Manufacturing in China is a sensitive topic. So sensitive, in fact, that several companies iStart approached to discuss their strategies considered the topic to be a brand risk.

That’s understandable: ‘disaster stories’ about Chinese manufacturing are easy to find. Suntech’s troubles are rocking the world’s solar power business; last year, three Rio Tinto executives including Stern Hu were jailed. Companies such as Pacific Brands have seen both their share price and public reputation battered by the decision to move manufacturing to China (its recovery and the long haul back to profitability were far less well reported).

Manufacturing in China can even have political implications, especially if it goes wrong: the Reliance Rail contract for new rolling stock for the state of New South Wales has involved delays, production problems and an expensive bail-out. Even investments in China can carry both financial and brand risk, as Fonterra experienced when its subsidiary Sanlu dragged the dairy giant into China’s milk contamination scandals.

Yet manufacturing in China can be done successfully – and for any company that wants to maintain its place in a competitive world, it’s often a commercial necessity. iStart spoke to three businesses for their impressions and advice on what it takes.

THE VETERANNETCOMM – SYDNEY Netcomm is a veteran technology supplier that began life manufacturing analogue modems in the 1980s, when (among other things) the peculiarities of national telecommunications networks encouraged product localisation. Having spent more than ten years supplying the ADSL and wifi router markets, the company is now focusing on the emerging machine-tomachine communications market. While design and engineering remain in Australia, the company now has more than a decade’s experience in off-shore manufacturing. THE STARTUP COMPOSITE PRODUCTS – ADELAIDE Composite Products has spent three years working on its ModPod. The ModPod uses a honey-comb carbon composite material to create a lightweight, re-deployable and completely self-contained housing unit. While its initial market is Australia’s resources sector, where it hopes the ModPod can displace the containershed accommodation common in remote mines, the company also believes the unit can be deployed to disaster-prone locations as stackable pre-built emergency accommodation. Australian production is used for pre-production units, but Composite Products has used offshore manufacturing from its inception.

Paul Russell of New Zealand company Global Design and Production says that over many years of dealing with Chinese manufacturers, he has developed methodologies for identifying and assessing new manufacturers.

“Manufacturing in China can be done successfully – and for any company that wants to maintain its place in a competitive world, it’s often a commercial necessity.”

Even so, he says that the concept of guānxì or relationship building is central to ensuring that outsourced manufacturing will work: both the client and the supplier need to be comfortable with the close contact needed to ensure delivery and maintain quality.

“The minefield is the relationships – that’s where things come unstuck,” he said. Since you can’t know what relationships will prove fruitful, there is inevitably a degree of “flying blind” at the beginning. “You have to start relationships, and hope they turn into good ones,” Russell says.

That’s a challenge, though, due to the sheer scale of the market: anybody arriving in China for the first time will quickly learn that for any given product, there are thousands of manufacturing facilities to choose from, making distinguishing the good from the bad the first challenge.

It’s vital to match the scale of your business with that of the supplier, he said.

It’s easy to look at China and characterise its production capabilities in terms of companies whose names we already know – Foxconn, for example, because of its high profile as supplier to Apple, Amazon, Sony, Nintendo and others.

All of these, however, are relationships between peers – and therein lies a catch for the unwary. Put simply, a small Australian or New Zealand company arriving in China will not be of interest to Foxconn. At best, the giants will ignore you, Russell believes, at worst, they will take on the business, but won’t give you either the attention or resources needed for you to get what you need.

The same, he says, applies across the board: find a company whose scale is comparable to your own. That way, your business will be important to them – and you’ll be more likely to have access to, and form relationships with, the key executives of your supplier company, rather than being relegated to a third-tier sales manager.

David Stewart, CEO of Sydney-based telecommunications manufacturer Netcomm, agrees. “Look for a factory size that’s geared to your business – there are very big factories that do huge volume, but are not interested in our business. The volume you’re offering has to be interesting to the supplier or you will get no attention.”

