Spring 2011 Newsletter Feature

Russ Hall, General Manager of China Operations, Armstrong Fluid Systems

Introduction:

Russ Hall is the General Manager of China Operations for a global leader in fluid management systems.  He has 30 years combined experience in North America, Europe and Asia including 6 years in China and 3 years in Singapore.  In the past 3 years, Russ has grown his company’s China operations from 2 to over 25 people and has launched a new “greenfield” manufacturing facility.  Prior to joining Armstrong, Russ was Vice President and China General Manager for one of the largest tier-1 automotive suppliers, based in Shanghai.  Russ has also held executive roles in purchasing, manufacturing and sales in North American, European and Asia Pacific operations.

Interview:

1.  How do you view the current state of the China economy? How has this affected the industrial system manufacturer industry?

China is still the growth market globally both due to the overall size of the market and the growth rate.  Unlike other countries that have gone through economic cycles, China just keeps growing.  Many industry sectors, like automotive, set new records almost every quarter.  With that, the demand for commodities, fuels, iron ore, and energy, increase the cost of doing business.  I do believe that China will keep growing, but China will face pressure from the rest of the world and internally.

Internally, China has to balance their energy plans, the environmental aspect of it with coal vs. nuclear, the rising cost of fuel, the rising cost of electricity, . . . how does China keep that under control while at the same time keeping wages under control and in balance? China also will have to address high housing prices with low occupancy rates and the wealth and expense gap between large eastern cities like Beijing, Shanghai and Guangzhou and inland cities.  These challenges also create opportunities for companies that understand the market, can operate throughout the country and can offer solutions.

Globally, China’s costs are going up relative to India, Vietnam, Thailand, and Indonesia. Those places are becoming much more competitive from a labor standpoint, but they don’t have the market, raw materials, and infrastructure that China has.  China’s infrastructure is as good as anywhere else I have been - not just compared to developing countries, but also relative to Western countries. Some people question the quality of China’s infrastructure.  In my opinion, the infrastructure is solid, the finishing is not as strong as some places, flooring, insulation, painting, etc., but to build a place like Shanghai I don’t think it’s reasonable to believe that the infrastructure is not sound.

I believe that China doesn’t want to grow at greater than 10%, to provent inflation, they would rather have 7% growth that is steady.

2.  China has just released its 12^th 5-year plan. What do you believe will be the plan’s general impact on the China market and specific impact on industrial system manufacturers?

The part that I’m interested in is the energy savings.  The focus is definitely on energy savings. The challenge is that although the plan can be mandated from the central government, the question will be as you push it down to the provincial and local government, how do you execute it?  People have relationships and ways of doing business locally.  That will be the challenge.  For companies that have energy savings solutions, the more the 5-year plan is pushed, the more it will create opportunities and incentives for their products and services.

3.  Doing business in China sometimes has more uncertainty and ambiguity than in other countries.  As someone with extensive experience in China, North America and Europe, what's your opinion of managing ambiguity while doing business in China?  What are the major differences between doing business in China vs. North America or Europe?

Generally, the goals in business are the same, to try to make money – to be successful – and to do it sustainably.  The difference in achieving these general business goals in each country is the local culture, so you have to appreciate how that can affect how you do business. In China, there is guanxi. People do business based on relationships and this does have a big impact.  Everywhere in the world relationships play a role in conducting business, for example you wouldn’t buy a car in the US from a salesperson that you didn’t like.  In China, you can achieve more by using relationships to push down from the top vs. in North America, relationships at the bottom are used more to elevate issues.  

In Asia, I have found that it is generally accepted that English is the language of business, even if that sometimes requires a translator.  In Europe, English is not always the business language.  When you’re in France, French is the business language.  When you’re in Germany, German is the business language.

The economy drives a country’s attitude or vibe and this can also affect the way companies do business. In the States, due to the recession, everything is negative.  Laying off people creates a negative vibe and it makes it hard to create a positive attitude.  In China, there are many issues, but because of the growth, most of those issues are positive.  There’s a big difference between doing business when the economy is growing and prosperous compared to when it’s contracting.

4.  How do most industrial system manufacturers think strategically about their China opportunity? In other words, are strategies developed to capture the opportunities around China’s massive infrastructure investment or is the focus more on using China as a low cost manufacturing location to serve several markets?

I think it’s a combination of both. Companies view China as the growth market, number one, and as the hub for Asia Pacific.  They also view China still as a cost competitive product to export to the rest of the world.  I think everybody’s business case is a little different.  The case is interesting because of the outside factors that you need to consider, you have a labor cost and a product cost, then you get into currencies, inflationary issues with certain countries, political issues, and logistics.  Each factor can change your business model quickly.  If your business model is just export business, today it might make the most sense to operate from China, tomorrow it could be Vietnam, the next day it’s Poland, everyday it changes.  If your local business is supported, then the currency situation is less of a factor and you can be more flexible in pursuing export opportunities.

5.  You have extensive experience forming and managing joint ventures (JVs), establishing wholly foreign-owned operating entities (WFOEs), and making strategic acquisitions in China.  What are some of the advantages and disadvantages of these different investment options?

