China Strategy Pays Off

The challenges of doing business in China's booming automotive industry are, without question, overwhelming.

There is no network of stable, qualified suppliers for components. Logistics chains are so long that suppliers must stockpile reserves — hardly a model of just-in-time efficiency. The Chinese government occasionally institutes rolling blackouts when regional powerplants are nearing capacity.

In addition, the supply of raw materials is less than reliable, as China's construction frenzy consumes vast quantities of steel, oil and concrete. Parts legitimately produced occasionally end up on the street, copied and sold by counterfeiters.

But labor is cheap, the land plentiful and an emerging market economy is embracing foreign investment. In this world of global pricing, it appears all roads in the auto industry lead to China.

ZF Friedrichshafen AG has opened 11 plants in China since 1994. Three of those have come on line in the last 12 months, and more facilities are on the way. Despite all the difficulties of doing business in China, ZF executives say the payoff is well worth the trouble.

“We have risks, of course — energy, material, logistics, so on,” Hans-Georg Haerter, ZF board member and CEO of ZF Sachs AG, says on a recent tour of the company's Chinese operations. “But we have opportunities, and these opportunities are much greater than the risks.”

All of ZF's plants in China either have made money or broken even in the recent past. “We are not earning a fortune here, but we definitely are not losing money,” says Siegfried Goll, CEO of ZF Group. Maintaining profitability will be difficult due to recent downward pricing pressure in China's auto industry.

ZF holds the majority share in 10 of its 11 Chinese operations. With its first partner, Shanghai Automotive Industry Corp. (SAIC), the supplier formed ZF Shanghai Steering in 1994. The supplier now supports manufacturers of cars, commercial vehicles, construction machinery, trains and boats in China.

“We've got good partners — they are reliable partners,” Haerter says. SAIC, for instance, has partnerships with Volkswagen AG, General Motors Corp. and others, but those relationships are not problematic for ZF. “The Chinese flexibility is accepted,” Haerter says. “We don't have JV contracts that are limited for a number of years. They are long-term contracts. It builds up trust.”

ZF supplies in China nearly everything it produces elsewhere in the world: clutches, automatic transmissions, steering systems, shock absorbers and chassis parts. But some of the facilities merely assemble components produced elsewhere. For instance, ZF's Shenyang plant (see sidebar) may not add much value beyond assembly, but the company is planning for production at the plant to meet government mandates that 40% of content be locally produced.

Meeting local content requirements is difficult without a qualified supply base, and ZF admits this is one of the biggest challenges in the region.

“Go back three or four years, and there was nothing available, but it becomes more and more sufficient for us,” Haerter says. Localizing more production will require ZF to hire more engineers in China, which the company says will not be a problem.

A senior engineer in a developed area such as Shanghai costs RMB151,900 ($18,500) per year, including health care and social benefits. That is roughly one-eighth the rate of pay and benefits for a similar engineer in the U.S. or Europe, ZF says.

As for hourly labor, the price is much lower. At ZF Shanghai Steering, for example, workers are paid RMB36 ($4.35) per hour, including the cost of benefits.

But within China, there is massive disparity in wages. Uwe Trautmann, general manager of ZF Shanghai Steering, says he visited Yantai in the Shandong province in the north, near the Korean peninsula, and learned that labor costs there are less than half that of Shanghai.

In Shanghai, some counterfeiters consider any product to be fair game. Trautmann says counterfeiters not only have sold power-steering pumps based on product from ZF Shanghai Steering, but some fake goods even have surfaced with the company's label attached. ZF recently prevailed in a court case — but only in blocking brazen counterfeiters in China from using the ZF label. Trautmann says the Chinese government is doing what it can, but struggles to prosecute unless a company's label is used.

ZF identifies China and Eastern Europe as its two most ambitious growth markets. The company had 2,727 employees in China in 2003, and headcount by the end of this year is expected to reach 3,243. ZF posted 2003 sales of €317 million ($387 million). Sales are expected to reach €700 million ($856 million) by 2006.

The supplier's latest venture in China is ZF Transmissions Shanghai Co. Ltd. ZF holds a 51% stake, and SAIC has the remaining 49%. The new company will supply Shanghai Volkswagen Automotive Co. Ltd., which has three plants and is building a fourth.

And with every new plant comes increased concern that China's capacity to produce energy will not keep pace. The government has initiated a massive energy and water project, which still is in the planning stages.

“It can be that the government says you must stop working on Monday or Tuesday, but then you can produce on Saturday or Sunday,” says Haerter. “It's difficult if you have just-in-time delivery, and you have to stop for two days.”

Goll says the inconsistent energy supply is why ZF has multiple locations in different regions of China.