And without that attention, there won’t be the opportunity to build the personal relationships that make the manufacturing relationships work.

THE OUTSOURCERGLOBAL DESIGN AND PRODUCTION – NEW ZEALAND Global Design and Production (GDP) acts as a “manufacturing plug-andplay” operation, taking a position within its customers’ design, manufacturing and logistics departments. Paul Russell, CEO, is an industrial engineer and production designer. With manufacturing in New Zealand, Australia, China, Taiwan and Cambodia, it’s able to follow the complex relationship between supply chain, production process and manufacturing facility to get the best mix for a customer’s product. GDP also helps its customers “design for commercialisation”. HOW TO GET IT MADE IN CHINA • Get local – All interviewees agree: for any serious, long term manufacturing relationship, local personnel are vital. Not only will it smooth the tortuous paths through another country’s legal and bureaucratic processes, it demonstrates a commitment to the market. • JV – Joint ventures likewise demonstrate a commitment to a longterm relationship. They also align the interests of both parties. • Legals – Don’t skimp the legal support needed to establish contracts to support the business relationship. • Building a relationship is incremental – expect to make many, many trips to support the business relationship.

CULTURE AND BUSINESS
Many of the assumptions and expectations carried by western businesses are the result of a century of corporate culture. China’s extremely rapid development, urbanisation and industrialisation means that there’s an awful lot of learn-as-you-go happening. In a single generation, hundreds of millions of people have been lifted out of their formerly-rural lives and plunged into the world of urban business.

Some things that seem obvious to those steeped in a longer business culture are not yet part of peoples’ assumptions, Russell explains.

“If I take you on as a client, I want to be selling to you for ten years or more. Similarly, Chinese suppliers may say that it’s all about long-term business, but often it’s not. The understanding that it’s cheaper to do more business with an existing customer than to find a new customer can be missing in China.

“Of course, that understanding can also be missing in Australia or New Zealand!”

Even simple matters like payment terms can catch the unwary by surprise. Russell explains that, “In Australia or New Zealand, you’d expect to set up an account relationship with a manufacturer.

So you’re paying, say, 50 percent up front and the remainder after the product is shipped and accepted.”

It doesn’t work the same in China, he says – the unwary might not even see a product before they’re liable to pay for it. “If you can’t check the product before it leaves, you may as well throw money on the roulette wheel.”

And, as Simon Modra, CEO of Composite Products, notes, a business that takes that risk unawares only has itself to blame if it gets caught out.

“It’s up to you to honour that deal, so make sure that you prime the pump before you start it. Get your manufacturer to make one before you order 1000.”

It’s a lot cheaper, he says, to go through many iterations before committing to volume, than to try and short-cut the process.

THE OVERHEAD IS UNDER YOUR FEET
If there is a ‘process’, it starts with wearing out the shoe leather. You can’t arrive in China, spend a week on the ground, and return home with contracts signed, ready to go.

“If you send an executive to China, hire a translator for a week, come back and expect things to go smoothly, you’re very naïve,” Modra says. “From when we started – it took a full year to get first products delivered.”

That year, he says, included setting up the joint venture, disseminating the intellectual property, working through the manufacturing processes and systems, setting up the factory, setting up the bank accounts and the customs processing.

It’s about expectations: a year sounds like a long time to someone expecting to be swamped with suppliers at the airport, but “if I set up a factory from scratch in Sydney or in Auckland, it wouldn’t move much faster than that.”

Establishing and maintaining relationships costs money, which is probably why so many companies get their forecasts wrong when they first move to China.

A company that set its sights on getting its product for two dollars instead of ten dollars is going to be burned, Russell says, as soon as it turns back its first batch of unsatisfactory product and starts down the much longer – and more expensive – road of forming relationships and shepherding the manufacturing production.

“I spend well in excess of US$100,000 a year for my travel – and there’s an opportunity cost of lost business here,” Russell says. “The total impact could be US$250,000 per year, but we have over 40 clients that we supply products to.

