INTERNATIONAL BUSINESS EXPANSION
International Business Expansion
The emergence of China as the world’s manufacturing hub happened in a much shorter span of time compared to the time it took for U.S or U.K to industrialize. China took just over a decade to double its GDP per capita and improve the living standards of its people ever since 2001, when it entered the World Trade Organization and opened up its borders welcoming investors from all over the world. There have been a host of favorable factors that made China the global manufacturing hub. Some of them include the abundant availability of cheap labor, political stability, artificially undervalued currency, favorable and hassle free government policies and regulations, easy availability of inexpensive land, high investment in infrastructure build up, financial incentives, etc., all of which enabled the global MNCs to set up operations and manufacture goods at highly competitive rates. During the ten year period from 2000 to 2009, China transformed itself into an export oriented economy and increased its exports fivefold to approximately $1.2 trillion, which was 9.7% of the total global exports . Also, China’s competitiveness was not limited to any one particular sector, but MNCs in various verticals like metallurgy, petrochemicals, medicines, paper making, automobiles, ship building, textiles, light industries, electronics etc. poured in investments to make China as their export hub.
This critical thinking paper will focus on advising a U.S based automobile company contemplating internationalization by expanding its manufacturing operations in China. This paper will throw light on the automobile sector in China, the major economic and political risks involved in the process and will advise the automobile company on the strategies to be adopted for ensuring success in this internationalization process. The paper will use Ownership-Location-Internalization (OLI) framework to analyze the expansion possibilities.
Since 2009, China has remained as the world’s largest automobile market and auto manufacturing country, surpassing the traditional giants like the U.S and Japan . The combined production and sales figures in China for the year 2014 was more than 20 million which is at a CAGR of 11.4% from 2004 . It is estimated that the Chinese automobile production plus sales will touch 22 million by 2020, which will be larger than the combined figures for North America and European Union . In China, it is mandated by law for the foreign car companies to form joint ventures with the domestic players as a measure to protect the home grown companies . These joint venture companies garner a lion’s share of these production, export and domestic sales numbers and is led by the Volkswagen group. Other prominent joint ventures in China include GM-SAIC joint venture and the Hyundai-Beijing Automotive Group joint venture . The passenger vehicle segment in China is dominated by the foreign brand led joint ventures and hold 62% of the overall market. The situation is polar opposite in the commercial vehicles segment, where 90% of the market share is gobbled up by the domestic automobile companies .
The major automobile market in China can be classified into five major segments- passenger vehicles, buses, trucks, semi-trailer tractors and auto component manufacturers. It is not just manufacturing, exports and sales; China imports a few vehicles as well. In 2014, 1.4 million vehicles were imported into China of which SUVs accounted for 41%, followed by sedans at 33% . Europe leads in exports to China followed by Japan, U.S and South Korea.
In spite of these rosy statistics mentioned above, the industry as a whole is facing a lot many challenges, which will be explained in detail in the following section. However, automobile manufacturing is one of the key industries that holds a great deal of promise in the medium to long term. The major factors acting for and against China as an investment destination for manufacturing companies will be explained in the next section.
Factors Favoring FDI in China
There are several major factors that drives FDI in China in the automobile sector.
Domestic market size - China being the most populated country in the world with a huge rich and middle class population with the capacity to own cars makes for an ideal FDI destination. As seen in the previous section, China is already the largest automobile market in the world and continues to chug along, even if the growth rate has slowed down due to the recent economic slowdown.
Natural Resources Availability - China is rich in natural resources like oil, coal, minerals and iron. The country also abundant water supply and electricity generation capacity, which all acts in favor of making China as an attractive investment destination.
Labor - China has abundant supply of educated, skilled and qualified labor to work for automobile companies. The labor cost is low compared to the developed economies and the political climate is investor friendly. The rising labor cost in the recent years has taken the sheen out of this unique selling proposition, but still the labor rates are competitive compared to other global manufacturing locations.
Infrastructure - China boasts of a strong physical, technological and financial infrastructure to support and attract FDI, particularly in the manufacturing sector. Abundance of land enables the government to build sufficient infrastructure facilities from grounds up and the country is technologically advanced as well. The country was able to reap the benefits of its government’s initiative to strengthen the physical and telecommunication infrastructure by attracting FDI from almost all the major countries in the world.
Openness to Foreign Trade - China has investor friendly foreign trade policies like promotion of exports reduction of import tariffs. As of 2010, the import tariff rate stands a low 4.2% . The country also enjoys its location advantages. Owing to the size of its geography and long coastline, the country has easy access to almost all Asian countries and other global markets like the U.S, Canada and Australia.
In addition to the above mentioned factors, there are other major factors as well like the favorable regulatory framework and economic policy, investment promotion and protection policies, favorable tax regimes, ideal distance and exchange rates , political stability and capital availability .
Now that the favorable factors are analyzed, the following section will focus on the major economic and political challenges and risks involved in taking the FDI route in China.
Economic and Political Challenges
A strong export oriented economy has transformed China’s society into a consumption based economy with the creation of jobs, reduction in unemployment and enhanced spending capacity of the local population. Some of the major challenges to be expected while expanding the operations to China include-
Rising factor costs - Over the years, the cost of manufacturing in China has witnessed a spike, with appreciation in the cost associated with almost every other component in the value chain. The per hour labor cost has witnessed a steep increase, as people are becoming more aspirational. The currency appreciation is another factor that has contributed to the rising costs. In addition to this is the government’s strategic change to promote domestic consumption and give secondary preference to exports. In spite of all these, China’s domestic market itself is too huge to be ignored.
