We first met “Crazy Chen” at the Hong Kong Football Club two weeks ago. The venue still retains a somewhat cute residue of colonial snobbishness (alert: you are not allowed to make calls with your mobile phone in this venue, but the vintage landline phones at the lobby are ok!). It was part of a two-week workshop for professionals from major global corporations (banks, funds, insurance companies and manufacturing corporations) and non-governmental groups to better prepare themselves for the challenges of the 21st century, with a focus on Asia. A key component of the workshop was to spend a week with a real Chinese SME (small and medium-sized enterprise) to help it solve problems and in return gain some insights for ourselves.
When this Wuhan-based businessman refers to himself as “Crazy Chen”, you know it carries a sort of pride in it. It’s not lunatic crazy. It’s Steve Jobs crazy. He is the Chairman and founder of this Chinese start-up that makes a kind of environmentally-friendly plastic (I will not reveal too much technical details here). As someone who moved from real estate into manufacturing at the age of 54, Chen carries the mixed disposition of new money shamelessness and entrepreneurial respectability. He spent the first ten minutes of his speech boasting about how rich he was (he had a dozen debit cards each containing over 5 million RMB). He used inappropriate language to refer to women (a common feature of Chinese men of his age). He even bragged about how young he looked (indeed he did not look like someone over 70. Not sure how much money he had spent on cosmetics). On the other hand, his personal story of self-elevation does carry a flavor of legend on the verge of mythology. He decided to pursue a master’s degree in polymer science well after middle age, with almost zero preparation in math and English (two key subjects of the entrance exam). He claimed that he mastered math by himself within a few month and gave up completely on English (got only 26 in 100). Even so he still managed to get into one of Hubei province’s major universities and got his degree in a few years. Through the exposure to the academic world he developed this weird idea of citations: that citation means borrowing from others without innovation. And he wanted to do something new. So he started to spend long hours in his laboratory developing new materials, materials that are more friendly to the environment than traditional fossil based plastics. He claimed that once he stood in the lab for a straight seven days without rest. After he got home, his legs were so swollen that his wife had to use a scissor to cut off his pants before he could get into bed. He fell into sleep and stayed in a coma-like state for 48 hours.
When the 25 of us landed in Wuhan last week, we were immediately shuttled to Chen’s company headquarters, the fruition of his crazy hard work in the laboratory. The company is now managed by his son, “Crazy Chen Junior”. He brought us to our first stop inside the office building, a fancy showroom with all their products, certificates and awards on display. Two years ago, China’s President Xi took some interest in their products when he visited Wuhan. And not surprisingly his picture was featured prominently in the exhibition.
Our immediate next stop was their research labs which they seemed to take particular pride in. The director of their R&D department, a young petite woman, showed us around and introduced the working of their equipment and devices. The labs betrayed a resemblance to those rudimentary ones that you saw in high schools. But the company’s technological edge is not to be underestimated. It held dozens of international and national patents and was among the first Chinese companies to have had received the most stringent certificates from Europe and Japan for its materials. At this point I realized that this was not a poster boy Chinese SME that was complacent in making quick money by manufacturing fake Louis Vuitton handbags or tainted food. It is a technology driven enterprise that represents the break-away from the stereotype “made in China” workshops.
Yet the company was in trouble.
The reason why its management invited us to Wuhan was that it’s stuck. As a new material start-up, it was stuck in making two things: garbage bags and disposable utensils. It was not a very comfortable place to be in as a company. For one thing, it was a low-end, low-recognition category where price competition was fierce and no brand loyalty can be expected. Their biggest markets are those street-side restaurants and wholesalers who sell to those restaurants. But such customers are extremely price sensitive and would strive to cut corners particularly on items like disposable utensils. In this area the company faces formidable competition with cheap plastic products, especially at a time when oil price is at its low point. The policy environment isn’t giving them any edge against its competitors either. For years Chinese cities talk about setting up garbage separation systems and composting facilities which would favor more degradable eco-materials over non-degradable plastics. But such efforts are often fitful and are constantly stalled by a lack of political will and incentives. One city in China took the drastic approach of banning non-degradable plastic bags at the beginning of this year, but it was seen more as an exception reflecting the personal inclination of the mayor rather than a future norm. When we met with a group of municipal officials last week to discuss about this issue, their attitude was visibly tepid. I sensed it when they started to lecture us about the “complexity” of the issue. The underlying message was two-fold: first, they were not ready to disrupt the powerful industry of plastic makers; second, they fear if they did take measures, the “Crazy Chens” and their companies would not be able to bring production to a scale that would fill the opening, which would undermine the legitimacy of such policies.
