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2.2.4 Is China a Market or a Factory?

From the perspective of US companies, India and China are both distant and close within the CAGE framework. Given that, the question lies in how companies should globally expand based on the differences in domestic and foreign business environments? Before introducing theories of global strategy, we first examine whether China should be perceived as a market or a factory.

There are variations in the types of global businesses operating in China depending on whether they perceive it as a market or a factory. Figure 2.2 classifies these businesses in four ways, with its “advantage in production” axis, in which companies view production in China as “being more advantageous than production in Japan,” and the “market advantage” axis, in which companies view China as having “a more attractive market than that of Japan.” One major “distance” critical in this case is the difference in income levels between Japan and China. China's total GDP approximates that of Japan. However, China's population is ten times that of Japan. Thus, the per capita GDP of China is less than one-tenth of that of Japan. Of course, China is a vast country with wide regional disparities. Many Chinese natives along coastal regions of Beijing and Shanghai have income levels higher than the Japanese. However, the country as a whole has low labor costs and its consumers prefer lowpriced items, which is different from the case in Japan.

Fig. 2.2 Is China a market or a factory?

The top-right corner depicts the so-called “locally-produced, locally consumed” consumer products, produced in China for domestic consumption, such as vehicles and beer. High tariffs on vehicles in China and high transportation costs make local production more feasible. China's auto market is second only to the US and is growing annually, giving rise to manufacturing of vehicles primarily for domestic use. The percentage of transportation costs to the overall production costs for products such as beer are relatively high, rendering such consumer durables to be “locallyproduced, locally-consumed.” With China's entry into the WTO, foreign capital regulations in the distribution industry have been reduced, resulting in an increase in the expansion of retail stores such as convenience stores and supermarkets.

The lower-right corner applies to products that are manufactured in China and exported to the rest of the world, according to the “China as a factory” model, and applies to almost every known product. In particular, electronics and textiles are manufactured in the agglomerations at the Pearl River Delta area called “the factories of the world.” These products are exported throughout the world. In addition, with Japanese food product manufacturers recently making forays overseas, there has been significant development in frozen foods and vegetable production in China for the Japanese market.

Among other costs, China's low labor and land costs, present a production advantage for many products. On the other hand, products that must be manufactured in Japan are limited to those requiring a high level of manufacturing technology. For example, high-end electronics such as ultra-slim laptops are manufactured in Japan. In addition, vehicles are manufactured in Chinese factories; however, high-performance automotive parts are often manufactured in Japan and then exported. These products are universal parts supplied throughout the world being manufactured specifically for the Chinese market. Finally, there are only few product categories that are manufactured in Japan exclusively for the Chinese market. Perhaps Japanese animation films or high quality rice, sold as Japanese brands, can be placed in such a category.

The objective of management strategy from the perspective of globalization is the maximization of corporate value (i.e., long-term profitability). There are two ways to increase profitability: increase revenues or reduce costs. Our exercise of questioning China as a market or a factory effectively asks whether a company should elect to increase revenues (the market) or reduce costs (the factory) in its approach to conduct global business operations in China. A conclusion is arrived at by considering the distance in business environments between Japan and China. Generally, when viewing China as a market, the smaller the differences the better, as it becomes relatively easier to manufacture domestic Japanese products specifically for the Chinese market. On the other hand, when viewing China as a factory, differences will be exploited; thus, the larger the differences the better.

This exercise considers how to conduct business operations in China with existing products and services; it is not meant to provide answers to the strategic question of how to foster midand long-term growth in developing nations such as China and India. We have already discussed case studies on Japanese corporations entering China as they are easy to understand. However, in case of India, there are very few Japanese products that can be sold in India as-is. Because of the high cost of Japanese consumer electronic products, Japanese companies lag behind Korean companies such as Samsung and LG. While the potential market for beverages and food products is large, food culture and customs are very different in India, making it difficult to expand the market for Japanese foods there. Specific local circumstances must be taken into consideration while developing products and services for local markets.

