Technological Innovation in China

A CEO’s guide to innovation in China

Dynamic domestic players and focused multinationals are helping China churn out a growing number of innovative products and services. Intensifying competition lies ahead; here’s a road map for navigating it.

MCKINSEY QUARTERLY FEBRUARY 2012 • Gordon Orr and Erik Roth

China is innovating. Some of its achievements are visible: a doubling of the global percentage of patents granted to Chinese inventors since 2005, for example, and the growing role of Chinese companies in the wind- and solar-power industries. Other developments—such as advances by local companies in domestically oriented consumer electronics, instant messaging, and online gaming—may well be escaping the notice of executives who aren’t on the ground in China.

As innovation gains steam there, the stakes are rising for domestic and multinational companies alike. Prowess in innovation will not only become an increasingly important differentiator inside China but should also yield ideas and products that become serious competitors on the international stage.

Chinese companies and multinationals bring different strengths and weaknesses to this competition. The Chinese have traditionally had a bias toward innovation through commercialization—they are more comfortable than many Western companies are with putting a new product or service into the market quickly and improving its performance through subsequent generations. It is common for products to launch in a fraction of the time that it would take in more developed markets. While the quality of these early versions may be variable, subsequent ones improve rapidly.¹

Chinese companies also benefit from their government’s emphasis on indigenous innovation, underlined in the latest five-year plan. Chinese authorities view innovation as critical both to the domestic economy’s long-term health and to the global competitiveness of Chinese companies. China has already created the seeds of 22 Silicon Valley–like innovation hubs within the life sciences and biotech industries. In semiconductors, the government has been consolidating innovation clusters to create centers of manufacturing excellence.

But progress isn’t uniform across industries, and innovation capabilities vary significantly: several basic skills are at best nascent within a typical Chinese enterprise. Pain points include an absence of advanced techniques for understanding—analytically, not just intuitively—what customers really want, corporate cultures that don’t support risk taking, and a scarcity of the sort of internal collaboration that’s essential for developing new ideas.

Multinationals are far stronger in these areas but face other challenges, such as high attrition among talented Chinese nationals that can slow efforts to create local innovation centers. Indeed, the contrasting capabilities of domestic and multinational players, along with the still-unsettled state of intellectual-property protection (see sidebar, “Improving the patent process”), create the potential for topsy-turvy competition, creative partnerships, and rapid change. This article seeks to lay out the current landscape for would-be innovators and to describe some of the priorities for domestic and multinational companies that hope to thrive in it.

China’s innovation landscape

Considerable innovation is occurring in China in both the business-to-consumer and business-to-business sectors. Although breakthroughs in either space generally go unrecognized by the broader global public, many multinational B2B competitors are acutely aware of the innovative strides the Chinese are making in sectors such as communications equipment and alternative energy. Interestingly, even as multinationals struggle to cope with Chinese innovation in some areas, they seem to be holding their own in others.

The business-to-consumer visibility gap

When European and US consumers think about what China makes, they reflexively turn to basic items such as textiles and toys, not necessarily the most innovative products and rarely associated with brand names.

In fact, though, much product innovation in China stays there. A visit to a shop of the Suning Appliance chain, the large Chinese consumer electronics retailer, is telling. There, you might find an Android-enabled television complete with an integrated Internet-browsing capability and preloaded apps that take users straight to some of the most popular Chinese Web sites and digital movie-streaming services. Even the picture quality and industrial design are comparable to those of high-end televisions from South Korean competitors.

We observe the same home-grown innovation in business models. Look, for example, at the online sector, especially Tencent’s QQ instant-messaging service and the Sina Corporation’s microblog, Weibo. These models, unique to China, are generating revenue and growing in ways that have not been duplicated anywhere in the world. QQ’s low, flat-rate pricing and active marketplace for online games generate tremendous value from hundreds of millions of Chinese users.

What’s keeping innovative products and business models confined to China? In general, its market is so large that domestic companies have little incentive to adapt successful products for sale abroad. In many cases, the skills and capabilities of these companies are oriented toward the domestic market, so even if they want to expand globally, they face high hurdles. Many senior executives, for example, are uncomfortable doing business outside their own geography and language. Furthermore, the success of many Chinese models depends on local resources—for example, lower-cost labor, inexpensive land, and access to capital or intellectual property—that are difficult to replicate elsewhere. Take the case of mobile handsets: most Chinese manufacturers would be subject to significant intellectual property–driven licensing fees if they sold their products outside China.

Successes in business to business

Several Chinese B2B sectors are establishing a track record of innovation domestically and globally. The Chinese communications equipment industry, for instance, is a peer of developed-world companies in quality. Market acceptance has expanded well beyond the historical presence in emerging markets to include Europe’s most demanding customers, such as France Télécom and Vodafone.

Pharmaceuticals are another area where China has made big strides. In the 1980s and 1990s, the country was a bit player in the discovery of new chemical entities. By the next decade, however, China’s sophistication had grown dramatically. More than 20 chemical compounds discovered and developed in China are currently undergoing clinical trials.

