June 1996 € Volume 23 € Number 3

China Syndrome

Reflections on applying operations research and operations management techniques in a unique economy where efficiency often takes a back seat to employment


By David F. Pyke


I make it a habit of asking participants in our executive programs whether they do business in China. The responses have changed dramatically over the past eight years, from an occasional "yes" to an overwhelming majority who not only work for firms that are in China, but have been there themselves. Why all this interest in China? To many, the answer is obvious. China's population of nearly 1.2 billion represents a massive market for our products; and the enormous labor force that is willing to work for relatively low wages represents an ideal place to manufacture and assemble high-volume products.

But there are many misconceptions about China as well, and many firms that entered China with the promise of reaping large benefits have been disappointed. Too many people neglect the fact that 70-80 percent of the population lives and works on the land. So the market for certain products is really much smaller than 1.2 billion.

In this article I want to share some reflections about China from the perspective of an academic who researches, teaches and consults in the area of operations management, and who has had a long-standing interest in that country. The purpose is to provide a brief introduction to the Chinese economy and to reflect on how the skills of operations research and operations management professionals can be applied in this unique environment. First, however, let me share some personal thoughts and disclaimers.

My interest in China dates back to childhood when my family was a home away from home to many Chinese students and friends. My great grandfather went to China as a missionary in the 1870s, initiating three generations of missionaries in that land. Only after the war and revolution did my parents and grandparents return to the U.S. This family heritage spurred my interest in studying China from my own professional perspective, and led to two trips there, first in 1992 and again in 1995. (I was accompanied on the latter visit by colleagues Medini Singh of Dartmouth and David Robb of the University of Auckland, to whom I am indebted for many insightful observations.)

I have visited urban and rural China, read countless articles and books, visited many factories, and had numerous conversations with Chinese living in the States as well as with Chinese academics from Tsinghua University. Nevertheless, it will be made clear through this article that I know far less than those who have lived and worked there for even a short time. Verifying my reflections with these experts would be most wise. Finally, because of my training and interest in operations management, I cannot comment knowledgeably on the application of OR techniques in marketing, finance or other areas.

Lest I give the impression that the Chinese have not contributed to OR, we should remember that China is the source of several classic OR problems, as well as many in mathematics. The "Chinese Postman Problem," for example, was first reported in 1962 in the journal Chinese Mathematics by Mei-ko Kwan (Volume 1, pg. 273). Many variants of this problem have appeared in more recent OR literature. Some vehicle routing problems, for example, can be formulated in these terms.

The Chinese are also credited with the independent development of the solution of a set of simultaneous equations and with developing pivot techniques.


The Chinese Economy
The economic world changed for China in 1978 when Deng Xiaoping initiated economic reform in a speech in Guangdong province. Since then, China's real GNP has grown by around 10 percent per year. Except for the brief setback in 1989 because of the Tiananmen Square incident, the Chinese economy has been bustling with life. China has 70 billion dollars in foreign exchange reserves, and Chinese shops are crammed with goods and customers. Walk down a shopping street in Beijing in the evening and you will see hundreds of shops and sidewalk stands and thousands of shoppers. Shanghai's Nanjing Road shopping area sees 1.5 million people and $50 million spent per day.

In 1993, however, China's economy was growing too fast, with inflation running higher than desired. Vice-Premier Zhu Ronghi's austerity policies helped slow down the overheated economy, and government leaders are wary of letting it take off too fast again. (In 1995, growth was 10%, down from 12.6% in 1994; retail prices rose about 15% in 1995, after a 21.7% rise in 1994, as reported in Business Week, Jan. 15, 1996.)

We must distinguish various types of enterprises as we think about using our skills in China. As noted in Table 1, there were nearly 8 million enterprises owned by individuals in 1993. But these represent a small portion of total output. By contrast, the state sector, which includes enterprises that are state-run or collective-owned, contains far fewer enterprises but the vast majority of the output. ("State-run enterprise" is a shorthand term for the Chinese designator "enterprise under the ownership of all the people." Collectives are owned by the workers rather than by "all the people.") Of the state-run enterprises and collectives, some are large and centralized, such as steel manufacturers. Some are owned by a town, county or other administrative unit.

