Silence and Gold

I have written nothing for months and part of the reason for that is that we have been busy.  And that, of course, is very good.  However, I have also been concerned about the risks to my business of recording my observations, especially those that might be interpreted as having a critical edge.  I will say no more online (except this) because anything can be used as damning evidence if and when the authorities decide to act against you.  If you cannot say what you think, then there is not much point in saying anything.  As a small business we have no choice.

New Year's Resolution

We have been operating here for five years now, and that should mean that things are getting better. In some ways they are, but there are also areas where things in our company are getting worse.  When we started the GFC had just begun to unfold with the collapse of Lehman Brothers and we had immediate cash-flow worries as well as all of the teething problems that might be expected for any small start-up company. On top of that was the China Factor, which meant that each day would bring some surprise and possibly a nasty shock.  But at least the factory was neat and tidy and there was time to keep things in order. After five years the more serious threats to our survival have receded and we generally feel more relaxed and comfortable here, but on the other hand the operation is untidy and dirty.  We are a wood business and it is very hard to be neat and clean all the time, but we are looking like every other Chinese factory and that is embarrassing.

The local government is now revamping our industrial park and there are new car parks, new gardens and even fully-grown trees appearing around us.  Our own factory now has a neat garden with a nice tree of its own.  It all looks pretty good, but that makes our shortcomings more pronounced and, as the authorities are keen to promote this as a high-tech park, we are a nasty little anomaly that they would rather see quietly disappear.  That is not an option for us and so the challenge for 2014 is to pull our operation into line and even to try to present ourselves as some sort of model factory that stands out within our industry. Our environmental credentials are okay, but we are certainly not high-tech.  So we need to clean up and at least look good and that is going to be very difficult.

The fact is that we should never have got into this state in the first place, but the cause of that problem is the same thing that is going to make change difficult.  It is a cultural problem.  As foreign managers we try to inculcate our values and standards into our workers, but instead we are overwhelmed by their inertia. A factory should be pretty much the same anywhere, but in reality it is just a microcosm of the society and culture that hosts it.  At the bottom of this problem is that Chinese work places are driven by a crude mix of incentives and punishments, which discourage initiative and breed resentment.  Generally incentives are paid for output (piece work) and punishments are meted out in the form of fines or reduced bonuses.  There is no trust between management and workers and very poor communication so that most workers find it easier to shut down their creative and critical faculties and behave like zombies.  The only change that they hope for in their lives is switching one lousy job for another with slightly higher pay.

In our case most of our workers have been with us for a long time and they know they are well treated so our relationship with them is quite good.  We do not pay more than other factories, but we give regular days off and we strictly adhere to the labour law even though we could get away with ignoring many aspects of it. Even so, Chinese work attitudes die hard and it is difficult to get them to be pro-active.  They tend to cut corners and will not readily or consistently follow established procedures.   

One area where this shows up is with their attitude to tidiness.  In China it is normal to drop your trash on the street and even where bins are available most people do not use them.  If binning rubbish does not enter people’s heads, then separating it is certainly considered a waste of time and effort, so although bins are provided in the factory for metal, plastic and paper waste they will not use them, or use them indiscriminately.  The management of tools is the same.  They dump them where they finish with them and then spend time searching for them when needed again.  This is a huge waste of time and contributes to damage and loss of valuable tools.  In another manifestation of slackness, maintenance schedules are not adhered to and QC procedures are left out or checked off in a cursory way.  In short there is a very low level of commitment on the part of many workers.

To change this is my resolution for 2014. I know that this has to be done through leadership and that it is not going to be easy. Having a clear vision of the end point is easy, but communicating that vision and motivating people is going to be hard. I think it can be done, but that it is going to require me to change first, or at least to change the way I do things.  It cannot be done from an office or through others who do not share the vision.  I am going to have to spend more time on the factory floor and I am going to have to become a full time motivator and teacher of lean production and continuous improvement.  It sounds a bit pretentious but unless we can unlock the wasted human potential of our workforce, that makes them willing partners in pursuing improvement, we will never build an outstanding business. 

