Business Case Studies, Executive Interviews, Kai-Alexander Schlevogt on The China Factor

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Executive Interviews: Interview with Kai-Alexander Schlevogt on The China Factor
January 2008 - By Dr. Nagendra V Chowdary

Dr.Kai Alexander Schlevogt
Professor of international strategy
leadership at the National University of Singapore Business School
He serves as a Program Director of the Nestle Global Leadership Program
delivered in association with London Business School.

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    The Chinese government cannot freely use monetary policy to combat overheating, since it is largely determined by the exchange rate target. Thus, it needs to resort mainly to cruder administrative intervention, which makes it difficult to orchestrate a soft landing. One soft social engineering measure, which however becomes effective only in the medium term, is educating the ordinary Chinese, who tend to focus exclusively on potential gains, about the risks of stock investments.One key insight is that prices tend to regress to their mean, or, put more simply, what goes up is likely to go down.Social housing projects similar to the highly successful Singapore model and rent subsidies for the poor are ways to limit the pain from rising real estate prices.

    It would be good if caps on energy prices were removed. In this case, prices would send the correct signals and thus lead to an efficient allocation of resources. If prices rise, the government can provide income support to the poor to soften the blow, but everybody would have a strong incentive to save energy.

  • You mentioned that multinational companies are investing in China for various reasons, such as lowering costs by shifting manufacturing there and selling to Chinese consumers. Do you foresee an overcrowded market? Do you expect China's low-cost advantage to persist in the long run?
    Multinational companies in search of large uncontested markets are often disappointed by China. The Middle Kingdom has already become one of the most competitive business turfs on earth. All major foreign companies and strong Chinese companies are battling for supremacy on this growth frontier, often resulting in cut-throat price competition and a squeeze in profits. At the same time, costs are rising rapidly, which depresses margins further.

    To start with, we are witnessing a total war for labor at all levels of the organization. Low suitability rates and fragmentation make the problem worse. Less than 10% of the estimated 15.7 million Chinese university graduates from 2003 to 2008 are deemed suitable to work in multinational companies. Out of the resulting pool of 1.2 million graduates, only 815,000 individuals are accessible.

    No wonder, payrolls are increasing dramatically even in times of low inflation. From 1998 to 2003, when the inflation rate was only 0.01%, the average wage of employees in China grew at a compound rate of 13.4%. Wage levels were highest in the rapidly growing coastal regions. Besides, low retention rates lead to a further increase in expenses, for example, for recruiting and training. To improve the social protection network, the Chinese government is likely to require higher contributions, which will further increase labor cost. The prices of advertising and real estate are increasing significantly, too.

    The total costs of operating in the Middle Kingdom are often even higher than what is reflected in the profit and loss accounts of the Chinese units. Overheads, such as the time committed by headquarters personnel to coordinate and control operations across a globally disaggregated value chain, are not always fully allocated to the activity centers. China usually requires particularly high time commitment from the top leaders of the corporation and their support staff. Besides, the opportunity costs of foregone investment opportunities, possibly even making neglected operations elsewhere vulnerable to attacks from China, are not calculated.

    In view of all these trends, the leaders of multinational companies should think twice before moving operations to China, especially the coastal regions, solely to reduce expenses. To generate more options, they should analyze the costs in the Chinese hinterland, including expenses resulting from the underdeveloped infrastructure and other disadvantages, as well as in other emerging markets, such as Vietnam or the Philippines. Besides, given that the Chinese market exchange rate is controlled by the government and thus may be distorted, it is necessary to use Purchasing Power Parity (PPP) exchange rates, for example, to convert wages into foreign currencies. To account for productivity, analysts should use unit labor costs as a benchmark in comparison instead of just focusing on wages.

1. Wal-Mart's Strategies in China Case Study
2. ICMR Case Collection
3. Case Study Volumes

The Interview was conducted by Dr. Nagendra V Chowdary, Consulting Editor, Effective Executive and Dean, IBSCDC, Hyderabad.

This Interview was originally published in Effective Executive, IUP, January 2008.

Copyright © January 2008, IBSCDC No part of this publication may be copied, reproduced or distributed, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or medium electronic, mechanical, photocopying, recording, or otherwise without the permission of IBSCDC.

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