Table 1
Enterprises and Gross Output Value By Ownership
ITEM 1985 1990 1991 1992 1993
ENTERPRISES (1,000)
Total 5,185.3 7,957.8 8,079.6 8,612.1 9,911.6
State-Owned Enterprises 93.7 104.4 104.7 103.3 104.7
Collective-Owned Enterprises 1,742.1 1,668.5 1,557.2 1,640.6 1,803.6
Township Enterprises 217.1 228.7 229.6 229.5 209.8
Village Enterprises 632.6 680.8 675.2 709.7 777.3
Joint Urban Enterprises30.9 29.5 39.6 68.1
Joint Rural Enterprises 741.7 565.7 483.5 506.8 576.1
Individual-Owned Enterprises In Urban and Rural Areas (a) 3,347.8 6,176.0 6,386.7 6,854.0 7,971.2
Urban Areas 330.1 432.5 450.6 507.0 681.7
Rural Areas 3,017.7 5,743.5 5,936.2 6,347.0 7,289.5
Enterprises of Other Ownership (b) 1.7 8.8 10.8 14.2 32.1
GROSS OUTPUT VALUE OF INDUSTRY (1,000,000 yuan at current prices)
Total 971,647 2,392,436 2,824,801 3,706,571 5,269,199
State-Owned Enterprises 630,212 1,306,375 1,495,458 1,782,415 2,272,467
Collective-Owned Enterprises 311,719 852,273 1,008,475 1,410,119 2,021,321
Township Enterprises 76,055 244,141 300,131 441,724 749,560
Village Enterprises 66,272 239,402 293,408 453,983 645,429
Joint Urban Enterprises 5,453 6,901 10,188 15,552
Joint Rural Enterprises 15,175 48,447 50,026 76,794 116,644
Individual-Owned Enterprises In Urban and Rural Areas (a) 17,975 129,030 160,910 250,680 440,205
Urban Areas 3,339 10,724 12,928 19,538 39,618
Rural Areas 14,636 118,306 147,982 231,142 400,586
Enterprises of Other Ownership (b) 11,741 104,756 159,958 263,358 535,206
SOURCE: China statistical yearbook, 1994.
State Statistical Bureau of the People's Republic of China. English ed.
(a) Individual-owned firms employ less than 8 workers.
(b) Includes private firms employing 8 or more workers, joint ventures, foreign-owned firms, and other ownership forms.

These large, state-owned enterprises (SOEs) have been the subject of much debate among Chinese bureaucrats. The state sector is one of the biggest drags on the economy, due to poor economic performance and heavy indebtedness. Yet state-run enterprises play a critical role in the economy. A Nov./Dec. 1995 World Bank report, "Reform of China's State-Owned Enterprises," states that these enterprises are responsible for 46 percent of industrial output currently (down significantly from 1990), most urban employment, half of all exports, and most large-scale activities in the economy. However, because these enterprises have been unable to compete on a global scale, some bureaucrats advocate letting them fully face market forces. Of course, many would fail, and millions of people would be without jobs. The World Bank report indicates that roughly 30 percent of state-run enterprise workers are redundant. Because of the prospect of this widespread unemployment, other bureaucrats advocate continued government support. The government position in early 1995 was to employ tax breaks, and direct support and other measures to maintain the viability of these enterprises. Although there have been promises of change, little seems to be different at this writing.

The World Bank report indicates that Beijing has accepted the need for ownership reform of state-run enterprises, but it opposes complete privatization. Many large and medium-size enterprises may become joint-stock companies "with public ownership spread across a variety of state institutions and enterprises. In this way, majority 'state' ownership is maintained, even though the central government has little or no direct role in running the company." Some state-run enterprises have now been listed on domestic and foreign stock exchanges. At least some SOEs will presumably become candidates for bankruptcy, merger, divestiture and management buyout.

It is not clear whether the new owners in these revised ownership structures will be allowed to close plants and lay off workers. Yet, increased operational autonomy is the central issue for any real progress toward economic reform in the state sector. Indeed, there have been some recent advances that the World Bank report specifies. Top managers sign contracts identifying performance targets, and their pay is often linked to sales and profits. State-run enterprises are now free to set relative wages, rather than being burdened by the former system of uniform wage increases. But, according to official figures, almost 50 percent of state-run enterprises reported losses in the first half of 1995 (others reported healthy profits). It seems clear that as long as loss-making companies can depend on subsidized credit, managers have limited incentive to improve performance.


OR and OM in China
To the extent that managers are given autonomy to streamline operations, they will need skills and tools to help them become more efficient. And if foreign firms share ownership of these firms, they may be able to introduce OR and OM models to help.

