Nike and the third world.

This paper is based on the business case “Hitting the wall: Nike and International Labor Practices." It analyses the labor issues that Nike faced in the late 90’s and the companies’ response to accusations of child labor and inhumane working conditions in its factories. Was Nike’s response to widespread criticism sufficient? As an example, the Nike’s wage policy in Vietnam will be discussed.

History.

In 1964, Phil Knight, a track athlete founded a running shoe distributor named Blue Ribbon Sports . The company initially operated as a distributor for Japanese shoe maker Onitsuka Tiger, making most sales at track meets out of its founder’s car. In 1966 BRS opened its first retail shop in Oregon, when the relationship with Onitsuka Tiger neared to an end. To continue business, BRS designed the first line of footwear that would contain the soon-to-be-famous swoosh. The name of the shoe would be “Nike” after the Greek goddess of victory. In 1978, BRS, Inc. officially renamed itself to Nike, Inc .

By 1980, Nike had reached a 50% market share in the United States athletic shoe market, and the company went public in December of that year. Nike has been manufacturing throughout the Asian region for over twenty-five years, and there are over 500,000 people today directly engaged in the production of Nike products. The company utilizes an outsourcing strategy, using only subcontractors. Nike has more than 700 locations around the world and offices located in 45 countries outside the United States. Most of the factories are located in Asia, including Indonesia, China, Taiwan, India, Thailand, Vietnam, Pakistan, Philippines, Malaysia, and Republic of Korea. The factories are 100% owned by subcontractors, with the majority of output consisting solely of Nike products. Currently, Nike employs a team of four expatriates in China, Indonesia and Vietnam, focusing on both quality of product and quality of working conditions. Nike’s manufacturing model is based on a minimal cost strategy. This strategy takes direct, short term cost heavily into account when considering a manufacturing location. Nike’s practice of contracting third parties to manufacture the shoes and other apparel made the selection process less complicated because most of the whole supply and manufacturing chain would be managed out-of-house leaving Nike with the only decision to choose the lowest bidder.

It wasn’t until the early 1990 when an activist named Jeff Ballinger focused consumers attention on the conditions under which Nike let its products be manufactured. Ballinger’s argument was that by removing direct responsibility for manufacturing, Nike was encouraging local manufacturers to abuse and mistreat workers to maximize their own margins. Only by offering the lowest possible price could a contract from the Oregon company be obtained. This meant that laborers were paid below minimum wage, factory conditions were often below standard and working hours were long. Ballinger knew exactly how to use Nike’s fame and image against the company when campaigning for better working conditions in Indonesia. As a Country Program Director for the Asian-American Free Labor Institute (now the AFL-CIO's American Center for International Labor Solidarity) he wrote the first expose of Nike’s labor policies, coinciding with Indonesia’s political turmoil and sweeping strikes of the early 1990’s.

In 1992 Indonesia had increased the minimum wage in a response to pressure from the unions and other political factions. Local contractors however largely ignored the legislation or petitioned for exemptions, which would be easy to obtain due to Indonesia’s rampant corruption. Seeing the potential damage that an anti Nike campaign could cause, Nike drafted a series of regulations that each contractor had to adhere to. It refrained from taking any substantial action to directly address the labor issues, leaving responsibility with the local contractors.

Countering Jeff Ballinger’s arguments.

Despite the undeniable facts that Ballinger brought against Nike’s practices, there are a few counter arguments that Nike could have used. In countries where Nike products were made, the wages were earned not to sustain families but to supplement household income. The fact that workers were paid below minimum wage therefore should have led to a shortage of workers, as they left the company for better paying jobs. Comparisons with workers in the West that are paid many times the amount of the average Indonesian worker are often unfair, since local prices are much lower. Even the argument that children as young as 14 years work for Nike ignores the fact that these children would otherwise have to work on the land or in the family business to help sustain the family. This has been a practice for hundreds of years and can’t be changed by the practices of one company.

Nike’s response.

Nike’s response against Ballinger was less than convincing. First it ignored the wage issue. Later it stated that it couldn’t be held responsible because it didn’t control the factories. The workers weren’t on the Nike payroll but were paid by the subcontractors. For consumers and activists these arguments were largely semantic. The contractors for all intents and purposes acted as wholly owned subsidiaries and as such any blame on them would be blame on Nike Inc. To distance the company from the issues would prove to be impossible. With the large difference between the wages paid to make a Nike shoe and the price of the product it would be hard to convince the average Nike consumer that the company can’t influence the way it makes its products. Reports of physical and sexual abuse make the matter even worse.

Nike and the press.

When the issues in Indonesia hit the mainstream, Nike began to realize that a negative image could seriously damage its revenues. Nike had always seen itself foremost as a sports apparel manufacturer but in reality a large portion of Nike’s sales came from fashion conscious teenagers and students. The issues that plagued Nike in Indonesia now became apparent in other countries like Pakistan, Vietnam and China. In April 1997, 10,000 Indonesian workers went on strike over wage violation. In the same month, 1,300 workers in Vietnam went on strike demanding a one cent per hour raise and last year 3,000 workers in China went on strike to protest not only low wages, but hazardous working conditions .

Nike contracted Andrew Young to write a report on Nike’s labor practices. Young was largely positive but concluded that Nike could and should do better. The media however condemned the report for the fact that the writer had been paid by Nike and therefore couldn’t have been impartial. This gave rise to the word “Nike-writing ”

On May 12, 1998, Phillip Knight spoke at the National Press Club in Washington, DC and made what were, in his words, "some fairly significant announcements" regarding Nike's policies on working conditions in its supplier factories.

Knight made six commitments:

1. All Nike shoe factories will meet the U.S. Occupational Safety and Health Administration's (OSHA) standards in indoor air quality.
2. The minimum age for Nike factory workers will be raised to 18 for footwear factories and 16 for apparel factories.
3. Nike will include non-government organizations in its factory monitoring, with summaries of that monitoring released to the public.
4. Nike will expand its worker education program, making free high school equivalency courses available to all workers in Nike footwear factories.
5. Nike will expand its micro-enterprise loan program to benefit four thousand families in Vietnam, Indonesia, Pakistan, and Thailand.
6. Funding university research and open forums on responsible business practices, including programs at four universities in the 1998-99 academic year.