China’s solar- and wind-power industries are also taking center stage. The country will become the world’s largest market for renewable-energy technology, and it already has some of the sector’s biggest companies, providing critical components for the industry globally. Chinese companies not only enjoy scale advantages but also, in the case of solar, use new manufacturing techniques to improve the efficiency of solar panels.

Success in B2B innovation has benefited greatly from friendly government policies, such as establishing market access barriers; influencing the nature of cross-border collaborations by setting intellectual-property requirements in electric vehicles, high-speed trains, and other segments; and creating domestic-purchasing policies that favor Chinese-made goods and services. Many view these policies as loading the dice in favor of Chinese companies, but multinationals should be prepared for their continued enforcement.

Despite recent setbacks, an interesting example of how the Chinese government has moved to build an industry comes from high-speed rail. Before 2004, China’s efforts to develop it had limited success. Since then, a mix of two policies—encouraging technology transfer from multinationals (in return for market access) and a coordinated R&D-investment effort—has helped China Railways’ high-speed trains to dominate the local industry. The multinationals’ revenue in this sector has remained largely unchanged since the early 2000s.

But it is too simplistic to claim that government support is the only reason China has had some B2B success. The strength of the country’s scientific and technical talent is growing, and local companies increasingly bring real capabilities to the table. What’s more, a number of government-supported innovation efforts have not been successful. Some notable examples include attempts to develop an indigenous 3G telecommunications protocol called TDS-CDMA and to replace the global Wi-Fi standard with a China-only Internet security protocol, WAPI.

Advantage, multinationals?

Simultaneously, multinationals have been shaping China’s innovation landscape by leveraging global assets. Consider, for example, the joint venture between General Motors and the Shanghai Automotive Industry Corporation, which adapted a US minivan (Buick’s GL8) for use in the Chinese market and more recently introduced a version developed in China, for China. The model has proved hugely popular among executives.

In fact, the market for vehicles powered by internal-combustion engines remains dominated by multinationals, despite significant incentives and encouragement from the Chinese government, which had hoped that some domestic automakers would emerge as leaders by now. The continued strength of multinationals indicates how hard it is to break through in industries with 40 or 50 years of intellectual capital. Transferring the skills needed to design and manufacture complex engineering systems has proved a significant challenge requiring mentorship, the right culture, and time.

We are seeing the emergence of similar challenges in electric vehicles, where early indications suggest that the balance is swinging toward the multinationals because of superior product quality. By relying less on purely indigenous innovation, China is trying to make sure the electric-vehicle story has an ending different from that of its telecommunications protocol efforts. The government’s stated aspiration of having more than five million plug-in hybrid and battery electric vehicles on the road by 2020 is heavily supported by a mix of extensive subsidies and tax incentives for local companies, combined with strict market access rules for foreign companies and the creation of new revenue pools through government and public fleet-purchase programs. But the subsidies and incentives may not be enough to overcome the technical challenges of learning to build these vehicles, particularly if multinationals decline to invest with local companies.

Four priorities for innovators in China

There’s no magic formula for innovation—and that goes doubly for China, where the challenges and opportunities facing domestic and multinational players are so different. Some of the priorities we describe here, such as instilling a culture of risk taking and learning, are more pressing for Chinese companies. Others, such as retaining local talent, may be harder for multinationals. Collectively, these priorities include some of the critical variables that will influence which companies lead China’s innovation revolution and how far it goes.

 

Deeply understanding Chinese customers

Alibaba’s Web-based trading platform, Taobao, is a great example of a product that emerged from deep insights into how customers were underserved and their inability to connect with suppliers, as well as a sophisticated understanding of the Chinese banking system. This dominant marketplace enables thousands of Chinese manufacturers to find and transact with potential customers directly. What looks like a straightforward eBay-like trading platform actually embeds numerous significant innovations to support these transactions, such as an ability to facilitate electronic fund transfers and to account for idiosyncrasies in the national banking system. Taobao wouldn’t have happened without Alibaba’s deep, analytically driven understanding of customers.

Few Chinese companies have the systematic ability to develop a deep understanding of customers’ problems. Domestic players have traditionally had a manufacturing-led focus on reapplying existing business models to deliver products for fast-growing markets. These “push” models will find it increasingly hard to unlock pockets of profitable growth. Shifting from delivery to creation requires more local research and development, as well as the nurturing of more market-driven organizations that can combine insights into detailed Chinese customer preferences with a clear sense of how the local business environment is evolving. Requirements include both research techniques relevant to China and people with the experience to draw out actionable customer insights.

