A lot has changed in these recent years for the chemical industry when doing business in China and Asia due to the changing regulations and globalization. Now that China continues to become more and more self-sufficient, chemical companies are called to embrace adaptability and versatility in the future. Joining Victoria Meyer is Dan McLeod of East West Associates to explore the industry's current status in the Chinese setting. He looks at the topic from various perspectives, from the alarming environmental regulations that cause shutdowns and relocations, the many adjustments in logistics, to the country's call for more local business leadership. Dan also talks about the impact of the COVID-19 pandemic on the chemical industry in China, exploring the many opportunities western companies can still find there after a challenging time.
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Doing Chemical Business In China And Asia With Dan McLeod
I am delighted to have with me Dan McLeod, Director of East West Associates. Dan has a long history in the chemical industry and, throughout most of his career, has spent a lot of time working in Asia. We're going to have a great discussion about doing business in China and Asia as a chemical company and learning a bit more about what East West does to help facilitate that. Dan, welcome to the show.
Thanks for having me. I've been in the chemical industry for the better part of 40 years. I started in operations and engineering and had several roles in the US and around the US. In 1997, I moved to Shanghai. I was with Hercules Inc. at that time and we were building our first facility in China. I went on to manage that effort. I went there for a two-year assignment and stayed for 21 years. Thirteen of it was in China. Also, I covered the region of Singapore for about seven years. I spent a little time in the Philippines as well. Mostly in an engineering operations management background. I managed capital projects. I had a little bit of experience running businesses at the time.
For the last few years, I’ve been working with East West Associates. East West started in China in 2005, working with manufacturing companies primarily that were trying to enter the market. If they had been in the market and they were having operational issues, performance improvement, needed to develop their organization, find people. Also, risk management concerns, fraud and corruption investigation and background checks. It’s a whole range of operational services focused on China. We've expanded beyond that into Southeast Asia, Mexico and Central Europe. We have a chemical practice that we've started up and I'm running that. That's focused on China and Asia. We’ve gained experience in those markets and people I've worked with over the years.
China is a critical market for chemicals both from an end-user perspective but also a lot of growth going on in China. Can you talk about that at all?
It's a $1.5 trillion market. It's larger than the US and EU combined and has been growing. When I was first there, growth rates were substantially starting from a relatively low base mostly in the commodity and basic chemicals. Starting in the late ‘90s, you started to see more specialty chemical investment. Over the years, the growth rate is about 15% a year from a relatively small base. Now it's bypassed the US and North America. I mentioned the specialty chemical sector because early on, many foreign companies, particularly Western companies, were going there to participate in that space. Those gross growth rates have tailed off and are now more tracking with GDP, 5% to 6% a year. That's still a substantial growth rate.
Given that they’re industry-based, it's still a lot of growth.
The industry is a bit different than other parts of the world. It's a mix between state-owned enterprises, which are large and, in some cases, designated national champions, which are being promoted. Our growing domestic private industry sector and Western or other multinational companies are playing there. It's a little different. It’s a fragmented marketplace, although that's changing. You've seen a significant amount of industry consolidation over the years but it's still relatively fragmented and immature from a market standpoint.
Another change that's different from other industries in China is there's little export from China to the rest of the world with chemicals. There are some but it's not a major part of what they do. It’s primarily for domestic consumption. If you went back years ago, there's significantly more import into the country than there is now. It's becoming a much more self-sufficient industry. You see US and European companies do export into China but it's a much smaller fraction of the industry than it used to be years ago.
That seems to be by design for China, which is a great opportunity there but also a challenge for all of the businesses. If I think about the petrochemical boom that’s taken place in North America. A lot of that product is destined for China. As China becomes more self-sufficient, it's challenging to that market and to the producers that are, hopefully, depending on that or presumed that they will have that growth there.
