China’s Manufacturers and the Quality Control Conundrum

Consumers in China are all too familiar with the realities of shopping locally. In the kingdom of "caveat emptor," the buyer who doesn't beware faces a daily gamut of frustration and disappointment with substandard purchases — clothes unraveling in the first wash, lids not fitting pots and pans, and kitchen gadgets exploding as soon as they're switched on are as frequent as the scandals involving substandard, and often toxic, food and medicines.

Call it one of the paradoxes of modern industry: Countless consumer goods multinationals have built global empires by contracting out manufacturing to partners in China, generally without cutting corners or letting quality standards slip. Yet for one reason or another, Chinese firms aren't replicating that success at home. Shaking off the shackles of low-quality manufacturing is a mammoth challenge for many. But as China's once formidable cost advantage shrinksand the country aims to reduce its reliance on exports, the need to address the issue is intensifying by producing more products that can collectively escalate the country up the "value chain" of manufacturing.

"It is happening very slowly, but it is happening," says Michael Clendenin, managing director of RedTech Advisors, a Shanghai-based consumer technology research and consulting company. "For every one Chinese company that is improving [product quality], there are probably 10 out there that are still cutting corners and two [other] new companies are coming into the market by cutting more corners."

Get Rich Quick?

In 2007, the world woke up to what Chinese consumers had long contended with, when a number of Western multinationals, including toymaker Mattel, were forced to recalls all sorts of tainted or faulty China-made products. While regulators tightened policies and many corporate risk managers swung into action as a result, there is still no getting away from the fact that "some Chinese industries suffer quality problems — especially in food, where stories of contaminated or adulterated foodstuffs simply do not go away, despite numerous government initiatives to correct the problem," says Wharton management professor Marshall W. Meyer.

Other industries — notably consumer electronics — are doing a better job of raising the bar. "Chinese companies that are playing at the higher end of the market understand slightly better how manufacturing works," notes Paul Midler, a consultant and author of Poorly Made in China. Yet those companies seem to be in the minority."Many manufacturers are not interested in making a quality product and building a long-term reputation," he says.

One reason for that, he adds, is China's booming real estate industry. A number of manufacturers "got into manufacturing mainly because they saw [the money they could make in manufacturing] as a stepping stone to real estate," he says. In a roundabout way, that spells trouble for quality: "Compare two manufacturers. One wants to make a product to generate a small profit and have repeat business. The other simply wants your order so that he can [make enough money to] build a shopping mall. Which one will be focused on the quality and integrity of the product?"

But short-term gain may lead to long-term pain. "If Chinese brands want to have longevity, they need to improve consumer brand perception and build consumers' trust," states Thomas Isaac, commercial director of the global market research firm TNS in Hong Kong. "Trust comes from ensuring your products are good quality and durable. If there is a problem, you have to address it."

The problems are particularly glaring at companies whose managers suffer from the belief that the trade-off between cost and quality is inescapable. That's the case in the country's small, but burgeoning, electric bicycle business, according toEd Benjamin, managing director of Florida-based eCycleElectric Consultants. "A Chinese businessman boasted to me that he just made a lot of money by reducing the cost of materials. He thinks that he is a smart businessman," he says. "In fact, he is destroying his business and destroying China's reputation. In our ebike space, we still have a lot of old-fashioned businessmen who have not learned their lesson. Customers find a lot of trouble with inconsistent quality."

Yet beyond the get-rich-quick ethos, other, arguably harder-to-address forces are at play, notes Meyer. For one thing, the huge number of small companies and widespread fragmentation of industries make controlling supply chain networks far more complex in China than in other developing economies, such as India. That's compounded by endemic subcontracting — or cheng bao, as it's known locally — which leaves companies grappling with layer upon layer of suppliers involved in making their products, according to Meyer.

Kazuto Suzuki, a professor of international politics and economy at Hokkaido University in Japan, points to China's heavy focus on developing technology for military purposes, rather than civilians, as a key hindrance to upgrading quality. While the government has made huge strides in space and other military applications, commercial technologies have gotten short shrift. "In the military side, you have major military clients. In the commercial world, you have a huge market where you are not sure what kind of technology is needed or what kinds of products people want," Suzuki says. "Chinese companies don't want to invest in uncertain technologies. It is less risky to copy technologies that are established or proven to be profitable."

How to Get the Know-how

So can't China's firms simply imitate their way out of the problem, replicating what they learn from foreign multinationals? Only sometimes, notes Wharton management professor John Paul MacDuffie, who cites China's auto sector as an example. Overcrowded with local suppliers and manufacturers, the sector faces fierce competition domestically from foreign brands. Despite decades of government policies aimed at favoring domestic companies, all the top-selling brands in China are foreign — Volkswagen, with 15.2% of the market, GM at 8.2% and Nissan at 5.6%, followed by Toyota, Hyundai and Honda. The largest local manufacturer is First Auto Works, with 5.2% of the market, as BYD, Chery and Geely fight for the remainder, according to 2011 figures from Global Insight China and Synergistics.

