International Buyers and Foreign Entrants

International Buyers And Foreign Entrants

International Buyers and Foreign Entrants

The Influence of International Buyers and Foreign Entrants on Chinese Supplier Management Control Behavior.

Much has been written about the increasing costs of China, especially labor costs, leading multinationals to pivot their strategy to other countries in the region (e.g., Vietnam, Cambodia, and Myanmar). However, little is known about how Chinese suppliers cope with not only the increasing costs of or shortage of labor, especially when they are seeking to market their goods internationally or when foreign firms enter their market domestically. What is important to buyers is that the Chinese supplier “get it” in terms of managing the factory in a sustainable way. That is, the supplier can make good quality products continuously, make profit and be around in years to come. Often having a good management control system in place and contribute to this end.

We conducted 21 interviews with suppliers to gather insights from managers regarding the types of pressures that foreign firms place on suppliers. Understanding these pressures can help to better structure the contracting and control arrangement with the supplier so as to make a more sustainable relationship. The interviewees were middle-level managers from thirteen exchange-listed Chinese manufacturing firms, and senior- and middle-level managers from eight international firms operating in China. None of these firms were included in our original survey sample. The firms were drawn from a wide range of industry sectors. Six interviews were face-to-face (with an average duration of one hour) and fifteen were over the phone (with an average duration of thirty minutes).

What are the pressures placed on suppliers by international buyers and foreign entrants?
Table 1 provides a summary of the factors extracted from the content analysis related to the threat of foreign entrants and the buyers’ bargaining power, respectively. The content analysis yielded four factors associated with the threat of foreign entrants: cost pressure, budgeting/imitation of foreign entrants, hiring terms and conditions, and brand image pressure. Further, the content analysis yielded five factors associated with the buyers’ bargaining power: formal contractual demands, profit margin pressure, formal monitoring, warranty risk, and exporting costs.

The most widely noted factor, related to the threat of foreign entrants and importance of management control use, was cost pressure (cited by twelve of the twenty-one interviewees - see Panel A of Table 1). The comments from interviewee N were especially insightful:
The factory design, machines, and labor must be at the same level as those of the foreign competitors. Otherwise we will lose the market because we produce the same products, so price competition is not a good way to survive. Except, you need to do some under-the-table deals…for example…perform fewer quality control tests…pay less to the workers in order to maintain low costs; if we are in the same level we need to do good planning.

The second most widely cited factor regarding the threat of foreign entrants was the imitation of management practices of the foreign entrants (cited by eight of the twenty-one interviewees—see Panel A of Table 1). This imitation appears to be strategic, as suggested by interviewee K: In China, at first they [the domestic firms] did not have the practice of budget control. But now, because more foreign competitors are involved in this market, they [the domestic firms] may learn something from them [the foreign competitors]. That is why they [the domestic firms] will use the same practices as the foreign players.

The most widely noted factor related to buyers’ bargaining power was formal contractual demands (cited by thirteen of our twenty-one interviewees—see Panel B of Table 1). For instance, the interviewees agreed that relative to domestic customers, international customers tend to impose more safety/quality/environmental standards and require more capital investment. They also require certification (e.g., ISO 9000), on-time delivery and scheduling, and warranty claims and product recalls. Interviewee I provided the following comments:
We have to match the buyers’ taste with the procurement procedures. For the procurement procedures with Wal-Mart we need to recognize what Wal-Mart needs or likes and we need to create internal procedures to match their taste. For example, Wal-Mart forces the manufacturing companies to drop their prices, so we have to control our costs a lot more than before. Indirectly we have to establish some management system to control many things, for example: cost, contract management, logistics management, and pay more attention to the terms and conditions in the contract. Systematically, we have to improve internally.

The second most widely cited factor related to buyers’ bargaining power was the profit margin pressure from international customers (cited by twelve of the twenty-one interviewees—see Panel B of Table 1). For example, Interviewee N commented:
Every year we do cost control and we review everything, for example, product design, material cost, we cut the cost from our suppliers. Let’s say last year I buy from you for $100, this year I cut the cost by 5 percent, we pass the pressure from the customers on to our suppliers. Therefore, you need budget planning systems to help us do that.