“Unless you’re buying more than US$500,000 worth of product per annum, off-shoring to China won’t make sense. And if you’re planning to subcontract, it will go over a million.”

Stewart says Netcomm’s experience is similar to Russell’s. “I’m in Asia regularly. We’ve used a number of factories, and I have a close relationship from the president down in those organisations.

“You have to be there, look at the factory, the people, the process – you measure that in thousands of dollars, an airfare and accommodation and time. It’s not a fortune, but… if you think you can do it remotely, you’ll lose everything.”

GETTING THE TECH LINKS
In a world in which connectivity is assumed, it may come as a surprise that everybody contacted by iStart put such a premium on face-to-face interpersonal contact as the basis of building and maintaining successful business relationship.

However, successfully creating the technological links that support the business relationship remains vital. For Netcomm, Stewart said, the experience of years has taught the company to build and maintain a large number of systematic links between staff and systems, covering the supply chain, finance, engineering functions, test systems, and logistics.

In particular, Stewart nominates supply chain software and quality control systems as key points of interactions between the different businesses that finally deliver a Netcomm product. “The personal one-to-one relationship does not replace electronic interchange, but rather builds the trust and relationship,” he says.

“For Netcomm the experience of years has taught the company to build and maintain a large number of systematic links between staff and systems, covering the supply chain, finance, engineering functions, test systems, and logistics.”

Russell cites similar effort and experience for GDP. “Offshore production is built on systematic structure. We invest in a host of components.”

For example, he says, his company has created a “Globalproduction” system that plugs into the Xero accounting software suite, which went live during April 2013 and allows management of suppliers in Cambodian, Chinese and English.

OVER THE FENCE
In spite of the differences in their products, Stewart, Modra and Russell all agree that the most common customer mistake is when people believe they can hand over a design and deadline and collect a finished product.

Even with long standing relationships behind the Netcomm products, Stewart says, “you can’t just send a product over to a factory, tell them to do it, and expect it to be correct when you get it back.

“You have to provide lots of detail and lots of support to the people you’re working with. The documentation, the manufacturing processes, the test scripts – they all have to be right. And the supplier has to understand what it is you’re looking for. Not just the product – the quality, the performance and the functionality you’re looking for,” Stewart says.

“We send engineering people to China continually to work through the process, the testing and the debugging. For any new product, we send engineers over to work with the supplier on how to make it and how to test it.”

The aim of that investment in people, travel and relationships, Stewart says, is to make every transaction “as seamless as possible”.

“It has to be a partnership,” he emphasises.

BARTER, DON’T BATTER
The most cautionary note Stewart sounds for someone looking at offshore manufacturing is “be careful what you ask for”.

“I’ve seen people who act like if you wish hard enough, or if you’re belligerent enough, you can get any price you ask for,” Stewart says.

“If the price you want is unrealistic, you’re just encouraging people to cut corners. If someone agrees to meet it, you won’t get what you want.”

There is also a desire to say “yes”, driven by culture and competition. With the thousands of potential competitors available, if a supplier wants your business it’s likely to try and accommodate even unreasonable pricing demands – “yes, sure, we can do that” – and only with the delivered product in hand does it become clear that unreasonable demands are only going to be met with unacceptable product quality.

“If the price you want is unrealistic, you’re just encouraging people to cut corners. If someone agrees to meet it, you won’t get what you want.”

There is, Modra suspects, a cultural component to this. Australians and New Zealanders don’t bring the same legal, structural and procedural habits and assumptions to the table in their business dealings. The cross-cultural challenge – hardly unique to Australasian-China business dealings – is this: how does a supplier learn when and more importantly how to say ‘no’ to a customer.

“In Australia or New Zealand,” Modra said, “we’ll hammer a supplier down to the bones, and then he’ll stop trying. He’ll tell you what can’t be done.

