Corporate Governance and Technological Capability Development: Three Case Studies in the Chinese Auto Industry




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LIU & Tylecote /


Corporate Governance and Technological Capability Development:

Three Case Studies in the Chinese Auto Industry
Jiajia Liu and Andrew Tylecote

Sheffield University Management School



9, Mappin Street, Sheffield UK

Jiajia.Liu@sheffield.ac.uk

A.Tylecote@shef.ac.uk
Abstract

In this paper we apply theories of the effects of corporate governance on technological capability (see Paper 1) in the context of China’s auto industry. Corporate governance here has a very broad meaning of ‘who controls the firm and how’. Through case studies we confirm that shareholder engagement and stakeholder inclusion in corporate governance affect a firm’s strategy and behaviour in technological capability development.
Three state-owned companies are chosen for case study. Shanghai Auto Industry Corporation receives explicit state support as one of the “Big Three” auto manufacturers; after recognizing that little was gained regarding technologies from foreign partners, it resorts to mergers and acquisitions. Chery, as a small latecomer struggled to gain official recognition at the time of establishment, managed to launch its first self-proprietary car just 2 years into production and another 4 in the following 2 years. Guizhou Tyre resembles SAIC in its long history as an SOE, but a less favoured one. It resembles Chery in its successful endogenous capability-building. Longitudinally, in the case studies we investigated the firms’: 1) corporate governance system, with emphasis on the level of shareholder/owner engagement and stakeholder inclusion; 2) the strategies adopted when developing technological capabilities, and implementation of these strategies at various levels of operation; 3) their technological as well as product (market) performance over time, with a view to comparison with domestic and international competitors. Data was gathered on SAIC and Chery mainly from secondary sources (which in their cases are abundant); on GTC, mainly from extensive interviewing of management (top-down interviews with the Chief Executive, the Party Secretary/ Chief Operating Officer, the Chief Engineer, one line manager, and complementary interviews with shop-floor operatives) combined with site observations.
There are two major findings from the case study. First, it was the two with unusual engagement which were more successful in developing ‘endogenous’ or ‘self-reliant’ technological capability. Second, two alternative technological strategies could be distinguished: ‘bundled’ or ‘unbundled’ technology acquisition. Chery and GTC are most untypical in terms of external corporate governance – in the highly-engaged behaviour of the government levels concerned, and (crucially) in the autonomy and time given to the top managers. This led them to follow strongly-inclusive policies within the firm, and the unbundling strategies that led to technological success. In contrast, SAIC conformed to ‘large favoured SOE’ type, in the characteristics of its corporate governance and its easy access to funds. It conformed to type, too, in the strategy of technology bundling that it followed, and in that strategy’s poor results.
It is notable that the variations in corporate governance and technological performance in these firms were within the context of majority (indeed 100%) state ownership. (Earlier studies have shown that important improvements in technological performance may result from the increased engagement and inclusion which results from minority state ownership.) This therefore indicates how corporate governance might be reformed even in firms which for strategic reasons are to be kept under full government control.


  1. Introduction

The rapid growth of the Chinese economy has not been matched by the development of ‘indigenous’ or ‘independent’ technological capability by Chinese firms. That has been, at best, patchy. As Gu puts it (2003, p.14): ‘China as a whole has not moved to the stage of being able to create distinctively specialised competitiveness in the international market beyond labour-intensive manufactures’. Indeed, even on the national market, Chinese firms in medium and high-technology industries have in general remained dependent on technology transferred from abroad. The automobile industry – which in the OECD classification is a medium-high-technology sector – is an appropriate sector to consider when seeking an understanding of this Chinese failure, or limited success. It is, after all, one of the priority sectors chosen by the Chinese government for development. The privileging of private cars in Chinese transport policy – with its inevitable downside in terms of congestion, pollution and dependence on foreign oil suppliers – can only be explained and justified in terms of the government’s determination to build a strong Chinese car industry.
The last decade has indeed seen the Chinese automobile industry surge - sales have grown 40-60% p.a. It has emerged as an “engine” of the Chinese economy, providing a huge number of jobs, spillovers into the wider economy, and contributing to regional economic development. While achieving substantial success in terms of content localization and capacity building, it has been weak in developing its own technological capabilities and remains, or remained until the last year or two, almost completely reliant on foreign joint venture partners for advanced automotive technologies (Gallagher, 2003; Lu & Feng, 2004).
Lu and Feng (2004) offered two main reasons for the unsuccessful story. First of all, flawed industrial policy failed to foster capability development and innovation. In order to consolidate the highly fragmented industry to build a group of globally competitive large, multi-plant corporations, the 1994 Automobile Industrial Policy set up entry barriers such as stringent assets and capacity requirements for start-up companies; investment was only officially encouraged in three large-scale companies, called the “Big Three”. Such favouritism curbed domestic competition and hence firms’ incentive to develop endogenous technological competitiveness. Second, while the industry relied passively on technology spillovers when joint-venturing with foreign companies, little knowledge was gained along with production capacity. The foreign companies essentially selected what would be transferred and how, without necessarily teaching their Chinese partners anything significant.
A growing body of literature (Lee et al., 1996; Harwitt, 2001; Wang, 2001; Jin, 2004 and Lu & Feng, 2004) criticizes large-scale Chinese enterprises as lacking the incentive and ability to develop ‘self-proprietary’ cars – cars whose intellectual property they own and whose technology they have mastered - despite explicit and substantial financial and policy privileges. However a few smaller-scale late-comers are doing significantly better – e.g. Geely and Chery. The former gained orders for over 100,000 self-branded cars to 100 countries at the 2005 Frankfurt Auto Show, making it envied by the well-bred “big brothers”. Chery, after pioneering joint ventures overseas in 2003, has just announced the launch of China’s first passenger car engine with full intellectual property (http://www.chery.cn). In this context, it is pertinent to raise the following question: why has the performance of enterprises varied so much under similar market conditions?
The main aim of this paper is to show how existing theories of the effects of corporate governance on technological capability can be adapted to extend our understanding of the above. Tylecote and Cai (2004) showed how the governance flaws of Chinese state-owned enterprises (SOEs) can affect technological development. Their arguments help in understanding the failings of the ‘Big Three’ car companies. But one of the rather successful ‘latecomers’, Chery, is a state-owned enterprise too. We need to explain success as well as failure among SOEs in developing technological capability. In Section 2 we explain how corporate governance can vary among Chinese SOEs in ways which can be expected to affect technological development. In Section 3 we describe case studies of three state-owned enterprises in the motor industry which exemplify just such corporate governance variations as we expect to be significant. Shanghai Auto Industry Corporation (SAIC), Chery, and Guizhou Tyre Co.Ltd (GTC) are studied: the first two mainly from published sources, the third mainly on the basis of semi-structured interviews with senior and middle managers during June 2006. Analysis is made both longitudinally (how changes take place within the organisation) and laterally (how behaviour varies between two different companies). A combination of archive search, site observations and cascade interviews was employed in the GTC case study. In-depth semi-structured questions were put to 5 interviewees – the chief executive, the party secretary/ chief operations officer, the chief engineer, one line manager and one of shop-floor workers – to find out the evolution of the firm’s technological capability and corporate governance. Section 4 discusses major findings and makes suggestions on future work.


