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Betting on the tortoise or the hare: China's machinery market

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Caterpillar Inc. enjoyed boosts in total revenue in 2010 of 31% to $42.59 billion. This was spurred on by a 43% increase in sales in the Asia/Pacific region.

BEIJING – Politicians and pundits in China and the U.S. have long espoused an idea of win-win scenarios, whereby both countries and their respected companies can coexist and thrive.

In China’s heavy machinery market though, all signs point to a pitched battle for market supremacy.

U.S. heavy machinery giant, Caterpillar, released its fourth quarter profits for 2010 last week, reporting a 62% increase in revenue to $12.8 billion on the back of renewed demand in emerging markets.

One market in particular that has been the focus of American construction and machinery companies is China. In the case of Caterpillar, the company deems this market so important that it listed “Win in China” as one of its “Big 8 Imperatives” for 2011-2015.

In the eyes of Caterpillar though, nothing short of being number one in China will do. At a trade fair for its suppliers in Tucson, Ariz., in 2006, Caterpillar executives effectively declared that if they weren’t number one in China by 2020, their status as a major world player should be called into question.

It was a bold claim to make and one that will pit Caterpillar against an entire Chinese machinery industry that has undergone dramatic growth in the last decade. A Morgan Stanley report that came out earlier this year forecasted that Chinese original equipment manufacturers (OEMs) could possibly increase their capacity to build large tonnage excavators by 2012 by 300% to 130,000 units – the anticipated total need for the entire market.

To put that in perspective, China’s OEMs did not even make excavators 10 years ago.

Chris Edwards, Chief Representative for Ritchie Bros. Auctioneers in China – the largest heavy machinery auction company in the world – has spent the better part of six years trying to open the Chinese market for its first auction run by a wholly-owned foreign auctioneer company.

In the process, he has gained a unique perspective on the machinery market in China, the problems foreign companies face trying to compete here and Chinese manufacturers’ global ambitions.  

Q. China has garnered this reputation as being a difficult place to invest into for American companies. In the case of heavy machinery, that seems to start with the way Chinese construction companies view and value their investments in equipment. How is the Chinese machinery market different than the American?

A: It’s different in maturity of the marketplace. China as we all know is only thirty years into its economic reforms. In the construction machinery business, the rapid development and changes have only come in the last decade or so and started at a very low baseline. So the maturity of the construction/machinery market has rapidly changed, but it started at a low end where price was the number one issue for anyone investing in a construction machine.

Americans value efficiency. In an underdeveloped growing marketplace, there are a lot of inefficiencies. Whereas in a highly competitive, mature economy market…To compete you need to be sure your machine is working, is of top quality and that the service chain of that manufacturer can also be there to fix that machine quickly so you can get it back to work. Those are the demands of a highly mature market.

In the case of a market like China, companies are not looking for high quality as much as they just want to keep their capital costs low and try to maximize their profits. They aren’t necessarily concerned about factors like efficiency, because there are other factors that create advantage for them other than efficiency and competition.

Ed Flanagan/ NBC News

Chris Edwards, Chief Representative for Ritchie Brothers Auctioneers in China has been working for the company in Asia since 1996.

Q: Taking into account the over-capacity issues and this completely different value system towards machinery, where is all of this optimism towards the Chinese market coming from?

A: Well, the overcapacity is in production of product. Why Cat and any high-end foreign company think they can break into the market is because there is a lack of capacity in good service and that’s where they hope to succeed and that’s where they compete all around the world. They compete in value-added on top of the high-level product they have.

It’s like the story of the tortoise and the hare: Chinese machinery companies have shot ahead, ramping up production and sales in the China market while foreign companies are playing the waiting game – waiting for the market to evolve to match their level while planting the seeds and developing the business.

Q: The Morgan Stanley report noted that companies like Caterpillar, John Deere and Komatsu have competitive advantages over Chinese machinery companies in higher tonnage equipment. Can you explain what exactly higher tonnage vehicles are compared to what China dominates?

A: Like anything, the bigger the size of the machine, the more complex it is and the more technical advantage you need to create a quality machine. So what you can see from that report is that in excavators, the Chinese market is dominated by locals because in the low tonnage, excavator machines are less complex and it’s simpler for them to compete. As you get into the higher tonnage, it takes more technical expertise and experience and currently the foreign manufacturers have that advantage.

In China, the two workhorses in the market are wheel loaders and excavators. Everybody uses them: mining, infrastructure, there are multiple applications. So when we are talking about thirty ton excavators that’s where the foreigner manufacturers have their advantage because of their technical know-how in building them.

With wheel loaders, the other workhorse, it’s a pretty simple machine. It’s four wheels, two axles and an engine, it’s not that technical. So that’s dominated by the Chinese manufacturers, it’s very hard for foreigners to break into that market, because it’s so simple and the value-add that foreigners put on their wheel loaders, there is no need for it in this marketplace. So you can buy four or five Chinese wheel loaders for the price of a new foreign one, so there is no price advantage.