“They won’t say that in China – and you’ll get just what you deserve. So we have to change our attitude […] when we go over there.”

The suppliers need to make a profit, need to pay their staff, have their own mouths to feed – and if you don’t care about those things, he said, the relationship will fail.

Here’s a paradox: businesses have the opportunity to save money and improve business processes – but many resist doing so. Welcome to the world of ‘carbon accounting’, and a lesson to be learned from the potato crisp.

The potato crisp in question is sold in the UK under PepsiCo’s Walkers brand – as iconic there as Smith’s in the antipodes. Undertaking a comprehensive audit of its carbon footprint (an exercise in detailed carbon accounting), Walkers discovered a perverse incentive in its supply chain.

By paying its suppliers strictly by delivered weight, the chip-maker was encouraging everyone from farmers to its factory door to maximise the potatoes’ water content. This was energy-expensive twice: the suppliers spent money on temperature-controlled humidifiers to protect their precious crop, while Walkers then spent money on extra frying time to drive off the extra moisture.

Having discovered the wasted carbon input during a joint project with the UK’s Carbon Trust, Walkers crafted an incentive to reward farmers for lower water content, and cut its own emissions by saving 10 percent of the frying time.

If there’s a good enough reason to make the attempt, the dull business of carbon accounting can pay for itself, not under the coercion of regulatory compliance, but because it helps identify and eliminate waste.

Steven Hafey, product manager at Pronto Software in Australia, says many companies can benefit by the greater visibility into costs that carbon accounting can provide. “Why is our biggest cost here in diesel?” is a good rhetorical example, he says. “‘Why is a particular facility using more carbon?’ If you’re not tracking it, you can’t do anything about it. It starts with having a look.”

SAP’s Asia Pacific-Japan director of sustainability, Darren Green, says “Really, it’s all about energy. If you can focus on energy, there’s a real cost saving.

Three percent is a genuine bottom-line saving. So carbon accounting is about understanding energy use, because for most companies, that’s where the real savings are going to be.”

An emerging, but as yet inconsistently applied segment in the business software industry, carbon accounting is a straight-forward enough proposal.

National emissions reduction schemes are based on attributing and charging, in some way or another, for carbon emissions, which means that to comply with such schemes, businesses need to account for their emissions.

That’s an opportunity for the IT sector, met variously by integrating carbon accounting into existing systems (vendors such as Pronto, SAP, Epicor, TechnologyOne and others), or by creating standalone systems (Carbon Systems in Sydney).

Today, it’s an activity which companies seem only willing to complete under compulsion – something which has hampered the deployment of purpose-built carbon accounting systems’ ability to take the place of nearly everybody’s default entry to carbon accounting, the spreadsheet.

Carbon schemes
There are also international differences between carbon schemes, even between Australia and New Zealand, which can make carbon accounting more complex to execute and, in the case of New Zealand, often voluntary.

Australia’s emissions trading scheme, the Carbon Pollution Reduction Scheme (CPRS), targets companies whose annual emissions exceed 25 kilotons of carbon units – given the media shorthand of the “top 500 emitters” (the list, maintained by the Clean Energy Regulator, names 317 companies as at 12 December, 2012).

These are the companies required to obtain permits under the CPRS – permits which attract a fixed price today, but which will become a fully-tradable instrument between 2015 and 2017. The scheme is also to be linked to Europe’s ETS in 2015, allowing the purchase of permits from European sources as well as Australian.

All of this rests on a dataset much older than the CPRS itself: the 2007 National Greenhouse and Energy Reporting Scheme (NGERS) established reporting requirements that are the foundation of the CPRS.

That Act requires reporting companies to track emissions under three ‘scopes’:

Scope 1 emissions: the direct impacts of their operations in terms of carbon dioxide equivalent emissions (with the Act’s accompanying regulations listing equivalencies for 23 other chemicals, all the way up to Perfluorohexane whose greenhouse potential is 7400 times that of carbon dioxide).