The commitments, although at face value impressive, still failed to appease the ever growing criticism that Nike treated the matter as a public relations rather than a human rights issue. “The promises made by Phillip Knight in his May 1998 speech were an attempt by the company to switch the media focus to issues it was willing to address while avoiding the key problems of subsistence wages, forced overtime and suppression of workers' right to freedom of association. ”


What does Nike do wrong?

Nike failed to realize that the consumers that buy Nike gear are mostly well educated, socially active and outspoken. Instead of immediately going to the heart of the matter, Nike played the issues down, thereby not only underestimating the issue but far worse, underestimating the intelligence of its customers. Reebok and adidas, which had similar issues have responded in force, mainly by improving wages and working conditions but also by taking its critics seriously, providing open and transparent communication. Nike on the other hand is still unwilling to disclose which contractors are responsible for its manufacturing process. Its code of conduct that is now distributed to every factory worker contains a statement that “full and fair compensation” will be paid but does not say how much this would be. Nike also refuses unannounced inspections from outside organizations.

Fair wage in Vietnam.

President Franklin D. Roosevelt declared in 1937, "All but the hopeless reactionary will agree that to conserve our primary resources of manpower, government must have some control over maximum hours, minimum wages, the evil of child labor, and the exploitation of unorganized labor."

In the US, the Fair Labor Standards Act of 1938 established a national minimum wage, guaranteed time and a half for overtime in certain jobs, and prohibited most employment of minors in "oppressive child labor," a term defined in the statute. When a worker puts in 40 hours per week, the worker should be able to pay the minimal bills to survive. That, and health benefits, are the definition of the "living wage."

At the end of 1994, Nike had shifted part of its production from South Korea and Taiwan to Vietnam in an effort to control cost. In Vietnam, minimum salaries for unskilled and manual laborers in FIEs in all three labor zones are $55 USD monthly in urban Hanoi and Ho Chi Minh City, $50 in suburbs of those cities and within many of Vietnam’s major cities and ports, and $45 in all other areas . From the moment contractors started producing; Nike has been accused of paying below minimum wage, thereby circumventing local labor laws. Workers at VN Nike shoe manufacturing plants make on average 20 cents per hour. Team Leaders at VN Nike plants make only $42 per month, below the Vietnam minimum wage. Regular workers make even less.

At the heart of Nike’s predicament lies the fact that workers that make Nike’s expensive running shoes according to consumers are not getting paid enough for the job. To justify spending $150 on a pair of sneakers, the average modern consumer needs to know that his money isn’t going to the pockets of greedy shareholders and overpaid executives but ends up, at least in part, to sustain the man or woman that made the product in the first place. The International Monetary Fund rates Vietnam at number 129 for Purchasing Power Parity per capita, only slightly higher than most African countries. The issue with PPP when considering “fair wage” however is that when workers get paid more, price inevitably go up, lowering PPP again.

Conclusion.

Nike should make its contractors accountable for their wage practices. Instead of a “lowest cost strategy” it should take the long term cost of image damage into account. With a transparent compensation policy the public can see for itself if a fair wage is paid. Most of all, an open dialogue with all stakeholders instead is crucial to understanding the issues. Without it, Nike is just guessing what the best policy would be and will lose out in the end.

Evolution of the Xbox supply chain.

History of computer gaming

Few industries have had such a meteoric and world-altering rise as the computer industry. From the number crunching military machines of the Second World War to the sophisticated miniature offices we keep in our pockets today, they all serve their purpose to make our lives safer and more convenient. Along with the design of serious applications came always the need of the mostly young engineers and programmers for relaxation and competition. In February 1951, Christopher Strachey tried to run a draughts program he had written for the NPL Pilot ACE. This became the first computer game ever written, even though the first version overloaded the computer’s memory banks.

Tennis for Two was the first computer action game. It was developed in 1958 by American physicist William Higinbotham and ran on an oscilloscope which simulated a game of tennis or ping pong.

The commercial success of video gaming came in the 1970. Although coin operated games were available as early as 1971 it wasn’t until Nolan Bushnell and Ted Dabney founded a company called Atari and released the VCS (later called 2600) system in 1977 that computer gaming entered the living room. The big names in the industry weren’t Microsoft or Sony but Intellivision and Colecovision. In 1977 the market had become over saturated, creating the first video game crash. Quality had become second to quantity which led to an overproduction of mediocre machines and questionable cartridges. Fairchild and RCA left the industry leaving Atari and Magnavox as the sole contenders.

The home computer market took off with the release of the Commodore 64, Sinclair ZX 81 and Spectrum and the late success of the Apple II computer. The driver behind the surging sales was the ability to play realistic games in color and with sound. Soon home computers had taken a big bite out of the console market, especially since adults now could buy a computer to “do work” on and play games besides. In 1984, the computer gaming market took over from the console market causing the second video game crash.

In 1985 one brand dared to enter the market with an 8-bit console. The Super Famicom, or NES as it was renamed in the US, was manufactured by the innovative Japanese company Nintendo. The Nintendo Entertainment System was one of the greatest successes in computer gaming history. The effective use of gaming icons like Mario made the games instantly recognizable and the Japanese sense of humor made a refreshing contrast to the often violent and serious games of its US counterparts. Nintendo is the only company from that era that is still active and successful in the computer gaming business. Atari has become all but extinct, the brand name changing hands frequently.

The PC industry has traditionally kept its focus on the professional market. Geared toward word processing power and number crunching, it never gained the popularity as a gaming device like the consoles did. In the 90’s however, dedicated graphics and sound chips meant that games could be played on PC’s as well. Microsoft was never very interested in the gaming market (although they made a very good Flight Simulator) but the release of third party software using Microsoft’s DOS operating system created a whole new genre of gaming. Three dimensional shooters like Castle Wolfenstein and Doom pulled the serious gamer away from “kiddy consoles” like the NES. The PC soon became the gaming platform of choice for immersive, time consuming games while the console was used for fast moving action gaming and Japanese style adventuring. Big names in the console industry were Sega, with their Master System and Megadrive and again Nintendo with the 16 bit Super NES, leveraging on the popularity of Mario, Zelda and other brand characters.

