AMPONTAN

Japan from the inside out

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.

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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 same thing is happening in the green energy sector.

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?

Afterwords:

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:

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17 Responses to “Letter bombs (11): Coming up on the rail”

  1. Brendon Carr said

    You know, there is actually no obligation to do business in or with China, especially if one has advanced technology to protect. By this point, any multinational corporation which is surprised at the way the People’s Republic of China compels the multinational to create its own Chinese competitor deserves to be mocked and belittled. Let somebody else do it.

  2. James A said

    This reminds me of what happened with McDonnell Douglas and their Trunkliner project back in the 90’s. They fell into the same trap Kawasaki did, sold the plans and toolings for MD-90’s to the Chinese and got screwed. They were banking on this project to save their company but instead they ended up getting gobbled up by Boeing in the mid-90’s.

    In the meantime, a plane called the COMAC ARJ21 recently flew in China. Guess what it looks like? That’s right, the MD-90 (Albeit, a shorter version).

  3. toadold said

    Ayup, this also happened in the 1980’s. So you have at least three decades of the Chinese government pulling the same trick. I haven’t checked but I wouldn’t be surprised it it happened in the 1970’s also. There is apparently no institutional memory in either Western industry or Western government. Then considering the state of history instruction in the institutes of higher learning, I shouldn’t be too surprised. I suppose it won’t end until stock holders and voters have a blanket party for those who keep doing this.

  4. Joe Jones said

    The million-dollar question is which 30% of the train was withheld from the Chinese. As you can see on any tech blog any day, Chinese companies are excellent at copying the outer look of a device, but they usually make up the cost of duplicating the outside by cutting corners on the innards. Think fake Rolexes or iPhones.

    That new ARJ21 aircraft is also a good example (there’s also a 737/A320 copy in the works now). China is capable of building the fuselage and wings sort of close to the same spec as Boeing or Airbus, and they can also pull off final assembly, but the flight control electronics and engines have to come from non-Chinese companies, and those are (along with the wings) by far the most critical and expensive parts. (Not to mention that the MD-80 series wings and fuselage are basically completely out of date now; many of the biggest operators, like American, Delta and JAL, have been ditching the series entirely and switching to newer, more efficient Boeing, Airbus, Embraer and Bombardier equivalents.)

    I suspect that the innards of the Chinese high-speed trains are lacking many key features of their Japanese Shinkansen counterparts — probably in the areas of power conversion, traffic control and other internal systems like that — and that this will make them relatively unattractive to buyers who do not happen to be the Chinese government. It’s essentially like a “Rolex” that doesn’t have a smoothly-sweeping second hand. I rode a Chinese copy of a Japanese limited express train between Guangzhou and Shenzhen a couple of years ago, and it was plainly obvious from the inside that the train was Chinese — you could tell by all the crappy components in the seats and doors, even though the train looked just like a Romance Car from the outside.

    The other factor, of course, is that both right-wingers and unions will explode if Schwarzenegger buys train cars from China, the only plausible enemy of the US who is participating in the bidding process.

  5. Andrwew in Ezo said

    Yoshiyuki Kasai, chairman of JR Tokai has long been wary of Chinese intentions, and apparently even warned JR East/Kawasaki years ago of selling any high speed rail technology to China. The model JR East/Kawasaki design sold to China, the E2, was an older model, but nonetheless Kawasaki must be rueing their decision to sell. I think Kawasaki will be much more cautious with their latest E5/E6 models, and JR Central is promoting its state of the art N700 only in markets that have respect for patents and intellectual property rights (i.e. the USA)

  6. bob said

    I much enjoy the blog, but just wanted to let you know the excerpt above supposedly from the story “Japan Inc Shoots Itself in the Foot on Bullet Train” is not accurate (it seems to come from a shoddy wikipedia summary…)
    ——
    B: Thanks for that on both counts. I deleted that excerpt.

    – A.

  7. James A said

    Joe,

    Interesting observation. So even though the Chinese are getting new planes, trains, and cars that look like state-of-the-art Japanese/German/American designs, their interiors still show the limitations of Chinese technology.

    Speaking of the ARJ21, the wings are not the original McD wings but ones designed by the Russian company Antonov. And various other US and European companies have supplied components for it including the avionics (Rockwell Collins) and engines (GE). It really is hard to call it an “indigenous” Chinese jet when so much of it comes from other countries.