Many multinationals have these capabilities, but unless they have been operating in China for some years, they may well lack the domestic-market knowledge or relationships needed to apply them effectively. The solution—building a true domestic Chinese presence rather than an outpost—sounds obvious, but it’s difficult to carry out without commitment from the top. Too many companies fail by using “fly over” management. But some multinationals appear to be investing the necessary resources; for example, we recently met (separately) with top executives of two big industrial companies who were being transferred from the West to run global R&D organizations from Shanghai. The idea is to be closer to Chinese customers and the network of institutions and universities from which multinationals source talent.

Retaining local talent

China’s universities graduate more than 10,000 science PhDs each year, and increasing numbers of Chinese scientists working overseas are returning home. Multinationals in particular are struggling to tap this inflow of researchers and managers. A recent survey by the executive-recruiting firm Heidrick & Struggles found that 77 percent of the senior executives from multinational companies responding say they have difficulty attracting managers in China, while 91 percent regard employee turnover as their top talent challenge.

Retention is more of an issue for multinationals than for domestic companies, but as big foreign players raise their game, so must local ones. Chinese companies, for example, excel at creating a community-like environment to build loyalty to the institution. That helps keep some employees in place when competing offers arise, but it may not always be enough.

Talented Chinese employees increasingly recognize the benefits of being associated with a well-known foreign brand and like the mentorship and training that foreign companies can provide. So multinationals that commit themselves to developing meaningful career paths for Chinese employees should have a chance in the growing fight with their Chinese competitors for R&D talent. Initiatives might include in-house training courses or apprenticeship programs, perhaps with local universities. General Motors sponsors projects in which professors and engineering departments at leading universities research issues of interest to the automaker. That helps it to develop closer relations with the institutions from which it recruits and to train students before they graduate.

Some multinationals energize Chinese engineers by shifting their roles from serving as capacity in a support of existing global programs to contributing significantly to new innovation thrusts, often aimed at the local market. This approach, increasingly common in the pharma industry, may hold lessons for other kinds of multinationals that have established R&D or innovation centers in China in recent years (read about AstraZeneca’s experience in “Three snapshots of Chinese innovation”). The keys to success include a clear objective— for instance, will activity support global programs or develop China-for-China innovations?—and a clear plan for attracting and retaining the talent needed to staff such centers. Too often, we visit impressive R&D facilities, stocked with the latest equipment, that are almost empty because staffing them has proved difficult.

Instilling a culture of risk taking

Failure is a required element of innovation, but it isn’t the norm in China, where a culture of obedience and adherence to rules prevails in most companies. Breaking or even bending them is not expected and rarely tolerated. To combat these attitudes, companies must find ways to make initiative taking more acceptable and better rewarded.

One approach we found, in a leading solar company, was to transfer risk from individual innovators to teams. Shared accountability and community support made increased risk taking and experimentation safer. The company has used these “innovation work groups” to develop everything from more efficient battery technology to new manufacturing processes. Team-based approaches also have proved effective for some multinationals trying to stimulate initiative taking (read about General Motors’ approach in “Three snapshots of Chinese innovation”).

How fast a culture of innovation takes off varies by industry. We see a much more rapid evolution toward the approach of Western companies in the way Chinese high-tech enterprises learn from their customers and how they apply that learning to create new products made for China (read a perspective on the evolution of its semiconductor sector in “Thee snapshots of Chinese innovation”). That approach is much less common at state-owned enterprises, since they are held back by hierarchical, benchmark-driven cultures.

Promoting collaboration

One area where multinationals currently have an edge is promoting collaboration and the internal collision of ideas, which can yield surprising new insights and business opportunities. In many Chinese companies, traditional organizational and cultural barriers inhibit such exchanges.

Although a lot of these companies have become more professional and adept at delivering products in large volumes, their ability to scale up an organization that can work collaboratively has not kept pace. Their rigorous, linear processes for bringing new products to market ensure rapid commercialization but create too many hand-offs where insights are lost and trade-offs for efficiency are promoted.

One Chinese consumer electronics company has repeatedly tried to improve the way it innovates. Senior management has called for new ideas and sponsored efforts to create new best-in-class processes, while junior engineers have designed high-quality prototypes. Yet the end result continues to be largely undifferentiated, incremental improvements. The biggest reason appears to be a lack of cross-company collaboration and a reliance on processes designed to build and reinforce scale in manufacturing. In effect, the technical and commercial sides of the business don’t cooperate in a way that would allow some potentially winning ideas to reach the market. As Chinese organizations mature, stories like this one may become rarer.

China hasn’t yet experienced a true innovation revolution. It will need time to evolve from a country of incremental innovation based on technology transfers to one where breakthrough innovation is common. The government will play a powerful role in that process, but ultimately it will be the actions of domestic companies and multinationals that dictate the pace of change—and determine who leads it.

 

Changes in Chinese Demographics Pose Economic Challenge

China Faces Dwindling Labor Supply

By Bloomberg News – Aug 30, 2011 2:12 AM

Lin Chang Jie is battling to save a family business making towels, cushions and robes in the eastern Chinese city of Ningbo as a dwindling supply of workers forces him to pay higher wages.