The fifth generation saw a new name emerging. Sony, the Japanese electronics giant, had an opportunity to conquer the gaming market with its PlayStation. The 16 bit system sported sophisticated 3D graphics and, more importantly, could also be used as a CD and Video CD player. The PlayStation was a huge success, committing Sony to the still expanding gaming market. In 2000 Sony had surpassed Nintendo as market leader and released the second incarnation of its gaming system, the PlayStation 2. Microsoft in the meantime had seen a whole industry grow on what was basically their business operating system and wanted to have a piece of the market. In 2001, the Xbox was launched.

Supply and demand.

The Xbox took off in a complicated and demanding market. In 2005 Sony was still the undisputed market leader with 5 PlayStations and 4 PlayStation 2s sold for every Xbox. Nintendo had lost much of its luster with much lower sales numbers for its 5th generation GameCube system. The Xbox was a first for Microsoft and many people thought that Gates and friends couldn’t pull it off. PC gaming had become very popular with gamers buying equipment that cost multiple times that of the Xbox. It was almost impossible to believe that a machine that was basically a PC in a different package with limited memory and no expansion slots could survive against a dedicated console like the PlayStation 2. Microsoft had delayed the launch of the Xbox to be able to provide the latest processor and graphics chips to directly compete with Sony’s flagship. To gain sufficient market share, Microsoft would almost certainly have to sell the Xbox console at a loss and try to make up with software licenses given out to third party game designers.

An additional challenge for Microsoft was that the manufacturing and distribution needed a completely different approach from the traditional software the company was used to. The machine was made out of hundreds of parts that needed to be supplied at just the right time to avoid bottlenecks at the manufacturing plants. Time to volume was the critical factor. There were only a few time windows, like the Holiday period, to successfully launch the machine.

Microsoft’s sought help in the supply chain management from Flextronics, a contract electronics maker which provides electronics manufacturing facilities to original equipment manufacturers (OEM). Together with Flextronics, Microsoft selected 40 major suppliers, negotiated continuity of supply agreements; ensured capacity was in place, established complex logistics channels, found software tools to automate some of its supply chain tasks. To keep transportation lines to the markets in the US and Europe short, the company decided to use “industrial parks” in Mexico and Hungary. Suppliers were invited to set up shop in the parks making supply both flexible and efficient. There was an average of 600 [engineering change orders] weekly across the supply chain in the early stages of the design so flexibility was very important.

Manufacturing in Asia would be cheaper but as Sony had experienced, long transportation lines can lead to shortages at critical moments. The higher cost meant that Microsoft’s entrance in the computer gaming market came at a price of $4.4 billion in operating losses in May 2005. The first generation of X-boxes were market driven and not cost driven since Microsoft could not afford supply shortages in stores. Later models had a less critical time to market factor, which led Flextronics to move manufacturing from Mexico to much less expensive Chinese factories. Microsoft is now sourcing components locally within different geographies, creating new logistics channels, and doubling supplier capacity to support manufacturing in new regions, like the Asian market .

The sixth generation of consoles was a culmination of everything the most demanding gamer could want from a console. At the same time, new market segments were being identified. The Sony Play Station 3 not only provided the power for next generation gaming but was also a weapon for expansion in the broader electronic entertainment market. The next generation of video content carriers was Blu-Ray and HD-DVD. Sony as one of the founders of the Blu-Ray standard saw an opportunity for leverage and included a Blu-Ray player in its next generation console. Microsoft had already made several attempts to distribute content online and decided not to include an expensive add-on, managing to keep the price of its next generation console, the Xbox 360 below its competitor.

Although Microsoft kept its main supply chain and manufacturing manager, Flextronics it decided to out-source some of the designs to cater to non-US markets. Instead of keeping production close to the end-user, the cost factor was a bigger issue this time. Xbox 360’s would be made in Chinese factories and shipped to the US and EU as readymade products. Sony’s delays in bringing out the competing PlayStation 3 meant that Microsoft had some time to build up a head start. The success of titles like Halo and Halo 2 meant that there was an established base of Xbox enthusiasts that almost certainly wouldn’t wait for the Sony product to come out. IBM designed and co-manufactured the custom microprocessor that powers the Xbox 360. The microprocessor is a triple-core PowerPC that runs at a frequency of 3.2GHz. At a cost of $106, this single part accounts for 20.2 percent of the total Bill-of-Materials cost for the Xbox 360. Factoring in costs for the hard disk, the DVD drive, enclosures, the Radio Frequency (RF) receiver board, power supply, wireless controller, cables, literature, and packaging – the total BOM cost for the Xbox 360 Premium reached $525, well above the retail price of $399 .

To keep decreasing cost, Microsoft would continually have to redesign the components which made centralized manufacturing critical. To change the supply chain now required changing only the plant in China instead of changing several links in different parts of the world.

Global launch.

One of the characterizing features of the video game industry is that the end-users don’t want to wait for the product. In Japan, gamers are known to wait for days in front of a store to be the first to buy a new game or console. When Microsoft decided to launch the Xbox 360 globally it took a big risk. If supply wouldn’t be able to keep up with demand, the potential for damage to the brand name were great. For the first time ever, Microsoft plotted the near-simultaneous rollout of Xbox 360 on three continents: November 22, 2006 in the U.S., December 2, 2006 in Europe and December 10, 2006 in Japan.

Microsoft had already started planning the supply chain with its logistics partners more than a year before. The goods moved by barge from the factories to Hong Kong, at which point Microsoft took nominal ownership. The shipper had chartered Boeing 747 freighters for transit to its main distribution centers in Memphis, Tenn., and Duren, Germany, about 37 miles from Cologne. The booking of high-security trucks, both in the U.S. and Europe, was coordinated with customs clearance to keep product from sitting idle between its release and movement inland. Once again, flexibility was the hallmark of Microsoft’s distribution strategy. Most shipments went to the major distribution centers, where they were processed by one of the company’s “distribution turnkey vendors,” or DTVs. Rail played an important role in North America. Railroads have come under criticism in recent years for severe delays and capacity constraints, Microsoft sidestepped the problem by shipping on dedicated stack trains moving directly from Los Angeles to Memphis, via the Burlington Northern Santa Fe .

