Light assets, heavy operation and control complexity from Zhenhua Heavy Industry

At the end of 2010, "China Machinery Industry" issued a question, Zhenhua Heavy Work was a state-owned star enterprise, with rapid growth for more than ten consecutive years, from fixed assets of 1 million US dollars to 27.6 billion yuan in turnover (2009). ), became the leader in the international market, but why did it lose money in 2010? Two years later, this article seeks answers from a supply chain and operations management perspective.

Bullwhip effect: equipment manufacturing is a cyclical industry

Let's start with the industry. Zhenhua Heavy Industry takes heavy equipment as its core business and is at the back end of the industrial chain, and its business volume is greatly affected by the bullwhip effect. For example, the rebound of GDP and the enhanced purchasing power of consumers will drive the output and sales of manufacturers; the increase in output and sales will drive the transportation business, including shipping; the increase in shipping will drive the port business; the existing port equipment is not enough, so the port equipment is increased. Drive Zhenhua's business. The opposite is true. The more in the back end, the greater the impact. For example, in 2009, the global GDP dropped by 2.25%, and Zhenhua's actual contract signing volume dropped by 50%, which directly led to the first loss in 2010.

Attributable to the bullwhip effect, whether it is agricultural machinery, mining, telecommunications or semiconductor manufacturing equipment, aircraft manufacturing, it is difficult to escape the periodic ups and downs. In just 20 years, thanks to the rapid development of China's economy and the cost advantage of "Made in China", Zhenhua Heavy Industry has not experienced many ups and downs, but this does not mean that the cyclicality of the industry does not exist. Under the 2008 financial crisis, global infrastructure investment dropped sharply, new contracts dropped sharply, revenue in 2010 dropped by 38% compared to 2009, and huge fixed costs such as equipment depreciation were exposed like a stone, and Zhenhua lost money.

This loss is caused by the fact that the cost is too rigid and cannot be reduced in proportion to the revenue. The answer must be found from the supply chain and operation management. It can be summed up in three words, which are asset-light, operation-heavy and control complexity. .

Light assets: change fixed costs into changes

From 7.1 billion yuan in 2004 to 27.4 billion in 2008, Zhenhua Heavy Industry has experienced explosive growth, and fixed assets have also surged from 2.5 billion to 11.5 billion . In 2010, equipment depreciation was about 1 billion yuan, almost double the amount three years ago, and the increase accounted for about 70% of the 2010 net loss. Once fixed assets are invested, they must be depreciated. If fixed costs can be changed into changes, the company's cost structure will be more flexible. This is the concept of asset light, which can be achieved by outsourcing non-core businesses.

In high volume industries, the concept of asset light is prevalent. Apple, for example, has shut down production facilities since Jobs returned in 1997 and outsourced production to contract manufacturers in Asia. General Motors divested Delphi, AMD divested its chip manufacturing business, IBM divested from production and entered the service industry, all of which are asset-light. In small batches such as equipment manufacturing industries, the concept of light assets is relatively new, because in these industries, product design and production process design are often closely linked, and the separation of the two can easily affect the development and introduction of new products. Can't do light assets. For example, Boeing's latest-generation aircraft, the 787, is a typical example of asset-light: Boeing has changed its traditional practice and significantly outsourced R&D and production to global suppliers. Despite several delays in the product development phase, it has been quite successful in controlling fixed costs.

Some people would say that Zhenhua Heavy Industries started out with manufacturing, and manufacturing is its housekeeping skill. Is it still a business if it is outsourced? This distinguishes core and non-core competitiveness, and the corresponding cost.

One of the capabilities of Zhenhua Heavy Industry is long-range, large-tonnage complete machine delivery capability. It has its own fleet and can deliver tens of millions of tons of steel structures all over the world. This capability can indeed give Zhenhua a certain competitive advantage, but with such a large fleet, how high should its effective utilization be? Do the benefits outweigh the costs? Just like Apple can build its own factory to produce chips, so it doesn't need to be subject to Samsung or Toshiba. You can also say that chip manufacturing determines Apple's fate and is a key competitiveness, but the cost of producing chips by itself is too high, and Apple continues to rely on suppliers. On the other hand, local vertically integrated, large and comprehensive companies, due to backward concepts and historical burdens, are still supporting large ships with heavy assets and moving forward in the economic tide.

Focus on operation: reduce costs and improve performance

After talking about asset-light, then focus on operation. The explosive growth of local entrepreneurial companies often relies on the keen business awareness of entrepreneurs, coupled with hard work and hard work. Its low cost is not entirely due to good management and cost control, but because of low domestic labor costs.