Scope 2 emissions: the indirect impacts by way of (for example) energy purchases.

Scope 3 emissions: those associated with a product’s lifecycle after sale (such as the consumer’s usage of a microwave oven) are not mandated for reporting.

Offsets and abatement activity are also required to be reported, and in the case of offsets, the regulations demand the identification of the source, because developed and developing nations are treated differently under the Kyoto Protocol.

The bulk of Australia’s reporting regulations are, in fact, concerned with outlining the special cases involved in particular industry sectors – mining, energy, mineral production, and waste businesses.

There is, additionally, a set of what Erwin Jackson, deputy CEO at the Climate Institute in Australia, called “onerous obligations” for proving that someone is “fit and proper” to engage in carbon trading.

NGERS imposes penalties of up to AU$200,000 (with extra penalties for running late) for companies whose reporting isn’t compliant.

While the long years of international debate over climate change abatement have failed to produce dramatic international action to reduce greenhouse emissions, they are clearly visible in much more prosaic outcomes – such as the development of international reporting, recording and classification standards. Hence, both Australia and New Zealand – along with a large number of other countries – base their greenhouse policy on the Greenhouse Gas Protocol (ghgprotocol.org/).

New Zealand stipulates the same Scope 1-2-3 classifications as Australia for reporting purposes. However, New Zealand’s reporting regime is being rolled in gradually. As the Environmental Protection Authority’s 2012 Climate Change Response Act report states:

• The forestry industry has been reporting under the ETS since 2008;
• The stationary energy, industrial process and fossil fuel sectors had their first full reporting year in 2011; and
• The waste and agricultural sectors’ data will first be published in 2013.

A Ministry of the Environment spokesperson noted that New Zealand treats some sectors differently from Australia. For example, emissions from fossil fuels are reported by the source, rather than by the users: a coal mine reports the carbon, rather than the factory that burns the coal. On-farm agricultural emissions, on the other hand, are shifted down the supply chain to processors, however, the New Zealand government recently announced that it would put off, indefinitely, the date at which farms will be brought directly under the ETS.

An important administrative detail is that rather than a single regulatory instrument as has been adopted in Australia, New Zealand has opted for sector-based regulations (the full suite of regulations is listed at the government’s Climate Change information page, at tinyurl.com/c7by4kc) and other than the companies covered by the ETS, all reporting is voluntary.

Sources: New Zealand – Ministry of the Environment, Environmental Snapshot, April 2012, Australia – Department of Climate Change, Quarterly Update of Australia’s National Greenhouse Gas Inventory, June 2012

Standards and interfaces
Erwin Jackson, deputy CEO of Australia’s Climate Institute, identified international standardisation as a key issue, especially for companies with an international footprint.

“You need consistency with the international rules – you don’t want it to be a wild west.” Standardisation also helps reduce compliance costs, he says. “Having alignment across the globe in terms of common accounting metrics is in everybody’s national interest.” Measurement that’s based on “robust science” builds confidence in carbon accounting, he added, and simple regulations makes compliance more likely.

Hafey agrees: because of the international standardisation embodied in documents like the Greenhouse Gas Protocol, he said, “the calculation algorithms are pretty much international … nice and generic.”

However, Hafey notes, governments in both countries are lagging behind IT reality in the matter of reporting, with mechanisms that rely on online forms without the convenience of a published API (application programming interface) – meaning that whatever IT system a customer puts in place, there’s inevitable double-handling of the data.

Why Bother?
The market as it now stands poses a problem.

Carbon accounting has arguably reached most of the Australian organisations covered by the mandatory scheme (and probably those at its periphery, since they will be watching their emissions closely to try and avoid crossing the 25,000-tonne mark); and in New Zealand, government policy has dramatically reduced the need for such systems.

That has turned the IT industry’s mind to other things: whether carbon accounting can find its payoff in other ways. According to Green from SAP, projects rarely get off the ground on feel-good alone.

