Localization - Key to Success for Multinational Chemical Companies in China   

Dr. Kai Pflug, CEO, Management Consulting - Chemicals
In those areas of the Chinese chemical segment that are relatively open to foreign companies (which excludes most petrochemicals and some base chemicals), the competition between domestic companies and multinationals has so far largely been one between cost and customer relationship advantages on the side of the domestic players, and advantages with regard to quality and product portfolio on the side of the multinationals.
    Multinationals will surely try to keep their past and current advantages by keeping their focus on product quality, and by staying ahead of the domestic competition via constant innovation and thus a superior product portfolio. However, these actions alone may not be enough to guarantee their success in China. In many areas, particularly for some base chemicals, but also for selected fine chemicals, the quality of Chinese companies is already quite comparable to that of multinationals. Though not all customers have realized this yet, it is only a question of time until they will discover. It will be harder for Chinese companies to close the innovation gap, but given the number of scientists available, at least the potential is already there.
    Apart from maintaining their advantages, multinationals will therefore simultaneously have to work on reducing the weaknesses mentioned above. The key to this is localization, i.e., selectively taking up characteristics of domestic chemical companies.
    Why does localization help to stay competitive, and what areas does localization cover?
    Localization brings costs closer to the lower local Chinese level, thus reducing the cost advantage of domestic companies. At the same time, localization brings a better understanding of the local market and better customer relationships. And localization can be a beneficial strategy for essentially all aspects of the chemical value chain as outlined in Fig. 1. Let us take a look at these aspects.
    For Research & Development, there are obvious benefits to accessing the large number of Chinese scientific university graduates with salaries of only 10%-20% of their Western counterparts. Though this salary gap is shrinking, it will still remain relevant in the foreseeable future. Apart from the cost aspect of hiring local scientists, they will also have a better intrinsic understanding of local product requirements - not least as they are able to communicate directly with all their Chinese customers. Thus the costly development of over engineered products can be reduced.
    Indeed, with regard to product development, most multinational chemical companies have already established capacity in China. For example, DSM just opened a Composite Resins R & D center in Shanghai which will not only be responsible for local resin formulation but will also be the global center of excellence for specific areas of composite development. Further expansion of R & D work in China seems likely given that for example BASF claims that they will further double their local R & D staff by 2020. The only limitation of these activities is that despite the DSM example just given, most R & D work done by multinationals in China focuses more on development than on basic research. However, this may be the result of basic research often being located at the headquarters of a business unit, though intellectual property (IP) concerns regarding China are certainly an additional reason.
    Local sourcing is an obvious approach to achieving a cost structure more comparable to that of local competitors in China. Far from all raw materials are cheaper in China, but selectively employed, there is a potential for savings. As the quality of Chinese raw materials has improved (the MDI of Yantai Wanhua being an obvious example), multinationals are now much more confident to procure locally, with the added benefit of shortening the lead time. Local sourcing seems particularly natural in the case of JVs, e.g., the Cabot Bluestar JV sources its silane raw material from Bluestar, one of the parent companies. Another frequent case is multinationals buying chemical raw materials that are being produced by Chinese companies directly inside the same chemical park they themselves are located. In several cases, local sourcing goes as far as multinational industry leaders not only sourcing raw materials but even products they themselves produce outside of China - and brand and market them as their own in China. For example, one multinational sources a specific fragrance from a Chinese competitor while another relabels certain pigments as their own. Overall, with the quality of Chinese products continuing to improve, the locally available product range increasing and cost pressure on multinationals not lessening, local sourcing will become even more widespread. Of course, multinationals have and will also use sourcing from China to lower their cost at other production sites.
    Local production as a way to reduce costs even dates back from the times when products made in China were mostly for export and not for the domestic market. A few years ago, multinationals such as Dow, Ciba and Rhodia already announced goals for increasing local production - on average, the proclaimed change was from about 30% local production in 2006 to 70% - 80% in 2010. And increasingly, local production is now done not only for bulk products (such as the massive investments of Bayer and BASF in Caojing and elsewhere), but also for specialty products. For example, Clariant recently announced to produce formulation inert agrochemical ingredients in China. Another way of increasing local production while getting closer to local customers is to open multiple production sites at different locations in China. AkzoNobel is following this approach with their powder coatings business, which just opened its sixth location within China in Wuhan, a region so far largely ignored by multinational chemical companies.
    A fast way of getting into local production is the acquisition of a Chinese player, which of course also gives a headstart with regard to customer base and market knowledge. For example, LANXESS bought domestic producers of iron oxide pigment as well as polyols.
    A similar approach may be taken in marketing and sales. Acquisition of a domestic player obviously helps establishing a local brand and may do so even without diluting the own brand. AkzoNobel just bought Prime, a major player in the Chinese market for auto refinish involved in development, manufacturing and sales for the domestic auto market. As this example shows, acquisition of a local player can be a very effective strategy in staking out a position in the fast-growing mid-market segment in China. Of course, localization simply requires making the whole range of company marketing tools available in Chinese. While most companies have achieved this for basic information such as the company website, localization is far from complete with regard to more technical and product specific information. And while e.g. the engineer of a German customer of a multinational company may be expected to understand technical information in English, this does not necessarily apply to the engineer of a smaller Chinese customer.
    Localization of distribution may be seen as a two-step process. The first is making a company's products available in China in the first place. Most companies have already done this by selecting suitable distributors covering the different regions and customer segments in China, though due to the vast extent and diversity of the marke