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ESMT–310–0115–1 ES1151

December 20, 2010

ESMT Case Study

Options for growth: The case of Haier (A) Franziska Frank

The beginning Zhang Ruimin, Haier’s newly appointed CEO, took a sledgehammer and started smashing the faulty refrigerator in front of his staff. Once it lay broken at his feet, he asked the workers (standing by with tears in their eyes since they earned in two years what a refrigerator cost) to destroy another 73 refrigerators. Seeing their disapproval, he added: ‘‘If we do not smash these refrigerators today, the market will shatter this enterprise!’’1 This happened in 1985 a few months after 35-year-old Zhang Ruimin had made one of his first visits to the Qingdao Refrigeration Factory. Renowned for little but bad quality, wealthy in little but debt, the factory and its shabby buildings as well as the workers within were registered by him shortly thereafter. There was the factory floor – cluttered and soiled, and a canteen with dismal food. There were the accounting books, badly kept but showing that the factory had suffered losses of RMB1.47 million,a that is was close to bankruptcy and that, for all intents and purposes, it should be taken off the market – a relief possibly even for the customers who regularly, and in vain, complained about the bad quality of the refrigerators they bought.2

a

With a fixed exchange rate of ca. 3 to 1 for the US dollar in 1985, that makes for an official deficit of ca. $500,000.

This case study was prepared by Franziska Frank of ESMT European School of Management and Technology. Sole responsibility for the content rests with the author. It is intended to be used as the basis for class discussion rather than to illustrate either effective or ineffective handling of a management situation. Copyright 2010 by ESMT European School of Management and Technology, Berlin, Germany, www.esmt.org. All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means - electronic, mechanical, photocopying, recording, or otherwise - without the permission of ESMT.

ESMT–310–0115–1

Options for growth: The case of Haier (A)

The economic situation in China Following the victory of the Communist Party in 1949, a state-directed economy was introduced with five year plans to jump-start industrialization. The most famous of these was titled “The Great Leap Forward,” initiated in 1958. Its aim was to massively increase both agricultural and industrial output, the latter mainly in steel. As a consequence, peasants were organized into communes and strict rules were instigated as to how, what and where agricultural production should take place. At the same time, each commune was put in charge of a backyard steel production plant in order to produce as much steel as possible. For this the countryside was stripped, the needed iron from material was smelted down and workforces were removed from their agricultural tasks. The steel produced was largely impure and therefore too brittle to be used – at the same time harvests were failing. The year 1958 had yielded an excellent harvest but due to so much of the workforce being allocated to steel production, the harvest was largely left to rot. The following years saw drought and locusts. Altogether between 14 and 43 million people are estimated to have died as a consequence of the famines over the next few years.3 In the 1960s the next economic upheaval struck with the Cultural Revolution. Started by Mao as a means for strengthening his political control, it focused on the destruction of the Four Olds: Old Customs, Old Culture, Old Habits and Old Ideas. This led to a massive witch hunt whereby economic life more or less ceased and millions were sent to the countryside to be “reformed” via labor. “Intellectuals” such as teachers, physicians and also managers were considered as “liberal bourgeoisie” who should be eliminated. As a consequence the running of companies became virtually impossible, since - as a small side effect - any form of incentives and rewards for work were abolished.4 Once the Cultural Revolution ended in 1976, economic reforms slowly started to take place. In 1981 collective farms were dismantled and ownership of private property was allowed. In the industrial sector, enterprises were allowed to keep a substantial share of earnings so that managers could be rewarded.5 Managerial authority was strengthened and labor laws relaxed. Still, over the next few years there were numerous swings back to a more directive-oriented style, leaving management deeply unsure as to what would be considered right in a few months time.6