Commercial Graffiti

When we came to work yesterday there was freshly painted graffiti on our front wall.  But this was not vandalism by delinquent kids, it was an ad for forklift services; just two characters and a mobile phone number.  Our whole park is in the midst of an upgrade, so to have our factory defaced in this way was more galling.  When I first came to China I was struck by the ubiquity of this ugly phenomenon.  It is not just on factories, it is on most visible walls, in elevators, in stairwells AND on my front door.  There are more than two dozen roughly pasted stickers and stencilled details on and around the door for various services.  It is the same for everyone.  My instinct is to call them and ask them to come over on the pretext of getting my toilet fixed (or whatever it is that they claim to be able to do, but can't) then to stand over them while they clean it up.  Of course this is would achieve nothing and that is why Chinese people do nothing about it.  But the big question is why the authorities let it happen.  It really is just a matter of calling up the number and then fining the person who turns up.

 The only thing that I can think of is that the police do not care.  It is easy to say that they have more important things to do, but the fact is that they do not do a good job of anything.  The blatant and dangerous flouting of the traffic laws goes totally unpunished.  In fact, it is not noticed.  Even where there is a policeman on point duty making a totally amateurish and desultory effort at directing traffic, drivers do what they please and nobody cares.  It seems to me that in the end no one is held responsible for anything. "When you gotta job to do you gotta to do it well", doesn't seem to apply here.

I do not fully understand what is going on, except that perhaps when things are so chaotic and on such a vast scale, no effort by any one individual to change anything can have any effect.  There is a sense of resignation to the inertia.  It is like the tired junk yard owner who manages to make a living in spite of the chaos, but never musters the energy or the money to get his operation organised.  There is simply so much to do and no obvious place to start.  In the case of China, the leadership does launch campaigns now and then to improve this or that, as in the case of the public education campaigns before the Olympics and then Expo in Shanghai two years later.  In those two cases there was some improvement, but normally there is not. I think in that case it comes down to the fact that there was a clear aim that was accepted by the public as legitimate. On other occasions it is not seen that way.  Even genuine attempts by officials to improve things will be seen as just another campaign driven by someone's desire to make their mark and get a promotion.

So in addition to the overwhelming sense of inertia that confronts anyone contemplating reform, there is the cancer of illegitimacy i.e. the public does not have respect for authority.  I have indeed seen drivers get out of their cars and challenge the duty policemen to the extent of engaging in fisticuffs.  In any other country that I have experience of, this would lead to arrest, but not necessarily in China.  The policemen knows that this guy may have powerful friends and if arrested will simply get himself off the hook and, to boot, make sure the the arresting policeman's life is made difficult.

There may be progress, but it is very slow and very tentative.  A few days ago I can home and found that the housing estate managers had sent someone around with a bucket of whitewash and a mop.  They had clumsily covered up the phone numbers on the wall next to the door.  They were only half covered and you could still read the numbers.  The idiot sent to do the job had slopped the paint all over the landing and the stairs, so that the clumsy cover up job was worse than the original problem.  That is another common story here.

Rule by Law

At first impressions, Australians and Japanese are very different, but once you understand the language and spend some time in Japan you realize that we share some very important fundamental values.  In spite of the occasional scandal and the odd incidence of corruption of public officials, there is a high level of trust in public institutions.  There is awareness of rights and a certain level of respect and consideration for other people.  In short there is some sort of unspoken social contract that impels people to behave well, without the need for immediate legal sanctions.   Things work because people generally see the value in cooperation.  Even strangers tend trust each other to some extent if there is no immediate reason not to do so.

When I arrived in China as a long-time Japanese speaker I was struck by a superficial resemblance to Japan.  The people were not affluent or as fashionably dressed, but they looked much the same.  Signage was largely legible to a Japanese speaker and there was some similarity in language due to the use of characters, although not in structure.   There were at a deep historical level a lot of shared traditions.

China however is not like Japan in many important ways and this quickly becomes very obvious to anyone doing business.  These differences stem from a lack of trust in the system and in each other.  I hear from friends that this was the same in Eastern Europe and the Soviet Union before the 1990s and even to some extent today as a result of the Communist legacy.  I suspect it goes back further than that and that the differences are as much related to the emergence of democracy in our parts of the world versus the lack of it in some less-developed countries.  Unchecked power is at the root of the problem.