A joint venture is more challenging to manage than a WFOE.  In a WFOE you make decisions based on your own business.  In a joint venture, you need approval from the partner most of the time.  Also a joint venture is a separate company and if both partners’ objectives aren’t to make sure that the JV is successful, or they have ulterior motives, then you’re going to have problems.  The advantage of a joint venture is that the infrastructure is usually already in place, relationships are already set up, and often contracts are already in place.  However the JV can be restrictive since the China partner may have existing relationships that prevent you from pursuing opportunities with some customers since your partner may view certain customers as competitors to their key relationships.   There are also constant issues involving management control and how to deal with employees.

6.  What are the most important factors to consider while planning for new investments in China (location, labor cost, supply base, logistics network, access to talented managers and skilled employees, tax benefits, utility infrastructure, land and building cost, expat livability, etc.)?

For a company setting up its first investment in China, I believe you need to be in a location that has people who are very “westernized”.  As far as setting up a company, whether it be in Shanghai, Guangzhou or Beijing, so many companies have done it already that the markets are mature relative to other places in China.  The resources and infrastructure are in place to help facilitate new investment.  A new company should also consider where their market is in China and whether they need to be close to the sea for export business.  For companies that already have a China infrastructure in place, you can go anywhere in China with incremental investment.

7.  In your China experience, how closely did what actually occurred in setting up an operation track with what was initially planned and what was initially expected?  What have been the major causes of deviations from plan?

In general, my experience is that the first year costs are worse than plan. But when we did the ROI, we were better than plan because growth was better than anyone had forecasted.  Often costs are higher than planned due to factors like obtaining environmental licenses or government approvals.

In terms of timing, if you plan for 4 months, it will typically take 6 months. In Europe and North America, projects typically track closer to the timeline.

8.  When sourcing materials, parts or components from China, what has been your experience with sourcing Chinese suppliers compared to international suppliers or JV’s operating in China?  How do Chinese suppliers typically compare on price, service, quality, etc.?

It’s so fragmented. My expectation is that an international company that comes and sets up an operation; there is no reason that they should not have the same practices or better implemented in China. I find that some companies think that the China market accepts cheaper product, so they find a way to get cheaper. They don’t always implement their international standards.  In fact, they sometimes have two tiers of products, one for international export and one for the local market. If companies are only driven by supplier part cost reduction, I think it’s wrong. It’s best to find a supplier that has the processes in place, or is committed to develop the processes and work longer-term so both parties can be successful.  Companies need to do their homework when looking for suppliers. I don’t believe that just because it’s made in China it’s cheaper. It’s not true. For example, I think that the cars GM makes in China are just as good as the cars that they make in North America.

9.  What are the main benefits and challenges regarding using sales representatives or distribution partners in China versus building an internal sales and marketing team?  Many companies start with sales representatives or distribution partners, and transition once they reach a critical mass.  When is it appropriate to make the transition?

It’s dynamic, every company has to look at the problem on an individual basis. It depends on each company’s outlook on the market.  Some companies prefer to keep information and technology confidential and that could drive their efforts to internalize their sales and marketing efforts – control your own destiny and your knowledge 100%.  Some companies just ‘throw the hook out there to see if they catch it’.  This approach minimizes the risk.  If your sales and distribution isn’t your own, it’s difficult to cut that tie and to make a transition.  Ultimately, it comes down to the company trusting and being committed to the people that are responsible for delivering the business plan.

10.  How can international companies maintain good relationships with the government?

At the local level, you are employing people in their district, so you’re a tax base for them.  They can definitely support you and help you out with issues that are local and provincial.  At the national level, businesses need to understand what incentives are available and tie into initiatives that can help drive their business.  Getting national certifications can help give you credibility.  You need to be local because those are the people that you’re dealing with every day.  It’s not a one-pronged approach.  It’s covering all aspects.  The people that do that for your company need to understand the system and how it works.

11.  Recently, some China industrial system manufacturers have listed on foreign exchanges and many have plans to grow in international markets.  What do you believe are the biggest challenges for these companies to be successful in international markets?

Chinese companies have a perception issue surrounding “made in China” especially in economies that are still recovering from the economic crisis. For a domestic China supplier to try to enter an international market with their brand name is a challenge. I can see them having success by going through a distributor and using their network or partnering with an international company and brand. The China company gets the volume but not the name. It’s the reverse of companies coming to China.  The top suppliers going to the EU or US have to meet a certain criteria but there is also a sizable market for high volume suppliers in the Middle East, Russia and Eastern Europe where criteria are not as stringent.

12.  In summary, what are your suggestions for companies that want to enter or expand in the China market?  Can you share a few key points that companies should consider while evaluating their strategies to sell into, source from, or invest in China?

Companies need to understand the opportunities that exist here.  A company that is coming and basically starting new, they need to do the market research first, their own research I mean.  Companies can’t just follow their customers or competitors; they need to look for their own drivers for long-term success.

If you are coming to compete in China with known technology, I think you have a very difficult challenge.  You will be competing with Chinese companies that have the technology and you will find it very challenging to compete on price since you will be way behind them on localization.  If you have a new technology or product, that’s the key.  To protect that technological advantage you need to keep moving up to the next level to stay ahead of everyone else in the world.  For some large companies that have been in the market a long time, they have gotten lazy since things have been so good.  They don’t have the drive to make it to the next level. This creates opportunities for small and medium-sized companies.