Saturday, October 30, 2010

The Changing Chinese Mindset Towards Product Quality: How China Is Looking for Its Place in This World

Given my love for sushi, the prediction that saltwater fish will be extinct by 2048, and the poor reality that we suck at protecting the natural habitat of seafood, I am left with two questions.  Firstly, how do I gorge on as much safe yummy sushi as I can while I still can?  My short-sighted rationalization tells me that it's OK, future generations wouldn't know what they'd be missing anyway; in fact, they'd just be very sad and upset if they did.  Those stupid ancestors!!!  All kidding aside, a second actually important question is: will anything fill the gap?  Maybe, maybe not.  So it was with great interest that I read this article about how China could take over the global (or at least the US) fish market by using landlocked fish farms.

For the record, I've eaten luofeiyu (or tilapia, as it is termed in English).  In fact, I had one for lunch a couple of days ago.  My first experience with luofeiyu was in 2005 in Xichang, Sichuan.  Xichang is perhaps most famous for being the location of China's spaceport.  It's the capital of the Liangshan Yi Autonomous Prefecture in Sichuan.  They happen to love their luofeiyu and seem very proud of it.  They have restaurants that are dedicated to luofeiyu.  So this article is a tad incorrect when it seems to say that Chinese in general hate the fish.  The fish itself is fantastic when barbecued with Sichuan spices.  However, when I ate it for lunch recently, it was broiled and not very seasoned. As such, I could see what the article was saying when it described the fish as bland.  I much prefer it barbecued on a stick on a street or lakeside in rural Sichuan.  Seasoned correctly, it's unlike any fish I can eat in Vancouver, and ranks among my favourites.  It's just too bad that it doesn't have any omega-3 oils.

But this blog post isn't about fish, is it?  It's about Chinese products and what Chinese people are starting to look for.  I want to talk about quality standards in China, and what I think it means for the world.  Two passages from the fish article really struck me as being the dichotomy for how western folks view Chinese products.

The view that Chinese products suck and are dangerous (i.e. why countries should import less from China):
A report last year from the U.S. Agriculture Dept.'s Economic Research Service called into question Chinese safety standards for farm-raised fish and seafood. "Fish are often raised in ponds where they feed on waste from poultry and livestock," the report said. Meanwhile, environmentalists are concerned about the impact of China's fish farms, as water filled with tilapia feces is flushed from the ponds. They also worry about the invasive nature of the species in the U.S. (Last year in Louisiana's Plaquemines Parish, for example, officials used poison to kill off tilapia in the area's canals and ditches.) "In theory there is quite a lot of regulation in place," says Pete Bridson, aquaculture research manager at the Seafood Watch program in Monterey, who traveled to China last year to visit tilapia farms. "But the environmental side of the regulation is not enforced very well."

A global aquaculture industry dominated by China worries Mike Picchietti, president of Regal Springs Tilapia, a company based in Bradenton, Fla., that operates tilapia farms in Indonesia, Honduras, and Mexico, and is a supplier to Costco (COST). For instance, he says Chinese farmers save money using fish feed only when the tilapia are bigger. When they're still young, he says, farmers toss animal waste in the ponds and allow the tilapia to feed on the algae bloom that follows. "They're able to cut their feed costs because they're able to use manure," he fumes. Raised-in-China tilapia are therefore much cheaper, according to Picchietti. "The Chinese are able to use cowshit," he says, "and I can't." Chinese tilapia growers deny Picchietti's claim.

The view that Chinese products strike an excellent balance between cost and quality (i.e. why everyone manufactures everything in China):
Other plants follow similar procedures. At the one operated by HQ Sustainable Maritime Industries, an Evergreen rival with offices in Seattle and Hainan, the clean suits are color-coded: Visitors wear white; assembly-line workers, blue; managers, red; quality-control supervisors, yellow. On a recent visit to the factory, plant manager Wang Fusheng points to a yellow-suited officer roaming the fluorescent-lit room. "That guy is powerful," he explains. "He can stop anything right away." Before HQ's fillets go into cold storage, the fish pass through a metal detector, just in case any stray flecks of a filleting knife have made their way into the product. "Every day we account for how many knives we've given to workers," he says. "If one knife is missing, you check everything."

