China's Industrial Policies and the Global Business Revolution The Case of the Domestic Appliance Industry (Routledgecurzon Studies on the Chinese Economy)

China’s Industrial Policies and the Global Business Revolution

As China has blended market reforms with comprehensive industrial policies which have their origin in the command economy, most research has focused on the national government’s strategies for economic growth. However, one of the unique characteristics of industrial policy in China is that it involves government intervention on all levels, from the central government all the way down to village leaders. China’s Industrial Policies and the Global Business Revolution looks in particular at the domestic appliance industry, and China’s three major business groups in this area – Haier, Hisense and Aucma. The Haier Group in particular is one of the most successful and competitive enterprises in China and is very well placed to compete globally as the Chinese economy becomes more integrated with the world trading system. This volume shows how industrial policy is formulated at the national level and implemented at the local level, and examines how local government frequently intervenes in local enterprises’ business strategy and management. Of urgent practical importance, this book provides academics, businesspeople and policymakers with valuable insights into the development process and a concrete understanding of the challenges faced in the global business revolution by one of the world’s most dynamic economies. Ling Liu received her PhD at the Judge Institute of Management at Cambridge University, and her Master’s in International Management at the University of Reading. Her research interests include globalisation, big business, public policy and development strategy in China, regional economic integration, strategic international business and emerging markets.

Routledge Studies on the Chinese Economy Series Editor Peter Nolan, University of Cambridge Founding Series Editors Peter Nolan, University of Cambridge Dong Fureng, Beijing University The aim of this series is to publish original, high-quality, research-level work by both new and established scholars in the West and the East, on all aspects of the Chinese economy, including studies of business and economic history. 1 The Growth of Market Relations in Post-reform Rural China A micro-analysis of peasants, migrants and peasant entrepreneurs Hiroshi Sato 2 The Chinese Coal Industry An economic history Elspeth Thomson

9 Corporate Governance in China Jian Chen 10 The Theory of the Firm and Chinese Enterprise Reform The case of China International Trust and Investment Corporation Qin Xiao

3 Sustaining China’s Economic Growth in the Twenty-First Century Edited by Shujie Yao and Xiaming Liu

11 Globalisation, Transition and Development in China The case of the coal industry Huaichuan Rui

4 China’s Poor Regions Rural–urban migration, poverty, economic reform and urbanisation Mei Zhang

12 China Along the Yellow River Reflections on rural society Cao Jingqing, translated by Nicky Harman and Huang Ruhua

5 China’s Large Enterprises and the Challenge of Late Industrialization Dylan Sutherland

13 Economic Growth, Income Distribution and Poverty Reduction in Contemporary China Shujie Yao

6 China’s Economic Growth Yanrui Wu 7 The Employment Impact of China’s World Trade Organisation Accession A. S. Bhalla and S. Qiu

14 China’s Economic Relations with the West and Japan, 1949–79 Grain, trade and diplomacy Chad J. Mitcham

8 Catch-Up and Competitiveness in China The case of large firms in the oil industry Jin Zhang

15 China’s Industrial Policies and the Global Business Revolution The case of the domestic appliance industry Ling Liu

China’s Industrial Policies and the Global Business Revolution The case of the domestic appliance industry Ling Liu

First published 2005 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN Simultaneously published in the USA and Canada by Routledge 270 Madison Ave, New York, NY10016 Routledge is an imprint of the Taylor & Francis Group

This edition published in the Taylor & Francis e-Library, 2005. “To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk.” © 2005 Ling Liu All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing the Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data A catalog record for this book has been requested ISBN 0-203-00199-0 Master e-book ISBN

ISBN 0–415–35560–5 (hbk)

For my parents, Guihua Chen and Jiansheng Liu

Contents

List of figures List of tables Preface Acknowledgements Abbreviations 1

Industrial policies and globalisation in theoretical and historical perspective

ix x xii xvi xvii

1

Introduction 1 Debates on government intervention 1 Debates on globalisation 16 Conclusion 20 2

Industrial policies in China

22

Introduction 22 Review of strategic changes in China’s industrial policies 22 Industrial policies in the domestic appliance industry 33 Local industrial policies: the case of Shandong Province and Qingdao City 47 Conclusion 56 3

The domestic appliance industry Introduction 58 Overview of the global domestic appliance industry 58 Overview of China’s domestic appliance industry 77 Conclusion 88

58

viii 4

Contents The Haier Group

90

Introduction 90 The background of the company 90 Expansion towards a diversified conglomerate structure 92 The Haier Group’s business structure 102 Discussion of the growth of the Haier Group 108 Discussion of the challenges facing Haier 115 Conclusion 125 5

The Hisense Group

127

Introduction 127 Background and history 127 Diversification: a journey of exploration to 3C 134 The model of a ‘neo-state-owned enterprise’ 138 New challenges after China’s entry to the WTO 142 The prospects 145 6

The Aucma Group

147

Background and history 147 Growth through diversification 150 Discussion of the challenges facing Aucma 153 The prospects 159 7

Conclusion

161

Introduction 161 Feasibility of industrial policies 162 The challenge of industrial policy in the epoch of global business revolution 168 Notes Bibliography Index

172 176 184

Figures

2.1 The organisational hierarchy of the Chinese Light Industry Association Union 4.1 The business structure of the Haier Group (prior to 1995) 4.2 The business structure of the Haier Group (1995–98) 4.3 The business structure of the Haier Group (1999 onwards) 4.4 The Haier Group’s organisational structure 5.1 The Hisense Group’s organisational structure (2002) 5.2 The business structure of the Hisense Group (2002) 6.1 The Aucma Group’s organisational structure (2002) 6.2 The business structure of the Aucma Group (2002)

40 104 105 107 124 131 132 157 158

Tables

2.1 2.2 2.3 2.4 2.5 2.6 3.1 3.2 3.3a 3.3b 3.4a 3.4b 3.4c 3.5a 3.5b 3.6 3.7a 3.7b 3.7c 3.8a 3.8b 3.9 3.10 3.11

Comparative composition of investment in fixed assets Production of domestic appliances in China (1978–2002) Selected economic data for Shandong Province Investment in technological upgrading during FYP9 in Shandong Province GDP of Qingdao City (1949–98) Investment in technological upgrading in Qingdao City World regional demand for major domestic appliances Changes in output and exports of Japan’s domestic appliances The top ten global domestic appliance manufacturers by volume The top five global domestic appliance manufacturers by value, 2001 Electrolux’s net sales by product line in 2002 Electrolux’s net sales by region in 2002 Electrolux’s major investment activities in China Whirlpool: selected performance data, 2002 Whirlpool’s sales of domestic appliance products by region, 2002 GE: selected performance data, 2001 BSH’s net sales by region in 2001 BSH’s sales by product group in 2001 BSH’s major investment activities in China Matsushita’s net sales by product line in 2003 Matsushita’s major investment activities in domestic appliances in China Ownership of domestic appliances in China The manufacturing capacity utilisation rates for major domestic appliances in China, 1996 The average output and concentration rate of the top four firms in the refrigerator and washing machine sector

26 39 48 53 55 55 60 64 65 66 67 68 69 70 70 71 74 74 75 75 76 79 81

81

Tables Industrial concentration of China’s domestic appliances, 2000 3.13a China’s imports and exports of domestic appliances, 1993–2001 3.13b China’s major exports of domestic appliances by volume, 1995–2000 3.14a The market share of the top ten domestic appliance brands in China, 1999 3.14b The market share of the top ten refrigerator companies in China 3.15 Output and exports by JVs as a percentage of total Chinese output and exports, first quarter 2002 3.16 Compressor exports by JVs as a percentage of total Chinese exports 3.17a The major manufacturers of refrigerator compressors in China 3.17b The major manufacturers of air-conditioner compressors in China 4.1 Haier’s partnerships in the high-tech sectors 4.2 Haier’s expansion into the finance sector 4.3 Output of the Haier Group 4.4 Selected performance data of the Haier Group (1984–2001) 4.5 Haier’s market share in China, 2001 4.6 Haier’s global business network 4.7 Haier’s geographical expansion through industrial parks 5.1 Selected performance data of the Hisense Group (1973–2001) 5.2 Hisense’s major foreign partnerships 6.1 Selected performance data of the Aucma Group (1990–2001) 6.2 The Aucma Group’s share of the domestic market for freezers (1995–2001)

xi

3.12

82 82 82 84 85 85 85 87 87 95 96 97 98 98 101 102 133 140 150 151

Preface

My interest in this research goes back to graduate student days, when I kept asking myself the questions: is there any possibility that a multinational company will emerge from China in the foreseeable future? Could this happen without any government support? The period during which this research was undertaken witnessed the most intense policy debates as to whether China should develop its own national industry through independent development and industrial policy or whether it should follow the competitive market system. Neoclassical economists, strongly supported by the Washington Consensus (the IMF and World Bank), have become increasingly influential in the debate, advocating policy reforms leading to liberalisation, deregulation and privatisation. Also, the period included a very sensitive time when China was negotiating to join the WTO. There were extremely important debates on whether China should integrate into the world economy by committing itself to trade liberalisation. In December 2001, China joined the WTO, agreeing to dismantle almost all the protectionist measures and associated industrial policies that had been supporting its economic growth for a long time. It is widely argued that the WTO commitment and the global business revolution present a greater challenge to policymakers than they had faced before. It is not surprising that China has implemented comprehensive industrial policies which have their origin in the command economy. The available literature discusses China’s industrial policies at national level, covering nearly all the country’s sectors and products. Recent research also shows that the actual results of these industrial policies are significant but far from satisfactory, given that they have failed to provide a solution to lingering structural problems and to build internationally competitive firms (Nolan 2001; Jiang 1996). However, one of the unique characteristics of industrial policies in China is that they involve government intervention at all levels, namely central, provincial, municipal, county, township and village level. Given the complexity of the political economy, as well as the size and autonomy of China’s local government, it is far from sufficient to examine the industrial policies at national level only. As this is an emerging field of study, literature on the subject is still thin, in part because the experience is

Preface xiii so recent, and in part due to the comprehensive and complicated nature of the issues. It is the purpose of this book to examine the definition and evolution of industrial policies in China at both national and local levels. Two essential interrelated sub-themes are highlighted, i.e. central–local government relationships and government–business relationships in China. The case studies in the research involve the domestic appliance industry and the Haier, Hisense and Aucma groups. The reason for choosing the domestic appliance industry is that this industry is widely considered, by both domestic and international observers, to be one of the most competitive sectors in China with the potential to compete in the global market. In particular, the Haier Group is a ‘national champion’, a flagship of national industry, believed to have the potential to be a global leader in the very near future. The relative success of the domestic appliance industry is considered by some popular economists to be the result of free market competition with minimal government intervention. In fact, government support has never been insignificant in this industry. This book will present an in-depth examination of the role of industrial policies in this sector and show why the popular view goes only part of the way to explaining their success. The emergence of big groups like Haier, Hisense and Aucma in Qingdao City in Shandong Province draws attention to the role of local government in promoting large businesses. Industrial policies in Shandong make it an especially successful province. However, little research has been done on local-level industrial policies. Also, there is little literature available on industrial policies and global competitiveness in the domestic appliance industry. This book consists of seven chapters. Chapter 1 reviews literature on the debate over government intervention and globalisation in both theoretical and historical perspectives. It is believed that only after we gain a clear understanding of this large picture can we examine the policy implications for many developing countries which hope to integrate themselves into the global economy, as well as their strategies to catch up. Chapter 2 examines the industrial policies pursued at both national level and local level. It will first review the strategic changes in industrial policy at national level during the progressive reform regime, and then discuss in particular the evolution of industrial policies in the domestic appliance industry; it will finally examine the role of local government in implementing industrial policies and in intervening in local enterprises’ business strategy and management in Qingdao City and Shandong Province. The evidence presented in this book suggests that, contrary to the conventional wisdom, there has actually been an increase in the degree of government intervention at local level. It also shows that the success of China’s domestic appliance industry is a result of both the market system and product innovation, and is due notably to entrepreneurs in collective enterprises with strong local government

xiv Preface backing. Although the industrial policies adopted by the government and the ways in which the firms operate differ among industries, the examination of the particular industrial policies pursued in the domestic appliance industry may help policymakers to reappraise policy mechanisms as a whole. Chapter 3 examines the domestic appliance industry. In the first section, a closer look will be given to the industry at a global level, in terms of industry features, supply and demand, industry structure, the ‘global business revolution’ and major global players and their strategies in China. The next section will focus on China’s domestic appliance industry, examining its history, demand and supply, and competitive advantages and disadvantages. The research will present an overall picture of the global business revolution as it affects the domestic appliance industry and the challenges facing the companies in developing countries. The following three chapters focus on the three case studies of the Haier, Hisense and Aucma groups, examining their development strategy and strategic choices in the regime of globalisation. Considered one of the most successful and competitive enterprises in China, Haier is a very interesting case that has received considerable attention not only domestically but also internationally. For example, in 1999, Zhang Ruimin, the CEO of Haier, was ranked twenty-sixth among the world’s thirty most respected CEOs by the Financial Times. Fortune ranked him as one of the most influential CEOs in 2003. The scale of Haier’s achievement is reflected by the fact that it was the sixth largest domestic appliance manufacturer in the world in 2001. Several case studies have been produced by leading business schools like Harvard and the International Institute of Management Development on its corporate culture and management innovation. However, little research has been done on its global competitiveness, international production and government support. The other two cases, Hisense and Aucma, are the subjects of an in-depth analysis both of the companies themselves and of their relationships with government. Though less famous than Haier, these two companies have also achieved significant development under the strong local support of Qingdao City. The comparison will enrich our understanding of the nature of government–business relations in China and the massive challenges they face in the global business revolution. It is argued that, even with enormous state support and positive entrepreneurship, the firms still suffer limitations on their sustained growth, particularly in terms of managerial and technological capabilities. Chapter 7 draws the conclusions of the preceding chapters. Intense and unresolved debate as to the role of industrial policies continues while China’s policymakers maintain their attempt to create globally competitive industries and nurture national champions to compete with global giants. The domestic appliance industry and the Haier Group were in the forefront of the attempt to build global competitiveness. Nevertheless, it is believed that government still remains the power with which the TNCs must negotiate

Preface xv in their implementation of a globally integrated strategy designed to increase their oligopolistic power in a hostile country. In fact, despite strategic changes since its transition to a market economy, China continues to implement industrial policies. The most recent notable example is the industrial policy on the automobile industry issued on 1 June 2004. This outlines new investment policies, scraps the requirement for localisation, and encourages the development of environment-friendly, small-displacement vehicles. It gives strong support to independent development and technical innovation, and the development of auto products with Chinese intellectual property rights. It directs the existing auto production enterprises to carry out mergers and restructuring in order to form large, strong auto groups in China, and avoid scattered, disorderly and low-level duplicated construction projects. However, given China’s policymakers’ relatively poor track record in implementing successful industrial policies, it remains to be seen how far and how effectively the policy will be implemented. The future is dynamic.

Acknowledgements

The research for this book has its origins in October 2000 when I started work on my PhD at the Judge Institute of Management at the University of Cambridge. I carried out the fieldwork on which this book is based between 2001 and 2002. I have accumulated many debts of gratitude to friends, colleagues and institutions. I am extremely grateful to the participating companies, the Haier, Hisense and Aucma groups, for allowing me to conduct in-depth research in their organisations. I would like especially to thank the local officials in Shandong provincial government and Qingdao municipal government who helped me understand the issues involved in local industrial policies and the local economy. The research would not have been possible without the support of these people who kindly provided help and those who gave up their valuable time to being interviewed. Grants from Suzanne Paine and Jesus College made my fieldwork financially possible. Their support is gratefully acknowledged. I owe the largest debt to Professor Peter Nolan, my PhD supervisor with whom I have discussed many of the ideas in this book and whose influence should be apparent. I would like to express special thanks for his encouragement and invaluable comments during all stages of my research. I thank Peter Sowden for his great support for the project as editor. Ray Lower deserves special thanks for helping me to improve my English. Finally, I owe a great deal to my family who have supported me throughout the research process. This book is dedicated to them.

Abbreviations

CDMA CLIAU CMOS CTV FDI FYP GDP IMF JIT JV MITI MLI MOF MOFT NIC NPC OEM R&D RMB SEK SME SETC SOE SPC TNC TPI/TPM TVE WTO

code division multiple access Chinese Light Industry Association Union complementary metal oxide semiconductor colour television foreign direct investment Five-Year Plan Gross Domestic Product International Monetary Fund just in time joint venture Ministry of International Trade and Technology Ministry of Light Industry Ministry of Finance Ministry of Foreign Trade newly industrialised country National People’s Congress original equipment manufacturer research and development renminbi (Chinese currency) Swedish Kronor small and medium-sized enterprise State Economic and Trade Commission state-owned enterprise State Planning Commission transnational corporation total productivity innovation/total productivity maintenance township and village enterprise World Trade Organisation

Industrial policies and globalisation

1

1

Industrial policies and globalisation in theoretical and historical perspective

Introduction This book attempts to answer the following questions: what are the rationales behind government intervention, the trend towards globalisation and the global business revolution? How do recent global tendencies affect governments and firms in developing countries? What are the new constraints and opportunities for developing countries trying to catch up in global industries? How do the industrial policies of the government, at central, provincial and municipal level, affect the domestic appliance industry in China? How can these policies nurture big businesses as they face the challenges of an ever changing world business system? What is the position of China’s domestic appliance firms as global production becomes integrated? Can Haier, Hisense and Aucma, the three firms in the case studies, compete with global giants with continued state support after China joins the WTO? To answer these questions, some theoretical and historical background on government intervention and globalisation is essential, as these underlie the internal debates over China’s industrial policies. This is the subject of this chapter. The first section reviews the literature on government intervention; the second section reviews the literature on globalisation and the global big business revolution.

Debates on government intervention Debates on the appropriate role of government in economic development have engaged policymakers and scholars since the study of economics began. Three mainstream views have emerged: neoclassical, revisionist and marketfriendly. The neoclassical view considers markets to be crucial mechanisms for generating efficient resources: once competitive markets are in place, investment can be left to take care of itself. It argues in favour of a minimalist state to reduce as far as possible unproductive state activities and rentseeking behaviour by public agents and bureaucrats (Bhagwati 1982;

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Industrial policies and globalisation

Buchanan et al. 1980; Findlay 1992; Krueger 1974). The appropriate role of government is to provide a suitable macroeconomic environment for the free functioning of the market and to supply certain ‘public goods’ where it has a clear comparative advantage relative to private agents, for example in physical infrastructure, defence and national security, and education. Policies should be geared to moving from inward-looking strategies towards liberalisation of the foreign trade regime and export promotion; ensuring a reliable legal framework for domestic and international competition; privatising state-owned enterprises; and following the dictates of the market price system. The revisionist view stresses market failure as a justification for government to lead the market in critical ways. Based on convincing evidence that the governments in East Asian economies – especially Japan and South Korea – intervened forcefully in their markets, the revisionist view argues that economic development can occur as a result of intelligent and strategic government intervention to promote long-term industrialisation, rather than through a free-market approach. By ‘governing the markets’ and ‘getting prices wrong’, government accelerates development by systematically distorting incentives; that is, it facilitates the establishment and growth of industrial sectors that would not have thrived under the workings of comparative advantage (Wade 1990). In sharp contrast to the neoclassical school, the revisionist view sees the rent-seeking activity of governments as a source of capital accumulation rather than inefficiency and corruption. The market-friendly view, addressed by World Bank (1993a), occupies the middle ground between the neoclassical and revisionist views. Bearing in mind that market failure and government failure are both important impediments to rapid growth, it perceives rapid growth in developing countries as associated with effective but carefully limited government activism, so-called ‘selective intervention’. To put it another way, governments ‘not only need to do less in those areas where markets work, they also need to do more in those areas where markets cannot be relied upon’ (World Bank 1993b). However, while recognising that both market failure and government failure occur, it believes that government failures are more frequent and more serious, and therefore should be carefully dealt with. Nevertheless, the role of government has never been insignificant in the history of capitalism, although for certain reasons it has sometimes been ignored in developed nations like Britain, France, Germany and the USA. This pattern is largely consistent with the rise of newly industrialised countries (NICs), particularly in East Asia where governments’ frequent and aggressive interventions have contributed significantly to economic growth. In the following section, our concern is to review the main theories relating to government intervention, and then to examine the specific industrial policies that were implemented in these economies.

Industrial policies and globalisation

3

Rationales for government intervention: a theoretical interpretation The theoretical interpretations of government intervention provided by the current literature are mainly based on the theories of market failure, government failure and political ideology. Market failure Market failure is a conventional motive for government intervention. Market failures can be categorised into allocative failures and dynamic or ‘creative’ failures. The former refers to failures resulting from monopoly power, public goods, externalities and merit goods, information failures, an incomplete market, macroeconomic disequilibria including inflation and cyclical unemployment, poverty and inequality (Stiglitz 1986: 90). The latter refers to failures to expand the production frontier at an optimal rate, either owing to suboptimal levels of investment and innovation, perhaps due to scale economies, or owing to inadequate entrepreneurial resources leading to failure to exploit economic opportunities and to propel the economy forward (Killick 1990: 25). To correct market failure, the government should promote capital accumulation and coordinate the allocation of resources through programming and planning. Stiglitz points out that: The recognition of the existence of imperfect and costly information, incomplete markets, and transaction costs and of the absence of future markets extended the range of market failures beyond the earlier attention to public goods and externalities that required only selective government intervention. (cited in Meier 2001: 21) This consideration applies to the developing countries, especially in their early stages of development, when markets may either not exist or be incomplete and highly imperfect. In such situations, market failures occur largely in terms of coordination failure resulting from insufficient and asymmetric information. Since the institutional arrangements for cooperation and information exchange are very weak, there is a greater need for government to play a role. In this sense, government is viewed as another form of coordination mechanism. Among the markets most affected by information problems are capital markets (World Bank 1993). In the absence of insurance and equity markets, government comes in as the ‘second best’ risk insurer and capital provider to substitute for missing and difficult-todevelop capital markets (Chang 1994). For example, in the East Asia economies the governments established credit-based financial systems in which they could exercise influence over the allocation of credit and over the balance between investment and consumption. Although such a control of

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Industrial policies and globalisation

credit was imperfect, it did contribute significantly to economic growth and international competition. By setting up and managing directed credit programmes, government reduced the risks borne by investors through explicit and implicit guarantees or other forms of intervention (World Bank 1993). On the other hand, firms depending on bank credit can concentrate on long-term investment rather than short-term profitability which can lead to pressure from shareholders in a market-based system. In response to information asymmetry, governments develop communication systems through which business and government can exchange information and coordinate investment decisions. A good example is ‘deliberate council’ in Japan and South Korea, which is used to facilitate formal and informal interaction between the private sector and government, among firms, and between management and labour. Government failure The second possible explanation of government intervention is concerned with the correction of government failure. Causes of government failure may include deficiencies in planning, inadequate information and resources, unanticipated dislocations of domestic economic activity, institutional weakness, and failings on the part of the administrative civil service (Chakrvarty 1991). Literature on government failure has three major strands – the information argument, rent-seeking theory and public choice theory. The information argument points out that government is not necessarily well informed about the nature of a given problem or about the complex consequences of its own policy actions, which may produce perverse or unwanted effects (Lal 1983: 74). It also argues that government may be able to collect and process all the information relevant for the correction of the market failure only at costs that are greater than the resulting benefits. Government failure seems inevitable. The rent-seeking theory argues that government intervention creates additional ‘waste’ that may more than offset the benefits it produces. Common examples include efforts by businessmen to secure import licences and to persuade governments to provide protection against competition or a budgetary subsidy, enabling them to consume resources without contributing anything to output. Government failure in the face of a market failure may worsen rather than improve the situation (Bhagwati 1982; Krueger 1974; Killick 1990; Tullock 1980). Public choice theory, stressing the self-serving or egoistic behaviour of government bureaucrats, has added further strands to this argument (Bhalla 2001: 29). Government failure results from the intrinsic difficulties in improving the accountability and control of bureaucracies; and the problem is aggravated both by the existence of corruption, nepotism and other malpractices and by the tendency for state agencies to be ‘captured’ by special interest groups ( Killick 1990; Stiglitz 1986).

Industrial policies and globalisation

5

However, there are ways and means to correct government failure, just as there are to correct market failure and to reduce the costs of government intervention while not forgoing its possible benefits (Chang 1994). Chang states: the state may resolve the co-ordination problem at a lower cost than the market (and other economic institutions) and thus reduce transaction costs, which are the costs of co-ordination, in the economy. Institution of an effective property-rights system, macroeconomic stabilisation, organising society into large groups, promoting national ideologies, and co-ordinating complementary investment decisions are examples of such a role. This type of intervention is particularly attractive because it is relatively cheap compared with other types, which may indeed incur large transaction costs (for example central planning). (Chang 1994: 54) This type of intervention depends to a great extent on government’s ability to establish the necessary institutions and mechanisms and to improve the quality of policies. Political ideology The third rationale for government intervention goes beyond market failure and government failure, both of which fail to tell the whole story as they focus merely on allocative and productive inefficiency without paying much attention to the political and ideological context. Instead, it suggests that some concepts of the old political economy, such as nationalism, power, ideology, class and the relationship between the state and society, may have some relevance. In reality, looking from a political viewpoint, the governments of East Asian countries have perceived economic development as the primary means of establishing their legitimacy and consolidating their own positions (Wade 1990). Following serious devastation during times of war, drastic measures were needed to rebuild the nations quickly. From an ideological point of view, although the governments claim they are conforming to free market principles, in fact they mistrust the free market and free competition based on comparative advantage. (Such anti-liberal ideologies can be traced to the half-century before the First World War, when the global economy was at its first peak in terms of colonisation and inequality of competition.) The creation of an ‘independent economy’ and ‘self-sufficiency’ were the dominant themes of the policymakers. In consequence, governments intervened in the economy, using subsidies deliberately to distort relative prices and encourage big business in the oligopolistic market in order to stimulate economic activity and compete with foreign rivals. This has been true of Japan and South Korea, also of Taiwan, Singapore and Malaysia.

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Industrial policies and globalisation

Industrial policies: government intervention in a historical perspective Having established the rationale for government intervention, we now examine the policies that different economies actually adopted for their development. Here we focus on industrial policy. We define industrial policies as anything involving direct or indirect government intervention in the market place typically by a range of policy instruments, in order to achieve a different allocation of resources to specifically defined priority industries at any point in time than would occur through the normal operation of the market place. (Patrick 1997: xiii)1 In this book, we do not intend to set trade policy and foreign investment policy apart from industrial policy, as the boundaries between them are becoming increasingly blurred and it is extremely difficult to distinguish the one from the other. In the following subsections, we first examine the industrial policies pursued in the three economies of East Asia – Japan, South Korea and Taiwan – and then the developed Western countries during the post-war period, including Britain, France, Germany and the USA. East Asia – Japan, Taiwan and South Korea It is not surprising that we examine these three economies together as they show striking similarities with respect to both institutions and instruments. This is in part because Japan was, to a large extent, the textbook example for both South Korea and Taiwan. With regard to their industrial policies, empirical evidence shows that there was considerable diversity across the three economies in terms of their exact policy mix and time scale. However, some common strategies can still be easily identified in the three economies: the governments focused on industries with a high entry barrier which could help overall productivity and growth. These industrial policies were designed to reduce the uncertainty associated with really large-scale investment by implicitly and explicitly sharing risks with the private sector. They included targeting, nurturing and protecting. TARGETING

Targeting is the practice of singling out particular industries for support and development (Porter 1989). Typically, governments select certain industries for ‘targeting’, and enact financial measures and other policies designed to create national champions. In Japan, the government targeted industries with high elasticity of demand, and constantly changed its targeting and

Industrial policies and globalisation

7

promotion measures. For example, the targeted industries to which huge credits were made available were steel, shipbuilding, automobiles, textiles and petrochemicals in the 1950s, and computer and consumer electronics in the 1960s. After the 1970s, targeting sometimes involved more of a signalling role, highlighting the importance of an industry and influencing private investment without explicitly offering subsidies or tax incentives. The targeted industries were semiconductors, aerospace and robotics in the 1970s, and biotechnology, fifth-generation computers and superconductors in the 1980s (Johnson 1982; Nester 1991). The same approach continued until 1999, when MITI announced that it would publish an Industrial Technology Strategy in 2000 which would identify technological sectors in which the private sector should concentrate its efforts (Porter et al. 2000). As in Japan, in South Korea it is common practice to give priority to certain industries; this originated in the very early years of economic development. In the First FYP (1962–66), cement, fertilisers and oil refining were targeted as ‘basic’ industries, then chemicals, steel and machinery in the Second FYP (1967–71). During the Third and Fourth FYPs (1972–81), non-ferrous metals, shipbuilding and electronics were added to the list. The selected priority sectors during the Fifth and Sixth FYP periods were machinery, electronics, automobiles, chemicals, shipbuilding and various high-tech industries (Chang 1994). In Taiwan in the early 1970s, the government promoted intensive growth in heavy industry, the chemical industry and technology-intensive industries, so as to reduce dependence on imported intermediates and upgrade the export portfolio. Unlike Japan, the government generally established new upstream industries – often, single factories – itself. Then it either handed the factories over to selected private enterprises (in the case of glass, plastic, steel and cement) or ran them as public enterprises. The government has helped by identifying particular items on Taiwan’s own production frontier and targeting them with fiscal investment incentives and concessional credit (Johnson 1982; Wade 1990). NURTURING

Targeting is not a single policy, but involves a group of policies. The three governments employed a variety of policy tools to nurture their domestic industries and to shield them from foreign competition until they reached a scale and level of product quality and sophistication that made them competitive in world markets. The greater the backwardness, the larger the amounts of government support needed, including subsidies, creation of recession cartels and mergers, and selective protection against foreign direct investment. Subsidies are one of the main sources of nurturing. An important feature of subsidies is that they are based on performance standards for private firms. Incentives were not give-aways; firms had to meet the performance

8

Industrial policies and globalisation

standards imposed by governments in exchange for subsidies. For example, in South Korea, the government subsidised firms through different measures of support such as access to foreign exchange and state investment funds and preferential tax treatment (tax holidays, accelerated depreciation allowances and so on). In return for this support, firms became subject to state controls on technology, entry, capacity expansion and prices (Chang 1994). In addition, export growth is a popular criterion for the assessment of performance because it provides the market test of success and failure as a monitoring tool (World Bank 1993). Cartels and mergers are viewed as effective vehicles for enhancing scale and avoiding excessive competition both in domestic and foreign markets. In Japan, the antimonopoly law has been consistently lenient, allowing the organisation of cartels under the administrative guidance of MITI to ease the exit of firms from declining industries. A cartel allows firms to share losses and provides an incentive for them to over-invest in capacity during good times, since they will be protected during downturns. Different types of cartels were designed to keep industries alive during hard times. For example, recession cartels were approved for automobile tyres, cameras, chemicals, paper, steel, sugar and yarn in 1965. The 1981 recession led to the formation of cartels in asbestos, slate, cement, fibreglass products, paper and petrochemicals; and the 1987 recession led to cartels in ships and diesel engines. A number of other types of cartel were also legalised in Japan, including rationalisation cartels and export–import cartels. The more competitive foreign products are, the tighter the collusion among the Japanese cartel members. Large mergers were actively encouraged by government, as a most effective means to achieve economies of scale. In Japan, a lot of large mergers were allowed to take place. A notable example is Nippon Steel, formed in 1970 by the merger between Fuji Steel and Yahata Steel. In the marine shipping industry, government forgave the interest on Japan Development Bank loans in the mid-1960s and led a process whereby the fragmented industry was consolidated into six groups. In the banking industry, the Ministry of Finance facilitated mergers and allowed the merged banks to rearrange branches, resulting in the creation of the Daiichi Kangyo Bank and the Taiyo Kobe Bank. PROTECTION

The protection of domestic industry takes two main forms: import restriction and foreign capital restriction. Import restriction, for example through trade barriers and foreign exchange control, is always viewed as a powerful tool to protect domestic companies from competitive imports. Fear of foreign domination of key sectors has been a major element in the Japanese government’s thinking; this is also true for South Korea and Taiwan. In Japan, trade barriers such as the Large-Scale Retail Law, the sole-agent

Industrial policies and globalisation

9

retail and commission-free wholesale system and distribution keiretsu have proved to be an enormous success in protecting small retailer and wholesaler employment, as well as in squeezing out competitive foreign goods and allowing Japanese corporations continued economies of scale. Although Japan is now under pressure to liberalise imports, its markets remain far from open. In South Korea, even in a relatively labour-intensive sector like cotton textiles, the government intervened to protect local industry from Japanese competition. Protection rose further in heavy industry, consisting of both tariff and non-tariff barriers. While the government utilises a variety of instruments, especially export targets and rebates, to ensure that exporters face international prices for tradable inputs, there is also considerable protection of goods sold on the domestic market (World Bank 1993). Taiwan, following a similar pattern to that of Korea, has used a mixture of devices in its protection systems, from direct foreign exchange budgeting to tariff trade barriers. Non-tariff barriers include quantitative restrictions, as well as limitations on the source of procurement or on the qualification of import applications, documents of approval from rival domestic producers, variable levels or supplementary import charges, health and safety regulations, quality standards, domestic content requirements and export restraints. The tariff regime, both before and after 1960, was varied by product, ranging from zero to well over 100 per cent. According to the World Bank (1993), as late at 1980 more than 40 per cent of imports received nominal protection in excess of 31 per cent. With respect to the restriction of foreign capital, the access of domestically based foreign firms to the domestic market was controlled from the beginning. In Japan, the government used to discourage foreign companies from taking stakes in Japanese companies, establishing Japanese facilities of their own, or buying Japanese stocks on the open market. Predominantly, the owners of companies have been Japanese banks, insurance companies and other domestic companies that sought stable business relationships through cross-shareholdings held in perpetuity. Not only could foreign firms not buy a Japanese firm without permission, they also could not even take a controlling interest in a joint venture with a Japanese firm. In the detergent industry, for example, the Japanese government prohibited foreign ownership of Japanese corporations throughout the 1950s and 1960s. It was not until 1970 that the government allowed 50–50 joint ventures. In 1999, there were eighty-six foreign acquisitions. This figure shows the strong prohibition on foreign investment, but also means that Japan has finally opened its markets (to however limited an extent) under pressure from foreign governments and owing to its recession of recent years. However, what will happen in the future is unpredictable. In South Korea, FDI is restricted to priority industries, infant industries, industries using large quantities of imported raw materials, consumer (especially luxury) goods industries, polluting industries and agriculture and

10 Industrial policies and globalisation fisheries. In these areas where it is allowed, there is a high degree of state control over foreign direct investment in relation to ownership. The fact that 6 per cent of multinationals in South Korea are wholly owned subsidiaries illustrates this well (Evans 1987). Even technological licensing, which was preferred to foreign direct investment whenever feasible, was subject to heavy restrictions. It is argued that between 1976 and 1985, with the rise of Korean electronics firms, most Japanese partners withdrew from their joint ventures with local firms, in part due to Korean government policies including the withdrawal of a special tax incentive for investors (Bloom 1991: 9). The Taiwanese government has become increasingly selective about foreign investment since the 1970s. Foreign investment proposals have been evaluated in terms of how much they open new markets, develop new exports, transfer technology, and intensify input–output links. In some cases, the government has also required foreign firms to help upgrade the capabilities of local suppliers as part of the approval process. However, investment in local security has not been allowed (Johnson 1982). To conclude, in the case of the East Asian economies, we cannot prove what would have happened in the absence of interventionism, nor can we prove that the very existence of government industrial policies resulted in accelerated growth. However, it is quite safe to say that overall, industrial policies played a positive role in their post-war economic success, creating the growth that has attracted worldwide attention despite the problems related with government intervention. It is argued that none of these economies would have developed competitive industries like shipbuilding, automobiles and electronics if their governments had relied on purely market forces (Nester 1991). The West – Britain, France, Germany and the USA Those scholars and politicians who support free trade and free competition sometimes ignore the fact that the role of government was far more crucial to the economic development of capitalist countries than is assumed. This is partly because these countries have recently become converts to free trade so as to allow their well-established powerful businesses free access to world markets. A closer look at the early history shows that their industrialisation was realised behind highly protectionist barriers; interestingly, it was the UK and the USA, the supposed homes of free trade policy, which used tariff protection most aggressively (Nolan 2001: 15–16; Chang 2002: 59). A historical review shows that almost all developed countries adopted some form of infant industry promotion strategy when they were trying to advance their economies.2 Even in the last few decades, industrial policies continued to play a key role in their development as well as in the growth of big business. This section focuses on some empirical evidence of the industrial policies implemented in the post-war period.

Industrial policies and globalisation 11 BRITAIN

In Britain, although government intervention had been essentially ad hoc and specific to one industry before 1966, it always existed. To some extent, the creation of the Industrial Reorganisation Corporation (IRC) in 1966 marks the beginning of a more comprehensive and continuous policy towards British industry (Maunder 1979). The IRC was set up with large funds to actively foster mergers by finding the most efficient firm in a sector and merging others into it. The Industrial Expansion Act of 1968 enabled the government to give aid to ‘desirable’ projects which could not be undertaken in the absence of state assistance. Under section 8 of the 1972 Industry Act, over £240 million were allocated for spending on ‘industry schemes’. The selected industries include ferrous foundries, machine tools, wool, textiles and clothing (Maunder 1979). However, to some extent, the example of Britain serves as a warning against subsidising yesterday’s industries. One of the most notable examples is the 1959 Cotton Industry Act. As the cotton industry had played such an important role during the Industrial Revolution in promoting the rise of British capitalism, the government wished to rescue it by providing heavy subsidies. To help manufacturers eliminate excess capacity and upgrade their equipment, the government subsidised two-thirds of the cost of replacing old cotton spindles and looms (Maunder 1979). Subsidy policies and discriminatory taxation were also used to foster industrial expansion. For instance, from 1967 to 1977, a wage subsidy was given to manufacturing firms in high unemployment areas. According to a survey in 1977, subsidies to privately owned firms between 1974 –75 and 1977–78 at 1977 survey prices are estimated at £1,849 million (Maunder 1979). In addition to subsidies, nationalisation is another means of rescuing inefficient firms. A notable example is the steel industry. The Wilson government nationalised the leading fourteen firms in 1967 when the industry was facing strong international competition and making very low profits. The government combined several medium-sized companies into large state-owned corporations such as British Steel, the British Aircraft Corporation and the British Motor Corporation (Nolan 2001). The government also tried to delay the closure of certain high-cost plants in order not to exacerbate the existing problem of high local unemployment. A similar policy was applied in the case of the coal industry in the 1960s. The British government also played a critical role in high-technology industries such as aircraft and computers. It has been estimated that for the period 1950–70 state support for the British aircraft industry amounted to £1,200 million. This could have been saved by purchasing aeroplanes from a lower-cost source of supply, i.e. the United States (Maunder 1979). Supported by the government since 1945, the size and state of the industry were obviously fundamentally affected by government decisions. The same is true of the computer industry. Being the major purchaser, the government

12 Industrial policies and globalisation has covered the bulk of its needs since 1968 by purchases from its holding company, International Computers Ltd. Since 1968 nearly £10 million have been given to the microelectronics industry by the government, principally through the National Research and Development Corporation, with the aim of encouraging and exploiting new inventions. FRANCE

Within Europe, France has had the most explicit state industrial policy, a reflection of its long tradition of strong state involvement going back to the seventeenth century (Dicken 1998). France presents a successful model of a decidedly interventionist strategy under which the government has acted decisively to reshape the national industrial structure and to increase its international competitiveness. The major component of French industrial policy has been the promotion of national champions. From the Second World War onwards, the state started to promote national champions in the capital-intensive, technologically advanced industries which had become dominated by global oligopolies and in sectors deemed strategic by the military or by politicians. This policy was reinforced throughout the post-war period due to the concern that the average French firm was too small to compete with those in other countries. Another concern was that the unprofitable and badly managed firms should be taken over by the good ones. This was effected by large-scale mergers and industrial concentration, famous cases including the Peugeot-Citroën merger and Air France. Another recent case was the merger between SanofiSynthélabo and Aventis in 2004, creating the world’s third-largest pharmaceuticals company. Substantial orders, loans, subsidies and tax concessions have been given to support national champions. If a firm failed to improve performance, the government took it over and restructured it (Hough 1979). The French government has also exerted considerable influence on its industry through its purchasing policies and through its control of the major financial institutions. State control of financial institutions enabled the French government to steer investment funds to targeted firms and sectors. It invested massively but selectively. For example, in the late 1960s and early 1970s the targeted industries were the nuclear, aerospace, space technology and electronics industries. Subsequently, the focus was narrowed to high-growth sectors in energy conservation equipment, office information systems, robotics, biotechnology and electronics as well as the problem sector of textiles (Dicken 1998). In addition to these high-tech industries, the French government played a critical role in reshaping the oil and steel industries. With its assistance, a new state-owned group became the largest French firm by assets and the world’s seventh largest oil company. The setting up of the Institut de Développement Industriel (IDI, Industrial Development Institute) can be seen as an integral part of the French government’s active industrial policy. Its capital was derived 49 per cent from the

Industrial policies and globalisation 13 state, and 51 per cent from banks and financial institutions. Modelled on the UK’s Industrial Reorganisation Corporation, the aim of IDI was to aid rapidly growing medium-sized firms by providing additional capital, either by taking a shareholding or by granting a loan, normally for a maximum of five years. From the 1880s to the 1960s the French government set protective tariffs and kept close control on foreign investment in order to protect French firms against foreign competitors. It is worth noting that French tariff barriers used to be the highest in Europe with an average rate of over 18 per cent plus a whole series of additional regulations, quotas and customs controls. GERMANY

Germany is now commonly known as the home of infant industry protection, both in principle and in practice (Chang 2002: 32), through policies according to which the government has played an extensive and direct role in promoting infant industry during its catch-up stage. Active industrial intervention was pursued to achieve government objectives and increasingly in order to combat rising unemployment, particularly since 1973. Although often described as ‘light’, the government’s role is far from insubstantial (Dicken 1998). The government, rather than market forces, has played the main role in resource allocation in industries like transport, agriculture, housing, shipbuilding and even, in a sense, banking. In some areas where government intervention has been minimal, the influence of large business concentrations and the commercial banks has probably had important economic effects. To some extent, the big three commercial banks have been seen as almost a substitute for state economic planning (Smith 1979). For example, the German banks both directly invested in and heavily lent to the steel industry and from time to time put pressure on ‘undisciplined’ companies to maintain cartel arrangements. Worried that the weak profitability and low market value of Germany’s banks could make them vulnerable to foreign predators and so undermine national economic interests, the government advocated further consolidation in the banking sector. As Mr Schröder, the Chancellor of Germany, said at a conference, ‘My pressing appeal to commercial banks is that they should finally start consolidating. What we need is one bank, possibly two, that can compete globally’ (quoted in FT, 13 May 2004). Subsidies and tax concessions are both viewed as legitimate industrial policy instruments and effective means of resource allocation in Germany. Subsidies to industry are widely used throughout the economy. In 1977, the total Federal, Länder and local authority outlay on subsidies was expected to be DM32.8 billion under section 12 of the 1967 St WC Act, plus a further DM50 billion mainly for the federal railways, research outside higher education and agricultural subsidies. On the other hand, tax concessions, including ‘invisible’ tax concessions and ‘visible’ financial assistance (grants,

14 Industrial policies and globalisation loans and interest relief ), have played a very important role in attracting investment. The government used various forms of assistance to protect its domestic industries from international competition. A typical example is the shipbuilding industry, where methods included tariff-free imports of materials, corporation tax refunds, favourable export credit terms, export credit insurance, investment assistance, support of research and grants to shipowners purchasing German-built vessels. The degree of assistance afforded to shipbuilding has had effects on the industry’s export and investment patterns. In 1977, when the industry was running out of orders because of excess capacity and intense competition internationally, the government assisted it by placing orders and raising the subsidy to German shipowners buying domestically produced ships from 12.5 per cent to 17.5 per cent. The German government has also intervened to stimulate advanced technological development in key sectors. During the 1970s in particular, the government granted heavy financial support for research and development in computer technologies (Dicken 1998). THE UNITED STATES

US government industrial policy has been overlooked for the following reasons: 1

2

3

Its industrial policies have tended to be implicit rather than explicit, given the dominance of a neoclassical faith in the effectiveness of non-intervention and market-based mechanisms of capital allocation. In comparison with other capitalist nations like Japan and France, America lacks an institutional mechanism for allocating capital to particular firms and industries and for using government ownership to shape industrial development, due to the strong private capital markets and the autonomy of financial institutions. Many of the most important efforts of the American government to stimulate industrial development are not limited to the federal level, but are actively carried out at the state and local level. In fact, all states differ considerably in the incentives they offer to entice new investment. The most common forms of state aid to industry are the industrial development bond and tax concession (Dicken 1998). For example, during the late 1970s and 1980s, state governments adopted a set of new industrial policies to promote high-technology development. At the centre of this effort were public venture capital programmes, under which state government invested public funds in new private enterprises (Leicht and Jenkins 1998).

However, the fact that it is implicit does not mean that government intervention is insignificant. Research by David Vogel found that the role of

Industrial policies and globalisation 15 American government has been far more extensive than has commonly been assumed, and that over the past half-century it has pursued sector policies no less vigorously than its major industrial competitors (Vogel 1995). The contemporary American industrial policy essentially dates from the 1930s when the New Deal significantly expanded the scope for government intervention in a large variety of sectors, including energy, shipping, trucking, communications, banking, power generation, housing, airlines and agriculture. In the last forty years, the American government has played a substantial role in promoting industrial development, particularly in the high-technology industries; two of the most striking examples are the areas of defence and space. Although the initial purpose of America’s large military budget was to maintain and promote the nation’s security, the result has been to give American firms important competitive advantages in a wide variety of high-technology sectors. The Defense Department has not only been heavily involved in funding research for advanced lasers, advanced computer software, semiconductors and fibre optics, but has also been the major purchaser of these products. For example, in 1979 the Defense Department initiated a joint development programme with nine computer and semiconductor manufacturers to develop large-scale integrated circuits: nearly US$1 billion was budgeted for this programme over the next ten years. In 1985 the defence budget allocated US$35 billion for R&D in new technologies – roughly one-third of all anticipated R&D expenditures in the USA. The space agency NASA and the Defense Department accounted for more than one-third of semiconductor sales in 1967 and for over 70 per cent of annual sales during the first four years of integrated circuit production. The federal government has also played a critical role in developing the American aerospace industry. Given the considerable expense and risk involved in this sector, the federal government has financed virtually all the initial development costs. Between 1925 and 1975 the federal government channelled more direct support for technological research to aviation than to any other industry. Likewise, the American biotechnology and pharmaceuticals industry, which later became commercially viable, initially benefited from military spending during the Second World War. More recently, significant federal spending has played a major role in the development of new medical technologies, as the government is not only the major purchaser of medical technology through its multibillion subsidy of medical treatment, but also is a major funding source for the development of specific innovations. In short, it is quite safe to say that virtually all the sectors in which American industry continues to enjoy a competitive advantage have benefited from direct and substantial government assistance. Through its national defence and aerospace programmes, the American government has contributed to US leadership in world sales of aircraft, communication satellite technology, hard plastics, synthetic rubber, computers, semiconductors, lasers, fibre optics, radio and television communication equipment, robotics,

16 Industrial policies and globalisation optical instruments, scientific instruments and many other products. The trend seems likely to continue, given that the corporate strategy of firms in the USA has become increasingly dependent on government decisions in terms of the expansion of the defence budget and social regulation, the increase in government spending as a proportion of GNP and so on. Concluding remarks Both government and market failure occur in developed and developing countries alike. Yet under the neoliberal paradigm there is a tendency to emphasise the former in particular, implying that markets failures are not as serious in their consequences as the failure of the government, organisation or bureaucracy (Bhalla 2001). However, despite intense and unresolved debates, the evidence shows that, in the economies discussed above, all governments intervened to varying degrees in the operation of the market. By any index, the role of government was never insignificant, and the industrial policies, explicitly or implicitly, were of crucial importance in the process of industrialisation and in growth of big business in these countries. As Chang has observed: Neither the market, nor the state, nor any other economic institution is perfect as a co-ordination mechanism. Each institution has its costs and benefits, and is therefore better than others under certain conditions. This means that different countries facing different conditions can, and should, have different mixes of the market, the state and other institutions. And, in fact . . . even economies that are usually lumped together as ‘capitalist’ or ‘market’ economies have been based on substantially different institutional mixes. (Chang 1994: 135) It is also safe to say that the scope of government intervention in the economy has increased enormously over the last few decades. Hence it still remains the most significant force shaping the different parts of the global economic map. However, in the 1990s, dramatic changes took place in the global business system, which provided a severe challenge to the philosophy underlying industrial policy. The following section will examine globalisation and the global business revolution and their challenge to the development strategies of governments and firms in the developing countries.