But paradoxically it is not a police state as one might imagine prior to living here.  In some ways there is more freedom than in the West. Essentially in China, if Big Brother is not looking, do whatever the hell you like. And Big Brother doesn’t really care much what you do as long as you don’t challenge him in any way. The result is that today’s China is like the Wild West; a largely lawless place.  More correctly, there is plenty of law, probably too much, but there is no rule of law. There is “rule by law” and that is different.  The law is a weapon to be used to keep people in line when officials so choose.  The law is not applied universally, and certainly not without fear or favour.  If you do anything to rock the boat, or cause any kind of disruption, the law will come crashing down on your head.   One boss said to me the other day that every boss in China operates with one foot in gaol.  Local companies cannot operate within the law because to do so would mean going bust.  For example, how can you obey an edict that says “from tomorrow you cannot use any electricity for 20 days”? That happened yesterday in the village where I have my warehouse.  The choice is easy, if stark: Obey and go broke, disobey and hope they will not call your bluff.

Of course, as a foreign enterprise we are different.  We are more closely scrutinized and are unable to flagrantly flout the law.  However in this case it is different because we too have no choice, but we will wait a day or two and see what the locals do.  I think I know the answer.   And what is the reason for this new edict?  The local officials have been told that they need to reduce power consumption (from coal-fired power stations) if they want to get promoted.  Great policy objective, lousy execution.

So what is the point of this ramble?   I have only touched on one or two implications of this systemic dysfunction, but once you recognize the problem you can see its consequences everywhere.   

Five-year Milestone

We have just celebrated our first five years of operations here.  I just submitted an article to an industry publication with a view to getting some free publicity.  I copy it below for those of you who may have been wondering exactly what we have been doing here, but were afraid to ask.  I apologise for the self-promoting tone, but that is what publicity is.

An Australian owned and operated flooring factory in China has just celebrated five years of successful operations.  Located in the regional city of Huzhou, two hours to the west of Shanghai, Ecquality Timber Products has about 40 employees and is run by its owners, Terry Newman and Sonoe Mishima.  Terry and Sonoe, a husband-and-wife team, are well known in the timber industry, especially to the Cypress mills of Queensland, where they have been sourcing timber and flooring for about 15 years for export to Japan.

The move to China was prompted by the rising Australian dollar and increased manufacturing costs that have accompanied the mining boom.   Terry explains that initially the plan was not to set up a manufacturing operation at all; “We came to China to outsource production, not to make things ourselves, but we quickly learned that China is not a place where you can simply write a contract with a manufacturer, go home and expect things to run smoothly”.  After finding that he was spending more time on factory floors in China making things work than in Australia, Terry and Sonoe decided to move to China to start their own operation.  “We knew it would be hard, but so was running around China trying to stay on top what was happening in our sub-contract factories.  We tried many factories and none of them could consistently produce what we needed”. 

On the personal side it was a huge change too.  “We brought our daughter, about to turn 14, with us, but our 16 year old son elected to board at his school and complete his last two years there, rather start in an international school at that late stage.  For them it was no doubt a big challenge too, but they both adapted quickly to their respective new circumstances and there were no major issues”.

The challenges for the family and the business were just beginning, however, because after soon after registration of the company, but before operations commenced, Lehman Brothers collapsed and what Terry calls “the great train wreck” began.  “We just got started with things went bad.  We had enough cash to carry us through a slow year or so, but this went from slow to zero at the beginning and took about three years to get back on track, so it was nerve-wracking on top of all the other challenges of operating here”.   Terry says that there is a book in these “other challenges”, but he is now clearly on top of things and is confident of growth.    “Our challenge now is to stay on top of orders and to manage growth.  Last year was 20% up year-on-year and I expect that will now continue”. 

The factory still produces Australian Cypress for Japan, but also does other Australian hardwoods and German Oak.  “Solid German Oak wide boards to the Australian market are now one of our biggest items”, Terry explains.   “We are also supplying some engineered products from nearby factories that we work with closely.  Trading is now about 20% of our sales, but we still do all the QC”.

Terry is first to admit that times are very uncertain, but says, “There are never any guarantees in life.  You just have to get on with it and give it your very best shot”.  It is pretty clear that this hard-working couple is giving it their best shot and that it is working.   Good luck Terry and Sonoe in the next five years!

Bubble, Bubble, Toil and Trouble

This week the bank came: not to us as we do not borrow, but to a big factory nearby. They took the bosses Benz, an Audi and a BMW.  The factory closed on the 30th of September, which is the end of the quarter and the day of reckoning in this case. This area is almost totally dependent on the timber industry. If you are not in the timber business, or servicing the timber business, you are probably not in business at all, so the closure of this factory and another large one on the same day, means serious trouble.

