The China Opportunity and the Value of Knowledge

By Kevin Meyer

Published: 29 August 2010

I just returned from another trip to China. My company, Specialty Silicone Fabricators based in Paso Robles, is selling TO China, not outsourcing to them. We are able to compete based on technology, quality, service, and yes, even cost. That success is also what has enabled us to start building a new 120,000 square foot facility in Paso Robles, with our general contractor being another top-notch local company, Specialty Construction.

From what I observed last week I believe that other U.S. companies have a unique but narrow opportunity to capture business in China.

After working in the medical device industry for over a decade I moved to San Luis Obispo in 2000 to run the telecom equipment operations of Newport. Six months later we had quadrupled production in the same floor space by leveraging lean manufacturing methods and especially the power of people and knowledge. We had recruited some of the best talent we could find, engineering and otherwise, and it paid off. Unfortunately the industry went off a cliff in 2001 thanks to excess fiber optic capacity, and we shut the operation down on September 10th, 2001. Not a fun week for our 150 employees or the nation.

I went on to start a specialty contract manufacturing company and then moved back into consulting before joining Specialty Silicone Fabricators – my medical device roots had coincidentally been in silicone components. I still do some consulting, primarily with some savvy VCs that realize that much of the value of a factory is not represented on a traditional balance sheet or P&L.

Many companies try to implement lean manufacturing methods as they’ve heard the stories of success. The lean programs at most of those companies will fail. The main reason they fail is because they forget about or aren’t aware of the second pillar of lean: respect for people. The first pillar, reducing waste and creating value from the perspective of the customer, can create considerable short-term return. But it will all fall apart if the second pillar is ignored.

Respect for people means a true understanding and leveraging of the power and value of experience, creativity, and knowledge. Unfortunately that value is not explicitly represented on traditional financial statements therefore it is often ignored. But it is real. That value, realized in terms of ideas and improvements, can more than offset labor cost differences. A “lights out factory” may seem competitive due to near-zero labor costs, but what happens over time? I have yet to see a robot that has submitted an improvement suggestion.

Over the last decade many companies have chased low labor costs around the globe believing that was the key to success. Their financial statements looked great until you probed at less tangible costs… long supply chains and the cash tied up in them, the risk of a quality defect being found while large shipments were still floating on the ocean, the need for additional supply chain management infrastructure across time zones and language barriers, and longer development cycles. Some of those companies are now realizing that error and are “reshoring” back to North America.

Fortunately there were some other companies that took a different approach. They realized that the largest cost in business is not labor, overhead, or material – it is unnecessary complexity. Many of them actually added labor – creative knowledge resources – and lowered their overall costs. They remained globally competitive by focusing on optimizing value from the perspective of the customer and leveraging the power of people. They realized that people were not just the cost of a pair of hands but the value of the brain attached to the hands.

Those enlightened companies represent all industries – high technology, heavy equipment, and even the furniture, textiles, and apparel industries. One of my favorite companies is a clothing manufacturer in Los Angeles that employs a couple thousand people, paying them above minimum wage with decent benefits, and out-competes Asian sweatshops on low-margin t-shirts and underwear. If they can do it then any other company that feels the need to chase low labor costs should be embarrassed.

In my opinion there is only one valid reason to move overseas: to be closer to a customer.

That brings us back to China. A few years ago China was all about providing a low labor cost base for companies to outsource to, and then stealing intellectual property in the process. That has changed rather dramatically. Thanks to a rapidly modernizing infrastructure, paid for in large part by interest payments on our national debt, the domestic wealth of their population is growing. That is triggering their own internal markets, which is driving demand – by over 1.5 billion people. Up until now we believed that we needed China to buy our debt and China needed us to export their products to. What happens when internal demand in China is unleashed, a potential demand of five times the population of the U.S., and they no longer need to rely on export markets? The effect on T-bills could be interesting.

That is why the next few years represent a unique opportunity for high quality, innovative, and cost competitive companies outside of China. Last week, for the first time, I heard a Chinese company say “cost is not an issue” – that particular medical device company had recognized the value of quality and was willing to pay for it. Other homegrown medical device companies are beginning to focus on the Chinese market and need components, yet there are no high quality domestic component manufacturers. They are also having a problem finding domestic talent – one other Chinese medical device company, which had grown from zero to over 1,000 employees in just five years, has created a technical college that now has 10,000 students. Just to feed that one company’s anticipated demand for talent.

Chinese internal demand is increasing rapidly, but high quality domestic component suppliers and knowledge resources are not available. That is the opportunity for North American manufacturers to get a foot in the door of a market several times the size of the United States. Manufacturers that have leveraged knowledge and creativity to compete based on quality, service, technology, and cost.