In addition to the CAGE framework and its distances in terms of global businesses, Ghemawat also proposes a three-axis “AAA” framework for global strategies, that comprises “aggregation,” as provided by domestic production; “adaptation,” or the localization of products for local markets; and “arbitrage,” which leverages distance. Figure 2.3 illustrates this framework. The horizontal axis balances adaptation and aggregation. Adaptation refers to the localization of products and services provided to a domestic market that reflects the needs of that market. Aggregation refers to providing standardized global products for common needs in varying overseas markets. Both adaptation and aggregation are parameters determined by global market characteristics; as the level of adaptation increases, a product will be more accepted by local markets, but will result in an increase in development costs, consequently, nullifying economies of scale for global markets. Companies must find the ideal balance in terms of national and regional market differences as well as in the size of local markets.

“Arbitrage” is presented as the vertical axis. Adaptation and aggregation form the dimension that determines the extent to which distances in global businesses can be diminished, while “arbitrage” derives the value out of these distances. Typical

Fig. 2.3 AAA framework

arbitrage strategy within global businesses can be seen in local production that exploits wage differences. India's offshore software development, depicted in the “The World Is Flat” (Friedman 2005) is a good example of this. Many Japanese manufacturers have adopted this arbitrage position and have established production centers in China. Arbitrage is a widely used term in the finance industry, and arbitrage trades refer to those trades that generate profit by exploiting differences in interest rates within financial markets. Financial products are quickly traded in the market even in case of a minute arbitrage opportunity; such actions in turn resolve market distortions. Arbitrage opportunities are likely in a global business environment with national barriers. China has become popularly known as the world's factory, and companies world over are investing in China, in the hope of taking advantage of arbitrage trading opportunities. For the same reason, western companies have concentrated offshore development in India.

We now return to examine the AAA framework by using the consumer electronics industry as an example. Consumer electronic products can be divided into whitegoods products, such as washers and refrigerators, and audio/visual (AV) equipment, such as televisions and video cameras. Generally, overseas expansion can be executed efficiently for white-goods products in terms of “adaptation” and for AV equipment in terms of “aggregation.” Sale of white-goods products is closely associated with country-specific lifestyles. For example, most washers in Europe are front-loading and have a vertically rotating drum; this design consumes relatively less electricity and water. Europe has a much stronger propensity to environmental awareness and has stringent energy conservation policy standards. On the other hand, washers in Japan and the US are typically top loading and spin horizontally; this design consumes relatively more water. Similarly, the capacity of refrigerators varies according to shopping frequency. In the US, consumers often buy goods in bulk because they can load them into their cars; this type of shopping requires relatively large refrigerators. Therefore, white-goods products must be localized for each market by observing how locals live. In lifestyle research centers located in developing nations such as China, Panasonic analyzes home environments and lifestyles of local consumers by visiting their homes. Product development is, therefore, based on information obtained in these lifestyle research centers so that products can be adapted to local market environments.

On the other hand, AV products such as televisions and video cameras are not impacted greatly by lifestyle differences. Of course, there are always differences such as in television's broadcast systems and frequencies, but the basic functions are universal. Selling these products in developing nations requires an “aggregation” strategy to reduce costs and increase cost competitiveness. The price of AV products drops annually. Manufacturers in China and other developing nations are technologically catching up with Japanese manufacturers, and while Japan may have higher quality products, their acceptance rate in many markets will be difficult without price reductions. Sony has standardized the design of components that are not specific to any particular region, such as digital video processing chips, to increase television development efficiency. In doing so, Sony has centralized development teams in Tokyo. In addition, Sony has strategized to distance itself from low price competition in developing nations by improving their brand image through their specialty shops, called “Sony Style.”

How is arbitrage used to the advantage of Panasonic and Sony? Both companies have production centers in low-cost regions such as China, and benefit from the merits of arbitrage through cost differences. Moreover, they are in the process of shifting product development and design to developing countries such as China and India; however, teams located in Japan still play a central role in these functions. As indicated in Fig. 2.4, companies must choose between adaptation and aggregation; however, it is noteworthy that arbitrage can be accomplished in combination with either.

Fig. 2.4 Porter's value chain. The integration of procurement and logistics, procurement, and logistics (Source: Porter 1980)

 
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