China’s Different Cost Perspective
One of the most important lessons that Jack has learned in over 25 years in China is that the Chinese have a fundamentally different—and lower—cost perspective than someone from a developed economy like the United States. In this interview, Doug Perkowski, who has lived, studied and worked in China, discusses with Jack why this is the case and why this unique characteristic of the China market has important implications for doing business in the country.
Excerpt: “Since then, I always carry with me two bills—a $100 bill with Benjamin Franklin, and an RMB 100 bill with Chairman Mao. The point I make is that these two bills are looked at and treated exactly the same way in their respective countries. A $100 bill is the largest bill you can get in the United States, and a RMB 100 bill is the highest unit of currency you can get in China.”
EPISODE TRANSCRIPT:
Doug: When you wrote Managing The Dragon, you devoted an entire chapter to China’s different cost perspective. Why is this important?
Jack: It’s important because it explains a lot about what has confused companies for many years about the country—how the Chinese can make things so cheaply? It also explains why many products that are reasonably priced in the United States don’t sell in China because the Chinese consider them too expensive. Since I’ve come to China, wages have gone up, raw material prices have gone up, but yet Chinese products are still priced more attractively. How can this be? The answer is that the Chinese think about money differently—they have a lower and fundamentally different cost perspective than their American counterparts.
Doug: Can you elaborate a bit about why you believe this is true, and how you discovered that the way in which Chinese think about money may be at work?
Jack: The penny dropped for me when I had been in China for about five years. During the first nine months of 1993, we visited over 100 factories in forty cities throughout China to determine if we could, in effect, do a roll-up of the automotive components industry. Because many of these factories were in the mountains where no foreigner had ever been, most of the hotels we stayed in were God awful– if you put a one star next to them, you’d be exaggerating!
In 1996, we acquired majority ownership of a piston ring business that was located in a small city in Jiangsu Province. So, when a nice 20-story hotel was built in the city where our company was located, we were delighted. It wasn’t the Ritz, but we could count on clean sheets, clean towels and hot water, most of the time. A couple of years after we did the joint venture, an American friend and I traveled to see our piston ring factory, and we stayed in that hotel.
As I came down the elevator the next morning, I saw my friend at the front desk holding up his bill—240 yuan. As I walked up to him, he did what every American does, and what I still do after being in China for twenty-five years: he divided by 8 (the approximate exchange rate to the U.S. dollar at the time). “Wow, $30 for this hotel room. Now I understand why overhead costs in China are so low,” he said to me.
I didn’t say anything, but by that time, we had completely localized our management, and all of our factories were being run by Mainland Chinese. “If any of my Chinese managers traveled to the city,” I thought to myself, “they wouldn’t even dream of staying in that hotel—they would consider it too expensive. Instead, they would look for a room that cost something closer to 150 yuan. In fact, if two of my managers were traveling together, they’d double up and split the cost.
That was when the penny dropped. My American friend looked at 240 yuan, divided by 8 and really saw $30, and then concluded that the room was cheap. My Chinese managers would see the same 240 yuan and come to the opposite conclusion. When my Chinese managers saw 240 yuan, what they really saw was something more like $240. A completely different way of looking at the same physical object!
Since then, I always carry with me two bills—a $100 bill with Benjamin Franklin, and an RMB 100 bill with Chairman Mao. The point I make is that these two bills are looked at and treated exactly the same way in their respective countries. A $100 bill is the largest bill you can get in the United States, and an RMB 100 bill is the highest unit of currency you can get in China. If I go to the Wegman’s supermarket near my farm in New Jersey and try to pay with a $100 bill, the cashier will take the bill and run it under a light to see if it’s counterfeit. If I go to the supermarket across the street from my apartment in Beijing and attempt to pay with an RMB 100 bill, the Chinese cashier will feel it and look at the serial number to determine if it is fake. When you look closely, Chairman Mao even looks like Ben Franklin!
When Americans look at an RMB 100 bill, they automatically divide by 6.8 (the current exchange rate) and see $15.00. But when Mainland Chinese look at that same bill–and I don’t care how wealthy they are–they see what Americans see when we look at our own $100 bill.
Two completely different ways of looking at the same physical object.
Doug: That’s fascinating, but what does that have to do with doing business in China?
