Supplying auto parts to the world
Lu Guanqiu, the founder of China’s third-largest private company, discusses the future of China’s automotive industry.
Paul Gao
The McKinsey Quarterly, 2004 Special Edition : China today
Thanks to a strong economy and falling automobile prices, more and more consumers in China are plunking down money for their first car. With 20 percent annual sales growth expected through 2007, China is on track to become the world's third-largest market for autos, after the United States and Japan. One company that seems well positioned to tap into this growth is Wanxiang, China's largest maker of auto parts.
Wanxiang started out in 1969, with barely $500 in capital, as a repair shop for bicycles and farm tractors. Now it is China's third-largest privately owned company. Wanxiang, based near Hangzhou, in Zhejiang province, controls or has stakes in 100 companies, both in China and overseas, that deal primarily in auto parts. Last year, it earned $165 million in pretax profits on $1.8 billion of sales, including $380 million in parts exported or produced abroad. The company employs 31,800 people, 920 of them in the United States and Europe.
There are challenges, however. A global glut of production capacity is forcing automakers to put heavy pressure on suppliers to reduce costs. In China, seven new companies have entered the auto market since 2001, and several more have announced plans to do so. Once this new production capacity comes on line, utilization at auto factories with foreign investment could dip below 60 percent, so automakers would put even more pressure on their suppliers to reduce prices. And although Wanxiang does have a labor cost advantage over many of its auto parts competitors in the West, they have strengths of their own, such as more advanced technology and much larger scale.
But Lu Guanqiu, Wanxiang's founder, continues to see opportunity in the face of difficulties. For the past several years, he has been on an acquisition spree, buying auto parts makers in the United States and Europe to plug gaps in his company's technology, markets, and brands. To tap into businesses with higher profit margins and funnel funds back into the core auto parts business, Wanxiang has also acquired stakes in several services firms. In addition, Lu is hatching plans to fuel growth and profits by building a complete automobile, with the ultimate goal of manufacturing autos bearing the Wanxiang brand. An important part of his strategy is the development of an electric car, which he hopes will help address the problems of higher fossil-fuel consumption and air pollution. Whether or not he eventually succeeds in moving his company up the value chain, Lu is still committed to his core auto parts business: "As long as cars are being made somewhere in the world, we'll be making parts."
Lu Guanqiu discussed his company's prospects in an interview with Paul Gao, a principal in McKinsey's Shanghai office.
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The Quarterly: What events have had the biggest impact on your business?
Lu Guanqiu: The first occurred in the early 1980s, when Wanxiang cut the number of products it made. The whole country's manufacturing industries were restructuring. This was aimed at state-owned enterprises, but Wanxiang wasn't one of them and wasn't asked to participate. We decided to take advantage of the opportunity to change, however, and initiated our own restructuring. We discarded our diversification strategy, which had grown out of the economic shortages of the 1970s. Wanxiang was involved with so many products: castings, drills, pumps, agricultural equipment. The company took an ax to all of them.
We decided to concentrate our human, financial, and material resources on building Wanxiang into a company specializing in universal joints.1 Costs went down, quality went up, and the impact on customers was enormous. Of the 56 makers of universal joints at the time, Wanxiang is 1 of only 3 that survived. Building on this base, we gradually developed our technology, products, and markets and became an industry-leading company that produced everything from auto parts to system parts. The second major event occurred in 1984, the year Wanxiang entered the US market. That was a turning point for us. It was then that we began the process of exploration and experience that I describe as "stepping out and bringing in." We brought our products and our people into the world, and in learning about the world we discovered our own shortcomings.
At the time, government policy strictly forbade us to operate outside of China. It absolutely would not allow us to take money out of the country. Nor could our people leave. And we couldn't export products. We thought of every way we could to create a shortcut that would allow us to get into international markets. We borrowed money from friends. We used various channels to export our products. Once we made it to the outside world—once we saw just how big the gaps between us and the outside world really were—we were just stunned.
The Quarterly: How did you respond?
Lu Guanqiu: We eliminated our most unsophisticated products, outdated equipment, and underperforming employees. We imported high-precision equipment, developed a pool of high-quality talent, and focused on producing high-quality products. By improving the overall quality of Wanxiang, we built the foundation for our future progress. Today we've acquired, merged with, or established 30 companies in eight countries, including the United States, England, Germany, Canada, and Australia. We have sole ownership or control over 18 of these. We sell our products to world-class automakers like General Motors and Ford. We have established strategic alliances with companies like Bosch and Delphi.
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The Quarterly: What are your long-term aspirations for Wanxiang, and what management approaches do you follow to achieve your goals?