  1. Corporate Governance in China and its Effect on Technological Development

Corporate governance is a multi-faceted subject. Understood broadly, it is the set of processes, customs, policies, laws and institutions affecting the way in which a corporation is directed, administered or controlled (Tylecote, 1999; OECD, 2004). The most-researched domain in corporate governance is the “agency” problem. The principal-agent relationship is defined as a contract under which principals employ the agent to perform on their behalf, which involves delegating some decision-making authority to the agent (Jensen and Meckling, 1976). Due to information asymmetry, opportunism and bounded rationality, the agent will not always act in the best interest of the principal. In China, the traditional principal-agent issues are particularly profound in state enterprises, manifesting themselves in two layers (Tylecote & Cai, 2004):


    • Agents being accountable to agents. In China by definition the ownership and residual claim rights of SOEs belongs to all – hence in essence to no-one. From the external governance point of view, government officials are in charge of the firm; firm managers answer to them. However, these officials too perceive themselves as agents, not principals; agents not of the people, but of the senior officials who appointed them. The agency problem is thus multiplied, or rather squared (or cubed).

    • Managers’ career paths as officials. Anyone familiar with the Chinese political system and industrial structure can confidently list the one-to-one matches between SOE managers’ positions at different levels with those of government officials. Thus CEOs of local firms are paid as section chiefs (Chuji Daiyu) or director generals (Juji Daiyu) whereas CEOs of “Central Enterprises” (Zhongyang Qiye) are normally regarded as vice ministers (Fubuzhangji Daiyu). Their quasi-official status largely shapes the mentality of SOE managers. They are usually picked by officials, and may be officials themselves already; anyway, they often end up as an official of a higher position after staying in the firm for a forecastable period of time (normally around 5 years). This makes the agency problem more acute, because it is inherently linked to term and time horizon. Given a long enough time in post, it is rather easy for an agent’s performance to be evaluated reliably and accurately: shrewd investments pay off in the end, while unwise economies in the building of capability and the nurturing of customers, come back to haunt the myopic manager responsible. An agent who expects to be elsewhere soon, must care more about superficial impressions than long-term consequences.

How do these flaws of corporate governance affect firms’ technological capabilities? Before going further, the meanings of several terms used in this paper need to be clarified. First, in this research technological capability is defined as a process of acquiring technical knowledge or a process of organizational learning (Rosenberg and Frischtak, 1985). The concept of technical knowledge here is distinct from that of accumulated experiences or tacit “know-how”, which can be gained automatically through day-to-day operations and survival – the former requires explicitly devised effort and investment (Bell, 1984; the italics are ours). Hence the approach to technological capabilities always involves active learning and most importantly, cost and risk. In turn, a firm’s technological capability development depends on how well its corporate governance system copes with the following three challenges (Tylecote & Conesa, 1999):

  • Visibility – capability-building activities within the firm may be low in visibility to outsiders (such as shareholders or monitoring officials); to the extent that they are, they cannot be properly monitored without close engagement.

  • Novelty – to the extent that technologies and the markets in which they are to be exploited are novel, capability-building activities cannot be properly monitored without industrial expertise. (This challenge has been subdivided into ‘need for reconfiguration’ and ‘technological opportunity in Tylecote and Visintin, 2008, but the need for industrial expertise emerges just the same.)

  • Stakeholder spill-overs – if technological learning requires substantial inputs from, and/or offers gains to, employees and/or related firms, these stakeholders need to be in some important sense included in governance – that is, they should have power or influence, or at least their interests ought to be taken into account.

Following this thread, the handicaps of the governance mechanism of Chinese SOEs for technological capability naturally emerge. First, as mentioned above, the engagement level of firm controllers is generally low and relationship between most SOEs and their supervising officials is mostly arms-length. Although in general managers maintain good connections (guanxi) with bureaucrats, this is usually done for easier access to cheap finance or insider intelligence about potential policy adjustments. Few would expect to see government officials going out of their way to monitor firms, let alone to understand and oversee their process of technology acquisition, and they also lack the industrial expertise to do this. Second, the key relationships which the managers need to cultivate are with senior officials. Their emphasis on this limits their attention to relationships with employees and related firms which are key for inclusion.

Central government’s drive to enhance technological competitiveness has (it must be conceded) put pressure on officials to worry about technological capabilities of firms they are in charge of. Lacking engagement and expertise, however, they are most easily satisfied by developments with high visibility and rapid effects. From this point of view the ideal means of (apparent) technology development is to acquire a single bundle of technologies. The concept of bundling is familiar in product markets – selling two products together (Nalebuff, 2004). In technology markets it goes back at least to Arora (1996), who argues that the notorious problems of selling tacit knowledge, or knowhow, can be avoided, or limited, by bundling complementary inputs with know-how in a technology package, making the contract more enforceable. This is seen from the point of view of the seller in a developed country. We consider technology bundling from the point of view of the buyer in a developing country.