Jack: I’m glad you asked that. Let’s take a US company that wants to set up a factory in China. Its Chinese competitor also plans to set up a new factory, making the same product in the same city. The US company asks Joe Smith, its facility planner, to oversee the project. The Chinese company gets its Mr. Joe–only this person’s name is spelled “Z-h-o-u”—-to do the same. When Joe Smith looks at the first input, priced at 100 yuan, he divides by 6.8 and says, “Wow, $15.00. That’s 30 percent cheaper than back home. Buy it.” Mr. Zhou looks at the same input, sees the equivalent of $100, and says, “100 yuan–that’s too expensive.” He then proceeds to negotiate the price down by 30 percent.
The result is two companies making the same product in the same city in China, and right from the get go, before all of the other production inputs are considered, one factory has significantly higher costs than the other. That is why foreign companies tend to build factories in China that are lower cost than their factories back home, but high cost in China.
The only reason this might work today is that there may be a quality and technology difference between the products made by the Chinese factory and those made by the Americans. But remember, China changes constantly and to the extent that there are quality and technology differences today, those gaps are probably already starting to close, and before long, will disappear. In business, lower cost always wins.
China’s lower cost perspective is the biggest reason why companies need to localize their management in the country. If a company wants to have long term success in China, its managers—the people making the purchasing and pricing decisions –need to have the same cost perspective as its customers and competitors.
Doug: You came to China over twenty years ago, and since then Chinese wages have gone up. The Chinese are wealthier, and per capita incomes are now over $8,000. Many Chinese consumers can now pay what their Western counterparts can pay. Does the lower cost perspective still apply?
Jack: Absolutely. I get that question all the time, so I tell people is that this is something they can test for themselves when they travel to China. One of my favorite sites in China is the Great Wall. After you have climbed the Great Wall and are walking down the steps, you will be overwhelmed by vendors who want to sell you an “I Climbed the Great Wall” T-shirt for 100 yuan. Now when you got off the plane in Beijing, I’m sure that your tour guide told you that, in China, you don’t just pay the price that is asked—you negotiate.
A good rule of thumb used to be that if you paid 30 percent of the initial asking price, you were a good negotiator. So, after about fifteen minutes of negotiating, you manage to get the price of the T-shirt down to 70, and then after another fifteen minutes, including walking away a few times, you get the price to 40.You are still 10 yuan away from the magical 30 percent, but I guarantee you that, at that point, you will look at your watch and think to yourself—“It’s getting late in Beijing and it’s time for dinner. What’s a dollar or two anyway?”—and you will then gladly fork over the 40 yuan. By the time I left ASIMCO, my managers were making a pretty good buck, but if you told them that you paid 30 yuan, let alone 40, for the T-shirt, they would think you were nuts. In fact, if they were to go to the Great Wall, the vendor would not even have the audacity to ask them for that amount.
It is true that China is much wealthier today, but you need to keep in mind that this wealth is concentrated in major cities like Beijing and Shanghai. While these two cities have a total population of over 50 million people, that is still only a small fraction of the 1.4 billion people in the country. In China’s major cities where per capita incomes are highest, the prices of many products are the same as they are in New York and Paris. But, when you get outside these major cities where the vast majority of China’s population live, per capita incomes are much lower, and the lower cost perspective is alive and well.
Having said that, I would argue that, even in China’s major cities where per capita incomes are highest, the same person who will gladly pay $70,000 for a new auto, will argue with the bean lady over a few fen. The cost perspective that you grow up with tends to stay with you throughout your life.
Doug: Given all that, what lessons can you draw?
Jack: When I first came to China and tried to apply my experiences from the States, the Chinese were quick to point out that: “This is China, and China is different.” In fact, they told me that so many times that I began to think of it as a cliché. However, the longer I’m in China, the more I realize that China is different, and factors such a the different way in which the Chinese look at money, need to be taken into account.
The important lessons to be learned are threefold:
First, China is now the largest market for most any product, but it is fundamentally different than other large markets like ones in the United States because of unique characteristics like the different way in which the Chinese look at money. Foreign companies need to keep this in mind when they come to the country.
Second, it emphasizes the importance of developing and empowering a local management team. If a company wants to have success in China, its managers must have the same cost perspective as its customers and competitors.
Third, the combination of China’s different cost perspective with the way in which the country’s economy has developed over the last forty years, gives rise to China’s two markets, a topic that we will discuss in a separate podcast.