This little town has about 20,000 permanent residents and around 8,000 workers from poorer parts of China who come here to work in the timber factories. These outsiders hear of the work opportunities from friends and relatives and make their way here on trains and buses without pre-arranged work. They just lob here and walk around checking out the chalk boards at every factory gate until they find themselves a job.  It used to be easy, but not now. They are gradually drifting back to the inland provinces and to penury.

All the talk now is of tough times. The collapse of these factories is no surprise, it has has been coming for a long time and in some ways is a continuation of the Lehman Brothers train crash, but it would have happened eventually. The industry was booming up until the the start of the Great Recession. All you had to do was start producing and wait for the customers to come. And they did come, from all over the world and from all over China. This area supplied 60% off all the solid wood flooring sold in China.  (Just think about that for a second!)  Cash was easy to come by. If you had land, the banks were willing to lend, and if you didn't have land the gray lenders would lend on a promise - at a price.  Every boss had a big Audi and a young girlfriend or two.  Nights were spent in tea shops and bars. It was party time.  

Decoration in the home of a minor timber boss.

A marquetry castle built on borrowed money

But the crash did not come immediately after Lehman as it did in the West.  There was plenty of momentum left in the Chinese economy and so the domestic market rolled on. In part that was because people here are not so economically literate and certainly not so well informed. I remember thinking at the time that this was a very good thing.  Imagine what would have happened if China also stopped when the music stopped in 2008. Luckily they also had the Olympics to think about and then the Shanghai Expo in 2010. Of course, they also had the Szechuan earthquake in 2008 and that was far bigger news than the collapse of some unheard of bank in the US.  

The Chinese banks were by 2009, of course, aware of the implications and so they responded by tightening credit to SMEs, but all that did was to boost the gray lending market.  The buckets of cash held by all these bosses were still sloshing about and the sharks were happy to pay them 20% because they could re-lend at 30% - and more for short-term money. These local timber factories should have been reining in spending at this time, but many of them went aggressively after domestic market share, opening their own retail networks across China. And to make matters worse, firms were still able to expand their lending from banks if they had guarantees from other strong firms. This could happen, I think, because of the absence of a sophisticated title registry for land and also because banks did not have a central database where they could check what loans were already made against what property. I am not sure if I am right about this, but if there is such a system, the fact that multiple loans and guarantees could be made without substance shows that it does not work. The fact is that corruption subverts whatever system is put in place anyway.

So the house of cards continued to be stacked higher.  All that was necessary to bring it all down was a tiny gust. The slowdown in the construction market here has not been sharp, but that is another complicated story so I won't talk about that now, but there has been a deep slump in the "decoration market".  What that means is that, even if apartments are being built and even if some of them are sold, they are not being fitted out. If no one is doing fit outs, then there is no demand for flooring. This has naturally led to cash flow issues for many factories in the last two years or so.

One weekend in late 2011 some fool-son of a factory boss blew a few million in the casinos of Macao. That caused the collapse of the business because no one was in a position to come to the rescue. This was just one of many money-losing scenarios that occur when money comes easily.  Another boss I know bought the family's first brand new car at about the same time. His son soon ran someone down causing serious injuries resulting in bills of several hundred thousand RMB. Soon after he managed to get the money together to settle this, his wife hit someone resulting in another bunch of huge bills. The factory bosses no longer had the cash to make further loans, indeed they were now calling in their money.  

At the end of 2011 a loan shark with a basement full of luxury cars in an office tower here in the city jut a few blocks from where I live woke up one morning knowing that the game was over.  I don't know all the details, but he was only in his 30s and the story goes that he had a few years earlier conspired with his mate who was managing a local bank branch. He borrowed a million with no collateral and immediately put it into another local bank, obtaining a gold credit card in the process. From these humble beginnings and an overdose of self-confidence he was able to leverage his cash and that of his young factory-owning friends into a multi-billion Yuan loan business.  On that day in late 2011 the police arrested him and his bank manager mate as well as a bunch of officials who had turned a blind eye in return for certain incentives. The collapse of this illegal lender wrought havoc the village where I have my factory.  There was a whole bunch of reciprocal loan guarantees that were being called in.  Many businesses went to the wall and those that survived were now crippled by debt including the two factories that limped on until last week. 