Lu Guanqiu: Wanxiang's corporate credo is, "Create value for the customer, create profit for the shareholders, create a future for the employees, create prosperity for society." To realize these aspirations, we've defined our company's mission as a "struggle to add a zero every ten years." In the 1970s, we earned 10,000 renminbi2 a day in profits. The most any worker earned in a year was 10,000 renminbi. In the 1980s, we earned profits of 100,000 renminbi a day. The most any worker earned was 100,000 renminbi. In the 1990s, we earned profits of 1,000,000 renminbi a day. The highest-paid worker also earned 1,000,000 renminbi. In 2009, when the company turns 40, we plan to earn profits of 10,000,000 renminbi a day, with the highest-paid worker earning 10,000,000 renminbi a year.
Above all, this is an easily understandable goal. It's also a way to link the interests of our employees tightly to those of the company. The employees can see and touch our company's goals and therefore believe in them. If all of the company's employees hold these goals close to their hearts, they will be able to think like owners, live like owners, take responsibility like owners, and, finally, experience the enjoyment of being owners.
I believe in speaking the truth and being practical in business. Seek truth from the facts, don't spout slogans about being able to do more than you really can, don't do things that exceed your ability. Take it one step at a time. As Chairman Mao once said, "Produce an inch and improve your life by an inch." You need to be consistent in word and deed when dealing with employees. When you speak, follow through with action; when you take action, it must produce a result. Once a company loses its reputation, even the best will collapse like a house made of twigs, no matter how good its products or how great its technology.
The Quarterly: What is your view of the new investment pouring into China's auto industry and of the potential for oversupply?
Lu Guanqiu: You might have oversupply in total production volume, but total demand is still growing. It's just a matter of how fast or slow this rate of growth is. A period when supply can't keep up with demand might conceal some of the problems of the weaker companies. When there is oversupply, the companies that really get hit hardest are the weaker ones. For the strong companies, there will never be the problem of oversupply. It's when supply exceeds demand that you find out which companies can really compete. As long as cars are being made somewhere in the world, we'll be making parts. If some companies fail, at least I'll be the last one to go.
The Quarterly: It has been reported that you want to be an automaker. What are the biggest obstacles?
Lu Guanqiu: It's been my dream to build a Wanxiang auto brand. I've announced that if I can't realize that dream, my son will; if my son can't, my grandson will. Through the effort of many generations, someday we'll fulfill this dream. We must do it. We're training and preparing our people. When the opportunity is ripe, we'll get into the business. It's the next logical step on our journey toward fulfilling our goal of becoming a large, world-class company. The reason we're not producing cars now is a lack of sufficient financial resources and of people who understand this business. Once both are in place, I'll get into it immediately; opportunities depend above all on one's own capabilities. I think the auto industry will definitely undergo a major restructuring. So how do I grab the opportunity as the industry goes through this change? I might merge with a domestic company or with a foreign one. It will depend on my resources and capabilities. We're confident that once our capabilities have reached a certain level, we'll produce a Wanxiang-branded car that meets people's needs. Right now, our focus is on building an electric car.
The Quarterly: Why electric cars?
Lu Guanqiu: In the past, cars were a luxury item; now, they've become a daily necessity. Customers continue to demand higher quality and lower prices. Styles have to be personalized. These requests are entirely possible to fulfill today. But when I look at these cars, I first see an energy problem. Second, there's the emissions problem. These two problems, along with worsening traffic, have become bottlenecks for the development of the market. I want to take a different path not only to conserve energy but also to get rid of emissions. I'm developing an electric car because I believe it must replace today's cars, which consume energy and create pollution.
Of course, this will be a long journey requiring a lot of effort. First I need to train a group of professionals. I'll also need capital. I'll take 5 to 6 percent of the money I earn from other industries and spend it on this project, investing each year over a long period of time. For example, there are the battery and cost issues to deal with. Today, drivers of electric cars need to recharge the battery after driving just a short distance. You'll need to be able to charge the battery so that you can drive at least 400 kilometers3 or even farther. If these cars cost 10 percent more than cars cost today, people should be able to accept that. Now electric cars are just too expensive for most people. This is why the market is not taking off.
Hybrid cars are now commercially viable and starting to take off in the United States and elsewhere, but this is a technology Wanxiang is behind on. With electric cars, however, nobody has really tackled the issue of battery life or resolved the issue of how to get the cars to accelerate faster and to achieve a reasonably high speed. So we can be first to market.
Once I've solved these problems, I will have fulfilled my dream of building a car. And if I can't do so? I'm not naive. Electric cars will be developed one way or another. If we can't build an electric car that meets the needs of customers, we can still continue to do what we've always done, which is to make parts, such as electric controls and batteries. As long as there are cars, there will be a market for our parts. I'm very optimistic about Wanxiang's future.
