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Globality: Harold L. Sirkin

Manufacturers: Rethink Your Bond with China

The U.S. and Chinese economies have been growing closer. Now it's time to decide: Do we drift into common-law marriage, get engaged and make plans for a permanent relationship, or just continue dating?

A little over a year ago, I met with the CEO of a $15 billion (sales) U.S. manufacturer who thought he was in fat city because 95% of his low-cost production and sourcing was from China. Though aware of certain risks, he was confident of his company's business plan and prospects.

I met again with this CEO toward the end of last year, and he was piping a different tune. His almost exclusive reliance on China had led to big problems. His customers had cut their orders in half, were asking for smaller lots, and wanted the products they were buying to be tailored to their specific needs. With production facilities half a world away and six months of inventory already in the pipeline, it was impossible for him to change course quickly.

This created a huge headache. He had massive amounts of his own capital and debt capacity tied up in his inventory. And he had little leverage: If he didn't give his customers what they were now demanding, he would risk losing their business altogether.

This scenario is all too common these days and underscores a tough decision many Western companies now face: Should they tie their futures to China, or should they rethink the relationship?

Decoupling Disappointment

There was a time last year (when the tea leaves pointed to but hadn't yet confirmed recession) that the U.S. and international business communities were still all abuzz about "decoupling." The long and short of this fantasy was that the powerful U.S. economy could slow down, even dip into recession, but that the rest of the world—driven by China, India, and other rapidly developing economies—would continue to hold its own.

How far removed from reality this seems today.

The fact that the economies of the U.S,, European Union, Japan, and Britain, among others, sank into recession virtually in tandem last year shows the world's major economies are more tightly coupled than ever. When one country sneezes, everybody needs to reach for the tissue box.

This is especially true of the U.S. and China. Prior to the recession, China's economy was booming, growing at an astounding 13% annual rate in 2007, according to the Chinese Bureau of National Statistics. But last year growth slipped to 9%, the lowest rate in seven years, falling in the fourth quarter to just 6.8%. Now even the World Bank's most recent forecast of 7.5% growth this year for the Chinese economy (made in November) seems wildly optimistic.

China will do what it can, of course, to maintain necessary growth. It's speeding up planned infrastructure projects, for example, and recently announced a $600 billion economic stimulus plan. But it will be a struggle to make up for the dramatic decline in demand for consumer and industrial goods from top trading partners hard hit by recession.

Despite the tough times we're experiencing, the U.S. business community's enthusiasm for the world's most populous nation remains unshaken. For example, a survey released in mid-December 2008 by the 4,000-member American Chamber of Commerce in Shanghai indicated that "China remained a bright spot for U.S. companies in 2008," with 78% of respondents expecting increased revenues over 2007. More than 70% of respondents reported achieving profitable operations, 77% of those realizing increased profits, and 60% said that "accessing China's domestic market" was the top priority for their company. In our frequent conversations with Chinese and American CEOs, we hear these sentiments over and over.

What is most significant about the China-U.S. relationship isn't the amount of trade between the two countries. It's that countless American companies are now doing business in China, and dozens of Chinese companies are making plans to do business here in the U.S. The U.S. firms are not just manufacturing in China or sourcing from China but have long-term business plans that recognize a significant portion of their future business will come from China's burgeoning middle class.

Undeniably a Couple

For similar reasons, Chinese companies are establishing beachheads in the U.S. BYD, for example, the Chinese battery maker (which Boston Consulting Group has spotlighted in recent Global Challengers reports), was all the talk of the recent North American International Auto Show in Detroit, where its subsidiary, BYD Auto, showcased a prototype electric car it hopes to introduce in the U.S. in two or three years. Yes, the recession may have caused things to slow down, but it doesn't change the fact that in the pantheon of nations, the U.S. and China have become a couple.

But there is a big difference between mutually beneficial economic relationships, involving large numbers of individual companies, and marriage, even a marriage of convenience. U.S. business and political leaders now have to decide whether it's in their interest to tie the knot with China. And this should give them pause, because such a relationship should never happen by default or without careful thought. Just as some people would argue for mandatory premarriage counseling, we need to stop, slow down, talk, and think this through. If we decide to move forward, we need to agree on the terms.

Marriage may not be in our national interest. And even if we decide it is, it won't be right for every company in every case. Some companies might be wise to consider other options. Maybe a more open relationship would be beneficial, with some companies outsourcing to China and other low-cost locations closer to home. Exclusive China sourcing, for example, can be a risky proposition at times; just ask the CEO I mentioned at the beginning of this article.

Companies need to create a more balanced portfolio of manufacturing facilities properly aligned with where they are and where their customers are to help set the right risk-benefit balance. While China is critical for the future competitiveness of many companies, it's not the only low-cost option. There are good reasons for some companies to do certain things here at home—or in India or Brazil, or close to home, in Mexico, for example.

What should company managers and executives do to find the proper balance?

1) First, as they say in football, go long. Look beyond the recession and your current or pre-recession customer base to where you want to be five and 10 years from now. Have you overweighted China and underweighted others? Are there reasons to have additional capabilities closer to home? Or should your operations be even more closely aligned with China?

2) Understand your options. China has many advantages. But it also has some disadvantages. You need to strike a balance between cost (advantage China), quality (not always so), capabilities (they're getting better, but not up to U.S. standards yet in many cases), and risk (don't forget the long and sometimes unpredictable China-U.S. supply chain).

3) Make a choice after careful consideration, and set the terms of engagement. The decision to source from or manufacture in low-cost China, or in slightly higher-cost but closer Mexico, or in Kansas or South Carolina or anywhere else, should be made carefully and deliberately. No company should wed itself to China or any other locale by default.

4) Reset your footprint. Perhaps you'll decide to manufacture all of your products in China. Perhaps only some of them will be made there—maybe only those intended for the Asian market. After you make your decision, you will have to recalibrate your operations; people and resources will have to be shifted. Additional commitments will have to be made. A decision without action leads nowhere.

An economic relationship, like any relationship, should be entered into by conscious and conscientious choice, not because the two parties found it convenient to get together and suddenly find themselves at the point of no return.

If we're getting married to China, we should fully understand the consequences and do it with open eyes.

Harold L. Sirkin is a Chicago-based senior partner of The Boston Consulting Group and author, with James W. Hemerling and Arindam K. Bhattacharya, of GLOBALITY: Competing with Everyone from Everywhere for Everything (Business Plus, June, 2008).

Harold L. Sirkin is a Chicago-based senior partner of The Boston Consulting Group (BCG), a professor at Northwestern University’s Kellogg School of Management, and co-author, most recently, of The U.S. Manufacturing Renaissance: How Shifting Global Economics Are Creating an American Comeback (Knowledge@Wharton, November 2012).

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