Executives with tilapia processors in China point to such requirements as examples of their determination to maintain product safety. Chinese government labs regularly inspect for melamine and other banned additives; some Western buyers have their own quality inspectors or rely on third-party auditors to test the fish. Given the frequent inspections by Chinese officials and Western nongovernmental organizations, HQ Sustainable Chief Executive Officer Norbert Sporns rejects accusations that Chinese tilapia is substandard. "China is the most scrutinized export market in the world," says Sporns. He's a six-foot-seven former immigration lawyer from Montreal who got involved in Chinese aquaculture in the late 1990s; his wife, HQ Chairman Wang Li, is the daughter of a former chamber of commerce chairman in Hainan. Sporns compares Chinese tilapia farms favorably to catfish farms in Louisiana, where he calls conditions "despicable." "Our standards," he says, "are way, way better."

Despite the fact that China manufacturers most of the electronics, clothing, and everything else consumed by the rest of the world, China still has a global reputation of manufacturing and consuming shoddy products.  How's that work?

Honestly, it's more correct to say that Chinese brands have a poor reputation worldwide.  The products that get manufactured by China for western brands are fine.  So China is trying to change their image as they look to move up the value chain.  One of the big topics that kept coming up again and again at this year's APCAC conference in Beijing (organized by the American Chamber of Commerce in China) was how China wanted to move up the value chain.  China wanted to stop being viewed as a white-label manufacturer used for outsourcing and start flexing its muscle as both a consumer and designer of products.  Manufacturers are servants.  The customer is king and the designer is the king's prime minister.  The servants are still servants.  If you get my drift.  And I would argue that being a major consumer and being a major designer are very symbiotic subjects for China.

China becoming a heavy-duty designer is an audacious goal.  But China becoming a heavy-duty consumer is now very viable.  In fact, it may even be necessary, simply because the economy is being squeezed on three sides to go in this direction.  Firstly, as the economy has grown, so has the wealth per capita.  There is a growing middle class that has discretionary income to spend on nontrivial luxuries.  And these people demand quality.  Secondly, as wealth per capita has grown, so has labour cost.  While labour is still relatively cheap in China compared to western nations, it's increasingly more expensive.  Thirdly, as China has grown to become more of a player in the global scene, there's this ferocious hunger in China to be recognized and considered among the world's elite.  Elites aren't forced to serve.  Elites are the ones being served.  The difference between China and other Asian elite-aspiring nations like Singapore and South Korea is that China has the mass and momentum to be taken seriously.  The four horsemen are BRIC: Brazil, Russia, India, and China.

Evidence for the ability to consume is in the people.  One day while looking for a restaurant where we could eat lunch, a friend pointed out a shop where I could buy some cheap stuff if I wanted.  But she also said the quality is so bad that she doesn't buy anything there herself.  Some other friends told me they were going to Hong Kong this weekend to shop, mainly because Hong Kong had better quality for the kind of stuff they wanted.  Just today, I went happily to a big outlet sale organized by my bank for a customer appreciation day.  Thousands of people thronged an exhibition hall browsing racks of Hugo Boss suits, Gucci bags, Nike microfibre windbreakers, and the like.  I didn't buy anything because the cheapest pair of pants I could find cost about $25 (that's Canadian currency); I saw suits on sale that came to about $2000.  I was disappointed because I thought I'd be able to find a ton of name-brand stuff cheaper than I would in Canada.  I was wrong, it was the exact same price.  And thousands of people filled the exhibition hall buying this stuff.