Debates on globalisation According to Held and McGrew (2000: 55), Globalization can be thought of as a process (or a set of processes) which embodies a transformation in the spatial organization of social

Industrial policies and globalisation 17 relations and transactions – assessed in terms of their extensity, intensity, velocity and impact – generating transcontinental or interregional flows and networks of activity, interaction and the exercise of power.3 Globalisation and the role of government in the epoch of globalisation are both hotly debated issues in the current literature. The debates have three main protagonists: the globalists, the sceptics and believers in the processorientated approach. The globalists At one extreme, the advocates of globalisation claim that contemporary globalisation is a real and significant historical development and a product of multiple forces, including economic, political and technological imperatives. It follows no fixed or given pattern of historical development. A truly global economy has emerged or is in the process of emerging in which time and space have been compressed and everywhere is becoming the same. With respect to the role of government, the globalists point out that the power of nation-states to influence economic activity is eroding as economies become more integrated, while the power of private and market forces is correspondingly rising. The role of government is in decline, given that it is increasingly locked into a multilayered system of governance – local, regional and global. The rapid emergence of international organisations, including the United Nations, G7, IMF, WTO, European Union and Asia-Pacific Economic Cooperation, acting as international policymakers, challenges both the sovereignty and the legitimacy of states. Ohmae (1995) argues that the nation has lost its legitimacy in the emerging global market, where financial institutions and global corporations allocate and move capital without regard to international borders. The sceptics At the other extreme, opponents assert that globalisation is a mirage. The concept of globalisation operates as a ‘necessary myth’, through which politicians and governments discipline their citizens to meet the requirements of the global marketplace. They conceive of globalisation as a primarily ideological construction which helps to justify and legitimise the creation of a global free market (Callinicos 1994; Hirst 1997; Hoogvelt 1997). The sceptics interpret current trends as evidence of a significant internationalisation of economic activity; that is, a simple extension of economic activities across national boundaries. Krugman (1996) argues that much of the recent growth in trade is simply a recovery to the 1914 level. International trade as a share of world GDP did not recover to its 1913 level until the mid-1970s (Wes 1996). In short, the contemporary world economy is significantly less open and less integrated than its nineteenth-century

18 Industrial policies and globalisation counterpart (Hoogvelt 1997; Hirst and Thompson 2000). The sceptics’ interpretations of the present epoch are mainly based on two strands: the Marxist and the realist. The former interprets the present epoch as a new form of the geographical reach of Western imperialism, dominated by the needs and requirements of finance capital within the world’s major capitalist states (Vogel 1995). The latter argues that the existing international order is constituted primarily by and through the actions of the most economically and militarily powerful states of the day, which shape the globe according to their preferences. Without the exercise of American power creating and maintaining the conditions necessary for an open international order, the existing liberal world order would eventually collapse (Waltz 1979; Gilpin 1987). With respect to the role of government, the sceptics argue that national governments still remain central to the governance of the world economy, and since they have the formal political authority to regulate economic activity and control access to vital national economic resources, they still retain considerable bargaining power with international forces like the World Trade Organisation (WTO) and the transnational corporations (TNCs). The process-orientated approach The process-orientated approach, described by Dicken (1998), falls between these two polarised positions. It claims that the current economy is qualitatively different from that of the past but is one in which processes of both internationalisation and globalisation and of both shallow and deep integration continue to coexist (Dicken 1998: 6).4 The world economy is shaped and reshaped by three major forces: the transnational corporations, the state and technological change. TNCs do so through their geographically extensive operations and business restructuring. The states attempt to build their own economies through government policies. At the same time, the internationalisation and globalisation of production of both manufactured goods and services have been facilitated by the dramatic changes in the technologies of transport and communications and in the processes of production (Dicken 1998: xiv). Global business revolution The global business revolution has occurred since the 1980s, and in the 1990s it reached an unexpected level, driven by several forces like the liberalisation of trade, capital flows, privatisation, the collapse of communism, information technology and the migration of labour (Nolan 2001). The revolution witnessed a sharp focus on ‘core businesses’ undertaken by individual large firms through restructuring and extensive outsourcing. The leading firms invest increasing sums in R&D, marketing systems and global brand building (Nolan 2001). They increase vertical integration by

Industrial policies and globalisation 19 building a sophisticated network from suppliers to consumers on the one hand, and they outsource service functions such as catering, billing, property management and even the production of components on the other. This is an ongoing process of revolution, comprising several significant features: 1

2

3

The world economy has changed, becoming increasingly more integrated, more interdependent. The significant changes are reflected in the accelerated internationalisation of production, the sharply increased mobility of capital and the greater mobility of information and technology (Strange 1997). Transnational corporations have played crucial roles in coordinating production chains, in improving sophisticated communications and technological systems and in transferring vast amounts of short-term capital. The gap between developed and developing nations and between the firms in these countries has become significantly wider.

The consequences and the challenges The global business revolution has produced three fundamental consequences. First, it has produced an unprecedented concentration in business power in large corporations headquartered in the developed countries (Nolan 2001). The overwhelming majority of production is concentrated in a relatively small number of countries. For example, in the 1990s, four-fifths of world manufacturing production was located in North America, Western Europe and Japan. The USA, Japan and Germany accounted for 60 per cent of the total. The vast majority of developing countries have only a very small manufacturing base (Dicken 1998: 27). Concentration at the industry level on a global scale has increased dramatically. The transnational corporations play a powerful determining role in the contemporary business system. The second consequence of the global big business revolution is that it has brought a new global division of labour in manufacturing. The technology of production itself is undergoing substantial and far-reaching changes as the emphasis is shifting from large-scale, mass production and assembly line techniques to a more flexible production technology. The emergence of new terms like outsourcing and strategic alliance reflects this trend. Through restructuring, the TNCs dispose of low-end products by outsourcing manufacturing production to the newly industrialising and transition economies of Asia, Latin America and Eastern Europe. Third, the revolution presents a fundamental challenge for both governments and firms in the developing world as a whole. In such an increasingly uneven global economic context, governments in the developing countries face severe constraints on their power to implement industrial policies

20 Industrial policies and globalisation enabling them to catch up; and firms face similar constraints on their power to pursue strategies enabling them to compete with the global leading companies. At the government level, the traditional ideas of industrial policy, under which national government provides incentives to keep domestic enterprises competitive in a world market, are facing a great challenge in the epoch of the global business revolution (Nolan 2001). With the interdependence of the world economy, it has proved more difficult for governments to distinguish between domestic firms and foreign firms that operate within their legal jurisdiction. Hence it is more difficult to discriminate in the way they treat them. At the firm level, the global big business revolution requires a reappraisal of the strategies pursued by firms in the developing countries to create and sustain competitive advantage in the face of intense competition from global giants. The crucial questions are: is there any possibility that they may ultimately catch up through intensive government support and become competitive players on the ‘global playing field’? In another scenario, if the global business revolution signals the end of government-led industrial policy to construct large, globally competitive firms, will it be possible for enterprises to grow merely by subcontracting high value-added production processes from TNCs? Here is the basic dilemma: firms in the developing countries need support from their governments to catch up or even survive in the intensely competitive global economy. On the other hand, following their integration into the world economy, governments in the developing countries face pressure from the international institutions that decide the rules of the game. Furthermore, yesterday’s policies won’t work in today’s environment. Thus, in a variety of ways, globalisation may require a reappraisal by governments as they seek to shield domestic big businesses within their area of jurisdiction (Dunning 1993, 1997). There is an urgent need for knowledge about the exact challenges they face and how to respond, country by country, industry by industry.

Conclusion The experience of the capitalist economies shows that the creation of wealth and power is best achieved when a government targets strategic industries for development, carefully manages both market coordination and competition, and promotes entry into world markets by national firms. In other words, appropriate and effective industrial policies have played crucial roles in furthering the national interest (Amsden 1989, 2000; Johnson 1982; Wade 1990). Chinese policymakers after the 1970s were deeply influenced by the industrial policies of the advanced capitalist countries in Europe and the USA during their catch-up phase of development; more recently, they have been influenced by the experiences of other East Asia economies, particularly Japan and South Korea (Nolan 2001; Yang 1995).5 China is trying to

Industrial policies and globalisation 21 emulate these countries, building large competitive modern enterprises that can succeed in the global marketplace. The task of the next chapter is to analyse the evolution of China’s industrial policies during the reform regime, focusing on the domestic appliance industry at both national and local levels.

22 Industrial policies in China

2

Industrial policies in China

Introduction In the early 1980s, Chinese researchers began to pay attention to the role of industrial policy in fostering the economic development of Japan and Korea. Learning from the experiences of its East Asian neighbours, China’s policymakers have promulgated a series of industrial policies that were totally different from those pursued prior to the reform. This chapter will try to explore this aspect by presenting case studies of industrial policies pursued at both national level and local level. It will first review the strategic changes in industrial policies at national level during the progressive reform regime; the emphasis will be on whether the Chinese government has been able to achieve its policy objectives in terms of resource allocation and industrial structural rationalisation; it will then discuss the evolution of industrial policies in the domestic appliance industry. It will finally examine the role of local government in implementing industrial policies and in intervening in local enterprises’ business strategy and management, focusing on the experience of Shandong Province and Qingdao City.1

Review of strategic changes in China’s industrial policies In China, the industrial policies pursued by the government have undergone significant changes in the past few decades, particularly in the reform period. Policy instruments have likewise changed over this period. Resource allocation, a key element of industrial policies, has been decentralised, with less direct control; it is directed at the more successful firms. Instruments of industrial policy During the period of most rapid growth, the government used a wide variety of instruments to implement industrial policy. The most popular ones were control over direct credit and interest rates; fiscal subsidies (i.e. tax exemptions); import restrictions and protection; licensing firms to

Industrial policies in China 23 engage in particular industries; regulations on exchange rates and foreign direct investment; intervention in mergers and acquisitions.2 There is no doubt that all policy instruments have played important roles in advancing industrial policy. The relative importance of these instruments, however, has changed significantly over the years as the whole economy has moved towards a more market-orientated system. Some instruments which worked effectively under the central planning economic system have become increasingly difficult to use in recent years. Direct credit To achieve the plan, the state has taken control of the allocation of capital through credit quotas imposed by the state banking system. Specialised state banks are obliged to provide so-called policy-related loans to meet the priorities set by the government. By 1994, policy loans accounted for 40 per cent of the loans made by the four major specialised banks (Lu and Tang 1997). Since 1990, stock listing has become pervasive. Priority to the stock market was given to companies in the targeted industries. For example, of the 200 companies listed in 1997, twenty-three were in the petrochemicals sector, sixteen in the machinery sector, fourteen in the electronics sector, ten in the automotive sector, and several in the iron and steel industry. Furthermore, the China Security Commission announced that it would give priority of listing to companies involved in mergers with loss-making companies. Fiscal subsidy Fiscal subsidy is also an effective tool to implement industrial policy. However, subsidies provided to state-owned enterprises through the fiscal system have decreased steadily in recent years. In 1993, state-owned enterprises in all sectors received direct fiscal subsidies equivalent to almost 2 per cent of GDP; in 1995, such subsidies fell to about 1 per cent of GDP, and by 1997 they had fallen even lower (Broadman 1999). Since 1999, in order to upgrade traditional industries and promote high-tech industries, a large amount of national debt has been used for investment in technical upgrading. Between 1999 and 2001, RMB26.54 billion of national debt was allocated to 880 technological upgrading projects which were considered essential to lead the way in improving ‘quality, variety, efficiency’ and in promoting exports (International Business, 23 November 2001). Apart from subsidised loans, the government contributed RMB20 billion of national debt to the targeted firms, in the hope that they could eliminate surplus production capacity and upgrade their technologies. In 2002, the government contributed RMB9 billion to ten targeted sectors, including steel, textiles, petrochemicals, machinery, IT, coal, construction and retailing (Economic Daily, 29 March 2002).

24 Industrial policies in China Direct control vs. indirect control A very obvious change in industrial policy is the decreasing degree of control. For a long time, direct control involving compulsory plans, project examination and approval systems had been widely used. The Five-Year Plan system, which was set in motion at the establishment of the People’s Republic of China, can well reflect the control and allocation biases towards different industries. In each plan, the state set not only percentage targets for industrial growth but also specific output targets for each product. For example, FYP5 and FYP6 specified the quantitative objectives of overall national economic performance as well as output targets for major sectors. FYP6 specified that all large and medium-sized capital construction projects must get approval from the State Planning Commission. However, with the further development of market mechanisms, guidance methods are now used in place of directives. A remarkable milestone is the paper ‘Decision on the Gist of Current Industrial Policy’, published by the State Council in March 1989, in which the concept of ‘industrial policy’ appeared explicitly in an official document for the first time. Some key issues concerning industrial policies were addressed, such as the use of state guidance to adjust the industrial structure and coordinate demand and supply; the development of basic industries such as agriculture, energy, transport and raw materials; granting priority to those industries where there is effective demand and technological progress, and which are export-orientated and efficient; restricting production by assembly industries with surplus capacity. Based on these principles, the state provided a list of industries and products to be given priority, to be strictly controlled or to be banned.3 Further to the ‘Decision’, on 25 March 1994 the State Council published a report ‘Outline of the Nation’s Industrial Policies in the 1990s’, which was, to some extent, viewed as the most comprehensive and integrated directive on industrial policies. The main issues in the report included: 1 2 3 4 5 6

the need to continue to strengthen the position of agriculture and develop the overall rural economy; the need to develop basic industries and improve the infrastructure to a significant extent; the need to accelerate the development of the ‘pillar industries’; the need to restructure foreign trade and improve international competitiveness; the need to accelerate high-tech industries and support new sectors and new product development; and the need to continue to develop the service sector and adjust the industrial structure.

Industrial policies in China 25 A remarkable point is the recommendation on state support for large business groups so as to promote ‘rational competition’, make economies of scale and increase specialisation. Based on these principles, the State Planning Commission drafted industrial policies for telecommunications, transport, construction, electronics, machinery, petroleum processing and production of chemical materials. It also proposed policies regarding foreign investment, foreign trade, industrial restructuring and technological development. However, due to the lack of coercion and concrete supporting incentives, these policies constituted a paper exercise, attempting to cover almost every aspect without any detail as how they would be accomplished. It is worth mentioning that the document suggests that a ‘socialist market economy’ was taking shape, in which the market would play a fundamental role in resource allocation under state macro-control and regulation. However, during the transition from a centrally planned economy to a ‘socialist market economy’, the state should be the main supplier of funds for the infrastructure projects and give selective support to key projects in the hightech and pillar industries. At the national economic meeting in September 1997, the government further emphasised the ‘principle of meeting demand in both the domestic and the international market, strengthening the supervisory role of industrial policies, increasing the efficiency of resource allocation’. Sector specific vs. firm specific Heavy industry orientation In a speech given on 25 April 1956, Mao Zedong discussed ten fundamental relationships in the economic and social sphere of socialist revolution and construction. He claimed that ‘the emphasis in our country’s construction is on heavy industry. Production of the means for production must be given priority; that’s settled. But it definitely does not follow that production of the means for subsistence, especially grain, can be neglected.’ Following this principle, the government rationed scarce capital under the central planning system, to carry out the great Leap Forward development strategy under which heavy industry and military production had priority (Table 2.1). For example, during FYP1, 85 per cent of industrial investment went to heavy industry, including the construction of 694 key facilities and 156 core projects designed with the help of the Soviet Union.4 As a result, heavy industry grew much faster than light industrial production and agriculture, leading to an imbalance in the industrial structure. From 1952 to 1978, an integrated heavy industrial framework was built and heavy industry grew at 14 per cent per year. In contrast, light industry was poorly developed, with an annual growth rate of 9 per cent (Nolan 1995: 217). In particular, both the quality and quantity of consumer goods failed to meet people’s needs.

26 Industrial policies in China Table 2.1 Comparative composition of investment in fixed assets (percentages) Period

Capital construction

Renewal of equipment and technical improvement

FYP1 (1950–55) FYP2 (1956–60) 1963/5 FYP3 (1965–70) FYP4 (1971–75) FYP5 (1976–80) 1981

96.2 92.3 84.5 80.7 77.5 73.5 66.4

3.8 7.7 15.5 19.3 22.5 26.5 33.6

Sources: SSB (1981); other statistical data adapted from Liu (2001).

To improve the maladjusted national economy, the government started giving light industry intensive support from 1978. One of the significant policies was the ‘six priorities’, granting long-term priority to the consumer goods industry in terms of allocation of energy and raw materials, loans and capital, investment in infrastructure, technical improvement, foreign technology and transport. The effort reversed the sectored pattern of industrial growth very quickly. From 1979 to 1990, heavy industry grew at 10 per cent per year, while light industry grew at 14 per cent per year (Nolan 1995: 217). Sector orientation The ‘foreign leap forward’ policy of 1978, under which heavy industry accounted for 53.3 per cent, light industry 5.5 per cent and agriculture 11.3 per cent of total investment in capital construction, worsened the maladjustment (Li and Huang 2001). Due to the severe shortage of energy and raw materials, around one-quarter of enterprises could not operate at full capacity. The sharply increased imports of steel and other raw materials brought great pressure on foreign exchange earnings. To rectify the situation, the individual sectors, initially energy and transportation, were explicitly targeted in FYP5, and were further emphasised in FYP6. Raw materials, telecommunications and construction were added in FYP7 during which the energy and transport sectors alone absorbed one-half of total state capital investment (World Bank 1990: 93– 4). Meanwhile, the government granted RMB100 million to an Information Technology Development Fund and 235 companies obtained grants from it (Zhao 1999: 30). At the Fourteenth Party Congress in October 1992, the concept of ‘pillar industries’ emerged, meaning electronic machinery, petrochemicals and the automobile and construction industries, which were considered vital for the rapid growth of productivity and per capita incomes. The number of targeted sectors reached twelve in FYP8. By 2000, the SETC had created the Tenth Five Year Plan for thirteen sectors including automobiles, iron and steel, petrochemicals, pharmaceuticals, coal, construction, light industry, textiles and electricity.

Industrial policies in China 27 Firm orientation A dramatic change in industrial policy took place at the Fifteenth Party Congress in 1995. Instead of targeting specific industries among the nonstrategic industries, the state initiated the so-called ‘Grasping the big and letting go the small’ strategy, extending resource allocation to the level of individual firms. The State Council published the ‘Notice of Opinions on 1996’s SOE Reform Implementation’ on 17 March 1996. The document proposed a series of policies to promote the concentration of production and achieve economies of scale. These included coordinating regrouping among large enterprises, regulating the marketplace, breaking monopolies and increasing competition, eliminating the discriminatory policies towards different types of ownership, and creating a fairer competitive environment. The centrepiece of the reform was to be the amalgamation of smaller, supposedly less efficient enterprises through mergers and the granting of more subsidies to large firms to achieve economies of scale, in the hope that they would develop quickly and would compete with foreign companies in the open market. In the process, 1,000 firms were selected for amalgamation into large groups; of these, 120 firms were selected to establish the modern enterprise system, and six firms were selected and groomed for entry to the Fortune 500. These firms were asked to focus on efficiency and productivity, rather than on expansion of production. Special privileges were given to the targeted firms, including priority for listing on the stock market and for obtaining bank loans at favourable interest rates, establishment of finance companies within the group, tax refunds and so on. To stimulate R&D generally, the government exempted equipment imported for R&D purposes from tariffs and allowed firms to put a percentage of profits into a tax-free reserve fund for a fixed period, for eventual investment in R&D. In 1996, the government contributed RMB200 million to their R&D investment. In addition, the six top companies – Sichuan Changhong Group, Qingdao Haier Group, Shanghai Baoshan Steel Group, Beijing University Founder Group, Jiangnan Shipyard Group and North Pharmaceutical Group – received an annual grant for R&D of RMB20 million each (CASS 1998). The firm-orientated strategy was exemplified in FYP10, under which the government aimed to nurture 20–30 big business groups and help them become multinational companies. The big business groups would be expected to enjoy the following advantages: strong capability in technological innovation with original intellectual property; effective ability in marketing, branding and management; economies of scale and scope, extensive marketing channels and sustainable market share; excellent performance at international levels in terms of productivity, profitability and risk management. The SETC was expected to lead the process by helping the enterprise groups to make their development plans and pursue specific policies, and by exercising supervision over their management.

28 Industrial policies in China Import substitution vs. export promotion Under China’s command economy system, foreign trade was determined strictly within the national economic plan and thus its scale was very small. For instance, between 1956 and 1977 China’s foreign trade amounted to no more than 4 per cent of national income, well below the level in other large developing countries such as Brazil and India (Hsu 1989: 1). The level of exports was determined, indirectly, by the level of imports, as the promotion of exports mainly served the purpose of financing imports. On the one hand, the country needed to import advanced technology and capital equipment to modernise the economy; on the other hand, the government needed to import primary goods to compensate for domestic shortages of food and raw materials. Exports mainly consisted of raw materials, low value-added textiles and other light manufactured goods. During the reform period, the government realised that the ability to earn foreign exchange was crucial to the country’s modernisation strategy. Keeping the experience of Japan and South Korea in mind, the central leadership believed not only that imports could contribute to increased levels of technological sophistication and economic growth, but that exports could also serve the same purpose. To stimulate exports, a wide variety of policies was introduced, including repeated devaluation of the renminbi, tax rebates, fiscal subsidies, preferential access to credit, low-priced energy and raw materials, and direct rewards. Export growth had become a fixed concept in official documents. FYP8 proposed a ‘machinery export promotion’ strategy, designed to improve product quality and adjust the export structure towards one more reliant on higher value-added manufactured goods, in particular machinery and electrical and high-tech products. The government set up the National Foreign Trade Development Fund and contributed RMB60 million each year to subsidise technical upgrading in order to facilitate exports of machinery. On 1 February 1999, the State Council published the report ‘Opinions on Encouraging Enterprises to Engage in Overseas Assembly and Processing Businesses’, which was submitted by the Ministry of Foreign Trade (MOFT), Ministry of Finance (MOF) and SETC. The report initiated the ‘marching out’ strategy, encouraging domestic enterprises to set up overseas R&D institutions and to engage in overseas investment. Part of the strategy was aimed explicitly at building multinational companies that could compete in world markets with the leading corporations of the advanced capitalist world. Soon after that, the SETC promulgated the ‘List of Famous Brands and Supported Export Products’, covering twenty-nine kinds of products, mainly in the categories of domestic appliances and textiles, which were considered to enjoy comparative advantages in the world market. A series of concrete policies were initiated in terms of capital support, financial services and export licence management. The facilities included: priority access to allocations from the Foreign Trade Development Fund and import quotas

Industrial policies in China 29 as well as subsidies for technical upgrading, including reducing or eliminating the tax or tariff on imports essential for export activities; priority in approval for exports including customs procedures and for business trips (Lu 2000). The tax rebate rate for textiles, certain light manufactured products and domestic appliances was increased from 9 per cent to 11 per cent in 1998.5 In contrast to this export promotion, import policy remained conservative, given that import substitution has been the basic theme of development strategy for several decades and has been remarkably successful. For example, China had to import 60 per cent of all machinery during FYP1, but since 1960 it has been able to produce 80 per cent or more of the machinery it needed (Li and Huang 2001). Trade liberalisation proceeded very cautiously, the government having imposed a wide range of quantitative restrictions and protectionist measures to support domestic industries, such as an outright ban on imports of certain types of products and rigorous inspection procedures for others. For example, 2,000 items were subject to import permits in 19926 (Yang 1999). In addition to strict non-tariff barriers, high tariffs were maintained, based on the development needs of domestic manufacturers. China significantly reduced tariffs in 1992 and 1996. In 1992, it reduced tariffs on 3,371 items by an average of 7.6 per cent; it then cut tariffs on 2,898 other items by an average of 8.8 per cent. On 1 April 1996, China launched a big tariff reduction that affected 4,900 items, or 76.3 per cent of all imported items, averaging 35 per cent (Chen and Feng 2001). The government maintained tight controls over foreign currencies, which were usually allocated for priority purposes, namely advanced technology and equipment. It is reported that between 1979 and 1990, China spent US$24 million on importing 4,000 types of advanced technology and equipment to upgrade national industry (Li and Huang 2001). As an incentive, the enterprises with good export performance receive priority for imports of the core components and raw materials they need. With respect to FDI, no foreign investment was permitted in China from 1949 until the late 1970s. As it has opened to the outside world, the government has increasingly used the country’s vast market potential as a lever to attract foreign investment. Initially, a series of measures were used to lure foreign investment into the light manufacturing export sector, and were then extended to priority industrial sectors such as heavy industry, communications and information technology. To channel foreign investment into the desired industries, the government not only granted licensing and approval based on systematic guidelines but also imposed various restrictions on foreign ownership. On 27 June 1995, the ‘Provisional Regulations of Guidance on Foreign Direct Investment’ and ‘The Project Guide List of Foreign Direct Investment’ were published jointly by the SPC, SETC and MOFT. On 29 December 1997, the State Council revised the list, encouraging FDI in 185 projects in 18 sectors, placing limitations on it in 79 projects in

30 Industrial policies in China 17 sectors, and prohibiting it in 23 projects in 13 sectors. In 2002, a new list was published adjusting the sectors, with FDI prohibited in 75 projects and encouraged in 262 projects. In summary, the government’s ‘strategic’ integration with the world economy is extraordinarily significant. Changes under the ‘machinery export promotion’ policy greatly facilitated the growth of foreign trade, which, in real terms, rose by an average of more than 20 per cent per year, in comparison with less than 4 per cent in the period between 1956 and 1977 (Li and Huang 2001). In terms of the volume of international trade, China ranked the sixth largest trading nation in 2002, up from thirteenth in 1989 and thirty-second in 1978. As a percentage of GDP, exports rose steadily from 5 per cent in 1979 to 19 per cent in 1997. With respect to foreign investment, China has become the largest FDI recipient among developing countries and is second only to the USA in the world. FDI has become a significant force in China’s economy and will undoubtedly continue to effect fundamental changes in the near future. Centralisation vs. decentralisation Decentralisation Provinces have been key political and administrative units in China for a long time. China’s provinces are large, in terms of both population and area. On average, each province measures 270,000 square kilometres and has a population of 50 million, the same as a medium-sized country. Before the reform, the role of the provinces and their leaders was highly restricted under the centralised economic system, given that resources were tightly concentrated at the central level, which controlled 80 per cent of fiscal income and investment capital.7 However, this does not mean that the role of provincial leaders was insignificant during that period. Rather, by tradition new policy initiatives have been launched by particular central leaders in alliance with particular provincial leaders. Thus one of the major tasks of provincial leaders is to establish close working relationships with central leaders so as to acquire more investment for their local territories. Decentralisation was a political strategy proposed by central government in the reform period. With the power of resource allocation being handed over to local governments, the role of the provinces and their leaders in national policymaking has become extremely important.8 In particular, the separation between fiscal revenue collected by central government and by provincial governments substantially enlarged investment and managerial autonomy at the local and enterprise levels.9 This intensified their demands for more autonomy from the central government in other areas.10 Given more independence to collect revenue, the local governments played an active role in developing the local economy through fiscal policies.

Industrial policies in China 31 Decentralisation brought a significant change in the conception of the planning functions of the central government. The proportion of ‘public revenue’ under either direct or tight indirect control of the central government fell sharply during the reform period. The state’s share of revenue from national production fell sharply from 31.2 per cent in 1978 to 10 per cent in 1996 (SSB 1997: 164); this was accompanied by a sharp rise in local officials’ share of ‘extra-budgetary revenue’ from 31 per cent in 1978 to 86 per cent in 1990 (SSB 1991: 35). Thus, the reform periods saw a significant relaxation of direct central control over resource allocation; the share of central direct investment in fixed assets fell from 28.1 per cent in 1981 to 2.7 per cent in 1996 (SSB 1997: 164). On the other hand, decentralisation enhanced local governments’ control over resource allocation. Provincial leaders, with their enhanced economic and political power, performed the role of entrepreneurs (Cheung et al. 1998: 14). They took advantage of the open door policy by instituting preferential policies, and took every legitimate opportunity to influence the policy-making process in their favour. They pushed central government regulations to the limit in order to attract foreign investment to their local territories. They heavily influenced the lending policies of banks to support the investments they had initiated. In 1984, there were 87,905 industrial SOEs in China, of which 83,167 were owned by local governments, accounting for 95 per cent of all SOEs and 64 per cent of the total value of production (CASS 1998). Because no law exists to determine the division of authority between central and local government, whether local governments acquired autonomy over management usually depended on individual administrative agents or on individual bargaining with central government. Therefore it is not surprising that local governments adopted certain tactics to respond to central-level policies. For instance, in order to avoid central control over investment in infrastructure, they normally either divided large projects into several smaller ones or underestimated the cost of projects to fall within their budgetary ceilings. Local protectionism Competition between local governments for preferential treatment from central government has always occurred in China. They also compete with each other to maximise the material welfare of their societies and to attract productive investment to build up their local production base and consequently, enhance their economic and political position. One result of this competition is local protectionism. Since 1980 there have been three remarkable waves of local protectionism. The first one took place in the early 1980s when local governments intervened in inter-province trade so as to protect their ‘infant industries’ and increase local revenues. Provincial

32 Industrial policies in China authorities intervened to allocate raw materials to local producers and erect tariff and quota barriers to imports from other provinces. The second wave of protectionism took place in the mid-1980s, particularly between 1985 and 1988. Facing severe shortages of energy and raw materials due to economic growth and the expansion of assembly capacity in the coastal cities, local governments made every effort to keep scarce resources within their territories. The most notable cases of inter-regional ‘resource wars’ affected tobacco, cotton, wool, silkworms and non-ferrous metals. The third wave started in late 1989 when, due to the restrictive policies, market demand shrank significantly. To secure the local market for local producers and guarantee their profitability, local governments used administrative methods or regulations to stop imports from other provinces. For example, they set up entry barriers for products by imposing requirements for commercial registration, hygiene inspection, technical supervision and so on. They also discriminated against non-local companies in lending and taxation. In summary, the issue of central–local relations has been fundamentally important throughout China’s history. In his speech ‘On the Ten Major Relationships’ in 1956, Mao made the following statement: Our attention should now be focused on how to change the power of the local authorities to some extent, give them some greater independence and let them do more, all on the premise that the unified leadership of the central authorities is to be strengthened . . . it is far better to have the initiative come from both the central and the local authorities than from one source alone . . . if we are to strengthen the central authorities, we must attend to the interests of the localities. (Mao 1977: V, 284–307) The strategy of decentralisation certainly played a considerable part in overall economic development in the past two decades. However, the tension between central and local governments has become far more extreme and sensitive than could have been predicted. In his speech at the Fifth Plenum, Jiang Zemin addressed the issue by appealing to local governments to be more compliant to central government: Some local governments and departments have paid undue attention to their own particular interests, and have failed to do what they should in implementing the central government’s principles and policies, and some even went so far as to disobey orders and defy prohibitions. The power belonging to the central authorities has not been completely decentralised, and in some aspects, it is over-centralised . . . we will not allow the existence of either local or departmental interests that jeopardise the interests of the country as a whole. (Xin Hua News Release, 8 October 1995)

Industrial policies in China 33

Industrial policies in the domestic appliance industry This section moves the analysis one step further by examining the industrial policies implemented in the domestic appliance sector. The reasons for selecting the domestic appliance industry are based on the following factors. 1

2

3

It is an industry that has experienced significant ‘global shift’ in the past few decades, initially from the USA and Western Europe, then from Japan and South Korea. Now there is an increasing trend for leading Chinese firms to expand their market share by exporting and manufacturing abroad. By any standard, China has enjoyed extremely rapid growth during the reform regime. After two decades of development, the domestic appliance industry has built up a huge production capacity that makes China one of the leading producers in the world. In 1998 China produced 11.99 million refrigerators, 13.24 million washing machines and 12.50 million air-conditioners, accounting for 16 per cent, 24 per cent and 30 per cent respectively of world production that year (CDAA 2000). In terms of sales value, China became the third biggest producer in 1997 after the USA and Japan, with the total value of production reaching RMB147 billion, up from RMB860 million in 1980 (CDAA 2000). It is considered by most scholars, officials and consumers to be China’s most competitive industry, one that is well positioned to face the open market after China joins the WTO. For example, according to an article in The Economist in August 1997, ‘refrigerators and airconditioners are an industry in which China’s technology is up to world standards’. In particular, the Haier Group, a national champion in the industry as well as a flagship of national industry as a whole, is considered to have the potential to be a global leader in the near future. However, a closer look at the industry indicates that the core technologies are still in the hands of foreign companies and the Chinese companies an trailing in terms of marketing, brand recognition and management. Is there any possibility that China’s domestic appliance industry will catch up with those of advanced countries and that Haier will catch up with the global leaders like Electrolux or Whirlpool? The reason for the explosive growth of the industry is hotly debated. Neoclassical economists attribute it to the market economy and free competition, accompanied by China’s continuing economic developments, resulting in a huge and growing market which has enabled domestic enterprises to enjoy rapid expansion. This is true to some extent, given that the government failed to carry out its policies as it intended. However, although the ‘rationality’ and effectiveness of China’s industrial policies are arguable, it is safe to say that China’s domestic

34 Industrial policies in China appliance industry, like many other sectors, would never have survived and would certainly not have achieved its rapid growth without massive government support and protection. This section aims to examine the industrial policies that were implemented in the domestic appliance sector; this investigation should provide us with crucial insight into the role of the government in a specific industry in China. The first half of the section will explore the evolution of the policies and the second half will evaluate their effectiveness. The evolution of industrial policies in the domestic appliance industry First phase (1979–92) TARGETING (1979–85)

Light industry, the category to which domestic appliances belong, had been ignored for decades after the establishment of the People’s Republic of China in 1949. The central government had pursued the Great Leap Forward development strategy under which heavy industry and military production received priority. In the capital-scarce period from the late 1940s to the early 1970s, the central government rationed capital, under the central planning allocation system, to strategic, important industries in accordance with the slogan: ‘Prepare for war and prepare for natural disasters’. Within a few decades, China had built its own integrated heavy industrial framework, ranging from the aerospace industry, oil and chemicals to steel and machinery. In contrast, light industry, especially consumer goods, was poorly developed in the maladjusted national economy in that both quality and quantity failed to meet people’s needs. It was not until the late 1970s that light industry was targeted. The first significant step towards forming an industrial policy was the publication of ‘The Report on Shifting the Emphasis from Heavy Industry to Light Industry’ submitted by the Ministry of Light Industry (MLI) in 1979. The report stipulated priority for the development of consumer goods, claiming that these were in desperate demand and offered a high profit margin, and could make a direct improvement in people’s living standards. The report also claimed that collective light industry enterprises should enjoy the same political and economic status as state-owned firms; and in particular that they should not suffer discrimination in their supplies of raw materials and energy. On 9 April 1979, the State Council published a report advocating industrial restructuring by ‘developing high-growth industry to support low-growth industry, and develop light industry to support heavy industry’ (‘Yi kuai yang man, yi qing yang zhong’). Furthermore, a series of reports were submitted to the State Council, which converted them into the

Industrial policies in China 35 appropriate legislation or directives. One of the significant policies was called the ‘six priorities’, granting long-term priority to the consumer goods industry in terms of supplies of energy and raw materials, loans and capital, investment in infrastructure, technical improvement, foreign technology and foreign currencies, and transport. The above policies generated a wave of investment in the domestic appliance industry in the early 1980s. In its FYP6, the MLI laid great emphasis on importing both assembly lines and domestic appliance products, in particular refrigerators and washing machines, as air-conditioners were restricted due to their high electricity consumption. In the plan, the MLI decided to build five big refrigerator factories with annual output capacity of 400,000 units each, located in Beijing, Guangzhou, Suzhou, Shanghai and Tianjin (Jiang 1996). It also planned to set up nine small and mediumsized factories across the country, with annual production capacity of 1.2 million units in total. In addition, it planned to establish several airconditioner factories with annual production of 600,000 units (Jiang 1996). In addition to the investment by the MLI, other administrative ministries also responded actively to the restructuring strategy as a solution to their excess capacity in heavy industrial and military production. For example, under the strategy of ‘Cutting the excess and making up the shortfall’ (‘Jie chang bu duan’), the Ministry of Defence Industry helped its subordinates – the military enterprises – to shift to civilian production. The Ministry of the First Machinery also encouraged heavy industrial enterprises to shift to consumer goods, ‘to increase and enrich light industry products and textile products by restructuring existing assets’. It took ‘six transforms’ and ‘five directions’ as its guiding principles. The six transforms were: (1) move from serving heavy industry alone to serving agriculture, light industry, the construction industry and others; (2) move from concentrating on new investment to serving both newly built and old factories; (3) move from merely manufacturing to designing, installing, supplying and training; (4) move from focusing on the domestic market to participating in the international market; (5) move from focusing solely on quantity to focusing on quality, variants and costs; and (6) move from small scale to economy of scale and specialisation. The ‘five directions’ were: (1) the needs of agriculture and light industry; (2) the needs for technical improvement and upgrading of existing factories; (3) the needs of urban collective enterprises and business enterprises; (4) the needs of technical servicing; and (5) the needs of exporting. In this process, more than 1,200 heavy industrial enterprises were closed or transformed into consumer goods sectors (Li and Huang 2001). It was reported that by the mid-1980s, the MLI accounted for only 19 of the 44 refrigerator factories, 9 of the 41 air-conditioner enterprises, 11 of the 107 washing machines enterprises, and 28 of the 2,000 electric fan enterprises (Gong 1993). The rest were owned by other administrative ministries, mainly the Ministry of Defence and the Ministry of Machinery Industry.

36 Industrial policies in China As a result, production increased dramatically: the output of refrigerators rose to 189,000 units from 28,000 units in 1978, and the output of washing machines rose to 3,659,000 units from 400 units in 1978 (SSB 1998). Meanwhile, a series of significant economic reforms had taken place since 1979, notably the policy of increased opening to the outside world and the policy of economic decentralisation. The former provided domestic firms with significant opportunities to close the gap with the developed economies through introducing advanced technology and new products from abroad. The latter granted local governments more power and incentives to boost the local economy; in particular, the large share of fiscal revenues allocated to provincial governments made them more powerful, giving them the opportunity to invest in local manufactures. During the early 1980s, the domestic market witnessed a huge demand for consumer goods. The formerly popular products – bicycles, sewing machines and radios – were no longer targeted by urban households; instead, new products – refrigerators, washing machines and televisions – became ever more popular. The young state-owned domestic enterprises that were equipped with imported production lines found that they could not meet the increasing demands of the market, where consumers were queuing for products before they came off the production line. The voucher required to purchase a consumer product often went to those, mainly bureaucrats, who had direct or indirect relationships with wholesalers and manufacturers. However, foreign products of better quality and good reputation were imported to fill the gap between supply and demand. Given the increasing demand for domestic appliances, local governments had a massive incentive to invest in the domestic appliance industry to boost their local economies. ‘Self-sufficiency’ was the public motivation, while the high profit and potential market were the key incentives behind the investment.11 In reality, many provinces and cities made the domestic appliance sector their ‘pillar industry’ by equipping local firms with imported production lines as well as technology. By the end of 1984, there were 116 factories in production or in trial production, 56 imported projects were under way or under negotiation, with annual production capacity reaching 13.5 million units (Jiang 1996: 125). In the washing machine sector alone, by August 1985, 30 imported projects had been undertaken with 18 production lines and annual production capacity of 8 million units. Investment under the Ministry of Light Industry’s jurisdiction rose to US$162.02 million in 1984 from US$20.84 million in 1983, an eight-fold increase within a year (Gong 1993).12 However, imports were mainly focused on assembly lines, rather than the core technology and key equipment. Thus production depended heavily on foreign components and raw materials. It was estimated that in 1985 the domestic appliance industry spent US$600 million on importing core components and raw materials (Gong 1992). The refrigerator sector alone spent over US$130 million on purchasing spare parts, compressors and other

Industrial policies in China 37 component parts such as condensers, temperature controllers and evaporators. The total value was equal to that of importing ten production lines with an annual output of 500,000 units (Gong 1992).13 RESTRUCTURING AND RESTRICTION (1985–92)

With the explosion of investment, huge amounts of foreign currency had been spent on importing production lines and components. The central government was limited by the extreme shortage of foreign currency and decided to restrict investment in imported production lines; this also helped to relieve surplus capacity. Under these circumstances, the MLI decided to adopt the ‘fixed production base system’ by granting production permission certificates to appointed factories only. It submitted urgently to the State Planning Commission and the State Economic Commission a report entitled ‘Petition for the Urgent and Strict Control over the Blind Import of Refrigerator Production Lines’,14 which in turn was redrafted by the State Council as the ‘Report on the Enactment of Refrigerator Industry Management and Control over Blind Imports’ (Document No. 77, 15 June 1985). The report ruled, first, that new imports would be prohibited for the next two years. Of the existing 116 refrigerator factories, forty-one were granted production permission, certificates while the rest were asked to cease production; thus annual capacity would be expected to fall from 13.5 million units to 8.22 million units.15 Second, the MLI was made responsible for management of the domestic appliance industry and for supervision of import projects with a contract value of less than US$5 million. Projects with a contract value above US$5 million should be submitted to the State Planning Commission for approval. Without approval, enterprises would not be issued with import permit certificates, and without these certificates they would be unable to access foreign loans from banks. Third, none of the administrative ministries or local governments was allowed to grant tax concessions or tax holidays to refrigerator enterprises. Fourth, it was recommended that the boundaries between regions and ministries should be broken down and that specialised enterprises and famous brand products should be supported. In July 1985, the State Council approved a report submitted by the State Economic Commission entitled ‘Report on Stopping Duplicated Importing and Prohibiting Multifarious Negotiations with Foreign Companies’. In the report, production lines for refrigerators, washing machines and airconditioners were listed as prohibited import projects. In August 1985, the MLI held a meeting in Beijing and discussed the consolidation of the washing machine industry. It stipulated that: (1) apart from projects which had already been signed, all projects for importing assembly lines should cease; (2) the MLI and the Ministry of Economics and Trade should be responsible for negotiations on import projects with foreign companies; (3) to consolidate the industry, MLI would support the twenty-two enterprises with annual

38 Industrial policies in China output of over 100,000 units, and close those producing fewer than 10,000 units; those producing between 10,000 and 100,000 units should be examined by the relevant administrative ministries or local governments to decide whether they should be recommended for closure or support. In its FYP7, the MLI planned to stop importing assembly lines for final products and to focus on importing production lines and technology for core components such as compressors, temperature controls, evaporators and motors. In 1989, the State Council published ‘The Decision on the Main Issues of Current Industrial Policy’, claiming that the focus should be shifted to industrial restructuring by developing agriculture, energy production and raw materials and restricting the domestic appliance industry. However, the implementation of investment restrictions was far from satisfactory, as is shown by the example of refrigerators. Driven by huge market demand and high profit margins, the local governments and the other administrative ministries were strongly against the official policy. They either bargained with the MLI for production permission certificates or repeatedly ignored the bans. New firms owned by different levels of local government continued to be created: in Zhejiang Province alone, for example, there were more than thirty refrigerator enterprises in 1988 (Jiang 1996: 210). To preventing themselves from being closed, the existing firms struggled to expand and reach the required level with the support of local government. It was reported that from 1985 to 1987 forty-two production lines were introduced from different foreign companies; among these, the Merloni Company, an Italian domestic appliance manufacturer, sold eight refrigerator production lines to various local firms within one year (Gong 1992). Output of refrigerators and washing machines peaked at 7.57 million and 10.47 million in 1988. After that, the figures decreased substantially to 4.63 million and 6.62 million respectively in 1990 (Table 2.2). The number of refrigerator factories also decreased rapidly from 256 at its peak to fewer than 200 (Ji and Jiang 1997). However, this was to a great extent due to the deflation policy adopted by the central government. It is worth pointing out that prior to 1992 the domestic appliance industry was strongly supported and protected by the foreign trade policy. The central government was cautious in screening foreign direct investment (foreign joint ventures were still in their early experimental stage), with strict restrictions placed on the extent of foreign ownership, and requirements stipulated on technology transfer, local content and the proportion of production that would be exported. Import licences for machinery and electrical products and utilisation of foreign currency were also highly controlled by the state. Until 1993 the import tariff on products was 100 per cent and the tariff on core components and parts was around 80 per cent.16 It is argued that without a wide range of subsidies, foreign technology transfers and import barriers, the domestic market would have been dominated by foreign products and domestic manufacturers would have been swept away by foreign companies as soon as they emerged.

Industrial policies in China 39 Table 2.2 Production of domestic appliances in China (1978–2002) Year

1978 1980 1983 1985 1988 1990 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

Refrigerators

Airconditioners (000s)

Freezers

(000s)

Washing machines (000s)

(000s)

Electric fans (000s)

Rice cookers (000s)

28 49 189 1,448 7,576 4,631 4,753 6,219 7,645 9,296 9,682 9,860 10,140 11,990 12,784 13,210 15,990

0.4 240 3,659 8,871 10,468 6,627 7,127 8,763 10,964 9,448 10,680 12,570 12,070 13,420 14,429 13,340 15,870

n.a. n.a. n.a. 123 n.a. n.a. 1,520 2,918 3,826 5,199 6,459 7,500 8,500 12,500 18,266 23,420 31,350

n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. 2,340 2,850 3,160 3,540 3,610 3,920 n.a. n.a. 4,646

n.a. n.a. n.a. 31,746 n.a. n.a. n.a. 64,030 81,950 89,070 87,410 72,730 67,210 61,580 76,616 82,330 90,560

n.a. n.a. n.a. 14,125 n.a. n.a. n.a. 16,500 16,450 16,080 14,370 15,090 10,570 18,710 n.a. n.a. 21,093

Sources: SSB (2001); CDAA (2002). Note: n.a. = not available.

Second phase (1992–2002) INSTITUTIONAL CHANGES

With the economic reforms and the transition from a command economy to a market economy, the institutional structure in China has changed dramatically since 1992. According to the constitution, the State Council is the highest organ of state administration, is the executive organ of the National People’s Congress (NPC) and is responsible and accountable to the NPC. The work of the State Council is presided over by an executive board composed of the Premier, Vice-Premiers, State Councillors and the Secretary General. Under the State Council are the various ministries, both comprehensive and specialised, commissions and ad hoc organisations that administer China’s economic and social life. The whole system is replicated at province and city levels. The Ministry of Light Industry consists of two bodies: the Bureau of First Light Industry which is in charge of the sectors covering raw materials and manual production, such as the brewing, tobacco, salt and food industries; the Bureau of Second Light Industry is in charge of the sectors covering assembly line production, such as domestic appliances, small tools and so on. The MLI was initially authorised by the State Council to oversee eighteen variants of products covering forty-four sectors, and then expanded to twenty-two variants covering 150 sectors. The

40 Industrial policies in China MLI was empowered to develop the industries through comprehensive fiveyear plans covering direct investment, a range of subsidies, depreciation allowances, import barriers and export incentives. In 1992, the State Council initiated a restructuring of ministries, eliminating the twelve specialised administrative ministries and replacing the Production Office with the State Economic and Trade Office, which was upgraded to commission level in 1993. The elimination of the ministries was understood by outsiders to indicate a significant step towards liberalising the economy and weakening the industrial policy regime. In practice, it rather indicated a shift of regulatory power to the State Economic and Trade Commission (SETC), which became one of the most powerful bodies in China’s economy, conceiving and implementing most of its industrial policies, including selecting and nurturing the strategic industries of the present and future. Instead of the MLI, the Light Industry Bureau was created, subordinate to the SETC. Further reform was pursued. On 19 February 2001, the SETC eliminated the Light Industry Bureau, together with eight other subordinate bureaux. Instead, the China Light Industry Association Union (CLIAU) was created, consisting of different associations based in various sectors, whose main responsibility was to conduct industrial surveys and then recommend policies designed to improve the sector in question (Figure 2.1). In theory, as a non-governmental organisation, the CLIAU was intended: (1) to prepare reports that would become the basis of government policy for an industry; (2) to provide government and enterprises with consultancy services; (3) to revise industry standards under the authorisation of the government; (4) to issue production permission certificates, to create quality

Chinese Light Industry Association Union

Management Office of the Domestic Appliance Industry

Other management offices of individual industries

Association of the Domestic Appliance Industry

Other associations

State-owned enterprises

Collective enterprises

Joint ventures and other enterprises

Figure 2.1 The organisational hierarchy of the Chinese Light Industry Association Union. Source: CASS (1998: 255).

