Supply Chain: Making It in China

When Arvinder Surdhar traveled to China in 1990 to form a joint venture between IBM and a Chinese manufacturing company to produce PCs, he wound up manufacturing something he hadn’t expected: cardboard boxes.

"When we opened up those first shipments from China, there was more dust in the boxes than anything else," recalls Surdhar, who is director of global logistics for IBM’s integrated supply chain division. Many of the PCs were damaged due to problems endemic to doing business in China, problems that still plague American companies 15 years later: bumpy, dusty, overcrowded roads (and train tracks); a fractured logistics network in which shipments are loaded and unloaded at the whim of provincial border agents; overburdened ports where products languish in humid containers for weeks waiting to board a ship. "We had to come up with special shrink-wrap and unique, thicker boxes and packing materials that absorbed shock and resisted dust and humidity," Surdhar says.

IBM’s new boxes did not wipe out the cost advantages of making PCs in a country where factory workers, truck drivers and longshoremen make one-tenth the salary of their counterparts in the United States and Europe. But they could have. According to research by consultancy Booz Allen Hamilton, the logistical costs of getting products into, around and out of China may end up outweighing the cost advantage gained by going there in the first place; if the labor costs of manufacturing the product in the West account for 25 percent or less of the total product cost, it may be to companies’ advantage to keep manufacturing in the West.

Besides logistical complications, other factors—such as inflexible production lines and limited ability for many Chinese factories to handle last-minute design changes—can also make the risk of going to China bigger than the potential savings. Broken, dusty, improperly specified or delayed PCs don’t sell, no matter how little it costs to produce them. IBM’s joint venture thrived after its initial logistical hiccups, according to Surdhar, and the joint venture eventually began making higher-end servers for IBM. (The PC part of the business was sold to Chinese giant Lenovo earlier this year.) Other companies haven’t fared so well with their joint ventures. Making sure that products built in China look, function and arrive as promised remains a tremendous challenge today.

The CIO’s Burden

The slice of that challenge that falls to CIOs—monitoring, managing, automating and feeding the Chinese supply chain with information—is the most daunting of all. Supply chain visibility is a precious commodity even in the West. In China, for all but the most advanced products, navigating the supply chain can be a matter of feeling your way through total darkness. IT, however, is not the automatic answer for lighting up the supply chain. Labor costs are so low in China that IT automation and monitoring projects may add more to costs—in terms of software, hardware and still-precious (and unreliable) bandwidth—than they save in productivity. (The median wage at a Chinese manufacturing plant is 1,000 yuan, or about $120, per month, according to a 2005 survey by The MPI Group.) Hence, some low-tech or commodity products may not be worth monitoring at all until they hit a ship in a Chinese port.

CIOs who have succeeded in China understand the country’s dramatically different cultural, political and business practices and how they affect the design and management of supply chains. They know, for example, that the Chinese government essentially becomes a third party in any dealings with local companies and can intervene, at any time, in capricious and costly ways. They realize that Chinese companies consider contracts to be starting points for developing a business relationship—and may not honor them to the letter. They understand that communism is merely a new name for a political and economic system that has stressed hierarchy and authority over independence and jurisprudence for hundreds of years.

Though neophytes assume that China will become "more Western" over time, CIOs with experience there aren’t holding their collective breath. In the meantime, these executives have developed strategies that accommodate Chinese differences without compromising the goals of low costs and high quality. They hire Chinese import/export companies to act as local ambassadors to navigate the thickets of government bureaucracy, cajole local suppliers and provide information links to their supply chains. They build their own factories in China, when possible, to instill the company’s own manufacturing and quality processes and provide more fertile ground for extending the company’s enterprise IT systems into China. And they make the necessary investments in relationship building, or guanxi, that provide the foundation for doing business in China. (For more on how to negotiate this ethical thicket, read "Bribes and Payoffs—Oh, My!" on Page 54.)

CIOs who act without this knowledge risk erasing the very cost advantages that brought their businesses to China in the first place. If they can’t provide cost-effective systems that give insight into the supply chain, "the complexity and unpredictability of China-sourced products become overwhelming," says Beth Enslow, VP of enterprise research for Aberdeen Group.

Stepping Back in Time

When the last chunk of Pacific Cycle’s bicycle manufacturing finally packed up and went to China in 2000, Ed Matthews’ information supply chain went dark. Gone were the detailed bills of materials and dedicated EDI that Matthews, who is Pacific’s director of information systems, had with factories in the United States and Mexico that enabled Pacific to ship bikes anywhere in North America in a matter of days and change production lines for a new model in as little as two weeks.