Sadly, a country perplexed by its ever increasing stream of urban wastes is not ready to pay for an eco-friendly option yet. Left on its own, the company tried to move up the ladder of values by creating its own brand name products and found its way into large supermarkets where middle class consumers picked their household products. Unfortunately, even on those shelves they were unable to collect a premium due the lack of consumer awareness and demand for eco-friendly products. Worse still, they saw themselves squeezed on both ends by better known paper and plastic products on the one hand, and surcharges from the supermarkets on the other, in the form of “listing fees” and promotional expenses. To stay competitive, they had to keep their margin at close to zero or even negative in some cases.
The Chens have their rationale. They would like to make their material more visible for a wider audience to see its possibilities and potential. The retail adventure therefore morphed into an expensive marketing undertaking. The sad thing, though, is that people do not associate garbage bags and disposable stuff with a cutting edge material of the future. And the disposable nature of the products probably turns the really eco-conscious customers away. After all, the “throw away” culture is an antithesis to conservation, which is intrinsically contradictory to the image that the company would like to build.
After a few late night soul-searching sessions with “Crazy Chen Junior” and his management team, we began to realize where the problem was. The company’s core technical edge lies in its “resin”, for which they possess all the patents. Like Coca-Cola’s secret syrup that it sells to bottlers all over the world, the “resin” can be mixed with regular plastics such as PP and PE to create materials with new properties. They are the largest producer of this niche material in China, and the second largest in the world. Its key advantage is the lower carbon footprint and higher degradability compared to fossil-based counterparts. Being located in China, close to the world’s largest manufacturing powerhouse, also gives it an edge against international competitors. But these advantages are all based on a scenario where it sells its “resin” directly, which also gives it a higher margin.
Here comes the pitfall: there is a huge risk in this scenario, which is associated intellectual property. Their biggest fear is that Chinese copycat competitors can easily reverse engineer the resin, wiping out whatever technological edge they still enjoy today. The answer to this challenge is “camouflage”: mixing the resin with other plastic materials to render the resin indecipherable. To do that, they have to source such materials from the open market, allowing their margin to erode in the process. Moreover, they have to invest in blending facilities to be able to blend the resin with other materials. Essentially, it means they’d turn themselves from a Coca-Cola to a bottler just to protect their own syrup. But in China there are tens of thousands of converters who are better at this kind of blending job with a larger economy of scale. That’s why they have to move into consumer products in order to generate more added-value out of the blended material. They are even careful enough not to purchase its production lines in their entirety, but to buy parts separately and then combine them by themselves, which further undermines efficiency. The purpose is again to prevent competitors from following suit. All these factors cut into their profit and keep their bleeding wounds open.
This revelation makes me a bit frustrated. In the end, all we could do to help was to build a business model for them showing that a resin-based business is better for the company. Yet we all realized that they had known it all along. It’s the circumstance that had prevented them from moving toward that direction.
On May 18 this year, the Chinese central government unveiled its ambitious plan of “Made in China 2025“, with an intention to “upgrade” China’s manufacturing sector. In later speeches, China’s Premier Li Keqiang made it clear that his country was no longer content of making T-shirts and other low-end consumer products. He would like to see its massive manufacturing prowess turned towards industrial equipment, telecommunication and new materials, among others. This is not a simple re-configuration of the country’s manufacturing portfolio; it represents a change of business model that would allow Chinese companies to move up the value chain in the global market. A model based on the export of high-speed trains and commercial airliners is qualitatively different from one that’s based on selling toys and cheap plastic cups. But the plight of the “Crazy Chens” speaks to the challenge that lies ahead. The pains that those Chinese SMEs has to take in order to move one tiny step up the value chain illustrates the distance between a vision and the reality.