The risks of the global launch were evident. The longer the supply chain, the more issues could occur. If the product wasn’t ready at the factory, the ships couldn’t sail which made the smooth transition from manufactured product to sold product difficult. The sheer size of the operation made it difficult to manage. There was however a hidden opportunity in the unprecedented scale. The “buzz” created by the anticipated launch of the Xbox360 meant that many more potential customers were ware of the new console. The global launch also meant that coordination was central and potential issues could be dealt with simultaneously. Despite the changes in supply chain management, the Xbox 360 was in short supply at its launch date , a fact that might have actually benefitted sales in the long run.

Multiple suppliers.

Microsoft used three suppliers to make the Xbox 360 instead of only one. Because the company owns the rights to all the component designs, it can switch to the lowest bidder at any time. Flextronics and Wistron stayed on as assembling partners, later joined by Celestica. The supply contracts specify that Microsoft can discontinue working with a partner at any moment and can have other partners join whenever needed. In 2007, Wistron phased out production for the console, ending a six year cooperation. With Microsoft dropping its selling price of the Xbox 360 console earlier this year, it tried to push the profit pressure onto its three OEMs. Wistron, seeing it’s gross margin drop to 5.49% in the third quarter of 2007 couldn’t cope with a lower margin. In 2008 Asustek picked up production for the Xbox 360, showing advantages of flexibility .

Using multiple suppliers has its limitations. The coordination and quality assurance control is more complicated. Using multiple suppliers hasn’t made Microsoft impervious to lack of supply. Quality issues with the DVD drive, heat problems and the dreaded “Red Rings of Death” have led to problems with 3 out of 10 Xboxes, setting Microsoft back $1.05 to $1.15 billion in the second calendar quarter of 2007 . Because there is not one “owner” of an issue it is hard to look for the root cause. Only after pressure from end-users did Microsoft admit there were problems, offering to repair the affected consoles for free “This problem has caused frustration for some of our customers and for that, we sincerely apologize," Microsoft's entertainment chief Robbie Bach said. "We value our community tremendously and look at this as an investment in our customer base."

Conclusion.

As an avid gamer I have owned almost every gaming console in existence since 1980. During my law studies I worked in one of the first computer gaming stores in The Netherlands and I have experienced the anticipation that a new console or game can bring from close by. The issues that companies like Microsoft, Sony and Nintendo are facing are different from most other products because the gaming market is a very personal and emotional market. The video game industry crashes of the 70’s and 80’ were caused by the lack of quality and the emphasis on quantity. The distance make supply chain management crucial for today’s complex consoles. Sony, Microsoft and Nintendo have all had supply issues and survived. Companies like Samy (too expensive), Sega (quality and margin loss), Atari and even Philips have been less fortunate. To survive a company needs to take the market very seriously and keep informing the customer of expected issue.

Update:

There's an interesting article on the pricing policy for the hard disk upgrade that is available for the X Box 360. You can find it at http://kotaku.com/387864/why-360-hdds-are-so-ridiculously-expensive

L’Oreal: Expansion into China

History

According to Yue-Sai Kan, a Chinese-American TV celebrity and founder of one of the most successful cosmetic brands in China, modern Chinese women didn’t wear much makeup until the early 1990. Although makeup is extensively used in Chinese opera and other performing arts, the use of color on nails and lips was more used to indicate social class then as a sign of beauty. Chinese people began to stain their fingernails with gum arabic, gelatin, beeswax and egg from around 3000 BCE. The colors used represented social class: Chou dynasty royals wore gold and silver; later royals wore black or red. The lower classes were forbidden to wear bright colors on their nails.

After Mao Ze Dong came to power, the use of makeup was considered decadent and anti-revolutionary. The aesthetic taste during the Cultural Revolution (1966-1976) advocated for a "revolutionary beauty" style like the gray Mao suit, army uniform and short hair, a unisex style which went hand in hand with Mao's advocating for women as the other half of the sky. "Growing up during the Cultural Revolution, I genuinely believed these were the only measurement for beauty and the uniform was the most beautiful thing on earth, that make-up and permed hair were a horror”, said Wang Ping who is now a university professor in Minnesota .

With the opening up of China in the early 1990, the interest for makeup increased and so did the interest of companies to access this largely untapped market. Yue-Sai , an American-Chinese started her own brand in 1992, leveraging on her fame as a television star and exclusively targeting Chinese women. Other entrepreneurs saw the growing cosmetics market as an investment opportunity. The Raystar Cosmetics Company was founded by Chinese investor Li Zhida who saw the potential of being one of the first mass market producers of brand makeup in China.

L’Oreal has a history going back to 1907 when Eugène Schueller, a young French chemist, developed an innovative hair-color formula he called Auréole . In 1909, Schueller registered his company, the Société Française de Teintures Inoffensives pour Cheveux ("Safe Hair Dye Company of France"), the future L’Oréal. The guiding principles of the company that would become L’Oréal were put into place from the start: research and innovation in the interest of beauty. Today, L’Oreal is the largest cosmetics and beauty company in the world with revenues of over 14 billion Euro and more than 52,000 employees. Although the company is listed, the founder’s daughter, Lilianne Bettencourt and the Swiss Nestlé company together own more than half of the shares and voting rights.

Growing the company, a sustainable strategy for L’Oreal.

Before planning to branch out in the Far East, L’Oreal always had a healthy growth. Like any successful company, its strategy is one of careful brand management and even more careful acquisitions. Competition in the cosmetics industry is fierce. Brands like Olay and Pond’s are brought in the market by giants like Procter and Gamble and Unilever, who have extensive experience managing brands for exact target groups. Even if they haven’t marketed cosmetics in a country before they can acquire practical knowledge of local culture before marketing more culturally sensitive products. Specialist brands like Avon and L‘Oreal may have knowledge of their respective products but can only enter a foreign market once.

By focusing on 10 global brands concentrated on hair color, hair care, skin care, color cosmetics, and fragrances, the company has turned into a global force by distilling the cultural cachet of different countries into its vials . Instead of doing exhaustive marketing research and running the risk of misreading their target group, they follow a strategy of acquisitions of local companies and established brands that already have that knowledge.

It was this strategy of “becoming a local brand” that led to the acquisition of the Mininurse brand from Raystar Cosmetics in 2003 and Yue-Sai in 2004. Having learned from their negative experience with the initial introduction of the Biotherm brand in the US, L’Oreal had set up only a modest amount of counters in Shanghai, Beijing and Guangzou and opened a plant in Suzhou in 1996. Despite being a latecomer to the Chinese market they still managed fast growth and an ever increasing market share.