“I have to find a new way,” says Lin, 29, who is turning his Dejin Textile Co. into an online fashion retailer to cut costs and keep the business from closing. “Wages are going up, up, up. If we don’t like somebody’s work we can’t say anything, in case they leave.”

China’s three-decade-old, one-child policy will accelerate declines in the workforce, forcing companies to upgrade to higher-value products in the way Japan did in the 1960s and 70s. China may have as little as five years to make the transition to avoid a slump in economic growth, according to Sun Mingchun, an analyst at Daiwa Capital Markets in Hong Kong and former economist at China’s State Administration of Foreign Exchange, part of the central bank. He said growth may decline in 2016-20 as low-cost producers fail and investment falls away.

“This is the big issue in China on which everything will turn,” said Barry Eichengreen, an economics professor at the University of California at Berkeley and former senior policy adviser to the International Monetary Fund, who contributed to the 2010 book: “Emerging Giants: China and India in the World Economy.” “China needs to really accelerate this transition.”

Factory Workers

The pool of 15 to 24-year-olds, a mainstay for factories making cheap clothes, toys and electronic products, will fall by almost 62 million people to a total of 164 million in the 15 years through 2025, United Nations projections show. The demographic shift is a result of the one-child policy implemented in 1979.

Products such as clothes, shoes and furniture that the General Administration of Customs doesn’t classify as “high- tech,” accounted for about 68 percent of China’s exports last year, or $1.09 trillion, little changed from the 71 percent share in 2005, when they were worth $544 billion, the agency’s figures show. Exports account for more than a fifth of China’s gross domestic product. High-tech industries include aerospace and aviation, medical instruments, software, computers and telecommunications.

“The low-end manufacturing industry is tough and will be getting tougher day by day as both labor and land costs are rising,” says Xu Hui, 39, the owner of Wenzhou Dazhan Photoelectricity Co. in Zhejiang province, south of Shanghai. She’s switched to making LEDs and solar parts after starting off in the 1990s manufacturing sunglasses that sold for a dollar or two. “Either you go for high-tech, high value-added industry or you just perish.”

Japan in 1969

China’s income growth and stage of economic development is similar to Japan in 1969 and South Korea in 1988, before their rates of expansion fell, according to Morgan Stanley. Japan’s growth slid to an average 5.2 percent in 1970-79 from 10.4 percent in the previous decade, the bank said. South Korea’s expansion cooled to 6.3 percent in 1989-98, from as much as 12.3 percent during the previous decade, government data shows.

Only five economies — Japan, South Korea, Taiwan, Hong Kong and Singapore — have moved from middle-income nations to developed country status while maintaining relatively high growth rates, according to Nobel laureate Michael Spence, a professor of economics and business at New York University’s Stern School of Business.

‘Inflation is Serious’

China’s economic growth may ease to 9.2 percent this quarter from 9.5 percent in the previous three months, the China Securities Journal reported Aug. 16, citing the State Information Center. The country’s inflation may rise to about 6.2 percent in the same period, from 5.7 percent in the previous quarter, the report said.

“Inflation is serious now,” said Chen Mei, 23, during her lunch break in the southern manufacturing city of Dongguan. Chen, a migrant, said she’s earning about twice the monthly minimum wage of 1,100 yuan ($172) and expects pay at the garment factory where she works to keep rising as prices increase.

The yuan’s gain of about 7 percent against the dollar since June last year has intensified cost pressures faced by China’s exporters, which price their products in the American currency. The yuan closed at 6.3805 per dollar in Shanghai today, close to a 17-year high.

While the bulk of China’s producers have yet to upgrade, high-technology exports are rising, recording a 31 percent jump in 2010 to $492 billion. That’s more than double the $218 billion in 2005 and almost a third of total shipments, according to the customs bureau.

Investment Theme

Economists including Deutsche Bank AG’s Ma Jun say companies that successfully make the transition will reap huge benefits.

“The single most important investment theme for China’s manufacturing sector over the next five years is its upgrading,” said Ma, Hong Kong-based chief China economist for the bank and a former researcher for China’s State Council. Investors have yet to price in the “potential outperformance” of the sector, he said.

Companies such as machinery makers Sany Heavy Industry Co. and Changsha Zoomlion Heavy Industry Science & Technology Development Co., will “emerge to be major winners not only domestically but internationally” said Diane Lin, a fund manager with Sydney-based fund Pengana Capital Ltd., which manages about $1 billion in global assets.

‘Forget Textiles’

“Forget textiles and all that, this is the future of China,” said Lin. “If you go and look back to Japan in the early 1970s it was a net importer of machinery as well, and within only three to four years it overtook the U.S. and became a net exporter.”

Shares in Zoomlion will double to HK$24 ($3.08) by July next year, according to Zhang Zharlen, an analyst with KGI Securities in Shanghai. Lin said she plans to buy shares of companies including Zoomlion once sentiment improves from the effect of government measures to cool the property market.

