The truth behind the mask and the potential of China

Photo Jean-Pierre Clamadieu / Chairman and CEO, Solvay / November 9th, 2010

The Rhodia Group made its first inroads into China 30 years ago at the precise moment the country initiated the political and economic reforms necessary to embark on its transformation to a modern market economy. Occupying a privileged perch from which to observe the transition from its early stages, the specialty chemical firm has set down solid roots in the Middle Kingdom, leading CEO Jean-Pierre Clamadieu to observe: the opportunities China represents are enormous. Nevertheless, they must be constantly balanced with an increasingly rigid regulatory environment and the near daily struggle to secure adequate supplies of the resources necessary for continued growth.

China is home to a number of enduring stereotypes but the country has a habit of upsetting predictions and turning expectations on their head. As of 2010 the rapidly expanding infrastructure is irreproachable and local administrations have been streamlined to become ever more responsive to the realities of the business communities they serve. The only real blemish on the horizon is found in the country’s labor market as while the country houses a seemingly inexhaustible supply of labor most is of poor quality and of the day to day variety. A massive influx of migrant labor to the Eastern cities from the Western and central regions of the country’s vast interior has until now been adequate to fuel growth in the so-called ‘workshop of the world’. As the country begins to place more emphasis on developing high value added industries however, the shortcomings of the current situation are becoming clear: qualified individuals are in short supply and while the Eastern coastal regions where Rhodia houses its operations are also where the highest numbers of skilled individuals reside they fall short of the numbers required to reach the levels of development currently occupied by regional competitors. South Korea for example, a country with a longer tradition of industrial development, also finds itself better equipped to respond to the increasing demand for skilled labor.

Success in China will increasingly rest on an organization’s ability to attract the best and the brightest talent and perhaps more importantly retain them. This is true at all levels of the enterprise but especially so in the domains of Management and Research and Development. This has meant focusing on the pool of locally available talent and in 2009 the majority of the investment Rhodia made in professional development and training was directed toward Chinese employees. This policy has begun to bear fruit and a full 90% of current management is Chinese. The picture in R&D is less clear cut and while there is an abundance of graduates from technical and scientific institutions there are significant gaps in knowledge that need to be filled along with special emphasis placed on the importance of respecting intellectual property norms. High turnover will need to be addressed through the creation of clearly defined career prospects which lead to positions of responsibility and long term growth at the heart of the company’s core business.

Of course every enterprise operating in the Chinese market is faced with another more immediate challenge. Rapid growth, which remains attractive in economic terms, has resulted in an increasing scramble to obtain and secure access to primary resources as well as rapidly dwindling energy supplies. China has become a net importer of many of the materials required for continued expansion of industrial capacity which include metals (China is the world’s largest importer of iron ore), petroleum products and coal. China’s two decades of rapid economic growth have fueled demand for energy that has outstripped domestic sources of supply and the country has lost the degree of energy independence it enjoyed until quite recently. One startling figure comes from last June when the Railways Ministry reported an increase of 17.9% in the amount of carbon carried by rail freight over the previous year. Indeed, demand has become so elevated that many of the booming coastal regions were placed on high alert for possible shortfalls of energy resources throughout the summer of 2010. Vigilance has become a requirement of doing business in China and this is doubly true in the energy intensive chemicals industry. Reliable access to electricity and natural gas are essential and this is, and will remain, a challenge for the foreseeable future. Government entities are perfectly aware of this fragile state of affairs and are not immune from its consequences. Working in partnership with the relevant local authorities we have reached the mutual conclusion that a number of projects will have to be shelved or relocated outside of China unless more reliable sources of primary resources can be secured in the future.

Rare earth elements have become crucial in the global high-tech industry and China currently enjoys a virtual monopoly in this domain and is responsible for 95% of the world’s supply. Production has been abandoned for the most part in the developed world due to the difficulty of exploiting geographically spread out deposits in a cost-efficient manner. China recently aroused widespread international concern when it announced plans to restrict exports of elements essential to some of the most advanced technologies which include automotive catalytic converters, energy saving lamps and certain flat display technologies and for which there exists no known substitution. To justify its policies the Chinese have advanced two arguments. On the one hand the country aspires to occupy a privileged position as a producer of high value added technologies while on the other it has become increasingly sensitive to the environmental damage caused by waste that results from the extraction and processing of rare earth elements. The resulting shockwaves have reverberated through the global supply chain but the decisions taken are not in and of themselves without legitimacy. On the other hand, given that alternative sources for these materials are few and far between and will take years to develop there is a real need for greater transparency in this domain. In the meantime, Rhodia has already developed alternative sources in Australia to meet its needs until the uncertainties surrounding supplies are alleviated in China.

