China is certainly one of the most active and involved countries as far as outsourc- ing is concerned. Nevertheless, outsourcing in China may be more risky in the medium and long terms than in other countries like India, East Europe or North Africa. This is due to the Chinese strategy to capture the know-how and the tech- nology of the buyers in order to develop their own competencies. Apparently, they have as a goal to eventually compete with the former buyers. In this section, we assess the long-term implications of outsourcing in China.
3.6.1 Recent History
The recent history of outsourcing in China can be summarized in a few points:
• In the 1970s, outsourcing activities concerned low added-value products such as textiles, consumer electronics (TV sets, for example), toys, etc.
• In the 1980s, outsourcing incorporated car parts and even full assembly of cars.
• In the 1990s, more and more outsourcing requirements concerned products with high added value such as software, semiconductors (for IBM, Intel, Texas Instruments,…), medical equipment, to mention just a few.
• Since the middle of the 1990s, outsourcing to China concerns higher added- value products and services: research and development (R&D), key auto parts (for Ford, Daimler-Chrysler, and Volkswagen), key airplane components (for Boeing), machinery, and so on.
Since China’s vendors are involved in value-added products and services, the related technologies migrate from Europe and the US to China. The reason is that outsourcing usually occurs through joint venture, equity stakes and coproduction agreements, which leads to sharing know-how and, in addition, makes the buyers more and more dependent on the vendors.
Most of the US and European giant companies outsource currently in China.
We can add to the companies already mentioned above Philips Electronics, Thom- son, Siemens, Airbus, General Motors, Renault, etc.
This evolution has resulted in a financial domination of China over Europe and the US. For example, China holds some 260 billion dollars in US Treasury In- struments. This situation is sometimes summarized by saying: “China supports developed countries as the rope supports the hanged person”.
3.6 A Country of Active Offshore Vendors: China 101
3.6.2 Consequences
Indeed, outsourcing in China may reduce production costs and increase buyers’
competitiveness in the short term, but leads to important negative side effects such as:
1. competitive dilemmas;
2. loss of initiatives in buyer companies;
3. acquisition by China of European and US high-tech companies and thus acquir- ing the related technologies and savoir-faire that goes along with them.
3.6.2.1 Competitive Dilemmas
Since European and US companies outsource critical functions, vendors are learn- ing vital know-how and technologies from the buyers, and thus gain access to core competencies of the buyers companies. This generates Chinese competitors who become able to require significant concessions in skills and technologies from for- eign firms that are willing to outsource. We summarize the “fatal circle” in Figure 3.2. This “fatal circle” summarizes how years of research efforts and billions spent in research and technology are offered to a country that will use its “social advan- tage” to destroy companies in developed countries.
BUYER VENDOR Outsources critical
functions
Increases pressure for further concessions Pressure of
competition
Gains access to core competencies
Figure 3.2 The fatal circle
3.6.2.2 Loss of Initiative in Buyers’ Companies
The following question deserves an answer: does outsourcing handicap compa- nies’ initiative? In other words, does outsourcing penalize the willingness of com-
panies to extend their competencies (i.e., to innovate)? To answer this question, we have to check if outsourcing introduces constraints that may impede the com- panies to develop their own strategy. The unsurprising answer is “yes”.
First, excessive reliance on outsourcing introduces constraints that restrict the freedom to undertake new developments.
Secondly, companies’ ability to invest may be eroded by outsourcing. The main reason is that vendors impose constraints that, in turn, reduce the freedom of the buyer.
Thirdly, the vendor who gained know-how and technical competencies has an increased negotiating advantage over the buyer and thus can extract even more lu- crative contracts from the buyer, reducing the level of investment accordingly.
Figure 3.3 summarizes the reasons why innovation is penalized by outsourcing.
Buyer
Reduction of enterprise freedom Decrease in investments Domination of vendor over buyer Outsourcing
Penalization of innovation Figure 3.3 Penalization of innovation
3.6.2.3 Migration of Production and Services to China
Some economists claim that foreign direct investments in China reached 0.5 tril- lion dollars during the 15 last years. Thus, foreign companies have built up an enormous manufacturing, service and research facilities in this country. Due to a rising base of skilled engineers and a huge investment capacity, Chinese compa- nies have acquired the know-how and key current and former technologies so that they can design and manufacture their own products to compete with those of their former buyers. The concerned market segments are, among others, software, ad- vanced semiconductors, engineered plastic, electronics, automotive and telecom equipment.
These aspects are summarized in Figure 3.4.
3.6 A Country of Active Offshore Vendors: China 103
Vendor
Buyer Vendor Vendor
Outsourcing Increase of know-how and
investment capacity Build local facilities
Competition Figure 3.4 From outsourcing to competition
3.6.3 Chinese Strategy to Acquire Know-how and Technology
The first aspect of the strategy has been implicitly mentioned in the previous sec- tions. It consists in encouraging outsourcing by giving competitive advantages to buyers. As soon as a company outsources in China, attracted not only by low costs, but also by an incentive tax policy, its competitiveness increases, which forces its competitors to do the same in order to remain competitive. At this point, Chinese companies increase the pressure for more technology and more knowl- edge as payment to allow outsourcing.
The second aspect of the strategy is to offer important advantages to Chinese educated abroad (US, Europe, Taiwan, etc.) to encourage them to return to their homeland. The move started at the beginning of the 1980s. Numerous highly edu- cated people accepted the deal since they felt that it was possible to build fruitful businesses. This support is of utmost importance to make the most of the savoir- faire and the technologies obtained from foreign companies as payments for the authorization to outsource.
The third aspect of the strategy is to focus investments in strategic industries.
The objective is obviously to take advantage of the benefits resulting from out- sourcing to improve and develop advanced technologies. Some Chinese econo- mists claim that the objective is to boost national R&D spending to 2.5% of GDP (gross domestic product) by 2010. The number of technically trained persons could fall slightly short of being able to fully take advantage of this financing: an- other reason to attract Chinese people that were graduated abroad.
The fourth – and last – aspect of the strategy is to develop new products and services, and commercialize them on the world market.
This strategy is clear and will certainly be efficient. It can be summarized as follows: use knowledge and technologies gained from foreign companies as the starting point of Chinese development, provide resources (money and skilled sci- entists and engineers) to support research and development in order to improve
these technologies, and finally enter in the world market taking advantage of low labor costs.
Already, the Chinese automotive industry took its roots when Volkswagen and GM outsourced to China entered the market in 2007 and plans to gain an impor- tant market share by 2010.