Jack Perkowski is the chairman and CEO of ASIMCO, a leading Chinese auto parts manufacturer, and the author of Managing the Dragon: How I'm Building a Billion Dollar Business in China. He left Wall Street in 1990 to make his fortune in China and has been an iconic figure in the western business community in China ever since. Nicknamed Mr. China due to his appearance as a central character in a 2005 book of the same name by Tim Clissold, Perkowski’s unbounded enthusiasm for the economic potential of the Middle Kingdom is legendary. As The China Perspective discovers, rising prices in China and an unsettled global market have done nothing to dim that enthusiasm.
In Chapter 13 of your book Managing the Dragon you talk about the need to keep costs low to benefit from China's low-cost manufacturing base as well as to be able to compete with local firms. With the recent rise in commodity prices, increasing wage inflation and the increase in value of the RMB, how much harder is this becoming and how has this affected your overall operations and business strategy?

We first need to separate costs that effect all operations alike, wherever they are located; those that are unique to operations in China; and those that only have an impact on a product’s export competitiveness. For example, rising commodity costs affect manufacturers everywhere, not just those in China, so ASIMCO’s operations are not necessarily impacted negatively versus other Chinese or foreign manufacturers. A rising yuan will have an impact on export sales, but because local sales are made in RMB, will have no impact on our local business.

Since 85 percent of ASIMCO’s sales are made in China, a rising RMB actually has a very positive impact on our operations. As the yuan appreciates against the US dollar, all of our assets in China are worth more in terms of dollars; any dollar denominated debt that we owe can be paid back with a smaller amount of RMB; any imported equipment or raw materials that we use cost us less; and every RMB we collect from our customers can be exchanged for more dollars. For those products that we export to the United States, we now insist on currency adjustments. If we don’t get that provision, we simply don’t export.

Wages have been rising in China and at ASIMCO’s operations — that is true. However, wage costs are only one part of the equation – the productivity of labor is the other. As a result of lean manufacturing initiatives we have implemented and our move to higher value-added products, ASIMCO’s increases in labor productivity have more than offset wage increases. Therefore, rising wages have not been a problem for us, and I would argue that this has been true for China’s manufacturing as a whole. That is why, despite the increases in labor costs in China, they are not mentioned as a major cause of inflation in the country.

Of all the cost increases that you mentioned, rising commodity costs are the most troublesome. It is not always possible to pass these costs along to customers so, unless action is taken, margins will be eroded. The first round of raw material price increases in 2005 hit us pretty hard. Since then, however, we have been doing more value-added engineering to reduce raw material content in our products; implemented lean manufacturing to reduce waste; weeded out products that are no longer profitable; gotten more aggressive about getting price increases; and have accelerated our new product development efforts. New products always command the highest prices. As a result of these measures, we have been able to more than offset many of these commodity price increases.

Our strategy remains the same. We have to provide value-added, high-quality products to the right customers at competitive prices.

You have also talked about China’s differentiated markets, which range from the low-cost low-quality end, competed for mainly by local firms, to the high-cost high-quality end where international and local firms are competing. How big an impact are local firms having on the higher-end of the auto parts market and are you starting to see signs of local firms that will be able to compete in the global marketplace?

It’s only a matter of time before local parts companies become large players in the global markets. With each day that passes, Chinese companies as a group get better in terms of technology and quality. And of course, they have substantial cost advantages over competitors that manufacture in high cost countries.

Chinese parts companies are already selling a great deal to the aftermarket in the United States and elsewhere, but these sales are made based primarily on price, not on quality or technology. In terms of original equipment products, we will first see China parts companies play a bigger role globally in the commercial vehicle segment. In China, approximately 98 percent of the trucks and 92 percent of the diesel engines that power them are made by purely local companies. In addition to the fact that the domestic markets for these products are growing rapidly, China will export as many as one million vehicles in 2008, one-half or more of which will be trucks. As these trucks leave the country, they leave with parts made by local companies. In this way, I expect Chinese suppliers to the truck and bus makers to begin to make real inroads into the global markets in the very near future.

The passenger car segment in China is a different story. Approximately 70 percent of the cars made in China are made by foreign invested companies and use technology that has been developed elsewhere. Chinese suppliers to this segment will take longer to make their presence felt in global markets as a result.

Auto sales increased 17.07% in the first half of 2008, according to CAAM (China Association of Automobile Manufacturers) figures. This is a very healthy number but is still down on the 22.26% growth in the market in 2007 and seems to be pointing to a general slowdown for the auto market. Is this slowdown temporary or do you believe that China's auto market is entering a longer-term period of more moderate growth? Also with growth slowing and competition increasing at the same time, what do you think the fall out will be in the auto manufacturing space?

First of all, the law of large numbers dictates that it is easier to grow at over 20 percent per year when the market is 2.4 million vehicles per year, as it was in 2002, than when the market is approaching 10 million vehicles per year as it is today. For this reason alone, I would be shocked if the market as a whole grows by 20 percent or more at any year in the future. Nonetheless, the market in China is far from saturated, and I would expect to see double digit growth rates for a number of years going forward. It’s quite simple — the more that the China economy grows, the more transportation that will be required to move people and goods around the country.

As the China market slows, those companies that do the best job designing and developing products for the China market will be the winners. In addition to meeting the Chinese consumer’s tastes and functionality needs, cars will need to fit the Chinese consumer’s pocketbook. Simply bringing models into China that have been designed elsewhere will no longer work, and affordability will be a key success factor. Expect a great deal of fallout in the coming years as some companies do a great job along these lines, and others struggle.

You recently told an American Chamber of Commerce lunch in Singapore that innovation will be the “next big surprise” out of China. Can you elaborate on that? What is driving innovation – eg cost, new applications – and what sectors have the most potential for China to surprise?

Innovation occurs when you combine an unfulfilled market need with a lot of smart people. In China, the unfulfilled market need at the moment is the need for products that are affordable. There are obviously a lot of smart people in China, so the conditions are ripe for innovation to occur.

One example – the 400 million or so Chinese that have per capita incomes in excess of $7,000 can afford to buy the same notebook computer that you have but, because of their lower cost perspective, they would prefer not to pay what you paid. (In my book, I devote an entire chapter to this phenomenon which I think is a key that unlocks the secrets as to the way the China market works. Simply put, when Chinese look at a 100 RMB bill, they see the equivalent of a $100 bill.) The other 900 million people in China, whose per capita incomes are only $500, understand and want access to the power of the computer and the internet, but they simply can’t afford to pay anything close to the Western price.

As a result, 1.3 billion Chinese wake up every day and try to make everything they use cheaper and more affordable. Incidentally, this not only means wringing costs and profits out of a product. It also means designing products to make them better and more convenient and easier to use. This relentless drive to make more affordable products will drive innovation in China. Clayton Christiansen, a Harvard Business School professor, has written about “disruptive technologies” that have changed the competitive landscapes in one industry after another in the United States. The forces at work are the same as those at work now in China. I recommend his book, The Innovator’s Solution, to better understand the theoretical framework for this phenomenon and how it will play out in China.

Innovation in China will cut across all industries. For example, expect Lenovo to design $400 computers. In autos, Toyota makes a Prius hybrid in China that sells for 260,000 RMB. Chang’an, a Chinese company, makes a hybrid that sells for less than 150,000 RMB. And so it goes.