Industrial policies in China 41 standards and to supervise quality and production; (5) to organise technical exchanges and cooperation; and (6) to make rules and regulations for industries. In other words, the association was envisaged as an industry designer, a policy adviser, a business coordinator and a government servant. However, in practice, the CLIAU lost its power to allocate resources, and so the implementation of industrial policy largely depended on whether or not the SETC decided to follow up its recommendations. In 1997, the CLIAU published an industry report which expressed the fear that China’s heavy dependence on foreign equipment and core components could result in competitive disadvantage after the country’s entry into the WTO. It concluded that the government must provide more support to domestic enterprises for technological improvement. In 2000, it helped the SETC to create the Tenth Five-Year Plan for the domestic appliance industry. It is argued that although direct commands to enterprises have clearly been falling in number from the 1990s, CLIAU officials are playing visible and important roles today in promoting industry in many ways, especially as regards technological capabilities. INDUSTRIAL POLICY AFTER 1992

In general, throughout the 1990s, the evolution of industrial policies in the domestic appliance industry proceeded slowly, in line with the gradual relaxation of government control over the entire economy. This is partly because of the elimination of the MLI, formerly a strong interventionist in the industry, with overt power to arm-twist enterprises into following its policies; it is also because from the 1990s China’s economic and industrial policies underwent significant changes under the auspices of the SETC. On the one hand, power over resource allocation changed drastically, being handed over to lower levels of the hierarchy: the more local autonomy there was, the less powerful central government became. On the other hand, China’s economy became more market orientated, notably in the case of light industry where over 80 per cent of consumer goods production was market led. At the Fourteenth Party Congress in October 1992, the machinery, electronics, automobile and construction industries were targeted as ‘pillar industries’. This position was further reiterated in the ‘Outline of National Industrial Policy in the 1990s’ published by the State Council in June 1993. The Outline also listed the priorities of foreign trade policy: boosting exports of certain agricultural products, consumer electronics and domestic appliances and other internationally competitive products; gradually reducing exports of primary goods and energy-intensive goods; encouraging imports of core components, equipment and technologies while discouraging imports of luxury consumer goods. The pillar industries were expected to receive wide-ranging government support. However, government targeting was more important not only as a signal to commercial banks that the industries were safe investments, but also as a signal to local governments to

42 Industrial policies in China follow suit by targeting the industries as ‘pillar industries’ and by subsidising local companies. The rapid expansion of the domestic appliance industry in the late 1980s led to excess manufacturing capacity. The industry witnessed severe competition among the local enterprises, among which one-third were profitable, one-third were breaking even and the remaining third were loss making. Few newcomers entered the industry, as there was no incentive for local governments or enterprises to invest in new production lines. Those enterprises that made efforts to improve quality and service, like Haier, Kelon and Meiling, became well established in the market, while those that put quantity before quality were in trouble. However, rather than closing, the poorly performing enterprises either lobbied local government for financial support or sought foreign partners to provide both capital and technological support to improve competitiveness. In the new round of foreign investment affecting JVs initiated in the early 1990s, more than sixty joint ventures were set up in the refrigerator sector, with contracted investment of US$3.17 billion and annual production of 6.75 million refrigerators (Liu 1995). During this period, the global giants entered the scene by acquiring major shares in some of the local enterprises.17 A significant change in industrial policy took place at the Fifteenth Party Congress in 1995. Instead of targeting specific industries in the non-strategic sector, the government shifted to targeting specific enterprises, a practice called ‘Picking the winner’ or ‘Grasping the big and letting go the small’. The policy, initiated by central government and focusing on state-owned enterprises in the strategic industries, was replicated by local governments which targeted their favourite local enterprises. To advance their favourite companies, local governments plied them with special privileges. To some extent, the policy, under which well-performing companies were encouraged to acquire loss-making ones, accelerated the consolidation process in the domestic appliance industry (for details see case studies in chapters 4, 5 and 6). In the refrigerator sector, for example, the number of producers fell from 114 in 1988 to seventy-two in 1992 and fifty in 1994; the output concentration rate of the top four increased from 29 per cent in 1988, to 44.4 per cent in 1991 to 65.3 per cent in 1996 (Ji and Jiang 1997: 26). In contrast to the first phase in which the industry was characterised by compulsory plans and heavy intervention such as the project examination and approval system, industrial policy in the second phase became a more benign, aiming simply to give guidance and information. In 1999, the State Council published the ‘Prohibition List of Industrial and Commercial Investment and Stopping Duplicate Investment Activities (first version)’. The prohibition on investment covered seventeen sectors, in which there were considered to be surplus capacity, energy inefficiency, backward technology or environmentally polluting projects. It was stipulated that the administrative ministries should not approve projects on the list, banks and other financial institutions should not fund them and administrative

Industrial policies in China 43 organisations in land management, city planning and customs should not assist them. In the domestic appliance industry, investment in certain types of production lines was prohibited, for example refrigerators and freezers, excluding energy-efficient and new big models (over 280 cu ft), washing machines, excluding models which were over 5 kg or less than 2 kg and ‘intelligent’ models. However, the policies were really directives without any well-defined mechanism for putting them into operation. In reality, administrative ministries and local governments were no longer the main bodies of investment, and the enterprises had acquired greater autonomy to make investment decisions on their own. Under the ‘marching out’ strategy initiated by the State Council, the domestic appliance and textile industries were targeted as export-orientated industries. In 1999, the SETC published the ‘List of Famous Brands and Supported Export Products’, granting priority to the following areas: overseas business development, participation in various trade fairs, allocation of Foreign Trade Development Fund Money, allocation of import quotas and allocation of technical improvement subsidies. To accelerate industrial restructuring in the domestic appliance industry, in 1999 the State Council published new standards of efficiency, requiring that production of refrigerators containing CFCs should cease by 2005. The policy forced firms to improve their technology and thus raised the entry barriers to newcomers. In 2000, the SETC drafted the Tenth Five-Year Plan for thirteen sectors, including machinery, automobiles, metallurgy, petrochemicals, oil, pharmaceuticals, coal, construction, light industry, textiles and electricity. In the domestic appliance industry, the state planned to help strong enterprises to engage in international operations and encourage them to use foreign intellectual resources to set up research and development institutions and design centres overseas. Evaluation of industrial policies in the domestic appliance sector If regulation means the ability of the government, independent of market forces, to formulate a market plan and then to implement its vision, then the bureaucracy failed. Not one market or production plan came close to being realised; the domestic appliance industry grew in an opposite pattern to what the bureaucracy intended. The MLI’s long-standing desire was to develop economies of scale through cartels, restrictions on market entry and consolidation. In fact, rather than production being concentrated into a few powerful national champions as the government desired, new small firms, mainly urban collective enterprises, continually sprang up; this happened before 1990. Being opposed to ‘excessive competition’, the MLI’s attempt to set up entry barriers by withholding production permission also failed, given the fact that the industry continued to expand with the actual number of domestic appliance manufacturers reaching over 600 at its peak. There are few big businesses which can compete globally after two decades’ development.

44 Industrial policies in China The effects on the domestic appliance industry were also the opposite of what the government intended. Ironically, none of the candidates, mainly SOEs, that were selected by the MLI for investment and promotion as national champions succeeded in the end. Instead, new entrants, mainly urban collective enterprises with strong local government backing, captured the market. As a result, they outpaced the first movers and became the major players under the leadership of aggressive entrepreneurs. In the refrigerator sector, for example, in 1982 the top four refrigerator enterprises were the Beijing (Snow Flake) Refrigerator General Factory, Guangzhou (Wanbao) Refrigerator General Factory, Shanghai Refrigerator General Factory and Suzhou Refrigerator General Factory, together accounting for 74.5 per cent of the industry’s output with production of 74,400 refrigerators. In 1985, their share of the output decreased to 39.4 per cent and then dropped further to 29 per cent in 1988. In 1994, all the former top four leaders were replaced by new leaders, namely Kelon, Meiling, Haier and Yangzi,18 with output share of 37.3 per cent19 (Jiang 1996: 215). The former leaders either lagged behind in terms of output or sales revenue, or set up JVs to upgrade their equipment and management.20 As a policymaker, the MLI’s intervention in the domestic appliance industry was ineffective and failed to achieve the expected results. Yet the MLI’s failure to enforce its policies does not mean that the industry was shaped entirely by pure market forces. China’s political economy runs on a dynamic mix of central government, comprehensive and specialised administrative apparatus and local governments. Within this complicated system, there is tremendous conflict among different interest groups, extensive competition among local governments and severe competition among firms under different jurisdictions. The three main reasons for the industry’s ability to resist the MLI are: (1) the MLI’s technical incompetence at formulating and implementing industrial policy; (2) the fragmented and unique nature of the industry itself; and (3) the wide range of institutional bodies that played roles as both policymaker and policy executive. These provided the industry with other means of support. In particular, resources have been shifted to local governments, which became ever more powerful as allocators of physical and government resources compared to the specialised administrative ministries. INSTITUTIONAL CAPABILITY

Being a senior policymaker in the domestic appliance industry, the MLI was empowered to develop and shape the industry by a series of five-year plans. In FYP5 (1980–85), the MLI made great efforts in granting priority to the industry, enabling enterprises to quickly acquire technology and raw materials on a relatively favourable basis. Within the open door policy, the infusion of foreign technology was greatly encouraged under the strategy of ‘catching up through imitating and learning from the advanced nations’.

Industrial policies in China 45 As in many other industries, foreign technology was a vital boost to the domestic appliance industry. In 1980–90, the MLI spent US$4.4 billion on importing technology and equipment, of which the domestic appliance industry accounted for 10 per cent (Gong 1992). However, in making these imports, the MLI was criticised for not setting up universal standards and closely screening investment projects. For example, in the refrigerator sector hundreds of assembly lines were imported from twenty-five foreign companies in more than twelve countries; this created a lot of problems in terms of technical standardisation and component product development (Gong 1993: 60). The MLI also failed to invest in components production and design by ignoring the supply chain in the industry. For example, in 1988, production of refrigerators reached 8 million units, while domestic suppliers could only produce 2 million refrigerator compressors (Yang 2000: 178). The huge gap had to be filled by imports. The MLI was also faulted for failing to make rational and accurate plans, its projections being based on ‘little more than guesswork’. Taking refrigerators for example, in 1980 the MLI underestimated demand by 50 per cent; its estimate was 320,000 units while actual demand was for over 600,000 units. If the industry had followed the plan, there would have been a 50 per cent gap between supply and demand, which would have been made up by imports (Jiang 1996: 235). In 1988, the MLI estimated the economy of scale was 200,000 units per annum for a refrigerator factory, 200,000 units per annum for washing machines, and 100,000 units per annum for air-conditioners. In fact, the average production output of the top four refrigerator enterprises was over 550,000 units; the washing machine enterprises with scale exceeded 600,000 units (Liu 1995). The MLI predicted that by 2000 household ownership of electric fans, refrigerators and washing machines would reach 80 per cent, 50 per cent and 30 per cent respectively, with projected output of 20 million, 15 million and 10 million units and product value of RMB20 billion (Gong 1993). In reality, in 1998 the total product value of domestic appliances reached RMB61.22 billion, far beyond the estimate (CDAA 2000). The output of electric fans reached over 70 million in 2000, over three times more than the prediction; the figure for ownership likewise more than tripled (CDAA 2001). The ability of the MLI to implement industrial policies was also a serious problem. This is partly due to institutional failure. There was no specific industrial law but a series of plans and inconsistent reports, which gave the MLI no enforcement powers to carry out any policy. Also, the decisionmaking process was extremely slow in the inefficient bureaucratic apparatus. Lack of foresight and effective communication led to late responses to changes in the industry. In the mid-1980s, the provincial governments were only authorised to approve investment projects worth less than RMB10 million. In 1984, among the forty-two import projects for refrigerators, twenty-four were worth less than RMB10 million with output capacity

46 Industrial policies in China between 50,000 and 100,000 units, far from the optimimum economy of scale required (Liu 1995). THE NATURE OF THE INDUSTRY

With further economic liberalisation after 1984, urban and rural collective industrial enterprises, particularly in the coastal provinces and cities, were given high priority and developed very quickly. One of the distinctive features of the light industry sector is that it is dominated by thousands of locally operated businesses, both collective and private. It was reported that there were more than 60,000 enterprises, 94 per cent of which were of small or medium size, and 80 per cent of which were collective enterprises (Zhao 1999: 212). Because of the proliferation of firms and the MLI’s failure to build national champions, the industry operated on relatively free-market principles, many firms competing fiercely with each other. Because different levels of government owned the collective enterprises and the ownership structures were complicated, it became more difficult for central government to consolidate the industry through mergers. It is also argued that the relationship between the government and the enterprises has become more dynamic and cooperative in the past few years. The more autonomous the enterprises, the more difficult for policymakers to pursue an industrial policy, even a well-defined one, without their cooperation. OTHER INSTITUTIONAL BODIES

It is worth pointing out that in addition to the Ministry of Light Industry, some other institutions played equally active roles as both policymakers and policy executives. This provided the firms with alternative sources of support. For example, a wide range of financial institutions, such as the Ministry of Finance, Ministry of Foreign Trade and the State Planning Commission, funded the industry, providing technical upgrading subsidies, export subsidies and various kinds of tax concession. Other specialised administrative ministries also designed and carried out policies for their own industries. For example, in the early 1980s, in order to adjust the industrial structure, the Ministry of Defence Industry and Ministry of Heavy Industry helped their subordinated enterprises to move to consumer goods production. It was reported that 2,000 electric fan enterprises were established by these ministries, despite the MLI’s attempt to limit numbers, with an annual output of 10 million units in 1989 (Li and Huang 2001). LOCAL GOVERNMENT INTERVENTION

The empirical evidence suggests that the prospects for industrial reform at the end of the 1980s depended largely on interpretation and decisionmaking at lower levels of government, as well as firms’ perceptions of the political and

Industrial policies in China 47 ideological climate (Byrd 1992: 28). In many respects, the domestic appliance industry prospered under heavy-handed government intervention at local levels. On the one hand, local governments, interacting strongly with their local businesses, played crucial roles in executing and influencing the industrial policies pursued by the central administrative ministries. For example, during 1984 and 1985, the MLI initiated the production permission certificate; the initial plan was to select twenty firms and help them to reach an economy of scale. However, under pressure from local governments and local ministries, the MLI had to balance different interest groups and so had to select forty-one firms instead, simply in order that there should be at least one refrigerator manufacturing firm located in every province or big city. In fact, of the forty-one enterprises, only eleven projects were approved by the MLI; the rest were approved by local governments and other ministries first and then submitted to the MLI. On the other hand, local governments created their own industrial policies to promote local industry. These included various kinds of tax concession, export subsidies, priority for bank loans, stock market flotation and so on. The domestic appliance industry was targeted as the pillar industry in almost all the coastal provinces or cities. In Shandong Province, for example, two cities, Qingdao and Jinan, were targeted as production bases for domestic appliances. Four groups, namely the Haier Group, the Hisense Group, the Aucma Group and the Little Duck Group, were nurtured by the local government, being provided with a wide range of subsidies for features including technical improvements, new product development and so on. This will be further discussed in the following section. In conclusion, China’s experience in the domestic appliance industry indicates that the actual results of the industrial policies are far from satisfactory. How did China’s domestic appliance industry achieve significant growth if the policies were so ineffective? By examining the relationship between the development of a highly competitive industry and the industrial policies associated with it, it is argued that market-orientated industrial policies and market competition are the prime movers behind development, rather than government planning and command. The experience of the domestic appliance industry also tells us that the role of local government should be examined carefully, as industrial policies adopted at local level played extremely crucial roles in promoting the industry. It can be concluded that the success of China’s domestic appliance industry is a mixed result of market forces and product innovation, and is largely due to entrepreneurs in collective enterprises with local government backing.

Local industrial policies: the case of Shandong Province and Qingdao City Shandong Province, with an area of 156,700 square kilometres, accounts for 1.6 per cent of China’s total area. With a population of 87 million in 1998 –

48 Industrial policies in China Table 2.3 Selected economic data for Shandong Province Year

GDP (RMB billion)

Share of China’s GDP (%)

Ranking among provinces

1978 1988 1992 1995 1996 1997 1998

22.910 103.520 219.653 500.234 596.042 665.002 716.220

6.38 7.40 8.33 8.59 n.a. n.a. 8.88

4 3 2 3 n.a. n.a. 3

Source: Zang (1999: 15 –17). Note: n.a. = not available.

7.2 per cent of China’s population – it is the second most populous province, behind only Henan. Its size and population are much bigger than those of most nation-states in the world. With the longest coast line (3,221 kilometres) in China, Shandong is well known for its deep-water ports such as Qingdao, Yantai and Weihai that position it well for foreign trade. It is rich in natural resources, ranking number one in China for its deposits of gold, sulphur and gypsum, and number two for its deposits of diamonds, petroleum and copper. Its rich endowment of oil and coal provides Shandong with energy advantages which are vital to its economic development. By any standard, Shandong stands out as one of the highly successful provinces following reform. It is one of the largest agricultural producers in China, with a wheat yield accounting for half of the total national output. Its share of total national industrial output rose from 6.38 per cent in 1978 to 8.89 per cent in 1998. Shandong has succeeded in making itself one of the four largest economies in China (Table 2.3). Despite its advantages in resource endowment and geographical location (i.e. proximity to South Korea and Japan), the growth of Shandong is certainly the result of preferential policies, strong local leadership and heavy intervention in economic development. However, compared with other provinces like Guangdong, the role of its local leaders and local industrial policies have hardly been investigated and are poorly publicised. This section will first highlight the revolution in the relationship between Shandong and the central government and then discuss the developmental role of Shandong Province and the industrial policies it has implemented in the post-reform period. It will finally examine industrial policies in Qingdao City. The relationship between Shandong Province and the central government Shandong Province traditionally lay under the looming political shadow of central government, which exercised tight supervision over its development.

Industrial policies in China 49 This is partly because of its geographical closeness to Beijing; also because of its fiscal and social importance to the central government.21 Shandong is one of the most important fiscal contributors. Under the centralised budgetary system between 1949 and 1976, Shandong had to remit all its revenue to the central government without any autonomy to collect taxes or allocate resources. At the beginning of the fiscal reforms in 1980, Shandong was one of fifteen provinces to implement the ‘sharing specific revenues’ system, under which it had to remit 90 per cent of its revenues from consolidated industrial and commercial tax, which accounted for one-quarter of its total income (Cheung et al. 1998: 266).22 In return for its fiscal contribution, the provincial government, by using personal networks, was able to get considerable investment from the central government. For example, during FYP5 and FYP6 (1976–85), large-scale investment in Shandong reached RMB24.96 billion, accounting for 9.4 per cent of total national investment. A number of heavy industrial enterprises were taking shape with this investment, including Qilu Petrochemical Group, Jinan Petroleum Group, Weifang Diesel Group, Shandong Aluminium Group, Shandong Electricity Group and Jinan Automobile Group. By the mid-1980s, Shandong had developed its own heavy industrial framework ranging from energy to machinery. Eight industries, namely energy, chemicals, electronics, metal, construction materials, machinery, textiles and food processing, produced 92.4 per cent of the total industrial output in the province (SPG 2001). After 1984, Shandong provincial leaders sought aggressively to rearrange its fiscal relationship with the central government in order to obtain more fiscal independence.23 The object was to acquire more control over its revenue and greater flexibility in local spending. The breakthrough took place in 1994 when the tax-sharing system was introduced by the central government. Under the new system, Shandong would retain all the revenue collected under the ‘local tax’ categories, and would share with the central government several ‘shared taxes’ such as value-added tax, consumption tax and stock transaction tax. Along with the fiscal decentralisation, Shandong benefited greatly from preferential treatment from the central government. In April 1984, two of Shandong’s cities – Qingdao and Yantai – were among the fourteen designated ‘coastal open cities’, which were empowered by the State Council to implement preferential policies to attract foreign investment and promote export-orientated industries. These two were designated as Economic Development Zones in 1985. In 1987, Shandong was designated as the key province for relations with South Korea, benefiting from various preferential policies to enable it to utilise fully the opportunities for foreign investment.24 To exploit these special policies to the fullest extent, the provincial leaders implemented them in an increasing number of localities throughout the province, including designating seven cities and fifty-three counties as open areas in 1990 and creating seventy economic development zones later

50 Industrial policies in China (such as high-tech, tourism and free trade zones). These open areas, accounting for 40 per cent of the province in terms of area and population, were all able to enjoy varying degrees of preferential treatment for foreign trade and the acquisition of foreign investment. The developmental role of provincial government Being one of a highly selective group of provinces, Shandong was granted more autonomy to manage its own foreign trade, increase investment decision-making powers, control the use of foreign currency, and even establish an independent provincial investment company that could deal directly with overseas businesses and financial institutions. To boost the local economy, provincial leaders consistently pursued an approach that conformed to the regional development strategy they had designed. They also gained greater autonomy to initiate local industrial policies to respond to the province’s own needs in agriculture, industry, education, technology and public health. Despite severe constraints set by the central government from time to time, the local leadership was able to take a flexible approach, interpreting central policies in its favour. In fact, provincial-level industrial policies have been extensively used whenever deemed necessary and practical. The provincial authorities were adept at promoting foreign trade and FDI by pursuing various policies with a scope and scale far beyond the central-level policy. To promote exports, for example, the government set up a Provincial Foreign Trade Development Fund, providing extra subsidies and VAT exemption as well as tax rebates to local enterprises. It was reported that the provincial finance ministry granted interest rate subsidies of RMB80 million annually to technical upgrading projects for export purposes.25 The Shandong government also gave intensive non-capital support to local enterprises, including releasing international market information and organising international trade fairs and international business training. To attract more foreign investment in such sectors as energy, transport and port construction, the government implemented more preferential policies such as extending tax holidays, cheaper land price and so on.26 The Shandong government even granted exemptions from local tax to foreign investors who made investments of more than US$30 million in the non-coastal areas of the province. The results of this ‘open policy’ have been quite remarkable, achieving a near total restructuring of Shandong’s rural and urban economies in a relatively short time. The provincial authorities took innovative approaches to collecting resources to support intensive investment in infrastructural projects. They realised that maintaining a high level of investment was crucial to development, and their own fiscal revenue was far from sufficient to support it. They took an active role in obtaining capital from both domestic and foreign financial institutions. For example, by 2002, Shandong had invested RMB70 billion in highway building and became the only province with

Industrial policies in China 51 more than 2,000 kilometres of highway in China.27 Shandong managed to have seven firms floated on the Hong Kong Stock Exchange.28 The relationship between government and business is extremely complicated, given that local officials are the dominant players in the local economy. Apart from having the rights to receive residual cash flows and to dispose of assets, the ownership functions of local governments are complemented by the broad regulatory power in their hands (Huang 2001). Through tight control over the selection of management teams, the local government has greatly influenced decisionmaking on investment. It also monitors the management and performance of companies, and removes any failing managers through an annual inspection. In fact, the provincial authorities not only determine the industrial structure by their allocation policies and through forced mergers, but can also improve management capability at company level. For example, they selected forty-two ‘famous brand’ firms and forty-one well-performing management teams as ‘models firms’ for other local firms to emulate (SPG 2001). Industrial policies in Shandong Province Throughout the reform period, the basic theme of industrial policy has varied, following political and ideological changes ordered by the central government. However, the major themes of industrial policy in Shandong included: developing an independent economy, building big business groups, upgrading the industrial structure, and boosting SOEs by diversifying ownership. Developing an independent economy For a long time, the central government encouraged local governments to develop ‘comprehensive and independent’ economies. The strong emphasis on ‘self-sufficiency’ is exemplified by further decentralisation at lower-level government. Being granted more economic and political power, the local governments were anxious to set up local businesses so as to increase revenue. Once the central government identified sectors with high-productivity growth potential and designated the ‘pillar industries’, the provincial government would target these sectors by granting credits and foreign exchange, state investment funds, preferential tax treatment and other supportive measures. The priority sectors were given more financial assistance than the non-priority sectors. The lower levels of government, namely municipal, county and township, would follow the same pattern. As a result, duplicated investments were pervasive. In Shandong Province, there were 201 paper mills, 120 wineries, 2,157 plastic product manufacturers, 526 cement plants and 541 cotton mills and wool spinning manufactures in 1998 (SPG 2001). These enterprises were mostly small-scale units serving the local markets.

52 Industrial policies in China Building big businesses In July 1993, Shandong government published ‘Opinions on Developing Local Business Groups’, just one month after the State Council published ‘The Outline of National Industrial Policy in the 1990s’, advocating the promotion of ‘rational competition’ and the establishment of large business groups. Since then, the centrepiece of the reform has been ‘Supporting the superior and the strong by concentrating on developing business groups’. To emulate the State Council, the provincial government selected 136 large groups to take under its direct supervision. These groups, though small in number, accounted for 48.1 per cent of total assets, 41.7 per cent of total sales revenue, 49.9 per cent of pre-tax profit and 52.6 per cent of total profit in 2000 (SPG 2001). Numerous policies have been introduced to support the selected groups, in addition to their having special political status. Foremost is financial support, including preferential tax rates, low-interest loans, stock listing and technical subsidies for R&D. For example, in one such policy, known as ‘Bank and enterprise walk hand in hand’, the banking system provides favourable loans to the business groups and attempts to write off crippling long-term debt. To stimulate R&D and help new product development, the government approved the establishment of technology centres by twenty-six groups, and sponsored 100 technological projects, aimed at improving the sixteen leading products produced by the provincial teams. Groups have also been given preference in allocations of vital supplies, such as fuel, water and electricity. The strong emphasis on economies of scale was highlighted at a provincial economic conference held in 1996. The conference concluded that it was hard to realise ‘strong/strong’ mergers by using market forces alone, due to the complicated ownership structure of many enterprises; ‘strong/weak’ mergers should be greatly encouraged, given that they are vital to maintaining economic and social stability by finding a place for small inefficient producers. As a result, whenever firms were considered to be smaller than the minimum efficient scale, state-initiated or state-subsidised mergers were implemented. The most dramatic example of this was the establishment of 552 enterprise groups through forced mergers of 3,237 inefficient firms. These groups possessed assets of RMB467.58 billion, accounting for 58.8 per cent of the total assets in the province, with sales revenues of RMB339.81 billion, accounting for 59.7 per cent of the total sales, and profit of RMB15.95 billion accounting for 69 per cent of the total profit (Dazhong Daily, 28 December 2001). One of the long-term targets is the creation of conglomerates with yearly sales in excess of RMB10 billion. To achieve this, the government selected eight special groups to be ‘provincial champions’ from among 136 enterprises which were regarded as the ‘dragon’s head’, leading economic restructuring. They are: the Shandong Mechanical Engineering Group,

Industrial policies in China 53 Langchao Group, Three Link Group, Qingqi Group, Xinhua Pharmaceuticals Group, Haihua Group, Haier Group and Qingdao Brewery Group. To build them as conglomerates on the model of South Korea’s Samsung, special backing was given, and smaller, often loss-making enterprises, were merged. A round of state-led mergers occurred under the heavy intervention of the government. In 1997, the eight groups incorporated another fifty-four enterprises with total assets of RMB6.5 billion into their operations (Dazhong Daily, 28 December 2001). A notable case is the Qingqi Group, a former motorcycle producer in Jinan. Rapid growth made it one of the biggest producers in China by the early 1990s. The local government targeted it and groomed it for expansion through intensive merger activities. By 2000, it had become a conglomerate with seventy-four subordinates and assets of RMB14 billion, including a wide range of businesses such as automobiles, computers, property, advertising, pharmaceuticals, restaurants and so on. Industrial restructuring Shandong has a large number of state-owned enterprises which accounted for over 60 per cent of provincial industrial output in 2000 (SSB 2001). Since the 1990s the main aim has been to improve the performance of inefficient SOEs through upgrading the industrial structure. For example, by 1994 the government had approved the plans of 150 enterprises for the establishment of technological centres to stimulate R&D, and it invested RMB268.6 billion in technical upgrading during FYP9 (SSB 2001) (Table 2.4). This reform was outlined in the document ‘Opinions on the Structural Readjustment of Industrial Production’ in 1998, which proposed the ‘Si ge yi pi’ policy (‘Transform a group, nurture a group, strengthen a group, eliminate a group’). Seven traditional sectors – papermaking, wine, pharmaceuticals, fertilisers, cement, textiles and plastics – were designated for transformation: this meant upgrading their technology, improving quality and attaining an efficient scale of production. It was recognised that these sectors would require large investment. Four industries – domestic appliances, petrochemicals, machinery and automobiles – were defined as promising sectors. Special support was given to these sectors, including subsidised

Table 2.4 Investment in technological upgrading during FYP9 in Shandong Province (RMB billion) Year

1996

1997

1998

1999

2000

Investment

42.9

50.2

54.4

57.2

63.6

Source: SPG (2001: 23).

54 Industrial policies in China loans, restrictions on granting licences to other newcomers, and subsidies on R&D. New investment was to be strongly encouraged in six new and high-tech sectors – information technology, bioengineering and medicine, new materials, chemicals, mechanical and electrical engineering and environmental protection. Other declining industries like coalmining, defence and textiles were to be phased out under a programme which involved subsidies for scaling down capacity. Large loans were allocated to technological upgrading. From 1998 to 2000, two million sets of equipment were upgraded and 120,000 production lines were imported. To support the loss-making SOEs, so-called close loans were granted for specific purposes: 241 enterprises were granted loans amounting to RMB1.19 billion. The government also merged, declared bankrupt or downsized 471 loss-making enterprises with crippling debts of over RMB7.333 billion (SPG 2001). In December 2002, at a meeting organised by the Province Economic and Trade Commission in Jinan, the government announced a four-year programme in which it would help 270 loss-making SOEs to leave the market. These were enterprises with debts totalling RMB32 billion and 390,000 employees (Dazhong Daily, 19 December 2002). Until recently, ownership diversification was emphasised, as expounded in the No. 105 Document published by Shandong Economic and Trade Commission in 2002. It advocated ‘ownership diversification through transferring shares and absorbing foreign and private capital’: foreign and private companies would be allowed to purchase shares in local SOEs, and the restriction prohibiting private companies from participating in projects with investment of over RMB500 million would be relaxed. In March 2002, the provincial government sent a group of delegates to attend the Hong Kong Economic and Trade Fair, introducing foreign investors to the 20 listed companies and encouraging them to buy their shares, including Xinhua Pharmaceutical, Shandong Aluminium, Little Duck Electrical Appliance, Yanzhou Coal Mining, Liangshao Group and so on. Meanwhile, 136 nonlisted provincial teams were asked to work on the feasibility of ownership diversification. The case of Qingdao City The experience of Shandong shows that industrial policy is a process that is actively undertaken at all levels of government. Examples of city-level industrial policies are also notable in Shandong: that of Qingdao City, where the Haier Group is located, is particularly striking. Being one of the top beneficiaries of preferential policies during the reform regime, Qingdao was designated as a ‘coastal open city’ in 1984 and a ‘city with an independent plan’ (‘jihua danlie shi’) in 1986. This meant the city had as much management autonomy as existed at the provincial level, and it was empowered to lead the way in the reform. Since the mid-1980s, the city has enjoyed rapid economic growth in terms of GDP (Table 2.5).

Industrial policies in China 55 Table 2.5 GDP of Qingdao City (1949–98) (RMB billion) 1949

1952

1957

1962

1965

1975

1978

1984

1986

1991

1998

2.87

6.80

10.99

9.31

15.41

28.67

37.99

69.70

91.80

195.10

888.40

Sources: QSB (various years).

Table 2.6 Investment in technological upgrading in Qingdao City (RMB billion) Year

FYP7 (1985–90)

FYP8 (1991–95)

FYP9 (1996 –2000)

Investment

2.05

18.2

34.0

Source: Qingdao Government Annual Report (2001).

Since the mid-1980s, city leaders have implemented various development strategies to boost the local economy. In 1988, it initiated the ‘Famous brands’ strategy, under which a number of products with well-known brands, including Haier refrigerators, Hisense colour TVs, Aucma freezers, Qingdao beers and Double Stars sports shoes, were promoted to penetrate the national market. The ‘Big projects’ strategy has been pursued since 1993 by targeting a number of big investment projects each year. The ‘Big business groups’ strategy was started in 1996 and involved supporting and nurturing ten big enterprise groups through intensive government support. These are Haier, Hisense, Aucma, Qingdao Brewery, Double Stars, Kailian, Qingdao Textile Group and Qingdao Steel Group, which together account for 40 per cent of total industrial output and 80 per cent of total profit in Qingdao.29 And in 2000, it proposed the ‘Industrial parks’ strategy, aiming to create ten industrial parks to promote technological upgrading and economies of scale for specific sectors (Table 2.6).30 In addition to the ten targeted groups, the municipal government selected sixty firms for an experimental ‘modern enterprise system’. Then, in 1996, it chose twenty enterprises for an experimental ‘principal banking system’, in which local specialised banks provided comprehensive loans to the designated enterprises. Meanwhile, the local government published ‘Regulations and Policies on Further Supporting Industrial Enterprises in Qingdao’: this formulated fifty policy elements intended to support municipal-level firms in terms of fiscal, finance and social insurance (QMG 1999). In 1997, thirtytwo groups were established, 781 SMEs undertook ownership reform (Gaizhi), and eighty-four firms were declared bankrupt. In 1999, RMB800 million were granted to support the targeted industries and enterprises.31 It is worth pointing that the domestic appliance industry has been continually targeted as a priority industry since the mid-1980s in Qingdao. This is apparent in the five-year plans. For example, in FYP8, the government identified eight pillar industries, domestic appliances, automobiles, petrochemicals, audio and telecommunications, bioengineering and marine

56 Industrial policies in China pharmaceuticals, textile machinery, shipbuilding and ship repairing, and power-generating equipment. In FPY9, city leaders devised preferential capital facilities to focus on four industries, namely domestic appliances, electronics, telecommunications, and marine products. It decided to focus on twelve groups including Haier, Hisense and Aucma and to help them achieve annual sales of RMB5 billion by 2000 through introducing new technologies. In FYP10, six pillar industries were targeted, namely domestic appliances, information technology, industrial rubber, food and breweries, automobiles and shipbuilding, bioengineering and marine pharmaceuticals. The government aimed to select thirty groups to support (the ten biggest, the ten strongest and ten high-tech companies). Among the ten biggest groups targeted by the local government, three were domestic appliance companies, namely Haier, Hisense and Aucma. The government supported these groups through priority access to capital, including interest-free loans and stock market flotation; export subsidies and political status; preferential policies including allocation of land tax exemption. In 2001, Qingdao received approval from the State Council to organise an annual China International Electronics and Electrical Appliances Exhibition. Haier’s profitability was initially ensured by government subsidies for capital costs and other financial incentives. Investment in infrastructure – in roads, industrial parks and electricity generation in the city – greatly assisted the company to prosper. The government supported the establishment of the Haier Group through various measures: it provided access to long-term low-interest foreign capital and import quotas for the purchase of equipment and components and for floatation on the Shanghai Stock Market. It provided tax holidays and other preferential treatment by establishing a High Tech Economic Development Zone. The government also provided Haier with discounted user rates for many government services, such as discounted land user rate and discounted overseas shipping rates. The 1997 Government Annual Report states explicitly that Haier is to be nurtured for entry to the Fortune 500 by further preferential policies and capital support. In-depth case studies of the Haier Group, Hisense Group and Aucma Group are given in Chapters 4, 5 and 6.

Conclusion Although Shandong is no different from other provinces in that industrial policy has created many inefficient state-owned firms, it proves the hypothesis that industrial policy could and did exist at local government level. In fact, the vast majority of SOEs are under the direct control of local governments.32 Given China’s great size, each province or region receives a substantial degree of autonomy. It is feasible, theoretically and practically, for local governments to nurture their own provincial champions which can exploit the vast local markets, and which can then penetrate the domestic market, expanding to be promoted as national champions.

Industrial policies in China 57 The research suggests that there is no strong evidence that local government should give up intervention in terms of industrial policy and local protectionism. China’s entry into the WTO is generally considered a ‘significant market opening step’ and a ‘further commitment to global economic integration’ (Nolan 2001). However, even in the WTO regime, it is still feasible for local government to turn a blind eye to unwelcome policies from central government, given that the latter has little bargaining power and ineffective mechanisms to monitor the former. Driven by the need to prevent massive unemployment and increase local revenue, local governments are expected to continue their policy of protection by enabling local firms to enjoy immense economies of scale and subsidies. In this sense, the central government is facing great challenges, having to deal simultaneously with local governments, enterprise conglomerates and foreign governments, especially the USA which demands strict observation of agreed terms. An empirical examination of the actual process whereby China’s industrial policy has been implemented provides us with a better understanding of the issues involved. In principle, industrial policies are designed to rationalise the use of scarce resources across different industries and to enhance China’s competitiveness in the world economy. The industrial policies China has implemented have brought tremendous changes in both the industries and the industrial enterprises. This is apparent in the case of the domestic appliance industry and the local enterprises which are discussed later in this book. However, despite the progress that has been made, attempts to build globally competitive industries and reform the SOEs have not fulfilled the policy aspirations of the Chinese leadership. The following chapter takes a closer look at the domestic appliance industry by benchmarking China against the global leaders.

58 The domestic appliance industry

3

The domestic appliance industry

Introduction The domestic appliance industry is one of the largest consumer goods industries with a world market valued at US$85 billion a year (FT, 24 February 2001). Domestic appliances can be classified in terms of customer use and technology. In terms of customer use, the products fall into three categories: for the kitchen (refrigerators, freezers, cookers, ovens, hotplates and microwave ovens, dishwashers and juice extractors); for the home laundry (washers and dryers); and air-conditioning units. In terms of technology, domestic appliances fall into three categories: plumbed items (dishwashers, waste disposers, washing machines and some dryers); refrigeration (refrigerators, freezers and air-conditioners); and cooking units. For the purpose of this research, we focus on the three major domestic appliances, refrigerators (including freezers), washing machines and air-conditioners. This chapter will examine the domestic appliance industry. In the first section, a closer look will be given to the industry, at a global level, in terms of industry features, supply and demand, industry structure, the global business revolution and major players. The following section will focus on China’s domestic appliance industry by examining its history, demand and supply, and competitive advantages and disadvantages.

Overview of the global domestic appliance industry Main features of the industry Technical progress In general, the manufacture of domestic appliances is mid-technology and capital intensive. Over the last five decades, technological advances in this industry have primarily focused on the development of new features, improving energy efficiency, environmental friendliness, product standardisation, the exploitation of new materials, reducing noise levels and operational improvement. Although the pace of technological change has

The domestic appliance industry 59 been relatively slow, product innovation is crucial to the competitiveness of the industry for three main reasons. First, continued new product development helps reduce replacement cycles, encouraging consumers in mature markets to buy models with newer features. Second, newer, feature-rich models can command higher profit margins. And third, innovative products help to strengthen the leading brands, giving them an advantage over their competitors in the long term. However, product innovation of domestic appliances which are regarded as mature in product cycle terms is rather rare in the industry, with R&D spending going largely on improving quality and creating variants rather than on new features and new products. With further development of information technology, it is expected that a number of breakthroughs will take place. For example, intelligent appliances are expected to be Internetenabled, making it possible for a network to be controlled via a mobile phone from outside the home. Economies of scale and scope When a product reaches the mature stage, competition is concentrated on production costs and price; this drives manufacturers to push down production and marketing costs through economies of scale and scope. The production process of domestic appliances consists of three related stages. The design stage is highly research intensive, particularly as efforts are made to develop new functions for domestic appliances and to improve the efficiency of the production process. The manufacture of components is a stage in which economies of scale are especially significant; a doubling of compressor plant output could reduce costs by 15 per cent (Allen 1993). Compressors, fractional horsepower motors and electronic controls, which are significant elements in the cost structure of final products, are both capital and scale intensive and can be sourced on a global basis. The final stage, assembly, is highly labour intensive, with the potential advantage of low labour costs in some countries. Economies can also be achieved by bulk distribution, installation and after-sales service. Most companies offer a full range of products and provide their own servicing in order to remain competitive. However, although high volumes and large-scale production are crucial, they are far from sufficient to guarantee success in the industry today. Strong market positions, strong brands and innovative products are key factors to performance in the consumer goods industry; therefore, a company must be the leader, not only in terms of scale in manufacturing, but also in relations with retailers, and in the minds of consumers.

60 The domestic appliance industry Supply and demand Demand Demand for domestic appliances is income-elastic and very sensitive to economic cycles. Buying patterns are related to purchase of a house, family change, increasing wealth and product failure. Global markets show uneven geographic growth due to different economic conditions and living patterns. World demand grew especially rapidly throughout the 1960s and well into the 1970s, with a strong geographical concentration of demand in three markets: the USA, Western Europe and Japan. Together representing more than 70 per cent market share, each of these markets remained relatively isolated from the others, showing great differences in terms of consumer preferences and technical standards. By the end of the 1970s, demand for domestic appliances was approaching saturation in these markets and replacement demand had become the major characteristic of the industry, due to the high levels of ownership and the long life expectancies of the products, which average 10–15 years. In the past decade, the overall traditional markets grew slowly and steadily, with an average growth rate of 2–4 per cent in terms of volume (Euromonitor 1999). The USA represents the largest market for major appliances, accounting for 41.7 million units in 2002, excluding microwave ovens and room air-conditioners (Electrolux 2000). By contrast, the most impressive increases in demand came from the developing countries, particularly the Asian Pacific, East European and South American economies, which have nearly double-digit growth rate (Table 3.1). Table 3.1 World regional demand for major domestic appliances* (millions of units) Region

1989

1993

1998

2003**

2008**

Total North America USA Latin America Western Europe Eastern Europe Africa and Middle East Asia and Pacific Area Japan China China (%)

197.8 48.0 41.2 10.9 55.2 26.2 11.0 46.5 15.3 15.2 7.7

212.5 49.5 41.9 12.8 59.9 21.3 13.1 55.9 14.9 20.4 9.6

256.3 58.4 49.3 18.0 64.9 18.1 16.9 80.1 18.6 35.1 13.7

302.7 61.4 50.7 21.3 69.7 23.3 20.6 106.4 18.4 54.7 18.1

354.9 64.4 51.8 25.4 73.9 31.9 24.2 135.1 19.1 75.2 21.2

Source: The Freedonia Group, Appliance Manufacturer, February 2001. Notes * Major domestic appliances are refrigerators, freezers, washing machines, tumble dryers, electric ovens, microwave ovens and dishwashers. ** Estimated data.

The domestic appliance industry 61 These markets offer huge potential for growth and development, based on low penetration. Their share accounted for approximately half of world demand in the late 1990s. For example, between 1998 and 2002, sales volume rose by 53.1 per cent in India, 41.4 per cent in Russia and 26.5 per cent in China (Euromonitor 2004). In terms of volume, worldwide demand for major appliances is forecast as follows: refrigerators and freezers: 97 million units; washing machines: 69 million units; air-conditioners: 40 million units; microwave ovens: 40 million units; dishwashers: 23 million units (Appliance Manufacturer, February 2001). Supply The major producers of domestic appliances have long been concentrated within the three regions. In 1997, the output of major domestic appliances was 60 million units in the USA, 57.5 million units in Western Europe and 14.6 million units in Japan, accounting for 70 per cent of world output (CDAA 2000). However, overall, continued worldwide overcapacity led to a decline in production. For example, in 1997, the output of refrigerators decreased by 10 per cent in the USA, by 25 per cent in Italy and by 4 per cent in Germany (CDAA 2000). Meanwhile, more and more Japanese companies have shifted their production bases from Japan to other Asian countries. By contrast, production in developing countries has increased rapidly. In Brazil, the largest economy in Latin America, the output of appliances grew at 20 per cent annually from 1994 to 1997 (CDAA 2000). The most significant growth was in China, which had an annual production growth rate of 32 per cent from 1986 to 1995 (CDAA 2000). China became the third largest producer in the world in 1997, after the USA and Western Europe (CDAA 2000). However, enormous investment has led to overcapacity and intense competition in a marketplace full of new brands, new suppliers and new products, sometimes with aggressively priced goods. It is reported that retail prices in the Chinese market witnessed a fall of 8 per cent in 2000 (Electrolux 2001). Industry structure The USA In the United States, there were approximately 300 specialist appliance manufacturers in the late 1940s. Almost all were quite small and single product line manufacturers; for example, GE made refrigerators, Maytag made washing machines and Hotpoint produced electric cookers (Allen 1993). The rapidly expanding market encouraged many companies to enter the industry. At one time all the major automotive manufacturers (GM, Ford, American Motors, Studebaker, Borg Warner, Rockwell, Bendix) except Chrysler and electric/electronics manufacturers (GE, Westinghouse, RCA, McGraw

62 The domestic appliance industry Edison) participated in the business, but all of them have withdrawn by divesting their appliance business units. Only GE remains as a major force. During the 1960s and in 1970 the output of major domestic appliances reached 28.2 million units per year with a sales value of over US$6 billion, representing an 82 per cent increase in units and a 62 per cent increase in sales since 1961 (Dossayboy 1984). The period also witnessed concentration due to overcapacity and intense competition. By 1980, with continuing concentration, only about fifteen companies remained active (Dossayboy 1984). Within six months in 1986, Whirlpool purchased KitchenAid, Electrolux acquired White Consolidated, and Maytag merged with Magic Chef, leaving 80 per cent of the US$11 billion American domestic appliance industry in the hands of four manufacturers – GE, Whirlpool, Maytag and Electrolux (Business Week, 4 August 1986). The consolidations were partly made to attain economies of scale and partly a result of pressure from dealers for full product lines. The market share of the four companies remained remarkably stable and increased to 72.6 per cent by value by 1998 (Euromonitor 1999). Although domestic appliance producers differ significantly in the extent to which they fabricate their full range of requirements for parts and components, overall there has been an increasing tendency towards outsourcing since the 1980s. All major producers not only outsource a wide range of components, but also select models and appliance categories from both independent suppliers and competitors. They have centralised components purchasing activities by significantly reducing the number of suppliers. They set up new relationships with suppliers by joint efforts for product development, improving quality processes, and just-in-time (JIT) delivery capabilities. GE is the most active in this respect, outsourcing all requirements for freezers, microwaves and room air-conditioners. The traditional sales outlets for domestic appliances are independent appliance dealers, national chain stores, discount stores and department stores. However, since 1990, the retail sector of domestic appliances in the USA has become increasingly dominated by major chains and hypermarkets like Sears, Best Buy, Lowe’s and Home Depot. The three largest chains account for more than half the sales of major appliances. The increasing concentration of distribution channels and general shift of bargaining power from manufacturers to distributors and retailers has prompted manufacturers to adjust their product ranges. Europe With similar market size and maturity to that of the USA, in 1970 the European market was fragmented, with 695 producers covering the region (Allen 1993). By 1980, there were still at least 400 companies in the industry serving the local and regional market: for example, Zanussi, Indesit, Merloni and Candy in Italy, Bosch-Siemens and AEG Telefunken in Germany, Philips

The domestic appliance industry 63 in Holland, Thomson in France, Hoover and GE in Britain and Electrolux in Switzerland. However, four countries – Italy, Germany, France and Britain – predominated and accounted for around 80 per cent of production and consumption (Stopford and Banden-Fuller 1987). In 1983, the top sixteen producers controlled roughly 70 per cent of European supply (Stopford and Banden-Fuller 1987). By 1988, while some 250 producers continued to survive (Allen 1993), six companies – Electrolux Zanussi, Philips Bauknecht, Bosch-Siemens (BSH), Merloni-Indesit, Thomson and AEG – controlled 70 per cent of the market.1 In 1998, there were about thirty-five domestic appliance firms, among which the top three companies – Electrolux, BSH and Whirlpool – owned 40 per cent of the regional market share (Euromonitor 1999).2 In 2002, the top three owned 47 per cent of the market share in the region (FT, 24 February 2002).3 The domestic appliance retail sector is rather fragmented and still in the process of concentration. There are approximately 60,000 retailers all over the region, including trading companies, independent dealers, speciality stores and various discount chains. Japan Japan used to be second only to the USA as a single national market for domestic appliances. The domestic industry has a tradition of oligopoly: the top six major Japanese companies – Matsushita, Hitachi, Mitsubishi, Sanyo, Sharp and Toshiba – held 84 per cent of the market in 1990 (Allen 1993). Matsushita is the market leader in nearly all product categories. Hitachi and Toshiba are fighting for second position while Sharp, Mitsubishi and Sanyo compete in the third tier. These companies are both electrical engineering and electronics producers and have significant levels of backward integration in manufacturing of components. Among their diversified range, major domestic appliances account for 10–20 per cent of their total sales. A significant change is that these companies are offsetting their declining domestic appliance sales by increasing their share of IT equipment and electronics components. For example, sales of Hitachi’s domestic appliances accounted for 20 per cent of total sales revenue in 1980 but these fell to 12.5 per cent in 1992. The domestic appliance industry in Japan is export orientated due to fierce competition and declining demand in the home market. Exports accounted for 28 per cent of output in 1965, 38 per cent in 1975 and 60 per cent in 1980 (Table 3.2). Since 1985, driven by the appreciation of the yen and trade conflicts with other countries, the Japanese companies started overseas manufacturing, mainly in South East Asia. The decrease in the number of employees in Japan, from 400,000 in 1984 to 305,000 in 1989, vividly illustrates the production transfer (Zhu 1998). The economic recession in the early 1990s forced the companies to explore new strategies such as outsourcing assembly production while keeping high value added

64 The domestic appliance industry Table 3.2 Changes in output and exports of Japan’s domestic appliances Period

1960–65 1965–70 1970–75 1975–80 1980–85 1985–90

Output

Export

(%)

(%)

13.4 18.5 11.5 10.8 6.8 3.3

23.9 35.7 15.1 23.9 14.0 −8.7

Source: Zhu (1998).

components production at home and establishing strategic alliances with foreign competitors. The distribution system in Japan is very complex and fragmented, involving several layers of wholesalers, different types of retailers and various trading companies. It is reported that were 85,400 appliance retailers in 1988 (Zhu 1998: 63). One of the distinctive features is that the leading producers have tightly controlled distribution networks with their own sales companies and a large number of company-owned outlets. In the 1960s, the top six companies controlled 55,000 small, franchised retail shops all over the country; Matsushita alone owned 24,000 outlets and 60 per cent of its sales were made through its national network (Zhu 1998). However, the old distribution system faces challenges with the emergence of independent supermarkets, speciality stores and discount chains that sell a diverse range of products. Bargaining power has gradually shifted from manufacturers to independent retailers, who gradually increase their share of the retail market through economies of scale. Global revolution of the industry Different consumer preferences in national markets combined with high shipping costs for finished goods make it uneconomic for producers to export most types of major appliances to other regions of the world. Exceptions to this are microwave ovens, home air-conditioners, compact refrigerators and high-end goods targeted at luxury niches. The total value of international trade in domestic appliance is US$8 billion, accounting for 7.4 per cent of total sales of these items worldwide in 1997.4 The logistical disadvantages can be overcome by direct investment and local production. The domestic appliance industry, initially characterised by a high level of fragmentation, has evolved towards increasing concentration since the 1980s due to the slowdown in the developed markets, which forced management to focus more on minimising costs and exploring new markets. The process was first initiated at national level and then at regional levels, particularly in North America and Western Europe. The consolidation of the industry was

The domestic appliance industry 65 set in motion by Electrolux’s purchase of the WCI group in the USA in 1988, followed by Whirlpool’s purchase of Philips’s major appliance business in Holland in 1989, Maytag’s purchase of Hoover in 1989 and GE’s purchase of a 50 per cent stake in the UK’s GEC appliance business in 1990. The acquisitions gave these companies footholds in both the North American and the European markets. At the global level, the process of concentration was set in motion in the late 1990s, and was characterised by intensive expansion in the emerging markets, particularly in Asia, Latin America and East Europe. The leading companies launched global operations by setting up joint ventures and wholly owned affiliates in the developing countries. Their strategic objectives included: to achieve growth of market and earnings; to reduce costs through economies of scale by manufacturing and purchasing components, and by transferring manufacturing innovations across a wider plant network; to achieve a better focus on the high-tech and high-margin business by shifting the low-end products to the developing countries. It is argued that one of the most important features of the global business revolution is that each industrial sector is dominated by a smaller number of players (Nolan 2001). This is true of the domestic appliance industry as a whole. Although the level of consolidation varies geographically, the trend is very clear. In 2001, the top ten global domestic appliance manufacturers accounted for 43 per cent of the world market in terms of volume, and the top five accounted for 46 per cent of the world market in terms of sales value, a significant proportion in the consumer goods industry (Tables 3.3a and 3.3b).