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The Quarterly: How do your acquisitions fit into your growth strategy?
Lu Guanqiu: The companies we've acquired overseas aren't simply acquisitions. It's really about pooling international resources. We'll combine whatever resources we can find to become a company that operates on a multinational basis, using the most advanced technology and playing in the key markets of the world. For instance, we acquired Schiller, Universal Automotive Industries, and Rockford Powertrain, among other companies, because they have what we lack most: markets, technology, and brands. The weakness of these companies is rising labor costs. Our strengths lie in our labor. We use a lot of labor for low-value-added products. We can bring these companies' low-value-added products to China and make them here while keeping the high-value-added goods over there. So by combining with these companies, we bring costs down and improve efficiency. This is how we could penetrate GM, Ford, and other major companies and markets so successfully. Everyone wins in the process.
Wanxiang will combine with companies in industries related to auto parts. Perhaps we'll take these companies' market share, add it to ours, and combine our resources in an optimal way. It's our way of contributing to society by providing jobs and supporting economic growth while building the base for a stronger company. Alliances are the fastest, lowest-cost way to grow.
The Quarterly: But you've also made domestic and foreign acquisitions in areas, such as finance and insurance, beyond your core business. Could Wanxiang lose focus again?
Lu Guanqiu: There are examples of successful diversification and examples of failures. There are examples of successful specialization and examples of failures too. The answer is to look at your company's abilities and understand what you're best suited to do. If we continued to diversify as we did in the 1970s and early 1980s, we would have ended up with nothing. And if Wanxiang today had only a single product, we wouldn't have built up our company to the scale it has reached today.
The industry we're in—auto parts—is really hard these days. It's a capital-intensive, labor-intensive, technology-driven business with very thin profits. You can't get rich in this business. If you want to do really well in it, you must expand volume, you must specialize, you must become more professional. But relying entirely on your own strength as an auto parts company will limit you. There's no way you can continue on your own to grow each year by more than 25 percent. So I've cultivated a group of talented professionals to bring the company into other businesses. This is Wanxiang's biggest resource. Through these talented individuals, we can get into services businesses that ultimately serve the auto parts business. If we can make a little money in them, we'll do so. But they are not my primary business. We'll plow the money we earn from them back into our core auto parts business.
The Quarterly: How do you attract and cultivate talent?
Lu Guanqiu: In the past, investing in "software" always took second place to investing in "hardware." So while we put a lot of investment into factories and equipment, we invested little in developing our human resources. The failure to prepare enough high-quality talent constrains our growth today.
In the early 1980s, we sent 44 people to college for training. We also recruited heavily. This group now forms the core of our leadership. But it's not enough. We have capital; I can buy technology; I can buy management. We've got a complete line of products. Sales—we can't supply enough products to keep up with demand. Given such rapid growth, the biggest bottleneck to our development has become human resources. It's the one factor that works against our development. You can't see the effects in a year or so; you definitely need 10, 15 years or even longer. Outstanding people can develop new products. We don't have enough outstanding talent, and that slows down the pace of our development.
The Quarterly: How do you manage the relationship between family managers and professional managers?
Lu Guanqiu: When you manage a business, it all comes down to the quality of your people. In Chinese we have a saying that goes something like, "Keep an open mind when deciding whether to nominate your son or an outsider for a position." When I recommend hiring someone, the key thing I look for is ability. It doesn't matter whether it's your own son or a relative—I don't care. If you are using a really outstanding person, you can't go wrong. If you make a mistake, it doesn't matter whether it's a relative or an outsider; the person will have to step down.
I'm always practical in business. I have a son. Between two candidates, if one is an outsider and one is my son, and they are more or less the same, I'll use my son. I once read that of the top 500 global companies, family companies make up 40 percent. In family-run companies, you have professional managers, but aren't they all family too?
The Quarterly: There's a lot of debate in the West these days about the impact of offshoring jobs to low-cost countries such as China and India. As an employer of people both in developed countries and in your home market of China, what is your view?
Lu Guanqiu: Foreign companies have many options besides outsourcing production to offshore companies like ours. They could set up their own operations in a lower-cost location, such as China or India. They could also invest in innovative technologies that would help them improve their products and charge higher prices. They could even reduce prices through lower costs.
Offshoring works both ways. We are actually helping people in developed markets to keep their jobs. By sending 6 of our employees from China to one of our companies overseas, we helped provide jobs for 920 people over there. If we hadn't invested in that company and sent those managers, 920 people might not have jobs today. The idea that we're a threat to the more advanced countries is preposterous. The fact is, developing countries are helping them.
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