The Chinese Industrial Swarm
Having been here so long, sometimes the scale and the speed are taken for granted, not noticed in the day-to-day. But once in a while, China jumps out and smacks a surprise into the face of all, even us. Last week in Shanghai was just such a moment.
It’s not Shanghai that surprises so much, but the sight of China’s Industrial Swarm that startles. Much is written in the West of China’s trade and industrial policies, but nothing that I have seen accurately describes the scale, speed and nature of what happens. The conception seems to be that there is some small group of autocrats that make a policy and send out the orders and that the country marches to their tune. There are industrial policies, and they are made in China’s own view of what is best for China. But that is not how it works. How it really works, and what it means is what I’m going to try to describe below. Now China does use other policy sets, frequently, but the Swarm is special and deserves to be segmented out for description.
First of all I hesitate, and apologize for, the use of the word “Swarm”. I am aware that it will raise a set of connotations and misconceptions. But unfortunately I can’t find a better adjective for what we see here. The industry at subject here is the China PV (Photovoltaics), which is an industry that has drawn considerable political attention of late. We have all read about the prices being driven out of China in this industry and how such pricing is making it difficult or impossible for PV manufacturers to remain in the US or Europe. While the whole value chain is more complicated, the direction has been clear for a couple of years now.
China is accused of using industrial policy to dominate this market, while actually using very little of such production for their domestic market. In fact this is true. The lack of domestic use is different from what many people assume, the reason is called State Grid, one of China’s massive, powerful and rich monopolies, but that story is for another day. But it is how the Swarm actually works that is so very interesting and amazing. At the PV show in Shanghai in February of this year, there were 13, yes 13, full pavilions. Large pavilions. Every level and every product of the value chain was represented, over-represented. And for what the Chinese are not yet able to make, all of the major engineering, technology and integration companies from Japan, the US, and Europe were all there to sell and teach. And buyers from all over the world were there in droves.
China Inc. has swarmed and there is no turning back – for them or for the rest of the world. In brief, this is how it works, and why I call in the Swarm. It works at different levels and intensities. What is described below is a generalized version at the national level. It works basically the same at each level and for each industry. Note that the intensity of the signals will be different in different cases, but the pattern holds true.
It starts with the policy makers in the NDRC (National Development and Reform Commission). Reports are made, policies are designed and then the approvals from senior levels of the administration and party are obtained. A round or five of policy discussions will be held with related ministries. Then consultations take place with provincial NDRCs and seminars, classes and circulars are held/circulated for various officials in related industries, and the provincial and selected city governments. After this, a set of incentives, usually modest, are promulgated for the provinces and selected cities. This is the first “swarm” signal. Now it is sometimes the case where the NDRC is picking up on something that was started by some enterprising local official in cooperation with an equally enterprising industrialist. Sometimes there are several rounds of experiment and signal at this level. This was the case with PV.
After this some time passes while all of the lower levels of government digest the seriousness of the program and the details and what they mean for them. In China political leaders and managers of State-owned Enterprises are evaluated on a series of criteria that the Party establishes from time-to-time. The promotion of national objectives is a major component of the evaluation schema. Thus, if any political, administrative or economic party member, at any level of the government or state-owned enterprise wants to get promoted, they must pay attention to such signals.
Every such individual has his/her own network of relationships. These will comprise of other government officials, and various industry participants, both state controlled and otherwise. They will then discuss this development within their relationship circle. This is Swarm signal transmission.
If the signals are strong, provincial and local governments will take the opportunity to expand the incentives, typically in line with other objectives and the needs of both their careers and their relationship network. In this way the Swarm signal is amplified.
There is a feedback loop built in. After the initial Swarm signals are out, the results will be observed, typically for a period of two to three years. Results are measured in both political and economic terms. Did the early stage result in awards and promotions for the Party members out front? Did the early stage result in revenues and growth for the economic participants? If so, then the signal is further amplified and the “pile-on” stage begins.
At this stage, every Province, every city, every bank, every producer that can apply some resources, whether political or economic, will start to jump in to the industry. This can be quite comic at times as little cities in far away places draw up big plans, give land away, and devise other local plans and incentives to “get in the game”. The same applies to companies. If they can modify an existing product, stretch a definition, modify a supply or distribution channel, or even if they can create from scratch, with local political help, they too pile-on.
The first result of the pile-on stage is radical cost competition in the easy segments. As this progresses, throughout every niche and specialty of the industry, every possible source of revenue is pursued aggressively, especially exports, but also domestically. As the cut throat competition enters full swing, the attempts to climb the value chain begin. Many, many of the parties jumping in will get squeezed out as the process continues. But sheer probabilities based on very large groups of participants – and again it must be emphasized that this is for every single component, niche, material or system in the value chain – ensure that a large number of second stage competitors emerge. It is these second stage competitors that proceed to destroy entire industrial landscapes globally.
It is now in full Swarm.
The important thing to understand out of this is that this is not industrial policy in the top-down fashion as is typically supposed. The people at the NDRC and other related policy bodies understand this swarming effect and specifically design their policies to act as chemical triggers within a system that responds fairly predictably to such signals. They fully understand that some resources will be wasted, and they fully understand that many of the companies that jump in will not survive. At the national level they will intervene for an individual company only in the rarest of cases. But at the provincial and local levels, such direct intervention is very common.
The other key to understand is that the Chinese government doesn’t care about trade problems. In the face of the swarm, traditional trade agreements, negotiations, and sanctions are ineffective to the extent of being worthless. The Swarm attacks everything in the industry, at the same time. Trade complaints, negotiations, sanctions and remedies take years. By the time they have targeted and processes one class of products, it is already too late. Even if they are successful in one class, all of the remainder of the materials, additives, components, niches et. all proceed unopposed.
After the show one night, I joined in with a group of professionals from the West for a couple of beers and some freer talk. They were working out how to deal with the Chinese industry. The various responses were interesting. In the majority of cases, they looked at the current state, and didn’t recognize what they were seeing. I could put a countdown clock on their corporate survival right now. Either they join the Swarm, or they will die. In a little corner of my head I was saddened because I knew that they were already too late. It’s a little like the Borg – without Captain Picard.
In other cases, the responses were more interesting. There was talk of M&A. There was one company that was aggressively pursing vertical integration with selective sourcing in China. There were others who were holding tight in the wager that the technical landscape will be changing. Without the specifics, it is impossible to tell what any given company ought to do in the face of the Swarm. As noted above, retreat into stereotypes is not the best option.
So there you have it, a brief description of one of the most amazing industrial policies in the history of industrial policy. We have seen the Swarm many times, in many industries. China Inc. has swarmed all over the PV industry – and there is no turning back. Companies in other countries had best be thinking how to move with, or get out of the way, of the Swarm.
About GCiS China Strategic Research
GCiS (www.GCiS.com.cn) is a China-based market research and advisory firm focused on business to business markets. Since 1997, GCiS has been working with leading multinationals in sectors ranging from technology to industrial markets, medical, chemicals, resources, building and constructions and a few others.