In the two years since that first collapse the banks have continued to withdraw their support. That was easier said than done because they were in up to their necks and they did not want to precipitate a crisis, so they trod softly while cajoling these companies with threats of foreclosure. The local informal-lending network based on family and business connections was in overdrive trying to keep the banks at bay, but the underlying businesses were no longer viable. It was an endless cycle of good money following bad and so the other day, two years after the first loan shark went down, the second wave crashed. People are saying that this wave is going to take out up to one third of the businesses in the village. I cannot say, but I know that it is not a pretty picture. The combined debt of these two firms was about US$25 million and I would estimate their assets at less than $10 million at best.  Another factory I deal with has debts of about US$8 million and their annual profits are only about $1.5 million and they have no cash.  Half of these debts are from loan guarantees to others.  

My sense living here is that this situation is a microcosm of what is going on all over China. I may be wrong and I really hope that other places are faring better than my area, but from what I hear there is not a lot of good news.  What we need is for the global economy to pick up quickly so that these business can step back from the brink. What I can say for sure is that the appetite for debt and high living among my timber colleagues has certainly been curbed. The hangover is painful and those that do survive will be a lot more economically literate then they were in the heady days before 2008.

Walking Backwards

Imagine that you are walking backwards along an unfamiliar road unable to look over your shoulder.  You have to go onwards only guessing what is to come.  You draw your conclusions about where to place your feet based on what you can see.  This is, indeed, life. 

We cannot see a nanosecond into the future even when we are looking squarely down the road ahead.  Practically speaking we are getting a useful picture of the present, of the lay of the land ahead, but strictly speaking, even when we look down the road at what is ahead, we are looking at the past because by the time the light reaches our eye the situation has moved on.  In daily life we are happily unaware of the speed-of-light problem and consider, sensibly, that we are seeing the present.  Indeed, we walk happily down the road believing that we are seeing the future and place our feet with total confidence.   This works fine most of the time and this ability to compute and predict the future well beyond the road ahead has made us what we are as humans.

Unfortunately, we are not always right.  Black-swan events teach us this.  We are unable to predict the future even a nanosecond ahead.  As we walk down the road confidently seeing what lies ahead there is nothing other than past experience and probability to back our confidence.  A sinkhole could open beneath our feet or a meteorite might obliterate us before we can take that next step.  (In practice think of 9/11 and the GFC).  Fortunately such events are rare and our ability to predict is an effective guide in daily life and decision-making, but it is important to keep in mind that we are not actually seeing the future.

This idea is particularly relevant when one finds oneself in a totally unfamiliar environment.  The entrepreneur or executive arriving in China probably has several decades of experience in life and business and has a high degree of confidence in his or her abilities.   However, past experience is of only limited use in a place as different as China.  The ATM incident comes to mind in this context.  I am surely not the first foreigner to experience this.  We all know the drill: you put in your card, enter the password, enter the withdrawal amount, take back the card, get the cash and probably get a receipt or the option of one.  Three hours after my first ATM withdrawal and two hundred kilometres down the tollway, I realized that I did not have my card.  The cause of this disaster was that I failed to notice that in China it is money first, then receipt then press finish and wait for the return of your card.  After almost seven years I still have to remind myself before every ATM transaction to make sure I do not forget to take back the card.  Another simple example is the expiry of cheques.  The first time we were paid by cheque we did not bank it immediately for some reason.  A little over a week later when we did take it to the bank we were told that it had expired!  That was news.  In my country that does not happen for one year, a period that in practical terms is of no consequence.

un·pre·dict·a·ble

ˌənpriˈdiktəbəl/

adjective

1. 1.

   not able to be predicted.

   "the unpredictable weather of the Scottish islands"

   synonyms:

   unforeseeable, uncertain, unsure, doubtful, dubious, iffy, dicey, in the balance, up in the air More

The lessons in China come thick and fast for the foreign entrepreneur, especially the pioneer without the backing of a large organization or head office.  I felt such “oh-fuck” moments were a daily occurrence in the first year or so.  They were then weekly and now, after more than six years, perhaps less than monthly.  There is no way to know!  All one can do is to try to avoid making assumptions, but that is not a simple matter.  Can I assume that my food is not poisoned?  Probably.  Can I assume that I can drive through a green light safely without slowing to crawling pace?  It depends on which city or, part of the city, you are driving in.   Can I look at the laws and assume that what they appear to say is what they mean?  Probably not.  Can I rely on people to do what they say they are going to do without scrutinizing the transaction at every stage?  It depends, but mostly not.

So walking backwards through China is hard, because your past experience is only a very rough guide to what lies ahead.  So the lesson fellow Sinophytes is to be very, very careful and to assume as little as possible.  Ask lots of questions of lots of people before you make any decisions.  Tread carefully.