China's family firms test home market By Benjamin A Shobert
WENZHOU, China - What their business does is simple enough: it assembles many
of the hairbrushes, bathroom scrubbers, and floor mops ubiquitous in the West
and which few pause to wonder where the products come from or who makes them.
But in many ways, the family that owns this company embodies the Chinese dream.
As owners of a small manufacturing business they started over 10 years ago,
they have seen their standard of living improve every year. Before their
business began, the family eked out survival as shopkeepers. Limited savings
meant they got started on the simplest of products which required the smallest
of capital investments, a small scrub brush. Now, their business occupies three
floors of a modern factory, with equipment capable
of complex molding, assembly and fabrication.
A meeting during a trade show several years ago led them to become one of
Wal-Mart's many Chinese suppliers. In concert with the growing demands put on
them by Wal-Mart and their other North American customers, the family invested
in new capacity. During peak production times, the company employs
approximately 200 employees, most of whom are rural migrants from China's
interior.
The family's two sons have recently returned to the business after completing
university education, with aspirations to see the business develop its own
portfolio of branded products for sale within the domestic Chinese market. From
anyone's perspective, they are the essence of China's success: entrepreneurs
who came from nothing to build a business which employs fellow nationals,
ongoing investments in industrial technology, all while they take good care of
demanding customers.
Up until the last quarter of 2008, the business had grown consistently, largely
reliant on exports. But with the global slowdown, this small company in
Wenzhou, Zhejiang province, may not have access to the capital it needs in
order to survive. At a minimum, it is unlikely it will be able to make the
transition from being a captive export manufacturer to a stand-alone business
with its own brand and distribution channels inside its home markets. But worst
case is that the slowdown in orders and credit freeze will cause this family to
shutter the factory and lose everything it has built, forcing it not only to
begin again, but to question what part of the original dream is worth keeping.
It is not alone in this struggle: the National Development and Reform
Commission estimates that the first half of 2008 was marked by the closure of
more than 67,000 small and medium-sized enterprises (SMEs). Chen Naixing,
Director of the Research Center for SMEs at the Chinese Academy of Social
Sciences, has stated that the first half of 2008 saw a 50% reduction in the
number of SMEs specializing in the manufacturing of eyeglasses, shoes and
lighters. It can be easy to trivialize these losses, since many of the
companies in question are very low tech manufacturers of goods with high labor
content and little in the way of value added. In many cases, these are the
types of jobs Beijing is happy to see either move further West within China or
leave the country entirely.
Because the SME sector is highly fragmented and historically transitory their
economic, social and political influence can be easy to overlook. China
officially recognizes five SME sectors: industrial, construction, retail,
transportation and hotels/restaurants. To fit within this official designation,
sales must range from 30 million yuan (US$4.4 million) to 400 million yuan and
employment from 500 to 3,000 (certain sectors have revenue or employment limits
within these ranges). About 95% of the estimated 4.32 million SMEs in China are
privately owned by 38 million businesspeople.
Yet SMEs account for more than 68% of China's exports and 75% of the new jobs
created within China every year. And while it might be easy to only see the
immediate economic influence of SMEs, according to the Chinese government, they
also account for more than 65% of China's patents, which suggests they are
pivotal as the country begins to emphasize innovation over low-cost
manufacturing.
Cumulatively, the difficulties SMEs are facing have an obvious negative
economic impact, but they also have a corrosive effect on the hope embodied in
China's growing entrepreneurial class. After years of seeing their businesses
grow, and learning how to participate in China's somewhat convoluted
relationship between business and government, these company owners are now
looking for help from Beijing in order to keep their dream alive.
Their frustrations are, at times, compounded by a cynicism that if only they
were better connected to the Communist Party they might have an easier time
finding capital. When critics of China's rapid ascent look for potential
sources of instability, many have believed political tension was most likely to
come from the countryside and disaffected peasants. And while SME owners are
unlikely to take to the streets any time soon, Beijing is becoming increasingly
aware that the owners of SMEs represent the foundation of China's economic
renaissance, and as such, need to be supported during this critical time.
Regardless of time or place, credit for entrepreneurs has always been
problematic, and in many ways the SME's lack of access to capital from within
China's banking system is not unique. What makes China's SME banking needs
different is that these small companies must compete with state-owned
enterprises (SOEs) that are slowing their moves towards privatization and
shouldering others aside in their demand for bank credit.