What then is a technology bundle for a developing country firm? An assembled product such as a car of course contains a multitude of components. Each is produced using certain process and product technologies. A number of components are combined into sub-systems (brakes, engines, etc.) which themselves require further process and product technologies, as does the final assembly into the finished product – the car. Many of the process and product technologies will be covered by patents or other forms of intellectual property protection which will be infringed unless licenses are granted. The successful adoption of the technologies will require blueprints for production methods, and training. The process technologies are largely embodied in more-or-less specific equipment. A full technology bundle will then contain the blueprints, licenses, training and equipment required for all the components, sub-systems and systems. (The classic form of providing at least the equipment is the ‘turnkey’ plant, in which the provider takes responsibility even for putting the equipment together on site.) It may well be, however, that the firm buying the bundle is not to produce all the components and sub-systems in-house. Some may be withheld from the bundle, either because the buyer is held not capable of handling the technology, or because it is regarded as unsafe from the seller’s point of view to disclose key technologies. The components withheld are then to be bought, on a continuing basis, either from the seller or from suppliers chosen by it.

The advantage from the seller’s point of view is clear, and is essentially as argued by Arora: the seller keeps control. The main advantage from the buyer’s point of view is speed and simplicity: there is one bundle, one deal, one provider who (presumably) knows how everything fits together and can quickly make sure it all works, as long as local conditions do not get in the way. (A further advantage is the obverse of the advantage to the seller: there will be more willing sellers because they have less fear of losing control.) It can easily be seen that the speed and simplicity of a bundle are of particular value for the typical Chinese SOE top manager. He can quickly show his ‘disengaged’ monitoring officials, results, in terms of technology: new products, new equipment, new processes. The new products will presumably show quick results too in terms of market share. The bundle is likely also to deliver quick profits: the main up-front payment will be for equipment, and that shows in the accounts as an asset not as a current cost to be subtracted from profits. Of course, large amounts of money will need to be raised – which has normally meant borrowed from banks – and interest paid on that. However, state-owned enterprises, particularly large ones owned and favoured by central government, have long been able to borrow very cheaply indeed.

Consider, on the other hand, what may be gained by a large measure of unbundling. Unbundling can be defined as acquiring the capability to produce each component and sub-system, and system, separately, and indeed at the extreme will involve separate acquisition of each element (machinery from one supplier, training from another, blueprints from a third). It is easily apparent that not every part of a car (or any other assembled product) is equally difficult to make. Some parts can be copied (legally or illegally) by a little reverse engineering. Others may require a modest amount of in-house R&D by the Chinese firm, or perhaps by a domestic supplier working to its specification. Not all the equipment need be bought, new, from foreign suppliers. Some may be available, used, on the market. Other equipment may be available to an adequate standard from a domestic supplier. Even where components and sub-systems do require technology from foreign sources, it is likely that the simpler the component (and element), the larger the number of potential providers, and thus the better the Chinese firm’s bargaining position. Another gain arises from the process of decomposition itself. Someone (or some team) in the Chinese firm has to work out how all the parts and elements, literally and metaphorically, fit together. To use the fashionable term, they have to master systems integration. That capability gives them the strategic ability to plan how they will develop new models with ever more in-house and in-country inputs, physically and technologically.

The disadvantages of unbundling are clear. It introduces a multitude of uncertainties: any one component may turn out to be unfit for purpose in itself. Or it may be mismatched with its neighbours in the assembly process: systems integration is difficult. The result will be a multitude of teething troubles. These will have to be worked through with the help of suppliers, customers and shop-floor workers, and this will take time. It is clear too that the corporate governance system of the typical Chinese SOE must magnify all these disadvantages. The top manager does not have much time to show results to dis-engaged monitoring officials. They will easily appreciate the result of the teething troubles – delays in product launch, poor initial reception by customers, slow build-up of production. They will not have time or patience to go round the factory having it explained to them how a second-hand machine here, a little bit of shop-floor ingenuity there, some discreet reverse engineering somewhere else, have each taken a per cent or two off production costs; still less, how the firm is learning to do better next time. Further, we pointed out above that the SOE manager needs to cultivate relationships with monitoring officials, and with other senior officials whose support may be helpful and whose hostility could be damaging. This leaves less time, and commitment, for the relationships key to inclusion – with employees and related firms – on which the firm will depend, to make unbundling work.


  1. Case Studies – Chery and SAIC

In this section, we will put our arguments in the context of the Chinese auto industry through case studies of two state-owned car assembling firms. Since capabilities are processes embedded in firms, we assume an organizational and empirical lens, rather than an economic and formal modeling one (Barney, 1991; Peteraf, 1993). In particular, we observe how both companies’ technological capabilities evolve over time; their different approaches to capability building are compared and analysed in relation to their governance mechanisms. Technological capabilities of both firms are assessed in terms of their ability to: i) identify technological needs and to select the technology to fulfil the need; ii) assimilate, maintain, modify and improve the selected technology; and iii) promote technological learning (Kumar et al., 1999; Lall, 2001).


  1. Snapshots and Features of Corporate Governance

SAIC

Shanghai Automotive Industry Corporation (Group) has a history that can be traced back till World War II. After the war, a Kuomintang magnate purchased Shanghai Car Plant from an English company to repair and assemble Chevrolet and Austin series. In December 1955 Shanghai Car Plant was communised and renamed as “Shanghai Internal Combustion and Components Company” and was conglomerated and renamed again in 1996 as “Shanghai Automotive Industry Corporation (Group)”. Together with First Auto Works (FAW) and Dongfeng Motor Corporation (DMC), SAIC is known as one of the favoured ‘Big Three’ and the largest on production capacity and market share (http://www.saicgroup.com). In year 2004, the $11.7 billion main business revenue brings it to the “Fortune 500” list as one of few Chinese firms. SAIC’s ownership entirely belongs to Shanghai State-owned Assets Supervision and Administration Commission (the regional division of SASAC). Its main body is SAIC Motor Co., Ltd, which owns 50% of SAIC’s two joint venture passenger car assemblers: Shanghai Volkswagen (SHVW) and Shanghai General Motor (SHGM). SAIC Motor also owns 70% of its listed company – Shanghai Automotive Co., Ltd (SA) and in 2004 became the controlling shareholder (48.92%) of Ssangyong, the fourth largest car company in South Korea. In 2004 it made 11 models of passenger cars. Apart from Saibao1, built by SA in its Yizheng plant since 2002, all other ten products are sold under the brand names of its foreign partners.


