Letter bombs (11): Coming up on the rail
Posted by ampontan on Sunday, October 17, 2010
READER MAGUS sent in an e-mail about the requirements international companies must comply with to do business in China, and what happens as a result. I thought his e-mail and the links he provided would make a fine post. He gave me permission to run it, so here it is.
Here’s an article from the Financial Times that talks about China’s booming train industry, and some background information. (Note: The Financial Times link might ask for registration. If it does, just Google the title “China: A Future on Track”, and no registration is required to read it.)
This article brings to light what every business with real R&D operations and advanced technology has known and been worrying about for nearly a decade when working with China.
In what many international executives see as a warning for other industries, these companies have spent years “transferring”, or selling, technology to state-backed partners in exchange for market access – only to be rewarded with shrinking market share in China as a result of state policies that favour local industry.
Now these companies find their high-speed technology has been “digested” – defined by the government as a multistep process of buying foreign technology, innovating on that existing platform then selling it under a domestic brand – by former Chinese partners. Furthermore, the foreigners find themselves competing head-to-head for tenders all over the world with Chinese companies selling digested high-speed technology at discount prices, often with cheap state bank financing thrown in.
In 2002, China unveiled their own high-speed domestic rail technology “China Star” to compete with the foreign rail companies that were dominating their huge rail industry. It ended in disaster, with the PRC declaring the technology “immature” less than a year later.
In 2004, Kawasaki entered the Chinese market with the promise by the PRC of more than $100 billion USD in future rail contracts. The catch is that to do business in China, at least 70% of the parts for any given train must be produced by a domestic Chinese company. That is different from business practices in other countries. Otherwise, Kawasaki could have simply set up a Chinese division, just as Honda or Toyota have US divisions that produce cars locally for their market. The Chinese require production by Chinese domestic companies.
This of course meant that if Japan wanted to do business in China, it had to share technology with Chinese companies. The result of the collaboration between China Railways and JR was the China Railways CRH2 (photo: Kimon Berlin).
If it looks a lot like the Shinkansen E2 series, that’s because it basically is (photo: Rda).
Now here’s where the problems come in. Kawasaki was promised $100 billion in future rail contracts, so they were happy to start up business in China, share technology with their Chinese partners, and work with their Chinese partners to produce that E2 series clone for the Chinese high-speed rail market. One would assume that as Kawasaki received some of those $100 billion in contracts, they would share more technology and start exporting their more advanced Shinkansen technologies.
That isn’t what happened, however. Starting in 2008, China Railways began producing their own CRH2s, without any help from Kawasaki, using their own “Chinese” technology (i.e., technology that Kawasaki gave them and helped them with). Now, Kawasaki finds itself in a position in the Chinese market in which, though they were promised $100 billion in contracts, they have to compete with the China Railways’ 100% domestically produced trains (which are the result of Kawasaki giving them technology so that they could fulfill the 70% domestic company requirement). Obviously, a 100% Chinese train is cheaper than Kawasaki could ever compete with. It also has the advantage of being domestic, thus providing local Chinese jobs and good PR for government contracts. Even if Kawasaki did get contracts for building more trains for China, 70% of its business would have to be subcontracted out to China Railways anyway to fulfill the 70%-produced-by-domestic-companies requirement.
Kawasaki entered the Chinese market in 2004 with the promise of hundreds of billions in Chinese rail contracts. In four short years, it single-handedly created its own cheap, Chinese competitor. Of course, everyone who does business in China knows that it runs the risk of such situations, but the speed at which Chinese companies were able to catch up to and displace Kawasaki from the market — four years — is nothing short of staggering.
Another Financial Times article, Japan Inc Shoots Itself in the Foot on Bullet Train, confirms that Kawasaki is no longer working with CSR Sifang Locomotive on heavy rail. Also:
Some observers say that while the 2004 contract meant KHI received only a tiny slice of the Chinese high-speed rail market – which is expected to be worth Rmb700bn ($100bn) this year alone – the licensing deal may have won it goodwill in Beijing that could open other rail-related opportunities.
The cost to Japan Inc could prove high, however. China is marketing its high-speed railway expertise, making it a potentially strong competitor on projects from Saudi Arabia to the US.
A Japanese executive familiar with the 2004 deal says members of the KHI-led consortium realised the deal could help give China a start in the industry, but they “could not imagine” the catch-up would be so fast.
The situation is the same with Bombardier’s Regina and the China Railways CRH1, Siemens Velaro and the CRH3, and the Alstom Pendolino and the CRH5.
All these companies (Kawasaki, Bombardier, Seimens, Alstom) entered China, were forced to give their technology to Chinese companies, and now the Chinese companies replaced them domestically. At least they made a quick buck.
But it gets worse. Here’s a photo of the Japanese E5 series (photo: D A J Fossett).
Well, take a look at China Railways’ new CRH2 380A (photo: alancrh):
In other words, Kawasaki dug its own grave in China.
It gets worse. China was one of the many countries that Governor Arnold Schwarzenegger visited in his search to find the right bullet train for California’s future.
“Today what I have seen is very, very impressive. We hope China is part of the bidding process, along with other countries around the world, so that we can build high speed rail as inexpensively as possible,” he told reporters.
Well, it turns out that China is now in the bidding process.
In short, Bombardier, Siemens, Alstom, and Kawasaki have not only created their own domestic Chinese competitor, but a cheap international Chinese competitor. With the mandatory 70% domestic production requirement, it seems that creating your own Chinese competitor is a requirement for doing business in China.
China claims that all these advancements (in four years) are due to the amazing ingenuity and work ethic of the Chinese people. While China’s people are indeed hard workers and frequently amazing and ingenious, they did not come up with the technologies required to make a state-of-the-art bullet train by themselves in four short years. That article in the Financial Times points out:
Despite its claims that all its high-speed technology is now homegrown, the ministry has organised a team of lawyers and officials to investigate how vulnerable state rail companies will be to IP lawsuits when they start selling in the international market.
The rail industry is not the only industry affected by these kinds of practices. If you plan to build electric automobiles in China, there is of course a requirement to partner with a Chinese company. The Chinese company is awarded all intellectual property rights as a result of the joint venture, and the Chinese partner must have a stake greater than 50%.
The plan is “tantamount to China strong-arming foreign auto makers to give up battery, electric-motor, and control technology in exchange for market access,” says a senior executive at one foreign car maker. “We don’t like it.”
Also, despite complaining about illegal Chinese trade practices, GE is forming a company with—surprise—51% Chinese ownership to create wind energy technology. The United Steelworkers Union filed a trade complaint with several objections, one of which is, “requiring foreign companies to divulge technology secrets to the detriment of the United States’ own wind industry.”
And then there was the debacle in the IT industry, in which IT companies would have to provide their source code to the PRC. Fortunately, that one caused enough of an uproar to have been mostly overturned.
So it seems that business-as-usual in China means creating your own cheap, international competitor. Kawasaki learned this the hard way. How will Toyota, Honda, and Nissan fare?
It’s worth the time to read the articles at all those links. Magus has done the research.
What the heck–it’s the weekend: