// . //  Insights //  Why European Manufacturers Should Refocus On China

Just before businesses all but closed and everybody rushed home to celebrate Chinese New Year with their families, we had the opportunity to visit 10 China CEOs and other senior management of our European industrial goods clients in the Shanghai area. Not surprisingly, these visits took place in a much-changed environment compared with a few years ago, especially regarding the economic situation and the overall geopolitical dynamics.

The visited companies spanned many markets and business models, from factory automation to plant engineering, construction equipment, and various production systems, with many of them global leaders in their fields. While the situation varies significantly between market segments and individual companies, and there are never “one-size-fits-all” answers, across most of our discussions there were many thematic commonalities, including a perception of a lack of attention from European headquarters, an increased need to manage costs, and an ongoing reevaluation of international market strategies.

New challenges for China operations of European manufacturers

Accustomed to decades of robust growth and supported by China’s vast market, the recent dynamics — some structural and some likely temporary — pose challenges for European industrial manufacturers operating in China:

Chinese market stagnation and excess capacities

One recurring theme is the fact that many segments of the Chinese market are facing stagnation or even shrinkage for the first time. Excess capacities are widespread, but particularly evident in sectors like heavy trucks and off-highway equipment. Most industry experts do not anticipate a fundamental recovery in these markets for the next two to three years. While these conditions are unpleasant and create huge challenges, there is appreciation that the current development should be recognized as a normalization, a ripening process in a large and maturing economy. Cycles exist.

Chinese players are catching up in technology and product performance

Chinese companies have made significant strides in catching up with their international counterparts in terms of technology and product performance. International players have suffered heavy losses of market share in most segments, with some even witnessing share declines of as much as 80%. On the back of their increased strength and in search of volume in no-growth markets, Chinese competitors are now entering premium and lucrative niche segments that were previously firmly in the hands of Western players. Chinese competitors are now also making huge efforts to expand into international markets (often following their Chinese customers when these go international).

Most of our discussion partners were keen to point out that — with some exceptions — the rise of the local players was mostly due to increased competitiveness of their peers and not to “government intervention,” and that the latter was an excuse too handily used by Western managers. Our discussion partners frequently noted a lack of urgency and speed at European headquarters. “While we are planning one new product generation, our local Chinese competitors have already launched two,” a local CEO pointed out.

Concerns over lack of attention from European headquarters

Although Chinese subsidiaries often account for 10-20% of their companies’ global revenues, many managers bemoan the lack of attention they get in their organizations. Some discussion partners highlight concerns beyond investment caution and a general sense of reservation. They point to deeply symbolic acts like being “demoted” from a region in its own right to merely part of Asia-Pacific on corporate organizational charts, or their global CEOs not having visited China since before COVID-19.

Navigating China’s changes with local action and global perspective

In light of these developments, European manufacturers of industrial goods should consider taking action on their China setups in three areas.

Firstly, local operations need to increase their focus on efficiency, operational excellence, and cost management. As China’s labor cost advantage has significantly shrunk in the past decade, Chinese operations now face increased price and margin pressures. Consequently, they must rigorously apply the cost management techniques long practiced in the more mature Western operations of their companies. “We have to do our homework,” confirmed one manager.

Next, to effectively compete with native Chinese players, European manufacturers should consider more comprehensive localization. The degree and philosophy of localization varies greatly between companies, but common themes raised in our discussions include adopting differentiated product standards instead of a single global standard (“CE compliance alone puts me at a 20% structural cost disadvantage,” one manager complained) and strengthening local research and development capabilities.

While intellectual property protection remains important, a sober and dynamic review of which IP truly differentiates the company is necessary given the competitive forces at play. Further localization of the supply chain may also be warranted. Chinese subsidiaries heavily reliant on imported pre-products face significant disadvantages compared with local competitors. These include long lead times and increasing prices, driven by inflation in Europe and exacerbated by the depreciation of the renminbi. “They have to understand that there is no inflation in China,” said one Chinese CEO. Another hardly surprising but probably still valid point raised in most interviews was the need to delegate more decision authority to Chinese management so that they can be faster, more responsive, and more entrepreneurial in the face of local competition.

Thirdly, European manufacturers should rethink the role of their Chinese operations for competing in international markets. Is China for China really the right strategy? Of course, the China set-ups — and European manufacturers overall — have to be prepared for geopolitical shock events and this has rightly been a focus in most companies over the last two years. But there is also a likely scenario of steadily intensifying international bifurcation, with native Chinese companies competing heavily in those international markets that remain open to them. Should European companies relinquish these markets, serve them from Europe or other international locations, or leverage their Chinese operations, which already have some scale and maturity? And what role can their Chinese operations play in the group-wide adoption of technologies and methods in areas where the “best practice” is increasingly set in China? We believe finding the right strategic answers to these questions should be a priority for each European manufacturer. Getting it right (or wrong) will significantly impact their long-term success and relevance.

The geopolitical and economic landscape shaping the involvement of European manufacturers of industrial goods in China has drastically changed in recent years. While risk reduction has been a priority for most companies, simply focusing on this won’t maximize the value of their Chinese operations, which often represent substantial investments. Action must be taken both locally and at group level. While getting this right will not be easy, ignoring China would be a mistake. With the competitive dynamics at play, China will continue to matter not only because of its market size but also as a “fitness center” to remain competitive for international markets. The China operations of European industrial companies deserve more attention.