Since 1978 SAIC has been ruled by four different executives, and their service terms were 4, 8, 4 and 7 years respectively (the fourth chief is still in position). Three out of the four were transferred from senior positions in Shanghai government and two remained officials after leaving SAIC2. Hu Maoyuan, the current CEO who was appointed in 1999, represents an exception. His career started in one of SAIC’s factories and he has been in the management since 1986 (http://www.saicgroup.com). SAIC has always been well looked after by government officials at both levels. One example is that since 1985 SAIC was given the privilege to retain $1,250 out of the profit from each Santana. By 2002 this reservoir had reached more than $50 million. However, SAIC’s R&D expenditure is no more than 1% of its revenue (Jin, 2004).
Chery

Chery Automobile as a small-sized SOE3 was founded in 1997. It is located in Wuhu, a medium sized city in the landlocked province of Anhui. It has 8,500 employees and sold 185,000 passenger cars in 2005, a 118% increase from 2004, of which all 4 models are branded with its own intellectual property (IP). With a market share of nearly 13%, it ranks 7th of 33 passenger car companies. Though small in size, short in history and simple in structure, Chery has caught the nation by surprise - it developed its first 2 models of cars in just 8 months, less than 2 years after its establishment; it is the first to export branded cars and the first to build cars with Chinese IP overseas4; shortly after announcing the launch of 4 new models in 2006 and China’s first full-IP passenger car engine, it is now selling to East Asia to warm up for its invasion of the American market in 2007 (http://www.chery.cn).


However, the creation of Chery was dramatic. The relatively remote city of Wuhu was a latecomer to the new economy. In desperate search of growth potential, the local officials were fascinated by the lucrative business of auto parts production. Despite the strict entry control by the central government, they decided to build their own car company. In 1998 they quietly skirted the regulations and recruited Yin Tongyao, a trained engineer, who had been a rising star in one of the joint ventures with VW. Yin became vice-president of Chery and has been in effective charge since then – a total of 9 years. Chery received whole-hearted support by Anhui and Wuhu government. National regulations forbade new entries, so the officials named the enterprise “automotive components” company. When Chery built its first car, VW was furious due to the apparent imitation, so was the central government (Hessler, 2005). But during the reform era, as authority has become decentralized there is a common strategy, push the boundaries first, and then ask forgiveness. For more than a year, Wuhu’s officials negotiated with the central government, finally a compromise was made: by giving out 20% of its shares, Chery became affiliated to SAIC. In so doing it obtained the necessary licenses to manufacture cars and establish a sales network. However, SAIC in this deal pictured its role as lenient rather than strategic, it made clear in the memorandum that SAIC’s relation with Chery does not involve investment, management, debt, or dividend. SAIC realised its mistake afterwards; however, their marriage stopped shortly after Chery won favour with high state officials, leaving settlement of the 20% share a rumour.


    1. Approaches to Technological Capabilities Development

SAIC

The first half of SAIC’s technological development history (1978 – 2002) resembles that of most other Chinese car companies, that is, seeking technological spill-overs from international joint-venturing. SAIC used to have its own brand and product development capability back in the 1950s. After Russian technical support withdrew from China, “Phoenix” was built in Shanghai Auto Assembly Plant, the predecessor of SAIC. “Phoenix” later was renamed “Shanghai” and expanded into 4 different models and reached a capacity of 5,000 in 19755. Since 1978, SAIC followed the government’s urge to seek co-operation with foreign companies. In 1984 it started a joint venture with Volkswagen and in 1997 another with General Motor. The first type built in Shanghai VW was Santana. In 1991 SAIC decided to cease producing “Shanghai” and devote 90% of its retained profit from “Shanghai” to Santana project. The initial form of production in SHVW was CKD (complete knocked-down) assembly. VW’s contribution mainly took the form of bundled product and production technologies - according to the contract, without VW’s discretion SAIC cannot make adjustment to the original design (“not even a screw”, Lu & Feng, 2004). Although VW and SAIC shared equal investments in SHVW, the later was not happy to see disproportional profit distribution, especially after paying extra to imported parts. Significant effort was hence made to develop parts and components production capacity. In 1991 Santana became the first to be exempted from import licensing, symbolizing its realisation of localised production. However, after satisfactory profit margin – also thanks to the monopolistic policy – was guaranteed6, little was achieved regarding independent product development. With only one major design modification, Santana dominated SAIC’s assembly lines as well as the Chinese market until recently, while in Germany its production stopped in 1993. Apart from its two joint-venture cash cows, SAIC barely has car production elsewhere. In 1999, it purchased a loss-making plant in Yizheng city, Jiangsu province. Three years later Saibao was launched as SAIC’s first branded car since 1958. This model was developed on GM’s Opel platform. However, Saibao did not appeal to the market and was short-lived; its total sale in 2003 and 2004 was 4,298, less than 10% of Chery’s best-seller QQ in 2004 alone. In 2005 its production came to an end (Daily Economic Review, 15 Dec.2005).


SAIC’s lack of technology and branding power is one reason it is resorting to offshore acquisition, which started shortly after the appointment of its new CEO Hu. The first big target was Ssangyong, the loss-making South Korean company. In 2003 SAIC bought 48.92% of Ssanyong’s shares and became its controlling shareholder. In 2005, after giving up bidding on bankrupt Rover, SAIC paid £67 million on the technology details and IPRs of all of Rover’s engines and its 75, 25 car series. It was hoped that the injection of new blood could enhance SAIC’s weak technology basis. However, as Rover’s equipments and human resources were bought by Nanjing Automobile (Group) Corporation (NAC), another well-connected last-minute bidder, SAIC encountered difficulties in mastering its newly purchased technologies: “…we now have four potential sources of technology, 1) Rover; 2) Ssangyong; 3) Ricardo in the UK (we pay them for engine design and technological consultancy); 4) our own joint ventures, Shanghai VW and Shanghai GM. Apparently we are doing a lot better…However we have a long way to go in understanding and integrating Rover and Ssangyong’s organisation and technologies, plus we are still dependent on our partners in the two joint ventures for turnkey technologies – we were rejected by VW when we offered to buy its Santana platform after more than 20 years’ co-operation”, said a senior member of management (First Economic Daily, 03, Aug. 2005).
Chery