Twenty-two years after starting as a welding factory, Sany Heavy has four billionaires on the board, more than 68,000 workers and sells products including concrete pumps and road rollers in 120 countries.

“For ages, people believed that Chinese can only make stuff like toys, clothes and hand torches — all cheap and of bad quality,” Sany’s Senior Vice President Zhao Xiangzhang said in an interview in Changsha, the capital city of the southern Hunan province. “Our dream is to change this bad image.”

Expanding in Germany

Sany opened an industrial park in June in Bedburg in Germany, home country of machinery makers Siemens AG (SIE) and ThyssenKrupp AG. (TKA) The company also supplied a pump that helped cool the crippled No. 4 reactor at Japan’s Fukushima nuclear plant after the March 11 earthquake and tsunami.

Chinese equipment manufacturers will be among the nation’s best performers over the next five years, according to Deutsche Bank. They have taken market share from competitors including South Korea’s Hyundai Heavy Industries Co. and Doosan Infracore Co., Japan’s Komatsu Ltd. (6301) and U.S.-based Caterpillar Inc., Pengana’s Lin said.

“We would avoid Komatsu because we think that Chinese companies will increase their competitiveness over the medium term,” Lin said. Komatsu is the world’s second-largest maker of construction and mining equipment, trailing Caterpillar.

Other potential “global losers” from Chinese competition include telecommunications companies Ericsson and Nokia Corp., industrial machinery maker Alstom SA (ALO) and General Electric Co., Deutsche Bank said in a report last year.

Lower-Cost Regions

The bank recommended buying Chinese equipment makers and avoiding “material- and labor-intensive companies” such as casual footwear maker Yue Yuen Industrial (Holdings) Ltd. and VTech Holdings Ltd., a maker of cordless telephones and electronic learning products.

Rising labor and other costs may force manufacturers to move production of some consumer goods to lower-cost regions including western China, Vietnam, Bangladesh and Indonesia to keep prices down.

“I don’t believe consumers in the United States or Europe are prepared to pay more,” Bruce Rockowitz, the chief executive officer of Hong Kong-based Li & Fung, the world’s biggest supplier of toys to retailers, said in May.

Cai Fang, a member of the Standing Committee of the National People’s Congress, said China’s leaders have not yet fully accepted that the so-called demographic dividend is declining. The economic benefit arises after a country’s birth- rate falls — creating a few decades when there are a higher proportion of working-age citizens and less need to spend on children and education.

Xi’s Task

Cai, a director of the Institute of Population and Labor Economics at the Chinese Academy of Social Sciences who helped draft the nation’s five-year plan through 2016, said advisers are “comforting” China’s policy makers with arguments that the dividend can last another 20 years or more.

The task of managing the transition in China’s economy may fall to Vice President Xi Jinping, who is expected to assume leadership of the Communist Party next year and succeed Hu Jintao as president in 2013. The new leaders will oversee a five-year plan that aims to boost consumer spending and “strategic emerging industries” such as biotechnology, new energy and advanced equipment manufacturing.

In the Pearl River Delta next to Hong Kong, the cradle of China’s industrial transformation, the government said this month it will set up a zone covering nine cities in Guangdong province to help companies upgrade. The statement, posted on the commerce ministry’s website on Aug. 22, proposes tax breaks and other incentives to help boost technology and research and development within three years.

In Ningbo, Dejin Textile’s Lin is preparing for his own upgrade: a new line of women’s clothes to be sold online and in two local stores, a “huge risk” that he says keeps him awake at night.

“In five years we may have a very big retail business,” he says. “Or we may be closed.”

Buffett Backed China Battery Company Struggles

REUTERS August 23, 2011  By Alison Leung

HONG KONG (Reuters) – BYD Co’s profit warning and failure to deliver its promised electric car plan sent shares plunging to a more than two-year low, as the Chinese auto and battery maker backed by Warren Buffett struggles with steady sales declines and waning popularity of its top model.

Shares in BYD plummeted more than 14 percent on Tuesday after the company warned it could post a third-quarter loss.

The grim warning and ensuing stock drop has put a spotlight on the company’s strategy and on Buffett, whose investment in BYD has lost around $2 billion in value since taking a stake in 2009. His stake is still worth twice what he paid, though.

BYD attracted Buffett’s Berkshire Hathaway because of its battery technology, which former Berkshire executive David Sokol called a “breakthrough.” Sokol has since left the company under a cloud related to his personal investing activities.

Despite BYD’s F3 sedan being China’s best-selling car brand in 2009 and 2010, the company sold only 480 units combined of its F3DM hybrid and e6 electric model. It has also delayed the U.S. launch of its e6 until 2012.

Sales may improve in the second half with the launch of new models, BYD Chairman Wang Chuanfu said on Tuesday.

The company planned to export electric cars and buses to the United States and Europe next year and other overseas markets such as Hong Kong as early as 2011, the chairman said.