The third most widely cited factor related to buyers’ bargaining power was the formal monitoring imposed by larger international customers (cited by ten of the twenty-one interviewees—see Panel B of Table 1). Furthermore, several of the interviewees mentioned warranty claims and product recalls, additional costs associated with exporting and tax management pressures, and the need for transparent transactions as factors that affect their management control sytem use. The following is an illustrative excerpt from interviewee N:
Let’s say our product doesn’t fulfil their requirements; if so, then they [the international customers] have the right to recall all the products back to China. The cost of the recall may be double or even triple and the factory may have to close down…[so the risk is very high]. When we deal with the international customers we take care of everything they need.

Regarding buyers’ bargaining power and firms’ international market orientation, some interviewees mentioned that the domestically oriented firms often enjoy the advantage of guanxi. For example, interviewee A commented:
It is impossible for a foreign brand to enter the China market without developing interpersonal relationships. Your products can’t get on the shelves of the department stores unless you bribe the managers of the department stores to develop a relationship with them. In addition, although they can find a local company in China to cooperate with them, they cannot be sure that the product will sell well because the China market is unique in terms of the size, colors, and the design customers want. This is the challenge of foreign brands.

How do suppliers use management control systems in response to these pressures?
As shown in Appendix A, we also elicited our interviewees’ views on how their management control system might be used more extensively to respond to the threat of foreign entrants and to buyers’ bargaining power. In general, the interviewees acknowledged the differences in the use of formal planning and budget controls between Chinese and foreign firms. The reactions from interviewees D and E illustrate this point: For example, for the international companies, budgeting is a very important activity and the management teams will deliver the budget at the beginning of the year. But for the domestic companies, budgeting is a more informal activity; it does not have the same role as they do in the international companies. The actual results are different from the budgets that managers presented at the beginning of the year. There is not a strong relationship between the budgets and the actual operating results. That is, the incentives and compensation of the management team are not strongly related to how the actual numbers are different from the budgets presented at the beginning of the year. (Interviewee D)

We have the balanced scorecard. But some companies use the balanced scorecard as a strict control. For us, it is just a tool, but it is not used to strictly control all of the activities. Every month we will update the balanced scorecards, but we may not use it to make decisions. (Interviewee D)

Most of the managers in domestic companies care too much about the “numbers game” and not so much about the improvement of business processes and optimization. Since I specialize in ERP and other management software, I know they don’t pay too much attention to what they can do to improve their management. (Interviewee E)

Other factors associated with the importance of supplier’s management control system

The interviewees’ responses to our open-ended questions also provided additional insights into other factors that may be associated with the importance the firms place on their management control system.
1. Chinese way of doing things (“under the table affairs”). According to several interviewees, many Chinese firms conduct business “under the table” to shield themselves against competition from foreign entrants. The following is an illustrative excerpt from interviewee N: Yes, we care about foreign entrant competition…let’s say the factory design, machine, labor. Otherwise we will lose the market to the foreign entrants. Because we produce the same products, price competition is not a good way to survive…you need to rely on some under-the-table affairs…let’s say… cash transactions with related parties, pay less payroll taxes, in order to maintain low cost. So you will find that most of the Chinese companies that rely on under-the-table affairs are medium level or small level. Otherwise, for the larger Chinese firms that have to compete directly with the foreign entrants, we need to do good planning to keep the cost level low and the labor cost low.

2. Management control system viewed as a passive activity. Several international customers we interviewed stated that some management control system practices were not being used as management tools.
The factories in China usually follow their production plans passively. As an international customer dealing with Chinese manufacturers, you always have to push them and tell them what they need to do. We always check their processes very closely. (Interviewee C)

Often the domestic companies do not actually put their management control system into practice; they just think the management control system practices are the kind of normal activities that they must conduct, like every month you will do the monthly closing of the accounts and reporting of results. They do not care about results. (Interviewee D)

3. Senior management leadership. Many Chinese firms are either family-owned or are spinoffs of large state-owned enterprises. This has implications for their managerial leadership (i.e., former state-owned enterprise managers versus entrepreneurs) and the importance that senior managers place on their management control system. These are illustrative excerpts from two interviewees:
If the CEO thinks the budget is very important, then the firm will use budget controls. If the CEO is from the finance department, then the firm will be especially sensitive to budget controls. (Interviewee K)