Beijing thinks about these things long-term. The objective is very much to become self-sufficient in all strategic sectors in the economy and the chemical industry is part of that. Particularly, when you talk about specialty in fine chemicals and more cutting-edge technology, that's where there's an emphasis out of Beijing to become more self-sufficient in that field.
You guys do a lot of work in East West with Western companies that are doing business in China or wanting to do business in China. Given this drive towards self-sufficiency, what are the challenges for international companies that are doing business in China or wanting to do business there?
There's a number of them. We'll start with one major challenge that's particularly impacted the chemical industry and that's around regulatory affairs and environmental awareness. It's not necessarily that the environmental regulations are more stringent than you've seen in the US or Europe but the enforcement of them has been much more aggressive. It’s much less of a collaborative relationship between regulators and industry.
Whereas years ago, if you had an issue, you could talk to your local regulators and you could figure out a solution to it and you work towards a resolution. Now, it's much more inspect, shut down until you fix your problem, call us when you think you've got it fixed and we'll talk about restarting. That has hit several industries and it's certainly across the industry but not just Western companies but it has an impact.
With Western companies, generally, your compliance activity is strong. You got good compliance. It tends to be hit a little bit hard from a shutdown perspective. Where it impacts companies in the chemical history and across the industry is on your supplier base. If you have key suppliers that are domestic companies and maybe they don't have the regulatory awareness of the compliance stature then they're going to be hit. That's going to cripple your business potentially. From a regulatory standpoint, that's what you see.
China is a $1.5 trillion market, larger than the US and EU combined, and it has been growing.
Do you see that there's genuine progress being made? I think about the regulatory, pollution, sustainability and all the environmental aspects. Is it to improve their environmental profile? Is that what's going on?
You see that in the quality of life. The most visible and obvious one is air quality, which years ago, was a huge issue and much less of a concern now. Years ago, everyone had an app on their phone that would give you real-time data on the particulate emissions in the air, for example. Whether you were red, yellow or green, over a couple of years, you can see that dropdown. You can see the progress on this. That was one indicator. They've made progress in improving the environment there. The challenge is around the relationship between regulators and the industry.
It sounds like there's a bit more animosity versus collaboration.
We’re starting to see that around.
What other challenges do you see international companies having in doing business there?
Many manufacturing companies have been concerned about cost increases, the cost of labor has grown. In the chemical industry per se, it's not a labor-intensive operation. The cost of labor is not a huge driver of what people do. However, many people find, chemical or specialty chemical sectors, their customers are being impacted by that. For example, the textile industry, textile manufacturers, leather manufacturers, they're leaving China. They've left China. They've gone someplace else.
Where are they going?
Primarily to Southeast Asia. They're focused on low labor costs. In the textile industry, you see a lot in Vietnam. Because they've established a garment sector where they are high labor, they're also trying to move upstream to the textile sector. Chemical companies are finding that, in some cases, their customers are leaving or being impacted more than they are per se by cost pressures. Another area that has been a concern for many years and improvements have been made but it's still a long way to go is around IP protection.
There is IP protection and the courts will listen to foreign companies when they bring suits. In favor of foreign companies, they will award if there's an issue. The problem with that is the penalty to someone who's appropriated your technology is not sufficient enough to discourage them from continuing or to start in the first place. The legal recourse is better than it used to be but there's still not enough of a disincentive to do that.
That's been a hard area for a long time, such as the lack of IP protection, enforcement and then the dilemma, particularly a lot of chemicals. There is a lot of proprietary technology that goes into the manufacturing processes, etc. Exposing that IP, that know-how, etc., is always a concern. I've worked with some companies that are pretty tech-heavy and technology licensing and elsewhere and they have to think twice as they enter the Chinese market. It's an attractive market in many ways and yet it's also a challenging market in terms of defending your position.
The rule of thumb that I've heard over the years for a Western company when they're thinking about bringing newer technology is maybe we can protect it for five years. It's unlikely we'll be able to protect it any more than that. That's how you weigh it. If we think the payoff and the risk of losing it after five years are still going to pay off, we bring it in or we don't. We’ll figure another way around it.
