Cost Innovation by Chinese Companies

The first impression that we get about the Chinese firms is that they produce inexpensive products. Chinese achieve this by strategically implementing the policy of cost innovation, Chinese firms are advancing into high-end products and industries and competing for such high-value activities as engineering, design, and even R&D. Cost innovation, which involves much more than simply manufacturing products cheaply.

The Chinese companies are capturing the market by offering customers high technology at low cost thus demolishing the fact that high technology is restricted to high end products and segments. These companies are presenting customers with wide variety of products in an otherwise standardized mass-market segments. They offer this all at mass market price, thus challenging the idea that if customers want variety and customized products they have to pay a premium price. Goodbaby Child Products, a Chinese company, for example, offers a product line which is four times the range of its nearest global competitor.

Another disruptive policy of these companies is that they are using their low costs to offer specialty products at dramatically lower prices, turning them into volume business. An example of this is consumer appliance maker ‘Haier’ which offered the specialized wine storage refrigerators into mainstream category at half the then prevailing price. This resulted in Haier having 60 percent market share.

Chinese policy of cost innovation is disruptive because it threatens the businesses in developed countries by killing their ability to earn high margins on high technology. It also affects their abilities to extract price premium on customized and variety products. If these companies try to use their specialties to move up market into niche segments, the Chinese dragons blow them away by exploding these niches into big volume business.

The best example of companies having cost innovation in action is China International Marine Containers Group (CIMC). CIMC began life in 1980 as one of the first Sino-foreign joint ventures in china. It is now the global leader in container business with 55 percent of the global market share, not just in low-end high volume business but also in sophisticated and specialized products. Driven by its slogan of “learn, improve, disrupt,” CIMC has captured one segment after another.

CIMC was no overnight success. Like its other Chinese counterparts it has survived the tough competition in the Chinese local market. Thus strength in china market establishes the perfect launch pad for these budding dragons. Due to the size of Chinese market, their protectionist provisional governments there are too many competing firms in china. Thus the strategy of becoming strong in china first, leaves the Chinese companies well placed to attack global market.

When going global, Chinese firms like CIMC are expert in finding loose brick in established competitors’ defenses and exploiting them using their cost innovation. Like in 1999 when global competition in container market intensified, prices hit the bottom. Thereby leaving the business of standardized containers unprofitable. Here CIMC had spotted a loose brick in its rival’s defense to dislodge. 

By streaming its processes for procurement of raw materials, benchmarking and rationalizing the activities in each plant, accessing international finance to cut its capital cost, and looking for more efficient ways to transport, it was able to squeeze 33 percent out of material costs and 46 percent out of its manufacturing cost. More efficient transport alone saved $5million per annum. Thus allowing CIMC to produce containers at a price far lower than its global competitors. Threatened by this fact the established global players began to retreat to high end leads which lead to a dramatic failure. One reason for this is that low volumes at top end of the market make it difficult to continue investing in high fixed costs of R&D and product development.

Having secured the volume business CIMC started moving up market using its cost innovation to carve out large share of more sophisticated products. Having established its own R&D centre in 1997, CIMC has since consistently invested 2 percent of its revenues in research. Thus CIMC was now having R&D capabilities greater than its volume starved rivals who tried to move up market to escape CIMC competition.

Many European companies think that the strategy used by Chinese companies is no different from that deployed by Japanese and Koreans in industries like consumer electronics and automobiles. But the Chinese competition is different because of following reasons
Cost innovation through process flexibility:

The Chinese secret of providing customers with wide range of products while maintaining low prices is that of cost innovation through process flexibility and recombination of existing technologies in novel ways.

A good example for this is Chint Electrics Company, a maker of electrical equipment such as transformers and power supply units that had recently entered into an alliance with General Electric to penetrate the global market. Chint began looking at how to reengineer its production process in an attempt to eke out its scarce investment capital. They divide their first plant into two areas. On one side were four fully automated production lines, with advanced technologies and just two operators. Adjacent to this were manual lines with thousands of workstations, swarming with people. These manual lines didn’t even have a conveyor belt.

Comparing the lines in the two areas, Chint found that the maintenance costs of the complex automated equipment alone were four times higher than the entire wage bill for workers in manual line. Thus by substituting labor for automation, Chint was able to achieve much lower operational costs. It saved them $600,000 in capital investment for every line. The lesson is “Don’t have blind faith in automation.” Chint built its business on finding the right balance between automation and manual processes to create the flexibility to produce high variety at low cost. This has been achieved just on the basis of low labor cost in china.

But Chint did not stop there it learnt how to add the right process to the work overflow, which is impossible for automated lines. To manage the elaborate balance between manual and automated processes, Chint developed sophisticated systems for coping with poorly educated recruits and high employee turnover, including graphics-based training, knowledge management and incentive systems to symmetrically improve efficiency of workers. It introduced computer integrated manufacturing systems in 1994, since then it spent more than $15 million on IT infrastructure to support the flexible, low cost manufacturing system. It has an annual R&D spending equivalent to 5% of sales. Chint reached turnover of $1.5 billion in 2004 to become the world’s fifth largest manufacturer of electrical products. 

