File photo of Chinese Foxconn workers checking integrated circuit boards in a workshop at the Shenzhen plant of Foxconn Technology Group in Shenzhen, China on May 8, 2010. China manufactures high quality goods like iPads and iPhones for export, but goods manufactured for domestic consumption do not meet the same standards.
How to Get the Know-how
So can’t China’s firms simply imitate their way out of the problem, replicating what they learn from foreign multinationals? Only sometimes, notes Wharton management professor John Paul MacDuffie, who cites China’s auto sector as an example. Overcrowded with local suppliers and manufacturers, the sector faces fierce competition domestically from foreign brands. Despite decades of government policies aimed at favoring domestic companies, all the top-selling brands in China are foreign — Volkswagen, with 15.2% of the market, GM at 8.2% and Nissan at 5.6%, followed by Toyota, Hyundai and Honda. The largest local manufacturer is First Auto Works, with 5.2% of the market, as BYD, Chery and Geely fight for the remainder, according to 2011 figures from Global Insight China and Synergistics.
While others say brand perception among locals plays a big role in the domestic companies’ fight for the market, MacDuffie also points out that the firms lack the core technologies and know-how to compete with global brands — something that their joint ventures with foreign manufacturing hasn’t provided, despite the widespread assumption otherwise. He notes that while the government requires joint ventures for auto assembly plants, but not for suppliers, his research suggests that the plants provide only limited access to foreign product design data and expertise. What’s more, strong sales from joint venture autos have left local suppliers with little incentive to develop their own models. As for the suppliers, MacDuffie says a smart way for them to gain expertise, and quality, is to do what Pacific Century Motors did in 2010 with its outright acquisition of Michigan-based Nexteer from GM.
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Many experts draw parallels between China today and other countries once known for low-quality manufacturing, including Japan before the 1960s. The big lesson for China? “Historical examples suggest no real way to bypass the need to develop technological and organizational capabilities internally,” MacDuffie states. “What they can learn from their foreign multinational partners — via partners or knowledge leakage — won’t be adequate.”
That could be a tall order. In Japan’s case, its manufacturers, unlike their Chinese counterparts, never expanded by making products under other companies’ brand names as OEMs. Rather, firms used plenty of reverse engineering and innovation and a tradition of craftsmanship to master numerous technologies, becoming leaders in electronics, automotive, chemicals and other high-value industries. “The Chinese have a hard time saying no to cash in the short term in exchange for a longer vision of the brand. Sony was famous for turning down the chance to make goods under other brand names,” says Midler. “Chinese industry is struck with a kind of myopia that defines its philosophy of doing business.”
Perhaps a better comparison is Taiwan. Unlike in Japan, Taiwanese firms have been heavily engaged as OEMs, yet also have improved their own product quality and technologies to become — in the case of HTC smartphones, Acer and ASUS computers, among others — big global brands. A big motivator has been necessity. In Taiwan, “people think differently because their domestic market is so tiny. They have been always looking for exports to U.S. and Europe,” notes Chi-Jen Yang, a technology policy analyst at the Center on Global Change at Duke University.
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Speed Bumps and Detours
As many companies have learned the hard way, raising a product’s quality can have its own pitfalls and perils. When Toyota grappled with its product recall crisis in 2010, Takahiro Fujimoto, an economics professor from University of Tokyo and an authority on the Japanese automaker, described to MacDuffie in a Knowledge@Wharton interview, how as the quality of its cars improved, the company struggled to keep pace with a number of subsequent changes “like the number of production lines, production facilities, number of models sold in the global market, and the growing complexity of each individual vehicle due to social pressure and market demand. All these things multiplied together created explosive expansion of the workload for handling quality problems.”
South Korea’s auto industry has also struggled to move up the value chain, having embarked on a journey that began some 40 years ago to achieve rough parity today with developed country OEMs, says MacDuffie. Quality and safety concerns plagued its brands throughout the 1980s, forcing them to invest heavily in internal R&D capabilities over the following years before brands like Hyundai gained credibility with car buyers.
Improvements in quality also depend on countering other tendencies in Chinese industry, including rampant counterfeiting. While making knock-off products that look genuine takes a certain amount of skill, notes Midler, manufacturers cutting corners, adulterating products and other sleights of hand abound. He argues that without a change in attitude across the board, among managers, factory workers and consumers, little is likely to change.
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Even if domestic companies were to sell good-quality products on par with foreign brands, Chinese consumers — increasingly wedded to brands — might not buy them. “Chinese engineers and companies are capable of making high-quality goods, but will the market reward them for making them? This is the biggest issue,” says Clendenin of RedTech Advisors. “Why should I waste 5% or 10% of my company’s R&D resources on creating super products that probably only a few people would buy? I am better off dropping lower end products and focusing on better mid-range products, which are still affordable and which people would buy.”
Until recently, China’s long-suffering consumers mostly put up with the poor quality of local goods, especially if they felt a bargain was to be had. But as income levels rise, their tastes — and patience — are changing. Consumer expectations may prove the most powerful inducement for China’s consumer manufacturers to improve quality. With a market of around 800 million low-income Chinese who accept poor quality for low prices, manufacturers can afford to cut corners. “When the majority becomes middle class, aware of quality and prefer quality to low prices, I think the Chinese market will change,” predicts Suzuki of Hokkaido University. Give it 10 or 20 years, he says, and “the Chinese will not buy poor quality goods even if the price is low.”
Republished with permission from Knowledge@Wharton, the online research and business analysis journal of the Wharton School of the University of Pennsylvania.