Taste of Cheap July 24, 2007

Just came back from my first trip to Qingdao, China. Qingdao is at the southern tip of the Shandong Peninsula. It is a famous coastal tourism city near Shanghai - also known for its Tsingtao Beer around the world

When I went, I had little idea of what to expect. I found a country that is undergoing change at a rate that is surely unparalleled. The Qingdao skyline resembles that of an American city; I caught glimpses of old China but that is all they were.

The high level of foreign investment was striking. The sheer number of people was something that has left a large impression. When this is coupled with the nation’s determination to develop, it is apparent why China will become the world’s largest economy. The highlight of the trip was spending time with the people who were not just kind, but fun loving with a rich sense of humor.

The visit was a huge success and carried a very steep learning curve for me personally. It involved a mixture of meeting suppliers and forming professional relationships on which to build, spending time with the company’s purchasing and outsourcing departments (both on and off-premise), seeing and learning about the production processes, learning about Chinese business customs, and lastly traveling about Qingdao and the surrounding area in order to develop an understanding of China and gain an insight into what doing business here might involve. Qingdao, which is on the Pacific coast, will act as host for the sailing events in the 2008 Olympic Games.

During my stay I made it a habit of picking up the local English newspaper, which pragmatism gladly surprised me. I could not help but notice how seriously the Chinese government and the media were paying attention to what is said here in the US about “Made in China” products in general and the latest succession of well-publicized problems with its food products including contaminated toothpaste and imported fish that was found to have traces of illegal antibiotics.

These are serious matters, no doubt about it. But there is nothing happening in China today that is fundamentally different from what has happened or is still happening in other countries - including the US. Remember the peanut butter contaminated with salmonella and E. coli contaminated spinach few months ago?

In many of its sectors, China’s booming economy is one of the most cutthroat in the world: Factories pare margins to the bone in order to beat out their neighbors for orders and market share, and they eliminate as many costs as possible. Bad ingredients are substituted for good ones if they are cheaper and non-apparent.

Even some of China’s best and most responsible companies, those with genuine ambitions to produce high-quality goods, are sometimes forced to choose between losing money, the Wal-Mart order or both.

Does this sound familiar? Of course it does. Go back and reread Upton Sinclair. Recall the sweatshops in New York’s garment district or what sparked the creation of the Food and Drug Administration and, not so long ago in ‘72, the Consumer Product Safety Commission.

This country is now furiously engaged in a remarkable frenzy of self-examination and criticism. As China looks at itself in the mirror and prepares to face the world’s markets, consumer expectations and demands are only slowly beginning to have an impact on product quality and safety. Truly blatant crimes of corruption and official misconduct may lead to highly visible executions, such as the ones we’ve witnessed in the last couple of weeks, but these punishments will have only a limited deterrent effect.

Real and widespread change in the Chinese regulatory environment will come from two much more important developments. First, the better Chinese companies with Western customers and international ambitions for their own products and brands, will band together and plead for better and more effective regulations. They will be joined by the Western companies with operations in China whose managers wonder about the quality of the ingredients that they use. These managers after all, are already under scrutiny by their regulators and customers outside China. Both the Chinese and the Western companies want and need a level playing field where the worst of the price-bound competitors no longer can play with an unfair advantage.

Second, the Chinese government will step in with rules and regulations that will be enforceable…and that in fact will be enforced.

Chinese and Western companies with huge Chinese operations face two challenges today. They need to manage and communicate their way through a series of crises - related to product safety, public health, environmental quality, labor practices and a host of other public issues - that are just now beginning and that likely will continue to challenge them. At the same time, they need to learn quickly how to help shape the new regulatory directions that the government is bound to take, how to help educate government officials about which rules will work and which will not and how to make the kinds of strategic bets about regulatory policies and their own investments that either will allow them to adapt quickly and prosper - or that will condemn them to a quick demise.

The U.S. Congress in 2002 passed the Bioterrorism Preparedness Act, designed in part to improve food safety. It includes new rules on how all domestic and foreign food facilities must register with the FDA – and give notice for any shipments of human or animal food.

Yet the FDA is able to inspect only 0.7 percent of all imported food products, down from 1.1 percent the previous year. In 2006, that means the FDA inspected just 20,662 shipments out of more than 8.9 million that arrived in US ports – employing about 1,750 food inspectors for ports and domestic food-production plants.

This only shows that the tasks at hand are much more complicated than our respected congressmen believe. The U.S. government and congress should be much more mindful of what they say and communicate to their constituency, since lashing out against the Chinese will only further alienate the US-Sino relationship. This is an issue facing governments globally and projected to increase with the growth of global commerce. A more careful and beneficial approach would be an international standardization of Food safety regulations and ongoing bilateral collaboration for faster and more flexible solutions.

In The Pursuit of Cheap June 17, 2007

Big box retailers are turning to do-it-yourself sourcing, when they have historically been purchasing primarily through domestic importers who developed and/or procured the merchandise on their behalf.

They began purchasing goods directly from cross-border suppliers and manufacturers, opening sourcing offices in such remote locales as Indonesia and Vietnam, and flying employees with the mission to haggle with local producers, audit quality and labor practices, and figure out how to ship merchandise to their stores.

