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WILL THE FIVE YEAR PLAN DERISK YOUR ICT SUPPLY CHAIN?

By RL Expert Leesa Soulodre

RL EXPERT Leesa Soulodre examines the impact of the 12th Five Year plan on ICT supply chains.
In 2006, China’s State Council published the National Medium and Long-Term Science and
Technology Development Summary Plan, 2006 to 2020 (the 2020 Plan), which articulates China’s strategy of moving up from “Made in China” to “Made by China.” Their mission is that by 2020, China’s research and development expenditure will reach 2.5 percent of gross domestic product, and invention patents granted to Chinese inventors will rank globally in the top five.
However, global information technology firms faced with managing the trade-off between costs,
effective manufacturing and reputation risks are now rethinking their strategy in China. Given
the current pace of rebalancing in the country, is China still the right place to be in order to build a profitable and sustainable business?

Whilst many observers are foreseeing an “Asian Century” with China playing a key role, even
their own policymakers agree that rapid growth cannot be sustained under the current approach.
Premier Wen Jiabao repeatedly called the current model “unbalanced, unstable, uncoordinated, and unsustainable.”

Since the 1990s, industries facing constant pricing pressure and flat or declining sales in their home markets, have turned to countries offering lower material and labor costs and good infrastructure. With a domestic market of more than 1 billion people, 2.7 million millionaires and a rising middle class, China has always been promoted as a strategic opportunity to reach a fast-growing new market for consumer retail companies, to deliver strong margins and to diversify country risk. China is still known for its better infrastructure and internal stability, compared to other low cost producers such as India and Vietnam. China’s shipping channels, manufacturing technologies and infrastructure are also known to be more reliable.
Combine that with a wide range of manufacturers that are open 24 hours a days, 365 days a year, a cheap workforce compared to Western standards, and a “no risk” engagement model of “no money down in exchange for your sample,” few could deny that the value proposition is not appealing. When you couple that with ample access to capital and the booming local market opportunities, it pays to understand and act on China’s new twelfth Five-Year Plan (FYP) (2011–2015) for building an innovation based economy.

In the plan, eight industries are targeted for rapid growth: information technology, new materials, biotechnology, advanced manufacturing, new energy automobiles, green energy, energy conservation and environmental protection.

Technology and telecommunications companies looking for cheap growth abroad are increasingly cautious about the risks associated with a low price and cheap access to capital.
Product issues for companies at Apple’s Green Point Enterprises, Foxconn, Unimicron, and Jabil Circuit factories have given weight to one important consideration in global manufacturing - that the biggest tradeoff executives must consider for profitability is the attention needed to ensure operational supply chain governance for sustainability. Stakeholders add to the argument that good economic times and future prospects of margin gain from Chinese consumers have steered many companies to discount business and reputation risks.
Whilst the FYP politically underwrites the industry’s success, it also imposes pressure from government on the once cheap access to capital, low wages, land prices, corporate taxation and regulation, lack of ESG standards and prevalent bribery and corruption.
This is a concern in consumer technology and telecommunications product areas where China’s cost advantage is already being impacted. As China has transformed from an agricultural economy to a manufacturing economy, the law of diminishing returns has seen average wages quadruple since 2000. Now as it moves to a service-based economy and its aging demographics sets in, the tensions of the FYP as China’s manufacturers make this
transition may put both worker and consumer safety at risk.

Business culture must also be a consideration. According to industry veteran Paul Midler, Chinese manufacturers are well-known to take a pragmatic, short-term view on the customer relationship. Often clients demand unrealistic pricing in exchange for highly-specified products.
To meet client expectations, projects are often managed based on a single order’s margin objectives and what is known in the business as “quality fade.”

These actions put a brand and its company at risk. Beyond one’s product input prices and CSR risks, there are other considerable bottom-line risks to operating in China. Oversupply of inventory and poor Intellectual Property (IP) protection continues to be an ongoing business risk.
The International Chamber of Commerce expects that by 2015, the value of counterfeit goods
globally will exceed USD 1.7 trillion. At more than 2% of the world’s total current economic output and with China the “global manufacturer,” it appears that this is a business that cannot be shut down. Particularly as production moves further away from the companies that originally designed the product, there is an opportunity for corruption and fraud in the manufacturing process. 
The question remains : Is China still the best place for international technology and telecommunications companies seeking to manufacture and capitalize on China’s rapid urbanization and rising middle class? The Asia Economic Institute reports that despite the many challenges, China still has a growing and highly vibrant middle class prevalent
in its cities. This means both a new consumer market and a readily available semi-skilled workforce. Apple remains committed. It is working on strong supply chain and IP governance, and a focus on sustainability.
Through its alliance with the EICC (Electronic Industry Citizenship Coalition), it is aligning with
the new Chinese consumer’s increasing demands and expectations. It has also developed highly integrated and sophisticated supply chains with its partners, coupled with co-investment into quality transport facilities and infrastructure that are unparalleled in many other competing nations in Asia.
Apple’s leaders appear to have learned that supply chain and IP governance must be implemented and these risks managed, for its business to be both sustainable and profitable.

The Chinese consumer is supporting the twelfth FYP plan to ensure Xi Jinping’s dream of clean water, clean air and natural food becomes a reality. By voting with their wallets they will satisfy an insatiable consumer appetite that is dependent on a brand’s promise of health and safety.
So too, will Premier Wen Jiabao, who acknowledges that failure to de-risk China’s own supply chains through implementation of the FYP, could jeopardize his own Party’s future and the stability of China’s economy.

Could these changes mean a pathway to sustainable profits moving forward for business? For companies that can reach a trade-off between the increased costs needed for improved supply chain and IP governance while also realigning their processes and risk management programs to sustainable business operations, the future looks bright.
This article, written by RL EXPERT Leesa Soulodre was published in the January 2014 Technology edition of RepRisk Insight, an ESG Risk publication co-founded by RL Expert and its partner RepRisk AG for the financial markets and their investee multinational corporations.
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