Our CEO takes an American approach. All the numbers are entered into the computer and then there’s a system to provide results (e.g., turnover rate, trends). Every figure is produced automatically by the computer so that managers can know each factory’s performance in real time. (Interviewee N)

4. Risks associated with high-power customers. One interviewee noted that while all manufacturers have some form of formal planning, it was difficult to foresee and prepare for the risks associated with losing big orders from high-power customers.
I think most of the companies in China do planning quite well at this moment. Even small companies, domestic or foreign, do their planning quite systematically and very well…They plan well but they cannot forecast with accuracy because a very large customer may have placed a long-term purchase order and suddenly the customer cancels the order. (Interviewee B)

I think size is the issue. Because the companies are big enough, they can attract foreign companies. Multinational companies pay their suppliers when they need them to meet certain criteria, including quality, safety, and some working conditions… They need these companies to have clear planning in their factory, but only large Chinese manufacturers can afford to apply for [industry specific] certificates. (Interviewee C)

Conclusions

Analyses of the interviews with managers of Chinese firms show that there are four main pressures associated with the threat of foreign entrants: cost pressure, budgeting/imitation of foreign entrants, hiring terms and conditions, and brand image pressure. Further, there are five factors associated with the international buyers’ bargaining power: formal contractual demands, profit margin pressure, formal monitoring, warranty risk, and exporting costs. Second, Chinese suppliers find it difficult to implement a management control system like those used in the international firms and that this is due to several factors such as the “Chinese” way of doing business, passive compliance with management control system practices instead of using them as management tools, senior management leadership, and the risks associated with high-power customers. Buyers understanding of these factors can help them to better prepare their strategy for working with Chinese suppliers in the long term.

Table 1

Content analysis of post-hoc interviewsa

Panel A. Summary of factors related to the threat of foreign entrants

Total

Chinese firms

Int’l firms

(21)

(13)

(8)

Cost pressure: As the threat of foreign entrants increases, opportunities to compete based on low cost decrease. Instead, firms compete based more on product differentiation (e.g., in terms of quality and features). As the threat of foreign entrants decreases, opportunities to use lower-cost labor and materials increase.

12

8

4

Budgeting/ imitation of foreign entrants: As the threat of foreign entrants increases (decreases), firms tend to rely more (less) on budgets to remain competitive. Firms imitate the management and marketing practices of foreign entrants.

8

4

4

Hiring terms and conditions: As the threat of foreign entrants increases, the firms’ pressure to match the hiring terms and conditions of foreign competitors’ increases (e.g., better salaries and benefits to hire and retain skilled workers).

4

2

2

Brand image pressure: As the threat of foreign entrants increases, the pressure to allocate more resources to marketing increases.

2

1

1

Panel B. Summary of factors related to the buyers’ bargaining power

Formal contractual demands: Relative to domestic customers, international customers impose more safety/quality/environmental standards and capital investments; require certifications (e.g., ISO 9000), on-time delivery & scheduling (e.g., ERP); warranty claims and product recalls.

13

7

6

Profit margin pressure: International customers have access to many global suppliers; thus, they have more bargaining power than domestic customers to negotiate lower costs.

12

7

5

Formal monitoring: International customers impose more monitoring and restrictions on outsourcing of direct costs (materials and labor) than domestic customers.

10

6

4

Warranty risk: International customers seek to recover full costs of warranty claims, which places greater burden on the Chinese supplier to have systems in place to manage these risks.

4

2

2

Exporting costs: Additional exporting costs associated with international customers include transportation, insurance, supply chain coordination and the need to have systems in place for customs duty and tax reporting.

3

1

2

a The content analysis is based on post-hoc interviews of managers in thirteen exchange-listed Chinese firms and eight international firms operating in China from the sectors listed in Table 1. The numbers in the cells represent the frequencies of factor citations, out of the 21 interviewees. Only factors cited by at least two interviewees are shown. All the interviews were digitally recorded and transcribed. The transcripts are available upon request from the first two authors.

 

Dr. Neale O'Connor
Cofounder of the China Sourcing Academy, founder and director of the China Supplier 1000 Project. Senior consultant of the China Lab at Silk Road Associates (Hong Kong). Currently teaching at the Hong Kong Baptist University.