“We will start selling e6 to individual customers in China in the second half and to overseas markets next year,” Wang told reporters. “The fourth quarter is the traditional high season for car sales in China and with the new models coming to the market, our auto sales should be better in the second half than the first half.”

He expects BYD’s gross profit margin, which fell to 13.7 percent in the first half, to improve in the second half.

BYD warned Monday its net profit for the first three quarters may fall 85-95 percent due to fierce competition in China, the world’s largest auto market.

“I drove their car two years ago and I love it,” said CLSA analyst Scott Laprise, referring to BYD’s hybrid car. I thought this is the winner and I thought this could go anywhere in the world because of relatively low price.

“The premium part of the valuation is zero because they can’t deliver what they promised years ago,” Laprise said.

BUFFETT BAILING?

Buffett’s Berkshire Hathaway paid about $230 million in 2009 for 225 million shares in the company.

That stake was worth as much as $2.47 billion in October 2009 when the stock peaked at HK$85.5 each. The 9.6 percent stake is now worth about $467 million.

Wang said the company continued to maintain a good relationship with Buffett, but declined to comment on whether the U.S. investor would sell BYD shares.

Within Berkshire, the champion for the BYD investment has been Vice Chairman Charlie Munger, who held a personal stake even before the Berkshire investment and who has spoken of BYD’s Chairman Wang in glowing terms.

At investor meetings in April and July, Munger said he intended to stick with the BYD stake, which some took as a signal that Buffett would as well.

Buffett and Munger have also brushed aside concerns — raised by U.S. diplomats in cables released by WikiLeaks — that BYD has copied industrial designs from competitors. Diplomats have said that and other factors may keep BYD from releasing cars in the United States.

Buffett’s assistant did not respond to a request for comment on Tuesday.

LOWER FORECASTS, TARGETS

BYD’s guidance for a further deterioration and the forecast represented a 154 million yuan ($24 million) loss to a 90 million yuan profit for the third quarter, Bank of America Merrill Lynch said in a note.

The consensus 2011 profit forecast for the company stands at 1.7 billion yuan, according to a poll of six analysts by Thomson Reuters I/B/E/S.

Bank of America Merrill Lynch on Tuesday cut the target price on BYD shares by 15 percent to HK$17, after lowering its 2011 earnings forecast by 61 percent and its 2012 forecast by 31 percent.

BYD’s Hong Kong-listed shares, which have lost more than three-fifths of their value this year, dived 14.3 percent to close at HK$$16.18, their lowest since April 2009, compared with a 2 percent gain in the Hang Seng Index.

However, its Shenzhen-listed shares were up 1.2 percent.

The market has high expectations on BYD’s newly launched sport utility vehicle S6, and the coming G3 model, which will replace the popular F3, analysts said.

“This (profit forecast) was a surprise to the market,” said Steve Man, an analyst at Samsung Securities.

“Maybe on top of that the year-on-year comparison will be pretty easy starting from the third quarter. So people are hoping the company’s earning starts to turning around,” Man added.

Chinese Wage Inflation Causing US Manufacturer Reassment

David Griffith’s Note: China’s reputation as the manufacturer for the world is under assault as wage demands drive costs upwards and US manufacturers look to relocate to rural areas or other less developed Asian countries.

Analysis: China costs start to worry U.S. multinationals

On Friday August 12, 2011, 8:54 am EDT

By Nick Zieminski

NEW YORK (Reuters) – For years, low prices on China-sourced goods helped dampen inflation in the United States. Now China’s efforts to boost domestic consumer spending, reducing reliance on exports, are leading to higher costs for multinationals that manufacture goods there.

Eventually, China could export its inflation.

Conglomerates ranging from Emerson Electric (NYSE:EMR – News) to Honeywell International (NYSE:HON – News) feel pressure on margins from double-digit wage increases in China. So have toymaker Mattel (NasdaqGS:MAT – News), fast-food chain Yum! Brands (NYSE:YUM – News) and computer maker Dell (NasdaqGS:DELL – News), analysts and investors say.

They have plenty of options besides raising prices, such as embracing automation or moving to China’s less-developed interior. Some companies relegate China costs to the category of minor headache; others point to long-term benefits from richer Chinese consumers. But the topic has became a talking point during the earnings season now winding down.

“Input cost increases have been a steady headwind to margins for some time now,” Fairchild Semiconductor International (NYSE:FCS – News) Chief Financial Officer Mark Frey said last month. “Metals and energy pricing, forex and China wage inflation are more difficult to forecast.

Yum, the No. 1 Western restaurant brand in the world’s fastest-growing major economy, generates a third of its profit from China. It said its full-year margins will dip this year, citing labor inflation in the mid-to-high teens.

“I do believe that labor inflation will continue high for quite a while,” Yum CFO Rick Carucci said on the company’s earnings conference call. He called commodity prices another “wild card” for the company.