One of the things you and I've talked about previously is that there also seems to be pressure on at least some of the smaller and more established chemical operations that are being forced to relocate. Can you talk about that?
As the industry grew, a lot of entrepreneurs jumped in. I was involved in an acquisition of a chemical company. The owners came from the motorcycle business and they had money. They had no experience in the chemical industry but it seemed to be a place where they could make some money. A lot of people jumped in without necessarily a lot of background. Where are they located? It was a variety of industrials zones, some general-purpose, some focused on the chemical industry. Much of the industry, particularly the smaller players, moved into general-purpose industrial zones. Those sites did not necessarily have the infrastructure in terms of wastewater treatment or energy supply that you would need in the industry. Often, they were sited in urban sprawl. They began to approach them. Those sites were inappropriate.
Economically, in the manufacturing and industry, things got back to normal in China by the summer of 2020.
Several years ago, Beijing started to look at both consulting industry and forcing companies to move into specialized chemical parks. That sounds like a good idea from an environmental and a safety standpoint. The difficulty is now you've got companies that are in the wrong location. Many Western companies find that the facilities that they had purchased, maybe they purchased a local company, now they were operated. They’ve taken the operation. They were faced with having to relocate. You don't get your relocation expenses fully reimbursed. You can negotiate something but it usually doesn't cover the cost. They've been faced with those costs and decisions whether to move and where to move and your options are limited.
Let’s say you have to go to a chemical or a chemical park. At the same time, the government has acted on the poor performing parks and closing those down. There's a shrinking supply of those zones. The ones that are remaining and the ones that are run professionally and run well can be choosier in who they allow getting in. What you see is the more well-established, well-run professional zones, larger ones that would be attractive to Western companies. The price of entry has got to be high where they're not interested. In many cases, they’re not interested in projects that are less than $50 million or over $100 million. The small to medium-sized specialty chemical company that's trying to find a place to set up shop, they're struggling.
They're getting squeezed out a bit. Are they establishing themselves elsewhere? Are they simply shutting down? What is it that you see? I know you get involved in some of this.
It's a combination. Some people walk away from the operation and most don't because the market is large. They find themselves having to move further away from the major population centers than they'd like. You can find professional well run zones further West or further North from the economic centers in East China, Shanghai and the Yangtze River, Delta area. You have to go further away. It's harder to find an appropriate site closer to that economic center.
How is the industrial logistics infrastructure in China? If you're moving for a long time, part of the centrality of locations also had to do with the infrastructure and the logistics of moving products. Is that still an issue? Has that improved? What are you seeing?
It improved over the years. The highway system is well developed. The rivers have always been used to transport. The Yangtze River, in particular, has always been used for transportation. That's pretty well established. If you've got operations in the West even as far as Zhongzheng for example all the way in the Southwest, you can still move product by river to Shanghai in the ports. Rail is not used much for freight. The rail system is primarily passenger service. They've got an excellent rail system that most people have heard about but little of that is used for freight. It's mostly barge, river traffic or roadways. It's improved substantially. The port system for import or export is large, busy but sophisticated. That works quite well also.
How has COVID impacted doing business there? China had some of the first impacts. They took a hard shut down line in a lot of the regions and at the ports and stuff. How has that played out for businesses in China and for businesses trying to grow perhaps or move or do business in China?
There were about three months where a lot of the economic activity shut down. Fortuitously, it was around the Chinese New Year holiday where not much happens anyway. By April 2020 or May 2020, things were beginning to get back to normal domestically. Companies were back in business and they ramped up. It took them a bit more time than normal because people weren't allowed to travel as easily. That sorted itself out before summer. Economically, in the manufacturing and industry, things got back to normal by the summer of 2020.
