China & Best Practices – Reality or Myth?

1. China & Best Practices – Reality or Myth? Paul Deis APICS – San Diego Chapter June 20, 2007

2. What We’ll Cover: • Best Practice Keys • China – facts, culture and context • Challenges to success – why its not easy. • The “Lure” vs. hidden costs. • How to Succeed with China outsourcing. • Best Practices & China business • Some fun photos (time permitting)

3. Best Practice Keys • Effective Leadership & Culture • Effective Enterprise Systems & Processes • Continuous Improvement Processes • Education and Training

4. It’s a BIG country! ~3000 miles SOME of the major manufacturing cities.

5. China - Big Numbers* • 1.3 Billion people; growth 0.606%/yr; Median age: 33.2 yrs old. • GDP – About $2.5 Trillion USD (US is about $13 Trillion) • Internet - ISPs – 3; 100 Million Internet users. • Literacy – 90% over age 15. • Area: slightly SMALLER than the US. • GNP around 10-11%/year • Industrial production growth rate: 22.9% • Electrical generating capacity – China adds generating capacity = to entire Australia or UK capacity each year – & it’s not enough! • Driven by: • Rural to Urban migration – 300 Million next 15 yrs • Rural poverty, starvation, unrest. • Drive for developed nation status • Government’s desire to avoid “unrest” (revolution) • Political power – use developed country money to fund expansion, development, political & military power growth. * Source: CIA World Factbook & other sources.

6. China – Political Factors: • Communist – yet pragmatic, realistic – “signal left, turn right” • Divesting State Owned Enterprises rapidly; major source of unemployment • Unclear intentions of government re: military power. • Manipulate exchange rates for advantage • Using developed world money to develop China, strengthen military, fund expansion ambitions. • Trade surplus – $1 Trillion, $800 Billion in USD. • Little/no real personal freedom as we understand it. • 25-30 yrs ago – like No. Korea now – starvation, etc. • Legacy of Mao – 1 party; everything subordinate to political interests.

7. Environment & Pollution Facts*: • 1998 UN/WHO report – 7 of the world’s 10 most polluted cities are in China. • Costs – about 7-10% of GDP/yr. • 410,000 deaths/yr. • Exempt from Kyoto • 90% of urban water “severely polluted.” Beijing - After rain Sunny day • Acid rain from coal. • Separate gov’t agencies for each area. *Sources: Wikipedia, Washington Post

8. China - Challenges • Pace of construction, change is intense • 3rd world mentality; endemic low-level corruption • Procuring in a “boom.” • Language, culture differences. • Little respect for intellectual property. • “Its how Chinese do business.” • “Tired of Americans telling them what and how to do things.”

9. Airport: getting a boarding pass…

10. Cultural Factors: • Very hard working; family loyalty, hard for westerners to understand. • Business culture – low self-responsibility; boss-driven; varies w/age. • Very weak commercial contract code, court enforcement. • Product quality – inconsistent. • Honesty/integrity – pragmatic, rather than principle-driven. • Foreigners stand out.

11. Unique Construction Methods: • Highlights: • Floors built above excavation • Pilings support • Excavation during building • 24/7 work • Tower cranes; a growth industry.

12. Trade & Outsourcing Overview • China - the world’s “workshop” • No meaningful pollution controls in China • Safety/HR standards not like the west • Many large corporations have been successful with China-based production • CAN be successful - much lower-cost • Vendor sourcing – challenging, difficult • Vendor negotiations – more challenging • Quality – usually needs independent inspection; little “process control” quality • IP – you teach them, then they own it.

13. Chinese Culture & Practices • Communist legacy & culture • Older workers – obedient, low initiative • Younger folks – changing; more inclined to take initiative, responsibility • Divesting SEOs; political connections still important. • Lack of “rights” – includes business, not just “personal.” • Contracts – Largely meaningless: • Language complex, opaque; due diligence • No real enforcement, resource, court system. • Depends on relative power, who needs what. • Other - • Hard working people; well educated • Strong desire to do better, succeed • Willing to learn from foreigners • IP – not respected, though improving some • Developing country – its not like the US, Europe; our assumptions trip us up.

14. The Low-Cost “Lure” • Key: Tilted exchange rate • Artificially kept low – • 15% to 40% less than • “real” value • 100 RMB (Renmenbi) = • $US 13.1148 More factors: • Subsidized exports - VAT refund • VAT is 15% • Exported products get 11% VAT refund • Subsidized industries (SEO’s) • Intense export focus by provincial governments. • Abundant reasonably skilled labor; good education. • Sheer numbers keep labor costs low • Little/no effective regulation • Continual in-flow from rural areas

15. Hidden Costs of China Outsourcing • Quality – biggest problem; must have on-site inspection • Inconsistent agreement compliance • Communication – engineering docs, specs, standards, quality, etc. • Transportation & logistics; customs, risk of damage, loss; 2-4 weeks on ocean, port time. • Increased inventory & carrying costs. • Slower response time to demand changes. • China sourcing bias – hard to import stuff into China; may force substandard materials

16. Hidden Costs – cont’d • Technology transfer - you invested in its development, now you’re giving it to them; make sure payoff is there. • Travel to/from for: communication, coordination – often substantial. • Chinese capabilities for your products: • May be very advanced, • May be primitive • Best Plan: “To teach them everything.”

17. How To Succeed in China • Face and resolve trust issue up front; get a China based partner who works FOR YOU who is independent of your proposed suppliers: • Not a family member or relative • Not part of the company • Best – works for a US-based company; led by US-citizens living and working in China. • Must be FLUENT in multiple Chinese dialects – Mandarin at least; both written and spoken; • Fluency in business practices and YOUR technology – in both languages. • Plan on heavy involvement, communication, travel up front and for a long time. • Don’t make a unit-cost only decision – hidden costs are all indirect, overhead costs

18. How to Succeed in China – Cont’d Prospective contract manufacturing suppliers: • Perform an in-depth Due Diligence. • Realize that financial statements may be worthless. • Use an experienced professional, on site analysis, familiar with at least similar industries. • Try to review detailed, auditable financial information – the check or “cash” book. • Interviews of key managers, supervisors – with an industry knowledgeable translator. • Reviews of process control practices & quality management methods.

19. China – Best Practice Summary • Best Practices – not “natural” to China; just like here or anywhere. • Asia not = to perfect quality: (Japanese quality came from Deming, and was not originally “native” there either.) • True Best Practices – depend on integrity, effective leadership, individual ownership of work; these may be at odds with your prospective Chinese supplier’s way of doing business. • Best Practices – may not be a business issue; you may be completely successful without them – IF cost, quality, dependability are present. • Most likely if: • Company is composed of younger • people. • Have had heavy exposure to • Western business practices, • manufacturing methods. • Company is/was, a successful • joint venture with a western • company.

20. Thanks! … and Good Luck! Paul Deis (818) 706-0160 www.pauldeis.com Paul@pauldeis.com Best Practices = Growth & Profit

21. Appendix – Working in China • These are some photos I took while working in China. • Intention – give you a flavor of what it looks like – as I saw it.

22. 1990 – 2 million people 2006 – 6 million people (Where I worked) Nanjing

23. Some Fun Photos - Nanjing

24. Going to work: the Yangtze Bridge:

25. Nanjing – From 32d Floor:

26. Nanjing – Hunan St.- KFC

27. Traditional Chinese shops:

28. Typical Street/Traffic:

29. The Sofitel: $70/nite: 5 star:* * Thanks to the manipulated exchange rate; which makes everything cheap in $US.

30. Nanjing - theSofitel – 5 Star hotel: