Japanese Companies' Strategies for China: From production base to development base
Faculty Fellow, RIETI
With its economy growing at an annual rate of nearly 10%, China is certain to evolve into the world's largest economic power during the 21st century. At the microeconomic level, the increasing competitiveness of Chinese high-tech industries is sometimes cited, as seen in Lenovo's acquisition of IBM's personal computer division. So, what sorts of strategies should Japanese companies pursue vis-a-vis China, a country that is undergoing rapid economic development? The development of the economy enhances the attractiveness of China as a market. However, this also means that Chinese companies are emerging as more powerful competitors. In this article, I would like to discuss what these new developments imply for Japanese companies' strategies for China based on the findings from my analysis of the Chinese economy's competitiveness.
How should China's industrial competitiveness be assessed?
Compared to Japanese companies, the competitiveness of Chinese companies undoubtedly lies in their price competitiveness upheld by an abundant labor force. However, product pricing is affected not only by the labor and materials costs but also by the level of productivity. There still remains a good possibility for Japanese companies - even those undertaking production activities primarily in high-cost Japan - to compete with Chinese ones by improving productivity. Given that, in order to evaluate the industrial competitiveness of Japan and China, it is important to assess the state of productivity for each industry. According to findings in the RIETI project, "International Comparison of Productivity among Asian Countries" (ICPA), as of 2000, the total factor productivity (TFP) of the Chinese economy at the macro level equaled 66% of that of Japan (note 1). This compares to 50% as of 1982, which indicates China has been narrowing the gap, particularly in the 1990s when Japan's productivity growth slowed. In the electronics industry, one of China's most flourishing, China's productivity, measured as a percentage of Japan's, rose from 34% in 1982 to 59% in 2000.
As such, China's industrial competitiveness has been steadily improving relative to Japan. However, it should be noted that a significant portion of the productivity increase observed in the high-tech industry in China is attributable to foreign companies. Of the total output of the electronics industry in China in 2002, 45% is accounted for by foreign (including Japanese) companies, 15% by Taiwanese and Hong Kong companies, and only the remaining 40% by mainland Chinese companies. The productivity of foreign companies is known to be 20%-30% higher than that of their Chinese counterparts. Thus, we need to discount the effect of these factors in assessing the aforementioned productivity figures as a measurement of Chinese companies' competitiveness (note 2).
China's attractiveness as a market
Chinese companies, as a rival to Japanese companies, are indeed rapidly closing in but the absolute level of their capabilities still remains low. This is also suggested from the fact that foreign companies - such as Matsushita Electric Industrial Co., Samsung, Sony Corp., and Royal Philips Electronics - occupy the top ranks in the number of patents filed in China. Among those in the electronics industry, the Haier Group, a home appliance maker, and Huawei Technologies Co., a telecommunications company, are highly reputed. However, the strength of these companies primarily lies in low prices and strenuous sales activities supported by a large number of service staff. In terms of innovation capabilities, they are nowhere near their Japanese and South Korean counterparts. But then, what about the attractiveness of China as a market?
No one would object to the idea that China is the most attractive market in the world both in terms of the pace of growth and the sheer size of market as it stands today. The 11th Five-Year Plan for National Economy and Social Development, covering the period from 2006-2010, has set out a new policy to prioritize quality over speed of economic growth. Yet the Chinese economy will likely maintain a growth rate of at least 7% for some time. Due to the effect of the one-child policy, the rate of Chinese population increase has turned negative in recent years, whereby the average living standard is rising rapidly. However, the transition to a market economy has widened income disparities within the country. In particular, there exist significant gaps between urban and rural areas' standards of living as well as in the environment. Therefore, it would be wrong to take China as a single, enormous market. Instead, it is important to formulate marketing strategies that can respond to the peculiarities of each region. Whatever the case, the Chinese market will undeniably become all the more important for Japanese companies now that they can hardly expect any expansion of their home market with its continually declining fertility.
Japanese companies' strategies for China: Need to set up R&D bases by taking a long-term perspective
What sorts of strategies should Japanese companies pursue in regards to China? Let's consider this question primarily in the context of the electronics industry. In order to develop strategies, it is necessary first and foremost to clarify which are the competitors with Japanese companies. As discussed above, Chinese companies have yet to become a full-fledged competitor as their technological levels still remain low. Thus, looking at the next five years, it is unlikely that they will grow into a powerful competitor in China's high-end market, which is the primary target of Japanese companies. For the time being, global companies from the United States, Europe and South Korea will compete with Japanese ones.
Japanese electronics companies established a foothold in China at a relatively early stage, as compared to their U.S. and European counterparts. Indeed, Japan is the largest investor in China, measured in the amount of direct investments. However, these investments are mostly for the establishment of production bases to take advantage of China's cheap labor force. And it is said that Japanese companies are lagging in localizing their products for the Chinese market. To develop products for China, a market of growing importance, it is indispensable to expand research and development (R&D) capacities there. Recently, a series of major U.S. and European information technology companies - including Motorola, Inc., Nokia Corp. and Siemens AG - have launched new research centers. Many of these new research centers are designated as a development base for the localization of products (note 3). In contrast, Japanese companies are slow in building R&D capacities in China.
To find out reasons behind this, we conducted interviews with a series of companies. We found that Japanese companies, compared to their U.S. and European counterparts, tend to: 1) transfer less authority to their local affiliates, 2) urge local affiliates to produce results in a shorter period of time, and 3) have greater concerns over the possible leakage of trade secrets through employee mobility. In contrast, U.S. and European companies define China as one of their key development bases in building their global R&D networks. Thus, they have been systematically expanding research facilities and staff. While they do acknowledge the leakage of trade secrets as a serious problem, their responses seem quite practical. My impression is that they consider the costs of such incidents as somewhat inevitable because there is simply no way of entirely preventing them no matter what management measures are implemented. The Chinese government has been stepping up efforts to enhance higher education in recent years and the country now offers a rich pool of inexpensive, high-quality human resources. Rather than defining China simply as a production base, Japanese companies must take advantage of such high-quality human resources and reinforce their R&D activities in China to better prepare themselves for global competition with their U.S., European and South Korean rivals. To this end, Japanese companies need to redefine China as one of its global R&D bases and work on the development of R&D capabilities based on a strategic long-term vision.
*The title of the fellow is as of the date of writing.
1. Refer to http://www.rieti.go.jp/en/database/d03.html for more details about the ICPJ project. For the results of productivity level analysis, refer to "Assessing Japan's Industrial Competitiveness by International Productivity Level Comparison with China, Korea, Taiwan and United States," Kazuyuki Motohashi, a paper presented at the RIETI Policy Symposium, "Determinants of Total Factor Productivity and Japan's Potential Growth: An International Perspective," July 25, 2006.
2. Regarding China's company-level productivity by type of ownership, refer to "IT, Enterprise Reform and Productivity in Chinese Manufacturing Firms," Kazuyuki Motohashi, RIETI Discussion Paper 05-E-025, 2005/09
3. Regarding R&D activities of foreign companies in China, refer to "R&D of Multinationals in China: Structure, Motivations and Regional Difference," Kazuyuki Motohashi, RIETI Discussion Paper 06-E-005, 2006/02.
July 25, 2006
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