In China, as in any country that privatizes formerly government-owned assets,
the implicit understanding on the part of banks is that the Chinese government
stands behind the credit needs of the SOEs. Banks need not be overly predatory
to see the risk of a newly formed SME, which may better embody the
entrepreneurial spirit the financial system normally wishes to reward, as
greater than a SOE whose ongoing operation and cash flow has the weight of
government behind it.
Consequently, banks in China have reluctantly - and, from the vantage point of
most SMEs, expensively - extended credit to the SME sector. In addition and
perhaps understandably, banks' desire to process fewer transactions with larger
values has meant the underlying commercial needs of most SMEs continue to be
overlooked. But Beijing is not wholly insensitive to the needs of its SMEs.
During the late 1990s, China made an effort to develop a network of loan
guarantee agencies, which by now number around 2,000. Late last December,
Minister of Industry and Information Technology Li Yizhong announced that the
SME loan guarantee business was expected to reach US$146 billion in 2009, and
that the government was introducing tax cuts and other incentives to banks
specializing in the SME sector with the hopes that such moves would help SMEs
find and access the capital necessary for their businesses to continue
operating and expanding. Additionally, in January the China Association of
Small and Medium Enterprises started a 3 billion yuan "venture investment fund"
in an attempt to introduce more opportunities for SMEs who need capital.
But access to capital is not the only support mechanism China has for its SMEs.
Beijing's value added tax (VAT) policy has unquestionably had a significant
effect on many business owners. Not entirely appreciated by some critics of
China's policy towards SMEs is the paradox the country's policymakers are
trapped in: their export markets are demanding VAT reform as part of trade
negotiations, but eliminating or reducing VAT will put many Chinese companies
out of business. Whatever the original intentions behind discontinuing certain
VAT rebates, the consequence for many SMEs was that losing this meant going out
of business. The higher the labor content of the SMEs production, the more
reliant they are on VAT.
In most cases, the companies in question counted on VAT as their profit margin,
a somewhat perverse relationship between government and business that while not
unique to China may never have been practiced on the scale China has. While
Beijing may have done them no favor when the VAT policies were changed, it is
hardly a sustainable business model to have your company's profitability
entirely represented by your VAT rebate. Three increases in the VAT percentages
in the last half of 2008 show Beijing's sensitivity to this concern, but it is
unlikely the SMEs most affected by this policy change have much in the way of a
long-term future.
For the family in Wenzhou, in the occasional moments they can think beyond the
end of the month, two concerns are foremost. First, as the cost of credit
continues to increase, their profit margins will further erode. Even though
they have poured everything they have into the business, they know a large
export customer such as Wal-Mart views them as a name on a bill of lading and
no more.
The family knows its customers can easily price shop and in today's environment
may find lower prices from companies creating short-term, very low prices in
the interest of obtaining cash flow, not profitability. The family knows it is
very unlikely it can get a cost increase through, especially as the competition
gets increasingly desperate. Closing its doors is certainly an option, but
before it does this, it is going to make a concerted effort to do something
most Chinese SMEs have been able to overlook: it is going to redirect every
resource it has back into the domestic market. This is the family's second
concern - whether it has enough time to develop a market which, while all
around, the family has not ever needed.
The trauma of the last year has taught the family one thing more clearly than
anything else: that its business is too reliant on North America. Yes, the
family will continue to support its export business, and may look more
aggressively at export opportunities in under-developed economies such as those
in Africa or Indonesia. But to survive, it needs to develop products and
distribution channels within its home country. In that, it is not unlike tens
of thousands of other SME owners across China who today are shifting resources
back into their own country, and thinking more carefully about product
development needs unique to their tastes.
In 1937 Carl Crow, one of the original expat explorers of China from the
American West, wrote a seminal book, 400 Million Customers, in which he
laid out the preferences of Chinese consumers, tantalizing his readers with the
sheer size of the untapped market in China. Crow could not know what lay in
front of China and the world, the many traps and pitfalls that would ensnare
those 400 million customers from ever materializing.
We now stand at another such point, where unless China's SMEs survive and
innovate, the grand possibility of China's markets may again slip through the
world's fingers; again untapped and unexplored, with the fundamental question
of why China struggles so mightily to become a consumer economy again going
unanswered.
Benjamin A
Shobert is the managing director of Teleos Inc (www.teleos-inc.com),
a consulting firm dedicated to helping Asian businesses bring innovative
technologies into the North American market.
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