The growth witnessed by China over the preceding 30 years has come at the expense of severe environmental degradation. In February 2010 a survey of the numerous sources of pollution in China—the first of its kind— was published after more than two years of footwork by a veritable army of investigators numbering over 570,000. This followed decisions taken in 2006 by the State Council and in the process 1.1 billion sets of data were collected on the various sources of pollution and close to six million pollutants were identified and sub-divided into categories such as industrial, agricultural or residential pollution. The sheer scale of the investigation is proof if any were needed of the Chinese government’s commitment to sustainable development. What has been revealed is that industrial growth in China, primarily fueled by coal power, has not only pushed China to the lead in global carbon emissions, it has also wreaked terrible havoc on the local environment shaving years off the lives of productive workers. Gone are the days of laissez-faire when the government placed economic development above all other concerns and it has become more and more common to witness central government intervention to halt operations in areas where operators of rare earth processing facilities are failing to meet the new more stringent standards such as a recent intervention we witnessed firsthand in the Inner Mongolia region. Emblematic of the new status quo was the government’s highly publicized move to halt the spread of a blanket of toxic blue-green algae that was threatening to choke Lake Tai near the economic hub of Wuxi in 2007. We can expect more of the same going forward.

Throughout Chinese history the scarcity of water has been a constant challenge and today occupies center stage in the government’s plans for sustainable development. The rather stark reality is that over a quarter of the population has no access to clean water. The implications of this unhappy state of affairs encompass more than just health concerns and could threaten the very legitimacy of the foundations on which the current economic miracle has been built. Acid rain afflicts one-third of the national territory and has intensified the process of desertification. The squeezing of arable land has forced the country to become a net importer of rice, wheat and soy for the first time in its history. Massive public works projects such as plans to divert water from the wet South to the arid North are well underway and are proof of the government’s commitment to address this problem. Stringent standards have been set on water pollution and Rhodia has found that in a non-negligible number of cases the environmental regulations are even more strict than those found in Europe or the US. Of our three Diphenol producing facilities in Lyon, Louisiana and China it is in the latter that standards are the most advanced. This has led us to increase our investment in R&D to develop modern environmentally friendly processes and technology. Additional difficulties have arisen from the fact that while the rules are the same for all they are applied more severely to foreign-owned enterprises resulting in a two-tier system. The dampening effect of this double standard means that despite encouraging steps in the right direction it will likely be decades before Chinese industrial infrastructure reaches international standards.

It is often said of the Chinese economy that it represents capitalism ‘with Chinese characteristics’ and so it goes with environmental standards. Make no mistake, the country takes its responsibility for sustainable global development seriously but will accomplish these aims in its own way and according to local conditions. The government has conveniently sidestepped the problem of global warming by refusing to limit its greenhouse gas emissions in absolute terms and has instead chosen to cut CO2 emissions per unit of GDP. In this scenario economic growth takes priority and while the country has refused to agree to the principle of verification by the international community it has invested billions of dollars to improve the efficiency of its technological leaders and shuttered the operations of organizations that fail to comply with the new directives.

In China, Rhodia’s activities are divided among three primary sectors: automotive (representing 20% of global sales); cosmetics and detergents; and electronics. With 30 years experience in the Chinese market and links that go back even further to the beginning of the 70s initial activity was restricted to bi-annual trade fairs where deals were struck and business transacted in the event that an import license had been granted for our products. By the 80s the company had installed a Representative Office in the country but lacked any ability to engage directly with domestic economic actors. Loosening restrictions allowed the Rhodia group to establish its first Joint Venture as early as 1993 resulting in the creation of Qingdao Silica. Finally, in 2000, during the heady days of the run up to China’s accession to the WTO we established our first Wholly Foreign Owned Entity. Since this time the Asia Pacific region has come to represent an ever increasing proportion of the Group’s global footprint rising from 16% of the worldwide total in 2003 to 28% in 2009 (France accounts for a mere 7%) and a projected 31% in 2010 with the recent acquisition of Feixang Chemicals. Rhodia expects its operations in the rapidly developing markets of Asia and Latin America to generate at least half of worldwide revenues for the foreseeable future.

The success of Rhodia in China can no doubt be traced to the fact that as the country was taking its first tentative steps toward a market economy some thirty years ago we were taking measures to join in the adventure that has led to the economic juggernaut we know today. As of 2010 China continues to confound expectations and defies any attempt at reducing the progress made to the simple stereotypes of the past. As the market matures the opportunities that made the country a kind of El Dorado of global investment opportunity have faded. The days when western companies were courted with promises of free land and tax incentives have vanished as surely as golden city of ancient myth. Make no mistake, local authorities have continued to invest in creating a modern infrastructure and are still working to ease the process of plant construction and implantation but contemporary China bears little resemblance to the anarchic conditions that followed on the heels of economic reforms introduced in the late-70s. Using outdated production techniques and unable to compete in a more liberal marketplace many industries including but not limited to metals, chemicals, automotive and textiles simply imploded on themselves or operated at a severe loss due to overcapacity as was the case with steel and plastics.