While others say brand perception among locals plays a big role in the domestic companies' fight for the market, MacDuffie also points out that the firms lack the core technologies and know-how to compete with global brands — something that their joint ventures with foreign manufacturing hasn't provided, despite the widespread assumption otherwise. He notes that while the government requires joint ventures for auto assembly plants, but not for suppliers, his research suggests that the plants provide only limited access to foreign product design data and expertise. What's more, strong sales from joint venture autos have left local suppliers with little incentive to develop their own models. As for the suppliers, MacDuffie says a smart way for them to gain expertise, and quality, is to do what Pacific Century Motors did in 2010 with its outright acquisition of Michigan-based Nexteer from GM.

Many experts draw parallels between China today and other countries once known for low-quality manufacturing, including Japan before the 1960s. The big lesson for China? "Historical examples suggest no real way to bypass the need to develop technological and organizational capabilities internally," MacDuffie states. "What they can learn from their foreign multinational partners — via partners or knowledge leakage — won't be adequate."

That could be a tall order. In Japan's case, its manufacturers, unlike their Chinese counterparts, never expanded by making products under other companies' brand names as OEMs. Rather, firms used plenty of reverse engineering and innovation and a tradition of craftsmanship to master numerous technologies, becoming leaders in electronics, automotive, chemicals and other high-value industries. "The Chinese have a hard time saying no to cash in the short term in exchange for a longer vision of the brand. Sony was famous for turning down the chance to make goods under other brand names," says Midler. "Chinese industry is struck with a kind of myopia that defines its philosophy of doing business."

Perhaps a better comparison is Taiwan. Unlike in Japan, Taiwanese firms have been heavily engaged as OEMs, yet also have improved their own product quality and technologies to become — in the case of HTC smartphones, Acer and ASUS computers, among others — big global brands. A big motivator has been necessity. In Taiwan, "people think differently because their domestic market is so tiny. They have been always looking for exports to U.S. and Europe," notes Chi-Jen Yang, a technology policy analyst at the Center on Global Change at Duke University.

Speed Bumps and Detours

As many companies have learned the hard way, raising a product's quality can have its own pitfalls and perils. When Toyota grappled with its product recall crisis in 2010, Takahiro Fujimoto, an economics professor from University of Tokyo and an authority on the Japanese automaker, described to MacDuffie in a Knowledge@Wharton interview, how as the quality of its cars improved, the company struggled to keep pace with a number of subsequent changes "like the number of production lines, production facilities, number of models sold in the global market, and the growing complexity of each individual vehicle due to social pressure and market demand. All these things multiplied together created explosive expansion of the workload for handling quality problems."

South Korea's auto industry has also struggled to move up the value chain, having embarked on a journey that began some 40 years ago to achieve rough parity today with developed country OEMs, says MacDuffie. Quality and safety concerns plagued its brands throughout the 1980s, forcing them to invest heavily in internal R&D capabilities over the following years before brands like Hyundai gained credibility with car buyers.

Improvements in quality also depend on countering other tendencies in Chinese industry, including rampant counterfeiting. While making knock-off products that look genuine takes a certain amount of skill, notes Midler, manufacturers cutting corners, adulterating products and other sleights of hand abound. He argues that without a change in attitude across the board, among managers, factory workers and consumers, little is likely to change.

Even if domestic companies were to sell good-quality products on par with foreign brands, Chinese consumers — increasingly wedded to brands — might not buy them. "Chinese engineers and companies are capable of making high-quality goods, but will the market reward them for making them? This is the biggest issue," says Clendenin of RedTech Advisors. "Why should I waste 5% or 10% of my company's R&D resources on creating super products that probably only a few people would buy? I am better off dropping lower end products and focusing on better mid-range products, which are still affordable and which people would buy."

Until recently, China's long-suffering consumers mostly put up with the poor quality of local goods, especially if they felt a bargain was to be had. But as income levels rise, their tastes — and patience — are changing. Consumer expectations may prove the most powerful inducement for China's consumer manufacturers to improve quality. With a market of around 800 million low-income Chinese who accept poor quality for low prices, manufacturers can afford to cut corners. "When the majority becomes middle class, aware of quality and prefer quality to low prices, I think the Chinese market will change," predicts Suzuki of Hokkaido University. Give it 10 or 20 years, he says, and "the Chinese will not buy poor quality goods even if the price is low."

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