Table 3.3a The top ten global domestic appliance manufacturers by volume Sales quantity (000s)

Market share (%)

Manufacturer

1999

2000

1999

2000

1 2 3 4 5 6 7 8 9 10

32,104 23,113 14,523 12,344 7,277 7,986 6,107 5,556 6,184 6,080

34,085 24,782 14,952 13,506 8,593 8,346 7,391 7,243 6,287 6,234

11.3 8.1 5.1 4.3 2.6 2.8 2.2 2.0 2.2 2.1

11.3 8.2 4.9 4.5 2.8 2.8 2.4 2.4 2.1 2.1

42.7

43.5

Whirlpool Electrolux GE Appliances Bosch-Siemens Samsung Haier Private Label LG Matsushita Sharp

Total Source: Forbes (6 August 2001).

66 The domestic appliance industry Table 3.3b The top five global domestic appliance manufacturers by value, 2001 Manufacturer

Net sales (US$ million)

Net income (US$ million)

Employees (no.)

Market share* (%)

Electrolux Whirlpool GE Appliances BSH Maytag

12,956 10,343 5,810 5,396 4,158

369 21 643 112 48

87,139 59,000 18,000 35,161 21,581

15.2 12.2 6.8 6.3 4.9

Total

45.4

Sources: Hoover website, 2003; Annual reports, 2002. Note * Market shares are computed by expressing the company’s net sales as a percentage of US$85 billion, the sales value of the world domestic appliance market in 2001 (FT, 24 February 2001). According to Euromonitor (1999), the world market was worth US$124.8 billion in 1998 and US$128.2 billion in 1997; accordingly, the market share of the top five companies was 31 per cent.

The leading companies have shaped the market not only through product innovation, standardisation and influence on the regulations, but also through intensive consolidation of the production platform as well as intensive integration of the supply chain. A closer look at the supply chain shows that each supplying sector is also highly concentrated, with a few major suppliers dominating the market. For example, in the compressor sector, four companies, namely Matsushita, Electrolux, Aspera and Embraco (Whirlpool’s affiliated companies), dominate the world market. In the fractional horsepower motors sector, the leading suppliers are GE, Electrolux and Emerson Electric. There has been extremely close collaboration between the manufacturers and the key suppliers in terms of joint technology development and quality control. To a great extent, suppliers become pre-assemblers of key parts of products, leaving the manufacturer to focus on production with greater value added. Furthermore, the leading companies also set up close strategic alliances with their competitors. A typical example is the pan-European electronic trading venture announced by Electrolux, Whirlpool and Bosch-Siemens in 2002. Under the scheme, the companies will establish a set of Internet sites where Europe’s 60,000 retailers will be able to order products online (FT, 26 November 2001). This will do much to create new standardisation for the distribution system and thus erect entry barriers to new competitors. In the developing economies, the process of consolidation is still going on. In Latin America, although there are around sixty-five manufacturers, the market is increasingly dominated by a few global giants. Whirlpool is the largest player in this market with a share of 17.8 per cent, followed by Group Vitro, Electrolux AB, Organization MABE, BSH and Philips BV

The domestic appliance industry 67 and GE (Euromonitor 1999). In the Asia-Pacific region, the market is diverse with fifty manufacturers serving it. Apart from Haier in China, all the top five players are Japanese manufacturers and South Korean companies like LG and Samsung, which are largely equal in their market share by value. Leading global players and their investment activities in China Electrolux AB ‘I would prefer to grow organically, but sometimes you don’t have the luxury.’ (Michael Treschow, CEO of Electrolux, quoted in Forbes, 24 July 2000)

Electrolux of Sweden is the world’s number one producer of domestic appliances under the brand names Frigidaire, Electrolux, Zanussi and AEG. The group is also the world’s largest producer of floor-care products, lawn mowers, garden tractors and portable petrol-driven garden equipment. It holds 10 per cent of the world market share with net sales of US$13.6 billion in 2002;5 sales of domestic appliances accounted for 77 per cent of total sales (Table 3.4a). Electrolux grew dramatically through extensive mergers and acquisitions. In 1986, the US$150 million takeover of Italy’s Zanussi gave it 23 per cent of the European market, and the US$773 million acquisition of White Consolidated Industries gave it third position in the US market. Other significant acquisitions include the Thorn EMI appliance division in 1987 and ARG Hausgerate of Germany in 1994. Since 1995, further mergers and acquisitions have taken place, increasingly in the developing economies.

Table 3.4a Electrolux’s net sales by product line in 2002 Product line

%

Consumer products White goods Floor-care products Garden equipment Other

84.0 77.0 8.2 14.7 0.1

Professional products Food-service equipment Laundry equipment Components

16.0 44.5 21.4 33.8

Source: Electrolux (2002).

68 The domestic appliance industry Table 3.4b Electrolux’s net sales by region in 2002 Region Europe North America Rest of the world Total

Net sales (SEK million)

Operating income (SEK million)

Operating margin (%)

61,633 53,026 18,491

4,743 3,511 −89

6.8 6.8 0.3

133,150

7,731

6.1

Source: Electrolux (2002).

With a global scale of operations, Electrolux has a very clear global strategy: to build a leadership position in the global market and obtain sufficient volumes in its core areas to minimise costs and product prices. However, in practice, the global march is not an easy task, given that sales revenue still comes mainly from the European and North America markets, which accounted for approximately 50 per cent and 40 per cent respectively of total sales of 2002 (Electrolux 2002). Although the company enjoyed growth in Eastern Europe, in particular in Russia, Turkey and Hungary, and significant shares in the large markets of Brazil, India and China, the overall operating income from the rest of the world was negative, in part due to cut-throat competition and the unstable economic environment (Table 3.4b). Cost cutting and restructuring are the major means to improve performance for Electrolux, as they contribute to the rationalisation of the production and purchase system. The restructuring programme aims to improve productivity; adjusting the cost structure includes consolidation of production, rationalisation of sales and marketing, and cutbacks in personnel. For example, since 1997, more than 14,500 jobs have been cut and twentyseven factories and fifty warehouses shut down (FT, 20 May 2000). A global purchasing council has been set up to coordinate purchasing activities. The company has also increased efforts to improve the supply chain and develop brand building and marketing by reducing the number of local brands and using Electrolux as a global brand. Electrolux entered China in 1995 by establishing a joint venture with the Zhongyi Refrigerator Factory in Changsha. It later expanded investment into the refrigerator compressors and air-conditioner sectors. Its Chinese ventures are geographically focused mainly in big cities like Shanghai, Changsha and Tianjin, where the company has made great efforts to build extensive distribution channels and service networks (Table 3.4c). It is reported that the company had captured 5 per cent of the refrigerator market by 2000, which is significant in the industry (Economic Daily, 18 January 2001). However, due to downward pressure on prices, a less favourable product mix and higher marketing costs, the company is still struggling to make a profit.

The domestic appliance industry 69 Table 3.4c Electrolux’s major investment activities in China Company

Holding (%)

Shanghai Zanussi Elettromeccanica Co. Ltd Philco Air Conditioning Co. Ltd Electrolux Home Appliances (Changzhou) Co. Ltd Electrolux Zhongyi (Changsha) Refrigerators Co. Ltd Zanussi Elettromeccanica Tianjin Compressor Co. Ltd Zanussi Zhongyi (Changsha) Refrigerators Co. Ltd

30 5 100 60 50 60

Source: Electrolux (2002).

Whirlpool Whirlpool holds second place worldwide after Electrolux, with the leading market position in North and Latin America and third in Europe. It markets under eleven major brand names including Whirlpool, KitchenAid, Roper, Inglis and Speed Queen. The company also makes appliances under the Kenmore brand for Sears, Roebuck and Co. In contrast to American companies like GE and Maytag which have limited their domestic appliance operations to North America, Whirlpool started presenting itself as a global domestic appliance manufacturer soon after making significant acquisitions within the USA. In 1985, it took a majority interest in Inglis, Canada’s second largest appliance company. In 1986, it acquired a 65 per cent interest in Aspera, an Italian compressor manufacturer. In 1989, Whirlpool purchased N.V. Philips’s troubled European appliance business for US$1 billion. In 1995, Whirlpool merged two of the Brazilian affiliates, Brastemp S.A. and Consul S.A. into a new entity, Multibras S.A. In 2000, Whirlpool purchased additional shares in its Brazilian subsidiaries Bransmotor and Multibras for US$283 million, bringing its equity interest in these companies to approximately 94 per cent. In 2002, it acquired Polar S.A. of Poland and Vitromatic S.A. de C.V. of Mexico. The company has carried out manufacturing and servicing operations at forty-eight locations, thirty-six of which are located in twelve countries outside the USA (Tables 3.5a and 3.5b). The intense competition in the industry has forced the company to cut costs by making improvements in productivity and carrying out restructuring programmes. It now operates a global manufacturing system by using a standard platform to compete in most global markets while customising products for some local markets and preferences. In 1998, a new global development organisation was introduced to replace its traditional regionally based design and development work, with the aim of increasing the integration of its global business and improving efficiency and productivity in each business unit. Whirlpool has increased its efforts in customer service and branding. As a key to its global marketing strategy, Whirlpool has made extensive use of the Internet to improve its relationship with its consumers.

70 The domestic appliance industry Table 3.5a Whirlpool: selected performance data, 2002 Region

North America Europe Latin America Asia Other Consolidated

Net sales % of total Operating (US$ net sales profit million) (%) (US$ million) 7,306 2,199 1,266 391 (146)* 11,016

Gross margin (US$ million)

Employees (no.)

66 20 11 3

830 81 107 14

22.6 22.2 23.4 23.7

32,000 14,000 17,000 5,000

100

692

23.2

68,000

Source: Whirlpool (2002). Note * Elimination.

Table 3.5b Whirlpool’s sales of domestic appliance products by region, 2002 Region

Units sold (000s)

North America Europe Latin America Asia Other

24,324 11,024 4,386 2,279 (31)*

Consolidated

41,982

Share of total units sold (%) 58 26 10 5 100

Source: Whirlpool (2002). Note * Elimination.

It has adopted a segmented approach to branding in North America, with its main brands aimed at different price and value points in the market. For example, its mainstream brand, Whirlpool, is marketed as the brand that helps consumers manage their homes better. Two new brands have been introduced to target the premium end of the market – Whirlpool Gold, for busy consumers who want quality, and KitchenAid Classics, for the buyer wanting top-of-the-range quality. In China, Whirlpool has a different philosophy from its competitors; its Chinese ventures are geographically dispersed, allowing it to leverage distribution, warehousing, logistics and other skills. Whirlpool entered China in 1995 through aggressive investment and joint ventures with local companies, including Beijing Snowflake in refrigerators, Shenzhen Raybo in air-conditioners, Shunde SMC in microwave ovens and Shanghai Narcissus in washing machines. However, the unexpectedly tough competition in China’s market and continued substantial losses led the company to rethink its strategy. In 1998, Whirlpool withdrew from the refrigerator and

The domestic appliance industry 71 air-conditioner sector, and focused on microwave ovens and washing machines. It purchased the remaining ownership in Whirlpool SMC Microwave (Shunde) Product Company and Whirlpool Narcissus Co. Ltd, and later merged the domestic sales and marketing operations of the two companies. The microwave factory in Shunde became the production base for its global markets. The long-term strategy for Whirlpool in China is to continually build brand awareness and loyalty in the consumer market and achieve leadership in the high-end component market. It is worth mentioning that Embraco, its Brazilian affiliate in the compressor business with manufacturing operations in Italy, Slovakia and China, is one of the top three refrigeration compressor manufacturers in China. GE Appliances General Electric Co. is one of the largest conglomerates in the world. Its products include large appliances; lighting products; industrial automation products; medical diagnostic imaging equipment; motors; electrical distribution and control equipment; locomotives; power generation and delivery products; nuclear power support services and fuel assemblies; commercial and military aircraft jet engines; and advanced materials, such as plastics, silicones and quartz. Its sales revenue reached US$132 billion in 2002, with domestic appliance sales of US$6.1 billion accounting for 4.6 per cent of the total sales (Table 3.6). GE Appliances, the main subsidiary of General Electric, is the second largest major household appliance manufacturer after Whirlpool in the USA. It sells its appliances with brand names including GE, Monogram and Profile to retailers and building contractors. Although GE Electric is a global company with operations across the world, GE Appliances is much less international in scope than GE as a whole, being principally an American operation, with relatively small interests in Asia and Europe. Its main European operation is GDA (General Domestic Appliances), a joint venture with GEC of the UK established in 1989. GE Appliances controlled 6–7 per cent of the world domestic appliances market and its affiliated company GDA controlled a further 0.9 per cent in 1998.6

Table 3.6 GE: selected performance data, 2001 Region

Sales revenue (US$ million)

Profit (US$ million)

Operating margin (%)

Employees (no.)

GE Electric Co. GE Appliances

126,000 5,810

13,684 643

19.6 n.a.

218,000 18,000

Source: GE (2001). Note: n.a. = not available.

72 The domestic appliance industry GE Appliances is struggling to cut production costs to face intense competition. In doing so, it outsourced most of its non-value-added processes and relies entirely on its component and parts suppliers. The key suppliers are encouraged to participate in GE’s Six Sigma quality programme and to become involved in new product development. It appears that, at least in Europe, GE no longer regards white goods as a core part of its business portfolio – which in recent years has increasingly focused on financial services and high-value engineering products such as jet engines. In 2002, the group combined GE Appliances and its lighting division to form GE Consumer Products (GECP). By 2001, GE had established more than thirty joint ventures or wholly owned companies in China with total investment of US$1.5 billion and 8,700 employees. However, most of its investment went into engineered materials, lighting products, medical equipment and so on. GE Appliance is very cautious about investing directly, in the domestic appliance sector, given its severe over-capacity.7 Rather, it serves upstream markets such as plastics and electronic controls, and selects local manufacturers on the basis of its strict Six Sigma programme as long-term OEM suppliers. The final products are exported to the US market. In 2000, GE purchased domestic appliances through its suppliers with product value of US$170 million (China Appliance, September 2001: 16). The Aucma Group, a local refrigerator and freezer producer, is one of GE Appliance’s OEM suppliers. The case study of Aucma will be discussed in detail in Chapter 6 below. Maytag This company is the number three manufacturer of domestic appliances in the USA, after Whirlpool and GE. It sells washers, dryers, dishwashers, refrigerators and cooking appliances under the high-end brand names Maytag and Jenn-Air and the lower-priced brands Magic Chef and Admiral. Maytag also makes Hoover vacuum cleaners and Dixie-Narco beverage-vending machines. Its sales in 2002 reached US$4,421 million of which 95 per cent came from domestic appliances (Maytag 2002). Maytag’s strategy includes offering ‘great products, great consumer value, and a great consumer brand to support both product and value’. In 2000, Maytag announced the formation of an enterprise-wide global supply chain to consolidate and coordinate procurement, manufacturing and logistics across the corporation. It also signed an agreement with ServiceNet Inc. to manage the company’s extended warranty and service contract programmes. The multi-brand warranty programme allows retailers to sell Maytag-branded extended warranty and service contracts not only on Maytag products but also on all appliances and consumer electronic products carried by its stores (Appliance Manufacturer, 8 May 2000). In 1996, the company invested US$70 million in acquiring a 50.5 per cent ownership of a joint venture, Rongshida Maytag, in Hefie, China, which

The domestic appliance industry 73 manufactures laundry products and refrigerators. Half of the investment was to go on upgrading an existing washing machine production line, while the other half was for the ‘greenfield’ development of refrigerator manufacturing (Jancsurack 1999). Rongshida Maytag comprises six manufacturing joint ventures: a washing machine company, three washing machine components companies, a mould company and a refrigerator company. To further extend its marketing reach, Maytag acquired a domestic washing machine maker, Three Gorge Company, in Sichuan Province. In contrast to other multinationals which have sought to use their foreign brand name to establish themselves in China, Maytag has taken a different approach. The products are primarily marketed under the Rongshida brand name, through the existing solid national distribution network in China. However, due to the competitive environment in China’s market, the company has sustained major losses, especially in the refrigerator market. Its unsatisfactory performance has made the company consider cutting back operations. BSH Group BSH drives the development of the global home appliance market forward, instead of following on behind. We provide the market with the impetus we need to achieve high-quality growth. This power to shape the course of events embraces every aspect of our activities, from development and production right through to marketing. This safeguards our ability to cope with the future, an ability that rests on our own particular strengths. . . . By creating value, we shape markets. By shaping markets, we create value. (Dr Gutberlet, chairman of the Board of Management, quoted in BSH (2002) )8

As the 50–50 joint venture of Robert Bosch and Siemens, BSH’s major appliances include ovens, dishwashers, microwaves, washing machines, air-conditioners, refrigerators and vacuum cleaners. It also makes small appliances such as coffee makers and hair dryers. The company’s primary brands are Bosch and Siemens, but it also produces a dozen regional brands, including Balay, Constructa, Gaggenau, Neff, Thermador, Ufesa and so on. Its long-established brand power is based on reliable and durable products. In 1998, BSH accounted for 5.2 per cent of the world domestic appliance market (Euromonitor 1999). Its major strength is in Western Europe where it is the second largest manufacturer after Electrolux. BSH emerged as a global player between 1990 and 2000. In 1990, it had factories only in Germany, Spain and Greece; it expanded quickly through acquisitions and new developments. For example, in 1998 it acquired Ufesa, the Spanish and Portuguese market leader in the small appliance sector, and Eval, a Turkish small appliance maker. By 2003, it operated twenty-two production sites in Western and Eastern Europe, including France, Poland,

74 The domestic appliance industry Table 3.7a BSH’s net sales by region in 2001 Region Europe Western Europe Germany Eastern Europe North America Latin America Asia Other Total

% of total net sales 83 49 29 5 6 5 5 1 100

Source: BSH (2002: 29).

Table 3.7b BSH’s sales by product group in 2001 Product Cooking Refrigeration/freezing Washing/drying Dishwashing Consumer products Customer service Other Total

% of total units sold 28 21 20 16 9 4 2 100

Source: BSH (2002: 29).

Russia, Croatia, Slovakia and Turkey. Sales in European markets accounted for 83 per cent of total net sales in 2002 (Tables 3.7a and 3.7b). BSH has a strong presence in North and Latin America, with operations in the USA, Brazil, Argentina, Mexico and Peru. It enjoys a leading position in the refrigerator and cooker sectors in these markets. However, it is now targeting the South East Asian region as the strategic market. In October 2000, BSH and Hitachi of Japan set up a US$5 million joint venture to produce washing machines serving the South East Asian market as well as Australia and New Zealand. In 1995 the company entered China where it acquired a local refrigerator manufacturer in Chuzhou and later set up a JV with Little Swan to produce washing machines in Hangzhou. BSH enjoys exceptional success in the Chinese market with sales expanding from virtually nothing in the mid1990s to about a200 million in 2002. Its Siemens-branded automatic washer-dryers, targeted at rich families, has captured around 55.4 per cent of the market with a retail price above RMB5,000 per unit (China Appliance, August 2001: 20) (Table 3.7c).

The domestic appliance industry 75 Table 3.7c BSH’s major investment activities in China Company

Holding (%)

BSH Household Appliances Co. Ltd, Wuxi Anhui BSH Cooling Appliances Co. Ltd, Chuzhou

60 100

Source: BSH (2002).

The key strategic theme of BSH is to become a global leader by expanding outside Germany and Europe, and by shaping the global market through its positive impetus. Its production strategy is to keep manufacturing close to the market, so that products can meet regional requirements, thus serving them better and faster. Its marketing strategy is to focus on ‘branding’ and ‘differentiation’ by targeting the high-end market. R&D accounted for 2.4 per cent of total sales in 2001. Matsushita Electric Industrial Matsushita held 5.7 per cent of the world domestic appliance market in 1998. It has manufacturing and sales operations in every major regional market with five principal brands: National, Panasonic, Technic, Quasar and JVC. The majority of its turnover is still derived from its national market in Japan. Its main strength lies in the Asia-Pacific region where it is the regional leader and its market strength is largely confined to Japan. Domestic appliances and household equipment have been of declining importance to the group since 1996. In 2003, net sales of home appliances accounted for 11.9 per cent of its total sales (Table 3.8a). Matsushita aims to improve its internal organisation and market focus in order to expand international operations and reform sales structures. It is establishing a global manufacturing system, based on the concept of a strategic international division of labour. At the same time, it also supports Table 3.8a Matsushita’s net sales by product line in 2003 Net sales Product line

(US$ million)

(% of total sales)

Electrical construction materials Home appliances Building products Electronic and plastic materials Automation controls Other

4,333 1,355 3,068 840 1,363 353

38.3 11.9 27.2 7.4 12.0 3.1

Source: Matsushita (2003).

76 The domestic appliance industry Table 3.8b Matsushita’s major investment activities in domestic appliances in China Company Hangzhou Matsushita Home Appliance Co. Ltd Hangzhou Matsushita Home Appliance and System Co. Ltd Hangzhou Matsushita Kitchen Appliance Co. Ltd Matsushita-Wanbao (Guangzhou) Electric Iron Co. Ltd Guangzhou Matsushita Air Conditioner Co. Ltd Shanghai Matsushita Microwave Oven Co. Ltd Wuxi Matsushita Refrigeration Co. Ltd Wuxi Matsushita Refrigeration Compressor Co. Ltd Source: Online. Available http://panasonic.co.jp/appliance/global/company/cc_0004.html9 (accessed 30 June 2003).

individual manufacturing systems in each region. The company is aiming to sustain growth by focusing on its fastest-growing businesses, such as semiconductors, mobile phone components and digital TV systems. Unlike many of its Western rivals which adopt a multi-branded strategy, Matsushita has adopted a single global brand strategy outside its home market. A key factor behind this strategy is that outside Japan Matsushita mainly markets microwave ovens and consumer electronics, while supplying the components on a global basis. Matsushita has been marketing its products in China since the mid-1980s and has established more than fifty joint ventures and subsidiaries with total investment of US$1 billion and 40,000 employees (Table 3.8b). Its sales revenues reached US$2.4 billion in 2001. Matsushita has been fairly well positioned in the local market and has enjoyed a significant market share in a wide range of products, including consumer electronics, domestic appliances and components. For example, the Panasonic refrigerator and National washing machine are among the top ten brands in China. Matsushita is also one of the largest suppliers of air-conditioner compressors and colour screen tubes in China. The company continues to give close attention to business expansion in China. It is shifting its production bases there, with new investment focusing on semiconductor, integrated circuit and component development, recreating its integrated manufacturing, sales and technology system. To face China’s severe competitive environment it has set up a strategic alliance with LG of South Korea in the air-conditioner and microwave oven sector in order to compete with local companies. Concluding remark Global firms in the appliance industry enjoy several distinctive competitive advantages:

The domestic appliance industry 77 1 2 3 4

5 6

They enjoy a large global market share backed by the power of strong brand names. They own sophisticated and advanced worldwide distribution systems. They have highly integrated manufacturing systems. They use shared product platforms and standardised components that can reduce the cost of product variations and can respond to customers’ preferences flexibly and at high speed. They are well able to integrate across the value chain within the relevant sector and are better integrated with key suppliers at a global level. They have very strong capabilities for continuous development of new products with strong capital support.

It is apparent that the investment patterns undertaken by multinational companies in China depend on their different strategies. For example, companies like Bosch-Siemens and Electrolux target the high-end market; companies like GE purchase final products through OEMs and supply raw materials; companies like Matsushita and LG dominate the core components market and finished product manufacture through aggressive marketing. China’s commitment to further opening up to international markets, particularly its entry into the WTO, has induced foreign companies to implement new strategies in their investment activities. This has had a significant impact on competition in the industry, as well as on the concentration of manufacturers. The effect has been to make China’s local enterprises rethink their own strategies and positions in the global industry and market. The following section will take a closer look at the industry in China.

Overview of China’s domestic appliance industry History of the industry Like many other industries, the domestic appliance industry in China has gone through several stages of development, in keeping pace with the expansion of the ongoing economic reform and opening to the world economy. Before 1949, the industry was almost non-existent, apart from a few firms producing some small domestic appliances, such as electric fans, irons and electric stoves. Inspired by foreign products, the government started trial production of major domestic appliances in the late 1950s. The first refrigerator with open compressor was produced in the Shenyang Medical Equipment Factory in 1954 and the first refrigerator with sealed compressor in the Tianjin Medical Machinery Factory a year later. The first vacuum cleaner appeared in 1962 and the mono-phase air-conditioner in 1964. However, trial production was suspended during the Cultural Revolution. In 1975 there were approximately seventy-five domestic appliance enterprises in China, producing thirty-one products, mainly small appliances, with an annual turnover of RMB230 million. By 1977, the accumulated

78 The domestic appliance industry output of refrigerators was 150,000 units, all of which were allocated to party members. It was not until the late 1970s that the industry was selected by the national government for investment. Various industrial policies initiated by the central government provided local governments and companies with great incentives to invest. The emerging indigenous manufacturers were equipped with imported production lines and technology. This large-scale investment led to a rapid increase in production. In the refrigerator sector, for example, annual output increased from 55,600 units in 1981 to 1.45 million units in 1985. However, the output was far from meeting the dramatically increasing demand. The gap was filled by imports which took nearly 50 per cent of the market (Gong 1993). Imports of refrigerators rose from 18,700 units in 1981 to 979,000 units in 1985 (Gong 1993). The second half of the 1980s witnessed significant expansion of the industry, with impressive numbers of indigenous firms entering the market. Locally manufactured products began gaining ground during this period. This was partly due to the significant demand driven by improvements in living standards. Also, the economies of scale achieved were strongly stimulated by heavy protection of domestic producers. Import barriers, such as tariffs, import quotas and foreign currency restrictions, played a significant role in shaping the industry. For example, prior to 1993, the import tariff for refrigerators was 100 per cent and the tariff for components and spare parts was 80 per cent.9 The whole industry entered a phase of restructuring in the late 1980s because the restrictions imposed by economic policies had created a slowdown in demand. Facing overcapacity of production and fierce competition, few new firms entered although the industry witnessed the emergence of famous local brands such as Haier and Kelon, among the numerous existing manufacturers. These firms paid great attention to quality and service and became well established in the market. On the other hand, those that merely managed to meet the requirements of quantity but ignored quality ran into trouble. For example, previously famous state-owned companies like Snowflake in Beijing and Kenai in Tianjin faced difficulties in selling their refrigerators, and had huge amount of products in stock. However, rather than leaving the industry, the poorly performing firms sought support through either local government or foreign partners. China’s policy of opening to the rest of the world induced more and more foreign companies to invest there. Since 1992, the industry has witnessed the second wave of investment initiated by foreign companies.10 The global leaders such as Electrolux, Whirlpool, Maytag, GE, Matsushita and Bosch-Siemens entered China’s market.11 They either set up joint ventures by acquiring a majority share or established wholly owned subsidiaries. In the past few years, foreign brands have shown a strong presence in the Chinese market, with increasing market share and market value, particularly at the high end. Furthermore, they also dominate the supply of components like compressors, which are capital intensive and technologically advanced.

The domestic appliance industry 79 By any standard, the achievement of China’s domestic appliance industry is extremely significant. After two decades of development, the industry has built up a huge production capacity, making China one of the leading producers in the world. In 1998, China produced 10.14 million refrigerators, 12.07 million washing machines and 8.5 million air-conditioners, accounting respectively for 16, 24 and 30 per cent of world production. It became the third biggest appliance producer after the USA and Japan (CDAA 2000). In 2002 the output of the three major appliances reached 15.99 million, 15.87 million and 31.35 million respectively (CDAA 2003), making China the second largest market after the USA (see Table 2.2). Supply and demand Demand The economic growth driven by the reforms and open policy since the 1980s has made China one of the largest consumer markets in the world. The demand for domestic appliances in China was driven by several factors, including: (1) increasing revenue and the improvement of living standards; (2) the decreasing price of the products combined with improved quality; (3) the improvement of infrastructure, for example the improved supply of electricity which has increased the ownership of domestic appliances in urban areas since 1980; (4) the housing reform and the development of property ownership. However, the demand for domestic appliances shows an uneven growth due to variations between urban and rural markets. By far the most demand comes from the urban market. In urban areas, the ownership of refrigerators and washing machines is 85.4 per cent and 90 per cent respectively, and new demand will come from replacement. By contrast, the rural market is still in its infancy with very low ownership. Even for refrigerators, ownership is only 8–9 per cent (Table 3.9). According to studies and surveys, two

Table 3.9 Ownership of domestic appliances in China (per 100 households) 1985

2002

Product

Urban

Rural

Urban

Rural

Refrigerators Washing machines Air-conditioners Electric fans Microwave ovens Vacuum cleaners

6.58 48.79 11.60 73.91 Nil Nil

0.06 1.90 Nil 9.66 Nil Nil

91.88 94.32 43.76 171.73 53.28 11.74

44.47 37.24 Nil 126.07 14.45 n.a.

Sources: CDAA (2000); SSB (2003). Note: n.a. = not available.

80 The domestic appliance industry of the major reasons for the low penetration rate in rural areas are low income and high electricity charges. Different domestic appliances show different growth rates due to their product life cycle. The refrigerator and washing machine markets grow relatively slowly because of the high penetration rate in the urban market. By sharp contrast, air-conditioners represent by far the fastest-growing sector with great market potential. Sales of air-conditioners rose from 0.64 million units in 1992 to 7.5 million units in 1999, a twelvefold increase (China Appliance, November 2001: 14). Demand grew by 19.2 per cent and exports by 63.5 per cent per year on average from 1997 to 2001. By 2001, China surpassed America and became the world’s largest market for room air-conditioners with demand of over 12.50 million units, or 29.43 per cent of world demand (CDAA 2002). It is predicted that the demand will continue to increase and total output will reach 24 million units by 2005 with exports of 10.8 million units (China Appliance, November 2001: 14). It is predicted that by 2008, the overall demand for domestic appliances in China will increase to 76 million units, accounting for 21.19 per cent of world demand. The sales value of the four major products is predicted to be RMB243 billion (US$29.3 billion), giving an average annual growth rate of 10 per cent, which is much higher than the annual growth rate of 4 per cent in the global industry (CDAA 2001). Supply After two decades of development, the industry has established a huge production base, which is extremely strong in the assembly process and weak in core component production. The huge production capacity it has built up makes China one of the leading producers in the world, with output of major domestic appliances accounting for approximately 20 per cent of world output. A careful study by the Japanese Refrigeration Industry Association shows that Chinese-manufactured air-conditioners captured 43 per cent of the global market in 2001, making China the largest producer and exporter in the world. It is worth pointing out that the Haier Group, a leading domestic appliance company in China, was ranked sixth largest global manufacturer in terms of volume in 2001 (Forbes, 6 August 2001). One feature of the industry is overcapacity of production. A survey shows that only 50 per cent of the manufacturing capacity was utilised in 1996 (Table 3.10). The overcapacity created intense competition between firms which were struggling to expand and advance through economies of scale and scope. The average production capacity of the top four refrigerator manufacturers was less than 100,000 units in 1985, increasing to 500,000 units in 1990, 1 million units in 1995, and 2 million units in 2000 (Table 3.11). The competition accelerated the speed of concentration in the industry, which witnessed the emergence of a few big companies and famous brands. The production concentration of the top four manufacturers was 59.06 per cent

The domestic appliance industry 81 Table 3.10 The manufacturing capacity utilisation rates for major domestic appliances in China, 1996 Product

Production capacity in 1995 (000s)

Output in 1996 (000s)

Utilisation rate (%)

Washing machines Refrigerators Air-conditioners Vacuum cleaners Extractor fans Electric water heaters

21,832 18,208 20,354 12,836 8,925 1,989

10,747 9,796 7,862 8,797 3,092 881

49.2 53.8 38.6 68.5 34.6 44.3

Source: CASS (1998: 295).

Table 3.11 The average output and concentration rate of the top four firms in the refrigerator and washing machine sector Year

1982 1985 1988 1990 1996* 2000 2001

Refrigerators

Washing machines

Total output (million)

Average output (million)

CR4 (%)

Total output (million)

Average output (million)

CR4 (%)

1.01 14.48 75.76 46.31 97.97 127.85 132.10

0.19 1.43 5.50 5.10 n.a. 19.00 n.a.

74.5 39.4 29.0 44.0 65.1* 59.1 56.0

25.33 88.72 104.67 66.27 107.47 144.30 133.40

1.34 4.60 6.22 6.02 7.24* 20.00 n.a.

21.1 20.7 5.3 6.3 n.a. 57.3 n.a.

Sources: Data before 1996 from Jiang (1999); others from CDAA (2002). Note * The data in 1996 are CR6. n.a. = not available.

for refrigerators, 59.86 per cent for washing machines and 38.23 per cent for air-conditioners in 2000 (Table 3.12). Restructuring is going on, and observers predict a 50 per cent elimination rate over the next 5–10 years. Exports Exporting is the most important way to absorb the oversupply of production. In fact, domestic appliances have been China’s fastest-growing export products with an annual growth rate of 20 per cent since 1995 (Tables 3.13a and Table 3.13b). In 2002, total exports of domestic appliances were worth US$8.959 billion, 28.41 per cent up on 2001, accounting for 2.2 per cent of total exports. With US$6.75 billion of trade surplus, exports of domestic appliances accounted for one-fifth of China’s total trade surplus (CDAA 2003).

Table 3.12domestic Industrialappliance concentration of China’s domestic appliances, 2000 82 The industry Product

Manufacturer

Output (unit)

Share of the total output (%)

Refrigerators

Haier Kelon Meiling Xinfei

3,053,945 2,414,110 1,003,288 1,079,655

23.87 18.89 7.85 8.45

Total Washing machines

59.06

Little Swan Haier Rongshida Jingling

3,581,738 3,061,871 1,242,961 823,067

Total Air-conditioners

24.32 21.22 8.61 5.70 59.86

Haier Meide Gree Chunlan

2,100,630 1,941,073 2,005,979 1,101,798

Total

11.50 10.62 10.08 6.03 38.23

Source: CDAA (2002).

Table 3.13a China’s imports and exports of domestic appliances, 1993–2001 Year

Import

Export (US$ million)

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

n.a. n.a. 800 1,020 950 930 1,260 1,427 1,780 2,209

670 1,500 2,320 2,750 3,210 3,520 4,220 5,623 6,929 8,959

Sources: CDAA (2000); data of 2001 from Xinhua News (2002); SSB (2003).

Table 3.13b China’s major exports of domestic appliances by volume, 1995–2000 Year

Refrigerators (000s)

Washing machines (000s)

Air-conditioners (000s)

Microwave ovens (000s)

1995 1996 1997 1998 1999 2000

980 1,020 1,240 1,450 2,130 4,050

500 560 710 640 1,000 1,000

290 480 840 1,180 2,010 3,870

940 1,500 2,080 3,270 5,820 n.a.

Source: CDAA (2001).

The domestic appliance industry 83 Though still serving the low-end global market, the exports of domestic appliances imply progress in the manufacturing capability of domestic companies. To capture a greater global market share, the industry was targeted as an export-orientated sector by the government. Under the ‘marching out’ strategy initiated by the central government, domestic firms were encouraged to start overseas manufacturing. A notable case is the Haier Group, which has built thirteen plants all over the world. Dependence on international markets is likely to be increased by China’s entry into the WTO, which necessitates big cuts in tariffs and elimination of discrimination against foreign companies. It is argued that, in return, Chinese companies will enjoy cheaper raw material imports and lower barriers in their own export markets. However, this might not be the case, given that exports from China face continuous anti-dumping measures and various protectionist actions from the developed economies. Visible trade barriers are playing less important roles while invisible barriers such as regulation and standardisation become more significant. A recent example is that on 13 February 2003 the European Union published two regulations, the Regulation on waste electrical and electronics equipment and the Regulation on restriction of the use of certain hazardous substances in electrical and electronic equipment, which came into force on 13 August 2004. The regulations will greatly affect Chinese domestic companies, as the substitution of hazardous materials and the reclamation of waste products will increase the cost of both production and marketing. Competitive advantages and disadvantages The competitive advantages It is widely accepted that China’s domestic appliance industry has achieved great success in its twenty years’ development, under a favourable political and economic environment. Thanks to the strong support of different levels of government, domestic firms grew extremely quickly. The vast domestic market enabled them to achieve economies of scale within a very short time, while they enjoyed advantages over foreign companies at the same time in terms of price, brand, local preference and distribution channels. By 2001, domestic companies accounted for 80 per cent of the market share (Table 3.14a). This is the one of the few industries which are believed to have the potential for technical advance to meet global competition. In particular, the Haier Group is considered a serious competitor with the potential to become a global player in the near future. The industry enjoys the great advantage of low labour costs. Also, it has attracted skilled design and production engineers. However, this suggests that we should be very careful in drawing any conclusions on the competition between local and foreign firms, given that the real battle is still in its infancy and will become more intense with the ongoing consolidation of

84 The domestic appliance industry Table 3.14a The market share of the top ten domestic appliance brands in China, 1999 Refrigerators

Air-conditioners

Automatic washing machines

Brand

Market share (%)

Brand

Market share (%)

Brand

Market share (%)

Haier Rongsheng Xinfei Siemens Meiling Changling Electrolux Panasonic Samsung Sharp Others

28.8 15.9 12.6 10.1 9.0 5.3 4.8 2.2 1.9 1.6 7.8

Haier Meide Chunlan Hisense Gree Hitachi Mitsubishi Kelon LG Changhong Others

33.6 12.5 7.8 6.5 6.2 5.4 4.7 4.4 3.5 2.7 12.7

Little Swan Haier Rongshida Sanyo Matsushita Jingling LG Little Duck Hitachi Weili Whirlpool Others

30.0 24.6 14.2 7.7 5.8 4.9 2.4 2.1 1.9 1.6 11.6

Source: Beijing Youth Daily, 17 February 2000.

the industry. China’s huge and fast-growing domestic market certainly constitutes a great incentive for foreign firms to enter. Although global companies already have a strong presence in the market, the outcome is rather mixed, with few in profit and more in loss. However, since the Chinese market is strategically important to their long-term strategy, rather than being a short-term focus, they will not give up. If they reduce their investment in China, then the industry may consolidate more quickly, which would be unfavourable for them in the future. The consequence of the intensifying competition is clear. The evidence shows that although the major domestic players are relatively stable in their positions, the production concentration of major domestic appliances has decreased and foreign brands have an increasing presence in terms of market share. For example, in the refrigerator sector, foreign brands from Electrolux, Siemens and Samsung now have more than 20 per cent of the Chinese market, owing to their increasing efforts on their distribution network, local production and intensive marketing (Table 3.14b). Foreign companies’ share of total washing machine sales in China rose from about 15 per cent in 2000 to more than 25 per cent in the first six months of 2003. In some of the most profitable lines such as fully automatic machines, the foreign share has gone from 15 per cent of the national market in 1999 to 42 per cent (FT, 11 September 2003). In addition to market share, export performance also clearly indicates the trend. For example, in the first quarter of 2002, output and exports of foreignbranded refrigerators accounted for 22 per cent and 25 per cent respectively of the overall output in China; output and exports of foreign-branded

The domestic appliance industry 85 Table 3.14b The market share of the top ten refrigerator companies in China Brand

2000 (January–September)

1999

Sales volume (000s)

Sales volume (000s)

Share (%)

1998 Share (%)

Sales volume (000s)

Share (%)

Haier Rongsheng Xinfei Meiling Samsung Hualing Electrolux Siemens Changling Wanbao

2,530 2,150 1,000 840 790 410 360 350 320 230

28.2 23.9 11.1 9.4 8.8 4.6 4.0 3.9 3.5 2.6

2,590 2,610 1,220 900 710 250 290 300 320 280

27.4 27.6 12.9 9.5 7.5 2.6 3.0 3.1 3.4 3.0

2,240 2,520 1,050 1,030 340 320 170 40 480 330

26.3 29.6 12.3 12.1 4.0 3.8 2.0 0.5 5.5 3.9

Total

8,980

100.0

9,470

100.0

8,520

100.0

Source: Economic Daily, 18 January 2001.

Table 3.15 Output and exports by JVs as a percentage of total Chinese output and exports, first quarter 2002

Output Export

Refrigerators (%)

Washing machines (%)

Air-conditioners (%)

Microwave ovens (%)

22 25

20 32

30 57

42 59

Source: CDAA (2003).

Table 3.16 Compressor exports by JVs as a percentage of total Chinese exports Year

Refrigeration compressors (%)

Air-conditioner compressors (%)

2000 2001 2002

33 32 41

90 86 88

Source: CDAA (2003).

air-conditioners accounted for 30 per cent and 60 per cent respectively (CDAA 2003); output and exports of foreign-branded microwave ovens accounted for 40 per cent and 60 per cent (Table 3.15). Exports of foreignbranded air-conditioner compressors and refrigerator compressors accounted for 88 per cent 41 per cent respectively (Table 3.16).12

86 The domestic appliance industry Competitive disadvantages TECHNICAL DISADVANTAGES

During the last two decades, the development of the domestic appliance industry has followed the pattern of importing complete production lines and technology, then digesting the technology and substituting domestic products for imports. The domestic companies began as assemblers of simple products, then set up JVs with foreign companies while constantly and systematically building up their own competence, skills and resources. For example, Little Swan, one of the leading washing machine producers, has deals with Bosch-Siemens of Germany, Panasonic and Fuji Motors of Japan, Merloni of Italy and Schulthess of Switzerland for different types of washing and dishwashing machines. It also has R&D partnerships with NEC of Japan and Motorola of America. However, they are still not independent of foreign technical assistance, and rely heavily on importing core components and key equipment. The gap is considerable in terms of innovation and design capability. For example, China imports 50 per cent of air-conditioner compressors to meet its demand for annual output of 30 million air-conditioners (CDAA 2003). China has become the largest supplier of microwave ovens, but the key components – the magnetic control tubes – are supplied by foreign companies. Technological development covers a wide range of aspects such as computer assisted design (CAD), intelligent control, frequency, energy efficiency, noise level reduction, new materials (e.g. CFC substitution) and recycling issues. In refrigerator and air-conditioner production, for example, new technology used in the compressor includes frequency, vortex and double rotor. The technological development of the domestic appliance industry is connected to the development of other industries including steel, plastics, chemicals, electronics and machine tools. Obviously, technological disadvantages in the heavy industries in China create barriers for the domestic appliance industry. CORE COMPONENTS

The development of domestic appliances in China started with the import of assembly lines. Core components and spare parts were also imported. Domestic production of components was not a target until the late 1980s. In the case of refrigerator compressors, production equipment and technology were first introduced in 1983. By 1990, domestic companies produced fewer than 3 million compressors, far below the demand resulting from production of 8 million refrigerators (Yang 2000: 178). Also, refrigerator manufacturers preferred to purchase compressors from foreign companies rather than from local makers due to their quality difference. The breakthrough took place in 1995, when more and more foreign companies set up joint ventures, thus improving quality. Twenty companies produced 18 million

The domestic appliance industry 87 Table 3.17a The major manufacturers of refrigerator compressors in China Manufacturer

Output in 2000 (million units)

Beijing Embraco Snowflake Compressor Co. Jiaxibeila Compressor Co. Ltd Wanbao Refrigeration Group Co. Ltd Zanussi Electric Appliance Mechanical (Tianjin) Compressor Co. Ltd

13.340 n.a. n.a. 0.835

Source: Guangzhou Daily, 8 January 2003. Note: n.a. = not available.

Table 3.17b The major manufacturers of air-conditioner compressors in China Manufacturer

Output (September 2001–July 2002) (million units)

Output in 2000

Shanghai Hitachi Co. Ltd Guangzhou Panasonic Wanbao Co. Ltd Guangdong Meizhi Co. Ltd* Shenyang Huarun Sanyo Co. Ltd Misubishi Electric Engine Co. Ltd Xian Anqing Co. Ltd* Zhuhai Lingda Compressor Co. Ltd LG Electronic (Tianjin) Co. Ltd

410 400 320 260 240 240 n.a. n.a.

318 247 257 155 167 108 85 71

Sources: Guangzhou Daily, 8 January 2003; China Appliance, October 2001, p. 23. Note * Guangdong Meizhi Co. Ltd is a JV between Meide Group and Toshiba of Japan. ** Xian Anqing Co. Ltd is a JV between Anqing and Gulun Co. of America. n.a. = not available.

units in 2002, and twelve of these accounted for 80 per cent of the market. The top four manufacturers are all joint ventures with global players including Electrolux, Whirlpool and Matsushita (Guangzhou Daily, 8 January 2003) (Table 3.17a). In the air-conditioner compressor sector, the top four manufacturers are joint ventures with Japanese companies including Toshiba, Hitachi, Matsushita and Sanyo, with an annual output of 15 million units (Guangzhou Daily, 8 January 2003) (Table 3.17b).13 MATERIAL SUPPLY

The development of the domestic appliance and other industrial consumer goods sectors created substantially increased demand for heavy industries such as steel, chemical fibres and plastics. However, the poor performance of China’s heavy industries, due to their backward technology, made them

88 The domestic appliance industry unable to compete with foreign suppliers to meet the demands of the domestic appliance manufacturers. In the case of steel, for example, the domestic appliance industry’s requirements include untreated cold-rolled steel, silicon steel, hot-rolled zinc-plated steel, electroplated galvanised strip and stainless steel. The market share of domestic steel manufacturers increased significantly, from 22 per cent in 1996 to 58 per cent in 1999 (Bao 2001). The domestic leading companies are Baoshan Steel Company, Wuhan Steel Company and Banzhihna Steel Company, with market shares of steel used in domestic appliances of 33 per cent, 20 per cent and 7 per cent respectively in 1999 (Bao 2001). However, vast amounts of the steel have to be purchased from abroad, mainly from Japan, Germany and South Korea; in particular, 80 per cent of stainless thin sheets are imported, as the local producers are not able to meet the local demand. In 2001 China imported 17 million tons of steel (FT, 21 January 2003), 58.61 per cent of which were cold-rolled thin sheets, cold-rolled stainless thin plates and colour-coated sheets that were mainly used by domestic appliance makers.

Conclusion The rise of the Chinese appliance industry in the world market has been well received. China’s development into one of the world’s greatest domestic appliance producers was extremely rapid. How did its domestic appliance sector grow so rapidly? 1

2

3

Although some attribute it to the market economy and free competition, China’s domestic appliance industry would never have survived without massive government protection, subsidies and compulsory foreign technology transfers. Import barriers were probably the most important factor. Continuing economic development and rising living standards in China provide the industry with a huge market, which enables producers to increase demand by expanding in both scale and scope. The market and labour costs give China an advantage in attracting the foreign investment which has supplied the industry with both technology and capital in the past twenty years.