GO WEST, YOUNG MAN

Nearly a third of Emerson Electric’s total workforce is in China, where it employs more than 40,000 people. Amid 20 percent wage increases, the company has said it could move some production to China’s interior, and it might move 20 percent of its capacity to other Asian countries.

“The economy is going into a more costly mode,” CEO David Farr said on Emerson’s second-quarter conference call. “We are going to have to refix where we’re manufacturing.”

Emerson’s network power business was the only of its five units to show lower operating profits in the latest quarter. The company cited labor inflation among the causes.

“A lot of the wage increase is to keep civil unrest at a minimum,” said William Blair analyst Nick Heymann, who said suicides at an Apple (NasdaqGS:AAPL – News) supplier and the “Arab Spring” protests have alarmed Beijing. “These guys have watched North Africa and the Middle East with a lot of trepidation.”

A related, complicating factor is that local competitors, many state-owned and not too worried about margins, are challenging companies like Emerson on price, Heymann said.

Multinationals have figured out they cannot compete on cost: they must differentiate their products, making them smaller, faster or more energy-efficient. Then, depending on the product, they might be able to ask for higher prices.

Others, such as makers of labor-intensive shoes and toys, have to take into account a cost-conscious consumer now potentially facing a new recession. Still, Hasbro and Mattel have pushed through price increases this year, and Hasbro’s CEO has said China remains its preferred manufacturing hub.

MANUFACTURING A CONSUMER CULTURE

China this year adopted a five-year plan that calls for 7 percent growth in per-capita income, ahead of earlier targets, and fresh investment in research and development, to boost domestic consumption and modernize its economy.

Manufacturing wages are a fraction of those in the United States but are narrowing the gap, both fueling and responding to China’s inflation, now at three-year highs. Between 1978 and 2009, wages jumped almost 13 percent a year, six times the pace of U.S. wage rises, according to BernsteinResearch.

Since 2006, that growth has accelerated.

By 2015, wages around Shanghai, adjusted for productivity, will be 61 percent of those in low-cost U.S. states like Alabama, according to the Boston Consulting Group (BCG). Transport and other considerations further shrink that gap.

“Wages are getting large enough that you start to feel the difference,” said Hal Sirkin, a BCG senior partner, who said U.S. companies are looking at alternative manufacturing sites. “One of the answers is to start moving back to the U.S.”

The next few years will bring a wave of reinvestment by U.S. multinational manufacturers in their home base, as rising wages and a strong yuan currency make China a less attractive production center, BCG predicts. Its July BCG paper names 14 companies rethinking where they produce goods, including NCR (NYSE:NCR – News), Ford (NYSE:F – News), Flextronics (NasdaqGS:FLEX – News), Ashland (NYSE:ASH – News), and Jarden’s (NYSE:JAH – News) Coleman unit.

Where China once had ample labor, and supply was well balanced with demand, that equilibrium has broken down, BCG argues. The change does not mean shutting Chinese factories and firing workers; it means selectively scaling back future expansion or investment. China’s size will ensure it remains a major global player.

China’s well-developed infrastructure is an advantage over other countries such as the Philippines, Indonesia and Vietnam. And any short-term hit to margins has to be balanced against the long-term opportunity in a richer China. For many producers, costs such as oil and metals are a bigger headache than the soaring cost of labor.

“I’m not that worried about it,” Honeywell CEO Dave Cote said, referring to wage inflation. “I don’t put it up there in one of these economic perils kind of categories.”

Manufacturers including Honeywell are looking inland, where wages are lower, Cote said, or they are automating production.

“You’d look at it in the past and say, instead of a machine, it’s worth having 10 people do it,” Cote said. “Well, that may not be true anymore.”

Cote’s comment points to a crucial silver lining for some U.S. companies. If factories invest in machines, that helps Emerson and Rockwell Automation (NYSE:ROK – News). If China expands its consumer middle class, the Yums of the world benefit as families eat out more or adopt a protein-rich diet.

Ultimately, the success of that drive to shore up China’s consumer base may determine how U.S. companies perceive the risks and rewards of operating in China.

“The customer base in China is just so immense,” said Tim Hanley, Deloitte LLP U.S. Process & Industrial Products Leader. “Companies that were in China as a low-cost exporting base recognize they need to be there. That’s where demand is.”

 

Looking for Work – Consider Moving to China

China Wants to Hire You — Should You Go?

ByJoe Mont, Staff Writer , On Thursday August 4, 2011, 8:00 am EDT

BOSTON (TheStreet) — NBA players may soon follow the lead of a growing number of Americans looking for work in China.

With the upcoming basketball season jeopardized by an expiring collective bargaining agreement, several NBA superstars — among them Dwyane Wade and Carmelo Anthony — have said they would consider playing for Chinese teams, which have been growing an increasingly rabid fan base.

In looking for opportunities in the so-called Middle Kingdom, the players are not much different than others turning to China for job prospects.