The real challenge that continues particularly for multinational Western companies working there, the Western management and technical staff can't get in. There was a lot of back and forth whether or not it was management expertise, technical expertise going into support or vice versa. Your Chinese staff was going into headquarters for training and development and working with their colleagues and peers there. That's all stopped. That's where companies have struggled to maintain momentum. The status quo stuff and the routine daily operation continues. If you're trying to move the ball down the road as far as developing an organization, any transformation of your operation, M&A activity. It's not likely a company is going to proceed with a purchase or an acquisition without a senior management team getting over there and take a look at things and kick the tires.
While M&A has been heating up elsewhere, you see it still slow in China from an M&A across chemicals perspective.
There are opportunities as things continue to consolidate as an industry. It's been a little slow to rebound because people can't travel in and out. One of the things is we get a lot of requests to support due diligence activities because we got people in the country. Normally, you might send a team over there for 1 or 2 weeks to work through some of the issues that can happen. The other is it's not uncommon if there's a senior management change in a company. If you lose a managing director or general manager, maybe somebody from another operation would come in and help out until you found somebody. That's not happening. The demand for interim general management capability in-country to be able to provide a stopgap and maintain business continuity, that's another area that we talked to a lot of people about. It's challenging if somebody leaves. How are you going to replace them?
Especially if you would replace them perhaps from outside of China, then it's difficult to get back in. I've seen some of the large international companies doing business in China. Shell, for instance, has been on this path for years trying to get more local management and leadership there. China itself wants more local leadership. Is this a leapfrog opportunity for individuals and companies that are trying to establish that? Are the right resources there to be able to do that?
There's a push for more localization of senior leaders in multinational companies. Many companies over the years have talked about that and made good progress on it. It's become a talking point for Beijing and that they have specifically stated in the past that one of their objectives is, “We want multinational companies. We want international companies. We would be we would prefer them to be run by local people.” For me, that's a bit disconcerting.
Domestic competition tends to be much more entrepreneurial freewheeling and willing to take risks.
From a political standpoint, China has drifted away from a liberalization tack that they were on for the early part of this century and they've gone the other way. There's a more command and control environment, more top-down driven economy. Quite honestly, local hiring of senior positions can be influenced a lot more easily. Confidential discussions with party people admit that is part of an objective and that's a bit nefarious. That's a concern.
In a lot of ways, that's hard for Western companies to grasp because we've had so much independence. If I think about how businesses operate in the US, Canada, Europe and elsewhere, there is a separation between private entities and government. There are relationships but it's not internal influence, so to speak.
It's a different culture. It starts with state-owned enterprises, which are overtly aligned with the objectives of the party. When you get into privately-held companies, those relationships are not quite as well defined but there's a desire to be able to direct those private companies.
We've talked about a lot of challenges and yet there are still opportunities. What are the opportunities that you see? How do Western companies ensure their success in doing business in China?
Some of the areas I see are around particularly specialty chemicals and certain sectors. Those areas are related as the economy grows. As the standard of living continues to increase, things like personal care products, for example, are sophisticated. If you're into that space and continuing to increase the operators, those businesses are still growing and particularly higher-end applications of those. Packaging materials continue to get more sophisticated as you go through time. Environmentally-friendly replacements for some older technology look interesting. It could be adhesives, coatings. There are thousands of small coatings manufacturers in China. Many of them are solvent-based. They're being pushed out through various regulatory reasons. To be able to replace them with more environmentally-friendly technologies is an opportunity.
Years ago, China came out with its Made in China 2025 policy, which was looking to add high-value industry sectors. It could be around electronics, aerospace, electric vehicles, battery technologies. There are about a dozen that were targeted. If you're in the chemical space and you're supplying into those industries, there are opportunities because the objective is to make a quantum leap in manufacturing capability and technical know-how for the domestic industry. To the extent that foreign companies have some inputs into those industries that are needed to get there, they're going to be encouraged to come in, set up and produce there.