They were replaced by paper and pen, or at best, e-mails (when they went through) and simple spreadsheets. Matthews’ step back in time is not unusual: 63 percent of companies surveyed by Aberdeen Group manage their global trade processes using paper and spreadsheets. Production schedules for Pacific’s Chinese factories are in spreadsheets that are manually adjusted to fit Pacific’s specifications and purchase orders and then manually entered into Matthews’ U.S.-based SAP ERP system.

"There is a lot of manual work at both ends of the supply chain now because the Chinese factories aren’t sophisticated enough to have the systems," Matthews says. Consequently, he can’t track bikes in anything approaching real-time until they hit the ports on China’s eastern rim.

Matthews and other CIOs working with Chinese companies compensate with lead time. The less visibility you have in the supply chain, the more time you need to get things right. Lead time for Pacific’s bikes is now as long as 270 days, from a maximum of 60 in the old days, Matthews estimates. It’s the same thing for many companies going to China: 42 percent of companies surveyed by Aberdeen had lead times of 60 days or more.

Longer lead times also mean much higher logistics costs—especially as Pacific does business with factories farther inland. (The farther in you go, the lower the costs are, because inexpensive labor is in much greater supply in China’s vast, impoverished western interior than in its coastal areas.) Products face a long trek across China (40 percent of those surveyed by Aberdeen said their products languish for 30 days or more inside China) and the oceans (20 to 30 days) before reaching the United States. Aberdeen found that 63 percent of companies with the longest lead times were spending more than 6 percent of revenue on logistics (for high-tech companies it was as much as 9 percent) while logistics costs in many U.S.-based companies were as low as 3 percent.

Longer lead times result in higher risks for any supply chain. Inventories will need to be higher to accommodate unforeseen demand, damage to shipments and variations in quality. When working at arm’s length with many suppliers that change frequently, as Pacific’s factories do, constructing deep IT connections doesn’t make much sense, according to Matthews. "I once asked if a factory could accept EDI," he recalls. "A message came back asking, ‘What is EDI?’"

Despite the problems, the arrangement makes sense for Pacific Cycle. Low-end bicycles are fairly bulletproof commodity products that don’t change much year-to-year. So Pacific can afford to absorb the long lead times and switch factories often. The labor savings Pacific reaps from manufacturing in China blow away the losses in supply chain flexibility, Matthews says.

Your Ambassador to China

Matthews does what he can to shorten the lead times by working closely with importer/exporters in China. He has constructed EDI connections with Pacific’s representatives in China for purchase orders and advanced shipping notices, among other notifications. The importer/exporter tracks the bikes all the way through the Port of Long Beach/Los Angeles and on to Pacific’s U.S. distribution centers.

Importer/exporters and third-party logistics providers have emerged as the linchpins of China’s supply chain. They are like local ambassadors for foreign companies. They cajole factories to perform, cut red tape with the government, and push products through customs and onto boats and airplanes.

The importance of the importer/exporters can be tied to the role that relationship—or guanxi—plays in Chinese business. Familiarity is critically important in China. Veterans of China all report the importance of direct, face-to-face dealings to building and cementing business relationships. There are the bizarre examples—IBM’s Surdhar recalls drinking a mixture of snake blood and wine to demonstrate his commitment to a Chinese supplier. And there are the mundane—meeting suppliers at the airport in the United States and never discussing business during the first meeting. Both are designed to create trust. "Dealing with anyone there you have to be patient," says Surdhar. "That is one of biggest issues foreigners face."

The importer/exporter is an important link between Western expectations and Chinese realities. They understand better than any foreigner the system of favors—some legal, some not—that have helped the Chinese navigate the complexities of their hierarchical and arbitrary political systems for hundreds of years.

In the United States, laws and ethical rules that govern business behavior are relatively clear and uniformly accepted. Not so in Asia. "China is a much more hierarchical society than here in the U.S.," says Tom Stipanowich, president and CEO of the International Institute for Conflict Prevention and Resolution. "People respect authority and place much more emphasis on people’s relative positions—superior and inferior—than we do." For thousands of years, Chinese businessmen have brought their disputes to a recognized authority figure, such as a village elder, for resolution, says Stipanowich. That tradition survives, but the number of authority figures has increased, as has the overlap in their roles: city, regional and national officials may each have different interpretations of a law written by one of China’s national ministries, for example.

"The Chinese system is arbitrary and can easily change," says Oded Shenkar, professor of management and human resources at the Fisher College of Business at Ohio State University and author of The Chinese Century. "Anything you want to get done depends on a network of people, not a single individual."

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