Chery’s strategy can be summarised as a high degree of technological unbundling. In 1996 Chery bought its first manufacturing equipment from an outdated Ford engine factory in England and moved it to Wuhu. It also acquired manufacturing blueprints for a model called “Toledo” from a struggling VW subsidiary, SEAT, in Spain. In secret, the factory made its first engine in May of 1999. Seven months later, it turned out a car. It used Jetta parts, from suppliers who were supposedly exclusive to VW. 2000 cars named “Fengyun” were made that year. Since Chery did not have the license to produce or sell assembled cars, Wuhu government convinced its local taxi company to gulp the batch. In late 2000, Chery got hold of its first research team – a group of around 20 engineers who had previously worked for Dongfeng, another officially-supported company just like SAIC. Dongfeng’s decision on closing down its research centre triggered their collective resignation. 8 months after coming to Chery, this team launched two new models, “Son of the Orient” and “QQ”. The former looks like Volvo’s “S80” and “QQ” reminds people of Chevrolet’s “Spark”. In fact, Chery’s own team was only capable of design, or imitation of the bodies. The chassis were done by Tower (USA) and the majority of moulds by a Taiwanese company. In addition to producing engines on the Ford assembly line, Chery also receive external supplies. As for smaller parts like accessories, electronic devices and engine accessories, prototypes were provided by Chery to parts suppliers for batch production. By breaking down product technology to the most detailed elements possible, and by only paying for things that Chery could not do by itself, cost was brought down. QQ was 1/3 cheaper than its Chevrolet competitor and so was Son of the Orient. Both types became hits in the market and soon ranked as top-sellers.


After winning the first buckle of gold, Chery started investing heavily in R&D and technological training. It is spending 10%-15% of its revenue on R&D (Chery website March 06) and between 2000 and 2005’ time its research division expanded to 11 departments with 800 staff. In order to cultivate its own development capability, Chery chose to work jointly with some of the most competent players, and its cooperation with AVL in Austria (the world’s 4th engine designer) is an example of this. Chery was responsible for initiating ideas and setting up standards while the latter specialises in designs and blueprints. “The most important foundation of our cooperation is that, we can ask any question regarding the technical details of their design and we can send our staff to observe and finally to participate” (Wang, 2005: 29). More than 100 Chery engineers went to AVL to take up training, some other 900 to other countries during the past years. The strategy of learning by training and learning by doing enabled Chery to develop the first China-made engine with its own IP. Compared to the large extent of pure imitation and reverse engineering in the previous phase, its new models, Tiggo, A5, F and M series obviously feature more in-house development.


  1. Guizhou Tyre Co.: a long march to endogenous innovation.

4.1 Methodology

In this case study a combination of archive search (journal articles, news reports, and official statistics), site observations and cascade in-depth interviews was adopted to collect data. 5 semi-structured interviews were conducted in the firm and interviewees were selected according to their job responsibilities and knowledge of different aspects of the research question. Longitudinal questions regarding evolution of the firm’s technological capabilities and its corporate governance were put to the Chief Executive, the Party Secretary7/ Chief Operating Officer, the Chief Engineer, line manager and one of the shop floor operatives. Due to cultural reasons, tape recording was not conducted in interviews; however, detailed notes were taken with interviewees’ signed consent.



4.2 Company history.

Guizhou Tyre Co.Ltd (hereafter referred to as GTC), was founded in 1965 through the merger of Guizhou Tyre Factory with Great China Rubber Company, which relocated in that year from Shanghai to Guiyang. In 1995, GTC was restructured as a shareholding firm and listed in 1997 in Shenzhen. It is one of the 520 “key enterprises” selected by the State Council and one of the top 10 tyre companies in China. In 2002 it became the biggest heavy-duty tyre exporter in China and ranked 38 in the industry worldwide in 2004. (See Appendix on Tyre types and the Chinese tyre industry.)



Its main products include bias-ply tyre, radial-ply tyre, steel-belted radial tyre, heavy duty tyre, agricultural tyre, tubeless tyre and gas spring. 25% of its product is exported. By the end of 2005 it has 6,532 employees, 349 of which are technical staff. Its shareholding structure from May 2006 is: state shares: 27.2%, tradable shares: 72.8%. Before this it was: state shares: 51%, tradable shares 49%. The state share reduction was operated through bonus issues to original holders as a gift (10:3.6). This is perhaps a neat expression of the fact that private property in a formal sense in China is less important than a clear recognition by the relevant people in power that one has the right to the yields from a particular asset. The state shares officially belong to Guiyang State Asset Management Co., Ltd, which is the provincial branch of SASAC; just as SAIC is owned by the Shanghai branch of SASAC.

Table 1: A Snapshot of GTC’s Market Performance




Jan. – Nov. 2005

Increase from same period 2004

Gross Output

RMB 2.47 bn ($298 million)

22.46%

Total Production (Units)

3,374,243

5.26%

Total Sale (Units)

3,041,613

11.75%

Total Gross Revenue

RMB 2.78 bn ($335 million)

31.41%

Net Export

USD 64.83 million

39.45%

Source: GTC internal statistics.
Like most state-run enterprises in west China, in the 60s and 70s GTC almost had no technological input. In 1985 an engineer who had worked in the tyre industry for over 20 years became executive of this firm. GTC at that time was lagging behind its domestic competitors. One example is that its designed capacity in 1965 was 300,000 per year; however, GTC’s annual output never reached that amount even 20 years later. With the help of the then supervising authority - the National Ministry of Chemical Engineering - Guilin Institute of Rubber Industry drafted a “ten-year development plan” for GTC, stating that it should “acquire and assimilate advanced foreign equipment and technology, adjust product structure, improve quality and realise economies of scale”. GTC’s major technological activity mainly revolved around this plan in the next decade. A total of 220 million RMB was invested into technology-related activities such as the expansion of the heavy-duty tyre workshop, the light-weighting of nylon tyres and the purchase of a 1.05 million-capacity small tyre manufacturing line and the follow-up process innovations.
In less than 8 years GTC accomplished its first 10-year objective, sales increasing by 20%-30% annually, and it became the first and largest heavy-duty tyre producer in China. Seeing the higher profit margin of radial tyres, a second “10-year plan” was initiated, aiming at developing radial tyres capabilities while maintaining its advantageous position in the traditional bias tyre and heavy-duty tyre market. From 1996 to 2000 RMB1.05 bn was channelled from retained profit, government bonds, and bank loans (at subsidised interest rate) to acquire the capability to produce radial tyres. Product details were bought from Michelin and GTC designed the production line by itself. Key equipments were imported from different suppliers through a series of 4 biddings, and other complementary equipments were tailor-made by a private company in Tianjin. By the end of 2005 GTC’s steel-belted radial tyre capacity has reached 1.5 million (the national capacity is 11 million), ranking the 8th. The product was certificated with DOT, E-mark, ISO9001, and National 3C, and was given the official “Famous Brand Product” (mingpai chanpin) title in 2004.