However, the industry is still in the ‘infant stage’, given that it is too vulnerable to be put into the global market. Becoming accustomed to the Chinese market, foreign companies have become aggressive players in the domestic appliance industry, bringing dynamic challenges to the industry structure. More fundamental changes are and will be taking place after China’s entry into the WTO in December 2001. In joining, China, committed itself to high-speed integration into the world economy. This involved comprehensive dismantling of an array of protectionist measures and associated industrial policies, used by the Chinese government in the past two decades

The domestic appliance industry 89 to benefit local indigenous manufacturers (Nolan 2001). This poses enormous challenges to all China’s industries, including the domestic appliance industry. However, the Haier Group, a leading domestic company in the industry, is being targeted by the central government as a national champion. Under the strong entrepreneurship of Zhang Ruimin and with strong government support, Haier is ambitious to become a top global player. This brings a dynamic element to both the global and domestic Chinese appliance industry. Apart from Haier, other local firms like Hisense and Aucma that have enjoyed rapid growth thanks to increasing local demand and local government support have to rethink their strategy of how to respond to the changing environment. An in-depth case study of the Haier Group will be given in the next chapter, followed by case studies of the Hisense Group and Aucma Group.

90 The Haier Group

4

The Haier Group

Introduction Grown from a nearly bankrupt producer of poor-quality refrigerators into China’s number one domestic appliance manufacturer, Haier has attracted a great deal of attention both nationally and internationally. Its annual growth rate was 78 per cent from 1984 to 2001. In 2002, Haier was ranked sixth of global appliance manufacturers in terms of sales volume by Forbes. Haier is certainly a star among China’s national industries. The company’s overriding ambition for the coming decade is to enter the Fortune 500 and make Haier a globally known brand like GE or Sony. This chapter attempts to enquire more deeply into the nature and sources of growth at Haier. The first section describes its background and history. The second examines the expansion of Haier’s core business – domestic appliances – and its transition from a specialised domestic appliance manufacturer to a diversified conglomerate. The third explores the reasons for its success and the fourth analyses its new aim, to enter the Fortune 500 within the framework of the WTO. The fifth section concludes by exploring several alternative strategies for Haier.

The background of the company1 Haier was officially established in 1984 although, the history of the company dates back to 1955. The original plant involved a small collective commune group of artisans engaged in manual production under the governance of the local government. In 1959, the commune was transformed into a corporative factory called the Qingdao Electrical Motor Plant, and later renamed the Dongfeng Electrical Engine Plant. Initially, it produced simple electrical goods such as electric motors and, later, domestic blow dryers and electric fans. In 1979, the factory developed the single-tub washing machine and the cylinder washing machine. In 1980, with the approval of the Qingdao Light Manufacturing Industry Bureau, it merged with Qingdao No. 4 Instruments Plant to form the Qingdao Daily-Use Electrical Product Plant. Until 1983, the factory produced 58,000 washing

The Haier Group 91 machines in total, but the models were hardly acceptable to consumers due to their very poor quality. In accordance with guidelines from the provincial and city governments, collective enterprises were allowed to take economic initiatives. The plant started to look into the refrigerator market. On 1 January 1984, it renamed itself the Qingdao General Refrigerator Factory with the approval of the Qingdao Economic Committee, and concluded a seven-year licence contract with the German Liberhieer-Haushaltsgerate Engineering Ltd, under which modern refrigerator manufacturing technology and equipment would be introduced to China. Zhang Ruimin, a former bureaucrat in the municipal government, was the fourth person appointed to run the factory. The three presidents before him had left the position due to their ineffective management leadership. When he took up the post, the factory’s total sales were worth RMB3.4 million per year, with an annual deficit of RMB1.47 million and a debt of RMB1.56 million. A quarter of the workforce had applied to leave the company. Zhang’s first urgent task was to borrow from surrounding villages to pay the workers’ salaries. When Zhang looked into the market, he found that over 100 refrigerator manufacturers were racing to produce goods with no regard to quality. The priority was to meet the rapidly expanding demand: consumers were queuing up to buy refrigerators as soon as they came off the assembly line without waiting for them to reach the local stores. Zhang also found that there were no famous brands in the market, though some local brands had emerged such as Snowflake in Beijing, Kenai in Tianjin, and Zhongyi in Hunan. Most of the manufacturers were focused on regional markets rather than the national domestic market, due to the strict limitations of the planned economy. However, Zhang predicted that competition would become tougher and a price war was inevitable. He believed that Chinese customers would become sophisticated enough to want higher-quality products and reliable service. Therefore, in order to distinguish the factory from its many competitors and avoid the coming price war, Zhang decided to develop a national brand, focusing on improvements to quality and providing first-class service. In 1988, the company won a gold medal for quality from the Chinese Quality Management Association. In 1990, it won the top Golden House Award for quality and the National Quality Management Award. In 1991, its refrigerator was awarded the prize National Famous Brand Product. After April 1992, when it obtained ISO 9001 Certification and then the American Underwriters Laboratories Certification, the company began to target foreign markets. Zhang Ruimin achieved the status of top national branded refrigerator manufacturer within seven years. The brand strategy paid off during the price war caused by production overcapacity in the late 1980s, and built the solid foundation for its later development. More importantly, the company

92 The Haier Group became more consumer-oriented and built a competitive edge into management capability, quality control, technological innovation and marketing. However, the annual output of refrigerators was only 300,000 units, not nearly enough to cover the expansion of the consumer economy or compete with other manufacturers. To achieve true market leadership, Zhang needed to develop the company’s scale and scope. At that time, he seized another new opportunity – expansion through aggressive acquisition and diversification.

Expansion towards a diversified conglomerate structure Growth of the core business: vertical diversification of domestic appliances In the early 1990s, affected by the Tiananmen Square events, the Chinese domestic economy stagnated. Local officials and businesses were uncertain about government policy, and therefore hesitated to reinvest in production. Deng Xiaoping made an unexpected speech during a visit to south China, advocating ‘reform and quick action’ by a focus on long-term development rather than short-term interest. In September 1991, in the meeting of the State Economic Work, six incentives were offered to encourage the further development of state-owned enterprises and the development of big enterprise groups. On 14 November 1991 the municipal government in Qingdao responded quickly by merging the Qingdao General Refrigerator Factory, the Qingdao General Freezer Factory and the Qingdao Air-conditioner Factory to form the Tsingdao Haier Group. In September 1993, it was renamed the Haier Group and its trademark was changed to Haier. Sensing the central government’s determination to bring about further opening and reform, Zhang Ruimin decided to build an industrial park to expand production capability. The industrial park occupied 520,000 square metres of land in the High-Tech Area of Qingdao. The project cost RMB1.6 billion including the land purchase and the construction of facilities. The initiative was criticised by some officials in the municipal government, who believed that Zhang was over-reaching his resources and should be prohibited from taking such a risky decision. Nonetheless, the plan was strongly supported by other officials, particularly the Mayor of Qingdao, Yu Zhengsheng, who was determined to provide full support to help develop Haier into a big branded company. The construction of the industrial park was started in 1992 and finished in 1995. With the support of local government, Haier raised money by borrowing from banks and issuing A shares on the Shanghai Stock Market. In November 1993, Haier issued 50 million A shares for 43.7 per cent of its refrigerator division, raising RMB369 million. Soon after, the freezer division and the air-conditioner division were both floated. The capital of RMB700 million thus raised from the stock market was used to enhance Haier’s production capability. Refrigerator output rose significantly from 300,000 units in 1993 to 1,510,000

The Haier Group 93 units in 1996, and profits rose from RMB81.87 million in 1993 to RMB200.65 million in 1996. Haier first moved into freezers and air-conditioners by acquiring the local freezer and air-conditioner companies. The original annual production capacities of the two companies were 75,000 freezers and 700 air conditioners. To improve management and acquire product technology, Haier cooperated with foreign partners. In 1993, it established a joint venture company with Mitsubishi Heavy Industries Ltd of Japan, called Mitsubishi Heavy Industries Haier (Qingdao) Air Conditioners Ltd, to handle the manufacturing and sales of packaged-type air-conditioners. The total investment was US$30 million with Mitsubishi holding 55 per cent ownership shares. By 1995, Haier had sold 300,000 freezers and 670,000 air-conditioners. Haier then moved on to washing machines, another domestic appliance sector. As it had for refrigerators, the Haier Group entered into a joint venture with Merloni Designing Co. Ltd of Italy in July 1993, forming the Tsingdao Haier Merloni Co. Ltd. The new company produced a line of rolling basket washing machines with annual production capability of 710,000 units. However, Haier took a negligible market share as it was very small scale in a market of 9 million units comprising single-tub, semi-automatic and automatic washing machines. Its production capability and product line were very small. Haier then took over the Qingdao Red Star Electric Appliance Co. Ltd, one of the top three washing-machine makers at that time. The company, a collective enterprise under the governance of the municipal government, had five plants and 3,240 employees and sales reached more than RMB0.5 billion per year. Drowning in losses aggravated by the corruption of its founder, the company was in great financial trouble. Its total assets were RMB0.4 billion but its debt was more than RMB0.5 billion, and its debt ratio was over 140 per cent (Liu 1999). The municipal government kept the factory open so as to avoid the unemployment which would result from declaring it bankrupt. It therefore pressured Haier to take over the company without laying off its workers. Haier, using its boot camp approach, turned the company round without a penny of its own cash. This acquisition was considered a most significant and successful event that not only tested Haier’s management skills but also brought the company to a new scale, with its production capability doubled. Initially, acquisition targets were limited to local candidates, as acquisition outside a city or province required multiple levels of approval from other cities and provinces. The support of Mayor Yu had played a crucial role in Haier’s expansion. With the close involvement of the municipal government, the Haier Group acquired four major local firms (freezer, airconditioner, washing machine and condenser factories) which were known as ‘golden flowers’ in Qingdao. However, with the government encouraging further reforms and industrial restructuring, it became feasible for Haier to consider cross-border acquisitions.

94 The Haier Group Zhang began to develop Haier primarily through the acquisition of troubled manufacturers. He undertook geographical diversification in China through the purchase, at very low cost, of companies with good products in promising markets. The first inter-province acquisition took place in 1995 when Haier acquired a 60 per cent share of Wuhan Landao Xibo Company, a freezer and air-conditioner maker in Hubei Province. In March 1997, Haier held a 60 per cent share of Shunde Haier Electric Appliance Co. Ltd, an automatic washing machine maker, part of the Guangdong Aide Group; the company had ceased production two years earlier due to poor adaptation to the changing market. In 1997, Haier acquired Fenghua Refrigerator Factory, a former military subordinate of Guizhou Aircraft Group, and formed Guizhou Haier Electric Appliance Ltd, producing refrigerators. By 1996, Haier’s acquisitions enabled it to offer a full range of domestic appliances. During the implementation of its diversification strategy, it sought to grow by expanding its range to the entire white goods sector. This is apparent in the group’s Annual Report which defined the core business as ‘nine fist products’: refrigerators, freezers, separate air-conditioners, cabinet air conditioners, display cabinets, microwave ovens, the credit business, real estate and so on. Development of the none core businesses – horizontal diversification To achieve economy of scope, Haier continued to expand by acquiring new businesses other than white goods, to ‘avoid having all the company’s eggs in one basket and to fully utilise the value of the established brand name’. In 1997, Haier made a ‘ten-year plan’, aiming at expansion through further diversification and entering the Fortune 500 before 2010. In other words, Haier would follow the South Korean or Japanese business models to build itself into a diversified conglomerate. According to this ambitious plan, Haier would slow its heavy investment in domestic appliances and target the high-tech sector and pharmaceutical engineering. The sales revenue of the group would be divided into three parts: one-half would come from information products, one-third from domestic appliances, and one-sixth from pharmaceutical engineering (Liu 1999: 363). Meanwhile, the group would enter into the finance sector, setting up its own futures trading, security, insurance and finance consulting companies. Overseas activities were considered as another effective way of diversification by Zhang Ruimin, who formulated a ‘one-third-by-three’ strategy according to which Haier would divide its business equally between sales in the domestic market, exports and foreign sales generated by overseas manufacturing facilities. Black goods business On 5 September 1997, Haier moved into the highly competitive consumer electronics business by establishing a joint venture with West Lake Electric

The Haier Group 95 Group in Hangzhou producing wide-screen colour TVs. Several months later, it acquired the Yellow Mountain Electrics Group in Hefei, Anhui Province. This acquisition greatly increased the production capability for colour TVs, VCDs and DVDs. Information sector In 1998, Haier expanded into the high-tech sector which was being greatly encouraged by government policy and was popularly argued to have good growth potential. It includes computers, digital technology, software development, integrated circuits and plastics engineering. In April 1998, the Haier Computer Department was set up. In August, Haier 3C Co. Ltd opened branches in Beijing, selling a wide range of computers and telecommunications and consumer electronic products. In 1999, the proposal for ‘A large development and production base for mobile telecommunication devices’ was approved by the State Planning Commission and Ministry of Information Technology. Haier became one of eleven domestic manufactures that were allowed to produce mobile phones and the first batch of GSMA mobile phone sets was rolled out in the same year. To acquire the technology, Haier entered into a joint venture with China Construction Telecommunication Company in Hong Kong, and formed Haier CCT, producing mobile phones in Qingdao from 2000. It was argued that this would be a vehicle through which Haier CCT would be floated on the Hong Kong Stock Market. The main goal of the listing was stated to be the expansion of Haier’s capacity to produce mobile phones. In early 2002, Haier was reported to have got its first order, for 800,000 CDMA mobile phones from China United Telecommunication Company. To develop other businesses aggressively, Haier continued to enter into a number of partnerships with domestic and foreign enterprises and institutions (Table 4.1). Table 4.1 Haier’s partnerships in the high-tech sectors Year

Partner/Joint venture company /Business

1998

Chemical Institute of National Science Academy/Haier Kehua Engineering Plastic Research Co. Ltd/Plastics engineering Research Centre of the Broadcasting Film and TV Bureau/Haier Guangke Digital Technology Developing Co. Ltd/Digital technology Beijing Aircraft University and America C-MOLD Company Bei Hang/ Haier Software Co. Ltd/CAS/CAM/CAE software Microsoft Co./Venus Programme/Computer software United China Construction Telecommunication/Haier CCT/Mobile phones Haier Integrated Circuit Designing Co. Ltd/Integrated circuit design LG Company/digital television

1998 1998 1999 2000 2000 2001

Source: Company documents.

96 The Haier Group Service sector In addition to its aggressive expansion into the consumer electronics and information sectors, Haier was embarking on the new venture of expanding into the services sector. According to Zhang Ruimin, First, the financial sector is a very important sector which Haier wants to enter to further the process of international expansion. Second, to be a global company, it is crucial to connect the technology sector with the finance sector. Third, after China’s entry into the WTO, the retailing sector is the first one that will interest foreign companies, and then the financial services sector. When these sectors are open to foreign competition, they will surely open to domestic companies as well. We hope to lead by grasping this opportunity and have taken some steps in these. (quoted in China Newsnet, 21 April 2002) Zhang also admitted that risk does exist and the future is unknown, ‘but it is a newly opened business with space to grow, and we want to develop at a quick pace like GE’. It was reported that Haier had invested RMB1.5–2 billion in the sector by taking ownership shares in a local bank, a trust company and a security company. For example, it spent US$24 million on setting up a 50:50 joint venture company with the American Life Insurance Company in 2001 (Table 4.2). Other businesses Haier acquired several small local firms in Shandong Province producing small appliances such as microwave ovens, gas ovens, dishwashers, irons and electric heating. This full range of appliances enabled Haier to set up a new business of selling complete kitchen and washroom facilities in 1998. The business grew rapidly and the sale of complete kitchens was worth RMB0.4 billion in 2000. Apart from the appliance business, Haier also entered into other fields, including restaurant chains, bioengineering, travel and property. For example, Haier took a controlling share in Qingdao

Table 4.2 Haier’s expansion into the finance sector Date

Partner company

Shareholding (%)

1999 September 2001 2001 July 2002

Qingdao Commercial Bank Anshan Trust Company American Life Insurance Company Yangzi River Security Company

60 20 50 20

Source: Company documents.

The Haier Group 97 Table 4.3 Output of the Haier Group Product

Refrigerators Freezers Air-conditioners Washing machines Colour TVs Microwave ovens Electric heaters Computers Mobile phones

Output (000s) 1999

2000

2001

2,595 532 1,902 2,354 798 113 466 n.a. n.a.

3,055 727 2,101 3,062 1,093 361 609 117 n.a.

3,681 880 2,807 3,560 1,452 572 620 n.a. 1,327

Sources: Qingdao Year Book (2000, 2001, 2002); company documents. Note: n.a. = not available.

No. 3 Pharmaceutical Factory in early 1997. However, none of these businesses were operated successfully and represented only a small fraction of total turnover. Zhang admitted that the pharmaceutical business has not been successful because it could not share the resource advantages enjoyed by the white goods business. Nevertheless, the result of the expansion is remarkable. Up to 1998, Haier acquired or merged with eighteen loss-making firms all over the country with total assets of RMB1.52 billion and 15,000 employees (interview at Haier, January 2002). The variety of products has diversified from one model of refrigerator in 1984 to sixty-nine models in 2001, with 13,000 variants, including large and small domestic appliances, consumer electronics, communications products and other information products. The number of employees rose from 600 in 1984 to 30,000 in 2002. The group comprises eighty legal-status enterprises. Within eighteen years, Haier has transformed itself from a refrigerator specialist to a famous diversified conglomerate (Tables 4.3, 4.4 and 4.5). Growth through internationalisation Exporting The first export trial Haier made was to Germany in 1986 based on a licensing contract with Liberhieer-Haushaltsgerate Engineering Ltd. To compensate for the shortage of foreign currency, the government placed the foreign licensee under an obligation to purchase a small proportion of the refrigerators for their home market. By the end of the 1980s Haier had won the bid to be the United Nations’ refrigerator supplier. In 1989, export sales were only RMB3 million, a very small amount, but this initial access to

98 The Haier Group Table 4.4 Selected performance data of the Haier Group (1984–2001) Year

Sales revenue (RMB million)

Profit (RMB million)

Taxation (RMB million)

Employees (no.)

Exports (US$ million)

1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

3.48 18.20 80.26 143.35 267.02 411.63 535.62 591.05 1,048.24 1,487.00 2,565.00 4,335.00 6,160.00 10,880.00 16,200.00 26,800.00 40,600.00 60,200.00

−1.47 1.07 7.05 13.88 22.93 32.13 35.05 30.45 50.84 125.07 176.00 249.00 312.00 426.00 536.00 625.00 1,360.00 n.a.

– –

820 758 773 844 1,013 1,243 1,265 1,342 5,083 4,820 5,086 11,025 10,907 18,901 20,601 20,721 27,810 31,281

– – – – – – – – –

3.78 5.25 8.28 10.17 17.62 41.27 46.57 53.50 157.20 173.30 234.50 255.00 476.00 705.00 n.a. n.a.

18.00 18.40 42.00 50.00 56.36 76.65 138.00 n.a. 420.00

Product variety (no.) 1 1 3 n.a. 30 100 300 n.a. 1,000 1,500 n.a. 3,000 5,000 7,000 n.a. 9,200 n.a. 10,800

Sources: Liu (1999); company documents; QSB (2002). Note: n.a. = not available.

Table 4.5 Haier’s market share in China, 2001 Products

Market share in China (%)

Global market share (%)

Refrigerators Freezers Air-conditioners Washing machines Microwave ovens Dishwashers

7.95 34.50 23.86 24.33 n.a. n.a.

6.0* n.a. 2.8 5.8 2.8 1.3

Total white goods

n.a.

3.7

Sources: company document; Wu (2003). Note: * This includes refrigerators and freezers. n.a. = not available.

international markets built up confidence in the quality of the products. Also, it laid the foundation of Zhang Ruimin’s ‘First hard, then easy’ strategy. Rather than targeting poor countries in Asia, Africa and Latin America for his first foreign expansion, as other Chinese companies had done, Zhang started with America and Europe. He believed that if Haier could survive in such demanding markets, it would have developed world-class technology and management skills, which would presumably give it a great advantage over local competition in weaker markets, including China’s own.

The Haier Group 99 In the mid-1990s, competition in refrigerators in the domestic market became ever more fierce. To obtain more sales, Haier accelerated its export programme. Its real breakthrough is that it is managing to sell its own brand in the West. Haier is virtually in a class of its own in having a name outside the home market. This was extremely difficult to achieve, due to the very poor brand and quality image of Chinese products in the international market. At this time, China was still trying to dump its raw materials and labour-intensive commodities in exchange for foreign currencies and then reinvest in importing advanced technology from the West. To access the international market, Haier set up a Consulting and Certification Centre devoted to getting the various quality certifications. It obtained six international quality certificates, including the American Underwriters Laboratories, CSA, the European GS, VDE and EMC, and Japan’s S-MATH. Meanwhile, Haier took a very active part in numerous international trade fairs and product demonstrations, attracting foreign agents and dealers who were granted extremely favourable discounts. Meeting every possible order was the chief objective of the company. Exports rose at a very rapid rate, from US$3 million in 1993 to US$420 million in 2001 (interview at Haier, January 2002). Overseas manufacturing The first overseas manufacturing activities took place in 1996 when Haier invested US$20,000 in an assembly joint venture in Jakarta, Indonesia, producing, 50,000 fridges and air-conditioners per annum for the South East Asian market. In June 1997, Haier LKG Electrical Appliances Co. Ltd was set up in the Philippines; Haier Industrial Asia Ltd was set up in Malaysia. However, Haier left after several years’ operation, partly due to the domestic political crises in these countries resulting from the Asian financial crisis. Since 1997, the government’s ‘marching out’ policy has encouraged more and more companies to expand overseas, particularly those in consumerfocused sectors, as light manufactured goods are considered to be the most competitive and there is overcapacity of production. This presented Zhang with the opportunity to make more aggressive decisions. The most significant international expansion was entry into the USA. To do this, Haier initially exported through agents. In 1999, with trade increasing rapidly, Haier established Haier America Trading, a joint venture with a local agent. Haier accounted for the majority of the share capital and the remainder was held by a small group of US investors. The company recruited a number of aggressive local industry veterans to run the business, which has been given significant autonomy in its aims of capturing greater market share and drastically increasing growth. The trading company devoted its sales energy to deals with big national retailers such as Wal-Mart, Target, Best Buy and Sears. It started with low-end items like compact refrigerators and minifreezers that local manufacturers could not produce

100

The Haier Group

profitably. It promised logistical support such as inventory control for stores as well as hassle-free service for consumers. The compact refrigerators have become the best seller in the US market, accounting for over 30 per cent of the market (interview at Haier, January 2002). Furthermore, Haier has opened up a refrigerator plant in South Carolina. To explain its activity, Zhang said: In the era of globalisation, you can’t separate domestic and international markets, we’ve got to learn how to compete with GE and Whirlpool on their home turf . . . Only by entering the international market can we know what our competition is doing, can we raise our competitive edge, otherwise, we will lose the China market to foreigners. (Zhang Ruimin, quoted in New York Times, 23 July 2000) The 280,000 square foot facility was built on a 110-acre site near Camden. The project cost US$28 million and 230 workers were employed to assemble the refrigerators, primarily the larger-sized units that hold the potential for bigger margins. In March 2002, Haier spent US$14.5 million on purchasing a landmark Greenwich Savings Bank building in midtown Manhattan in New York to serve as its headquarters for the Western hemisphere, a tangible asset to highlight the company’s commitment to the American market. In 2000, Haier took further steps to localise production in overseas markets. It set up plants in South Asia and North Africa. An industrial park was built in Pakistan producing refrigerators. In June 2001, Haier spent US$8 million purchasing a refrigerator plant owned by Menghetti, a domestic appliance maker in Italy. To keep exports growing, Haier was seeking to enter new markets with higher entry barriers by establishing strategic alliances with local companies. For example, in January 2002, Haier signed an agreement with Sanyo agreeing to sell Sanyo’s products in China through its domestic distribution network; Sanyo would sell Haier’s products in Japan. A joint venture company was set up in Japan. One month later, a similar agreement was signed between Haier and Shampo of Taiwan. By 2001, Haier products were being sold in over 146 countries and regions and more than 40,000 sales outlets had been established worldwide. Overseas sales reached US$720 million of which Haier’s own-branded products constituted US$420 million. In the USA, the sales of the American plant were claimed to be US$50 million; with imports from home, total sales reached US$200 million. Haier vowed to hit US$1 billion by 2005. It claimed that its compact refrigerators had captured 30 per cent, freezers 12 per cent and compact wine coolers 50 per cent of the US market. Its air-conditioners had captured 10 per cent of the European market, and twin-tub washing machines had captured 10 per cent of the Middle East market (interview at Haier, January 2002). Haier divided the globe into twelve economic areas: South East Asia, South Asia, North American Free Trade Area, Central America, the

The Haier Group 101 Table 4.6 Haier’s global business network Region

Trading company

Design centre

Manufacturing company

North America Latin America East Asia East Union South Asia Middle East West Asia European Union Africa

3 1 3 2 – 1 – 4 –

2 – 2 1 – – – 3 –

1 – – 3 2 2 1 1 3

Source: Company document.

European Union, the Mediterranean Cooperation Group, the Russian Federation, Southern Africa, North Africa, East Asia, South Europe, South America. It planned to establish an overseas centre in each economic area and utilise local design, manufacturing and sales. Haier has established information centres and design centres all over the world to collect stateof-the-art information about markets, industrial trends and consumer preferences. By the end of 2001, it had ten information centres located in the USA, France, the Netherlands, Canada, Japan, Australia, Austria, Taiwan and Hong Kong, six overseas design centres, two overseas industrial parks, thirteen overseas factories and fifty-six overseas trading companies (Table 4.6). Summary Haier’s growth was greatly affected by the nature of the competition within the domestic appliance sector as well as by government industrial policy. As a latecomer to the refrigerator sector, Haier sought to distinguish itself through brand name recognition and high-quality products. To achieve economies of scale and scope, Haier diversified quickly to the full range of domestic appliances by acquiring enterprises with potential. Facing increasingly tough competition from both local and aggressive global players in the domestic market, Haier decided to ‘march out’ through exports and overseas manufacturing. Almost all the acquisitions were undertaken with the involvement of the local government. Local officials had asked Haier to take over their failing enterprises in the hope that these would be reinvigorated by Zhang’s touch. According to the company, from 1996 to 1997, over 300 firms asked to be considered for mergers and acquisitions. Haier selected its M&A targets carefully: they usually had adequate equipment and a competent workforce, but suffered from an inability to adapt to market trends and from operational problems (interview at Haier, January 2002). Zhang called these the ‘stunned

102

The Haier Group

Table 4.7 Haier’s geographical expansion through industrial parks Date

Location

Products

16 November 1992 13 August 1998 28 December 1998

Qingdao Industrial Park Qingdao Information Park Qingdao Development Area

3 April 1999 28 March 2000 28 June 2000

10 April 2001

South Carolina, USA He Fei, Anhui Province Qingdao International Industrial Park Qingdao Jiaozhou International Industrial Park Pakistan Industrial Park

18 September 2001

Dalian, Shenyang Province

19 March 2002

Wuhan, Hubei Province

White goods, mobile phones CTVs, moulding Air-conditioners and spare parts Refrigerators White goods, CTVs Overseas suppliers from Acer etc. Overseas suppliers from Amerson Refrigerators, washing machines Refrigerators and air-conditioners Air-conditioners

8 July 2000

Source: Company document.

fish’. Haier would activate them through introducing its own management system, trade name and marketing network. Since 1999, the pace of domestic acquisition has slowed and more attention has been paid to greenfield investment and overseas expansion. It is assumed that the increasingly flexible environment provides Haier with more alternatives for expansion both domestically and globally. Within China, rather than acquiring troubled companies, Haier has preferred to build industrial parks on greenfield sites where local government’s grants encourage investment. Outside China, more expansion activities have been undertaken by Haier, such as developing agent relationships, strengthening distribution channels, establishing new plants to avoid trade barriers and exploring new markets by setting up strategic alliances with foreign partners. Following the first industrial park in 1992, Haier quickly built a further nine industrial parks, four in Qingdao City, three in other parts of China, and two overseas (Table 4.7).

The Haier Group’s business structure During its rapid expansion, Haier has evolved into a diversified conglomerate. The institutional structure has accordingly changed several times. Business structure prior to 1995 In the early phase of the Haier Group, the business structure was composed of a number of holding companies. In 1995, there were 101 companies with legal status and 12,000 employees. There were four different types of holding

The Haier Group 103 companies: production enterprises, trading companies, research and development centres and components manufacturing factories. The headquarters of the group consisted of five functional departments: the planning and development centre, capital control centre, enterprise culture centre, consulting and certification centre and asset management centre (Figure 4.1). Each holding company comprised a highly automated plant, with operational autonomy and responsibility for every aspect of business within the company. The holding companies enjoyed very loose relationships with each other and were asked to report directly to the president. Given that the headquarters failed to control the subsidiaries effectively, Zhang consolidated control by setting up the business department system within the group. Business structure 1995–98 Under the business department system, Haier set up a four-layer management system. At the top of the vertical hierarchy, the headquarters of the group, which made decisions about the strategic investment, consisted of eight centres and ten offices responsible for the overall governance and administration in the group. The second layer was the business decision centre, consisting of seven general business departments, each with its own administrative sector, such as the enterprise culture, energy sales, finance, human resource, law, research, quality management, equipment and testing centres. The third level was the profit centre, including business departments dealing with specific product scope. The bottom layer was the cost control centre covering various production enterprises (Figure 4.2). Under this system, the general business departments were granted great autonomy. They pursued the strategies made by headquarters and reported directly to the president; also, they could invest in any project they liked with the approval of headquarters. The profit centre concept forced all front-line managers to become more sensitive to market needs and more conscious about how profits are generated. Meanwhile, risks could be minimised due to the dispersed investment activities of each department. But the resources of the group could not be fully utilised due to decentralised accountability. For example, the bargaining power created by the large scale and scope of the group is considered as one of its competitive advantages. Business structure, 1999 onwards In 1999, Haier implemented a strategy to transform the company from a domestic market player into an international market player, expanding it from being a solely manufacturing company into being a service provider. The big challenge would be to achieve consistent profitability across all operations, while building an organisation and implementing a strategy to propel the restructured business forward. Haier re-engineered its business operation, radically restructuring its organisation in an innovative way. The

104

The Haier Group

President’s office

Production enterprise

Consulting and certification centre

Planning and development centre Haier Group Enterprise culture centre

Asset management centre

Haier Refrigerator Share Holding Co. Ltd Haier Freezer General Co. Haier Air-conditioner General Co. Haier Refrigerating Equipment Co. Mitsubishi–Haier Airconditioner Co. Ltd Haier Cleaning & Kitchen Appliances Co. Ltd Haier Metal Processing & Plastic Injection Moulding Base Haier Washing Machines Co. Ltd Haier Merloni Co. Ltd Haier Microwave Oven Co. Ltd Haier Medicine Co. Ltd

Commercial and trading companies

Haier Sales Co. Haier Material Supply Co. Haier Import & Export Co. Haier Economic & Trade Development Co. Haier Transportation Co.

Research and development organisations

Technology Centre Haigao Industrial Design & Manufacture Co. Refrigerating Technology Research Institute Household Appliance Mould & Equipment Research Institute Haishi New Technology Development Co.

Components and spare parts manufacturing factories

Hanchangtai Plastic Company Printing Factory Plastic Coating Powder Factory Wires & Cable Factory Condenser Factory Package Factory

Capital control centre

Figure 4.1 The business structure of the Haier Group (prior to 1995). Source: Company document.

The Haier Group 105 Planning & Development Centre Finance Centre

Refrigerator, Electrical Engineering General Business Dept.

Refrigerator Business Dept. Small Appliance Business Dept. Overseas Refrigerator Business Dept. Kitchen Business Dept.

Freezer, Electric Heating General Business Dept.

Freezer Business Dept. Electric Heating Appliance Business Dept. Supermarket Business Dept.

Air-conditioner, Electric Business Dept.

Air-conditioner Business Dept. Mitsubishi–Haier Electronic Business Dept.

Washing Machine, Housing Construction General Business Dept.

Washing Machine Business Dept. Haier–Merloni Co. Ltd. Shunde Haier Co. Ltd. Housing Equipment Business Dept.

Industrial Equipment Business Development Dept.

Moulding Business Dept. Experiment Business Dept.

Finance Business Development Dept.

Future Trading Business Dept. Investment Consulting Co. Insurance Agent Co. Consulting Co. Accountant Agent Co.

Bioengineering Business Department

Haier Pharmaceutical Co. Qingdao Haier Third Pharmaceutical Factory

Human Resource Centre Assets Management Centre Enterprise Culture Centre President’s Office Technology Centre Law Office Sales Centre President

Energy Centre Construction Supervision Co. Safety Dept. Organisation Dept. Propaganda Dept. Youth Members Office Trade Union Discipline Inspection Committee

Figure 4.2 The business structure of Haier Group (1995–98). Source: Company document.

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new structure was built on two principles: (1) centralisation of responsibility; and (2) individual accountability through the market chain strategy. Instead of the former decentralisation, Zhang centralised the business by setting up four Promoting General Business Departments in August 1999. These were the Overseas Promoting General Department, the Transport Promoting General Department, the Products Promoting General Department and the Capital Promoting General Department. The seven-Product General Business Departments covered the seven product groups: refrigeration, air-conditioners, washing machines, information technology, small domestic appliances, technical equipment and new products such as mobile phones and bioengineering. The sectors of finance, purchases and sales of each general business department were separated from their original department and merged into the newly created Promoting General Business Departments. The product departments were only production centres focusing on efficiency and quality. The Promoting General Business Departments consolidated control over business activities such as purchasing, transport and finance within the group (Figure 4.3). The market chain strategy was intended to reinforce individual accountability and market focus by transferring external market pressures to individual staff within the company. The essence of the market chain concept was that every unit, every operation and every worker was linked directly to a market, and each was someone else’s customer, despite the differences between business units and jobs. The market chain concept was claimed to have three main advantages: (1) it encouraged middle managers and even shopfloor workers to take initiatives to cut costs and improve the product by giving them a sense of ownership and responsibility; (2) it helped overcome the dysfunctional nature of hierarchy and created relationships based on mutual obligations; and (3) it served as a basis for payment and compensation between different units within the organisation. One business unit provides products or services to another, under negotiated terms and at an agreed rate. However, if the selling unit fails to meet the terms, it should not expect to be paid, and the buying unit could even claim compensation. The new concept emphasised the need for clear division of management roles, the delegation of responsibility to the operating level, and the need for strict accountability. However, the big question in most observers’ minds was whether Zhang and his top management team could make the demanding management principles and sophisticated organisational structure work effectively. In reality, they were becoming increasingly aware of the difficulties involved. For example, the rather ambiguous accountability of the middle managers highlights the difficulty of defining their exact role. Under the principles of the market mechanism, they tend to avoid taking on work which may not be theirs so as to avoid responsibility. With the implementation of Business Re-engineering Programme initiated in 1999, the supplying network underwent significant change. The company consolidated its suppliers, down from 2,300 to around 900. Among the 260,000

The Haier Group 107 Board of Directors

Strategic Decision Committee

President of the Group

Secretary Office of Board Chief Executive Officer

Deputy Director Promoting General Business Department

Housing Dept.

Hefei Haier Co.

Bioengineering Dept.

Computer Dept.

Capital in Dept. Capital out Dept. Accountant Dept. Assets Audit Dept.

Washing Machine Dept.

Experiment Dept. Moulding Dept.

Shunde Haier Co.

Energy Co.

Haier-Merloni Co.

Electric Engineering Dept. Refrigerator Dept.

Electric Heating Dept.

Overseas Refrigerator Dept. Freezer Dept.

Air-conditioner Dept.

Supermarket Dept.

Business-used Air-conditioner Dept. Mitsubishi Haier Wuhan Haier

Figure 4.3 The business structure of the Haier Group (1999 onwards). Source: Company documents.

Affiliated Business Dept.

Electronic Dept.

Refrigerator Client Dept.

Washing Machine Client Dept.

Technology Equipment General Dept.

Communication Dept.

Stocking Dept.

CTV Client Dept.

Air-conditioner Client Dept.

Kitchen Electrics General Dept.

Information Product General Dept.

Emerging Market Dept.

Washing Machine Product General Dept.

West-South Dept.

Air-Conditioner Product General Dept.

Mid-South Dept.

Travelling Dept.

Asia-Pacific Dept.

Refrigeration Product General Dept. Allocating Dept.

West-North Dept.

Middle East Dept.

Captial Promoting General Dept.

Transport Promoting General Dept.

Products Promoting General Dept.

Overseas Promoting General Dept.

Purchasing Dept.

North–east Dept.

South China Dept.

EU Dept.

Product General Business Department

Shandong Dept.

East China Dept.

US Dept.

Deputy Director

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kinds of raw material and components, overseas suppliers accounted for 67.5 per cent; 32.5 per cent of the suppliers are able to collaborate with Haier in areas such as product design and improvement (interview at Haier, June 2002). Recognising that the success of his strategic vision depended on the effectiveness of the new organisation, Haier invested heavily in the information system to establish linkages between the different businesses and operations. Four systems are in the process of being developed: the Enterprise Resource Planning system (EPR), the Product Development Management system (PDM), the Customer Relationship Management system (CRM) and the Finance system. The ERP system aims to set up a network connecting purchasing, stock control and manufacturing to facilitate the JIT management of each business. The CRM system aims to construct a network between consumers and the group by using the Internet for ordering and general contact. The Finance system aims to set up a standard accounting system to enable financial control to be exercised over all business activities. Although still in the test phase, the information system has actually shortened the purchase cycle to three days from the previous average of ten days. We are trying to break down the walls between the companies externally and between the departments internally. For example, we coordinate with Amerson, the major global engine supplier. Amerson does not only provide us with components, but also participates in the design of the product. (Interview with Zhang, June 2002)

Discussion of the growth of the Haier Group As a company based in Mainland China, Haier has achieved remarkable success. However, it is not easy to explain its exceptional growth. Some have summarised it as a fortuitous self-made success story. Some have attributed it to the extraordinary entrepreneurship of Zhang Ruimin and the unique enterprise culture Haier has sustained during its growth. Some have attributed it to the special benefits the company received from the Qingdao municipal and Shandong provincial governments. Some have argued that Haier benefited from the advantages of the new industrial policy and open border policy adopted by the Chinese government. All these factors have contributed to the recipe for success, but none of them is adequate on its own. On a close inspection, Haier’s rise is a complex product of the symbiotic relationship between an entrepreneur, a public enterprise and the state. Strong leadership and corporate culture Like many enterprise turnaround stories in China, Haier’s success can be attributed largely to one man’s vision, talent and determination. Like a preacher, Zhang Ruimin constantly instils his corporate philosophy and

The Haier Group 109 objectives into his employees. In his factory, he implemented his own management philosophy, a mixture of American, Japanese and Chinese thought. Zhang frequently tells the story of how he smashed seventy-six defective Ruixue refrigerators with a sledgehammer when he became the president of the refrigerator factory. This was a great shock to his workers, as a refrigerator was an extremely expensive commodity for the Chinese consumer and desperately in demand in the market. At that time, the retail price of a refrigerator was RMB800 while a worker’s salary was only RMB40 per month. In this way, Zhang taught his workers to take care of quality and to build trust in the company. Many modern management practices have been introduced by Zhang Ruimin. This has involved the establishment of a large network of salespeople, constructing the marketing system to develop brand names, and building a strict system of quality control. One of the most remarkable practices, the reliable after-sales service, is considered to be the key ingredient of Haier’s later success. In a country where customers’ calls for help often went unanswered, the company’s stress on after-sales service as well as the motto ‘A forever sincere Haier’ resonated deeply with the consumer. In 1990, Haier opened a service centre in Qingdao which kept a computerised record of tens of thousands of customers. In 2001, the firm’s maintenance network comprised 11,976 outlets and 53,000 sales outlets nationwide. Zhang asks his workers to pay meticulous attention to the consumer’s preferences through innovation and speed. All R&D investment is based on optimising consumer satisfaction. The company innovates quickly: for instance, acting upon the request of a consumer, it has launched a tiny machine called Little Prodigy which washes less than 1.5 kg of clothing. It was an instant hit in the market. Since its appearance in 1996, Haier has developed eleven models of the product and sold over 2 million units. A customer in Shanghai told Haier that they were charged for electricity at a higher rate for daytime use and a cheaper rate for nighttime use; the latter was 50 per cent cheaper than the former. Haier responded quickly by adding a timer to its electric water heaters so the consumer could use the hot water in the daytime that was heated automatically during the night. This modification was so welcome that sales doubled within two months in Shanghai. The company also encourages consumers to send in their ideas about the products, and grants awards for suggestions that are accepted. There are many stories about this. Zhang also loves to tell how, when it was discovered that Sichuan peasants were using his washing machines to rinse newly dug sweet potatoes, the machines were adapted so as not to clog. Zhang focused on improving management skills within the group by expounding the key concept ‘Overall, Every, Control and Clear’ (OEC – ‘Ri Qing Ri Bi’): overall as in all dimensions; every as in everyone, everyday, and everything; control and clear as in keeping things in control and clean. This implies that everyone has his or her responsibility at work; today’s work must be finished today and work must be improved day by day. This

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concept reflects Haier’s desire for overall optimisation of resources to achieve excellence. It expresses the core spirit of Haier’s corporate culture, which encourages (and enforces) personal accountability, combining high quality, quick service and meticulous attention to customer preferences. However, management is not always a gentle philosophy. Zhang drives his employees with a mixture of fear and reward. One notable example is the ‘6S’ shoe-print approach. Workers who do not meet their daily performance goals are forced to stand in a painted box in the corner of each department after the shift and publicly explain their shortcomings. Employee performance is assessed monthly, and pay is adjusted accordingly. Employees with the poorest performance are humiliated: the slowest worker in each shift has to stand in the ‘6S’ box, middle managers whose performance falls below the required level are named in the company’s weekly newsletter, and ineffectual senior managers have to ‘volunteer’ a pay cut. Zhang turned the company round by brute force and imagination. In his opinion, the most important factor of production was human capital, and the constant challenge for management was to motivate workers. In the workplace, slogans like ‘Never say no to the market’, ‘Watch the market closely and create superior quality’, ‘Haier style: prompt reaction to the market’ and ‘Haier spirit: work diligently to serve the country, pursue excellence’ are displayed everywhere. The weekly company newsletter, a vehicle for internal communication within the group, frequently contains Zhang’s articles and speeches. Besides, every member of staff is given an eighty-five-page brochure, edited by Haier’s Enterprise Culture Centre, which expounds management philosophy. It is widely argued that the enterprise culture not only played a crucial role in Haier’s exceptional growth, but also served as a powerful instrument for turning around the companies acquired during Haier’s development. However, this has not always worked easily, particularly when Haier, under government pressure, had to retain the staff of acquired state-owned enterprises who were accustomed to being looked after as members of a big family. For example, in 1997, when Haier acquired the state-owned Yellow Mountain Television Plant with 2,000 workers, it found it very hard to instil its management and corporate culture. The general reaction was resistance, and some workers went on strike in protest against the strict discipline. Zhang asked the plant to stop production until the workers changed their attitude. In the end he won. When the plant returned to operation, its monthly output was equal to the former annual output. Other strikes were sometimes reported when Haier started running other acquired plants. With his strong will and determination to realise his strategy, Zhang has accomplished many of the achievements he dreamed of, such as brand name recognition and becoming the number one domestic appliance maker in China. Now he is being driven by another dream, as written on a poster at his headquarters: ‘We have a dream. China should have world-famous brands of its own . . . letting the people of China hold their heads high in the world.’

The Haier Group 111 Effective utilisation of government resources At first glance, Haier presents a rather simple story of a successful entrepreneur with strong vision and determination. However, on careful inspection, it is unique in that it happened in a former planned economy dominated by state-owned enterprises with strong government intervention. Despite the fact that government involvement was a constant factor, Zhang enjoyed the advantage of being able to run Haier with a high level of managerial independence. Thus, he could use his imagination and implement his aggressive strategy with relative autonomy. To a great extent, this explains the unique corporate culture of Haier under the leadership of Zhang Ruimin, who has exceptional capabilities in the utilisation of government resources, these being loosely defined as any positive factors that could impact upon the relationship between the government and an enterprise such as industrial policy, trade and labour regulations, public notification, access to information, subsidies and so on. The collective enterprise and the government A collective enterprise lies in the middle ground between private ownership and state ownership. In theory, the assets and profits of a collective enterprise are owned by public investors, mainly the employees; and the government does not own it or have any claim on it other than taxes. In reality, collective enterprises are operated within a legally ambiguous system of governance due to the complexity of China’s economy. Collective enterprises are a remnant of the commune-brigade enterprises begun in 1958 with the establishment of the people’s communes. They were renamed collective enterprises with the economic liberalisation and disbanding of the people’s communes in 1984. Under the command system, such businesses receive neither funding nor technological aid from central government. Instead, they are influenced to a much greater degree by their provincial and local governments. On the other hand, collective enterprises are relatively free of the extensive central government regulations typically associated with state-owned enterprises. For example, they are able to utilise an accumulated tax system rather than the income tax system; this typically results in much lower taxes than the 55 per cent rate that state-owned firms have to pay. In addition, the less stringent regulations result in lower labour costs and fringe benefits. According to the 1996 China Statistical Yearbook, the average total cost for workers in township and village businesses was only 65 per cent of that for state businesses (SSB 1996). However, collective enterprises receive more benefits from local governments which are motivated to provide them with protection from outside forces, valuable information and sometimes financial aid. This protection is not given free, as collective enterprises have to manage their business in the

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manner that best accommodates local demands and local interests. With the policy of economic liberalisation and further reform, local governments were given greater incentives to develop collective enterprises to generate more tax and employment within their own region. The resulting growth, neither planned nor anticipated, was remarkable. It is claimed that the number of such businesses has expanded to an estimated 900,000 firms employing approximately 17 per cent of the nation’s workforce and producing over 41 per cent of the national industrial output (SSB 1996). As a result, government involvement has increased the economic importance of collective enterprises, leading some Chinese economists to describe them as the ‘second state sector’. The domestic appliance industry and the firms within this sector represent a typical example of the great financial success of the collective system. As a collective enterprise, Haier was under the control of the Qingdao municipal government which was responsible for monitoring public assets. The municipal government remained deeply involved in the appointment of managers and in strategic decisions. Such tight control led to a strong cohesive relationship between managers, workers and local government. In 1984, when Zhang Ruimin, a former government administrator in the Domestic Appliance Management Office, was appointed as the president of the factory, he was certainly considered the appropriate candidate to serve under the supervision of the municipal government. In principle, the municipal government evaluated his work performance annually; thus Zhang could be dismissed for any reason such as poor performance, labour disputes, mismanagement of funds or some other factor. However, with the continuing success of Haier, Zhang’s leadership has been undisputed both within the group and by officials in the municipal government. Zhang has undoubtedly shown remarkable ability in running a complex business in the political environment of China’s transition from a planned economy to a market economy. This may be partly due to his earlier career as a municipal official and partly due to his personality and sophisticated philosophy. In a complicated society like China’s, these qualities were crucial to the success of the firm. With many years work in the municipal government, he could easily convince municipal officials that his strategies were sound. For example, when he needed to purchase new technologies and equipment from abroad to upgrade production lines, he persuaded the government to approve the projects and provide support in the form of grants and loans, both at low interest and interest free. When he found that local manufacturers failed to supply high-quality components, he could obtain them through access to the import quotas and foreign currency that were under the strict control of the Foreign Trade Ministry (interview with local official in Shandong Foreign Trade Committee, January 2002). It is also well known that Zhang has maintained a very good personal relationship with Yu Zhengsheng, Mayor of Qingdao from 1988 to 1997, who enjoyed a good reputation for nurturing local big businesses. Under his

The Haier Group 113 leadership, some nationally famous brands emerged such as Tsingdao Brewery, Haier, Hisense, Aucma and Double Star. In 1998, Yu was appointed Minister of Construction and then Governor of Hubei Province in 2001. In March 2002, Haier started building its tenth industrial park in Wuhan, the provincial capital of Hubei. The project represents quite a good example of the significant relationship between them.2 The collective enterprise and the industrial policy In one of his speeches, Zhang said: ‘We work in a mixed economy. You must have three eyes: one fixed on the market, one on the employees and one on government policy.’3 Haier’s eighteen-year history offers many stories about how promptly and firmly has Haier seized the opportunities presented. Haier’s growth began with the central government’s policy of economic liberalisation and further opening to the outside world. In the late 1980s, as well as state-owned businesses, different ownership structures were allowed which had previously been prohibited. The government’s statement of policy made it clear that collective enterprises would be especially encouraged as a solution to the problems of scarce resources and high unemployment. As well as having greater autonomy, collective enterprises were also granted priority in the supply of raw materials, water and electricity, which were still under tight control in the planned system. The government advocated the licensing and use of Western advanced technology to modernise outdated Chinese industry. Haier took the opportunity to acquire state-of-the-art technology from Germany at the very beginning of its operations, which enabled it to be the first producer of four-star refrigerators in China. The increased consumer economy and emerging universal domestic market led by the reform enabled Haier to build itself into a branded refrigerator leader in China in approximately seven years. In 1992, after Deng Xiaoping made an important speech appealing for ‘reform and quick action’, Zhang Ruimin was inspired to take the aggressive step of building an industrial park for future development. Under the policy of industrial restructuring, Haier was in the vanguard of an officially sanctioned trend towards company mergers and industry consolidation. The acquisition of eighteen enterprises enabled Haier to diversify out of white goods at very low cost and very high speed. The large domestic market helped Haier to reach the size to benefit from economies of scale and the consequent cost advantage before entering foreign markets. The Chinese government has adopted a series of measures to encourage overseas penetration. For instance, apart from allowing a 17 per cent VAT rebate for exports, it has urged domestic banks to extend loans to Chinese enterprises which have foreign manufacturing sites or are involved in the export business, particularly of machinery and electronic products. President Jiang Zemin declared at the Communist Party’s

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Fifteenth Congress in 1997 that state enterprise reform was to be the new revolutionary path under which more attention was to be given to China’s biggest firms. Under the policy of ‘Grasping the big and letting go the small’, Haier had just been selected by the state as one of six ‘national-level experimental enterprises’: model companies expected to enter the Fortune 500 in a few years’ time. The central government granted special privileges to these six enterprises, as well as to 120 state enterprises earmarked for conglomerate status. Such privileges included getting priority for listing on the stock market and obtaining bank loans, establishing finance companies for internal use, tax refunds, and engaging in foreign trade without going through state trading companies. Special support was given to the six companies, including an annual grant for research and development of RMB20 million each. Moreover, as we have seen in Chapter 2 above, provincial and city governments showered benefits on their own big businesses. In such a complicated society as China’s, the public media, a government resource, represent a powerful vehicle for business with more ability to persuade consumers than advertising. Zhang definitely knows the value of publicity and how to make it work effectively. It is reported that senior figures visit the company frequently, and ask other domestic companies to visit and learn from Haier. It is claimed that Haier receives 500,000 visitors per year (interview at Haier, January 2002). In fact, the more successful Haier has become, the more political status it could obtain from higher levels of government, and the more independence it receives from the municipal government. Learning by benchmarking and rapid innovation Management and technology are crucial elements to the success of a company. As a latecomer in the domestic appliance industry, at the beginning of its operations Haier learned almost every aspect of its business from global leaders in the industry. Zhang Ruimin has read a lot of management books produced by Japanese and Western companies, and has admitted being greatly influenced by Jack Welch, the former CEO of GE. He devoted his energies to combining the practices of both cultures and putting them into operation in his own way. He tried the Japanese ‘Total Quality Management’ and GE’s ‘Six Sigma Programme’ in his company but finally modified them into his own OEC method. He learned from the Japanese organisational model and in the mid-1990s developed the general business department system which used to be very popular in Japanese companies such as Matsushita and Mitsubishi. In 1999, he turned to GE’s strategic business unit model, and centralised the purchasing of raw materials, distribution and business operations by establishing four departments concentrating on international business, distribution, sales and financial services (interview at Haier, January 2002). To improve competitiveness, Zhang continued to re-engineer business

The Haier Group 115 procedures and declared the theme for 2002 was ‘Speed, Innovation and SBU’ (Strategic Business Unit). With respect to technology, Haier strove to learn through partnerships with international companies. It is manifest that company will never become dependent on regular infusions of foreign technology. For example through collaboration with the likes of German’s Liebherr for refrigerators, Japan’s Mitsubishi for air-conditioners and Italy’s Merloni for washing machines Haier has learned from its partners how to make high-quality products. ‘First we observe and digest the new methods, then we imitate them. In the end, we understand them well enough to design them independently’ (interview at Haier, February 2002). All this should be done extremely quickly; in 2002 company statistics showed that 1.3 new products were introduced and 2.5 items of technological innovation made every day. Zhang asks his staff to learn by benchmarking innovatively and quickly. They are instructed to draft a business strategy after comparing their own business with a targeted competitor. During the benchmarking, detailed plans and tactics are made and steps are taken towards meeting the targets. The benchmark targets vary according to the product and marketing strategy. For example, GE, Matsushita, Sanyo, LG and Samsung are mentioned in different plans.