“The world of carbon accounting has changed in Australia,” Green stated. “Before there was no board-level motivation to get rigorous.” For companies like BHP Billiton or Macquarie Generation, “If the carbon bill is in the hundreds of millions of dollars, you can’t run it on a spreadsheet.”

The record-keeping looks relatively straight-forward, Dr Sumit Lodhia of the University of South Australia’s School of Commerce explained – but the scope of the data gathering can be surprising, especially for large emitters.

Scope 2 emissions, Lodhia says, are the easiest to report – since they can be easily derived from the energy bills. The challenge for companies reporting Scope 1 emissions is not that they’re especially complex, he says, but that they can involve a very large number of data points.

Market responses
The reasoning behind integration into financial software is simple: “The structure of the information that the [Australian] government wants, and how they want you to report it, is very similar to a general ledger profit and loss – and that ties in very nicely with the way people structure their financials,” Pronto’s Hafey explained.

He says Pronto looked at the required data structures and implementation challenges for some time before launching into the carbon accounting segment. Its two key decisions have been to integrate carbon accounting for free, and to make it backwards compatible to older versions.

Even if the software problem is easy to solve, SAP’s Green says, business processes – the simple decision of who should capture carbon data at what point in a business process – need consideration.

“Accounts payable is a familiar, well-thought-out process,” he says. A data entry operator “takes a bill, the data, the vendor, the price – but until now, not the kilowatt-hours. “So one question is: do you re-engineer accounts payable to capture it, or design a separate process?”

Pushing cost data back to departments also needs thought.

“It might even be a concern for cost-centre accounting. In SAP’s branch office in Melbourne we have half a floor of a commercial building that we don’t own but there are five departments represented here. Do we try and allocate a carbon cost against the three people in the corner, because ‘Melbourne office’ isn’t a single cost centre?

“We’re asking our customers to think about the level of granularity they want,” he noted – and this is not a software challenge, but a business challenge.

However, in spite of such considerations – and the fear that the words ‘new business processes’ can engender in IT departments – Green firmly believes that the payoffs are worth the effort, regardless of the strength of the reporting obligations that exist.

“Some companies might get caught up in the negative aspects, and miss the opportunity. You can start to compare, measure, benchmark, and understand your opportunities to improve.”

Hafey agrees: “Even though we’re not charging for it, a lot of customers are still looking at [carbon abatement schemes] with a sense of fear. It’s something extra that they don’t want to do.”

But the understanding that leads to examples like Walker’s chips, he says, is something that benefits both the company’s finances and the environment. Why not see if the ROI exists independently of regulation? he asks.

NZ CARBON ACCOUNTING A NON-EVENT Some commentators have criticised New Zealand’s more recent revisions of its ETS scheme. Gordon Shaw of Auckland sustainability consultant SempriAvanti explained that 50 percent of New Zealand emissions are associated with agriculture. This makes greenhouse gas abatement extremely sensitive at the grassroots political level. That, he explained, is why the New Zealand Government has now said it will defer indefinitely the date that farms will be brought directly under the ETS – leaving the scheme only covering the fuel and forestry industries it now covers. Calling the decision an “unwinding” of the Government’s commitment to the ETS, Shaw says the lack of policy from the Government means that New Zealand businesses are “operating in a vacuum”. Shaw also pointed out that there is no mandated reporting scheme analogous to Australia’s NGERS in New Zealand, so with neither a requirement to report, and with an ETS with a very small business footprint, there’s little reason beyond corporate citizenship for any company to attempt accurate carbon footprint measurements. One vendor contacted for this article was privately more blunt: “Carbon accounting isn’t a discussion topic in New Zealand. The New Zealand emission trading scheme isn’t a happening thing.” Whether or not that last statement is hyperbole, it’s a fact that New Zealand’s ETS is trading well below expectations – as New Zealand Herald commentator Brian Fellow put it, the roughly $2.50 pertonne price means “$200 per million dollars in revenue”.