Wednesday, 24 October 2012

Asian quality issues can undermine Western businesses

As explained in my last blog: "Will technology reshape global supply chains," the perils of outsourcing manufacturing or parts supplies to Far Eastern countries are many but, perhaps, none can be worse than poor quality issues that cause their western customers to collapse. The crucial importance of checking quality issues in any Far Eastern supplier when considering outsourcing cannot be overemphasised, as the recent collapse into Administration of the UK company, Manganese Bronze, (MG) vividly shows.

MG makes London's iconic black cab taxis but it struck a deal with its Chinese partner, Geely, in 2006, who took a 20% stake in the company and transferred taxi production to China. The rationale behind the move, as it is for most companies outsourcing to China, was to reduce production costs to compete better on the world markets.

The latest cause of MG's financial embarrassment was the recall of 400 of its London taxis following problems with its power steering. It succeeds a fiasco in 2008 when it was forced to withdraw 5,000 taxis after some burst into flames. Reports claim that the latest fault was caused by a component from an unnamed Chinese supplier, introduced as part of wider moves to cut costs.

There are parallels to this even within Europe when a reputable company switches to a cheaper country within the EU without always informing their customers. One British manufacturer of forklifts, for example, had a reliable relationship with a West German gear box manufacturer who subsequently sought supplies from East Germany where quality issues fell short. The result was the British company spent 10 times as much rectifying problems as it received in compensation from the German supplier. And that does not include any potential sale losses caused by the damage to the truck brand. The incident also damaged the German company as the UK truck producer switched to Italy for its gear box supplies.

It should not be thought that Chinese manufacturing quality is inherently risky. When Japan was recovering from World War 2 the Western perception of its production quality was one of shoddy, cheap products. Today, Japan's quality issues, especially in car production, albeit with a few recent hiccups, is second to none. There is no reason why China should not become a top quality producer but it may need State intervention to hasten the process before too much damage is done. The Chinese authorities should also be more vigorous  in dealing with wholesale intellectual property theft committed by its corporations. Another British forklift producer whose trucks came from Taiwan felt obliged to reshore its production back to Britain because of concerns by its component suppliers who were reluctant to supply because they feared leakage of their product designs to China for copying.

It should be said in fairness to Chinese producers that there are other problems with MG that seem to have contributed to its collapse. MG reportedly tried to secure a £15 million loan from Geely because it stopped sales while investigating the steering fault and so had no income. Geely owns Volvo so such help would not have been too onerous but it may have felt wary about a bailout given the discovery a few weeks earlier of a £3.9 million accounting black hole allegedly connected to the introduction of a new IT system. When its delayed interim results were announced it showed widening losses of £3.6 million for the six months to the end of June and it has made only losses for the last four years. This seems to indicate that despite several years of Chinese production their production costs could not be reduced sufficiently, hardly surprising given strongly rising Chinese wage rates and soaring fuel bills impacting distribution costs. This has salutary lessons for all companies setting up businesses in China supplying customers half way around the world. China is losing its allure because the law of comparative costs in their favour is diminishing.

At one time holding a virtual monopoly in the London black cab taxi market, MG's woes grew as its market share fell when new entrants, like Mercedes, secured successes with its Vito model. Nissan is also about to enter the London cab market. Even so, as many other Western companies have found when outsourcing to the Far East, keeping a handle on quality issues is very difficult and so should be considered carefully as a key determinant when outsourcing.