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Engineering & MachineryOvercoming Constraints and Driving Value-Up for Chinese Manufacturing Plants


As of June 2016, 3,639 Korean companies had established operations in China, with 2,095 of these in manufacturing, according to the Korea Economic Research Institute. Establishing and growing a legal entity in China presents numerous challenges, including political risks such as THAAD-related sanctions, regulatory hurdles like transfer pricing policies, geographic constraints, rising labor costs, volatile market characteristics, and cultural nuances in the local workforce. These factors necessitate expert guidance in understanding and navigating China's unique business environment when formulating and executing Value-Up strategies.

Drawing from extensive experience with Value-Up projects in China, this article highlights key constraints and directional improvements for success.

Prioritize Economic Profit (EP) Over Profit Margins

In Korea’s manufacturing sector, Value-Up efforts often focus on cost reduction to achieve immediate cash flow improvements. However, for companies operating in China, such strategies can be less effective due to several factors:

  1. Limited Supplier Pools: Developing new suppliers demands significant time and resources for quality assurance.
  2. Transfer Pricing Policies: The Chinese government closely monitors corporate profit margins, with higher margins leading to increased tax burdens or heightened scrutiny.

To navigate these constraints, companies should maintain reasonable profit margins while maximizing volume within fixed cost structures to expand absolute profit levels. Growth strategies, rather than aggressive cost reduction, often prove more impactful. Considering the vast size of China's domestic market, expanding coverage and increasing market share offer substantial potential.

Strategic Management of Sales and Service Networks

For B2C industries, establishing extensive sales and service networks across China is critical. However, this requires significant investment in fixed costs, prompting many companies to rely on local distributors or outsourced providers. While this approach reduces upfront costs, it can compromise control, leading to margin erosion and increased expenses.

For example, distributors may monopolize customer information, impose excessive demands on pricing or delivery schedules, and adversely affect profitability and productivity. To mitigate these risks, businesses should adopt policies that maintain control from the outset, such as:

  • Distributor Tiering: Introduce competitive dynamics among distributors to prevent dependency.
  • In-House Expertise: Retain a proportion of highly skilled internal personnel to balance reliance on external partners.
  • Operational Diagnostics: Regularly evaluate the efficiency of sales and service resources and their effectiveness from the customer’s perspective.

Given the complexity of these networks, companies should establish a phased roadmap for gradual policy adjustments.

Diversify Supply Chains and Secure CAPA Buffers via Outsourcing

China’s vast and volatile business environment presents unique supply chain challenges. Fluctuations in order volumes, coupled with the need to handle large-scale demands, necessitate robust capacity planning.

To manage these dynamics effectively, companies should:

  • Outsource Certain Operations: Transform fixed costs into variable costs by outsourcing specific production processes, mitigating risks associated with fluctuating order volumes.
  • Diversify Supply Chains: Establish a broader network of suppliers to ensure additional capacity buffers.

These measures enable businesses to handle sudden surges in demand while minimizing financial risks.

Restructure the Supply Chain for Cost, Quality, and Delivery Excellence

Historically, many companies entered China to leverage its low labor costs. However, rising wages and a shift toward high-tech, value-added industries necessitate a re-evaluation of supply chain structures.

Key challenges include:

  • High Dependency on Korean Suppliers: Many companies still rely heavily on partner suppliers for modules and units.
  • Limited Local Procurement Capabilities: Local procurement teams often lack the expertise to manage diverse sourcing pools, leading to single-supplier dependencies.

Addressing these issues requires long-term structural improvements, such as:

  • Dual Sourcing: Reduce dependency on single suppliers to foster competition.
  • Transparent Procurement Processes: Implement standardized procedures for supplier selection and pricing to enhance fairness and transparency.
  • Supplier Development Programs: Build capacity among new suppliers to ensure they meet quality and delivery standards.

By diversifying the supply chain, companies can exert greater pressure to drive improvements in cost, quality, and lead times.

Strategic Leadership by Expatriates, Execution by Local Teams

With 2,095 Korean manufacturers employing approximately 540,000 local workers in China, expatriates account for only 2.5% of the workforce. While expatriates typically oversee strategic planning, local employees handle execution.

To ensure successful Value-Up initiatives, businesses must:

  • Foster Collaboration: Involve expatriates in strategic planning while integrating local employees into task force teams for execution.
  • Overcome Communication Barriers: Develop clear communication protocols and structured processes to bridge cultural and linguistic gaps.
  • Define Clear Responsibilities: Use action lists, RACI matrices, and regular status checks to ensure accountability and progress.

Understanding cultural nuances, such as strict adherence to assigned tasks and limited flexibility in problem-solving, is crucial when managing local teams.

Conclusion

Achieving Value-Up for Chinese manufacturing plants requires a shift from short-term cost reduction to long-term growth strategies that maximize Economic Profit (EP). Structural improvements in supply chains, coupled with well-defined processes for continuous improvement, are essential.

Given the rapid advancement of local competitors, Korean companies operating in China face an average lifecycle of 10 to 30 years before potential market exit. To sustain competitiveness and maximize returns, companies must establish Value-Up strategies tailored to China’s unique environment from the outset and execute them systematically over time.



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LOOXENT

A  21F. Parc.1 Tower2, 108, Yeoui-daero, Yeongdeungpo-gu, Seoul, Korea 07335

T  02-546-8222      F  02-546-8226

E  service@looxent.com 

© 2024 LOOXENT. ALL RIGHTS RESERVED.