Clearly, this growing middle class cares more about what they buy; it's no longer about the cheap fake knock-offs.  The big light bulb moment came when I saw all these photos of people lining up to purchase iPads at the new Apple stores in China.  So how's that iPed doing, eh?  Yeah, iPad may be designed and sold by Apple, but it's manufactured by Foxconn right here in Shenzhen.  Two products manufactured in the same city, but only one is viewed as a product that people aspire to have.  People in China are starting to have money and want to strut their stuff.  This is both good and bad.  It's bad because maybe too many little emperors (a social effect of the one-child policy) will may end up feeling way too entitled about everything, making for a society that is unable to meet the expectations of its population.  As well, you only see this kind of consumer behaviour in the major urban centres.  In the rural areas, it's much less developed, and the economic disparity poses risk for civil unrest.  This is definitely also a cause for concern.

But it's also good because it demonstrates economic progress.  And in a strange way, I think this demand for high quality global brands is good for China, because it will force Chinese companies to get their act together in order to compete.  If Chinese citizens are demanding high quality products, then Chinese companies will not be able to compete with shoddy products.  This is the link.  This forces China to think more like an original designer than a cheap me-too copycat.  Chinese brands are going to need to figure out how to increase quality and customer service, eliminate all the product safety scandals, earn consumer trust, and develop noteworthy brands.  Once they are able to achieve this, only then will Chinese consumers be able to jump for joy when purchasing an iPed instead of an iPad.  And when Chinese brands are able to win over consumers on their home turf, that's when Chinese brands can start trying to compete on the global market as respected players.  In the worst case, they'll be pushed back and remain #1 only in China like Baidu and Tencent's QQ.  That's still a step forward because it's better than seeing BMW and the like slap around Chinese luxury autos in their own backyard.  Quality and market success needs to start at home before similar achievements can even be contemplated worldwide.

So things are changing in China.  In fact, wages are rising so much that it was discussed plentifully at APCAC 2010 whether it was viable for China to retain its manufacturing strength, with companies even starting to choose Vietnam instead of China for manufacturing facilities.  The general response from American business leaders was that although Vietnamese labour may be cheaper, Chinese labour is more productive.  As well, China has the opportunity to increase its industry out west, a region that has not seen a lot of attention until now, since the government wanted to modernize the major urban centres out east first.  So despite the higher wages, China is somehow maintaining its luster and may be able to have its cake and eat it too.  And get seconds.  With the higher wages and consumer demand for higher quality comes a correlated societal demand for respect.  The Foxconn suicides did well to highlight important issues about business practices in China.  Many people cried out against Foxconn and decried the "sweatshop conditions" allegedly typical of Chinese manufacturers.  I agree that this was an issue for sure in the past, and can still be.  But people don't understand the significance of this quote:

Hon Hai and the Hong Kong-based Foxconn unit have struggled this year with the fallout from a series of suicides that focused international attention on labour practices in the region.

The issues prompted the company to raise wages and were a trigger for a series of labour disputes over working conditions in a region dubbed the world's workshop.

The practices of manufacturing companies in China is one thing.  However, the work conditions are far greater influenced by a single factor: western consumerism.  Western consumers have only been able to have such a nice life because they've outsourced all the nasty bits to cheap labour in other nations, including China.  Fake Steve Jobs said it best:

We all know that there's no [bad word] way in the world we should have microwave ovens and refrigerators and TV sets and everything else at the prices we're paying for them. There's no way we get all this stuff and everything is done fair and square and everyone gets treated right. No way. And don't be confused — what we're talking about here is our way of life. Our standard of living. You want to "fix things in China," well, it's gonna cost you. Because everything you own, it's all done on the backs of millions of poor people whose lives are so awful you can't even begin to imagine them, people who will do anything to get a life that is a tiny bit better than the [expletive] one they were born into, people who get exploited and treated like [expletive] and, in the worst of all cases, pay with their lives.

You know that, and I know that. Okay? Let's just be honest here. Just for a [bad word] minute, let's all be honest.

China's got money now.  The world has been feeding it for years to get cheaper products.  All this huge investment and growth happened despite the fact that the social infrastructure may not have been ready.  They still may not be ready.  There are still a lot of issues.  But now China has scale and resources, so they're coming for the rest of the world.  It's payback time and China wants some recognition; they are flexing muscle.  They already have the most foreign ownership of US debt and according to some were instrumental in saving the euro from collapse.  And fortunately for China (and unfortunately for other nations), China is seen as a huge growth market where everybody wants in.  This gives China ridiculous leverage to negotiate deals that allow Chinese industry to accelerate its progress in the goal to become a house of globally respected brands and designers, not simply manufacturers used for outsourcing.