Put simply, there are at least jobs to be had. Unlike the U.S, with near double-digit unemployment, there is great demand in China for skilled professions such as banking and finance. That demand shows little sign of slowing, bolstered by the fact the country had 10% growth last year and will experience nearly the same rate this year.

There has traditionally been demand for English-language teachers in China, a job niche that typically attracts young graduates enticed by the prospects of living abroad. Now U.S. companies are looking to move top managers into Chinese territories, and executives have found themselves forced to relocate. Recently, General Electric moved the headquarters for its X-ray division and top division executives to China to capitalize on growth in the Asian marketplace.

Entrepreneurs are also enticed by lower taxes, decreased regulation, cheap labor and a pipeline into the massive Asian marketplace, while Chinese companies are looking to expand globally by building their U.S. brain trust.

An exact count of how many Americans are working in China is not readily available, as neither country has a uniform process for registering such employment status.

UniGroup Worldwide, an international mover of household goods with headquarters in St. Louis and Amsterdam, used its own shipping business to gauge the trend. It found a 46.7% increase in the number of American’s relocating to China for work over the past three years.

Its international migration study, released last week, was based on more than 15,000 household goods moves completed in 2010 for major corporations. In the U.S., UniGroup is affiliated with Mayflower Transit and United Van Lines.

It shows that last year European countries topped the list of destinations for U.S. residents moving abroad, consistent with trends over the past 10 years. Asian countries, however, appear higher and more frequently on the top destinations list.

The U.K and France were the top two countries American’s were moving to, followed by China. In 2000, China wasn’t even among the top 10.

Once you get there

Adapting to local customs can be just as challenging as the logistics of moving there for a transplanted worker.

Similar to Japan, there is a ritualistic nature to rules of etiquette and even to business cards — they should be printed with English on one side, Chinese on the other; always presented and received with two hands; and momentarily studied before being carefully tucked away.

English is not as much a barrier, but interpreting subtext is crucial, given China’s stoic traditions. Hierarchy and one’s place in the “food chain” of a company can dictate nearly all interactions, and direct confrontation is considered impolite.

The website The idle Kingdom, run by expatriates Matt and Kara Banker as a resource for those planning to live or work in China, offers a rundown of some of the common types of visas China requires of all working foreigners.

The “Z” visa is for those working for an established company in China and are tied to that workplace. Businesses are issued a limited number, which typically cover only full-time employees. A Z-Dependent visa is available for a spouse and children.

The “F” visa covers foreign experts in China temporarily to work on a specified project.

Transportation, if walking or biking doesn’t meet your needs, has to be addressed.

“Purchasing a car in Beijing has become much more problematic in the last year,” says Matt Banker, who moved to Beijing to be the youth director at an international church. “To get a car you will need to win the license plate lottery, about a 1-in-5 chance, then you can purchase a car for about two to three times the cost of what you would pay in America. You’ll also need to pass the written driver’s license test, since China doesn’t recognize foreign licenses.”

The other option is to hire a driver, which will cost roughly 5,000 yuan a month, or about $777.

Another expense beyond food and housing an overseas worker or employer will need to be prepared for: securing an international health insurance policy.

For those with children, English language schooling needs to be considered. Homeschooling can range from $500 to $20,000 or more for an international school, Banker says.

Stateside expenses, such as storage of belongings, and the cost of trips back home also need to be part of a total budget.

If you are a U.S. citizen or a resident alien of the United States and you live abroad, you are taxed on your worldwide income.

According to the IRS, however, you may qualify for a foreign housing deduction. Anyone who lives in China for more than a year also pays taxes to that country on their worldwide income (less than a year incurs only domestic income) at a progressive rate that ranges from 5% to 45%.

Decide fast

Despite the demand for foreign workers, the job market pendulum could eventually swing back toward America.

Within the next five years, the U.S. is expected to experience a “manufacturing renaissance” as the wage gap with China shrinks, proposes a recent analysis by Boston Consulting Group, a global management consulting firm. With U.S. wages stagnating while Chinese wages rise at about 17% per year and the value of the yuan continues to increase, the gap between U.S. and Chinese wages is narrowing rapidly.

“All over China, wages are climbing at 15% to 20% a year because of the supply-and-demand imbalance for skilled labor,” says Harold Sirkin, a BCG senior partner. “We expect net labor costs for manufacturing in China and the U.S. to converge by around 2015. As a result of the changing economics, you’re going to see a lot more products ‘Made in the USA‘ in the next five years.”

As the wage gap shrinks, once inventory and shipping costs are considered, China’s advantage may be minimal at best, BCG says. It predicts that products that require less labor, such as household appliances and construction equipment, are most likely to shift to U.S. production. Goods that are labor-intensive and produced in high volumes, such as textiles, apparel and TVs, will likely continue to be made overseas.

That trend may already be revealing itself.

NCR has flipped production of its ATMs back to domestic soil and toy manufacturer Wham-O last year returned 50% of its Frisbee production and Hula Hoop production from China and Mexico to the U.S.