The white goods sector in China Despite the political uncertainties, the 1980s were a period of steady growth. Yearly growth rates of 10 percent were typical and the Chinese population, particularly in the cities, began to benefit from it. In the first three decades of Communist rule (1949-1979), people in China had aspired to own three durable goods: a wristwatch, a bicycle and a sewing machine.7 By the end of this period, these possessions were universal in urban areas (though not in the countryside, where this level was only reached in the late 1980s). As a next step, urban dwellers aspired to acquire televisions, refrigerators and washing machines. As a consequence, production increased

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Options for growth: The case of Haier (A)

ESMT–310–0115–1

steeply (Exhibit 1) and by 1990, 78 out of 100 urban households owned a washing machine and 42 out of 100 a refrigerator (Exhibit 2). The rural population took much longer to reach these figures (even in 2002 only 30 percent owned washing machines and 15 percent owned refrigerators). During this period of strong growth, demand easily outstripped production. This led to a favorable condition in which companies could sell any product, regardless of how defective it was. Depending on the number of defects, the product was classed from grade 1 down to 2, 3, 4 or even off-grade or “special.” It also allowed companies to continue believing in their success even though they were producing imperfect products. By the late 1980s numerous companies had sprung up in order to satisfy the demand and competition was slowly beginning regarding brands and quality. In the course of the late 1980s and early 1990s, competition intensified (Exhibit 3). More than 200 refrigerator companies existed in 1989, but many were eliminated in the price wars that followed. The key players in the market were local ones such as Haier, Rongsheng, Xinfei, Meiling, and Changling, who all together in the later 1990s would hold more than an 80 percent market share in the Beijing refrigerator market.8 Distribution in China was an enormous hurdle for suppliers within this vast country. In the 1980s there were no national chains by which both distribution and service could be ensured across the country. The chains Suning and Gome - later to become leading retailers (by 2008 with ca. 700 shops each) - were just being founded. As far as direct sales were concerned, the countryside as well as smaller towns were virtually unserved.

Zhang Ruimin and the factory Zhang was born in Qingdao in 1949 to parents who had put a great emphasis on education. Zhang excelled in most of his studies, but with the rise of the Cultural Revolution, he was sent to work at a metal processing plant. Confronted there with numerous bad processes and bad product quality, he slowly developed for himself a concept that placed top product quality at the forefront.9 He became successful at this work and was made Vice General Manager responsible for control and approval of technology for new products. In 1985 he was transferred to the Qingdao Refrigeration Factory (which later became Haier). “I didn't want to have anything to do with it. I had often visited the refrigerator factory and knew it was in poor condition – not really like a factory at all.”10 The Qingdao Refrigeration Factory had been founded in 1958 as a cooperative to repair and assemble electric appliances. By 1984, it had been run for many years as a loss-making, stateowned company. Just like so many of the state-owed companies in China, it served less to satisfy customer demands than to fulfill official quotas. Since Chinese labor laws gave little leeway for replacing poorly qualified or recalcitrant workers, neither the management nor the workers produced anything better than very basic and often malfunctioning sets of refrigerators.

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ESMT–310–0115–1

Options for growth: The case of Haier (A)

Creating Haier Once Zhang Ruimin started managing the factory, there was little that was not changed in the first few years. His clear vision for the first years was that the company needed to learn how to deliver quality and become a top quality brand.11