  8. Magus said

    @Joe Jones:

    All of the trains coming off the final assembly line in China have significantly faster max speeds than their Japanese counterparts.

    Chinese-market E2 series max speed: 250 km/h

    Modified Sifang CRH2 E2 series max speed: 350 km/h

    From the financial times,
    Some in the industry suggest that, in seeking to gain advantage over their global competitors in China, foreign companies have transferred much more advanced technology to Chinese partners than they admit publicly, which is one reason the domestic companies have been able to increase the speed of their trains in such a short amount of time. They say that without that assistance it would be very hard to increase the train speeds so much without cutting corners on safety.

    If you consider the fact that Kawasaki was competing with most likely the greatest minds and businessmen at Bombardier, Siemens, and Alstom, I don’t find it difficult to believe that Kawasaki might have taken the calculated risk to share some “nicer” technology with the Chinese to gain an edge on their North American and European counterparts.

    The end result of that calculated risk was to the detriment of every train company in the world, sans Chinese companies, however.

    My personal belief is that these kind of predatory trade practices are the most destabilizing force in the world today — much more destabilizing than the aggressive, more politically and militarily-assertive China that we are seeing now. AFAIK, such blatant bias and government sponsorship is illegal under international trade law and CERTAINLY any “highly favored nation” or free trade agreement statues. Boeing/US and Airbus/EU are involved in a pissing match about this very thing. The fact that this sort of trade dishonesty is occurring in seemingly every industry in China should be swiftly taken to the WTO and, if not corrected, stiff embargoes should be enacted, no matter how much it hurts us in the short term. Because ultimately, I think, a China that has essentially taken for free all of the technology from the best companies in the world, for the purpose of creating a country with super-companies, will cost many millions, perhaps tens of millions of jobs in the industrial world, which will, in turn, cause an unfathomable drop in exports, which will, in that turn, destroy the economy of China and the rest of the exporting world, too.

  9. Magus said

    @Bob:

    I’m not sure which quote you’re talking about (since I don’t see it on this blog). You might be referring to the quote from Wikipedia:
    A Japanese official affiliated with the 2004 deal stated that “they could not imagine that the catch-up would be so fast.”

    If so, I might suggest that you not be one of those people so quick to condemn Wikipedia on ideological grounds. Wikipedia, in fact, sourced the original article for that quote. I wanted to check the authenticity of that quote, in particular, and though the Financial Times requires registration, a quick search online will find the same quote from the Financial Times article.
    http://www.google.com/#q=japan+inc+shoots+itself+in+the+foot

  10. Joe Jones said

    Meanwhile, the most high-tech aircraft in production at the moment, the Boeing 787, is comprised of something like 50% Japanese components, including carbon fiber materials (Toray), wings (MHI) and fuselage pieces (KHI). It currently has 847 orders from all over the world. The ARJ21 currently has 237 orders, and almost all of them are from Chinese airlines.

    Also, by the time the 787 is operating, passengers in it will be able to get high-speed internet via satellite from anywhere in the world, courtesy of a company called Panasonic.

    Martin Fackler, take a look around and re-examine your theses.

  11. Magus said

    @Joe Jones:

    You’re talking about planes — a machine that is still at the very pinnacle of modern engineering prowess — that one of, if not the single best defense contractor in the world is producing with the help of the world’s top divisions at the world’s top companies.

    The issue with China, here is that we’re talking about high-technology in industries that it’s much easier to catch up in. Look at Hyundai. They were the laughing stock of the world in the 1980s. They sold, perhaps, the crappiest cars that have ever been sold in the United States. 30 years and untold billions of dollars later, they’re now at a point where they are genuinely competing with Japanese cars. Given another couple of decades, all of Hyundai’s handicaps against the likes of Toyota, Honda, and Nissan will be gone.

    But that evolution from crappy car to good car took a whole generation of time. It would be very disrupting if Japan just gave Hyundai all of their technology back in the 80’s and Hyundai didn’t have to invest hardly anything to get up to its current position in the market.

  12. Joe Jones said

    @Magus: I can’t really argue with you because I don’t know what will happen in the future, nor do I know how good the technology is getting in China. For that matter, I don’t know much about trains. It could be that China tweaked a higher speed out of its trains by having straighter tracks, using more power, ignoring safety standards or any number of other methods. Wikipedia indicates that the E2 and CRH2 have similar top speeds (both get up to 360-370 in testing), but that the late-model CRH2s operate at 300 kph, versus 260 kph (due to intentional speed controls) for the Japanese originals. That makes it sound to me like the Chinese engineers are just playing fast and loose with what they got from Japan, not having the memory of Amagasaki on their minds.