Discussion of the challenges facing Haier The global strategy One of the most debatable issues is Haier’s global strategy. With China’s entry into the WTO, Zhang was determined to establish Haier as a global player and make its brand name famous worldwide in the coming decade. The rationale for international expansion is that overseas manufacturing enables Haier: 1

2

3 4

to bypass the intangible trade barriers of the advanced countries. Trade disputes between China and the developed countries haven risen dramatically due to increasing Chinese exports. For example, in order to counter imports the USA has drawn up rules and regulations on specifications and environmental standards of appliances and these are upgraded annually. The EU has repeatedly brought anti-dumping lawsuits against Chinese electrical products; to overcome the entry barriers facing firms in the developing countries by approaching the technological and innovative frontier. Establishing overseas manufacturing and design centres abroad can mitigate remoteness from the main international sources of innovation and R&D; to increase competitive leverage and enhance consumer choice by access to sophisticated consumer markets and distribution channels; to counterattack foreign competitors in their home countries.

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However, the journey to global marketing will be extremely tough and expensive despite the fact that Haier’s overseas sales have increased rapidly. It is argued that Haier does not benefit from cost and market advantage, the key incentives that drove foreign companies to pursue a global strategy as well as to invest in China. Although Haier insists that it is winning its market share through innovative design, service and price, its initial success in the USA has come from low-end items with such razor-thin margins as not to interest local manufacturers. For example, the most popular 2.7 cu ft compact refrigerator typically used in college dorms, offices and small apartments is priced at only US$115 at Wal-Mart (Business Week, 11 April 2002). Hitherto Haier has only managed to tap a few niche segments in the major appliance markets, mainly refrigeration products including minifreezers and wine chillers. Haier claims that it has over 40,000 overseas sales outlets and fifty-six trading companies. However, with overseas sales totalling US$420 million in 2001, the average annual sales of each outlet come to approximately US$10,000. To promote overseas expansion, sales staffs were repeatedly told to take every possible order. Acceptance of loss-making orders was not unusual although Haier has publicly stated that it stopped taking lossmaking orders in 2001. It seems fairly optimistic to expect any profit margin, given that the domestic appliance industry as a whole is suffering from shrinking margins as a result of tough competition. According to an observer of the industry, Haier has not earned any profit from its export activities for the last few years. In the global market, competition is extremely tough and several existing oligopolistic players are struggling to make money. They enjoy substantial advantages in terms of capital, innovative technology, management skills, intensive worldwide marketing systems and strong brand recognition. They have years of experience in the implementation of global strategy, and in breaking up and integrating the value chains of their business activities in different countries. They have to pay a lot of attention to Haier’s activity, not only in their home market but also in China.4 Furthermore, all the global domestic appliance companies have considerable production facilities and already have strong footholds in China, in some cases including R&D centres. While Haier is trying to go global and localise its overseas operations, they are localising their Chinese operations and have managed to bring down costs to the same level as domestic producers. As discussed in Chapter 3 above, in producing in China, global giants are not only aiming at cheap labour but are also competing with domestic firms for local markets and local technical talent. It is assumed that China’s membership of the WTO will trigger a fresh wave of foreign direct investment. In fact, the foreign giants are making preparations and some have even taken an active part in the coming consolidation of the Chinese domestic appliance industry.

The Haier Group 117 Compared with other global companies, Haier’s strategy is not a truly global one in which efficiency is generated from the strategic placement of the value chain around the world. Rather, it is a multi-domestic strategy in which most of the value chain is reproduced in different countries. Haier’s international operations are still in the early stages, characterised by inefficient communications and management. The managers admit that the boot camp approach that has served it so well in China may not be suitable for less deferential workers elsewhere. For instance, only Mainland Chinese managers undergo the Haier system of criticism in plants in Malaysia, Indonesia and the Philippines (interview at Haier, 2002). A new corporate model will have to be found if Haier’s success at home is to work abroad. Moreover, building a quality brand image abroad may be a lengthy process due to the very poor-quality image of Chinese products. The company also acknowledges that two constraints are already being felt, even as the company gears up for international expansion: scarce financial resources and a shortage of qualified staff. Meanwhile, competition is also extremely tough in the domestic market. Although Haier has managed to keep its leading position in the domestic appliance sector, in almost every sector, it faces strong competition not only from local companies but also from those subsidiaries of global players who enjoy certain technological advantages over it. For example, Kelon and Electrolux are close runners-up in the refrigerator sector, Little Swan ( joint venture with Bosch-Siemens), Rongshida and Matsushita in the washing machine sector and Glee, Meidi and Chunlan in the air-conditioner sector (see Table 3.14a). A critical strategic decision facing Haier is how to divide its precious resources between the domestic market and the international market. It is a tough decision, as both markets demand huge inputs. Technological innovation One of Haier’s dreams is to become the third domestic appliance maker in the world, after Whirlpool and Electrolux. However, technological innovation, a core aspect of competitive advantage, is always crucial to the success of leaders of industry, even in the domestic appliance sector where innovative breakthroughs are rare. This is a significant disadvantage for firms in the developing countries such as Haier, as it is almost impossible to close the technological gap through imitation and subcontracting services. The initial success of Haier is largely attributed to its acquiring advanced technology from developed countries. Thanks to the mid-level technology of refrigeration and to the large domestic market, Haier could grow rapidly and enjoy cost advantage from economies of scale. Haier still continues to rely heavily on the external acquisition of technology to offset its lack of homegrown R&D. For example, Haier has entered into strategic alliances with almost twenty international firms and institutions such as Philips of

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The Haier Group

Holland, C-MOLD Co. and Netscreen Co. of America, and Ericsson of Sweden. In 1996, Haier set up a joint venture with a Japanese design company to keep abreast of the latest international trends. Zhang says: Things are different today from the traditional economy. Then companies all had their own researchers. Now that’s not as necessary. I can form an alliance with Ericsson for Bluetooth technology. Tomorrow I can work with Motorola. Two days from now I can work with Nokia. (quoted in Forbes, 6 August 2001) To avoid the need for inhouse R&D, Haier has set up close connections with more than 120 domestic universities and research institutions to develop cooperative and joint R&D projects. For example, Haier has signed an agreement with Ha Er Bing Industrial University to undertake a robot development project. Haier invested RMB500 million on building the Centre Research Institute in 1999 and plans to raise its inhouse R&D investment. In 2001, fifty ‘venture projects’ were selected, including robotics, integrated circuits, digital technology and so on (interview at Haier, March 2002). However, due to the lack of talent available, most of the projects were undertaken externally, and the main task of the institute is to collect information, keep in regular contact with outside contractors and monitor the projects. Haier claims that it normally used to spend 3 per cent of sales revenue on R&D, which rose to 6 per cent in 2001. Despite the reliability of the figure, the amount is far less than that spent by its global competitors. Although avoiding raising inhouse R&D investment, Haier did devote its technicians’ energies to satisfying consumers’ preferences through innovative features and designs. Zhang said: ‘We grasp the consumers’ preferences in one hand and control the global supply chain which enables us to meet these preferences with the other, then we have the core competence in the competition’ (interview with Zhang Ruimin, June 2002). Diversification vs. specification Haier’s diversification process follows a pattern: from highly related, to moderately related, to non-related. The traditional wisdom tells that related diversification centred on the same pool of core competences has a better chance of success than non-related diversification. In reality, the growth of Haier shows that the higher the degree of relation, the better performance has been. Diversification is a two-edged sword. It may be either a benefit or a trap. The danger arose when Haier wanted to get into almost every sector that seemed to offer better returns than its existing line of business, as the approaches to each business are quite different. So far Haier’s diversification strategy has yielded mixed results. The information business presents a vivid example. In 1998 Haier announced it was to enter into the high-tech sector,

The Haier Group 119 a highly competitive field where even giants such as IBM and Legend struggle to make money. Because the distribution channels of white goods and computers are different in China, Haier could not exploit its existing distribution network and had to open new branches engaging in selling a wide range of computer and telecommunications products. After four years of struggle, continuing losses made Haier decide to stop producing computers itself and to buy budget equipment (interview at Haier, January 2002). In its transformation from an electronics manufacturer to an electronics innovator, Haier is planning to outsource more non-core business (interview at Haier, 2002). Haier believes that the service sector it has just entered will present more opportunities with China’s entry to the WTO and the more flexible capital market. However, it is rather difficult to examine its activities in their infant stage. Observers suggest that Haier’s partners are all insignificant local players, none in a leadership position in the domestic finance sector. In the rush to get big quickly, Haier risks trying to do too much at once, overstretching its management resources and making questionable decisions, that may even affect the growth of the core business. The more limited the resources, the greater the risk. The management resource To become a leading global player, Haier adopted an extremely aggressive strategy: to grow by a combination of internationalisation and diversification, both requiring huge inputs of capital and human resources. With the ever-increasing need for capital, Haier looked into every possible way of raising funds. One source of capital is extensive borrowing from major Chinese banks, which are always generous in lending money to big clients like Haier. For example, the Bank of China granted Haier a global credit quota of US$300 million in June 2001, which enabled it to access capital for the international projects of its overseas branches (Haier Press, 25 June 2001, see company website). Holding minority shares in local finance institutions offered another source of money, but the small size of the partners means the company’s requirements are nowhere near being met. The capital market is another option. The Qingdao Haier Share Holding Company, the only company in the group to which this option is available, issued shares for 43.7 per cent of its refrigerator division, raising RMB369 million in 1993. Since then, with the ever increasing demand for capital, it has raised over RMB3.5 billion in total through issuing shares in other divisions (Haier 2003). In September 2001, it applied to issue 2.58 billion transferable bonds, which would raise RMB1,000 million and would be used to purchase the capital of the other firms in the Haier Group (Haier Press, 16 November 2001), including 59 per cent of Guizhou Haier Electric Company, 60 per cent of Wuhan Haier Electric Company, 60 per cent of Shunde Haier Electric Company, 75 per cent of Qingdao Haier Airconditioner Electric Company, 78 per cent of Hefei Haier Air-conditioner

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Company and 80 per cent of Hefei Haier Washing Machines Company. These large-scale activities provided the Haier Group with a large cash flow, but it is far from sufficient. As expansion drives up capital demand, Haier is looking into overseas listing of its subsidiaries in Hong Kong and New York within three years (China Economic Times, 1 June 2004). Both domestic and international capital comes with risks. In addition to the fact that the large amounts borrowed and the subsequent repayments and interest due could have an adverse affect on innovation and expansion, excessive borrowing and over-expansion will certainly adversely affect financial performance, a question that is constantly raised by investors who witness the poor performance in the domestic appliance industry as a whole and the great losses made by other listed companies like Kelon and Changhong in the increasingly tough price war. In fact, in its first half-year report in 2002, the net profit of Haier Electric Company dropped from RMB399.5644 million to RMB219.1805 million, 45.15 per cent less than that in 2001 (Nafang Dushi Bao, 30 July 2002). It is suggested that given the financial situation, if one of the product groups were to get into financial difficulties, it might cause a loss of confidence in the company in general. This could lead to a ‘domino’ effect on the stock market, causing serious problems. Human resources are another crucial concern. New skills are in great demand due to the expansion of new businesses. Haier faces the challenge of attracting new blood from first-class universities and keeping them in the company. However, this is becoming tougher due to the changing environment. With the increasing demand for talents in popular sectors such as IT, finance and telecommunications all over the country, Qingdao is definitely not able to compete for first-class talent against cities like Shanghai and Beijing. Internal promotion is considered an effective way to retain young staff, as advancement is a great career incentive. But the pressure that results from advancement has led to a high turnover in the company. Zhang Ruimin expressed his concern about this: ‘Haier has grown too fast in the past twenty years. The high speed growth resulted in the exhaustion of people’s energy. The problem is that we have no time to take a rest’ (interview at Haier, 2002). In addition, the company no longer enjoys the advantage in wages that it had in the past, as many competitors pay the same or even higher rates than Haier. A worrying trend is that more and more senior management and sales staff have left the company to work for competitors. A typical example is the Electrolux Chinese subsidiaries where many senior positions, from deputy chief representative to regional sales managers, are filled with former Haier staff their motto is ‘Learn from Haier and beat Haier’ (interview at Haier, January 2002). The government intervention factor Political risk is another concern, given the unstable political relations between China and the USA, the uncertain outcome of WTO membership

The Haier Group 121 and the unstable domestic political and economic environments that will be aggravated by China’s entry into the WTO. The Chinese government is struggling to nurture its domestic firms to become global players. Haier is certainly one of those most likely to succeed. The government wants Haier to be a model national industry, and urges other Chinese firms to emulate it and build international competitiveness. Some positive support has been given to Haier, both financially and morally, such as official rewards, political status, substantial loans and subsidies. For example, in June 2001, the State Council approved Qingdao to host the annual China International Electronic and Electrical Appliances Exhibition. In the past twenty years, Chinese bureaucrats have failed to implement an effective industrial policy aiming to develop world-beating industries. Apart from the fact that business operations are always risky, Chinese policymakers’ inept record in corporate management hardly qualifies them for their task. The firms complain that the huge number of regulations hampers their further development; these include regulations on importing raw materials, restrictions on overseas projects and foreign currency exchange, on VAT rebates on exports and so on (Zhang 2001). For example, Haier applied to set up a financial company for internal use in 1994, but was rejected due to the severe restrictions placed on collective enterprises at that time; the application was finally approved by the State Economic and Trade Commission in January 2002. Another example is the strict restrictions played on foreign currency exchange. The procedure for approval is extremely complicated and time consuming, and this has a serious effect on firms that attempt to further their international business operations, particularly on emergency advertising campaign budgets (Zhang 2001). Despite the fact that the bigger Haier became, the more independent it got from the local government, government intervention is still an unavoidable constraint. Within the framework of the WTO, this constraint will be intensified. Haier wants to be released from every possible social obligation and restriction and enjoy complete freedom in its business operations on a truly level playing field with its competitors. But local governments are reluctant to give up control due to their own vested interests. In fact, Haier started negotiations with the municipal government about its intention to move its headquarters to Pudong in Shanghai. In the end it stayed in Qingdao. Haier is in further negotiations with the provincial government over its application to set up a special zone in Qingdao. Some analysts argue that the big test for Haier’s future will be its ability to detach itself from the local governments of Qingdao City and Shandong Province (interview with a municipal official in Qingdao, 2002). The ownership structure In theory, the collective enterprise was designed for the transition period from the private economy to a socialist economy in the early 1950s. When

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private ownership was prohibited, self-employed artisans and small entrepreneurs were allowed to band together for the purpose of commercial activity, under the supervision of different levels of government. In contrast to state-owned enterprises which are owned by the government, the assets and profits of a collective enterprise are owned by public investors, mainly the employees. According to the constitution’s regulations of city and township collective enterprises, employees in a collective have the right to elect the management. However, as a special by-product of the socialist economy, the resulting ownership structure is extremely vulnerable. The laws governing collective management evolved through an ill-defined process, and collectives often operated according to local custom following negotiations with local politicians. In reality, it is not uncommon for the local government or relevant administrative authority to appoint or dismiss the management of a collective enterprise and deal with property rights and assets on behalf of the collective. The ambiguity of the ownership structure of collective enterprises is an extremely difficult historical problem, and the central and local governments are expected to find a radical solution. There are two main positions on reform. One is nationalisation, which argues that, historically, local government owned and controlled most collectives; and as government involvement was such a deeply rooted factor, some people have even described the collective enterprises as the ‘second state sector’. In fact, the increase in their economic importance is mainly attributed to their being targeted and nurtured by the local governments. Others argue that collective enterprises should be granted full autonomy with no government intervention: they should be owned, in the true meaning of the word, by the public investors. In the domestic appliance industry where most of the companies are urban or township collectives, various methods of reform have been experimented with by different local governments. For example, the Shunde City government sold its shares in collectives including Kelon and Meide to private investors. The Hefei City government divided the property rights and assets of Rongshida into three parts: 2 per cent is owned by the state, 5 per cent by senior managements and 97 per cent by the collectives. The Chuzhou City government finally agreed that the total assets of Chunlan Group should be owned by the employees. In the case of the Haier Group, ownership is collective. The original plant, established in 1955, was a small handicraft producers’ cooperative (or collective commune group of artisans engaged in manual production) which in principle turned over a percentage of its profits to the Qingdao Second Light Handcraft Industry Association, a non-governmental organisation that existed at that time. In 1958, the commune group was transformed into a cooperative factory called the Qingdao Electrical Motor Plant (later renamed the Dongfeng Electrical Engine Plant). The shares of the factory were defined by fixing the price for the collective capital and individual capital; however, the individual capital was refunded in 1965 (Liu 1999). In

The Haier Group 123 March 1980, with the approval of the Qingdao Second Light Manufactured Industry Bureau, it merged with the Qingdao No. 4 Instruments Plant to form the Qingdao Daily-Use Electrical Product Plant, a collectively owned company. In 1984, the General Refrigerator Factory was established, funded by the urban and municipal collective capital and corporation capital (including the fixed assets and liquid assets invested by the Second Light Handcrafts Industry Association). In 1989, the company was renamed Qingdao Haier Company Limited. In 1992, the Qingdao municipal government passed the total assets of the Qingdao Air-conditioner Factory and Qingdao General Freezer Factory to Haier and then established the Haier Group. The Group has expanded by mergers, affiliations and the establishment of new subsidiaries for additional product ranges. It now consists of approximately 100 subsidiaries and affiliates, including a listed company, the Qingdao Haier Share Holding Co. Ltd. The initial capital of the listed company was RMB170 million, of which the group owned RMB105 million, the Second Light Handcrafts Industry Association owned RMB5.86 million and public shareholders owned RMB59.14 million. In 2001, the shareholders consisted of three ‘legal persons’, the Haier Group, the Second Light Handcrafts Industry Association and the Haier Electronic Appliance International Limited Company (Haier 2001) (Figure 4.4). It is claimed that the Group succeeded in becoming independent from the control of the Second Light Handcrafts Industry Association after hard negotiations with the local government, although details of the deal are unclear. In this sense, the Group is a collective owned by public investors, i.e. its 30,000 employees. However, it is far from a clear ownership structure, since the share value and holding of each employee have not been defined. It can be assumed that it will be extremely difficult to find a satisfactory solution that will please both local government and the management. After rapid expansion in the past twenty years, the Group’s ownership structure has become more and more confusing and complicated, not only to outsiders but also to insiders. Given that collective enterprises are operated within a legally ambiguous system of governance due to the complexity of China’s economy, the outcome of the ownership reform is still uncertain. There is no evidence that radical progress to change the ownership structure is being made by either the local government or the Group. The earnings structure within the Group is still mainly based on the that of the local state-owned company. However, attempts are being made to find a better solution, such as an annual pay system and an equities incentive system (China Economic Times, 1 June 2004). A significant change is that the Group has transferred over 14 per cent of its share in the Qingdao Haier Co. Ltd to the Haier Electrical Appliance International Co. Ltd, which makes it the biggest shareholder of the listed company. Haier Electronic Appliance International Co. Ltd, with a registered

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Haier Group

Haier Electrical Appliance International Co. Ltd

Haier Refrigerator Share Holding Co. Ltd

Holding companies of the listed company Haier Refrigerator Co. Ltd Haier Refrigerator International Co. Ltd Haier Air-Conditioner Co. Ltd Haier Meloni (Qingdao) Washing Machine Co. Ltd Haier General Freezer Co. Haier Special Type Refrigerator Co. Ltd Zhangqiu Haier Electric Engine Co. Ltd Haier Intelligent Electric Co. Ltd Haier Health Domestic Appliances Co. Ltd Qingdao Meier Powder Co. Ltd Qingdao Electrical Appliance Equipment Research Institute

Sales and trading companies 42 Haier Industrial Trading Co. Ltd Haier Components Purchasing Co. Ltd Haier Physics Distribution Co. Ltd Haier Import & Export Co. Ltd Haier Air-conditioner Electronics Selling Co. Ltd Hefei Haier Air-conditioner Selling Co. Ltd Haier Group E-Commerce Co. Ltd

Overseas companies Haier America Trading Co. Ltd Haier America Refrigerator Co. Ltd Haier Europe Trading Co. Ltd Haier (Italy) Appliance S.P.A.

Joint ventures Mitsubishi–Haier (Qingdao) Air conditioner Co. Ltd Haier Haigao Design & Manufacturing Co. Ltd Haier R&D Special Type of Steel Plate Co. Ltd Haier Sanyo Co. Ltd Manufacturing companies Wuhan Haier Electrical Appliance Co. Ltd Guizhou Haier Electrical Appliance Co. Ltd Shunde Haier Electrical Appliances Co. Ltd Hefei Haier Air-conditioner Co. Ltd Hefei Haier Washing Machines Co. Ltd Qingdao Haier Air-conditioner Electronic Co. Ltd Haier Dishwasher Co. Ltd Haier Moulds Co. Ltd Haier Communication Co. Ltd Haier Housing Construction Co. Ltd Haier No. 3 Pharmaceutical Factory Haier Fengcai Printing Co. Ltd High-tech companies Beijing Haier IC Design Co. Ltd Shenzhen Haier Information Technology Co. Ltd Beijing Haier Guangke Digital Technology Co. Ltd Beihang Haier Software Co. Ltd Haier Kehua Engineering Plastic R&D Co. Ltd Haier China Construction Telecommunication Co. Haier Technology Co. Ltd

Finance and security companies Haier Investment Co. Ltd Haier Economic and Business Consulting Co. Ltd Haier (New York) Life Insurance Co. Ltd

Figure 4.4 The Haier Group’s organisational structure. The Haier Group consists of around 100 related companies. This list shows the major affiliates and subsidiaries. Source: Annual reports and company documents.

The Haier Group 125 value of RMB631.9 million in 1988, is a company with a very clear ownership structure: the Haier Group owns 590.5 million shares (93.44 per cent), the Haier Economic and Business Consulting Co. Ltd owns 40 million shares (6.33 per cent), and the employees own 1.5 million (0.33 per cent). It is a meaningful candidate, if Haier is looking into the possibility of overseas listing. Should the company succeed in being floated abroad, the management could run it according to international practices, and the employees could all benefit from the clearly defined ownership structure (China Economic Times, 1 June 2004). Of course, this proposal would depend on official policy. Nevertheless, the hope is there.

Conclusion Haier is the pride of China. With nearly 30 per cent of domestic refrigerator sales and 20 per cent of washing machine and air-conditioner sales, Haier has shown an unparalleled mastery of quality, service and distribution in China’s difficult consumer market. Haier’s rise is no accident, if the domestic appliance industry as a whole is taken into consideration. As it is the most successful sector in China, it can be assumed that there are important reasons for its development, beyond the injection of technology: 1

2 3

The industry is suited to China’s current technological level. Chinese manufacturers could easily master the technological obtained through licensing agreements and joint ventures with foreign firms and reverse engineering. Chinese consumers provided strong demand due to the rapidly expanding economy and improvement of living standards. With a proactive learning style, management understood how to do business in the market economy at an early stage.

Apart from Haier, a number of other strong domestic firms emerged under strong, market-orientated and even visionary leadership. These business leaders, such as Zhu Dekun of Little Swan, Pan Ning of Kelon and Chen Rongzhen of Rongshida, are turning out high-quality products, expanding marketing channels, creating strong brand names. They were able to hone their skills even as the first foreign firms, mainly Japanese, were setting up factories and distribution channels in China in the late 1980s. However, what separates Zhang from the rest is his far-sighted and bold strategy of becoming a global player. Most domestic companies are working as hard as they can to meet demand by focusing on satisfying the increasing demands of Chinese consumers, taking market share from national competitors and filling OEM orders for export. Even those that do think bigger and look outside only see the difficulties involved in setting up international sales and service networks from scratch. Haier was determined not only to penetrate the export market with its own brand but also to manufacture the

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products abroad. Zhang is sticking his neck out, although the outcome of his strategy is not clear. Success is largely dependent on capital injection. Some observers argue that if capital resources could compensate for overseas losses for, say, ten years, it might be possible for Haier to be a successful global brand; if not, it could fail overnight. In 2001, at the conference marking Haier’s seventeenth anniversary, Zhang outlined his three strategies: (1) to generate value-added orders and avoid price wars; (2) to integrate global resources through local operations and cooperation with local competitors; and (3) to build Haier into a multinational business group combining manufacturing and financial businesses by entering into the finance sector. In the transition of the business, the first thing he has to do is make his management team understand his new strategic concepts. Nevertheless, to achieve these strategies, Haier needs to gather huge resources and allocate them properly while minimising financial and strategic risks in the short term. In the long run, like many other companies in China, Haier needs to overcome the weaknesses which hamper sustainable growth: over-reliance on a single leader, an ambiguous ownership structure and massive social obligations.

The Hisense Group

5

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The Hisense Group

Introduction In 2001, the Hisense Group, a Qingdao-based state-owned company with thirty years of history, had consolidated net sales of RMB16.1 billion, and became one of the top ten electronics enterprises in China. The realisation that the structure of the industry was changing led the company to reflect on its position. Since the company had become a major player in the industry, it might be necessary to reappraise its competitive strategy. Its managers faced a number of major challenges. Changes in the industry caused by technical progress were raising questions about Hisense’s historical product range policy. And perhaps the company had bitten off more than it could chew by diversifying into the IT and telecommunications sectors. Finally, there was widespread concern about the future of the company in the absence of radical reform of the ownership structure. This chapter will take a closer look at the company’s history, development strategies and challenges.

Background and history In the 1970s The history of Hisense can be traced back to December 1969, when Qingdao Number Two Radio Factory was founded, with thirty employees and a facility area of 1,000 square metres. With RMB107,000 invested by the municipal government, the only good the factory produced was a radio receiver with the brand name Red Lantern, using manual production methods. In early 1970, following a request by the Shandong National Defence Office to trial-produce black and white television sets and radio transmitters, the factory started research into television production. Three workers were sent to Tianjin 712 Factory for technical training; a month later they assembled a 14-inch screen vacuum tube television set, with components and spare parts provided by the 712 Factory. It was the first set produced in Shandong Province. By the end of 1971, the factory had produced eighty-two TV sets. However, output was extremely constrained

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by shortage of the core component – the picture tubes that were under strict control in the planned economy. Furthermore, without approval from the senior authorities, the factory could not be supplied with raw materials for TV production. So it had to give up large-scale production of televisions, but insisted on doing independent research into television manufacturing techniques and thus ultimately acquired the capability to produce 9-inch, 12-inch and 14-inch screen transistorised televisions. The turning point came in 1979, when the Ministry of Electronics held a meeting in Beijing and decided to develop the civil-use electronics industry. It allowed the municipalities that were directly under the central government (Tianjin, Shanghai, etc.) to set up television manufacturing companies and the district cities to set up general television factories. The policy led to a substantial growth in television receiver production. In quick response, the Qingdao municipal government merged the Number Two Radio Factory with three other local factories and established the Qingdao General Television Factory in May 1979. Two hectares of land were purchased as the production base. It became one of the biggest television makers in Shandong Province with output of 6,375 sets per annum, and in 1981 the turnover reached RMB25 million with 835 employees. In the 1980s With further economic reforms and increased living standards for Chinese consumers, there was an increase in demand for colour televisions. Encouraged by the industrial policy of import substitution as well as being granted more autonomy, Qingdao General Television Factory seized the opportunity to sign an import agreement with Matsushita of Japan in 1984. The purchase of the production line and technologies enabled the factory to produce 100,000 14-inch screen colour televisions per annum. The investment, which cost the factory RMB40.57 million, was so successful that sales revenues reached RMB37.48 million with a pre-tax profit of RMB7 million in 1984 (Hisense Group 1999: 8). Its high quality made the Qingdao brand CTV well known and the products captured the local market very quickly. Growth was sustained for several years due to increasing demand in the domestic market. In 1989, the factory became one of the 500 largest state-owned enterprises in China and ranked twentieth among the top 100 electronics enterprises with a production capacity of 410,000 sets per annum as listed by the Ministry of Machinery and Electronics. Since the first CTV production line in China was imported in 1979, the television industry expanded very quickly, comprising around 300 manufacturing enterprises at its peak. As a result, the domestic market was highly fragmented with many small-scale enterprises which were highly profitable but merely served their local areas. However, when the economic environment deteriorated in the late 1980s, to control inflation the State Council slowed down domestic demand by putting a high level of tax on luxury

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goods, including colour televisions. The policy, which was not repealed until 1992, led to the sudden shrinkage of demand and an inevitable increase in competition between manufacturers in the consumer goods industry. The colour television industry was in trouble, as most manufacturers, including Hisense, faced the problem of reduced demand. In the 1990s In 1992 the state was resolutely determined to bring about further liberalisation and opening; it was also the hardest year that many television manufacturers experienced. In 1992, when the president of Qingdao General Television Factory, Li Dezhen, was appointed chief director of Qingdao Electronic Instrument Bureau, Zhou Houjian, the 35-year-old vice-president, was appointed by the municipal government to succeed her. Feeling that the company had to keep growing by diversifying both vertically and horizontally, Zhou pursued his strategy of ‘developing the television sector without solely relying on it, and engaging in consumer electronics without being confined by it’. He decided to purchase technology from Matsushita to produce wide-screen CTVs. Furthermore, to improve consumer awareness as well as to reach the nationwide domestic market, he changed the company name and brand name to Hisense instead of Qingdao. An opportunity came when the central government initiated the strategic restructuring of state-owned enterprises, requiring SOEs to resolve the problems of loss-making enterprises by reorganising their business structure, changing management methods and introducing advanced technology. To consolidate the industry, a wide-ranging process of mergers took place. The government advocated innovative ways to deal with complicated issues involving property rights and assets. This enabled Hisense to expand its economy of scale and scope. In 1994, Hisense took the lead in the capital market and initiated experiments in how ‘to deal with capital and market from the capitalist point of view’. Penetration of the provincial market in Shandong became Zhou’s priority, and he carried out a series of mergers and acquisitions in Qingzhou, Linyi, Feicheng, Zibo and other cities, using various approaches including ‘transferring state-owned assets under the supervision of different administrative authorities in different cities’, ‘transferring creditors’ rights into shareholders’ rights’ and ‘transferring technical know-how into investment’ (Hisense Group 2002). For example, in February 1994 Hisense acquired Zibo Television Factory, a TV manufacturer which had imported its production line and technology from NEC of Japan in 1985. Due to poor management, it was running at only 3 per cent of its capacity of 150,000 units. With RMB80 million of debt, the factory was on the verge of bankruptcy. After negotiations with the local government, Hisense invested RMB15 million in cash, plus intangible assets such as management skills, brand name and technology, accounting for a 51 per cent share in the joint venture, Zibo Hisense Electric

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Co. Ltd. The new company, while not bearing any liabilities from its parent companies, was soon put into operation with a production capability of 150,000 colour TVs and black and white TVs. Subject to negotiation with the Zibo municipal government, Hisense promised to keep 300 workers and had the right to appoint new management and reorganise the production structure in the factory. The merger was a great relief to the local government, which acquired over RMB3 million in taxation in 1994 and 1995. In 1994, the sales revenue was RMB160 million with profit of RMB2.38 million. In 1995, the sales revenues reached RMB300 million with profits of 7.20 million (Hisense Group 1999: 99). In 2001, the Hisense Electrical Appliance Share Holding Company acquired the remaining 49 per cent of shares and made the company a wholly owned subsidiary. In August 1994, the Hisense Group was established, consisting of seven wholly owned subsidiaries, seven holding companies and several participating companies (Figures 5.1, 5.2). With the launch of the Hisense TC29DSP model in 1995, Hisense became one of the state-designated manufacturers of large-screen colour televisions in China. The Hisense Electrical Appliance Share Holding Company, a wholly owned subsidiary of the Group, was floated on the Shanghai Stock Market, listing 70 million A shares, on 22 April 1997. The flotation successfully raised RMB420 million. The tough competition caused by the price wars in 1996 resulted in further consolidation of the TV industry, and this offered Hisense more opportunities for transprovincial mergers and acquisitions. To follow these up, as had did within Shandong, Hisense acquired Guiyang Huari Electrical Appliance Company in 1996 and Liaoning Jinfeng Group in 1997. The acquisitions not only increased the production capacity but also expanded the market penetration. For example, Hisense entered into a joint venture, the Hisense Guiyang Electrical Appliance Co. Ltd, with Guiyang Huari Company, a troubled company with debts of RMB57 million. Apart from RMB13.6 million cash (accounting for 36 per cent), Hisense contributed technologies, processing techniques, and its brand name as invisible assets valued at RMB5.66 million (accounting for 15 per cent). Huari Company put in investment of buildings and equipment which were valued at RMB18.5 billion (accounting for 49 per cent) (Hisense Group 1999: 100). The joint ventures, strongly supported by the host local government which insisted on retaining 85 per cent of the previous workforce in the company, enabled Hisense to get quick access to the markets of south-east China. Until 1998, with assets worth less than RMB300 million, Hisense acquired ten loss-making companies with total assets of RMB3 billion, taking control of a majority share in these companies. These activities made Zhou Houjian known as a ‘red capitalist’. The sales revenue of the Hisense Group rose from RMB400 million in 1993 to RMB13,470 million in 2000, net assets rose from RMB89.13 million to RMB1,850 million, and the debt/ assets ratio decreased from 85 per cent to 53 per cent (Table 5.1). In 1997, Hisense was selected by the Shandong government as one of the twelve big

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Hisense Group

Listed company Hisense Electrical Appliance Share Holding Co.

Holding companies of the listed company Zibo Hisense Co. Ltd Linyi Hisense Co. Ltd Guiyang Hisense Co. Ltd Liaoning Hisense Electrics Co. Ltd

Overseas companies Hisense South Africa Share Holding Co. Hisense Indonesia Co. Ltd Hisense Japan Co. Ltd Hisense Hong Kong Co. Ltd Hisense Brazil Co. Ltd Hisense Italy Co. Ltd

Wholly owned companies Qingdao Hisense Technical Centre Qingdao Hisense Electrical Appliance Co. Qingdao Electric Instrument Measure Test Centre Qingdao Hisense Advertising Co. Qingdao Hisense Import & Export Co.

Holding companies Qingdao Hisense Electrical Appliance Share Holding Co. Qingdao Hisense Air-Conditioner Co. Ltd Qingdao Hisense Computer Co. Ltd Qingdao Hisense Optics Co. Ltd Qingdao Hisense Packing Material Co. Ltd Qingdao Hisense Moulds Co. Ltd Qingdao Hisense Real Estate Developing Co. Ltd Qingdao Hisense Quamm Electric Co. Ltd

Participating companies Qingdao Lucent Telecommunication Equipment Co. Ltd Beijing Gaoteng Commercial Computer System Co. Ltd Qingdao Chengyang Condenser Factory Others

Figure 5.1 The Hisense Group’s organisational structure (2002). The Hisense Group consists of around twenty-five related companies. This list shows the major affiliates and subsidiaries. Sources: Annual reports and company documents.

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President’s Office

Wholly owned companies

Strategic Research Centre

Human Resource Dept.

Market Promotion Dept.

Holding companies

Hisense Group

Planning and Finance Dept.

Overseas Developing Dept.

The Law Centre

Overseas companies

Technology & Quality Promotion Dept. Participating companies

Qingdao Hisense Technical Centre Qingdao Hisense Electrical Appliance Co. Qingdao Electric Instrument Measure Test Centre Qingdao Hisense Advertising Co. Qingdao Hisense Import & Export Co. Qingdao Hisense Electrical Appliance Share Holding Co. Qingdao Hisense Air Conditioner Co. Ltd Qingdao Hisense Computer Co. Ltd Qingdao Hisense Optics Co. Ltd Qingdao Hisense Packing Material Co. Ltd Qingdao Hisense Moulding Co. Ltd Qingdao Hisense Real Estate Developing Share Holding Co. Qingdao Hisense Quamm Electric Co. Ltd Hisense South Africa Share Holding Co. Hisense Indonesia Co. Ltd Hisense Japan Co. Ltd Hisense Hong Kong Co. Ltd Hisense Brazil Co. Ltd Hisense Italy Co. Ltd Qingdao Lucent Telecommunication Equipment Co. Ltd Beijing Gaoteng Commercial-Use Computer System Co. Ltd Others

Figure 5.2 The business structure of the Hisense Group (2002). Sources: Company documents.

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Table 5.1 Selected performance data of the Hisense Group (1973–2001) Year

Sales (RMB million)

Net assets (RMB million)

Profit (RMB million)

Export (RMB million)

Output of CTV (000s)

Employees (no.)

1973 1985 1987 1992 1993 1995 1996 1997 1998 1999 2000 2001

22 214 – 410 – – 2,500 5,411 8,250 10,625 13,470 16,100

– 16 – – 89 200 – – 1,840 1,600 1,850 2,560

3.00 757.00 – – – 884.60 147.30 226.91 401.00* 540.00* – 299.00

– – – – – 74.10 61.20 154.50 – 8.33** 286.00 –

– 400 410 – – – – 1,249 1,500 2,180 1,800 –

103 1,271 1,408 – – – – 7,403 – 9,000 – –

Source: Author’s notes. Note * pre-tax profit. ** in US$ million.

groups it would support. In January 1999, Hisense was awarded the China’s Famous Brand prize by the State Industrial and Commercial Administration. In 2002, it ranked eighth among the top 100 electronics enterprises in China (Hisense Press, 15 May 2002, company website). Into the twenty-first century At the beginning of the twenty-first century, Hisense aimed to be a leading world-famous company in the electronics, IT and telecommunications industry. Within the group, there were some significant changes concerning the business structure and the business strategy. The 43-year-old president of Hisense, Zhou Houjian, held the position of chairman of the Board of Directors of the Group. The former vice-president, Ms Yu Shumin, became CEO. This implies, according to Zhou, a preliminary separation between the executive body and the decision-making body, and the new position enabled him to focus on the long-term strategies of the Group instead of daily management. To restructure the product lines, Hisense divested such business as components, packing and retailing, and paid more attention to its core business. Enormous physical investment was put in to accelerate the overall implementation of the ‘3C’ strategy (C standing for Consumer electronics and domestic appliances, Computers and Communications). Hisense spent billions of renminbi on technical innovation and industrial parks construction. The Information Industrial Park, located in Qingdao High Tech

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Development Zone, occupies 800,000 square metres of land and cost RMB2 billion. Three other industrial parks are in the process of construction, including the Pingdu Appliance Industrial Park (500,000 square metres), Zibo Electric Industrial Park and Guizhou Information Industrial Park. In a very short time, Hisense has built up a huge production base, its main products, covering seven areas, having 280 variants, including TVs, air-conditioners, refrigerators, computers, DVDs, CDMA mobile phones, computer software and network equipment. The rapid expansion has given Hisense the capacity to manufacture 4 million CTVs, 1.5 million inverter air-conditioners, 1 million CDMA mobile phones and 0.5 million computers per annum (interview at Hisense, June 2002). These increases form a key part of Hisense’s attempt to increase the shares of IT and telecommunications in the Group’s total revenues. The Group aims to increase the share of computers and mobile phones to account for one-third of total revenue, which is projected to reach RMB100 billion by 2010. In 2001, Hisense was awarded the National Quality Management Award. Zhou Houjian was elected to the list of China’s Top 10 Famous Economic Figures in 2001. In February 2002, Hisense CTVs and air-conditioners were declared the ‘Nil Complaints Products of 2000’ by the China Consumer Association. On 1 July 2002, Hisense Electrical Appliance Share Holding Company was selected as one of the Shanghai Stock 180 Index.

Diversification: a journey of exploration to 3C Consumer electronics Consumer electronics products cover CTVs, flat screen TVs, black and white TVs, VCDs, DVDs, multi-media TVs, PDP (plasma colour television) and so on. When the government removed price control of CTVs in 1996, a price war broke out among the manufacturers in China. Changhong, an industry leader, initiated the war by reducing its prices to very low levels. In quick response, other TV makers such as Konka and TCL followed suit. As a result, the price of CTVs fell by over 80 per cent by 2001. The competition in the CTV market is so tough that the main domestic manufacturers such as Changhong and Konka are suffering significant losses and have suddenly shifted to the computer and mobile phone business in the hope of offsetting their losses in the TV market. Hisense was also badly hurt in the price war, but it strove to maintain profitability by launching new products. It became one of the few companies that made stable progress in sales and profit. To consolidate the TV sector, Hisense stopped the development of analogue technology in 1997 and devoted its energies to developing digital technology. Since 2001, it has pursued an ‘80:20 strategy’ under which 80 per cent of the company’s capital and technological resources are used in high-end products such as digital TV, and the remainder in low-end

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products. In addition, the company intends to inject a further RMB1 billion in high-clarity film information CTV. In 2001, the company set up strategic alliances with three network companies and introduced the Internet TV (ITV), a wide-screen colour television that can access the Internet. In August 2002, Hisense produced a 42 inch 16:9 PDP, which can receive high-definition digital signals. Domestic appliances – air-conditioners and refrigerators Before moving into the air-conditioner sector, Hisense investigated the Japanese market and found that constant-speed air-conditioners were to be replaced by frequency conversion air-conditioners. It purchased the technology from Sanyo of Japan and then set up the Hisense Air Conditioner Co. Ltd in Pingdu with annual capacity of 300,000 units in 1996. In the following five years, the company continued investment in technical and equipment upgrading and, as a result, its capacity has reached 1,500,000 units per annum. In 2000, Hisense initiated a price war by selling its frequency conversion air-conditioner at prices as low as the constant conversion model. The promotion was such a success that it enabled Hisense to capture the market in a very short time. On 19 June 2001, Hisense entered the refrigerator sector by establishing an alliance with Rongshida of Hefei, a famous domestic appliance manufacturer engaged in washing machine and refrigerator manufacture. Rongshida had invested, with Maytag of the USA, millions of dollars in building a production line for 1.2 million refrigerators per annum. However, it only managed to sell about 100,000 units by itself. It claimed that the OEM system would save Hisense RMB600–1,000 million for investment (interview at Hisense, June 2002). Instead of building up its own production base, Hisense would sell the branded refrigerators through its own distribution channels. A merger with Beijing Snow Flake showed Hisense’s strong commitment to the refrigerator business. Beijing Snow Flake, a well-known refrigerator leader in the early 1980s, had set up a joint venture with Whirlpool in 1995; however, this short-lived company only managed to produce 60,000 units before shutting down. Continuing losses and management conflicts had inducted Whirlpool to withdraw after three years, leaving the production facility to the local government, which found it a headache and begged investors to take it over. A senior manager of Hisense said, We are attracted by two factors. One was the modern equipment Whirlpool had left, the other being the advantage of geographical position. Beijing is a strategically important place in terms of the economy, culture, business and talent. Therefore, in the long term, it is very meaningful for Hisense to be positioned in Beijing. (quoted in China Economic Times, 23 June 2002)

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The Hisense (Beijing) Appliances Co. Ltd, in which Hisense holds a 55 per cent share, aims to reach a production level of 500,000 units per annum in several months, increasing to one million units in three years, and to become one of the top three manufacturers in China. As well as producing large appliances, Hisense also entered into the small appliance sector by introducing intelligent electric heaters into the market in May 2002. Information technology sector In February 1993, Hisense moved into the IT sector by establishing a JV (with RMB20 million investment) with Qingdao Qume Electronic Co. Ltd to produce cash registers. Hisense Computer Co. Ltd was established in 1996. With 600 employees, the company has set up production lines for desktop and laptop computers, palm notebooks, servers, workstations and network products. The company realised production of 3,900,000 units in 2001. The Hisense Network Technology Co. Ltd, established in October 1998, was co-founded by Hisense Electric Share Holding Co. (investment of RMB450 million, accounting for 38.54 per cent), Yu Gang International (Hong Kong) Co. Ltd (35 per cent), Hisense Real Estate Co. Ltd (3.06 per cent), Qingdao University (6.5 per cent) and individual investors (16.9 per cent). With 300 employees, the company developed customer software programmes for commercial and medical use such as customer relations management systems, business management systems, transportation systems, financial software, education software and so on. It also provided integral solutions including demand analysis, project design, general wiring configuration, network equipment and system integration. In 2001, the turnover of the company reached over RMB100 million. The year 2000 witnessed the establishment of Hisense Digital Technology Co. Ltd, with staff of seventy, producing digital cordless telephones (DEC) and network security products. In 2001, the turnover of the IT sector was over RMB1 billion, accounting for 10 per cent of the total revenue of the group (interview at Hisense, June 2002). Communications sector The company first entered the telecommunications sector in 1993 by setting up a joint venture company with Lucent called Lucent (Qingdao) Technologies Co. Ltd, producing large-scale programme exchangers. As the telecommunications industry was upgrading very rapidly, Hisense shifted its attention to CDMA when the technology appeared. In 1999, the Hisense Mobile Communications Research Institute signed cooperation agreements with Hitachi and Qualcomm respectively, for the design and development of mobile communications terminal products for third generation CDMA networks. In 2001, the State Planning Committee and the Ministry of Information Industry included Hisense among the nineteen approved manufacturers of CDMA mobile phones.

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The CDMA project is by far the largest investment Hisense has ever made. The first-phase construction alone cost RMB400 million. Hisense spent nearly RMB80 million on purchasing the most advanced testing equipment and highly automated production line. On 21 November 2001, the CDMA cell phone production line was officially put into operation in Hisense Information Industrial Park, with a planned annual production capacity of one million units. This figure is forecast to increase to 5 million by 2004. Hisense aims to capture 10 per cent of the domestic market. Just when Hisense’s two models of CDMA colour screen mobile phone, C2101 and C520, were launched off the production line, China Unicom, one of the two mobile phone network operators in China, opened its CDMA network on 8 January 2002. Hisense hopes that the CDMA project can perform as well as the air-conditioner business and become highly profitable in the coming decade. However, it has not been in the market long enough for its performance to be evaluated. Other businesses In addition to the core businesses described above, Hisense has also engaged in some non-core businesses, particularly the service sector. The year 1995 witnessed the formation of the Hisense Real Estate Development Company. Hisense had several advantages in developing its property business. The municipal government pursued a policy of ‘Exiting the first sector and entering the third sector’ (‘Tui er jin san’), allowing troubled companies to make use of their workshop facilities and engage in the property business to pay their workers. The government closed the Qingdao Electric Instrument Corporation (the former Qingdao Electric Instrument Bureau) and put its members (including over twenty subordinates, most of which were loss-making companies) under Hisense’s administration. Hisense refused to acquire the corporation but, under great pressure from local officials, agreed to supervise the member companies separately. Then Hisense selected those companies with valuable land and property and incorporated them in its property business. For those with nothing but debts, the ‘empty shell companies’, the group set up a trusteeship office dealing with issues related to bankruptcy and pensions (interview at Hisense, June 2002). Hisense also set up the Hisense Industrial Company by acquiring six subsidiaries of the Qingdao Electric Instrument Bureau. A number of service companies were formed including the Hisense Trading Company, Hisense Audiovisual Company, Hisense Optics Company, Hisense Appliance Store, Hisense Hotel and so on. Like many other Chinese SOEs that have a duty to workers and their families, the service sector pursues diversification in order to avoid redundancies. In fact, more than 1,000 redundant workers were provided with new jobs in these businesses. However, the Hisense leaders were well aware that there was a potential danger in such activities. Business is always accompanied by risk. From 2000, Hisense decided to

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eliminate the non-core business from the Group, and a number of businesses such as the advertising and components business have been sold to public investors. It also intended to separate the service activity from the Group by establishing a specialised service company, called Saiwei Electrical Appliances Service Co. Ltd. The sales revenue of the Group reached RMB16 billion in 2001, 90 per cent of which came from the core businesses – colour televisions (50 per cent), air-conditioners (30 per cent) and IT (10 per cent) – and the balance coming from a diversified base of products including property (interview at Hisense, June 2002).

The model of a ‘neo-state-owned enterprise’ After further reform, a group of SOEs took on an entirely new look and were defined by some academics as neo-SOEs. They possess three distinctive features: (1) they are state owned; (2) they began life with the transition to the market economy; (3) they are part of the modern enterprise system. Although it has certainly enjoyed dramatic growth, Hisense is, arguably, not a major company in China. None of its core businesses appear in the national top three in terms of sales and market share. In the CTV sector, it ranked fourth after Changhong, Konka and TCL, with market share of 10 per cent. In the air-conditioner sector, it ranked seventh after Haier, Midea, Geli, Kelon and others with 6 per cent market share (interview at Hisense, June 2002). Its annual sales volume amounts to 7 million CTVs, 1.2 million air-conditioners and 400,000 refrigerators, figures which do not represent a significant scale (interview with Zhou Houjian, quoted in Economic Reference, 17 March 2004a). Rather, Hisense is a local leader in Shandong Province with more than 40 per cent market share of CTVs and airconditioners. However, Hisense attracts ever more attention due to its healthy industrial balance sheet, paralleled by stable performance, extremely rapid growth and strong government support. State-mediated merger As a thirty-year-old state-owned company, Hisense has experienced all the significant changes of the transition to a market economy in China. The reforms include the autonomy policy of 1979–86, the contract and responsibility system of 1987–91, and the modern enterprise system after 1992. When a large process of mergers took place at the request of high-level government, some SOEs seized the opportunity to develop rapidly through extensive mergers with smaller domestic producers. Hisense was one of them, its extraordinary growth coming from both internal accumulation and complex investment decisions made extremely quickly and at extremely low cost. Government intervention has been a constant factor in the growth of many SOEs in China. This has meant favourable terms for the purchase

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of industrial land, technical assistance, import and export quotas, various subsidies in the forms of low-interest or interest-free loans, reduced taxation and even giveaways. For example, the Qingdao Camera Company, a former subsidiary of the Qingdao Electric Instrument Bureau, was on the verge of bankruptcy with debt of RMB80 million. In 1995, the Qingdao government wrote off the debt, and granted its assets, RMB200 million, to the Hisense Group. The Group set up Hisense Optics Co. Ltd and made it a production base for optical instruments, cameras and telephones. Since 1994, Hisense has acquired some ten loss-making companies with total assets of RMB3 billion. Mergers between such enterprises were typically handled by administrative coordination, either by a single local government or between different local governments. Typical of the process was the merger of the Qingzhou Radio Transformer Factory. Owned by the Qingzhou City government, the factory had been a supplier of television transformers to Hisense for many years. In 1993, the factory initiated a proposal to join the Hisense Group. The Qingzhou City government fully supported the initiative and transferred RMB6.76 million of net assets to the Qingdao State Assets Management Bureau, which forwarded the assets to the Hisense Group (Hisense Group, 1999). The Group reinvested the total amount and made the factory a wholly owned subsidiary, renamed the Qingzhou Hisense Electrical Appliance Co. Ltd. In the case of the Liaoning Hisense Electric Co. Ltd, subject to negotiations with the Fushun City government, Hisense was exempted from taxation for the first three years; it then received a 50 per cent reduction in the subsequent two years’ taxation provided the business was in profit, it was also refunded 50 per cent of the value added tax (VAT) collected by the city government during this period (Hisense Group 2002). Conservative management style In Qingdao, compared with the Haier Group, a well-known giant ambitious to become a global leader, Hisense is characterised as less aggressive and more conservative. This is apparent in company slogans like ‘Safety before profitability’, ‘Never damage the credit structure for higher profit’, ‘Never overstock even if it means missing market opportunities’, ‘Never over-invest even if it means missing investment opportunities’. These rules have kept the company on guard against investment risks and financial risks. Unlike some SOEs which have been fighting for market share at the expense of efficiency, Hisense believes that profit is always crucial to a company’s survival and competitiveness. As a local SOE in the consumer electronics industry, Hisense does not enjoy much advantage in terms of scale, scope, brand and cost. Its limited resources make Hisense emphasise efficiency and effectiveness of management. Rather than targeting the whole domestic market, it has focused on certain local markets (Shandong, north-east and south-west China). It has

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established an effective system for evaluating human motivation. The financial target accounts for 80 per cent of the overall evaluation; the outcome of the evaluation is closely linked with such factors as manager’s annual pay, bonus and promotion. For example, at the annual pay review, general managers of subsidiaries are not given a rise if bookkeeping exceeds 5 per cent of sales revenue or if the debt/capital ratio and the stock turnover rate fail to reach the target. Monthly meetings are held at which middle and senior managers analyse bookkeeping, profitability and other financial issues (Hisense Press, 31 January 2002). Twenty years’ business experience has given Zhou a thorough understanding of integrity and reputation. To educate his staff, he purchased 1,000 copies of Pharmacy King of the Qing Dynasty, a popular TV play in China. ‘We distributed them to the staff to show them how Tongrentang Pharmacy maintained its name for more than two hundred years. It would never have succeeded without integrity and credit’, said Zhou. ‘Integrity and credit are essential to a healthy market economy, and are the passport to the international market. We will make Hisense a famous brand in one hundred years’ (quoted in Hisense Press, 8 April 2002). Technological innovation Zhou Houjian, a talented engineer, believes that technological innovation and people are crucial to the company’s survival. He made enormous efforts to improve the company’s technological capability at the very beginning of his management. Hisense entered into technological cooperation with many foreign companies, such as Lucent of America and Matsushita, Toshiba and Sanyo of Japan (Table 5.2). From 1993 to 1998, Hisense spent a total of RMB900 million on technical upgrading and RMB600 million on R&D, which accounted for nearly 5 per cent of sales revenue. And each year, the group spent RMB10 million on training employees (Hisense Group 1999: 68). Hisense also invested extensively in setting up its own R&D capability so that it could not only upgrade purchased equipment but also digest the technology and develop new products to meet consumers’ preferences. Table 5.2 Hisense’s major foreign partnerships Year

Partner

Technology

1984 1992 1993 1996 1999

Matsushita Toshiba Lucent Sanyo Hitachi and Qualcomm

14-inch CTV production line Wide-screen CTV technology Exchanger Conversion frequency air-conditioner CDMA mobile phone

Source: Company documents.

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Hisense enjoys a good reputation for technical innovation. The Hisense Technology Centre, with 140 postgraduates, was approved, by the state, to be a national-level enterprise technical centre, as well as the industrialisation base for the ‘National 863 Programme’. The technology centre is considered a Group ‘special zone’, where talents enjoy the most favourable treatment. In addition to receiving housing, well-equipped offices and a relaxed working environment, the technicians are well paid under the flexible motivation system. For example, the annual pay of a doctoral graduate is RMB100,000– 150,000, ten times more than that of a junior worker (Hisense Group 1999: 24). To show its respect for technical talent, Hisense made a famous advertisement in which forty-two doctors employed by the Group took leading roles. In 1998, the Technology Centre undertook ten state-level research projects with state subsidies; 111 new products were developed and introduced into the market, accounting for 85 per cent of annual sales revenue. In 2001, Hisense was granted a special fund (RMB10 million) by the Economic and Trade Ministry and Finance Ministry for development of the business decision support system and small and medium business management systems (interview at Hisense, June 2002). Various subsidies were granted to other new products such as the CDMA2001X mobile phone. For many years, Hisense has committed itself to a strategy of ‘developing high technology, producing high-quality products, providing high-level services’. It was claimed that its strong technological capability enabled the company to introduce new products up to one year ahead of its domestic competitors. For example, it was the first to introduce such products as the VCD-TV unit, multi-media TV, digital 100HZ CTV, ‘Intelligent King’ 200-channel CTV, the digital satellite receiver C/Ku, an environmentfriendly conversion air-conditioner, the KFR-(25G+45L)W/BP conversion air-conditioner, Intranet ITV-2911, Office Automation Intelligent Office Software and so on. However, given that the intellectual property rights of the CMOS chip and kinescope are still owned by foreign competitors such as Philips and Toshiba, which already dominate the high-end market in China, Hisense is well aware that its initial success can largely be attributed to acquiring advanced technology from developed countries, mainly Japan, and that its heavy dependence on external technology will continue in the long run. Zhou admits: We are at least ten years behind Japanese companies in terms of technology, production processes and organisational capability. Our existing technical resources are far from being able to support our long-term development. To catch up, we must make significant efforts in technical processes; after all, technology is the determinant factor in the competition. (quoted in Economic Reference, 17 May 2004b)

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Despite its continued heavy investment in R&D, Hisense is very keen to establish JV projects with leading multinational companies to develop highvalue added products and undertake research in aspects of integrated circuit design, network technology and new photoelectron display technology. ‘It takes time to break through, but it is not hopeless, since we are not absolute beginners and also we can stand on the giants’ shoulders,’ Zhou said.

New challenges after China’s entry to the WTO Rush for expansion Hisense is famous in the industry for its conservative management style. Compared with its competitors, Hisense has sought to grow by taking control of the TV sector and it has been relatively cautious about diversifying into other businesses in the past thirty years. However, its strategy changed drastically during the past few years. As we have seen, Hisense has built up a huge production base through enormous physical investment and acquisition of land, and thus increased economics of both scale and scope to an extent where some begin to worry about the dangers of its becoming big too quickly. The motives for the change are based on the following factors: (1) Entry into the WTO will greatly change the nature of competition as well as the rules of the game. China will be a global production base. Hisense will have to fight with competitors who enjoy significant scale, abundant resources and significant advantages in marketing capability. Thus size is a crucial factor for domestic companies in the competition. (2) Hisense’s relatively small size matters because it makes it unable to benefit from economies of scale and scope, and thus puts it at a great disadvantage. (3) It is argued that size also matters in relation to attracting foreign investment. A significant production base will enhance bargaining power in negotiations with foreign giants. A senior officer explained: ‘It is very clear that the consolidation of the industry in a few years is unavoidable. This forces us to take action at once, or else we might be beaten overnight’ (interview at Hisense, June 2002). The Group’s 3C strategy makes it clear that Hisense aims to be a leading manufacturer of consumer electronic and domestic appliances, IT products and telecommunication products. According to Zhou, Chinese firms must take advantage of the opportunity to grow while there is still space for them to do so, for example in the marketing network and after-sales service. Compared with multinational enterprises, local firms can establish or expand their existing marketing network rapidly at very low cost, given the fact that labour costs are very low in China. Chinese firms can take this advantage for a certain period and use it to promote technological development (quoted in Knowledge Economy, 5 May 2002).

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Export capability Hisense’s export performance has generally been poor, although it entered international markets several years ago by establishing overseas subsidiaries in the USA, Japan, Brazil and Indonesia (interview at Hisense, July 2002). The major international markets, the USA and Europe, have extremely high entry barriers to manufacturers in developing countries. In Europe, in order to protect local manufacturers, an anti-dumping customs duty of over 40 per cent is levied on imports of CTVs from China, and this won’t be lifted until 2005. In the USA, Japanese companies dominate the high-end market, while the South Korean companies LG and Samsung and other companies in developing countries are fighting for the low-end market. From 2004, a high anti-dumping customs duty has been levied on Chinese manufacturers who export CTVs to America. Having witnessed others Chinese companies’ performance (i.e. Changhong which has struggled to compete by supporting its overseas businesses with profits generated from its domestic activities), Hisense realised it is still far from being able to compete directly on a global level playing field with the leading manufacturers. Hisense therefore shifted its attention to the emerging markets, namely South America and South Africa. In 1996, Hisense set up a production base in Post with capacity to produce 100,000 black and white TVs per annum. In April 2000, Hisense spent US$4 million on acquiring a factory owned by Daewoo of South Korea. The acquisition enabled it to double the manufacturing capability of TVs, and to produce 50,000 VCDs and DVDs and 10,000 hi-fi units per annum. The products had captured nearly 10 per cent market share in South Africa by the end of 2000 (Hisense Press, 21 January 2002). However, due to unfamiliarity with the local society and local culture, the business performance was disappointing. In addition, the deteriorating economic environment and political risk increase the uncertainty of the investment. There are already warning signs of the difficulties that depreciation may pose for the company’s balance sheet. However, its increasing production capability and the stagnant domestic market pressured Hisense to pick up speed for entering international markets. On 30 July 2002, Hisense signed an agreement with Sumisho Corporation of Japan, establishing a JV, Hisense Sumisho (Japan) Co. Ltd, each party holding a 50 per cent share. According to the agreement, Sumisho would sell Hisense’s products through its distribution networks in Japan. Hisense aims to sell more products and generate more revenues from exports. Senior officials admit that the company is not able to follow others methods and set up overseas networks as this would be too costly and risky. Instead, they intend to make use of Sumisho’s global marketing network, and obtain mutual benefit from the cooperation. The strategy sounds good. However, since Sumisho does not own any electrical appliance retailing stores in Japan, the outcome of the JV is quite uncertain and will greatly

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rely on how effectively it utilises local channels. In contrast, Hisense is an ideal partner for Sumisho, as it owns twenty marketing centres, 100 sales and service companies and 10,000 service outlets in China and has significant experience in selling electrical appliance products through its own extensive network. Sumisho hopes to benefit from the cooperation by selling its digital electrical appliances through Hisense’s marketing network in China. The TPI/TPM system To improve efficiency, in 2000 the Group implemented the ‘profit recovery plan’ under which it shut down some unproductive sectors such as the audiovisual and components sectors so as to focus on the core businesses. It also rationalised the management process between the Group and its affiliated companies. From February 2002, the Hisense Group, together with the Hisense Air Conditioner Company, started an experiment with TPI/TPM. They employed consultants from Samsung to instruct them in how to undertake the process. The ownership structure Perhaps the deepest concern was the one that usually remained unspoken – ownership reform. Zhou argued that in addition to technological disadvantage, another big barrier to growth is the ownership structure system, which creates very complex issues surrounding SOEs. On this, Zhou said: ‘We will, with support from both central and local governments, undertake the institutional reform step by step, and make the ownership structure more applicable to the requirements of the modern enterprise system’ (quoted in China Economic Times, 21 December 2002). But how? Being a state-owned enterprise, Hisense is still under the tight control of the local government, which is extremely reluctant to relax it. Hisense’s leaders are actively seeking to remove government restrictions on the ownership structure. However, so far there is no evidence of any reform of or radical changes to the ownership structure of the Group. However, within the Group, reforms have taken place quietly. By 2001, the Hisense Group had restructured the shareholding of half the affiliated companies. The new ownership structure, through various approaches, reduced the proportion of state shares and increased the proportion held by the employees, particularly the management and the technicians. For example, the group sold a 60 per cent share of the Hisense Industrial Company to the employees in 1996, and sold all shares in the Qingdao Counter Company and Qingdao No. 1 Instrument Company to the employees in 1997. In 1998 the group also sold a 50 per cent share of Linyi Hisense Electric Co. Ltd to the employees and only kept 5 per cent. In the Hisense Digital Technology Company, which was established in 2000, the core

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technicians were granted technology shares with a maximum holding of 6 per cent per individual (interview at Hisense, July 2002). For those companies which were difficult to restructure, the Group has taken some alternative approaches such as indirect shareholding, annual bonus payments, stock options, etc. It is claimed that the Qingdao municipal government had accepted a proposal initiated by the Hisense Group, and granted the management 10 million shares by setting up a new holding company, Hisense Electrics Co. Ltd, which held shares in the Hisense Electrical Appliance Share Holding Company, Hisense Import & Export Company and Hisense Real Estate Developing Company (interview at Hisense, June 2002).

The prospects Institutional reform is a highly sensitive and complex issue. It is argued that the reform of the SOEs relies mainly on local governments, as there are no rigid restrictions or guidance from the central government. Therefore, the fate of Hisense will be largely determined by the local government. Compared with local governments in the south of China, Qingdao municipal government responded conservatively to the institutional reform. In the case of the TCL company, one of the top three TV makers in China, radical changes took place in its ownership structure: Huizhou City government reduced its share from over 50 per cent to 40.97 per cent, strategic investors (Toshiba, Sumisho, Jinshan, Pentel, etc.) own 18.38 per cent, the management owns 25 per cent and non-management and non-strategic investors own 15.65 per cent. It is very likely that Qingdao government will permit diversified ownership by reducing the proportion of state ownership. Once the limitation is relaxed, the company will seek more opportunities to develop by gaining access to much wider sources of capital. It is possible that Hisense will exchange part of its shares with foreign companies in return for advanced technology. The industry is in the process of further integration. It is argued that soon only five or six domestic companies will survive in the electrical appliance industry. Furthermore, the process has been accelerated with China’s entry to the WTO in 2001, as more and more foreign companies prefer to enter the market through extensive mergers and acquisitions. Obvious domestic candidates for mergers are those with production capacity and market shares above a certain level. Hisense, as one candidate, is enhancing its company identity through capacity expansion and brand recognition. It is possible, that at some point Hisense may be permitted to merge with foreign companies. This may be a solution that pleases all parties. Foreign ownership may enable Hisense to escape from the tight control of the local government and to operate more freely on the one hand, and provide mechanisms for modernising the company on the other hand. A merger would provide a means to upgrade technical capability, train managers in management skills and gain a closer understanding of international markets.

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Hisense and Haier In Qingdao, Haier and Hisense, standing side by side, are both famous companies which grew rapid by during the 1990s. Originating as a refrigerator manufacturer and a TV manufacturer respectively, both companies have quickly diversified into white goods, black goods, and the IT and telecommunications sectors. They compete face to face in almost every market. Each company has distinctive features, Haier being a keen follower of Matsushita and focusing on marketing and branding, and Hisense, a follower of Sony, focusing on technical capability. Compared with Hisense, Haier is more aggressive and active, aiming to become a global giant. During the late 1990s, both companies experienced challenges to their historic approaches, experimented with strategic and organisational changes, and attempted to alter company cultures. While Haier pursued more radical reorganisations aimed at centralising more decisionmaking and globalising its businesses, Hisense tried to maintain financial stability and decentralise assets in an attempt to build stronger organisations. With the China’s entry to the WTO in 2001, the domestic companies face more challenges from foreign competition. The growth of both companies slowed in 2002. Nevertheless, Hisense believes that two of the company’s principles will make it survive: a healthy balance sheet and technological competence. It is unclear to observers how successful the changes will be and how much the company can modify its strategy, organisation and culture in pursuit of new organisational capabilities. In theory, mergers and acquisitions are more likely to take place at the local level with further consolidation of the industry. However, when asked about the possibility of a merger between Hisense and Haier, senior managers in both companies denied that this could take place in the current situation, because (1) each company has a different strategy, management style and corporate culture; (2) as both companies become more powerful and independent, a government-mediated administrative merger also looks unlikely (interviews, 2002). However, in the long term, things may change and a merger may be brought about through the market. It will be very interesting to observe the outcome of the coming consolidation of the industry.

The Aucma Group 147

6

The Aucma Group

Qingdao Aucma Group has insisted on developing through technical upgrading and expanding from accumulated profit. It invested in total RMB35 million and created production capacity of one million freezers per annum. The fact that it has transformed itself from a loss-making company to the second biggest business in terms of tax, fully indicated that despite the difficulty, the SOEs also have great potential. It is crucial for the company to choose the path of development. The company should be aware of market need, insist on developing through internal upgrading and accumulation. This would create new competitive advantage for the SOE. (Wu Bangguo, Vice-Premier, 1999, address during a visit to the Aucma Group)

Background and history The history of the Aucma Group The Aucma Group originated from a subsidiary of the Qingdao Red Star Electric Appliance Company, a former famous local washing machine company that was later acquired by the Haier Group. The plant was located on Yellow Island, 10 miles from Qingdao City in Jiaozhou Bay. It used to produce machine parts for the parent company; however, due to poor transport and communications, the parent company stopped using it as a component supplier. The company rented a freezer production line from Japan for US$500,000, with annual capacity to produce 80,000 304 cu ft commercial freezers. The factory was renamed the Yellow Sea Freezer Factory. In 1988, 10,000 freezers were manufactured. It was extremely easy to sell them due to high demand. However, consumers returned the products soon after purchase because of their very poor quality. Holding a huge amount of stock and facing debts of RMB27 million, the factory was forced to stop production and declare itself bankrupt. From 1988 to 1990, eleven different presidents were appointed in the hope of rescuing the plant, but none of them succeeded. The municipal government, which was extremely unwilling to close the factory, initiated the proposal of selling it to the Double Star Group,

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a local sports shoe manufacturer. In March 1990, Lu Qunsheng, the former deputy president of the Red Star Electronic Appliance Company, was asked to check the assets before the acquisition. Lu found that the freezer market was expanding and there was a good possibility of making a profit. He thus persuaded the parent company to appoint him president. Under his strong leadership, the company turned itself round in a very short time. In October 1991, the Yellow Sea Freezer Factory became independent from its parent company and re-registered as the Qingdao Aucma Electric Product Company, under the direct administration of the Qingdao Second Light Industry Bureau. In August 1992, the Bureau merged three subordinates, namely the Qingdao Lamps and Lantern Factory, the Qingdao Kamen Electric Product Co. Ltd and Qingdao Gem Factory, and set up the Aucma Group. Given that the total liabilities of the three companies were over RMB30 million (with debts of RMB6.66345 million, RMB15.5318 million and RMB8.5791 million respectively), the formation of the group looks more like a way of assisting the poorly performing companies than a response to the central government’s policy of building big business groups. In November 1992, five more subsidiaries were incorporated into the group, namely the Qingdao Electrical Appliance Industrial Company Sales Department, Qingdao Electrical Appliance Store, Qingdao Electrical Appliance Company Hotel, Qingdao Electrical Appliance Service Centre and Qingdao Electrical Appliance Economic & Technical Development Company. These acquired companies were all very small with total liabilities of RMB4.21 million. From 1992 to 1993, thirteen loss-making companies were incorporated into the Group under the auspices of the municipal government. The Aucma Group enjoyed extensive growth from 1990. It won the Golden Bridge Award for the national best-selling brand in 1992. At its peak, it was the leading freezer manufacturer in China, capturing 40 per cent of the market. In 1995, it was awarded the title King of Freezer Producers in China by the National Statistic Bureau and National Technology Innovation Centre. Within ten years, the Group developed considerably from a lossmaking company with RMB27 million debts and 100 workers to a conglomerate with total assets of RMB7 billion and more than 8,000 employees. In 2002 the Group consisted of thirteen business departments and nineteen holding companies (see Figure 6.1). It had 2,874 sales outlets and more than 600 agents and retailers all over the country, but mainly in the north of China. Sales revenue reached RMB3.81 billion in 2001. Aucma under Lu Qunsheng As in many other successful enterprises in China, an industrial entrepreneur and industrial policies played crucial roles during the development period. The growth of Aucma tells us a story of one man with extremely strong determination, integrity and sincerity. When Lu Qunsheng first entered office, he was confronted with enormous pressures both internally and

The Aucma Group 149 externally: an old and dilapidated workshop and equipment, heavy debt, the lack of qualified technicians and the resistance of the workers. In his first year, he was taken to court by creditors thirty-seven times (interview at Aucma, April 2002). Rather than surrendering to the difficulties, he made every possible effort to improve the situation. Within the company, Lu Qunsheng showed strong leadership and determination in running the factory. He realised that the key to success was high-quality products made by high-quality people. He persuaded the remaining graduates to stay and work with him. A famous story tells how he retained Wang, a talented graduate from Shanghai Communication University who was disappointed with the company and had asked to leave. Lu begged him to stay for three months, promising, ‘If you still feel hopeless after three months I will find you a new job elsewhere and take you there myself.’ Within three months, they developed a small model freezer. The new product was so successful that it made a huge profit and turned the company round very quickly. Wang stayed in the company and was promoted to be vice-president of the Aucma Group. As the former workers had completely lost confidence in the factory, they disappeared from the workshop without any excuses. Lu Qunsheng dismissed the existing workforce and decided to recruit local peasants. However, the wages were so low that the peasants were reluctant to take the jobs, and Lu had to visit the countryside begging them to join the factory. When they did so, he gave them very careful training and quickly turned them into skilled workers. Lu made extraordinary efforts to improve the quality of the product by insisting on adopting the Total Quality Management System. Hundred of documents were created and 129 quality inspection points were established, with inspectors controlling the entire process from purchasing to selling. Lu educated his subordinates to pay attention to the quality with the slogan ‘Good, better, best, never let it rest’. He kept telling them that high-quality products are made by trustworthy, high-quality people. In fact, deeply impressed by his strong commitment and devotion, the employees worked hard for him and even spent their own money on company business without complaining. To raise funds and improve relationships with suppliers and retailers, Lu sold his company car. He begged the suppliers to let him have raw materials and spare parts on credit, and even borrowed money from his friends and relatives. To improve the company’s poor relationship with retailers who were complaining bitterly about poor quality and refusing to distribute its products, he invited 300 retailers to the company and promised them in person that he would mend the defective goods and compensate the losses they had suffered. The suppliers and retailers were impressed and agreed to continue cooperation. Lu overcame the extreme difficulties and successfully turned the factory round within one year. By the end of 1990, sales revenue reached RMB7.21 million with profit at RMB0.6 million, and the figures

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Table 6.1 Selected performance data of the Aucma Group (1990–2001) Year

Sales revenue (RMB million)

Pre-tax profit (RMB million)

Output of freezers (000s)

Debt/capital ratio (%)

1990 1991 1992 1993 1994 1995 1996 1997 2000 2001

7.20 40.70 93.30 218.00 319.00 1,050.00 1,200.00 1,253.00 3,000.00 3,810.00

0.05 4.20 18.00 36.80 67.90 293.00 140.00 156.00 171.00 168.00

8 40 84 125 166 656 – 597 1,200 1,000

– – – – – 65.44 66.92 67.48 67.63 –

Source: Annual reports and company documents.

rose dramatically to RMB40.68 million and RMB4.22 million respectively in 1991 (Table 6.1).

Growth through diversification In sum, the rapid growth of the Aucma Group comes from both economies of scale and extensive diversification. Aucma experienced three stages in its development: (1) from being a loss-maker to being the leading freezer manufacturer during the first half of the 1990s; (2) from being a specialised freezer producer to being a manufacturer of the full range of domestic appliances and consumer electronics during the latter half of the 1990s; and (3) from being a domestic appliance manufacturer to being a multi-sector conglomerate from 2000 onward. Freezers (prior to 1995) When Lu Qunsheng took control, he found that the 304 cu ft commercial freezer was not very suitable to China’s market, being too big and too expensive; the major demand was for smaller units and came from the self-employed who ran small convenience stores in the countryside and from street traders who sold ice cream and soft drinks. To learn how to make a smaller freezer, he paid several visits to the south of China to learn from the local manufacturers. Finally the company developed a new model and became the first small freezer manufacturer in the north of China. The new model, the B150 freezer, was so popular in the market that it became a cash cow as soon as it appeared. From 1990 to 1995, the company earned profits of over RMB100 million solely from the production and sale of 860,000 B150 freezers (interview, April 2002). In 1995 production of the B150 freezer ceased. A range of new products were developed, covering eight generations

The Aucma Group 151 Table 6.2 The Aucma Group’s share of the domestic market for freezers (1995–2001) Year

1995

1997

1998

1999

2000

2001

Market share (%)

40.0

17.9

20.5

33.0

n.a.

25.0

Source: Company document.

with over 200 models, such as the small freezer, the freezer with a glass door and the freezer with double levels of temperature. It also developed a freezer with a minimum temperature of 86 degree, below zero. The market share reached over 40 per cent by 1995 (interview at Aucma, April 2002). However, since then, with more and more competitors and saturation of the market, the industry has suffered from severe price wars. Both profit margin and market share have suffered significantly (Table 6.2). Aucma claimed that its profit margin on freezers fell from more than 20 per cent in 1995 to less than 2 per cent by 2000 (interview at Aucma, April 2002). In order to keep growing, the company sought to diversify into other businesses. Domestic appliances and consumer electronics (1996–2000) In 1996, the group invested RMB300 million in constructing an industrial park in the Economic Development Area of Yellow Island, occupying 667,000 square metres of land. Meanwhile, the Group diversified, both vertically and horizontally, into a full range of domestic appliances and consumer electronics. Aucma began mass production of air-conditioners in 1997 (the sales revenue of air-conditioners was RMB11 million in 1998, RMB450 million in 1999 and RMB700 million in 2000), refrigerators in 1998 and electric water heaters in 1998. It signed an OEM agreement with the Yingkou Washing Machine Company to produce washing machines. The company now sells, under the OEM system, almost every kind of domestic appliance (including microwave ovens, dishwashers, electric gas ovens, electric water heaters, drinks machines, electric rice cookers, electric fans, juice extractors and egg cookers), consumer electronics (including CTVs, VCDs, DVDs), and electrical equipment (including sockets, plugs, page and sauna bath fittings). In 2000, the Aucma International Electric Instruments Business Department was set up to produce accessory parts for electrical appliances and power supply cables. In 2001, the Group acquired the Qinhe Electric Cable Company, producing electric cables. Production capacity reached 1.5 million freezers, 0.5 million refrigerators and chilled display cabinets, 1.5 million air-conditioners, 0.5 million washing machines and 0.6 million electric heaters in 2001 (interview at Aucma, April 2002). However, apart from freezers, none of the businesses are significantly successful in the domestic market in terms of sales value or market share.

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The information technology sector and finance sector (2000 onwards) Facing the slowdown of the domestic appliance market and tough competition, Aucma’s leaders were well aware that they were not in a position to compete directly with both local and global giants in the domestic appliance industry, which is in the process of further consolidation. The decreasing market share of freezers pressured them to expand into new sectors to continue growth. The high-tech sector was targeted as it was considered to have the potential for growth and for favourable grants from the government. In fact, the changeover to high-tech products provided a sound strategy for acquiring approval for flotation on the Shanghai Stock Market. Furthermore, the development of high-tech products enabled the company to acquire various subsidies from the state, for technical upgrading and new products for example, and also interest free loans and tax holidays. The local government was willing to offer other incentives: for example, the Qingdao municipal government allocated 250,000 square metres of land to the Group as the Aucma Marine Organisms Industrial Park and granted a tax holiday to the company. On 29 December 2000, the Aucma Electric Appliance Company was listed on the Shanghai Stock Market. It was planned that the RMB800 million raised from the stock market would be invested in eight high-tech projects: lithium ion batteries, extension CMOS chip of super lighting electron diode circuits, solar energy equipment, marine organisms and bioengineering, multi-media projectors with a super-wide screen, palm notebooks, vending machines and pocket PCs. The Aucma New Power Technology Co. Ltd was established in 2001 with total investment of RMB200 million, concentrating on the design and production of environment-friendly energy. The main products include a series of lithium ion battery cells that can be widely used in mobile phones, portable computers and digital cameras. The current production capacity of 30 million units is expected to reach 50 million in 2005. However, it was argued that with the company’s very limited capital resources and technological capability, the outcome of diversification into the high-tech sector is rather uncertain. As well as rapid changes in technology, the high-tech business is featured as high input and high risk; it is arguable whether Aucma has the capacity to exploit the market potential. Its computer business has in fact suffered huge losses amounting to tens of millions of renminbi (interview at Aucma, April 2002). To raise more funds, the company sought to take an active role in the capital market. The Group is a minority shareholder in some local finance companies such as the Qingdao Guangda Bank, the Communication Bank, Yantai Commercial Bank and the Hongxin Futures Company. The Group also established its own finance and management department engaging in futures, insurance and other capital dealings. The business was reported a great success with RMB70 million profit in 2001 (interview at Aucma, April 2002).

The Aucma Group 153 Summary In its five-year plan (2000–5), the Board of Directors of the Group announced plans to transform Aucma from a traditional industrial manufacturer to a high-technology innovator by: 1 2

3 4 5 6 7

restructuring and technological upgrading of traditional industries, developing intelligent domestic appliances; investing heavily in high-tech products such as lithium batteries, vending machines, diode extension chips, multi-media projectors with super-wide screen and so on; developing the finance sector; developing the property sector; entering into the marine biological sector; improving the modern enterprise system; promoting international marketing by pursuing a global strategy.

According to the president, the diversification strategy was motivated by several straightforward factors. 1 2 3 4

Diversification into closely related sectors enables the group to fully utilise the resources of the brand and distribution channels. It enables the group to spread the risk, following the principle ‘Never put all your eggs in one basket’. Diversification into non-related sectors enables the group to seek new business opportunities and growth. Given that the implementation of the diversification strategy is relatively low cost in China, it is easy to shift into other sectors without much effort. It is even cheaper to diversify under the OEM system, as Aucma only produces white goods with its own production line.

In fact, the core business remains white goods. In 2001, sales of white goods accounted for 80 per cent of total sales, among which freezers accounted for 30 per cent and air-conditioners and other appliances for 50 per cent (interview, April 2002). Sales of consumer electronics only accounted for a very small fraction. The total assets of the group were over RMB7.1 billion.

Discussion of the challenges facing Aucma Diversification vs. specialisation Aucma has been widely criticised by observers for its over-diversification strategy on the grounds that ‘it got lost in the diversification trap’. Before 1995, the company merely manufactured one model of freezer. In 1999, the product lines covered sixty-two products, 183 series and 700 variants. In

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2002, the number rose to nearly 1,000 variants. With very limited resources in terms of capital, management and technological capability, the Group did too much too quickly. It is argued that it is difficult to guarantee quality without a powerful and integrated effective quality control system and component purchasing system; without these, brand reputation was at risk. Brand image is another concern. The success of Aucma depended partly on careful market segmentation. To avoid direct competition with big names like Haier and Kelon, Aucma has been targeting the low-end market, selling either to consumers in the countryside or to pedlars and family retailers in the urban areas, at prices RMB300– 400 cheaper than competitors. If the Group decided to enter the high-tech sector, management would have to transform the Group’s existing image of low-end producer into that of a high-tech company with strong brand recognition. Technology capability By any standards, Aucma is a middle-sized company. Under the leadership of Lu Qunsheng, who believed that it could produce high-quality products through their own efforts, the company has built a strong manufacturing capability. Groups of technicians are sent to Japan, South Korea and Australia for training every year. The junior and middle-level engineers are very skilled at production processes, especially energy matching and flux matching. In 1999, the Aucma Technology Centre was approved as the national-level technology centre by the Economic and Trade Commission. However, even in its core business, the freezer sector, Aucma has never made substantial investments in either advanced technologies or production equipment; rather, it spends its limited capital cautiously on independent technical upgrading and importing core components. It is claimed that investment in R&D in 1999 was only RMB520,000, less than 0.5 per cent of sales revenue (interview at Aucma, April 2002). Nevertheless, Lu was well aware that the stumbling-block to entry into the high-tech sector was technological capability. It is impossible to build inhouse R&D without sufficient resources of capital, talent and technology. Instead, Lu has been desperately exploring external sources. There were several alternatives. •

Setting up joint ventures with foreign partners. For example, Aucma set up a joint venture with the Swedish Lidu Group, called Zha Nuxi– Aucma Refrigeration Equipment Company, to produce freezers of over 400 litres capacity. Aucma also invited retired technicians from Sanyo and Sony in the air-conditioner sector to train its workers. On 1 February 2001, after eleven months’ negotiation, Aucma signed a contract with GE to supply 180,000 freezers to North America. According to the contract, GE would provide overall training in the ‘Six Sigma Quality Control Programme’, including quantitative management in

The Aucma Group 155

•

•

•

equipment, packing, servicing, etc. The programme aims to decrease the defective product rate to less than 0.0034 per cent. Despite the extremely narrow profit margin, the OEM contract provided Aucma with a solution to its surplus production capacity. It also gave Aucma a good opportunity to improve its product quality. ‘As a subcontractor to GE, we benefited greatly in terms of management and quality control,’ said Lu Qunsheng. The Group entered into unfamiliar territory through setting up JVs with other domestic companies under the strategy of ‘importing firstclass technology, and cooperating with the top three national leaders in China’. For example, the Aucma Haiwei Information Network Co. Ltd worked with Shenzhen Sangxia High Tech Company to develop a palm notebook. The Aucma Marine Organisms Research and Development Centre was a JV with the National Ocean Bureau, engaging in marine fertilisers and health care products. To enhance its R&D capability, Aucma initiated the the Double Ten Programme, setting up strategic alliances with ten universities and research institutions, including Tsinghua University, Shanghai Communication University, National Science Institute, etc. However, venture investment is still risky, as the investment relies heavily on external information from research institutes and universities. For example, Aucma entered a joint venture with Tsinghua University to develop a multi-media projector, but due to poor design it was unable to manufacture the product. It is having to do it under the OEM system with a Taiwanese manufacturer. To initiate new businesses, the Group has continued to recruit postgraduates by granting them shares in the newly established hightech company. Unfortunately, it has failed to retain its talented recruits for a variety of reasons. Those that have been cited include an ineffective corporate culture, a lack of incentives, unsatisfactory conditions and even unsuitable products. For example, Lu appointed a postgraduate who had worked on the lighting electron diode circuit in Silicon Valley in the USA to be the director of a business department and commercialise his idea in its final form. But the performance was extremely disappointing in the absence of a supportive environment with the necessary related technology and sufficient capital, and the appointee left the company.

Export capability In the absence of brand, capital and overseas experience, the company has been very cautious in its international business. According to Lu, Aucma pursued its global strategy in three stages: first, exporting a product; then, exporting the technology and production process; and finally, overseas manufacturing (China Industrial and Commercial Times, May 2002). In order to

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The Aucma Group

export, it made great efforts to obtain various international certificates for quality, environmental protection, and safety and hygiene, such as ISO9001, ISO14001 and OHSAS18001. In fact, the real breakthrough in exporting took place when Aucma became the subcontractor to GE Appliances in 1999. In 2001, the Group exported 230,000 freezers with a sales value of US$30 million. The Group claimed that it had sold more than twenty models to over twenty-six countries and regions, mostly developing countries in South East Asia, the Middle East, Eastern Europe and Africa. In response to the ‘marching out’ policy initiated by the government, more aggressive steps were taken: for example, the Group set up JVs in Egypt, Cuba and Brazil in 2000. It also set up a JV in Vietnam with millions of dollars’ investment, producing freezers with a production capacity of 100,000 units per annum. Management Management is another crucial issue. At the beginning of its operations, Lu Qunsheng aimed to organise the company as a big family in order to survive in the market, with profits as the means for growth rather than the end purpose. Slogans like ‘Be kind to employees and love the company’, ‘More appreciation, fewer complaints’ can be seen everywhere in the company. Initially, such corporate culture worked effectively due to the small size of the company and the increasing demand it enjoyed. However, with the rapid growth of the Group and increasing competition, the management was rather slower in adjusting to the changes than its local competitors. It paid little attention to the effectiveness and efficiency of management and institutions. When the Aucma Group expanded to be a conglomerate with more than seventy-five subordinate companies with legal status, the management frankly recognised the shortcomings of its system. These included lack of clarity in the responsibility held by subsidiaries, overlapping personnel and functions between the board of directors and the management group, and lack of clarity in relationships between the parent company and the holding companies (interview, April 2002). Given the fact that the headquarters failed to control the subsidiaries effectively, Lu followed the practice of his competitors and decided to consolidate control by setting up the business department system within the Group (Figures 6.1 and 6.2). Under this system, the headquarters of the Group consists of six functional departments and twelve business departments. The six functional departments are responsible for overall governance and administration in the Group, consisting of the enterprise management office, the personnel department, the audit department, the finance management department, the information department and the technology management department. The business departments are envisaged as decision-making centres in charge of a specific sector. In practice, each business department is either a holding company itself, plus some other

The Aucma Group 157 The Aucma Group

Listed company Aucma Electrical Appliance Share Holding Co.

Holding companies of the listed company Qingdao Aucma New-Power Technology Co. Ltd

Participating companies Beijing Security Co. Ltd Qingdao Tianlong Investment Developing Co. Ltd Wuhu Technology Co. Ltd Goods and Material Sales Co. Ltd

Wholly owned companies Qingdao Aucma Automatic Instrument Co. Ltd Qingdao Aucma Visual & Audio Equipment Co. Ltd Qingdao Aucma Group Economic and Trade Development Co. Ltd Qingdao Aucma Electrical Instrument Co. Ltd Qingdao Aucma Air Conditioner Co. Ltd Qingdao Aucma Water Heating Co. Ltd Qingdao Aucma Modern Appliance Co. Ltd Qingdao Aucma General Dish Washer Factory Qingdao Aucma Drinking Water Equipment Factory Qingdao Aucma Electric Technology Co. Ltd Qingdao Aucma Kitchen & Cleaning Factory Qingdao Aucma Internal Electrical Engineering Co. Ltd Beijing Aucma Shimeile Information Technology Co. Ltd Aucma Computer Consumption Co. Ltd Aucma Sauna Equipment Factory

Holding companies Aucma (Wuhu) Technology Co. Ltd Aucma (Zhejiang) Electric Appliance Co. Ltd Aucma (Yingkou) Electric Appliance Co. Ltd Aucma Advertising Centre Aucma Electric Instrument Co. Ltd Aucma Green Food Co. Ltd Aucma Measure Instrument & Equipment Co. Ltd Aucma Network Technology Co. Ltd Aucma Hongxin Futures Broker Co. Ltd Aucma International Business Co. Qingdao Aucma Import & Export Co. Ltd Qingdao Aucma Tristar Plastic Cement Co. Ltd Qingdao Commercial Bank Qingdao Communication Bank

JV companies Zha Nuxi-Aucma Refrigeration Equipment Co. Qingdao Aucma-Kaili Freezer Co. Ltd Aucma-Alamo Purifying Equipment Co. Ltd

Figure 6.1 The Aucma Group’s organisational structure (2002). The Aucma Group consists of around seventy-five related companies. This list shows the major affiliates and subsidiaries. Sources: Annual reports and company documents.

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The Aucma Group

CEO’s Office

Kitchen & Cleaning Business Dept.

Enterprise Management Office

International Electrical Instrument Dept.

Personnel Dept.

Property Development Dept.

Audit Dept.

Solar Energy Dept.

Aucma Group

International Business Dept. Finance Management Dept. Finance & Investment Dept. Information Management Dept.

Technology Management Dept.

The Big GE Business Dept.

Information Electronic Dept.

Small Electrical Appliance Business Dept.

Beijing Technological Development Dept.

Digital Technology Dept.

Figure 6.2 The business structure of the Aucma Group (2002). Source: Company documents.

small companies with similar products, or a department consisting of several holding companies. Each holding company has great autonomy in decision-making within its own administrative sector, such as sales, finance, human resources and so on. They have operational autonomy and are responsible for every aspect of business within the company. The holding companies enjoy very loose relationships with each other and report directly to the president. As a result of decentralised accountability, investment decisions are made by each company. The headquarters largely fails to integrate the group as an efficient network and the confusion of functions has led to bureaucratic management and even corruption within the Group.

The Aucma Group 159 The ownership structure and government intervention Aucma used to be a collective enterprise. In theory, the assets of a collective enterprise are owned and controlled by its employees under the supervision of the municipal government. In practice, as in many other local companies, government involvement in almost every aspect of the operations of the Group was a constant factor. With the initial success of the company, the Aucma Group was targeted and nurtured by the Qingdao municipal government as a city champion. The Qingdao City government is strongly motivated to see Aucma perform successfully, not necessarily as a shortterm profit maximiser but rather as a long-term contributor to the economic life of Qingdao City. In order to finance the ambitious diversification programme of the early 1990s Aucma borrowed heavily. In 1998, Aucma’s ratio of debt to assets stood at 67 per cent, compared to Hisense’s 53 per cent. But the borrowed funds were far from sufficient to support future development. Aucma’s leader asked for domestic listing, and after negotiations with the municipal government, the Group had to accept a proposal whereby the state would be the major shareholder in the listed company. Under the restructuring, on 28 December 1998, Qingdao Aucma Share Holding Company was established. The newly formed company, formally subordinate to the Qingdao State Assets Management Bureau, was floated on the Shanghai Stock Market on 29 December 2000. According to the new ownership structure, the state owns 73.11 per cent of the share capital of the listed company. The capital stock totalled RMB341.04 million of which the state owns RMB249.34 million accounting for 73.11 per cent, the Qingdao City Corporation owns 1.7 million accounting for 0.5 per cent, and public investors own 90 million accounting for 26.39 per cent (interview at Aucma, April 2002).

The prospects Although national industry and national enterprise are advocated publicly by the leaders of Aucma, in reality they realise that they do not have the capability to be a national leader. Survival is always the primary target, given that in Qingdao Aucma is in competition with Haier, an aggressive national champion in the domestic appliance industry. The Group’s consistent losses in recent years have forced the leadership to rethink its strategy. One of the hidden strategies is to build Aucma into a world production base for freezers, expanding production capacity and improving the technology through the mechanism of subcontracting. A good example of this system is Glanz, a Guangdong-based subcontractor of microwave ovens. However, compared with Glanz, Aucma lacks an explicit strategy, flexible tactics and skills in overseas marketing, cost control and innovation. The question facing the Aucma Group is: can the company be rescued through the mechanism of subcontracts and sub-system joint ventures?

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The Aucma Group

Subcontracting provides a means of gaining a closer understanding of international markets. However, Aucma does not have the capability to become an original design manufacturer. With advantages in assembly, the company is only capable of fulfilling the design requirements of foreign buyers. For example, GE has designed a model of condenser and given it to the company to produce. There is a likelihood that a breakthrough may take place in the ownership structure, if the local government forces further mergers with other local companies, or if it allows foreign ownership. However, given the overcapacity of production, the complicated ownership structure, and the lower cost of building new companies in ‘greenfield sites’ in China, who would purchase Aucma?

Conclusion

7

161

Conclusion

Introduction An accurate explanation of China’s economic growth in the past two decades requires a very careful analysis of the fortuitous combination of external and internal factors. However, it is also certainly safe to say that industrial policies at both national and local levels are too important to ignore in any explanation of China’s excellent performance. This is vividly illustrated by the cases of the domestic appliance industry and the individual enterprises examined in the preceding chapters. Therefore, my argument, as stated earlier, is that China’s industrial policies have brought tremendous changes to both the industries and the industrial enterprises and hence have contributed significantly to economic development as a whole. However, it is not easy task to create a convincing theoretical framework based on the empirical evidence. This is not surprising, given that contemporary normative economics are not wholly applicable to developing countries (Killick 1990: 8), especially one like China, in transition from a command to a market economy. We should be extremely sensitive when applying them and their policy implications to China. In this chapter, the questions that have been raised regarding the feasibility of industrial policies are discussed, and alternative views of globalisation and its impact on industrial policy are critically examined. The first section focuses on three fundamental issues: first, the rationale for the marketoriented industrial policies that account for China’s economic success is set forth and scrutinised; then questions surrounding institutional capability, the efficiency of industrial policies and the ownership system are critically examined; and finally an alternative model for local-level industrial policy is proposed. The second section discusses the challenges for China’s industrial policy in the era of global business revolution, especially following the country’s joining the WTO in December 2001.