The workforce There had been virtually no discipline on the factory floor before – shoddy workmanship had been accompanied by bad habits regarding work attendance, careless hygiene standards and a general unwillingness to make work more than a pastime that guaranteed a basic lifelong salary. Zhang Ruimin introduced strict attendance rules; he set standards for behavior (including not urinating on the factory floor) and fired a few persistent offenders – a most difficult process but one that gained him an enormous amount of attention among the remaining work force.12 In order to show the workforce that the factory management not only demanded things from its workers but was also there to take care of them, the canteen was rebuilt and the quality of food improved. There were no salary increases but instead a larger variable element of remuneration tied to the performance of the whole team was introduced: That meant that there was no differentiation according to age, number of years at the factory, gender, number of children, etc., as in the former system. Management was held 80 percent responsible for employee mistakes13 and managers were incentivized to coach their teams and communicate with them. Another process for quality assurance was instituted on the factory floor. Yellow footprints were painted on the floor and any worker who had performed badly was made to stand on these footprints before the assembled workforce and deliver self–criticism. Later, green footprints were added for workers who had been particularly efficient or innovative.14 Zhang Ruimin also developed his own concept of TQM called OEC, an acronym of Chinese words that roughly meant “empowerment and clarity”; in English it stood for Overall, Everyone, Everything, Everyday, Control and Clear. OEC meant that all employees had to accomplish their targets daily and even reach beyond on each day. OEC aimed at a 1 percent work increase compared to the previous day. Employees were required daily to fill out an OEC 3E Card. This was a Microsoft Excel sheet detailing production quantity, quality, defective product materials used, technology levels, equipment evaluations, safety operations and labor discipline evaluations.15

The core product It became clear to Zhang Ruimin that he could not radically improve the quality of the refrigerators with the resources within the factory or even within China. So he went to search for partners and finally succeeded in a joint venture with the German company Liebherr. This joint venture caused considerable improvements as far as the quality was concerned. It was an improvement even the Germans did not believe in until an independent test in Germany showed

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Options for growth: The case of Haier (A)

ESMT–310–0115–1

that Haier outperformed Liebherr in all aspects of quality.16 Liebherr also became the inspiration for the name Haier. Using the last part of “Liebherr” (= Herr, meaning mister and/or master), the Chinese way of speaking and writing it was “Haier.”

Outlook By 1992 Haier had captured a large market share of the Chinese refrigerator market. The quality was as high as the brand perception. In China's first survey of domestic trademarks in 1991, Haier was placed on the list of the top 10 Chinese brands.17 Due to his success, Zhang Ruimin had been approached by a number of other companies – in the sector of white goods, brown goods and even financial services sector – to inquire whether he could also turned them around. So there were many questions facing Zhang Ruimin. He had this vision of Haier as a diversified and truly global company among the top 10 of the world in the white goods sector – but was that realistic? He was faced with the following questions and issues: 1.

Should he expand Haier’s portfolio to include other companies from the white goods or brown goods sectors or even the financial services sector? There had been an opportunity to buy a number of similar companies from these sectors when it was still the old Qingdao Refrigerator Factory. There could be disadvantages in diversification, but what about gaining more market share or leveraging the existing brand?

2.

How could Haier better penetrate the Chinese market? Market reports had shown that there was a reluctance on the part of country people to accept the need for refrigerators and washing machines. How could he address this with his portfolio? Up to now Haier produced a series of solidly made, high-quality products. Should he strengthen the innovative powers of Haier?

3.

Should Haier even go abroad? Large multinational companies were beginning to enter the Chinese market. Should he attack them in their large and complicated home markets, such as America or Europe, or should he first try and build a base in other Asian countries?

4.

If he chooses to go abroad, how should he approach the markets – with Haier’s existing products? Or should he develop something new for a new market? That path seemed to be fraught with difficulties.

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ESMT–310–0115–1

Exhibit 1:

Options for growth: The case of Haier (A)

Output of consumer durable (in million units)

Product

1978

1998

Sewing machines

4,8

9,9

1990 7,6

Bicycles

8,5

32,3

31,4

Watches

14,1

54,5

86,7

Refrigerators

0,03

1,5

4,6

Washing machines

0,004

8,9

6,6 *

Electric fans

1,4

31,8

58,0

Radio sets

11,7

16,0

21,0

Television sets

5,2

5,2

26,9

0,004

4,4

10,3

Recorders

4,7

13,9

30,2

Cameras

1,8

1,8

2,1

Television sets color

* Peak with 10.5 million in 1988

Source:

Compiled from Chinese government statistics, 13-22 Output of major industrial products, http://www.stats.gov.cn/english/statisticaldata/yearlydata/YB2000e/M22E.htm (accessed March 3, 2010).