I find it helpful to consider 10 levers for the operating manager: facilities, capacity, vertical integration, vendor relationships, process and technology, human resources, new products, quality management, production planning & control, and inventory [1]. My reflections below will focus on several of these levers. Let me begin, however, with three general points. 1. The models and techniques should be presented at roughly the level of the Master's degree.

2. All models should be easy to recompute.

3. The investment costs should be minimal. The first point is certainly not a reflection of the quantitative ability of Chinese managers or academics. Rather, it recognizes the fact that the models and tools need to be communicated without too much effort, and they need to be applied on relatively old computing technology. I suggest thinking about what tools can be communicated easily to MBA or Master's in Industrial Engineering students, and focusing our efforts on those.

The second point follows directly from the above comments on the Chinese economy. If the environment can change quickly, and without notice, any models and tools employed should be very user-friendly and adaptable. My visit to Guangzhou Machine Tool Company (GMT) in 1992 highlighted to me the difficulty of managing in China [2]. The factory director had just been given authority to sell a portion of his output in the marketplace rather than to firms designated by the central government. And they had recently been granted an export license, so foreign customers could fax an order to GMT and expect delivery six to eight weeks later. Now GMT had to respond to orders for customized products from many countries, rather than meet production targets set long in advance. Any production planning or inventory management tools implemented a year prior would have been obsolete.

The third point follows from the fact that China is a developing economy with firms that are strapped for cash. An algorithm that requires expensive computer equipment or months of training will not be helpful. (Of course, if the client participates in a joint venture with a large foreign firm, the first and third points will not be as important because the partner can provide the capital, equipment and training.)

Now I shall comment briefly on several of the 10 management levers.

Facilities. Models for facility location, and for allocation of products to existing facilities, can be complex, but are often quite simple. It appears to me that the need is for simple models that examine decisions to locate operations in the interior provinces. There are strong governmental incentives to locate in the interior, but firms must carefully address this option. We hear of highway bandits, corrupt local officials, and other hazards of manufacturing in the interior and transporting to the coast. Some risk assessment, in conjunction with transportation cost, labor cost and tax incentives, needs to be incorporated into simple spreadsheet models that support extensive what-if analysis.

Capacity. The "Capacity" lever typically pertains to expansion. When, and by how much, should capacity be expanded? For growing firms, these decisions are crucial. Again, however, I recommend avoiding expansion models that employ optimal control, or other relatively complicated techniques. Rather, simple financial tools, such as net present value, can be used in conjunction with bottleneck and process analysis. The models should be simple and should support extensive sensitivity analysis.
But the opposite side must be examined as well. What portions of capacity should be taken off line as a large SOE faces shrinking markets? How should they retrench and begin to grow again? In spite of severe pressure to reduce the number of workers, employment at Guangzhou Machine Tool has decreased only slightly since 1992. GMT once had 32 departments. These have now been consolidated to eight departments and two groups, employing the same number of people as in the original 32 departments. (Since 1992, however, some departments -- such as the kindergarten -- have become independent economic units that contract with the company.) As the pressure to compete grows, GMT will face potential layoffs and other streamlining activities, and our skills can be extremely helpful in analyzing the options.

New Products. The speed with which new products are introduced is a major issue for many Chinese firms. As an example, GMT in 1992 was selling lathes that were developed in the early 1970s, but were based on models from the late 1950s. They were struggling to introduce CNC equipment that could hold tolerances as tight as those of world-class machine tool firms. It was a difficult battle. The engineering training simply was not there, CAD systems were non-existent, and they owned only one (German) high-precision machine tool that could actually cut parts at the required tolerances. Beijing Machine Tool, on the other hand, received more government subsidies, and had installed CAD systems, hired engineers trained in this technology, and was therefore 10 years beyond their sister company in Guangzhou. (It seems that GMT has successfully introduced CNC lathes in the last few years [3].) These firms can benefit greatly from the expertise of professionals who understand how to organize multifunction teams to bring products to market faster, and who can train them in design for manufacturability and other tools that ease the design-manufacturing hand-off.

Process and Technology. Process and technology choice are major topics that cover a wide array of issues. One that stands out from my visits, however, is assembly line balancing. The assembly line at Beijing Jeep, the joint venture with Chrysler, is an impressive achievement. Designed by Chinese engineers, it appears to run very smoothly. However, it was moving remarkably slowly the day I visited. There was little flexibility, and thus very little complexity. As the market grows, and as China begins to export more to other Asian countries, these lines will be required to assemble multiple products in higher volume. Models that assist managers in the line balancing problem could be very beneficial.