Rising consumer sophistication - The average consumer in China is increasingly getting aware of the importance of quality and value for money. It is estimated that by 2020, more than half of China’s urban homes will fall into the upper middle class category with significant purchasing power. This group is increasingly mobile and has knowhow about world class products and are not ready to compromise on anything less. Any company entering China will have to address this shift in customer preference and should be ready to invest more in R & D and provide the customer with products that will excite them. As things stand today, China lags behind the advanced economies when it comes to customer sophistication and has a lot of catching up to do.
Rising value chain complexity - The economic panorama of China, as mentioned earlier is witnessing a fast change. Development and wealth is not limited to the major cities like Shanghai or Beijing. Tier-II/III cities and smaller towns are mushrooming and the markets are expanding at a faster pace. For a beginner in China, catering to the demands of this customer base will be a challenge as establishing a credible supply chain will be difficult in the short term. The maximum growth is happening in these smaller cities and no manufacturer can afford to ignore them.
Heightened volatility - Ever since the great depression of 2009, the situation in China has been highly volatile. Uncertainty in the global economic environment has hit China hard as the country is the most preferred workshop of the world. During the period 2008-2013, the growth rate of China’s highly acclaimed automobile industry has varied between 7 percent and 52 percent . Even in 2015, the economy of China has witnessed a notable slow down. In short, the export market and the domestic market have been under strain for the past few years. This economic volatility makes the life difficult for automobile manufacturers.
Higher energy prices - Rise in consumption has resulted in the energy prices going through the roof. In comparison to the U.S, the energy price in China is considerable higher at many locations.
High Corruption Prevalence- China still scores high on corruption at various levels, in spite of the government taking stringent actions against the bribe givers and takers. In the corruption index for 2014 published by Transparency International, China scores a low 36 point out of hundred and is placed at the 100th position among the 175 countries considered .
The analysis of the major for against factors will help in arriving at the conclusion. Prior to that the Ownership-Location-Internalization (OLI) framework has to be applied in order to scientifically explore the expansion possibilities.
OLI Framework
OLI framework or the Eclectic Paradigm is a theory in economics coined by John H. Dunning in 1979 . The theory provides a three-tiered analysis framework for a company to decide on whether to go for internationalization or not. The three legs of the framework are Ownership, Location and Internalization. Let us now look into the application of OLI framework in this case-
Ownership advantages- The automobile industry in China is fairly matured with the presence of most of the global giants as well as a host of local players. The company aiming an FDI route to China should have ownership specific advantages like the capability to protect the trademark, innovate on production technique and ensure returns to scale. It should also be noted that a foreign firm cannot directly enter the Chinese market on its own, it can do that only through a partnership with the local companies.
Internalization advantages- As mentioned above, it is mandated by law to enter into a joint venture with at least one local player, which would also mean sharing of technology and intellectual properties. It may sound like negating the internalization advantages, but the attraction of the Chinese market is its scale. Chinese passenger car market is much larger than U.S, E.U or Japan . If the firm scores high on ownership advantages, it can reap the benefits in the Chinese market, even though it scores low technically on internalization advantages.
Strategy Recommendations
The recommendations for this evaluation will be made based on the pros and cons as well as the OLI framework. There are several factors that act in favor of international expansion like the scale of domestic market, the geographical location advantages, availability of skilled resources, plentiful natural resources etc. But there are a few concerns as well like the diminishing cost advantage of China vis-à-vis U.S, mandatory joint venture rule etc. As per the OLI framework, a firm should go after the FDI route only if the firm has ownership, location and internalization advantages. Else, the other options should be either to export or to go after the licensing route. In this case, the firm clearly has ownership and location advantages, but not in a good position on internalization. The recommended strategies to be adopted in order to make this expansion process a success include-
Enter into a joint venture with one of the domestic players- The top five domestic car manufacturing firms in China are Shanghai Automotive Industries Corp. (SAIC), Dongfeng Motor Corp., Geely Holding Company, BYD Auto Company and Great Wall Motors Ltd. . It is recommended to partner with the big players as they already cater to most of the foreign firms operating in China like GM, Volkswagen, Honda, Citroen, Nissan, Volvo etc. All of them have strong presence in the local market and world class production facilities which will help the new company to open and establish its presence.
Bring in innovation- Chinese customers are in a transformation phase and will greatly appreciate path breaking innovations. The concept of innovation through commercialization pioneered by GM by launching iterations of its electric car in China is a good example of bringing in innovation which helped them to avoid the expensive R & D route .
Utilize the location advantages: China can be made as the hub to export passenger cars to almost all markets in Asia, quickly and efficiently.
Focus on domestic market- Even though China is witnessing a slowdown in almost all sectors, the scale of the automobile market there makes it hard to ignore the domestic customers. Catering to the local population including those in tier II/III cities and towns should be a top priority item.
Internalization- The foreign player can partner with two domestic players at the maximum. It is recommended to partner with a medium to smaller player as well before acquiring it to bring in internalization advantages.
Diamond Model- Diamond model focuses on clusters and Shanghai and Guangzhou have been identified as the most important cluster in China for the automobile companies. It is highly recommended to invest in facilities in the Shanghai or Guangzhou belt to make use of the cluster advantages. For example, one of the primary considerations for GM to opt for Shanghai was to tap into the well-established supply chain environment of SAIC and Volkswagen .
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