One of the most important lessons that Jack has learned in over 25 years in China is that the Chinese have a fundamentally different—and lower—cost perspective than someone from a developed economy like the United States. In this interview, Doug Perkowski, who has lived, studied and worked in China, discusses with Jack why this is the case and why this unique characteristic of the China market has important implications for doing business in the country.
Excerpt: “Since then, I always carry with me two bills—a $100 bill with Benjamin Franklin, and an RMB 100 bill with Chairman Mao. The point I make is that these two bills are looked at and treated exactly the same way in their respective countries. A $100 bill is the largest bill you can get in the United States, and a RMB 100 bill is the highest unit of currency you can get in China.”
EPISODE TRANSCRIPT:
Doug: When you wrote Managing The Dragon, you devoted an entire chapter to China’s different cost perspective. Why is this important?
Jack: It’s important because it explains a lot about what has confused companies for many years about the country—how the Chinese can make things so cheaply? It also explains why many products that are reasonably priced in the United States don’t sell in China because the Chinese consider them too expensive. Since I’ve come to China, wages have gone up, raw material prices have gone up, but yet Chinese products are still priced more attractively. How can this be? The answer is that the Chinese think about money differently—they have a lower and fundamentally different cost perspective than their American counterparts.
Doug: Can you elaborate a bit about why you believe this is true, and how you discovered that the way in which Chinese think about money may be at work?
Jack: The penny dropped for me when I had been in China for about five years. During the first nine months of 1993, we visited over 100 factories in forty cities throughout China to determine if we could, in effect, do a roll-up of the automotive components industry. Because many of these factories were in the mountains where no foreigner had ever been, most of the hotels we stayed in were God awful– if you put a one star next to them, you’d be exaggerating!
In 1996, we acquired majority ownership of a piston ring business that was located in a small city in Jiangsu Province. So, when a nice 20-story hotel was built in the city where our company was located, we were delighted. It wasn’t the Ritz, but we could count on clean sheets, clean towels and hot water, most of the time. A couple of years after we did the joint venture, an American friend and I traveled to see our piston ring factory, and we stayed in that hotel.
As I came down the elevator the next morning, I saw my friend at the front desk holding up his bill—240 yuan. As I walked up to him, he did what every American does, and what I still do after being in China for twenty-five years: he divided by 8 (the approximate exchange rate to the U.S. dollar at the time). “Wow, $30 for this hotel room. Now I understand why overhead costs in China are so low,” he said to me.
I didn’t say anything, but by that time, we had completely localized our management, and all of our factories were being run by Mainland Chinese. “If any of my Chinese managers traveled to the city,” I thought to myself, “they wouldn’t even dream of staying in that hotel—they would consider it too expensive. Instead, they would look for a room that cost something closer to 150 yuan. In fact, if two of my managers were traveling together, they’d double up and split the cost.
That was when the penny dropped. My American friend looked at 240 yuan, divided by 8 and really saw $30, and then concluded that the room was cheap. My Chinese managers would see the same 240 yuan and come to the opposite conclusion. When my Chinese managers saw 240 yuan, what they really saw was something more like $240. A completely different way of looking at the same physical object!
Since then, I always carry with me two bills—a $100 bill with Benjamin Franklin, and an RMB 100 bill with Chairman Mao. The point I make is that these two bills are looked at and treated exactly the same way in their respective countries. A $100 bill is the largest bill you can get in the United States, and an RMB 100 bill is the highest unit of currency you can get in China. If I go to the Wegman’s supermarket near my farm in New Jersey and try to pay with a $100 bill, the cashier will take the bill and run it under a light to see if it’s counterfeit. If I go to the supermarket across the street from my apartment in Beijing and attempt to pay with an RMB 100 bill, the Chinese cashier will feel it and look at the serial number to determine if it is fake. When you look closely, Chairman Mao even looks like Ben Franklin!
When Americans look at an RMB 100 bill, they automatically divide by 6.8 (the current exchange rate) and see $15.00. But when Mainland Chinese look at that same bill–and I don’t care how wealthy they are–they see what Americans see when we look at our own $100 bill.
Two completely different ways of looking at the same physical object.
Doug: That’s fascinating, but what does that have to do with doing business in China?