    1. Unbundling

“We have been always very conscious about our costs.” says the Chief Executive, “we always use domestic machines if there is one available”. The 1998 radial project is a case in point. In order to get the best value for money, instead of importing the complete set of machinery from Michelin, it asked its technical team to work out the most appropriate combination of equipment that would meet their needs and organised 4 international calls for tenders to get the key machines. In fact none of them were bought from Michelin. For complementary equipments they looked for cheaper substitutes in China. After carefully comparing the price, quality and after-sale service between over 30 domestic suppliers they finally gave the deal to a private Tianjin company. It later proved that these equipments were well adapted in production and each cut the cost by USD 3.41 million and RMB 4.43 million respectively. According to the purchasing plan drafted by Michelin, GTC needed to buy 7 forming machines for this new project which would cost over RMB 38.5 million. After studying the process of radial tyre production in both Michelin and Dunlop, GTC technical staff found out that if they could shorten the sulfuration time they wouldn’t need to invest so much in equipment. 5 months later, the planned sulfuration process improvement was accomplished. This enabled GTC to cut their purchase of sulfuration equipment by 6 units, forming machines by 3 units, and in turn reduced the demand for radial parting moulds, which saved the group a total of RMB 29.46 million.


A retired tyre expert from Dunlop Australia was invited to work in the radial division as managing director until 2003. GTC sent one of its deputy executives to work closely with him and to take over after he left. The CEO commented that the radial division enjoys highly autonomous and liberal management, largely inherited from the Australian manager. All medium level managers are university graduates and the division manager has HR rights to hire and fire people right under him. Wage rates are generally higher than for the same posts in other divisions and give more weight to workload rather than years of service.
R&D expenditure in 2005 was RMB 140 million, thus 4.6% of its total turnover; by comparison, Michelin spends 4.2 %. “All the money that we got from our IPO was invested into technology activities,” said the Party Secretary, Mr Qian, with emphasis. In 2003 GTC set up a post-doc station and hired two post-docs from Sichuan University to conduct research in the area of macromolecule materials. All living and travelling expenses were paid by GTC. Each post-doc was assigned three GTC technical staff, who were to provide assistance and support and on the other hand to learn by working closely with them.
GTC also spends generously on staff training. Around ¼ of employees from its two R&D departments (the steel-belt radial project has its own R&D team) are now taking part-time degree-oriented studies, either at Qingdao University of Technology (MSc in macromolecule material) or at Guizhou University of Industry (MSc in mechatronics8). All tuition fees are reimbursed if staff pass all exams and receive the degree or 80% is reimbursed upon successfully finishing the course.
A visit to GTC’s radial tyre plants was rejected due to secrecy concerns. However, according to observations in the heavy-duty tyre and bias tyre divisions, the standard of routine operation is high; for example, the rubber-kneading workshop is kept very tidy, which is hard for such type of process. Shop-floor workers mentioned that their working conditions have been constantly improved with ongoing technology and process fine-tuning, carried out by engineers from the R&D department and themselves.


    1. Corporate Governance

External’ governance: relations of management with officials



Although officially supervised by Guiyang State Asset Management Co., Ltd which is an independent entity, GTC still perceives itself as a state firm closely associated with the local government: “We were very lucky to be favoured as ‘number one’ by the Guiyang government; it makes our life a lot easier. We received financial supports such as interest subsidy on bank loans in our radial project in the 90s. Even now when subsidy is no longer allowed, we can still get our projects approved by the bank much more easily than other local companies since we have the local government as our guarantor. And it is not only about that, there have been times when problems cannot be solved by us, and the senior officials played crucial roles to sort things out. Because we are doing quite well now especially in a remote province like Guizhou, the central government starts to notice us and has listed us in the mid-long-term Agenda of the National Technology Development, which will provide us tax benefit. It has a crucial meaning because we feel that in the period of growing competence it not only gives us the financial edge but also political support.” The Party Secretary of Guizhou province and Guiyang city and the Mayor often come to GTC, sometimes spending a whole day working on the site. “…the Mayor once said if our output reaches RMB 5 bn in 2007 he will give us this and that. We don’t know if he really means it, and we doubt if he could do so because of the financial constraint that Guizhou faces as a whole, but at least we know that he cares about the whole thing and would be pleased if we could …” (GTC’s output in 2005 was RMB 3 bn and according to the CEO 5 bn could only be reached in 2010)
Mr Ma Shichun, aged 71, has been working in the tyre industry for over 38 years and has remained chief executive since 1986. Apart from the stated salary, he and a few other senior managers also receive discreet remunerations from the local government. At the end of 2004 the amount paid to Mr Ma was RMB 1 million, while average net income in this company was less than 10,000 per year, and while the bonus paid to the company for their winning the “famous brand” title for radial tyres was RMB 300,000. However, this pay package is unofficial and is thus subject to the officials’ discretion. At the end of June 06 Mr Ma and his peers were still waiting for the payment for year 2005 and were not sure whether it would eventually come.
Performance measurement is conducted both on an annual and irregular basis covering a wide range of criteria, including political stability, gross and net profit, employment, staff income, tax contribution, market share and export, etc. However, nothing is directly related to technological performance. The CEO believes that it is reasonable: “the leaders are very busy and are in charge of thousands of firms, making tyres is a very complicated thing, we cannot expect them to understand what we are doing, and all we can expect is autonomy and support”.
Internal Governance’: relationships within the firm

Mr Ma, a Shanghai-born university graduate who has worked in GTC for over 30 years, is widely respected and regarded as the core of this enterprise. His name was mentioned by almost all interviewees with admiration: “if our enterprise were to be imagined as an innovative machine, then Mr Ma is the crucial axis that makes the machine start and work properly”, says the principal engineer/ deputy chief executive, aged 37. He was thought to be able to make important, right strategic decisions at the right time. For example, lorries in China are seriously overloaded, and ordinary tyres are not durable enough. Ma asked research staff to modify the formula of the heavy-duty tyres and sold them to the replacement market. Sales increased dramatically and the profit was later injected into their new radial tyre project, partially solving the fund-shortage problem. It was proved that such strategy secured GTC’s market competitiveness. He is also a diligent practitioner of ‘management by walking about’: shop-floor operatives are very familiar with him coming into the workshop and consulting them on strategic decisions.