L’Oreals strategy of managing global brands with local variations meant that they needed to become a “local” rather than a foreign company in China. The acquisition of the successful Mininurse brand and the Yue-Sai company fits exactly into this strategy. The group has three plants on the mainland, one in Shanghai and the others in East China's Jiangsu Province and Central China's Hubei Province, with their products exported to Japan, South Korea, Southeast Asia and Taiwan Province. This gives an exclusive “locally manufactured” feel to the products. "We are creating some formulas and products specifically for China and Asia and we will invest a lot to meet the different needs of customers in China", Thierry Prevot, managing director of the group's Asian operations said in an interview with China Daily .

L’Oreal’s brand portfolio, risks and opportunities.

L’Oreal markets 14 brands in China, including L'Oreal, Maybelline, Lancome, Biotherm, Helena Rubinstein, Shu Uemura, Matrix, Vichy, Garnier, and the local Mini Nurse and Yue-Sai. China is becoming increasingly important after sliding sales in the US due to the weakening economy . As mentioned, L’Oreal’s brand strategy is based on diversifying brands to fit local culture. While many companies seek to homogenize their brands to make them palatable in myriad cultures, L'Oreal's products embody their country of origin.

For example: in 1996, L'Oreal acquired the US cosmetics company Maybelline and began a complete makeover of the brand, including moving the headquarters from Memphis, Tennessee, to New York City to promote its U.S. origins. When L'Oreal marketers discovered that the moderately successful Maybelline Great Finish nail enamel dried in one minute, they changed the name to Express Finish—to be used by urban women on the go . Maybelline's share of the nail-enamel market in the U.S. has climbed from 3% to 15% since 1996.

By acquiring existing and successful brands in China L’Oreal took a risk. Each brand not only needs to have its own image, targeted towards its market group but also needs to stand out culturally. By marketing local brands, L’Oreal runs the risk of cannibalizing its existing “core” brands or estranging buyers who don’t recognize their “local” brand anymore. When differentiating brands, a company runs the risk of fragmenting, leaving the individual brands weaker as a whole. L’Oreal however has managed to keep its brands strong by realizing that its customers are individuals and that it should cater to individuals rather than a homogenous market.

L’Oreal’s future in China

The successful acquisition of two Chinese brands hasn’t ended L’Oreal’s ambitions in China. China is L'Oreal's largest market in Asia surpassing Japan in 2008, where the group saw a drop in sales. The company is now the second biggest cosmetics provider in China after Procter & Gamble which has operated in China for more than 20 years. Maybelline is the largest brand in China with 51.88% market share. In 2005 L'Oreal decided to launch its Chinese brand Yue-Sai globally “because of growing recognition of Chinese beauty”, completing the circle from localizing a global brand to globalizing a local brand.

The growth of L’Oreal has triggered a wave of consolidations and mergers in China making the already tough market even more competitive. In 2007 China sales rose 30 percent to 523 million Euro (777.4 U.S. million dollars) signaling that the Chinese markets is far from mature yet. L’Oreal is planning to set up the Giorgio Armani brand, starting with a boutique at Hong Kong International airport. Make-up and fragrance will be the focus, although a skincare offer is planned at some point in the future .

The growing economy and increase in spending power of Chinese women means that there is no end in sight for growing opportunities. L’Oreal’s unique approach sets it apart from competitors. The Chinese tradition of having a white skin has L’Oreal’s biochemists experimenting with Chinese herbs, roots, and flowers. Hua jiao, the flower of the prickly ash tree that adds tongue-scorching spice to Sichuan cuisine, is reputed to clear up acne and will be among them, as will traditional whitening agents such as ginkgo leaf, ginseng, and mulberry.

In contrast to its coastal cities, rural China is a largely untapped market for beauty products. Retailing and distribution is still badly managed in China's hinterlands therefore the companies that have the best strategies for reaching the women there, rather than the minority who shop for imports at department-store counters, ultimately will win the cosmetics race. L’Oreal may acquire more local brands but should be careful not to fragment the market too much. The R&D center in Pudong is part of L'Oréal's transition from the image its core brand it currently projects in China--its Chinese name, Oulaiya, means "elegance coming from Europe," and its ads feature pinkish colors on white faces--to something more recognizably Chinese.

Foreign Direct Investment in China

History

China’s experience with foreign direct investment has been a quite recent one. Although the Chinese traded with far away Europe as early as 114 BC, it were always the emissaries of the emperors who established contact and kept embassies in the countries along the famous “Silk Road” and the less well know “Porcelain Route”. The heyday of the Silk Road corresponds to that of the Byzantine Empire in its west end, Sassanid Empire Period to Il Khanate Period in the Nile-Oxus section and Three Kingdoms to Yuan Dynasty in the Sinitic zone in its east end. Trade between East and West also developed on the sea, between Alexandria in Egypt and Guangzhou in China, fostering the expansion of Roman trading posts in India .

During the Qing dynasty (1644-1912) China came under growing foreign pressure to
open up its borders to the Western seafaring powers. In 1535 Portuguese traders obtained the right to anchor ships in the harbor of Macao, a small island off the coast of mainland China. In 1557 the first walled settlement marked the earliest Direct Foreign Investment on Chinese soil. The island prospered under the new administration where the Portuguese acted as middlemen for traders on the route Guangzhou-Macau-Nagasaki, shipping silks from China to Japan and silver from Japan to China. Despite clashes with the Dutch, who were looking to establish trade colonies of their own, the Portuguese managed to hold on to their outpost (with a stint of independence in 1849) until the formal handover to China on December 20th 1999 .

Britain had its own reason for investing in the Middle Kingdom. In the early 19th century, British tea imports had taken such flight that a great trade imbalance between China and the British Empire existed. Although Britain exported commodities like silver, clocks and watches to China the market was too small to counter the local demand for tea. As a result, Britain started to export opium and soon established itself as the sole provider of the addictive drug. The Qing dynasty voiced their objections through the Chinese commissioner Lin Zexu to the British Queen Victoria but when the British Empire proved to be non responsive to Chinese complaints had to revert to military enforcement of its drug laws. During the resulting opium wars (from 1839 to 1842 and from 1856 to 1860) British victories forced the Chinese government to hand over Hong Kong which soon became the second foreign trade colony on Chinese territory.