Many retailers, ranging from Target and Federated Stores to Tesco and Wal-Mart, are looking to buy more without agents. Even companies that have been sourcing direct for years are pushing the direct approach to new levels. Hewlett-Packard, for one, not only purchases computers and monitors directly from its contract manufacturers, but it also sources parts and materials on behalf of those manufacturers.

What started as fledgling purchasing operations mostly handled by others has matured into true sourcing organizations.

Not surprisingly, cost is driving the switch to direct sourcing. This is particularly true in the retail sector, where cutthroat pricing from the competition is forcing rivals to focus on high-margin, private-label goods and wring new savings out of procurement. By sourcing goods directly, they can shave about 10 to 20 percent off the net average cost of their house-brand products.

The benefits of direct sourcing also includes greater control over the production, quality and transportation logistics of merchandise. While some retailers still use consumer packaged goods importers or agents, they now work more closely and consistently with a smaller number of factories, teaching them best practices, and then give them enough volume so they’re captive to them instead of handling work for 30 other importers.

However, the gains from direct sourcing come at a price. A company must develop products, find qualified factories, solicit bids, place orders, inspect the factories, monitor quality, handle logistics, customs, duties and various compliance issues—no small checklist. Determining the true cost of those activities can also prove tricky. While the purchase price of an item may look great, the true cost may be much higher. But the risks and costs increase when you add in factors like inventory management, branding and product innovation. A failure to deal with these dynamics can erode profitability because: Lead times to correct inventory shortages can be longer, Overseas manufacturers traditionally cannot offer innovation, and House brands generally can’t command a premium retail price. This results in the generation of commodity-based products that lack differentiation thus reducing sales and long-term profitability. Many Category Managers (buyers) agree with this line of reasoning; but in the end, their actions are driven by financial pressures.

In order to survive this movement, CPG suppliers/importers MUST focus their proposition on offering unique value to the end consumer so as to differentiate their retail partner; therefore commanding higher margins. They ought to collaborate with their diverse customer base on collecting better data on the value of their brands, how their customers buy from them, and what their strengths and weaknesses are, which in turn will help retailers understand the economic trade-offs. Data coupled with research can help determine where brands and innovation drive profit and where it will not. Additionally, they can implement testing, inventory management strategies and sales programs that will diminish risks and increase profitability - a degree of collaboration that overseas manufacturers will find difficult to duplicate.

China: The Next Cultural Evolution June 11, 2007

I just came across this month’s FastCompany magazine and was stoked by the well written, yet a bit too sensational, cover story: “China: The Next Cultural Revolution“. Author Aric Chen foresees that an emerging creative class will reinvent how China thinks and works, making it a creative Superpower in the next 20 years.

Having worked with many Chinese manufacturers in the last five years, I agree to a large part with the author that China will eventually get its creative Mojo and maybe even become an innovation powerhouse. However, I believe that it won’t be happening in our life (and I’m only 29). The social changes required will be rather evolutionary than revolutionary.

China has experienced phenomenal double digit growth in the last couple decades, has a deep pool of brain power and the government is willing to invest Billions of dollars in science and technology. But the resources are not the issue here; China lacks the culture, systems and processes to foster creativity and support innovation.

Most people in China belong to one large, all-embracing unit such as a factory, government office, or village. The unit is run by party branches, operates under common administrative rules and procedures, and reflects the current policies of the party. The consequence has been that most aspects of social differentiation, mobility, and tensions are now played out within an institutional framework. Most of the questions about any individual life and prospects can be answered by specifying the unit — the social cell — with which that individual is associated.

The nail that sticks up will be hammered down.

The education system teaches children to memorize facts, rather than questioning them. It’s a curriculum that’s good for a manufacturing environment where workers must follow procedures, but it doesn’t foster the creative thinking needed for innovation.

In the end, innovation capability depends on economic flexibility. The U.S. with its entrepreneurial culture, relaxed labor markets, and free capital flows, continues to be the most innovative economy in the world. China needs such an environment to bridge the growth and productivity gap to truly transform itself into an innovative, energetic economy.

For all of us living on the other side of the Pacific, China is the world’s largest consumer market which represents significant opportunities to innovative global brand owners who can develop products and services appropriate for its diverse market.

Building Chinese Brands May 19, 2007

Laura Ries wrote an excellent article after having come back with Al from a trip to Beijing…go check it out.

Some excellent points are made in her court…and I’m on her side for most product/service categories. I once thought heavily extended store brands might prove to be an exception. Costco’s Kirkland Signature brand sells extremely well (although that’s a special story of its own), in addition to Target and IKEA’s brands. But in the end, if retail shoppers are willing to purchase items where price & economy are not strong purchasing influencers…they’ll often choose the items with the unique brand name and packaging.

But back to China. I think Theory A is vastly superior and just plain more exciting from a buyer’s point of view, especially in the realm of FMCG (fast-moving consumer goods). I think electronics however, is a unique category where the normal rules don’t easily apply; buyers want to trust a brand they’re forking out more money to. Would you like a Sylvania or a Samsung?

Time will tell what will happen in China. I can’t make any educated guesses yet, but I’ll toss in some change after I finish reading China Inc. by Ted Fishman (highly recommended!).