Mr Wang also believes that sufficient autonomy has been given to the technical staff: “we are encouraged to carry out experiments and trials, and don’t need to worry about any fine or punishment if we fail…”
All senior managers have worked in GTC for at least 10 years and many of them have been on the post for more than 10 years. “We think it is very important that we have a relatively stable management team. I give you an example, there is another firm, for some reasons their senior managers were changed almost once every 6 months, and now the firm is just about to go bankrupt, surely there are many other reasons for this, but what a pity…” said Mr Qian, who started his career at GTC in 1965 and became Party Secretary in 1997.
Inclusion Factors:

As a state-owned company in Guizhou, GTC has relatively high wage rates. Salary consists of two parts: basic pay and performance pay. Shop floor operatives are paid according to their qualifications and workload, requirement for skills and job hazard. Maintenance workers are paid slightly more than others. However, skilled workers still tend to leave: “working in a tyre-making factory is a tough job, but we are not too worried about shop-floor workers, they are more or less attached to their jobs due to technical reasons (although we have a job-rotation scheme) and it is not too difficult to recruit young peasants from the countryside. It is maintenance workers that we are more concerned about at the moment. It’s a much more skilled job and it takes longer to train qualified staff. The nature of their jobs in our firm means that they must be very dedicated; there is hardly any time to sit down and chill out in a day. For the same money they can find much easier jobs in other factories, either in Guiyang or in other big cities.” Mr Wang admits that continuous loss of skilled maintenance workers has had an impact on the firm.


Technical employees have special bonuses based on their qualifications, experience and job titles. Project leaders enjoy an extra subsidy of 1000 Yuan/month. GTC also has various awards for outstanding technical performances: product development/innovation, process improvement, cost-reduction, etc. The highest award is cash RMB 50,000. The award committee is mainly composed of senior engineers and experts from research institutes and universities, while GTC’s senior management is not involved in the selection process.
Firm-level “model workers” are rewarded very generously as well: RMB 4,800. In contrast, a province level “model worker” only receives RMB 800 from the provincial trade union. “There are problems with that. I heard a lot of complaints. In some factories different workers are selected for these two awards to show so-called ‘equality’, and they end up receiving different benefits…” said Mr Wang.
GTC is also seeking opportunities for technological collaboration with research institutes and universities. It now has ongoing projects with China Science Academy and Qingdao University of Technology, and according to the contracts GTC owns the IPRs. Also, GTC relies heavily on retired experts from overseas to tackle unsolved technical problems. There is no formal collaboration with other firms, but on the other hand, according to Mr Qian, informal information flow (MacDonald, 1992) from peer research staff in competitor firms has always been active and largely contributed to the growth of GTC’s technological capabilities.
Three key problems that GTC is still grappling with are the surplus of manual workers and lower-level administrative staff that it is not allowed to fire, because of the poor employment situation in Guizhou; its rather poor brand reputation due largely to being a domestic firm in an unfashionable location; and its lack of basic R&D capacity which would allow it to tackle challenges like making full use of glass fibre.