    All this notwithstanding, the fact is that nobody is going to compete with China on the price of old technology for some time to come. If China can copy it, they will copy it and then undercut everyone. The big money for developed countries is going to be in new technology that China is either legally or technically incapable of duplicating. So it’s worthwhile to keep in mind that JR has gotten its new non-maglev Shinkansen testbeds past 400, and its maglev line continues to hold the land speed record (excluding rocket sleds) at 638 kph.

  13. Andrew in Ezo said

    The high speeds on the new Chinese rail lines are not the result of any further innovation by Chinese engineers, but, as Joe Jones said, running trains at higher limits, regardless of cost(and perhaps safety- Kawasaki was able to have themselves released from any liability in case of accident involving CRH2 types). Running a train at the top margins of speed results in higher track, wheel, and overhead wire wear, not to mention trackside noise. The again, maybe the Chinese Railways doesn’t have to worry about things like cost compared to a for-profit company like JR Tokai. Furthermore, I surmise the stations on the high speed line can be spaced further apart and in greenfield sites, resulting in higher average speed, as the Chinese Railway System is a two-tier system- high speed rail for the elite as well as the moneyed middle class, and the local trains which stop at every burg for the peasants.

  14. Magus said

    @Joe Jones:

    That is a good point. I was going off of the quote that it’s likely that manufacturers gave more technology than they’re willing to admit to get the speeds that high, but that did assume that the Chinese engineers cared about safety. I think the monthly, or so, mine blasts that occur over there show that they don’t mind safety too much. Also, I wasn’t aware that both had similar testing max speeds, so I’m sure the size of China does help things quite a lot on the statistics side.

    My worry is that many companies that invest in research & design of the technology of the future make a good part of their stable income from selling their tried-and-true older models to countries that can’t afford the more expensive, newer models. China will essentially get rid of any hope of that kind of income in the future.

    That said, it’s probably safe to bet that Kawasaki will NEVER give any technology to China ever again (until long in the future), so China can count itself out from getting any more, better technologies from Kawasaki (ditto for GE, Nissan, and the next poor company to make the same mistake). China can copy the world’s best technologies, but they can’t copy the world’s best engineers, physicists, and chemists. It’s probably that I worry too much.

  15. ampontan said

    After an exchange of e-mails with Magus, I confirmed that part of the quote that I removed in the FT article actually was in there, so I restored that part of it and added some additional material, with a link to that article.

  16. Kalidor said

    @Magus , @Joe Jones:

    The Speed issue of the E2’s and CRH2’s has been brought up before in a number of places, and you are right that there is a whole host of reasons, mostly related to various safety issues as to why the Japanese versions like to limit the speed.

    First there’s a sound issue that limits the allowed sound to about 75 db’s; when I went back to my high-school text was somewhere between a vacuum cleaner and a busy town intersection. Somehow I doubt China has a large problem with keeping the noise level down, especially as I recall the first implementation of this is targeted for the as a rail link between the Shanghai city center and it’s airport.

    Another limiting factor is turning radius, most tracks in Japan are laid down with curves that have a 4km turning radius so trains and speeds are designed with that in mind. Once again as it’s a new rail link I suspect China Railways will be working with a generally straight shot system where they can afford it.

    The final point which may or may not affect speed is of course the front nose cone which seemingly has been very carefully copied, while there is a slight effect on speed the main purpose of the design was to combat ‘tunnel boom.’ Think sonic boom coming from a tunnel because the shinkansen tunnels in Japan tend to be on the longer side and barely bigger than train. You get a massive pressure wave that not only creates a large noise when let loose at the end of the tunnel, but pushes back against the train. Once again, they are not dealing with previous infrastructure for the initial installs, so they have the options of making much wider tunnels, or foregoing tunnels all together.

    All of these factors could, plus the typical one-up-men-ship we see can result in a higher max speed, but it will definitely be at the cost of passenger and bystander saftey, and likely a few seized homes along the way with modest government recompense to ensure the easiest rail path possible.

  17. Good respond in return of this issue with solid arguments and
    describing the whole thing regarding that.

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