162

Conclusion

Feasibility of industrial policies Market-oriented industrial policies In the neoclassical view, the necessary institutional arrangements for generating efficient resource use are competitive markets. It is argued that once markets are in place to generate an efficient allocation of resources, investment can be left to take care of itself. Given that whatever investments are generated by these arrangements constitutes the social optimum, governments should leave private producers operating through market mechanisms to supply all but certain ‘public’ services. The advice of the neoclassical school on how to effect the transition from a command to a market economy comes down to liberalisation and privatisation. The populist neoclassical economists have pointed out that the economic reforms in China are based on a recognition that central planning approaches are not working well and on a desire to make more use of material incentives and market forces (Killick 1990: 17). With further reform ongoing, policies are clearly shifting in a more market-oriented direction. The new industrial policies favour indirect control through market forces and a smaller state sector achieved through privatisations. However, at a practical policymaking level, the evidence in China shows that policymakers do this by following a development strategy characterised as ‘going for stepping stones when crossing the river’. This suggests that a pragmatic, case-by-case strategy is the best approach to policymaking when seeking to correct largescale distortions in the economy (Killick 1990: 5). This research provides no evidence that China should diverge radically from the experimental and gradual reform path that it has followed in the last two decades. The case of China’s domestic appliance industry, a sector which has built itself into one of the world’s greatest of its kind within two decades, has also been well received by the neoclassical economists, who sometimes overlook the role of government and attribute the rapid growth of an industry to its ‘success in free market competition’ with little government intervention. In sharp contrast, the research indicates that the industry would never have survived without massive government protection, subsidies and compulsory transfers of foreign technology. It is to a great extent true that the government’s attempt to set a market plan independent of market forces failed, given that the industry grew in a pattern opposite to what the bureaucracy sought; none of the candidates initially targeted by the central government to be ‘national champions’ succeeded in the end. However, government failures in implementing a consistent, effective industrial policy at national level do not necessarily imply that the industry was totally shaped by market forces. It is somewhat naive to attribute the success of the domestic enterprises, Haier, Hisense and Aucma, discussed here, to free competition and strong entrepreneurship in the absence of heavy government involvement. It is clear that the same outcome would never have occurred without the mixture of the above factors.

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Besides drawing attention to the fact that China has a huge and comprehensive economy involving central government, a specialised administrative apparatus and local governments, this study strongly indicates that China’s large and autonomous local governments created a strong basis of local industrial policies for promoting the domestic appliance industry and the emergence of large enterprises. In this sense, the local governments have played far more crucial roles than the central government in influencing the business decision-making of domestic appliance enterprises. The empirical evidence also supports the proposition that industrial policies that operate through market forces are more likely to succeed than policies of control and command (Killick 1990: 32). The alternative model of local-level industrial policy will be presented later. Institutional capability1 The argument that more market-oriented direction can work far better than policies of control and command is likely to limit the scope for state interventions to some extent but not necessarily to reduce the role of government. As Lamb (1987: 15) points out: Market-oriented policy reform often in practice alters rather than reduces demands on public institutions – because intervention must compensate for widespread economic distortions, because efficient market functioning demands considerable sophistication in information and services to producers, or because there is a high degree of interconnection with other policy areas. This in turn raises the question of government’s institutional capability. Based on the experience of industrialised countries, the concept of a benevolent social guardian state is used to argue that any kind of external force constitutes a case for government intervention, the underlying premise being that governments and civil servants are in some sense ‘above the system’, selflessly promoting the welfare of the people (Krueger 1993: 55). In contrast, public choice theory sees politicians, bureaucrats and other individual actors in the political processes serving their own interests rather than social welfare. Literature on government failure articulates that industrial policy requires a high institutional capability – such as a capable bureaucracy and a well-developed forum for government–business dialogue – and governments in developing countries do not have the necessary capabilities to formulate and implement policies. This is true in the sense that the individual bureaucrat is not completely benign in his or her intentions, but this does not necessarily imply that the civil service cannot act on behalf of the public interest to achieve common goals and that institutions cannot be improved. The experience of Japan and South Korea demonstrates the feasibility of industrial policy.

164

Conclusion The targeting of industries in Japan or South Korea was not done by bureaucrats working in isolation; in fact, there was a close involvement of all interested parties – businesses, trade unions and academics, as well as bureaucrats – in developing a ‘vision’ for the future. When industrial policy is formulated through such a consultative process, the choice of industries for development would generally be made on a sounder foundation than the decisions of isolated investors. (Butt and Porter 1994: 34)

With special reference to China, there can be no doubt that its rapid industrial development is the culmination of its leadership’s commitment to the acquisition of technology through bureaucratic control over national economic development. Many of China’s bureaucrats hold strong ambitious for accelerated economic growth. The policies that were adopted were largely consistent with development thinking. The national elite has consistently pursued a pragmatic strategy involving economic nationalism to ensure that China’s sovereignty continues to be secure in the world of competing nations. The high levels of corruption and huge number of inefficient SOEs have caused profound pessimism about the possibility of Chinese industry ever catching up with the industrialised nations. However, institutions can be improved, and there are signs that institutional incapability to administer ‘complex’ policies is being recognised. Policymakers are trying to build up capabilities over time by learning from other countries. This is further exemplified by the fact that that local bureaucrats act as economic predators, given that local governments commit a high percentage of local revenue to the development of local infrastructure and local enterprises to accommodate new technologies and improve production processes. This observation in itself raises an important question as to the role of ideology in the formulation and implementation of industrial policy, which we will return later. Effectiveness of industrial policy The effectiveness of government’s industrial policies is difficult to assess. We first need to identify policymakers’ ideology and hence the objectives of their industrial policies. The welfare economics school suggests that the objective of economic policy is to achieve a Pareto optimum; this in turn is based on the implicit assumption that government intervention in the economy would only occur to correct market failures (Krueger 1993: 57). In practice, such efficiency criteria, which may be relevant in some industrial countries, may be inconsistent with the social objectives of many developing countries (Killick 1990: 38). Nevertheless, industrial policies can serve different purposes of much greater scope than efficient allocation of resources; these could be building national or global champions, protecting infant industries, maintaining social stability and security, and achieving some given rate of GDP growth.

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In the case of China, the neoclassical school attributes the inefficiency of industrial sectors and public enterprises to government intervention, and specifically to industrial policies, and argues that the industries would have grown faster without industrial policies. It is true that industrial policies have produced some disappointing results in terms of efficiency and international competitiveness. Besides drawing attention to many other factors that may result in unsatisfactory performance, it is worth pointing out that politicians’ decisions on industrial policy are based on balancing different interest groups on a national basis. However, we must try to understand industrial policies in the context of development. It should be recalled that China chose to pursue economic growth as a conscious and over-riding objective of its industrial policy, together with strong national economic independence. Policymakers were, however, even more concerned with development and independence. It should be recalled that the building of ‘global competitive enterprises’ was only one set of objectives, which were explicitly addressed and seriously benchmarked against the world’s leading firms within less than ten years. Behind the industrial policies designed to create global champions were another set of industrial policies to bring about rapid improvements in the living standards of the poor, to improve the quality and availability of utilities, and to maintain social and political stability by propping up inefficient highemployment sectors. In these senses, those of China’s industrial policies which were consistent with economic growth were very successful, based on the evidence discussed in Chapter 2 above. This is further reflected by the fact that local bureaucrats made every effort to adopt development strategies to further the growth of the local economy. Debates about what the evidence shows concerning the relative efficiency of markets and state interventions are far from over. The experience of China suggests that the objective of industrial policies may be concerned not with the efficient allocation of resources in a Pareto-optimum sense, but with stable growth and overall development. It also suggests that government can achieve economic growth by pursuing more than one set of rational industrial policies, for example one on potential global champions and others on different targets. The results of China’s industrial policies in the past two decades, though not satisfactory, are certainly significant. Although there is much room for improvement, they do not need to be dismantled overnight, as China promised at its entry to the WTO. Ownership structure The evidence comparing the performance of private and public enterprises is far from unanimously in favour of the former; the chief conclusion of analyses of the policy of privatisation or divestment is that the degree of competition in an industry is a more important determinant of the economic and social efficiency of an enterprise than the nature of its ownership (Killick

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1990: 27). Studies on China’s township and village enterprises (TVEs) conclude that growth occurs as long as there are property rights for some organised entity, and local governments, if they have sufficient incentive and resources to pursue growth, can assume an entrepreneurial role (Oi 1999: 193). This research provides further evidence consistent with the above conclusions. It shows no positive correlation between growth and property rights. What it does highlight is that the blurred and complex ownership system of collectives has worked quite well in the past two decades. The importance of clear property rights is not denied but is not decisive. In this study, I have taken seriously the difference between collective and private ownership and have examined the emergence of collective enterprises in the 1980s as a way for local governments to boost local industry and generate revenue. The case studies of Qingdao show how local governments participated in the decision-making process. The World Bank attributed China’s economic growth to the development of TVEs and small businesses, regarding them as private enterprises. However, this is misleading to some extent because: (1) TVEs were usually owned by town or village governments in the 1970s and 1980s, and partial privatisation began to occur in early 1990s; (2) the World Bank ignored the role of collective enterprises, and hence local governments, as driving forces of economic development during the reform period.2 Given the absence of large private capital in China, it was reasonable for public enterprises, either local SOEs or urban collectives, to be chosen and financed by local governments as means to boost the local economy. The case of Haier, Hisense and Aucma in Qingdao, which share the feature of ambiguous ownership structure, provides a good example.3 How long can this ambiguous ownership system continue to work? This is a question for future research, but it is clear that one should not expect it to work in all contexts or even in the same place over time. Ownership structures have been reformed in some sectors and in some provinces, including the domestic appliance industry in Shandong Province and Qingdao City in particular. Although in the experimental stage, it is expected that the outcome may be radical and significant. This is an extremely interesting area for future research. A model of local industrial policy Decentralisation is the most innovative and significant of the reform strategies initiated by China’s government. The performance of the local economy became a key official criterion for evaluation of local bureaucrats’ political performance and career progress. The autonomous local governments in China actually played a dual role, acting as agent in the central–local government context and principal in the government–business context. As agent, local government managed to expand its economic and political power by bargaining with central government, only by taking full advantage of

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preferential policies but also by pursuing policies far beyond the central level policy in scope and scale. As the principal to monitor public assets, namely local SOEs and collectives, they are eager to generate revenue by requiring high performance of and imposing close supervision on local industry and management. Informational constraints mean that industrial policy may not be effectively designed and implemented, resulting in inefficiencies. However, these can be overcome by creating a forum for intense government–business dialogue. Such a communication network gives government the information it needs to design and implement policies and set performance targets. The experience of Japan and South Korea also indicates that the success of their industrial policies resulted from the highly supportive, non-antagonistic relationships between their governments and private sectors (Killick 1990: 31). The findings of the research enable us to develop an alternative model for industrial policy at the local level. As we have seen, Qingdao City is an extraordinary example in that it has successfully nurtured four city champions, two of which later became national champions, namely the Haier Group and the Qingdao Brewery Group; the other two became provincial champions, namely the Hisense Group and Aucma Group. The case of Qingdao City provides a good example of how active government intervention in industrial development can, under certain conditions, achieve economic growth and efficiency. To boost the local economy, local bureaucrats managed to acquire as many concessions as they could from both central and provincial governments on behalf of local enterprises; these included floatation permission, import quotas, manufacturing licences, subsidies, etc. On the other hand, Qingdao City government has demonstrated its ability to target, nurture and support local enterprises; it selects capable managers and gives them sufficient autonomy in decision-making to enable them to respond to competition and take action to increase efficiency, end unprofitable activities and pursue new markets. The local government overcame coordination problems by various means, including restriction of entry in the industry, nominating capable local bureaucrats as managers, monitoring through annual performance contracts, etc. The Qingdao government is outstanding in giving local managers more personal political identity; the inclusion of Zhang Ruimin of Haier and Zhou Houjian of Hisense in the list of the top ten most influential figures in China in 2001 reflects this. Rent-seeking theory is perhaps better known and of particular relevance to China’s conditions. Besides drawing attention to such activities as an additional cost of government intervention, the main policy thrust of this theory has been to recommend the abolition or reduction of price and quantitative controls and other non-market interventions which create opportunities and incentives for directly unproductive profiting-seeking, including corruption. Some argue that information constraints may also create perverse incentives for rent-seeking, and thus result in inefficiency.

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The three enterprises examined in this research are to some extent all rentseekers, especially Haier, which is extraordinarily good at utilising government resources. The case study shows that Haier’s profitability was initially shored up by government subsidies and preferential policies, which were not available to other local enterprises. Rent, in this sense, can take various forms, including the designation of Haier’s industrial park as a High-Tech Economic Development Zone benefiting from considerable preferential policies, the promotion of mergers and acquisitions with local enterprises, public notification, political status and so on. Rent-seeking activities may create inefficiency, which seems unavoidable; however, this may be reduced by the market. The experience of Qingdao City government shows that inefficiency may be reduced by allowing a small number of enterprises to compete with each other for both markets and rent and by imposing harsh discipline on them through performance contracts and industrial policies.

The challenge of industrial policy in the epoch of global business revolution The widespread acceptance of the industrial policies argument as a rationale for economic growth clearly illustrates the views of policymakers towards markets and governments. Reflecting on the experience of industrial policy over the previous two decades, China’s policymakers could have chosen to learn from past failures and attempted to strengthen and improve their industrial policy. This would have been consistent with China’s approach to experimentation in its reform programme, with the incremental transition towards a market economy and with gradual, controlled integration into world economy (Nolan 2001: 857). An overview of the strategic changes in China’s industrial policies, as examined in Chapter 2 above, indicates that the country’s policymakers have never given up their ambition to build globally competitive companies. While recognising that they are facing a difficult international business environment, the bureaucrats still believe that there is a possibility for large Chinese enterprises to compete globally. Learning from the experience of Japan and South Korea, they have also gradually recognised that advantages could be created by the mobilisation of technology, capital and skilled labour, not just in order to nurture a few infant industries to supply the domestic market, but to guide the whole industrial sector towards areas of growth and opportunity in the world market. The ‘marching out’ policy, for example, could reflect this development strategy. However, this gradualism faces great challenges with Chinese entry to the WTO regime, a crucial turning point in the country’s history. Those industrial policies that worked in the former world economic system may no longer work in today’s environment. The favourable historical and international conditions that China has enjoyed are in the process of change since entry to the WTO, through which the rules of the the world business system

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are created and monitored by the developed countries, especially the USA. Joining the WTO is an epoch-making event in China’s economic history, not only radically changing the nature of opportunities for Chinese enterprises but also changing the nature of industrial policies. With the constraints imposed by joining the WTO, the challenge for Chinese policymakers is how to find a way of achieving economic development and creating and distributing wealth without violating its commitment to further integration and free trade. The motives for joining the WTO are based on the following assumptions: 1

2

3

The earlier experience of an inward-looking approach to development led to China’s failure to recognise the benefits of remaining open to competition in world markets. The opening to the outside world has contributed considerably to China’s economic development through making acquisition of foreign capital and advanced technology possible. Thus FDI can help to achieve further rapid industrial development. The WTO may help China gain further access to international markets, hence boost export-oriented industries and enterprises that enjoy comparative advantages. The WTO will provide huge opportunities for China’s small enterprises to become outsourced suppliers to the multinationals in almost every sector; it will make rapid penetration of the new information technology possible, and thereby increase the overall level and quality of employment.

Those who believe that FDI can help to promote rapid industrial development argue that China’s own private sectors did not have the institutional capabilities to achieve it. TNCs are an ideal supplementary source of experience and expert guidance. In theory, the influence of FDI and trade on the rate of economic growth and technical progress is debatable. We are far from having any systemic conclusion which links trade policy to technical efficiency. In particular, there is no good reason to expect trade liberalisation to be generally helpful to overall technological performance (Rodrik 1988: 270). In practice, the experience of Latin America gives us a good example of poor policy agreements under which foreign investors were encouraged to purchase public assets but were allowed to insist on importing high value-added components rather than using local production. Too often such agreements result in low-tech, labour-intensive work going to the developing countries while the advanced technology remains in the home country. Therefore, TNCs are a double-edged weapon in the quest for rapid industrial development. The theory of protecting infant industry needs little comment other than that it has been used by economic policymakers in developed countries as a reason for giving high levels of protection to domestic manufacturing

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industries. It is possible, particularly in large economies, that protection may foster innovation and long-run development. In the absence of outside competition, the home producer can reduce costs and increase output and may thus become internationally competitive and no longer in need of protection. The experience of China suggests that it is logically and practically possible for a country to protect both export-related production and domestic market-related production. The rapid growth of China’s domestic appliance industry has benefited significantly in the dual trade regime. The domestic appliance industry and the Haier Group were first targeted on the grounds of their significant position among Chinese national industries. There have been examples in the research of extremely ambitious entrepreneurs in China’s large enterprises. Faced with the dramatic widening of the gap between them and the global leaders in terms of technological and management capability, they are far more aware of the nature of the competition that awaits them on the global level playing field (Nolan 2001: 926). They are rethinking their development strategies in response to the new challenge, as shown in the case studies: Haier has chosen to become a ‘global player’, Hisense a ‘national player’ in the niche market, and Aucma a ‘subcontractor’ in the global supply chain. It is too early to evaluate the outcome, as the industry and global integration are still at an early stage. Nevertheless, the future of the firms will be determined by both internal and external factors. From the internal perspective, the growth of the firm relies heavily on its managerial capabilities, technological innovation and marketing strategies. Externally, the success of the firm relies on macro and micro government policies, in particular appropriate and effective industrial policies. These factors, together with changes in technology and international economic policy, combine to produce many dynamic possibilities. In conclusion, the success of industrial policies depends on a welldesigned strategy that recognises government’s limited capacities on the one hand and the significant accountability of policymakers on the other. It is a painful process to turn theoretical perspectives into concrete policy approaches in the transition from a command to a market economy. It is particularly painful within the dynamic contemporary global economy. However, this can be done through a process of institutional learning and innovation (Chang 1994: 136). With decreasing authority due to decentralisation, the central government is facing great challenges in dealing simultaneously with local governments and enterprise conglomerates which require protection, and foreign governments, especially the US, which demand strict observation of agreed terms. Nevertheless, China’s policymakers know this is something they have to do, as economic failure may not only erode political support for the government and threaten their own positions, but may also jeopardise national sovereignty. Either would be a disaster. Clearly, Chinese leaders are seriously concerned about America’s global intentions and potential ability to retard

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China’s growth. As Hu Jintao stated on the eightieth anniversary of the May Fourth Movement: The Cold War mentality persists. Hegemonism and power politics are making new headway. The world is not peaceful. The major Western powers have not changed, and may not change, their strategy of attempting to ‘westernise’ or ‘divide socialist countries and developing nations’.

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Notes

1 Industrial policies and globalisation in theoretical and historical perspective 1 A more narrowly defined industrial policy is one aimed at particular industries to achieve the outcomes that are perceived by the state to be efficient for the economy as a whole (Chang 1994). 2 For details of infant industry protection in the developed economies see Nolan (2001) and Chang (2002). 3 In this context, flows refer to the movements of physical artefacts, people, symbols, tokens and information across space and time, while networks refer to regularised or patterned interactions between agents, nodes of activity or sites of power (Modelski 1972; Castells 1996; Hirst and Thompson 2000). 4 The difference between internationalisation and globalisation is that the former involves the simple quantitative extension of economic activities across national boundaries, while the latter involves further qualitatively functional integration on the basis of geographically dispersed activities (Dicken 1998). 5 China had a strong interest in the Japanese experience as a model of successful industrial policies. From the late 1970s, numbers of delegations from government and academies were sent to the Japan to study the Japanese approach to economic development. 2 Industrial policies in China 1 The discussion and analysis in the section, unless otherwise stated, is based on published government documents. 2 According to Zhang and Long (1997), China has relied on six types of industrial tools: central government financing and planning; empowering key industries with direct financing; preferential interest and tax rates and favourable financing for target industries; infant industry protection; pricing policies; and administrative means. 3 Priority industries included agriculture and agricultural-service industries, selected products in light industry and textiles, transport, telecommunications, energy supplies, some important raw materials, machinery and the electronics industry, high-tech industry and export-orientated industry. Controlled industries included low-quality products and machinery, consumer durable goods that consumed ‘excessive’ electricity and luxury consumer products for which the required inputs were in short supply. Prohibited industries included those with obsolete production methods and those which wasted energy or were environmentally harmful. 4 The objectives of FYP1 were: to gradually carry out socialist industrialisation, to gradually realise the socialist transformation of agriculture, handicrafts and

Notes 173

5

6 7

8 9 10

11 12

13 14 15

16 17

18 19

capitalist industry and commerce; to gradually improve the people’s living standards on the basis of developing production and raising labour productivity. China introduced tax rebates for exports in 1985. The rates are adjusted according to export performance. For example, on 1 July 1995, the rates were reduced to 3, 10 and 14 per cent for the three categories of exports. On 1 January 1996, they were further reduced to 3, 6 and 9 per cent respectively. Since 1998, the government has raised the rates several times, bringing them to 5, 13, 15 and 17 per cent for four categories in 2000. The number required to have permits was reduced to 300 in 1998. During FYP1, for example, central government owned 75 per cent of fiscal income, while local governments owned 25 per cent. In 1957, the central government controlled 9,300 enterprises, accounting for 50 per cent of industrial output. The central government allocated 80 per cent of total investment (SSB 2000). Goodman and Segal (1999) rightly pointed out that ‘national decision-making was frequently an incremental process involving provincial experimentation before a final decision was reached.’ In 1984, the central government handed over most of the SOEs to local governments, keeping only 5.4 per cent of the total number at central level (CASS 1998). In terms of FDI, Tianjin, Shanghai, Guangdong, Fujian, Hainan and Beijing were authorised to approve projects worth less than US$30 million; Liaoning, Hebei, Shandong, Jiangsu, Zhejiang and Guangxi were authorised to approve projects worth US$5–10 million. In the Special Economic Zone, light industry projects worth less than US$30 million and heavy industry projects worth less than US$50 million could be approved at local level; other coastal cities (except Dalian) and inter-regional provinces were authorised to approve projects worth less than US$5 million, later increased to US$10 million, and further increased to US$30 million in August 1996. The average profitability of refrigerators and washing machines was 30 per cent between 1984 and 1988. It was reported that the Shanghai Washing Machine General Factory had enjoyed profitability of 77.4 per cent (Jiang 1996). As noted above, the MLI is only one of the investment bodies, as other administrative ministries and local governments also engage in investment in light industry. In China, imports of machinery equipment increased dramatically, from US$1.23 billion in 1977, to US$3.96 billion in 1979 and US$5.03 billion in 1980 (Li and Huang 2001). It was estimated that each refrigerator cost US$50 and US$40 in imported spare parts and raw materials respectively in 1987 (Gong 1993). As early as 1982, the MLI first put the refrigerator production line in the controlled list, in the report entitled ‘Additional Directive on Control of Fixed Capital Investment’ published by the State Council. Initially, the MLI intended to grant production permission certificates to twenty enterprises, but due to the difficulty of balancing the interests of different administrative ministries and local governments, it finally issued forty-one certificates. Haier and Kelon were the last two to obtain certificates (Ji and Jiang 1997). After 1993, there was a big tariff reduction but the rate was still high, with 50 per cent for final products and 35 per cent for components. For example, Electrolux set up a JV with Zhongyi in Changsha, Samsung with Xiangxuehai in Suzhou and Bosch-Siemens with Yangzi in Anhui; 75 per cent of the JVs were set up with foreign companies owning between 55 per cent and 60 per cent of shares. The Korean companies owned over 80 per cent of the JVs. The Yangzi Refrigerator Company was acquired by Bosch-Siemens in 1995. The output of the four companies in 1994 was as follows: Kelon 909,600 units, Meiling 690,700 units, Haier 625,000 units and Yangzi 623,700 units (Jiang 1996: 215).

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20 For example, the Beijing Snow Flake Refrigerator Company became a joint venture with Whirlpool in 1995. 21 In terms of GDP, Shandong ranked fourth after Shanghai, Jiangsu and Sichuan in 1978, and third in 1988 after Jiangsu and Guangdong. 22 Shandong’s fiscal contribution to the central government went well beyond budgetary sharing. For details see Cheung et al. (1998: 266–8). 23 The various fiscal reforms included: ‘Dividing revenue and expenditures, multilevel contracting’ (‘Huafen shouzhi, fenji baog’) in 1980; ‘A percentage payment of revenue sent to central government’ (‘Huafen shouzhi, zonge fencheng’) in 1981; ‘Dividing tax categories, checking revenues and expenditures, multilevel contracting’ (‘Huafen shuizhong, heding shouzhi, fenji baogan’) in 1985; ‘Fixed sum transfer system, Qingdao excluded’ (‘Shouru quanliu, ding e shangjiao’) in 1987; ‘Tax-assignment system’ (‘Fen shui zhi’) in 1994. 24 The arrangements that followed this decision included the opening of ferry routes between Weihai in Shandong and Inchon in South Korea, and permission for Shandong provincial authorities to issue entry visas to South Korean businessmen upon their arrival in China. 25 The figure was obtained during the author’s interview with a senior officer in the Shandong Foreign Trade Commission in June 2001. 26 The largest FDI is the JV with Dawoo in spare parts for automobiles with a total investment of US$7.79 billion in 1996. 27 Shandong invested over RMB70 billion in highway building and 60 per cent of the money was raised from domestic and overseas banks between 1998 and 2000. The province also commercialised the road, by transferring the ownership and selling the managerial authority. For example, Hong Kong Tonggao Development Co. Ltd purchased 60 per cent of the managerial authority of Jinan–Taian Highway for RMB1.2 billion. The government also borrowed US$110 million from the World Bank to build the Jinan–Qingdao Highway (People’s Daily, 16 January 2001). 28 The listed companies include Qingdao Brewery, Xinhua Pharmaceutical, Huaneng Electricity, Jinan Qingqi, Chenming Paper Mill and Qingdao Double Stars. The initial fund was US$870 million in total. 29 Qingdao also targeted six SOEs: Hisense, Qingdao Brewery, Sifang Machinery Plant, No. 2 Rubber Plant, Tobacco Plant and Alkali Plant. 30 The industrial parks included Domestic Appliance, Consumer Electionics, Brewery, Rubber, Textile, Garment, Pharmaceutical, Construction materials and Shipbuilding. 31 The figures were obtained at the author’s interview with local officials in the Qingdao Economic Commission in January 2001. 32 In 1998, industrial collective firms accounted for about 53.5 per cent of the gross industrial output value of the non-state sector (Huang 2001). 3 The domestic appliance industry 1 The market shares of the six companies were: Electrolux Zanussi 25 per cent, Philips Bauknecht 13 per cent, Bosch-Siemens 12 per cent, Merloni-Indesit 10 per cent, Thomson 6 per cent and AEG 4 per cent (Ghoshal and Haspeslagh 1989). 2 According to Euromonitor (1999), Electrolux owned 19 per cent of the regional market; BSH is the second largest player with 15 per cent market share; Whirlpool has 6 per cent market share. 3 In 2002, BSH had about 20 per cent market share by value, Electrolux 17 per cent and Whirlpool 10 per cent with sales of US$2.3 billion (FT, 24 February 2002).

Notes 175 4 The figure was obtained from an internal consulting report (1998) in the Haier Group. 5 The sales are worth SEK133,150 million. The exchange rate against the US dollar is 9.72. 6 GDA has sales of about £600 million a year. It employs more than 5,000 people in several manufacturing sites in the UK, its main factories being in Peterborough, Kinmel Park (North Wales) and Blythe Bridge (Staffordshire). 7 GE set up a JV with Tianjin Kenai Refrigerator Company in the mid-1990s. 8 The author is extremely grateful to Mr Ginthum for allowing us to carry out an interview at the headquarters of BSH in March 2002. 9 From 1993 to 1996, the tariff for refrigerators decreased to 50 per cent, and for components and spare parts to 35 per cent. Entry to the WTO will mean a cut in tariffs on imported white goods to 12 per cent over five years. 10 During 1992–96, sixty joint ventures were set up with the contracted investment of US$3.17 million. 11 GE acquired Kenai in Tianjin, Samsung acquired Xiangxuehai in Suzhou, Whirlpool acquired Snowflake in Beijing, Bosch-Siemens acquired Yangzi in Anhui, and Electrolux acquired Zhongyi in Changsha. 12 The foreign-invested companies became major players in exporting. Their share of exports of electrical and mechanical products increased from 0.3 per cent (US$50 million) in 1985 to 60.3 per cent (US$46.2 billion) in 1999 (Liu 2000). 13 It is worth pointing out that Japanese companies shifted most of their production lines to China in the 1990s. Output of air-conditioner compressors in Japan has fallen from 4,500,000 units to 700,000 units. 4 The Haier Group 1 This section is based on Liu (1999: 359–69). 2 See Liu Haimin (2002) ‘Haier set up industrial park in Wuhan, Yu Zhengsheng request enterprises in Hubei to learn from Haier’, Xinhua Newsnet. Online. Available (accessed 19 March 2002). 3 Later, Zhang changed it to ‘We should have three eyes: one fixed on the market, one on the company and one on the world’. 4 According to my interview with senior management in Bosch-Siemens, Haier is one of the Chinese companies that are considered by most global giants as a ‘serious competitor’. 7 Conclusion 1 See Killick (1990: 28–32). 2 Between 1980 and 1991, the growth rates of SOEs, collectives and private companies were 7.8 per cent, 18.6 per cent and 140.6 per cent respectively; their output shares in 1992 were 48.4 per cent, 38.2 per cent and 6.7 per cent, respectively (SSB 1992: 34–6). The World Bank defined urban collectives as enterprises affiliated with municipalities, counties or districts, and argued that they suffered from the same problems as the SOEs – bureaucratic inertia, interference, inefficiency and lack of clear autonomy (World Bank 1993: 66). 3 Collective enterprises were quickly developed in the late 1980s. The share of collective enterprises’ industrial output rose to 39.3 per cent in 1997, from 30.3 per cent in 1978, in Shandong.

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184

Index

Index

aerospace industry 11, 15 after-sales service 109 air-conditioners 39; demand 79, 80; Haier 93; Hisense 135 allocative failures 3 anti-dumping customs duties 143 Aucma Group 89, 147–60, 170; background 147–50; business structure 156–8; challenges facing 153–9; diversification vs specialisation 153–4; domestic appliances and consumer electronics (1996–2000) 151; export capability 155–6; five-year plan 153; freezers 147, 150–1; GE 72, 154–5, 156; growth through diversification 150–3; history 147–8; IT sector and finance sector (2000 onwards) 152; local industrial policy 55, 56, 167; under Lu Qunsheng 148–50; management 156–8; organisational structure 157; ownership structure and government intervention 159; performance 149–50; prospects 159–60; technological capability 154–5 Aucma New Power Technology Company 152 Bank of China 119 banks/banking 119; and business groups in China 52; China’s industrial policy and credit 23; Germany 13 Beijing Snow Flake 135–6 benchmarking 114–15 benevolent social guardian state 163 big business groups 27, 52–3, 55 ‘Big projects’ strategy 55 black goods 94–5, 134–5, 151

brand image 154 Britain 10, 11–12 BSH Group (Bosch and Siemens) 73–5, 77 business department system: Aucma 156–8; Haier 103, 105, 114 business groups, big 27, 52–3, 55 business re-engineering 106–8 business structure: Aucma 156–8; Haier 102–8; Hisense 132 capital markets 3–4, 119–20 capital restriction 9–10 cartels 8 CDMA mobile phones 136–7 centralisation: vs decentralisation 30–2; Haier 106 Chang, Ha-Joon 5, 16 Changhong 134, 138 China Construction Telecommunication Company 95 China Light Industry Association Union (CLIAU) 40–1 China Unicom 137 China’s domestic appliance industry 77–89; competitive advantages 83–5; competitive disadvantages 86–8; competitiveness 33; exports 81–3, 84–5; history 77–9; nature of 46; production capacity 33, 79, 80–1; rapid growth 33–4, 88; supply and demand 79–81 China’s industrial policy 22–57; centralisation vs decentralisation 30–2; collective enterprise and 113–14; direct vs indirect control 24–5; in the domestic appliance industry 33–47; evaluation of policies in domestic appliance sector 43–7;

Index evolution of policies in the domestic appliance industry 34–43; first phase (1979–92) 34–9; import substitution vs export promotion 28–30; institutional changes 39–41; local see local industrial policy; policy instruments 22–3; restructuring and restriction (1985–92) 37–9; review of strategic changes 22–32; second phase (1992–2002) 39–43; sector specific vs firm specific 25–7; targeting (1979–85) 34–7 Chunlan Group 122 city champions 55, 56, 167 coastal open cities 49 collective enterprises 46, 91, 165–6; and the government 111–13; and industrial policy 113–14; ownership structure 121–2 colour televisions (CTVs) 128–9, 134, 135 communications sector 95, 136–7 competitive advantages 83–5 competitive disadvantages 86–8 computer industry see information technology (IT) sector concentration: China 80–1, 82; global business revolution 19, 64–7; USA 62 conglomerates 52–3 conservative management style 139–40 consumer electronics 94–5, 134–5, 151 consumer goods 26, 35; demand 36 consumer satisfaction 109 control, direct vs indirect 24–5 core components 86–7 corporate culture 108–10 cost control centres 103, 105 credit 3–4; China’s industrial policy 23 decentralisation 30–2, 166–7 ‘Decision on the Gist of Current Industrial Policy’ 24 defence industry 15 deliberate council 4 demand: China 79–80; global 60–1 Deng Xiaoping 92 developing countries 19, 19–20 development: economic 5, 164, 165; role of local government 50–1 Dicken, P. 18 digital technology 134–5 direct control 24–5 distribution systems 62, 63, 64

185

diversification: Aucma 150–3, 153–4; Haier 92–102, 118–19; Hisense 134–8; horizontal 94–7; vs specialisation 118–19, 153–4; vertical 92–4 division of labour, global 19 domestic appliance industry 58–89; China’s see China’s domestic appliance industry; global 58–77; global revolution of the industry 64–7; industry structure 61–4; leading global players and their investment activities in China 67–77; main features 58–9; supply and demand 60–1, 79–81 Dongfeng Electrical Engine Plant 90, 122 dynamic (‘creative’) failures 3 East Asia 2, 6–10; see also under individual countries economic development 5, 164, 165 economic development zones 49–50, 56 economies of scale 52, 59 economies of scope 59 effectiveness of industrial policy 164–5 electric fans 39, 45 Electrolux 62, 65, 67–9, 77, 120 Europe 62–3 European Union (EU) Regulations 83 export promotion: import substitution vs 28–30; Shandong Province 50 exports: Aucma’s export capability 155–6; China’s domestic appliance industry 81–3, 84–5; Haier 97–9; Hisense’s export capability 143–4 ‘Famous brands’ strategy 55 fans, electric 39, 45 feasibility of industrial policies 162–8 financial sector 12, 96, 152; see also banks/banking firm-oriented industrial policy 27 firms: impact of global business revolution on 19–20; nature of China’s domestic appliance industry 46; targeting 27, 42, 114 fiscal subsidy 23 five directions 35 Five-Year Plan system 24 fixed production base system 37 foreign currency exchange restrictions 121

186

Index

foreign direct investment (FDI) 42, 145; China’s domestic appliance industry 37–8, 78; China’s industrial policy 29–30; East Asia 9–10; influence on industrial development 169; leading global players and their investment in China 67–77; provincial government and 50; restriction 37–8 foreign firms: market share in China 83–4, 85; mergers with 145 ‘foreign leap forward’ policy 26 foreign partnerships 100, 115, 117–18, 140; see also joint ventures foreign technology, imported 36–8, 44–5 France 12–13 freezers 39; Aucma 147, 150–1; Haier 93 GE 61, 62, 65, 71–2, 77, 114; Aucma and 72, 154–5, 156 Germany 13–14, 97 Glanz 159 global business revolution 18–20; challenge of industrial policy 168–71; consequences and challenges 19–20; domestic appliance industry 64–7 global division of labour 19 global strategy 115–17 globalisation, debates on 16–20 globalists 17 government: collective enterprises and 111–13; role and globalisation 19–20 government-business dialogue 167 government failure 4–5, 16 government intervention 1–16, 162; Aucma 159; East Asia 6–10; and Haier 120–1; in a historical perspective 6–16; rationales for 3–5; the West 10–16 government resources, effective utilisation of 111–14 ‘Grasping the big and letting go the small’ strategy 27, 42, 114 Great Leap Forward 25, 34 Guiyang Huari Electrical Appliance Company 130 Haier America Trading 99–100 Haier CCT 95 Haier Economic and Business Consulting Company 125 Haier Electronic Appliance International Company 123–5

Haier Group 33, 80, 89, 90–126, 170; background 90–2; benchmarking and rapid innovation 114–15; business structure prior to 1995 102–3, 104; business structure 1995–98 103, 105; business structure from 1999 103–8; challenges facing 115–25; Consulting and Certification Centre 99; development of non-core businesses 94–7; diversification vs specialisation 118–19; effective utilisation of government resources 111–14; expansion 92–102; explanations of growth 108–15; exporting 97–9; global business network 100–1; global strategy 115–17; government intervention 120–1; growth of core business 92–4; Hisense and 146; internationalisation 97–102; local industrial policy and 55, 56, 167; market share in China 98; national champion 89; organisational structure 123, 124; output 97; overseas manufacturing 83, 99–101, 115; ownership structure 122–5; performance 98, 120; rent-seeking 168; resource management 119–20; strong leadership and corporate culture 108–10; technological innovation 117–18; ‘ten year plan’ of 1997 94 heavy industry 25–6; emphasis shifting to light industry 34–5 Held, D. 16–17 High Tech Economic Development Zone 56 high-technology sectors: Aucma 152; Haier 95, 118–19; Hisense 136–7; Western countries 11–12, 12, 14, 15 Hisense (Beijing) Appliances Company 135–6 Hisense Electrical Appliance Share Holding Company 130 Hisense Electrics Company 145 Hisense Group 89, 127–46, 170; background and history 127–34; business structure 132; challenges after China’s entry into WTO 142–5; communications sector 136–7; conservative management style 139–40; consumer electronics 134–5; diversification 134–8; domestic appliances 135–6; export capability 143–4; and Haier 146; Hisense

Index Technology Centre 141; IT sector 136; local industrial policy and 55, 56, 167; neo-state-owned enterprise 138–42; in the 1970s 127–8; in the 1980s 128–9; in the 1990s 129–33; organisational structure 130, 131; other businesses 137–8; ownership structure 144–5; performance 130, 133; production capacity 134; prospects 145–6; rush for expansion 142; state-mediated merger 138–9; technological innovation 140–2; TPI/TPM system 144; into the 21st century 133–4 Hisense Sumisho (Japan) Company 143–4 Hitachi 63 holding companies: Aucma 156–8; Haier 102–3, 104; Hisense 130, 131 horizontal diversification 94–7 Hu Jintao 171 human resources 120 ideology 5, 164–5 import restriction 8–9; production lines 37–8 import substitution 28–30 imported technology 36–8, 44–5, 113, 115 independent economy 51 indirect control 24–5 industrial parks 55; Aucma 151; Haier 92, 102, 113; Hisense 133–4 industrial policies 161–71; challenge of in the epoch of global business revolution 168–71; China’s see China’s industrial policy; defining 6; East Asia 6–10; effectiveness of 164–5; feasibility of 162–8; historical perspective 6–16; institutional capability 163–4; local see local industrial policy; market-oriented 162–3; ownership structure 165–6; the West 10–16 Industrial Reorganisation Corporation (IRC) (Britain) 11 industry structure 61–4; restructuring see restructuring infant industry protection 13, 169–70 information argument 4 information system 108 information technology (IT) sector: Aucma 152; Haier 95; Hisense 136; Western countries 11–12, 14

187

Information Technology Development Fund 26 Institut de Développement Industriel (IDI) (France) 12–13 institutional capability 44–6, 163–4 institutional failure 45 institutional structure 39–41 international organisations 17 investment: FDI see foreign direct investment; prohibition list 42–3; Shandong Province 50–1 Japan 2, 4, 168; domestic appliance industry 63–4; industrial policy 6–10, 163–4, 167; management 114 Jiang Zemin 32, 113–14 joint ventures 86–7; Aucma 154–5, 156; Haier 93, 94–5, 95, 96, 99; Hisense 142, 143–4 Konka 134, 138 Korea, South 2, 4, 49, 168; industrial policy 6–10, 163–4, 167 Lamb, R. 163 Latin America 169 leadership: Aucma 148–50; Haier 108–10; see also management leading global players 65–7, 116; and their investment activities in China 67–77 Li Dezhen 129 Liaoning Jinfeng Group 130, 139 light industry 25–6; targeting 34–7 Little Prodigy 109 Little Swan 86, 125 local brands 91 local government 163; and collective enterprises 111–13; developmental role 50–1; economic decentralisation 30–2, 36; and Haier 101–2, 112–13; intervention 46–7; see also local industrial policy local industrial policy 56–7, 163; model of 166–8; Qingdao City see Qingdao City; Shandong Province 47–56 local protectionism 31–2 loss-making orders 116 loss-making enterprises 53–4 Lu Qunsheng 148, 148–50, 154, 155, 156 Lucent (Qingdao) Technologies Company 136

188

Index

machinery export promotion strategy 28, 30 management: Aucma 156–8; Haier 108–10; Hisense 139–40 Mao Zedong 25, 32 ‘marching out’ strategy 28–9, 43, 83, 99 market chain strategy 106 market failure 2, 3–4, 16 market-friendly view 2 market-oriented industrial policies 162–3 market share 83–4, 85; Aucma’s domestic market share for freezers 151; Haier’s market share in China 98 Marxism 18 material supply 87–8 Matsushita 63, 75–6, 77, 128 Maytag 61, 62, 65, 72–3 McGrew, A. 16–17 medical technologies 15 mergers and acquisitions 146; Electrolux 67; France 12; Haier 93–4, 95, 96–7, 101–2, 113; Hisense 129–30, 138–9; Japan 8; state-mediated mergers 52–3, 138–9; USA 62; Whirlpool 69 Merloni Company 38 minimalist state 1–2 Ministry of Defence Industry 46 Ministry of Heavy Industry 46 Ministry of Light Industry (MLI) 39–40, 41; evaluation of policies 43–7; restructuring and restriction 37–8; targeting light industry 34–5 Mitsubishi 63 Mitsubishi Heavy Industries Haier (Qingdao) Air Conditioners 93 motivation 110, 140 multi-domestic strategy 117 national champions 12; China 42, 44, 56, 89, 167 national debt 23 nationalisation 11, 122 neo-state-owned enterprise 138–42 neoclassical view 1–2, 162, 165 newly industrialised countries (NICs) 2 non-tariff barriers 9 nurturing 7–8, 56; see also subsidies OEC method 109–10, 114 organisational structure: Aucma 157; Haier 123, 124; Hisense 130, 131

‘Outline of the Nation’s Industrial Policies in the 1990s’ 24–5 outsourcing 62, 159–60 overcapacity 80–1 overseas listing 125 overseas manufacturing 83, 99–101, 115 overseas penetration 28–30, 113–14 ownership diversification 54 ownership structure 46, 122–5; Aucma 159; collective enterprises 121–2; feasibility of industrial policy 165–6; Haier 122–5; Hisense 144–5 pan-European electronic trading venture 66 partnerships, foreign 100, 115, 117–18, 140; see also joint ventures Patrick, H. 6 Pharmacy King of the Qing Dynasty 140 pillar industries 26, 41–2, 51, 55–6 policy-related loans 23 political ideology 5, 164–5 prediction 45 private enterprises 46, 165–6 process-orientated approach 18 product general business departments 106, 107 product innovation 59 production, concentration of 19 production capacity 33, 79, 80–1; Hisense 134 profit centres 103, 105 promoting general business departments 106, 107 property business 137 protection: East Asia 8–10; Germany 13, 14; infant industry 13, 169–70; local protectionism 31–2 provinces 30; see also local government, local industrial policy provincial champions 52–3 Provincial Foreign Trade Development Fund 50 public choice theory 4, 163 public enterprises see collective enterprises public goods 2 publicity 114 Qingdao Aucma Electric Product Company 148 Qingdao Aucma Share Holding Company 159

Index Qingdao Brewery Group 55, 167 Qingdao Camera Company 139 Qingdao City 49, 54–6, 166, 167–8; Aucma 159; Haier 112–13, 121, 168; Hisense 145 Qingdao Daily-Use Electrical Product Plant 90–1, 123 Qingdao Electric Instrument Corporation 137 Qingdao Electrical Motor Plant 90, 122 Qingdao General Refrigerator Factory 91–2, 123 Qingdao General Television Factory 128–9 Qingdao Haier Company 123 Qingdao Haier Share Holding Company 119, 123 Qingdao Number Two Radio Factory 127–8 Qingdao Red Star Electric Appliance Company 93, 147 Qingdao Second Light Handcrafts Industry Association 122, 123 quality certificates 99 realism 18 recession cartels 8 refrigerators 38, 39, 43, 77–8; evaluation of industrial policies 44, 45; Haier 91–2, 109; Hisense 135–6 regulations 121 rent-seeking theory 4, 167–8 research and development 27; Aucma 154–5; Haier 118; Hisense 140–2 resistance to change 110 resource management 119–20 restructuring 37–8, 78; Shandong Province 53–4; shift from heavy to light industry 34–6 revisionist view 2 rice cookers 39 Rongshida 122, 125, 135 Sanyo 63, 100, 135 scale, economies of 52, 59 sceptics 17–18 Schröder, G. 13 scope, economies of 59 Second Light Handcrafts Industry Association 122, 123 sector-oriented industrial policy 25–6 selective intervention 2 service sector: Aucma 152; Haier 96, 119; Hisense 137–8

189

Shandong Province 47–56; developmental role of provincial government 50–1; economic data 48; industrial policies 51–4; Qingdao City see Qingdao City; relationship with central government 48–50 ‘sharing specific revenues’ system 49 Sharp 63 shipbuilding 14 signalling 7, 41–2 six national-level experimental enterprises 27, 114 ‘6S’ shoe-print approach 110 ‘six priorities’ policy 26, 35 six transforms 35 socialist market economy 25 South Africa 143 space sector 15 specialisation vs diversification 118–19, 153–4 state see government, government intervention State Council 39, 40 State Economic and Trade Commission (SETC) 40, 41 state-mediated mergers 52–3, 138–9 state-owned enterprises (SOEs) see collective enterprises steel industry: Britain 11; China 88 Stiglitz, J. 3 stock market listing 23, 51; Aucma 152, 159; Haier 95; Hisense 130 strategic alliances 100, 115, 117–18, 140; see also joint ventures strategic business units 106–8, 114–15 subcontracting 62, 159–60 subsidies 7–8, 11, 13, 23 Sumisho Corporation 143–4 supply: China 80–1; global industry 61 Taiwan 6–10 targeting: East Asia 6–7; firms 27, 42, 114; sectors 26, 34–7, 41–2, 43, 51, 55–6 tariffs 9, 13; China 29, 78 taxation: collective enterprises 111; luxury goods 128–9; tax concessions 13–14, 139; tax-sharing system 49 TCL Company 134, 138, 145 technology: competitive disadvantages 86; globalisation and technological change 18; Haier and technological innovation 117–18; Hisense and technological innovation 140–2;

190

Index

imported 36–8, 44–5, 113, 115; technical progress in domestic appliance industry 58–9; technological capability of Aucma 154–5; technological upgrading 23, 53–4 telecommunications sector 95, 136–7 televisions 127–30, 134, 135 Toshiba 63 Total Quality Management 114, 149 township and village enterprises (TVEs) 166 TPI/TPM system 144 trade: import substitution vs export promotion 28–30; see also exports trade barriers 8–9, 143; tariffs 9, 13, 29, 78 transnational corporations (TNCs) 18, 19, 169; see also foreign direct investment Tsingdao Haier Group 92 Tsingdao Haier Merloni Company 93 United States of America (USA) 170–1; domestic appliance industry 61–2; Haier and 99–100, 116; industrial policy 10, 14–16 vertical diversification 92–4 washing machines 38, 39, 45; Haier 90–1, 93, 109 Welch, Jack 114 welfare economics school 164

Western countries 10–16; see also under individual names Whirlpool 62, 65, 69–71, 135 World Bank 2, 166 world economy 19; see also globalisation World Trade Organisation (WTO) 57, 88–9, 120–1, 165, 168–9; challenges for Hisense after China’s entry to 142–5; impact of entry on China’s exports 83; motives for joining 169 Wu Bangguo 147 Yantai 49 Yellow Mountain Electrics Group 95, 110 Yellow Sea Freezer Factory 147–8 Yu Zhengsheng 92, 93, 112–13 Zha Nuxi-Aucma Refrigeration Equipment Company 154 Zhang Ruimin 91–2, 101–2, 114, 125–6, 167; consumer preferences 118; expansion of Haier 92, 94, 96; human resources 120; and industrial policy 113; information system 108; internationalisation 98, 100; and local government 112; strong leadership 108–10, 111 Zhou Houjian 129, 133, 134, 167; ownership structure 144; ‘red capitalist’ 130; technological innovation 140, 141, 142 Zibo Hisense Electric Company 129–30