To avoid any chance of repeating past mistakes the Chinese government decided in 2005 to introduce increased rigor and discipline to the marketplace. The expectation is that top down direction can move industrial production up the value added chain. To achieve this aim the National Reform and Development Commission (NDRC) established guidelines to leverage its regulatory power in order to direct investment into desired channels. Foreign investment shows no signs of subsiding and remains colossal at about $90 billion in 2008 and again in 2009 but is being directed into the areas the government has identified as vital to the country’s economic interests. Investment funds are therefore being used to encourage the development of technological innovation, sustainable development and are being concentrated in the underserved interior of the country. Where vital technology is concerned investors are expected to share their experience with local partners. The stated aim is that local companies pick up the vital knowledge and information that will allow them to meet future demand and adapt to advances in the industries they serve.

This proactive and interventionist approach the state has taken helped create a blueprint for future development in the Chinese market and in 2006 the NDRC was able to identify and classify three types of investment: “prohibited” (industries related to national security or other sensitive areas of the economy as well as industries experiencing overcapacity); “restricted” (subject to regulation); and “encouraged”. The chemical industry falls under the latter category and Rhodia has been able to capitalize on these favorable conditions. Other industries, including petrochemicals and high-speed train technology have not been as fortunate as they are considered sensitive to national interests and in order to operate in these areas companies must partner with local business and agree to surrender control of any technological expertise.

Rhodia’s long experience in China combined with the favorable regulatory environment created through current NDRC directives should allow the company to continue to expand its presence in the region for the foreseeable future. The stability of our positions should by no means be taken for granted however as the playing field remains in perpetual motion and the government has made no secret of its desire to create its own national champions as part of long term industrial strategy. The current priority is to reduce the country’s dependence on imported chemical products and rebalance the equation to favor internal development by building the domestic industry from the ground up. Rhodia is already facing competition from a number of sources that include locally based small-to-medium size businesses as well as more traditional international rivals. This process is only set to accelerate as time progresses and specialty chemical companies multiply in the Chinese market. A period of consolidation is already underway and locally grown companies will soon be competing for our current customer base. The stakes involved couldn’t be clearer and the Group’s survival will depend on our ability to reinforce our current position through expansion by virtue of our advances in technology over local competitors. One recent example of this approach was the inauguration of a new facility producing silica for the next generation of low energy tires. Innovation is, and will remain, an essential component for any Western firm operating in China.

What lessons have been learned from evaluating the last 30 years of Rhodia’s adventure in China? We can affirm without hesitation that the overall experience has been an extremely positive one. Despite the pressures of such a competitive environment, the mounting regulations and tension surrounding access to primary resources the rewards have far outweighed the costs. Even when environmental challenges are added to the equation the benefits of a strong local presence along with proximity to the dynamism and growth of the Chinese market will provide immeasurable benefits to Rhodia in the years to come. When we take into account the fact that European markets continue to exhibit weak signs of growth the Asian market becomes all the more essential to our efforts to maintain a coherent global strategy in the face of economic uncertainty. China is spearheading our development in the region and will help insulate us from the ups and downs of the global marketplace of tomorrow.

In conclusion, Rhodia believes that its ability to meet the challenges presented by the Chinese market have allowed it to develop the key assets it will require to take full advantage of growth opportunities in the future. As a company resolutely committed to sustainable development it is prepared to meet the increasingly stringent regulatory and environmental requirements laid down by Chinese authorities. Even accounting for the fact that the nature of the Chinese market promotes a two-tier system where the bar is placed considerably higher for foreign owned firms the picture looks bright. By taking a proactive approach we have been able to integrate the principles of sustainable development into our operating procedures long before they became a requirement. Rhodia is one of the rare companies to be listed on the Dow Jones Sustainability Index and in 2005 a global responsibility agreement was signed between management and representatives of unions in the chemicals industry (ICEM). It was the first such agreement to be concluded in the sector and it sets down the company’s commitment to social responsibility and dialogue with union representatives. The company has been recognized by the Chinese government as a responsible manufacturer and as recently as June received the 2010 “Corporate Social Responsibility Special Award” at a conference in Beijing devoted to the contribution of international corporations to the country’s sustainable development. This is proof that our Rhodia Way framework for management has been a success since its implementation in 2005 and that our core operating principles are perfectly in sync with Chinese priorities for the future of the country’s industrial development.

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Note from the editors : Rhodia is a patron of ParisTech Review

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  • The truth behind the mask and the potential of Chinaon November 9th, 2010