Q. Caterpillar has famously said that if it isn't number one in China by 2020, its position as a global leader should be called into question. Is there concern that the maturity many foreign machinery companies are relying on may not happen and they will simply be surpassed by the current Chinese model of machinery production?

A: No, I don’t think there is concern that the maturity won’t happen, but just the estimated time. Will it be quick? Will it be slow? That’s the big question. But certainly the maturity will happen, it has to happen, its evolutionary it’s out of the control of anyone’s hands.

Q: At the same time that American companies are trying to take a larger part of the market here, Chinese manufacturing companies are branching out into the international market. Inversely to what Caterpillar declared, one Chinese manufacturer, Sany, has that by 2015 it wants to have 50% of their sales originate from outside of China. Is somebody making the wrong bet? A: Only time will tell who made the right bet.… Caterpillar is investing in China, but not only in China, all the BRIC (Brazil, Russia, India, China) counties as well. They see most of their growth coming from the developing market over the next twenty years, China probably being the strongest of those emerging markets. The domestic companies see the China market is building more and more capacity that this market can’t handle, so they have to diversify and that’s where Caterpillar’s strength is: They have global diversity so if one economy goes down, they can manage in another economy that is going up.

These domestic manufacturers are all just riding China right now and they realize they have to diversify and they are trying to find out where their strengths are. Well, they are going to expand overseas for sure, but it’s not going to come from the mature high-end economies like North America and Europe, it’s going to come from regions like Africa, the Middle East and South America.

Courtesy Ritchie Bros.

Despite being the largest machinery auctioneer company in the world, Ritchie Bros. has yet to have held an auction in China.

Q: Why not the North American market?

A: The challenge for them entering the U.S. market is that a highly competitive, high-level service market is the baseline there. High-level product quality is already expected by American customers, that’s a given for them. So to enter the U.S. market, Chinese businesses will have to learn how to compete on service level and the supply chain side, which they currently cannot do yet.

It’s easier for them to enter a maturing or developing market and provide those kinds of services where the expectations aren’t as great and you can compete on machine price, because in most developing countries, everybody is price first, services later and that’s their competitive edge.

Q: We’ve established that the next logical step for Chinese companies is to get into emerging markets. Is there concern for both Ritchie Bros. and American machinery companies that if these markets become heavily influenced by current Chinese machine consumption patterns, it’ll keep your companies out of those markets?

A: For us, it’s a good thing the Chinese are breaking into those markets. That means there are more people owning machines and more people needing a channel to resell them and we can provide our services to them.

From the manufacturers’ point of view, they know already that they get a niche market there, like here, for high-end, high-service machines. But the Chinese will certainly put pressure on those guys in those markets. But as those markets mature over time, they will gravitate to the high-end that American companies provide.

But that’s not to say the Chinese will always be low-end, they will always mature overtime. And just like the Japanese in the 70s and the Koreans in the 80s, when they entered into the market they were perceived to be lower-end quality. Since then, they have come right up to the high-end to the same level as their top-end western competitors. So you can very well see Chinese manufacturers competing at the highest levels in 15-20 years.

Q: Let’s turn to your company, Ritchie Bros. You are the biggest machinery auctioneer company in the world, but you haven’t done any auctions in China.

A: China only introduced auction laws in 1996 and they only opened up the market to wholly-opened foreign auction companies of any type – art, antique, etc. – at the WTO ascension in 2001. To this date, there is no wholly-owned foreign auction company running auctions due to a couple technical reasons. I believe the auction laws are a bit too rigid compared to international auction practices, even for arts and antiques.

The other side is just waiting for the market to mature. There is a certain time in the marketplace where used equipment becomes an important part market and that moment is just cresting now in China. It’s just emerging as Chinese manufacturers realize they have saturated the market with new machines over the last dozen years and now they need to go back and sell another machine or they want to increase their market share against other manufacturers.

They realize that used equipment is a starting point because every new equipment sale starts with a guy who already has a machine. So, that guy’s first question is, ‘What can you do for me with my old machine? I’ll buy your machine when you can help me get rid of this one.’ It’s just like cars. So these guys realize they have to get into the used equipment business to get those trade-ins out of the market and their new machines in there.

But then, the problem is that they still don’t have a viable used-equipment channel in China.  It’s very parochial, very immature, but the momentum is building and we believe we can get into that at the right time now as these manufacturers and dealers start realizing, ‘All right, I can take in a used machine, but it’s not easy just to sell it again.’ Our value-add is to give them a supply chain where it gets it out of their hands, it gets sold and they get that cash to sell again while also creating certainty of sale and certainty of disposal.