Emerging Markets: A China Perspective
By Andreas Limbert, Bishop & Associates Inc.

Working in China as a management consultant to the connector industry during the current economic crisis has been an illuminating experience. Our industry is clearly at a crossroads, and the decisions we make now will shape our work for years to come.

To begin with, let me put some figures in perspective. Worldwide connector sales for calendar year 2008 totaled US$43.976 million, with $7.629 million, or 17.35 percent coming out of China. The latest forecast of the worldwide connector market for 2009 anticipates sales of only $32.983 million, representing a 25 percent market contraction. For China, projected 2009 sales are expected to reach $6,485 million. Compared to $7,629.20 million for 2008, this represents a drop of 15 percent. North American sales are projected to drop by 25 percent, Europe by 33 percent, Japan by 30 percent, and Asia Pacific by 20 percent, adding up to a 25 percent drop in sales across the industry.

How do such numbers translate into the daily business experience for a small to mid-sized company? You may expect a disconnect from global trends, as individual companies serve specific markets and customers, and carry unique products. However, in my observations, it is almost astonishing how much individual businesses are in sync with such global developments. You may see a time delay or a different scale, but the pattern remains very similar.

In the second half of 2008, the connector industry in the U.S. had already experienced the downturn, while China and Europe still hoped that the impact would not be so severe in their areas. Order intake in China had slowed, but not dramatically, and the backlog was substantial. The industry was heading for a record sales year in 2008. The last quarter would not change this perception. Those who visited the electronica fair in Munich, Germany, last year noticed the difference in confidence for the year 2009. While U.S. manufacturers talked about severe shrinkage, European and Asian manufacturers were still confident in growth. But just a few weeks later, the crisis struck both continents in the form of a very steep drop in orders. Order intake collapsed by 85 percent over the prior year. In January and February 2009, it became obvious that this was not a short-term event, in fact, these low order levels would stay with us for a while. Basically, there was no demand from the market, and in the supply chain, there was still too much material.

What has caused this situation? Allow me a simplified summary. The origin of the crisis rests in the economic principle of permanent growth. When the natural demand did not support the expected growth, such as in 2001-2002, governments stimulated the economy by lowering credit rates. The demand for goods and services increased, but at the same time, the low interest rates pushed up prices. Once the amount of debt had exceeded the related collateral, the finance sector collapsed, affecting industry and consumers, first with high-investment items, and later, reaching all products and services, and consequently severely slowing down the economy. Unlike in 2001-2002, lowering the interest rate is not a workable option to jumpstart the economy this time, as the banks have to bring the debt value below the collateral value, and they will hesitate to issue new credits. This situation forces governments to stimulate the economy by direct investments via stimulus packages. This type of economic situation will not bring about changes quickly.

Why does China have an advantage in this situation? China’s government controls and decides the value of its funded projects in industry, real estate, and infrastructure. There has been a lot of speculation about the potentially huge bad debt in China. Until something new is publicly announced, the balance sheets of Chinese banks remain clean. For the time being, this principle works well and the rest of the world appreciates the stabilizing effect.

But here’s the current reality: The collapse of business came so suddenly we were practically unprepared. Within weeks we saw companies around us closing the doors. Some had enough time for a procedural closure, while some other overseas companies simply closed their doors overnight and the management secretly left the country. In South China alone, more than 60,000 factories were closed and unofficially 10 million people lost their jobs. The atmosphere became tense and discouraging. The media talked about workers who took matters into their own hands, storming factories to take whatever they could get, or just to air their frustration.

In my position as a manufacturing consultant, the management and I knew that we had to immediately take drastic actions in order to keep the company alive. We also had to give the staff confidence that we would be able to overcome the crisis and, that in this case, their interests would be secured. Costs had to be reduced to the lowest possible levels while maintaining all critical business functions. Still, in the preparation process, it became obvious that the achievable cost levels would not allow the company to survive such a downturn for a longer period of time. Tensions among managers and shareholders grew high, worst cases had to be considered, and legal advice had to be sought. Banks did not offer support to fill the cash-flow gaps. The only hope was that business would finally return to acceptable levels, but this was not enough as a supporting argument. Even the shareholders doubted whether injecting capital or securing credit lines was the right thing to do.

Concentrating on cost-reduction efforts, we had to address the headcount. In a country where labor costs are extremely low, labor-intensive processes are the right choice. The minimum salary of factory operators has hardly changed over the last 15 years and remains very low, at about $150 USD per month. The wages have stayed at this level because the vast number of employable people in China has never created a situation where demand would exceed supply, therefore putting pressure on salaries. Consequently, companies in China tend to have far larger numbers of employees in ratio to their turnover then companies would have in Europe or the U.S. It’s quite common for a mid-sized factory to have 2,000 to 4,000 employees. With such large numbers of staff and no orders on hand, headcount reduction becomes a must, despite the low salary levels. Headcounts for administrative and managerial staff had to be reduced as well, as those salaries had increased significantly over the past year, particularly in the wider Guangzhou, Shanghai, and Beijing areas.

Before 2008, production capacity was easily adjusted by changes to the headcount. Until then, it was common practice to have staff employed under fixed-term contracts. With the expiration of the contract, the company could release the employee with no further obligation. With the new labor law, which China declared effective in January 2008, the interests of the employees are much more protected. Under the new rules, it is in principle not possible for a company to terminate an employee, unless the employee is in material breach with their contract. Non-performance of the employee does not justify termination under most circumstances. The new law allows an employee to enter into only two consecutive, fixed-term contracts before the employment becomes open-ended. If the employer does not want to enter into a new agreement after the expiration of the contract, the employee is entitled to severance payment of one month’s salary for each year of employment, or part thereof.

The new law holds a provision to give businesses some means to react to difficult business circumstances. If evidence of continuous serious difficulties is provided, a company is only then permitted to reduce the staff by a minimum of 20. The requirements in regard to compensation are not affected. If a fixed-term contract is prematurely terminated, the salary has to be paid out for the remaining term of the contract. To utilize such provisions, staff and authorities have to be informed 30 days in advance.

In the companies I supported, we tried to avoid the complex and unpleasant process of terminating a substantial number of staff by offering the staff an alternative choice. If the staff had been willing to accept a significant reduction in salary for the period of the economic downturn, the company would refrain from terminating them. In the initial vote, almost all staff supported this approach. However, such an arrangement requires an amendment to the individual employment contracts, and each employee needed to sign and accept the change. At this stage, about 50 percent of the staff rejected the proposal, leaving the company with no other choice than to implement a headcount reduction.

Management and I proceeded, in close coordination with the assigned Labor Bureau, to avoid any potential, future legal implications or employee protest. With substantial mandatory and voluntary payouts significantly draining the cash flow, we had all cost-saving actions implemented by the end of Q109, without adverse staff reactions.

With the headcount reduced by 50 percent, and many other stringent cost-saving measures in place, it started to become difficult to properly execute the required standard business processes. Despite very low business levels, the on-time delivery performance started to deteriorate. This effect was amplified as the performance of suppliers also noticeably weakened. In the consolidation process and closure of numerous factories, companies had difficulties delivering products or providing the necessary support and customer service. With the beginning of Q2, matters became even more challenging. With an empty supply chain, customers unexpectedly placed orders requiring immediate delivery. With little to no stock of raw material in the warehouse and with reduced manufacturing capacity, it was not possible to fulfill such expectations. This struggle was the first indicator that business would return. By mid-Q2, business had reached sustainable levels. The fact that those levels were still significantly below 2008 did not and does not really matter.

What drove the business recovery in China? The strongest initial driver was the domestic market. With a $500 billion government stimulus package, industry and consumers fairly quickly regained confidence. Sales of new cars grew during the year 2008, and continued to do so in 2009. The automotive market in China became the largest in the world during Q109, bypassing U.S. automotive sales. Other domestic markets in China also rebounded quite rapidly. The government had committed, as part of its stimulus package, to upgrade the healthcare system, bringing advanced diagnostic equipment within the reach of all citizens. Particularly, domestic healthcare equipment makers grew over-proportionally and offered connector companies new opportunities. The enormous government investments in the railroad infrastructure brought good business to the related rolling stock and signaling industries. At the beginning of 2009, the government had committed to build 35 new high-speed train-links with speeds between 200 km/h and 350 km/h (125 mph–215 mph). Multinational companies were winners of such projects; however, a requirement is that almost all of these trains are being built in China, creating work and transferring technology. With the world economy stabilizing, the export business of China regained strength and growth. Even so, most indicators say, it will be a long and slow road to recovery in the established industrial countries.

What does this all mean for the connector industry? There is little doubt that the China connector industry will be the winner of the 2008-09 financial crisis in a global comparison. China offers substantial natural growth opportunities for a number of decades to come. This is recognized by most multinational companies who had drastically reduced their available production capacity. These companies have done so, preferably outside of China, and used the downturn to strengthen their position in China. They have expanded their capabilities in engineering and product development and brought the last missing technologies for high-quality and leading-edge connectivity to China.

Small and midsize connector companies will also find opportunities in China. Building strong engineering capabilities to serve the demanding market for specialized and customized products will give them the competitive edge. As the market in China is so attractive, you need to be aware that all of your competitors will also be in China and you may even face new competitors—the domestic companies. While local Chinese companies have normally focused on cost leadership with me-too products, they have now started to concentrate on technology and quality. With their incredible drive, these companies will challenge any multinational company. To manage such challenges, some foreign CEOs are considering relocating their offices to China in order to be in the place where the future will be shaped. Today, the country of opportunity and growth is China.

Andreas Limbert Managing Director, Asia Pacific-Hong Kong, Bishop & Associates Inc. Andreas Limbert has held key management positions and worked on diverse engineering projects throughout Europe, the Middle East, and Asia for more than 20 years. He has helped lead numerous team projects and international companies to financial success. Limbert’s expertise in China includes a China-based sales and manufacturing structure he established and managed for Thyssen Elevators, the fourth-largest elevator manufacturer in the world. He also established and managed a Asia Pacific regional sales, service, and manufacturing organization for connector manufacturer HARTING KGaA. Since 2004, Limbert has been a management consultant with FaberConsult, which helps global companies establish and perform operations in Asia, particularly in China. In this capacity, he also represents Bishop & Associate Inc. Limbert has a post-graduate engineering degree in mechanical engineering from the Technische Hochschule of Karlsruhe in Germany.