We talked a little bit about M&A. It's been a little bit slow for Western companies because it's hard to do due diligence but there are going to be opportunities there. I talked about the environmental challenges and the more confrontational environmental regulation regime regulators. That's going to push companies out of business or it's going to stress them. I wouldn't say it's a buyers market but there are a lot more opportunities there. For Western companies, if you're in the market, I encourage you to be more aggressive because domestic competition is aggressive in that field. Your domestic competition tends to be much more entrepreneurial freewheeling and willing to take risks. I encourage you to act before they've stepped up all the good deals.
Risk profiles are different not just across companies but across regions. I've always had a belief and dialogues with colleagues that there are some different criteria sometimes for doing business in China, what good business looks like in China and the willingness to do it. That plays into that risk profile arena.
Another area that folks maybe haven't thought about but it's certainly something that I think about and has talked to some folks about is the 15% growth rates. As your top line is growing, that covers a lot of problems in your operations. When you get down to growth rates, the GDP rates, even though that’s still 5% or 6%, there's not that go-go-go growth. The importance of having a good operating practice whether or not it's good HR practices or environmental, to be able to have a tight ship. It becomes more and more important. That's an area where most multinational companies excel. Maybe you're not seeing the big top-line growth that you were years ago but you're more than likely competitively advantaged versus some other domestic players if you've kept your operations pretty tight in previous years.
One of the dilemmas, when I talk to companies about doing business in China and being competitive in China, is around cost competitiveness. They said, “They're not willing to pay.” You talked about the fact that there seems to be a desire to become a bit more sophisticated in certain markets and more sophisticated products and packaging and stuff. Do you see an increasing willingness to pay? Are they willing to pay? Do you have to show them the value? Is there a different value equation that takes place to figure this out?
It very much depends from industry to industry. There have been a lot of educating of purchasing agents over the years. Its value is still a hard sell but it's improving. A lot of it depends on the end market. Successful companies figured out a few years ago that they needed to work harder at tailoring their product offerings to the market. Companies that I've seen that have been quite successful have set up an application in not necessarily R&D, although there is some R&D in the country, an application and formulation developed to target a local market.
One of the ones that I was involved with a few years ago is we developed a lot of personal care products and a lot of it was going into haircare. It’s not something I was familiar with. We set up quite an applications lab there because the properties of hair were different in Asia than they were in the rest of the world. We had to work hard on reformulating the products. It wasn't a matter of sending the same shampoo from Western Europe to Asia. That's pretty understandable across a variety of industries. Taking the time to develop products for the local market is increasingly important. If you do that, it's a little easier to sell the value proposition.
It makes sense, that localization. Particularly when you think about the desire for self-sufficiency, you need to be self-sufficient within that local ecosystem. Dan, any other recommendations that you might have for chemical companies doing business in China?
Yes, I do. Some are related to supply chain disruption because we talked to a lot of people about that.
Taking the time to develop products for the local market means it's a little easier to sell the value proposition.
That's been a big issue in particular.
A couple of things to consider. I mentioned environmental compliance is a concern and an emphasis there. It goes back to a point I made earlier. Understand your key supplier base and take the time to get to know who they are, where they are and evaluate their operations. Understand the risk of disruption. Particularly in the dye industry and the coating industry, there have been several disruptions companies shut down. I hear from companies how they've been struggling and scrambling around trying to find alternatives. Understand that supplier. Look at expanding your supplier base on some key raw materials. Companies are starting to look outside of China that they can import in if they're concerned about some key materials. If the sector's a little bit problematic, they're concerned about looking ahead to environmental issues.
They’re importing from other parts of Asia, is that what you're suggesting?
Primarily. I've also talked to companies that because of the difficulty, that makes it difficult to find space for new operations. Also, the permitting requirements become more difficult and more time-consuming. I've talked to companies that are looking at setting up operations outside of China in part to supply their China operations. You'll see people go particularly to Vietnam, not only for industrial manufacturing but to set up shops to supply their China operations as well as for export because they can get into business faster and easier. It's worth the extra logistics cost into China. That's another thing to consider.