  1. Discussion and Concluding Remarks

We argued that three factors, engagement, expertise and inclusion in corporate governance affect a firm’s strategy and behaviour in technological capability building. We began with a view of the ‘typical’ Chinese SOE as handicapped by the lack of engagement and expertise among controlling officials, and (partly in consequence) as having poor inclusion of employees and other stakeholders. It did, on the other hand, enjoy access to large amounts of cheap bank loans, particularly if it was a firm favoured by central government. All these factors conduced to strategies of technological bundling. The findings of our first case study fit precisely into this expectation: SAIC has had a problematic governance structure. Government parachuted its officials into the company who did not necessarily have industrial expertise, and they were moved away not long after. Managers came to their posts with assigned tasks, either to increase capacity or to enhance profit; anyway, both are quantitative, highly visible and easy to measure. Since they did not have much time, nor did they or those monitoring have sufficient expertise, it was sensible for them to choose bundled technologies which came from MNC partners – these are easy to understand, readily available, and fast in effect. Now threatened by competitors such as Chery, and having a CEO who came up from within the organisation and who has the potential to stay, SAIC started to try to fight its way out. Its advantage is that it need not worry much about its budget; therefore it is able to buy not only technologies but also organisations that own the technologies. It is too soon to say whether it will succeed, but at least this offers an alternative to its previous practices.
Chery by contrast followed a strategy of extensive unbundling, which so far has been strikingly successful. How can we explain this in terms of its governance? Certainly not in terms of superior expertise among monitoring officials. What did the local Party hierarchies of Wuhu and Anhui know about the motor industry? Engagement, then? Undoubtedly Chery got a great deal of attention from the highest officials in Wuhu and Anhui. Lacking expertise, however, it is hard to believe that, however closely they engaged, they would have been able to judge the quality of Yin Tongyao’s strategy. What they did was simply to take some trouble to pick the right man, highly experienced in the industry, and then to back him while he built them a successful motor firm from scratch. For this they gave him time (we do not know how much) and money – but certainly not much of the latter. As Hu Maoyuan of SAIC is alleged to have said when criticised for not following Chery’s road, they did it that way because they had to: unbundling was a great deal cheaper. (It is plausibly rumoured that the teachers of the whole province of Anhui had to wait several months for pay at one point, when Chery got one of its largest cash infusions: Anhui is dirt poor compared to Shanghai.) Chery’s market position followed from its shortage of resources: they started at the bottom end of the market, where their low prices were most appreciated and their low initial quality most forgiven. Yin Tongyao, not having to watch his back, could watch his front: he could concentrate on building strong relationships with employees and suppliers. In sharp contrast with large-scale SOEs, staff expertise and inputs were treasured and their potential explored during the process of learning. Chery again wins higher marks for employee inclusion. Chery may also have gained from its complete insignificance in its early years. Who cared what those hicks in Wuhu (where?) were doing? Who was watching when, within their unbundling strategy, they made what might be called questionable moves on others’ intellectual property?
Chery’s current success also has implications for SAIC’s strategy. SAIC’s old strategy is discredited, but it does not have to follow Chery’s style of unbundling. As we have seen, at the end SAIC was buying foreign technology by buying the firms that owned it, and could spend heavily on R&D to fill any gap in what it bought. As a large enterprise with strength in finance and experience of large-scale production of high quality, SAIC can take the ‘high road’ while Chery (initially at least) had to take the ‘low road’.
Our in-depth study of GTC strongly confirms our relatively tentative inferences from Chery. GTC is to Guizhou province and its capital Guiyang, much as Chery is to Anhui and Wuhu: a poor family’s favourite child. Again, the relevant officials picked the right man – an experienced tyre engineer and manager – and stood by him. Like Yin Tongyao, Ma Shichun did not have to watch his back. Even more clearly, he was given time to deliver though initially little money. (The shortage of money was compounded by the need to ‘carry’ surplus employees.) Hired in 1985, he was still in charge 20 years later and with no end of his tenure in sight – a dramatic difference from the traditional SOE rotation of officials doing a stint as an industrial manager. How expert and engaged the monitoring officials have been over the years it is hard to tell, and the evidence suggests, not very, but in this context it hardly matters: Mr Ma was very expert and very engaged and in effect, though not in any formal sense, he was a major shareholder of the firm: he could have every confidence that he would be handsomely rewarded if it succeeded, and he was. Clearly Mr Ma’s time horizon was very long: he had every opportunity and motivation to aim for real technological capability development and he did so. The endogenous growth is clearly built on thorough and intelligent unbundling, as illustrated by the radial tyre project, including the use of the retired Australian.
Under Mr Ma, there has been a great deal of inclusion, formally and informally. The Party organization within the firm (one of the laosanhui, old three organizations that controlled the firm) seems to continue to function and to do so in harmony with Mr Ma. (Not only can a good Party secretary – who in this case doubled as Chief Operating Officer - help to make relationships run smoothly within the firm, he can do the same for important relationships outside the firm, above all with senior officials.) There is a stable management team. Shop-floor workers are made to feel included partly by Mr Ma’s practice of Management by Walking About, partly by the care taken to reward valuable contributors. (The loss of skilled maintenance workers is however a point on the other side.) GTC’s close cooperation with various domestic universities and the national academy of science is evidence, if not of stakeholder inclusion, then at least of careful nurturing of important relationships. Likewise, the informal flows of information from rival firms can only be fully beneficial if those in the firm whose personal networks carry them, are fully committed to the firm.
We conclude that our general thesis about the flaws in the corporate governance of Chinese SOEs is supported by our three case studies. SAIC conformed to ‘large favoured SOE’ type, in the characteristics of its corporate governance and its easy access to funds. It conformed to type, too, in the strategy of technology bundling that it followed, and in that strategy’s poor results. Chery and GTC are most untypical in their success in developing ‘endogenous’ (or ‘indigenous’, or ‘self-reliant’) technological capability, and in the unbundling strategies that led to it. They turn out also to be untypical in terms of external corporate governance – in the highly-engaged behaviour of the government levels concerned, and (crucially) in the autonomy and time given to the top managers. This led them to follow strongly-inclusive policies within the firm. It is interesting to compare our findings here with those of Cai and Tylecote (2005), who found an advantage in minority state ownership, which gave room for top managers (and conceivably other employees) to hold a major stake in the enterprise. Both GTC and (so far as we are aware) Chery were during the period studied, wholly-owned state firms. But what is, or was, the real difference? From a conventional Western point of view, a large share stake gives a manager secure power and a clear-cut financial interest in the firm: its success means riches for the manager. But Yin Tongyao and Ma Shichun had that position without shares. Affluence and power in China have been better secured by official favour than by entries in share registers. Minority SOEs will no doubt be excellent vehicles for technological dynamism in future, property rights being now rather more secure. But the moral of our story for China is that regardless of formal institutions, the key underlying relationships need to be conducive to the right technology strategies.
Appendix: Tyre types and the Chinese tyre industry

A radial tyre (more properly, a radial-ply tyre) is a particular design of automotive tyre. The design was originally developed by Michelin in 1946 but, because of its advantages, has now become the standard design for essentially all automotive tyres.

Tyres are not fabricated just from rubber; within the rubber are a series of plies of cord that act as reinforcement. In the past, the fabric was built up on a flat steel drum, with the cords at an angle of about +60 and -60 degrees from the direction of travel, so they criss-crossed over each other. They were called cross ply or bias ply tires. The plies were turned up around the steel wire beads and the combined tread/sidewall applied. The green (uncured) tire was loaded over a curing bladder and shaped into the mould. This shaping process caused the cords in the tire to assume an S shape from bead to bead. The angle under the tread stretched down to about 36 degrees. This was called the Crown Angle. In the sidewall region the angle was 45 degrees and in the bead it remained at 60 degrees. The low crown angle gave rigidity to support the tread and the high sidewall angle gave comfort.

By comparison, radial tires lay all of the cord plies at 90 degrees to the direction of travel (that is, across the tire from lip to lip). This design avoids having the plies rub against each other as the tire flexes, reducing the rolling friction of the tire. This allows vehicles with radial tires to achieve better fuel economy than vehicles with bias-ply tires. It also accounts for the slightly "low on air" (bulging) look that radial tire sidewalls have, especially when compared to bias-ply tires.

Radial tyre has been widely produced and used as the main-stream product, the average radial rate of tyres used in car manufacturing has reached 90%, while in developed countries this figure is nearly 100%. In China research projects on radial tyre can be traced back to the mid 60s, however, mass production only started in 1996. With in 7 years of expansion by 2003 total radial tyre production has reached 75 million, of which steel-belted 11 million (GTC has 1.5 million) and radial rate of car tyres 60%.


Figure 1: Construction of Tyre Production in China in Year 2005

Figure 2: Production of Radial Tyres in China, Years 2003-2005

Reference

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