Japan and South Korea traveled the same road in trying to build their products into globally respected brands.  The story of how Samsung grew its brand in the US is a fascinating story; I heard it firsthand from the consultant who headed up the market entry strategy on Samsung's behalf.  It was just too difficult for Samsung to establish a noteworthy beachhead in anything until these consultants came in and recommended attacking cell phones, which was still a nascent market in North America at the time.  All the incumbent players in mature markets were too strong to displace.  After they established themselves in cell phones, the Samsung name was more recognized and acceptable in consumer eyes.  Then they started being taken seriously in other electronics.  Meanwhile, Sony is spelled with a Y because it made the brand name look more non-Japanese, an important factor back when Sony was trying to enter the US market.  I remember seeing old 80s newscasts of American rallies against Japanese products, even smashing and destroying Japanese-made cars in an exuberant rage of America patriotism.  Now we're seeing similar rhetoric in the US against China and Chinese products, though I don't know if it's to the same degree.  But if South Korea could create globally respected brands in the last few decades, I see no reason why China cannot within the next few decades.  Japan is special in terms of culture and creative output, so it cannot be compared.

So.  Is China going to be the next superpower or is it a house of cards being built ever higher and higher just waiting to be knocked flat?  Japan never did fulfill its hyped potential against the US.  But then again, did the US face as many problems back then as it is suffering now?  Fun times, where's a guy supposed to put his money for safekeeping?  Last quote:

VK: Sure, the growth you see today in China is there, but it's not a sustainable growth. It's not a growth that you'll see a few years from now. That is an important point for readers to understand.

TCR: Why is it not sustainable?

VK: Because the growth is being induced by government spending, by a misallocation of capital.

I'll give you an example. The vacancy rate on commercial real estate in China is fairly high, but they still keep on building new office buildings because they think they will always grow. So therefore as long as they keep building, that activity will be registered as growth, until they stop. And when they do stop, they'll drown in overcapacity, and they won't be building new skyscrapers for a very long time.

TCR: We read that note you sent about the South China Mall, which is pretty stunning. It's the second largest mall in the world but is mostly empty.

VK: That's right. But as outrageous an example as the South China Mall is, there's an even more outrageous example – namely that the Chinese built an entire city, Ordos, in Inner Mongolia for 1.5 million residents and it is completely empty. These are classic examples of the sort of excesses going on in China.

TCR: The equivalent of building bridges to nowhere, but on a very large – Chinese – scale.

VK: Exactly. There are no shortcuts to greatness. As long as they keep building new bridges, the economic numbers will register that there is growth, but at some point the piper will have to be paid, and these projects have a negative return on capital.

It would be a pity for China if the Chinese economy comes crashing down before Chinese companies are able to figure out how to create good products and establish good global brand presence.  Remember, for South Korea, it was a multi-decade process.  Or maybe that's when we'd see China's best.  The greatest stories are always built in the midst of adversity.


  1. Interesting, what a coincidence, I just read an article about Chinese products this morning:

  2. It's interesting because as the middle class grows in size, I wonder if people will just stop buying fake stuff. For example, I was really into pirating software, music, etc when I was in high school. Now that I'm making money? I'd much rather buy the real stuff, especially to avoid the security risks that come from using cracks, inability to install patch updates, etc. Quality is usually always better with the real thing. My prediction is that as the middle class grows here, fake stuff will decrease. Heck, I'm seeing that kind of consumer behaviour here already.

    And if on the rare occasion the quality is better in the fake stuff, whoever's making the fake stuff is better of creating their own independent brand and competing head to head with the incumbents, I hope? :)

  3. Mark Cuban has an excellent post on why people pay money for music and other content when they get older and start to make money: