Harnessing China

After four weeks of travel in China, I cannot claim to have become an expert on its chemical industry. But even short visits to a few Chinese chemical producers yielded some insights into their competitive strengths and weaknesses.

Chinese costs, including managers' salaries, are very low. Made-in-China equipment, including production vessels, is extremely cheap. Chinese companies are not particularly proficient at managing continuous processes such as those of the petrochemical industry, but they can very competitively produce a wide range of fine and specialty chemicals.

Some producers of fine and specialty chemicals based outside China see Chinese producers as a threat. But viewed from up close, Chinese chemical companies are not very threatening. Several fine chemicals producers I visited have sales of less than $5 million per year. Firms this small find it difficult to import foreign-made instruments that could raise product quality or enhance R&D capabilities.

Most companies that I saw don't have enough cash to set up sales offices in foreign countries. The salaries of Chinese scientists are low, but without firsthand knowledge of global market trends, their managers cannot tell them what products to develop.

One reason for the lack of money is the difficulty that emerging Chinese companies face in raising capital. Chinese banks lend to state-owned companies when instructed to do so by the government. But fast-growing private firms cannot get bank loans.

Listing on a stock market in China is certainly possible, but usually only for companies that already enjoy tens of millions of dollars in annual sales. Several managers of small companies told me they were financing the growth of their operations solely by reinvesting profits. It works, but it's a tough way to go at it.

There are other problems. Knowledge of how to effectively manage safety seemed to be lacking at most facilities. It was a rare event to see a lab or quality control technician wearing safety glasses when handling chemicals. At one plant in Chongqing, workers without any protection stood next to heavy equipment in motion.

At a Sinopec (China Petroleum & Chemical Corp.) petrochemical complex in Nanjing, I saw a motorcycle that had just been hit hard by a truck at an intersection. In developed countries, vehicles must drive extremely slowly in chemical complexes to reduce the risk of accidents.

Yet companies from rich countries and from China complement each other in many ways. Chinese chemical firms can supply chemicals at very competitive prices. They can also provide immediate access to China, the world's fastest growing market for many chemicals.

Firms from rich countries have money, global market knowledge, and access to sophisticated financial markets for funding. They also have superior management in the areas of safety, environmental control, and continuous production processes. Their research labs are equipped with the most advanced instruments. Finally, rich countries' companies are far more able than Chinese firms to set up the kind of customer service infrastructure that is often essential to success in specialty chemicals.

Foreign companies are responding to competition from China in two ways. One is sourcing from China, which allows Chinese firms to focus on what they do best without compromising the foreign companies' strengths in other areas. With the cost savings from manufacturing in China, foreign firms can strengthen their R&D and customer service, perhaps offsetting jobs lost if plants are closed.

Another way foreign companies can benefit from China is to set up production facilities there. Shifting production to a developing country like China, where the legal system is weak, is fraught with difficulties. But the differences in costs can be compelling.

A riskier strategy is buying out the Chinese competition. According to Hardy W. Chan, executive vice president of Taiwan-based pharmaceutical ingredients producer ScinoPharm, there is no way to prevent the founders of an acquired Chinese company from starting up another firm in exactly the same field. He adds that major companies may also find that the health, safety, and environmental practices of potential acquisition targets do not meet their standards.

Before China joined the World Trade Organization in December 2001, many commentators, including me, wondered how Chinese companies could possibly survive the onslaught of foreign competition once trade barriers went down. Later, the question became, How can companies in the rest of the world survive Chinese competition? The truth is in between: China may be competitive in manufacturing, but companies from rich countries still hold the aces.

As they continue to grow, many Chinese chemical producers will eventually get big enough to list themselves on Chinese or foreign stock markets and to set up a global sales network. Some fine chemicals producers located on China's coast are reaching that point already. Before their Chinese competitors get too big, chemical companies around the world have a window of opportunity to co-opt China's strengths in manufacturing to their own advantage.