event, email me.]

Keep Your Head Down, Let A Billion People Yell at You, Then Continue Selling to Them

The evolution of Beijing Olympics "enthusiasm" in recent months has brought few smiles to Western executives. First (seems like ages ago) threats of a backlash by Western customers for China's association with Sudan, then even more real fears of a backlash by those same customers for violence in Western China, and most recently a "backlash against the backlash" by Chinese customers for reactions to the first two. Few saw the last coming, but it dramatically complicates things. Strategies for now (and likely going forward) have been for Western companies to downplay their Olympics associations outside China, and drape the brand in Olympic pride within. As noted recently in the Wall Street Journal: "Initially people imagined they would have one global marketing campaign for the Olympics. Now the theory is that you need a separate campaign for China versus the rest of the world," says Greg Paull, the principal of R3.

What this "double-sided" strategy doesn't help with is Carrefour's recent troubles in China: largely innocent victim of Chinese nationalism reacting to events surrounding the torch relay in France in April, the company now faces a Chinese boycott and status (along with CNN) as the official victim of Olympic pride gone wild. The good news here is that if history teaches us anything, it's that these matters have a way of running their course. Dell, Heinz, Kraft, Procter & Gamble, Burberry, Starbucks, and others have all faced similar fervor [CEB subscription required] in China and all survived and now prosper. Most recently, McDonald's and Yum Brands around this time last year faced backlash from accusations of underpaying student workers in China. One year later, and all is better than well for both, with Yum experiencing 12% growth in China in 2007, and, incredibly, named by CCTV as one of China's 10 best employers.

The Carrefour, Yum Brands, and many other company experiences carry a few take-aways for companies worried about navigating the public relations minefield of China:
1. Be Ready Even When You Don't Think You Have To Be: In most cases these companies were playing by the rules in China, and were simply swept up by misunderstandings or became representative victims of larger movements. This makes active issue sensing [CEB subscription required] important, but also means setting yourself up to withstand any backlash is probably even more important.
2. Emphasize Your Commitment to China: In hard times and in good times, make your long-term commitment to, and respect for, China evident. This does not mean fawning, but rather investing in training employees, serving local communities, and otherwise demonstrating you're providing local value. Not much different, really, than what you'd do anywhere else.
3. The Government Is Your Friend: More important than diplomatically crafted public relations statements, which hold little sway against an Internet-fuelled tide of negative sentiment, is quiet and determined interactions with key government contacts to reinforce your commitment to China and gain their help in calling off the rigor. Cultivate these relationships preventatively, and use them actively in case of emergency.
4. Wait It Out: It will be rough; but it will go away. And when it does, as the WSJ notes, "For the sponsors that stay the course, there is more upside in the relationship they build with their consumers in China than downside globally."

For Managers in China, Communication Skills More Important than Language

Our weekly China discussion hit a topic we hear about often in China--if we do use expats there, how important is Mandarin language skill. The question referred specifically to the role of the CFO in China, and broadly speaking, our Members placed Mandarin language skills low, with much greater importance tied to being able to communicate well with both staff and HQ-based senior management. That the two were separated--language and communication skill--raises an instructive point about management in China.

While it's always an issue, and more important in some cases (e.g., working with local partners) than others (e.g., management), don't get overly caught up seeking individuals who can "navigate the culture." Expat success is rooted more in their ability to manage a team of Chinese employees, and less on the particular technical skills they bring (although of course those are important). Conversely, success of locals is rooted more in their ability to effectively keep HQ informed and expectations managed than in their ability to manage their native context (although of course that is important).

Deepen the Connection in the Comments: Are we oversimplifying here? Any cases, based on your experience, where this doesn't turn out to be true?

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Excerpts from Member responses to: I'd like to know what success or problems other companies have had employing an expat CFO in China who does not have Mandarin speaking skills.

US Company
It is quite common for American companies to have expat CFOs in China. Most expats that I have met in just 8 months here usually work in finance and/or accounting with 95% of them speaking limited to no Mandarin. We have had success with expat CFOs that are "home grown" in the U.S. then relocated to China because of their ability to communicate with Senior Management from the U.S. One issue we have had in the past is local management's inability to communicate effectively with U.S. Senior Management….some things get lost in translation.

Asia-Pacific Company
We have been operating In Asia generally and China specifically for some years and generally we prefer to have expat finance people who understand western style governance. Below the CFO role, we'll have locals who have the language and cultural skills.

US Manufacturer (Dissenting View!)
I think a Mandarin speaking CFO in China is a advantage today, the role of CFO has changed a lot over the past few years. Financial skill is part of his/her daily responsibility, and today more and more CFO has to be active in other areas too, e.g. negotiation with local banks, local stakeholders and so on…. However, it is still quite common that CFOs in China with foreign background companies are expat, you have to make sure that he/she has a competent local team, and very good internal, as well as external communication. Otherwise, it could end with the worst scenario and the CFO only get to know when it happened.

UK Company
Sometimes a bigger issue is employing a local who is expert in Mandarin but struggles to communicate clearly with Group (even though the person speaks English). If the CFO has to interact with government officials and external more local companies a lot, then the person needs a trusted aide to help with the Mandarin speaking side.