I always tell companies to develop relationships with their local regulators. If there's going to be a change in regulations, the local folks have a fair amount of leeway in how it gets implemented. Have that relationship and understand what's coming down the pipe, what's coming down in the future and how they expect to implement those regulations. In the factory I was working with, they were burning coals to generate their steam electricity. They were told that they're going to have to change to gas, which eventually happened. By working with the local regulators, they extended the timeline and made that transition a lot less painful than maybe a strict reading of the regulation would be.
I'd encourage you to be local. Develop some contacts. The large players in the chemical industry will have a government relations office to understand. The smaller guys usually don't. That's too big of an ask but you can develop some relationships with companies that specialize and looking at the regulatory environment and what's coming down the road. Often, the implementation timetable for these regulations is compressed. If a company is surprised by that, there's a lot of scrambling involved to try to do it. To the extent that you can develop a crystal ball and be able to look out ahead using some outside resources would be helpful for you.
You've personally done decades of work in China. I know that East West has as well. How do you factor in and are able to help companies in that way?
We do a fair amount of site selection work. We do a fair amount of relocation of facilities. Shut down of facilities is a difficult topic for some people. It's always a challenge in shutting down. From a regulatory and execution standpoint in China, there are special challenges associated with that. We've got quite a bit of experience with that. As difficult as it might be, if you manage it well, it can go smoothly.
Dan, I know you've been landlocked in the US for months. Are you planning to get back to China when travel reopens?
Yes. I hope. I'm going to wait until the quarantines are less onerous. It’s now fourteen days in a hotel room where you don't leave.
That's no fun.
I know several people that have gone through it. They've had to get back to their life. The timing of the pandemic was around a Chinese New Year holiday where many Westerners were already out of the country. They were out and they get stuck out for several months. They weren't allowed to get back in. The first person I knew got back in July 2020. He'd been away for 6 or 7 months. When the travel restrictions are lifted, I'll be back working.
Dan, I appreciate your time. This has been a great conversation. If people want to get in touch with you or to find out more about East West Associates, how do they do that?
I appreciate your time here. I'm sure people are going to love hearing about your perspectives on doing business in chemicals in China. Thanks, Dan.
About Daniel J. McLeod
Mr. McLeod currently holds the position of Director at East West Associates. He is a manufacturing expert with more than 20 years’ experience of designing, building, and running facilities in Asia and developing the high-performing organizations needed to operate them.
Before joining East West Associates, Dan worked for a private American-owned international consulting company based in Shanghai. His responsibilities included assisting China-bound companies perform due diligence to establish operations, site selection, product sourcing & equipment procurement, engineering, design and plant construction management, and start-up support.
In his previous position, as Director Asia Pacific Operations for Ashland Specialty Ingredients (previously AQUALON) in Shanghai, he was responsible for operations & supply chain for wholly-owned facilities in Jiangmen, Guangdong & Nanjing, Jiangsu, in addition to serving as manufacturing liaison to JVs with facilities in Suzhou and Luzhou. This experience included leadership of $200M in expansion investments executed in China, from concept through startup and operation.
Prior to Ashland Specialty Ingredients, Mr. McLeod was Director of Manufacturing and Supply Chain for Hercules Incorporated’s Asia Pacific specialty chemicals business, supplying processing aids and functional additives to the pulp and paper, petroleum refining, chemical processing, and municipal water treatment markets. Based in Singapore, his responsibilities included operation of facilities and sourcing in China, Taiwan, Korea, Singapore, Indonesia, India, and Australia. Additionally, he was responsible for managing factory design and construction projects in Indonesia, India, China, and Taiwan.
Dan began his career at Hercules and held numerous engineering and operations management positions in the United States before moving to Asia in 1997.
Mr. McLeod has a B.S. in Chemical Engineering from the University of Maine.