After the Second World War, cheap labor and capital brought in by refugees from Mainland China transformed Hong Kong’s economy from a trade colony to a manufacturing and industrial hub. On July 1st 1997 sovereignty of Hong Kong was handed over to China which kept the former colonies capitalist system intact and created a Special Administrative Region (SAR) .

FDI in recent times

Foreign Direct Investment started when China’s Communist government decided to loosen the reigns of socialist dogma and allow China to become part of the world economic community. In 1980 the first Special Economic Zones were created in Shenzhen, Zhuhai and Shantou in Guangdong Province and Xiamen in Fujian Province as well as the entire province of Hainan. In addition, 15 free trade zones, 32 state-level economic and technological development zones, and 53 new- and high-tech industrial development zones have been established in large and medium-sized cities. The SEZ’s were driven by a “four principles” policy namely:

1. Construction primarily relies on attracting and utilizing foreign capital
2. Primary economic forms are sino-foreign joint ventures and partnerships as well as wholly foreign-owned enterprises
3. Products are primarily export-oriented
4. Economic activities are primarily driven by market forces

The results were astounding. In 1999, Shenzhen's new-and high-tech industry became one with best prospects, and the output value of new-and high-tech products reached 81.98 billion yuan, making up 40.5% of the city's total industrial output value. Nowadays, the city rivals Hong Kong in size and scope. Guang Dong Province has become a major hub for electronic and industrial manufacturing mainly geared towards exports. According to a report by DTZ, there are over a hundred Fortune 500 companies established in Shenzhen with a total of about 84,000 foreign expatriates. In terms of FDI, Shenzhen has maintained a high rate of growth in the last few years, with FDI in 2006 registering 10.6% higher than the year before.

China’s vast labor market, low wages, good infrastructure and relatively disciplined work ethics have led to the largest manufacturing engine in the world. Foreign Direct Investment is crucial to the building efforts of Chinese manufacturers as well as foreign companies establishing a presence in Mainland China. The development of local economies goes hand in hand with the establishment of Special Economic Zones and shows a strong relationship with FDI.

The role of FDI in the development of a country.

In colonial times, foreign investment was a matter of domination. When the Dutch established their trade colony in the East Indies, they didn’t come as partners but soon took the reins of government from the local rulers. In modern times, this has made countries like China and India weary of foreign investment. Wherever Western countries have economic interest, they want to establish political and legal authority as well. The efforts of the US to push for reforms in China’s legal and economic system are not inspired by bilateral equality but by US interests alone. Still the beneficial effects of FDI on China’s economy are so great that China’s government can’t disallow it without risking severe economic and political repercussions. However, the story of FDI in China is not quite as rosy as these summary sentences suggest. By all accounts, the policy environment for foreign direct investors in China is difficult, and much anecdotal evidence suggests that some of these investors are becoming discouraged by this environment while other potential investors have been deterred by it.

An explanation for the effect of FDI on a country’s development can be found in an analysis of the local economic situation. Countries like China, India, Brazil and Mexico have a vast population but a relatively low income level. Large families with a low income spend most of that income on food, clothing and housing, leaving little to buy the luxury items that the country produces for export. As long as local demand for domestic products is low, a country remains dependent on export which in turn means foreign investment.

Examples like Singapore and Japan show that as soon as the internal market starts developing the economy becomes more self sufficient and less dependent on FDI. Singapore’s Direct Investment Abroad (DIA) now constitutes more than 4 billion dollars while DIA is a little more than 3 billion. Singapore has a well developed service sector, excellent medical facilities and a robust internal economy. Despite the gap in income between Chinese middle class families living in Beijing, Shanghai or Shenzhen and families living in China’s rural provinces the growing prosperity is visible. According to the IMF, China’s GDP in 2007 was $3,248,522 versus a US GDP of $13,794,221. China has a population of 1,321,851,888 while the US has about a third of that number. This means that if the Chinese can raise the average wealth of the population, the internal market potential is enormous.

Has the Chinese government maximized the benefits of their FDI policy?

Despite the establishment of SEZ’s there still exist significant issues for foreign investors to enter the internal Chinese market. Despite the economic freedom enjoyed within the confines of the SEZ, China still remains a communist country. The policy of “one country, two systems” has allowed the Chinese government to benefit from the economic growth of the capitalist enclaves while keeping the old fashioned centralized communist rule intact. As shown recently by the hard handed suppression of the Tibet protests, the government isn’t willing to give up its power just yet. The FDI policy attracts companies because of the liberal tax and economic climate it creates but because of the relatively underdevelopment of the rural provinces most of these companies are export oriented. The increase in buying power for Mainland Chinese has mostly been confined to the SEZ themselves and the surrounding areas. The further you go away from the SEZ’s the lower the average income and the poorer the countryside.

As the name suggests, FDI allows for foreign investment, which does little for China’s local capital markets. China has one of the highest savings rate in the world and this money isn’t invested locally but instead exported to countries like the US. The result is that local manufacturers and other SME’s benefit little from the FDI policy and since they are not allowed to establish a presence inside the SEZ’s can’t compete with the foreign firms. The lack of domestic economic development will slow the development of the local market keeping China dependent on foreign investment down.

Another issue that isn’t addressed by the FDI policy is the lack of sharing of technological knowledge. US companies like Apple use cheap Chinese labor to make their iPods and Macs but don’t share the know-how behind the manufacturing. Concerns about protection of intellectual property keep most foreign investors from forming equal partnerships with local companies.

More liberalization of the FDI policy will attract more foreign investors. The question is if this will benefit China’s economy. The marginal value of additional investors will be less because China’s economy is already on the point of overheating. Extending the FDI regulations to (selected) local companies as well as stimulating domestic investment would be more beneficial.

Investing in China from a foreign perspective.

So far, the Chinese FDI policy has been a great success in attracting foreign capital. However there are severe issues for foreign investors to consider when investing in China. The lack of transparency and regulatory oversight makes investing beyond the SEZ’s let alone tapping the Chinese market a risky business.