Another company following this strategy is the maker of rechargeable batteries, BYD, now second only to Sanyo In global market share. When the company was founded in 1995 the market belonged exclusively to companies like Toshiba and Sanyo. Together Japanese firms held 90% of the global market. BYD started its business in nickel-cadmium (NiCad) batteries which the Japanese companies were planning to phase out and replace with Lithium ion (Li-Ion) technology that offered improved performance at higher price, promising better margins. BYD also placed a manual line instead of a complex automated line. As a result, BYD was able to develop a production line with capacity for 3,000 to 4,000 batteries per day for a cost of roughly $125,000, as compared with the $1 million spent by Japanese manufacturers on an equivalent production line. Later it expanded to a capacity of 100,000 batteries per day with 2,000 employees. Japanese automated firms require only 200 workers for this capacity. Even with the extra labor BYD could produce a NiCad battery for a total cost of $1, compared with costs of $5 to $6 incurred by rivals in Japan.

Meanwhile the company started to apply the same strategy to produce Li-Ion batteries. BYD found that 90 percent of the materials for Li-Ion batteries had to be imported. BYD again developed a hybrid of manual and automated lines in addition to looking for local sources for the high cost imported materials used to make Li-Ion batteries. These moves resulted in costs falling from around $40 for each battery down to $12.

Recombinative Innovation:

Another tool the Chinese are using to deliver a variety and customization to the global market at low cost. An example for this is Haier’s, which creates new, improved models by recombining existing ideas and technologies in novel ways, rather than by developing additional products internally from scratch.

Due to limited resources it is not easy for the emerging Chinese companies to start new R&D centers like those of big established multinationals. As latecomers to the global market they apply the idea of cutting cost of innovation through recombinative innovation.
It was seen in Haier’s approach to the launch of new, high performance line of washing machines. It observed that washing machines technology and design in Asia, Europe, and North America had independent development paths. Each had its own advantages and drawbacks like European machines used less water, American ones were usually faster, while, Asian made better use of electronic sensors.

Haier decided to combine the best of all three. The result was a machine that used only half the water and achieved close to 50 percent improvement in cleansing power at twice the speed. As an added benefit it also reduced the wear and tear on garments by 60 percent. It’s clear that none of the underlying technology was really new. But this low cost recombinative innovation was awarded the only gold medal for any new product presented by industry at the National Invention Expo held in France in May 2004.

High Technology at low cost:

The Chinese achieve this goal by Leveraging low-cost R&D into the mass market. It is estimated that 4-5 Chinese engineers can be hired at the cost of one Engineer of equivalent quality in United States or Europe.

One of the most striking, and surprising examples of this phenomenon is the case of Dawning, a Chinese company that makes high-performance computers (HPCs). Generally the thought of HPCs brings to our mind the images of world’s fastest super computers with costs above our imagination. But Dawning decided to reduce the costs of these HPCs to make it available to in mass market.

Like many of its counterparts, Dawning faces tough challenges in its early years. Back in 1990, even Chinese government ministries were reluctant to include Dawning in their lists of approved suppliers for HPCs and opted for imported ones. Meanwhile ministry of Railways flatly refused to dive Dawning a procurement contract, so Dawning took the unprecedented step of donating HPC machines to a university attached to Railways. On a day when Ministry’s imported HPC failed, as a stopgap they turned to the Dawning’s HPC. To its surprise, the machine performed better than the imported one.

Dawning’s now focused on how to catch up with and even overtake the technological lead of its global competitors. It thought that investing resources in trying to come up with a revolutionary kind of computing had little chance of success. So, dawning decided to take the existing international processor technology used by companies like Intel and Motorola as a given and think of a step change in the performance by improving the capabilities for the processors to work together (parallel computing). Dawning learnt that of the 80 percent performance improvement computers had achieved in the previous decade, improved microprocessors (better chips) accounted for only 20 percent, better coding of software applications for another 30 percent. The biggest contributor, accounting for 50 percent was innovations in the way the chips interacted with each other. Dawning therefore directed it R&D efforts on the interaction between existing processors.

Dawning launched Dawning 2 in 1995, it had made a technological advance in the hardware and software required to get standard processors to work at super fast speeds. They named this as “Cluster system”.
Then Dawning cooperated with AMD in developing the world’s first “four route” server based on AMD’s Opteron chip in 2003. It also entered into close cooperation with Sun in 2005 to integrate its new server with Sun’s Solaris operating system.

Dawning started to direct its R&D to improving four aspects of computer performance: scalability, usability, manageability, and availability. Dawning worked in close relation to its customers and responded to the demand of transferring some of its supercomputer technology to the low-end server market by launching I220 server. 

Dawning bypassed its competitors’ advantage – individual chips with superior performance – and leveraged its own strengths by using low-cost R&D resources in the labor intense and painstaking task of developing alternative clustering technology to achieve the same high performance. 

Thus, China’s unique confluence of advantages, such as: Access to low-cost talent at all skill levels; Access to state assets and intellectual property at a discount; Exceptional management autonomy; Strong incentive to succeed, have worked wonders to them. 

To add to this are the strategies Chinese businessmen learnt from the others, such as, modular products and services; high technology products made available at low costs, leveraging low cost R&D into the mass market, betting on low cost, disruptive technologies, riding the open architecture wave and hopping from specialty to specialty, have worked miracles for China. The Western World did not visualize China as a possible threat when they encouraged their low cost products. But low cost has remained, what is new is they have taken in their fold the new technology, as well. And, here is a lesson for India to adopt. 

Zeng, Ming and Williamson, Peter S: Dragon at your door: How Chinese cost innovation is disrupting global competition. HBSP, 2007