Quality Management. In our visits to numerous factories we saw some evidence of statistical process control. Control charts were posted at many of these plants. However, its use seemed to be less extensive than in U.S., European or Japanese firms I have visited. These tools are simple to communicate and understand, and their value has been demonstrated over and over again. An inexpensive personal computer, or even a calculator, is sufficient hardware.

Because of the emphasis on new products, tools such as experimental design and Taguchi methods that generate robust designs show great promise. Again, these are fairly simple tools and can be applied with some ease.

Production Planning & Control. Production planning and control is another major topic area with models and tools that vary widely depending on the context. Some managers need to be familiar with job shop scheduling, others with MRP, still others with Kanban systems. We have sensed a need for Chinese manufacturing managers to understand the differences among production planning and control tools, and to discern which tools to apply in their factories.

GMT is basically a large job shop with 550 machine tools organized by process. We also visited China Schindler Elevator Company, a joint venture with a Swiss elevator manufacturer. It appeared to us that job shop scheduling tools such as forward and backward loading, input control, and dispatch rules would be enormously helpful. Simple queueing formulas, such as Little's Law, would be useful for predicting lead times in make-to-order environments, and are easy to understand and apply.

Perhaps the most compelling evidence of the value of relatively simple tools came from our visit to Tsinghua University, home to very highly regarded engineering and commerce departments. The faculty and graduate students at Tsinghua have successfully applied simple job shop techniques for a multitude of companies. If I recall correctly, a senior faculty member, Dr. Pan, has been involved in over 40 successful implementations of these and other tools. Our probing into the details revealed that, rather than expend resources on complex algorithms that rely on global information, Dr. Pan had successfully implemented simple forward and backward loading algorithms.

Because of the rapid growth of assembly operations in China, MRP has been widely used. This same group at Tsinghua has been involved in many MRP installations. It is clear, however, that although MRP works wonders in certain environments, it is the wrong tool in others. My sense is that Chinese managers can benefit from understanding both the pitfalls of using MRP in the wrong context, and some of the problems with MRP even when applied correctly -- problems such as predicting lead times and setting safety stock.

Guangzhou Machine Tool and Beijing Machine Tool provide examples of other issues I have seen. Both factories have large job shops that feed final assembly areas. As managers are given more autonomy over operations, they are departing from month-long time buckets for scheduling each department. And they are being forced to reduce cycle times and delivery lead times to compete with firms that can deliver customized products in half the time. Managers need to know how much work-in-process inventory to hold to buffer fabrication from assembly. They need to know how to coordinate fabrication and assembly. Should the job shop push parts to a WIP storage area, and then have assembly pull parts for make-to-order assembly? Inventory control models, queueing models and simulation could all be very helpful.

Inventory Management. Now that managers are responsible to serve markets, both domestically and internationally, without government control, they need inventory management tools. Again, these should be PC-based, simple and easily recomputed. Forecasting software is necessary, as is software that can determine optimal inventory policies when data is very soft or missing. There are inventory tools that optimize the worst case probability distribution so that managers do not have to rely on an ill-specified distribution.


Conclusion
Most large U.S. firms, from AT&T and GM to Merrill Lynch, have locations in China. They can bring resources and expertise to their Chinese operations. But state-owned and collective-owned enterprises in China are faced with a two-fold problem. They are facing intense pressure to improve operations, but they do not have the required expertise or resources. OR and OM professionals have skills, models and tools that can be very profitable for Chinese managers. It is difficult to overemphasize the potential value of simple tools applied in this environment. But every effort must be made to focus on simple models that can be implemented without a large training or computing budget and that can be adapted to a rapidly changing environment.


References
1. Pyke, D., "A Note on Operations Strategy," The Amos Tuck School of Business Administration, Dartmouth College.

2. Pyke, D. and Y. Li, "Guangzhou Machine Tool," The Amos Tuck School of Business Administration, Dartmouth College.

3. Pyke, D., S. Pyke and B. Xie, "Guangzhou Machine Tool (B)," The Amos Tuck School of Business Administration, Dartmouth College.



David Pyke is an associate professor at The Amos Tuck School of Business Administration, Dartmouth College. He can be reached via E-mail at: [email protected]