Doing business in China isn’t a matter of quick in, quick out. Establishing relationships with government officials, suppliers and local business partners is very important and can take a long time. Networking is an aspect of doing business around the world, but it takes on added importance in a society with a complex bureaucracy and a weak legal system. A web of guanxi helps firms navigate China's bureaucratic and distribution challenges.

China is a very diverse market with varying levels of development and regional industrial strengths. A mistake made by many investors is to consider the Chinese market as homogenous. Each region has its own consumer preferences and business needs. Some industries are spread all over the country, some are clustered, and others are heavily concentrated in one area.

The continuance of China’s FDI policy means that foreign investors are relatively sheltered from direct competition by local Chinese companies. If China decides to expand the SZE’s or allows economic freedom to extend beyond the zones, the effect on foreign investors can be profound. Local companies often have an established guangxi network, can benefit from an established presence and know the local market. If they can compete on equal footing and with equal access to foreign capital they have a head start in China’s local market. So far local capital is either locked up in savings accounts or has been invested abroad. If China changes or abolished it’s FDI policy in favor of more economic freedom this could lead to an influx of capital to boost local firms. Already domestic companies like Lenovo, China Mobile and Bosideng dominate the local markets. According to a survey conducted by the Business Brand Institute, International Advertising magazine and the Communication University of China Chinese consumers prefer local brands to foreign ones, with domestic products the top choice in 39 of 57 categories, or 68 percent. Foreign investors should take this into account when making a decision to invest directly or put their capital in local Chinese companies.

Remaining issues for direct foreign investors are labor and sustainability issues and their potential for reputation damage. So far, the low wages and willingness to work long hours under sweat shop conditions have given China’s workers the edge over their US and EU counterparts. As wages and prosperity increase so will the calls for better working conditions. The special tax and financial breaks that investors get through China’s FDI policy do not extend to domestic demands for a fair and equal working environment. US and EU regulations can apply to manufacturing conditions abroad which can negate the beneficial effects of the FDI policy.

Are the US heading towards political and economic suicide?

The image of Uncle Sam has been greatly diminished in most of the world. This had not so much to do with Americans as with the political regime that currently sits in the White House. Most Americans agree that the war on Iraq and the mishandling of the sub-prime crisis will cost the US trillions of dollars over the next 10 years. I just finished reading “The Three Trillion Dollar War” by Nobel Prize winner Joseph E. Stiglitz, who paints a bleak but realistic picture of the true cost of America’s wars. Even so, the true cost in loss of image and increased mistrust of US goods and policy can’t be calculated in dollars. Talking of dollars, the depreciation of currency makes it harder to export to the US but won’t have a large effect on trading partners like China, if they play their cards right. The internal markets of Asia and Europe combined have more potential then the ever shrinking buying power of American consumers can provide.

You would think that the Democrats, who have been standing idly by as Bush and his neo con coalition of the willing invaded a country, whose only mistake was that it had a crazy dictator for president, would take this opportunity to do some old fashioned Republican bashing. United we stand, divided we fall indeed! The race for the White House still looks more like a slugfest between Obama and Clinton than between Reps and Dems. You would think that Bush, with his stubborn refusal to abandon his rightwing corporate cronies would have dug a deep grave for his party that is impossible to get out of. On the contrary, the Democratic in-fight is actually paving a smooth road for yet another Republican presidency.

I must say, John McCain is playing it very smart and very professional. He keeps his support for the war in Iraq, without supporting the way the Bush administration is waging it. He has an image of an outsider in the Republican party, which he will use once it is clear who his opponent will be. If it’s Obama he can play his “I’m a seasoned veteran and an experienced politician” card. If it’s Clinton, he has the “I’m not a free spending Liberal” card (even though under Republican rule, the US has squandered billions more than under any past Democrat government) or even the “I’m not an extension of the Clinton clan” card. Off course his emphasis will be on his differences with Bush and how he will be the Republican guy that will make everything better. To become president he will have to charm the “swing voters” so he can't be too closely associated with the unpopular current administration. Right now, the choice is not so much between the best candidates but who the least bad will be. Clinton and Obama should have united their forces long ago, but instead are still dragging each other through the mud of the, as of yet unpaved, road to the White House.

So what will happen if the damage the Democrats have inflicted upon themselves is too large? McCain will win off course. He will distance himself just enough from his predecessor to distinguish himself as "different" but not enough to alienate the corporate sponsors that got him in the driver seat. What will this mean for the war in Iraq? A fast exit strategy will not be on the agenda. Too many Republican sponsors have an interest in prolonging the war. Eric Prince and his Blackwater mercenaries have worked too hard to win the favor of the current administrators and will certainly try to retain their influence on a new Neo con cabinet. So will Halliburton and the hundreds of other companies who invested heavily in the Bush camp. From a political point of view the result will be even worse. With a Democratic majority in the Senate and a Republican president every major decisions will become part of the political chess game. "If you support my budget proposition for yet another year in Iraq, I will not veto your child welfare bill."

Stiglitz can already make preparations for his sequel, “The Six Trillion Dollar War”. In the meantime the rest of the world will turn its back to America and the dollar and look towards the new economic giants, China, India and even Russia. I shudder to think what it will mean for the crumbling US infrastructure. Road, railway and sewer systems in large parts of the country are in dire need of renovation. As long as the billions go towards an external war and are not invested in domestic economy, the flames that fuel the economy will die down and ultimately extinguish. At that point the foundation that made the US economy the largest in the world will start to crumble as buying power becomes too low to spend on consumer goods. The rift between poor Americans who depend on local companies for jobs and income and rich Americans who can invest abroad will become ever larger.

Let’s hope I’m exaggerating and that who ever will be in the White House won’t be as stubborn, stupid and greedy as George W. Bush. The mistakes he has made and still makes have already been made before. The name of the place where that happened, was Rome.

The global credit crunch for the rest of us.

Panic has been the prevalent sentiment on the world’s financial stage the last few month’s. Bankers have made booboos when estimating the amount of risk they run when loaning out money. Off course bankers are people too and just as bend on making a good sale as any second hand car dealer. They just earn more money and have bigger bonuses, which makes their motivation on making sales even stronger.