Jack: I’m glad you asked that. Let’s take a US company that wants to set up a factory in China. Its Chinese competitor also plans to set up a new factory, making the same product in the same city. The US company asks Joe Smith, its facility planner, to oversee the project. The Chinese company gets its Mr. Joe–only this person’s name is spelled “Z-h-o-u”—-to do the same. When Joe Smith looks at the first input, priced at 100 yuan, he divides by 6.8 and says, “Wow, $15.00. That’s 30 percent cheaper than back home. Buy it.” Mr. Zhou looks at the same input, sees the equivalent of $100, and says, “100 yuan–that’s too expensive.” He then proceeds to negotiate the price down by 30 percent.
The result is two companies making the same product in the same city in China, and right from the get go, before all of the other production inputs are considered, one factory has significantly higher costs than the other. That is why foreign companies tend to build factories in China that are lower cost than their factories back home, but high cost in China.
The only reason this might work today is that there may be a quality and technology difference between the products made by the Chinese factory and those made by the Americans. But remember, China changes constantly and to the extent that there are quality and technology differences today, those gaps are probably already starting to close, and before long, will disappear. In business, lower cost always wins.
China’s lower cost perspective is the biggest reason why companies need to localize their management in the country. If a company wants to have long term success in China, its managers—the people making the purchasing and pricing decisions –need to have the same cost perspective as its customers and competitors.
Doug: You came to China over twenty years ago, and since then Chinese wages have gone up. The Chinese are wealthier, and per capita incomes are now over $8,000. Many Chinese consumers can now pay what their Western counterparts can pay. Does the lower cost perspective still apply?
Jack: Absolutely. I get that question all the time, so I tell people is that this is something they can test for themselves when they travel to China. One of my favorite sites in China is the Great Wall. After you have climbed the Great Wall and are walking down the steps, you will be overwhelmed by vendors who want to sell you an “I Climbed the Great Wall” T-shirt for 100 yuan. Now when you got off the plane in Beijing, I’m sure that your tour guide told you that, in China, you don’t just pay the price that is asked—you negotiate.
A good rule of thumb used to be that if you paid 30 percent of the initial asking price, you were a good negotiator. So, after about fifteen minutes of negotiating, you manage to get the price of the T-shirt down to 70, and then after another fifteen minutes, including walking away a few times, you get the price to 40.You are still 10 yuan away from the magical 30 percent, but I guarantee you that, at that point, you will look at your watch and think to yourself—“It’s getting late in Beijing and it’s time for dinner. What’s a dollar or two anyway?”—and you will then gladly fork over the 40 yuan. By the time I left ASIMCO, my managers were making a pretty good buck, but if you told them that you paid 30 yuan, let alone 40, for the T-shirt, they would think you were nuts. In fact, if they were to go to the Great Wall, the vendor would not even have the audacity to ask them for that amount.
It is true that China is much wealthier today, but you need to keep in mind that this wealth is concentrated in major cities like Beijing and Shanghai. While these two cities have a total population of over 50 million people, that is still only a small fraction of the 1.4 billion people in the country. In China’s major cities where per capita incomes are highest, the prices of many products are the same as they are in New York and Paris. But, when you get outside these major cities where the vast majority of China’s population live, per capita incomes are much lower, and the lower cost perspective is alive and well.
Having said that, I would argue that, even in China’s major cities where per capita incomes are highest, the same person who will gladly pay $70,000 for a new auto, will argue with the bean lady over a few fen. The cost perspective that you grow up with tends to stay with you throughout your life.
Doug: Given all that, what lessons can you draw?
Jack: When I first came to China and tried to apply my experiences from the States, the Chinese were quick to point out that: “This is China, and China is different.” In fact, they told me that so many times that I began to think of it as a cliché. However, the longer I’m in China, the more I realize that China is different, and factors such a the different way in which the Chinese look at money, need to be taken into account.
The important lessons to be learned are threefold:
First, China is now the largest market for most any product, but it is fundamentally different than other large markets like ones in the United States because of unique characteristics like the different way in which the Chinese look at money. Foreign companies need to keep this in mind when they come to the country.
Second, it emphasizes the importance of developing and empowering a local management team. If a company wants to have success in China, its managers must have the same cost perspective as its customers and competitors.
Third, the combination of China’s different cost perspective with the way in which the country’s economy has developed over the last forty years, gives rise to China’s two markets, a topic that we will discuss in a separate podcast.
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