Localization

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foreign partners was to force them to localize the parts supply. However, as seen in the AMC case, this enforcement not always was successful.

In the VW case, VW offered to build engines in China, they could not only be used for its operations in China itself, but also could be exported and sold to VWs international supply network. Through this, the SVW JV could generate its own Forex and therefore was not reliant on the national Forex reserves (Chin, 2010, p. 90). Martin Posth also explains, that not only imported CKD kits and parts did cost the company Forex, but also the staff, as some of it had to be paid in Forex – especially the German expats, who through agreeing to coming to a, at that state, very underdeveloped China, agreed to cut back on a lot of comforts with regard to lifestyle and amenities (Posth, 2006). Naturally they had to be compensated for the lack of comfort and increase in difficulties they had to suffer due to their move.

VW also agreed to procure some of the equipment it needed to build up its factory from local suppliers.

However, at the same time the two sides had agreed to build cars according to German quality standards and it soon turned out that the locally produced equipment was of too poor quality to actually use it for that purpose. This resulted in the fact, that of the equipment for which it had been agreed upon to source it locally, 60% had to be imported – in exchange for Forex. After much deliberation, finally the Chinese government granted the additional budget of Forex for the JV, but the pressure to localize increased dramatically (Chin, 2010, p. 92).

This is an example where at first, the good intentions of the German side did increase the trust the Chinese had into the project and the German company, however, in the end all good intentions could not be realized due to the state of the environment the JV had to operate in. Nevertheless did VW show that it understood the Chinese’ problem concerning Forex and it supported the Chinese side in trying to find a solution for it.

7.7 Localization

As mentioned before, the Chinese government was very keen on increased localization as it hoped that through this it could not only reduce its spending of Forex, which it had to use to acquire parts from foreign suppliers, but also the Chinese government hoped that the localization of parts would drive the local automotive industry and would increase the growth of it.

In the JV contract, Volkswagen had agreed to source some parts from local suppliers and to increase the local supplies content step by step. By this, driving a global standardization strategy: as the

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Santana and later other cars that were to be produced for the Chinese market were practically the same all over the world, and both sides had agreed to apply the same quality standards as anywhere else, pressure for local responsiveness of the supplies was very low, however, the pressure for cost reductions was very high, as price was a deciding factor in the Chinese environment. Nonetheless, VW was not contractually obligated to build a local supply network, instead it was clearly stated in the contract, that the local parts provision would be the responsibility of the Chinese side (Chin, 2010, p. 78).

But as mentioned before, in the beginning, the plan of locally sourcing equipment could not be fully implemented, due to the lack of quality of the local parts. After the AMC/BAW JV debacle in 1987, fearing to loose even more Forex and disappointed by AMCs management, Vice Chairman of State Economic Commissions, Mr Zhu Rongji warned the VW/SAIC JV: “If the quota of parts made in China does not increase to 40 percent in a short time, we will close Shanghai Volkswagen.” (Chin, 2010, p. 80). But Mr Zhu’s efforts did not stop there, painfully aware of the Forex risk that China took with the foreign companies that imported their supplies from back home, he also went to warn Mr Jiang Zemin, the then party secretary and mayor of Shanghai: “We have to be aware of the bitter lesson – we practically have made no progress in three years.” (Chin, 2010, p. 80). Alerted through this, the VW side of the JV decided to act. Even though in fact they were not obligated to ensure the local parts supply capacity, but the Chinese side was, they stepped in, because the Chinese were unable to handle the matter on their own in the foreseeable future and the survival of the whole JV and the payoff of all their engagement in China depended on it (Chin, 2010, p. 82). The German side insisted on that all parts, no matter if imported of locally supplied needed to meet German quality standards. However, for the Chinese that meant that they could not build up local supply capacity without the help of the German partner, as they simply lacked the knowledge of how to produce parts of the demanded quality. The threat by Zhu Rongji meant that the German partner had no choice:

either it supported the Chinese in the development of a modern supply network, or it gave up on its China operations. So the German and Chinese side together set out to build up a supply network in two steps: first, both sides together decided which of the local suppliers had the most potential. Due to the 50:50 arrangements in decision-making, VW basically only had a choice amongst the SAIC suppliers. This meant also, that the SVW supply network later on was almost exclusively within Shanghai (Thun, 2006, p. 105). After this first step, for each supplier it had to be individually decided, whether to transfer the necessary technology directly from VW to the supplier in a licensing

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agreement or if the German side would match one of its German suppliers with a Chinese one, and the two then built a JV to supply SVW. Here, the German side played a huge role, as without its outreach to its broad based supply network, no matching would have been possible. Many of the VW supply firms were hesitant to enter China and to transfer their knowledge, as they feared that the Chinese would “steal” their technical expertise. However, as Martin Posth pointed out, the JV with a Chinese supplier firm also opened up future business opportunities to them. As Mr. Messmann put it:

“VW and SAIC together played the role of “match-maker” in establishing the supply network” (Chin, 2010, p. 85).

After the identification and the match making, the training and teaching had to begin. The German side taught the Chinese side about how to produce up to German standards and in this, SAIC was lucky with its German partner: VW could, like in its management and technical training, draw upon its strong international experience in training. None of the other foreign partners had had this kind of backing (Chin, 2010, p. 88). The Germans also taught the Chinese about efficiency. One example here is, that they taught them that a supplier should group the parts made of the same material and through this could broaden its product range. For SVW this meant, that they could start purchasing one part from a supplier and then if the supplier proved to be reliable, could increase its sourcing amount and range from this supplier. This played into the “trust and family” way of doing business in China.

The Germans were very careful and kept a close eye on the quality its Chinese suppliers delivered, as the Chinese were very much tempted to sacrifice quality for the sake of short-term benefits. (Chin, 2010, p. 86). Gradually, the supply network in Shanghai increased in quality and quantity and SVW could increase its local supply-sourcing rate, until it reached a 90 percent local supply capacity.

However, the increased local sourcing rate was also due to the increased production rate in the SVW plant (Thun, 2006, p. 115). The willingness to help China building up a sustainable local supply network, including knowledge transfers in the technical, as well as in the managerial and financial field, helped VW to gain the trust of the local authorities, as it proved its long-term commitment.

Without the direct help of the Germans, the Chinese would have not been able to reach this level of modernization in the Shanghai area. However, credit also need to be given to the Chinese central authorities, as it is highly unlikely that VW would have made this kind of contributions without them exerting pressure on the JV.

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If one looks at VWs foreign competitors in the Chinese market, they had not understood what VW seemed to have understood pretty well: localization of the supply chain and building linkages between local suppliers and final assemblers into a network, provided the SVW JV with a clear cost efficiency advantage for the regional market, as this made production much cheaper than importing whole vehicles in the form of CKD kits. Also, as mentioned before, it provided SVW with the necessary trust and support from the Chinese government (Chin, 2010, p. 99). Its former efforts to win over government officials helped SVW also in the matter of localization. The Chinese Lu Jian was Vice Chair at the Shanghai Economic Commission, in 1987 however, when localization efforts were made, he also took over as a Managing Director in the SVW Board of Directors. His double role ensured that the local government did cooperate with JV in its localization efforts. Other Sino-foreign JVs, did not have this kind of connection.