Exhibit 2:

Household possessions (in percent)

Item

Rural households

1985

1985

1990

1990

Bicycles

152,3%

188,6%

80,6%

118,3%

Sewing machines

70,8%

70,1%

43,2%

55,2%

Electric fans

73,9%

135,5%

9,7%

41,4%

Washing machines

48,3%

78,4%

1,9%

9,1%

Refrigerators

6,6%

42,3%

0,1%

1,2%

Color television sets

17,2%

59,0%

0,8%

4,7%

Black and white television sets

66,9%

52,4%

10,9%

39,7%

Recorders

18,9%

35,5%

4,3%

17,8%

Cameras

8,5%

19,2%

-

0,7%

Source:

6

Urban households

Compiled from Chinese government statistics, 10-8 number of major durable consumer goods owned per 100 urban households at year-end, http://www.stats.gov.cn/ english/statisticaldata/yearlydata/YB2000e/J08E.htm (accessed March 3, 2010).

Options for growth: The case of Haier (A)

Exhibit 3:

ESMT–310–0115–1

Market facts and trends

“In 1989 there were 256 refrigerator companies in China.” CDS Market report

era of t of an ved ou ce-hungry o m s a h n pply oversu ountry . T he o “The c al shortages ted to see an nineties.” perpetu market star e in the earlyZhao, 2001 ou tic domes ds for first tiCmompetitive? Zh s e Good of goo es re Chin Why a Report China

“ A na and- lysts w wou nail ba arned th tt ld ra a ge o le for m t a toot n.” A arke hpplia t ncem share ag a

zine .com

“Over the past few years, local competitors have made large price cuts in markets for televisions, air conditioners, microwave ovens, refrigerators, and cell phones. Some of the prices were cut by half or two thirds, making the products affordable to more customers and increasing the market size in mid to low-end segments.” Corporate reputation: Pricing and competing in Chinese markets – strategies for multinationals, Chen, Journal of Business Strategy 2004

“It is also a fact that capability utilization (the Chinese call this utilization rates) is very low for many firms and industries. Rolled steel industry has a utilization rate of 62%, while industries for air conditioning, washing machines and vacuum cleaners had rates of 30 to 40 percent.”P ASCN Discussion Paper No. 99-23 The Macroeconomy of China in the Late Nineties Joseph Lim

Source:

Compiled by case author using the above given sources.

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ESMT–310–0115–1

Options for growth: The case of Haier (A)

Endnotes 1

Haier rises through reform and opening up. Opinion, People’s Daily. http://english.peopledaily.com.cn /200108/06/eng20010806_76638.html (accessed March 3, 2010).

2

Innovative Produkte von Weltruf. China Internet Information http://german.china.org.cn/german/48762.htm (accessed March 3, 2010).

3

Xizhe, P. (彭希哲) (1987). Demographic consequences of the great leap forward in China's provinces. Population and Development Review 13(4): 639–670.

4

Esherick, J.W., P.G. Pickowicz, and A.G. Walder (eds.) (2006). China’s cultural revolution as history. Palo Alto: Stanford University Press.

5

Satya, J.G. (1998). Economic liberalization in post-Mao China: Crossing the river by feeling for stones. http://www.mtholyoke.edu/courses/sgabriel/economics/china-essays/7.html (accessed March 3, 2010).

6

Liou, K.T. (1998). Managing economic reform in post-Mao China. Westport, CT: Greenwood Press.

7

Consumer durables ownership 1990-2002. http://www.chinability.com/Durables.htm (accessed March 3, 2010).

8

Market report of selected electrical home appliances. CDS Market Report. http://www.chinavista.com/database/cides/research_sample.html (accessed February 15, 2010).

9

Yi, J., S. Ye (2003). The Haier way: The making of a Chinese business leader and a global brand. Dumont, NJ: Homa and Sekey Books.

Center

(CIIC).

10

From near bankruptcy to no. 1 - Haier makes progress. Asian...