One of the great things about the US is that anyone can achieve their “American Dream”. Having your own house is considered a right, just like bearing your own arms. If you can’t pay for your property, no problem! The banks were always there to help you with the necessary cash at low interest, even if you weren’t sure you could pay the mortgage after Uncle Sam, Wal-Mart and Texaco had taken their cut. Millions of mortgages were sold to people who could barely pay their daily necessities, let alone an over the top mortgage. The banks weren’t too worried. Housing prices were always going up because ever one was buying. If Billy-Bob couldn’t pay anymore, he and his family could report to the nearest shelter, the bank would sell his property and still get their money, right?

Even the risk itself was a way for banks to make money. They could sell the mortgage backed debt or put them in collateralized debt obligations or CDOs. This way the liability could be kept off the balance sheet of the bank and even become an asset. Mix the mortgage backed debt with some other types of debt and presto! , a new product was born to sell to hedge funds, insurance companies and investment trusts and bring in lots of dinero. The commission alone was enough for investment bankers to finance another Lambo or a house in Aspen. Some investment companies even came up with CDOs backed by other CDOs, inventively named CDO squared. A whole new industry in trading other peoples debt sprang up and all was well in the great scheme pyramid

Billy-Bob in the meantime had great problems coming up with the cash for his mortgage every month. When finally the day came he didn’t pay, the bank told him they had no choice, put him and his family on the street and put his house up for sale. The problem was that it wasn’t just Billy-Bob that had troubles. His neighbors could soon be found in the same shelter as well and soon thousands of houses were up for sale. During 2007, nearly 1.3 million U.S. housing properties were subject to foreclosure, up 79% from 2006

The problem with a great invention like the free market is that the price of everything is determined by the amount of things that are for sale versus the amount of people that want to buy those things. In the case of Billy-Bobs house, the amount of buyers was virtually zero. So the bankers began to worry because if no-one wanted Billy’s house for a decent price, the mortgage became worth a lot less then they had estimated before. In fact, the value of Billy-Bobs mortgage became virtually zero as well. The value of mortgage backed CDOs is as good as the value of the collateral behind it. Guess what? Suddenly the CDOs, Squared CDOs, quadrupled CDOs and so on were not so hot after all.

The whole structure, built like a domino row on top of a house of cards began to topple. Bear Stearns was the first to have to close down two hedge funds that primarily invested in sub prime, mortgage backed securities. On June 22, 2007, Bear Stearns pledged a collateralized loan of up to $3.2 billion to "bail out" one of its funds, while negotiating with other banks to loan money against collateral to it’s other fund, the Bear Stearns High-Grade Structured Credit Enhanced Leveraged Fund. Merrill Lynch seized $850 million worth of the underlying collateral but only was able to auction $100 million of them. Millions of dollars evaporated overnight and Bear Stearns, who came to the funds rescue, finally had to foreclose the funds that once were worth billions.

In the meantime all was not so well anymore in the great scheme pyramid. Most US and a lot of European banks had invested heavily in the CDO pyramid scheme. Asian banks were a lot less exposed but since the global financial world isn’t defined by boundaries even they would be affected.

The blood of the world’s economies is pure cold cash. As long as this cash is liquid, can be spent like water, it can be used to make more cash. Companies lend money from banks, for instance to invest in new factories. Banks lend this money from other banks if they don’t have enough cash in their vaults. They can also lend money from the government but that’s bound by strict rules. When the sub-prime backed CDO pyramid started to collapse, the banks suddenly weren’t so eager to loan out money to each other or to businesses that wanted to expand. The banks’ credit portfolios, lists of expected revenue from businesses and other banks that owed money suddenly became a whole lot less valuable and a lot more risky. If Billy-Bob didn’t pay what about other companies, credit card holders and (shudder) car owners?

Like I said before, the price of everything in a free market is decided by the amount of sellers vs the amount of buyers. In this case the price of loaning money went up because the amount of eager sellers decreased dramatically vs the amount of eager buyers. The effect on the economy is still going on. Companies can’t expand because of lack of (cheap) funds. They’ll have to fire people who then don’t have money to buy stuff. Other companies can’t sell their stuff because there’s nobody with enough money to buy! Prices go down, profits slump and after a while depression sets in.

So far the only visible casualties have been Bear Stearns, Northern Rock and a few hedge funds. Dozens of banks world wide have suffered heavy losses but will survive. It’s now a matter of keeping trust. In my opinion, the world will look at Asia as the next leading economic powerhouse. It will be very interesting to see what the US government will do to make sure this won’t happen again. If I can make a small prediction, it will be something in the line of stricter regulatory rules, Basel III and tighter reigns for financial institutions. This may help in a small way but will be at best a remedy for the symptoms, not a cure for the disease. Prudent spending instead of unbridled consumerism would be a much better cure. If Americans can’t learn that a shopping spree is okay as long as you can pay in cash instead of pulling the plastic and that the extra value of your house shouldn’t be spent on a new big screen TV, the next bubble is already around the corner.

Fines, fines, fines

They say that Singapore is a fine city because you can get a fine for just about anything. When I started living in the Red Dot, I had already visions of policemen everywhere jumping from behind trees shouting "AHA!" whenever I crossed the street without looking left and right first. So far I've noticed the opposite. That rules are necessary but need to be enforced to mean something I experienced yesterday. The underpass from Parkway Parade to East Coast Park has large signs at the entrance to warn prospective bicyclists not to ride their bike down but to dismount and push the bike through the tunnel. I must say, the first time I crossed the tunnel I didn't see a good reason for this, as the tunnel is long and wide enough for bicycles. Yesterday however I changed my mind. I pair of kids came hurtling down the ramp on their ATBs ready to go to the other side. They obviously hadn't counted on the fact that there might be pedestrians in the tunnel and that their brakes where made in China. The combination of those two factors resulted in one bike coming down at me like a missile almost smashing into the wall making a bike-wall sandwich with me as the cheese. By jumping aside at the last second I could prevent turning myself into sandwich topping but the steering handle badly scratched my hand. The "no cycling, $1000 fine" sign wasn't damaged at all... My wife was more upset then me and wanted to call the police.

Where is a CCTV camera when you need one.? There are about 20 in each MRT station, but none in the tunnels which are much more prone to muggers, rapist and bikers smashing into innocent pedestrians. Anyway, the morale of this story: you can have a fine for everything but if you never collect, it doesn't mean anything.