Due to deficiencies in systems, processes, etc., many of these companies are usually inefficient and wasteful, as can be seen from the billions of sluggish inventories. Extensive management, good business and high profits, one beauty hides a hundred ugliness; revenue declines, this problem is like a stone exposed in the water. At this time, it is necessary to benefit from operational excellence.

Diesel, rice, oil and salt, the operation expert is to take care of the house and let the company operate in an orderly and efficient manner. For example, Apple's existence today is inseparable from the product development led by Jobs, but the excellent operation driven by the current CEO Cook is also indestructible. When Jobs returned to Apple in 1997, one of the big things he did was poach Cook from Compaq, let him straighten out the company's operations and supply chain, shut down numerous production facilities, enable contract manufacturers in Asia, establish JIT inventory system.

These initiatives have comprehensively reduced product costs, improved product quality, and shortened lead times, contributing to Apple's extraordinary success. It can be said that without operational excellence, Apple will still be an excellent innovative company, but it will never become the world's most valuable company.

For Zhenhua Heavy Industry, efficient and low-cost operation is inseparable from maintaining such a high market share of its flagship products. Entrepreneurship and success require different skills. Extensive management can conquer the world, but never defend the world. What is needed to keep the success is the talents of operation experts and prime ministers.

Guan Tongxian is like Steve Jobs, unique and irreplaceable. What he leaves behind is also a great business. The first priority of his successors is to maintain success, show their value in excellent operation, reduce costs and improve performance. To do it, develop new products and open up new markets on the basis of maintaining success, instead of taking the path of only competing on price, with market share but no profit.

Controlling Complexity: Fighting "Cost Retreat"

Small batch industry, many varieties, small batches, and many customizations. The result is more and more product models, smaller batches, a flood of part numbers, and a loss of scale advantages. The higher the market share of the company, in order to further increase the market share, it must enter a more segmented market; the more segmented the market, the more customization, the smaller the batch, the more complex the product design; the higher the complexity , the corresponding unit cost of production, procurement, and after-sales service will be higher, and the company's cost competitiveness will be lower. At this time, lower-cost competitors will take advantage of the situation and cannibalize the company's market share, which can be explained by the "cost retreat" curve. The "cost regression" curve shows that unit product cost is generally driven by two factors: batch size and variety. Experience shows that when the batch volume of the same product is doubled, the unit cost of the product decreases by 15% to 25%; when the number of product varieties is doubled, the unit cost of the product increases by 20% to 35%.

Before the rise of Zhenhua Heavy Industry, port machinery was monopolized by foreign companies. As a low-cost competitor, Zhenhua Heavy Industry first entered products with relatively large batches and relatively low technical difficulty. They enter at a lower cost and capture a certain market share, causing foreign competitors to lose market share in these products and in smaller batches. In this way, their batch-driven unit cost rises, as indicated by the arrows in Figure ①. As a countermeasure, foreign companies take advantage of their own advantages to develop more products with high technical requirements but often smaller batches. As a result, there are more product lines and product models, resulting in an increase in the variety-driven unit cost, as indicated by the arrow in the figure ②. Show. ① and ② together will cause the overall unit cost of foreign companies to rise. As shown in ③, this will give more space for low-cost competitors such as Zhenhua Heavy Industry, which will lead to more product lines of the former being attacked, forming a vicious circle. This is the so-called "cost regression" curve. In this way, Zhenhua Heavy Industry gradually eroded the market of international competitors, and the international market share of port machinery reached an astonishing 78%.

Interestingly, after the "cost retreat" made Zhenhua Heavy Industries become the industry leader, it is easy to become Victims of the "cost retreat" curve. For port machinery and equipment, domestic competitors are also eyeing. Its strategy will not be significantly different from Zhenhua Heavy's defeat of Japanese, American and European companies. Faced with lower-cost competitors, Zhenhua Heavy Industry can only choose one of two strategies: either effectively reduce costs and compete head-to-head; or completely withdraw from the corresponding product line and focus on higher-end products. Effective cost reduction is inseparable from the control of complexity, especially in the small batch production industry.

Complexity control starts with product design. The large equipment industry is characterized by customization. As far as port machinery is concerned, each port is different, and the size of port machinery may be different, which is an objective condition that needs to be customized; but all ports have certain commonalities, and port machinery is destined to have commonalities, which is the basis for standardization. There is a balance between customization and standardization. The question is how much effort the product developers put into balancing, or whether it is intentional. The ignorant customization will eventually lead to the enterprise falling into the dilemma of increasing complexity and unable to extricate itself.

In product development, designers rarely clearly understand the cost of product complexity. The common view is that the company has a set of production, procurement, sales, and service supporting systems anyway, and one more product is nothing more than "one sheep is put, and two sheep are put", which has little impact on the company's cost structure. Everyone thinks this way. If you do this, a company with tens of thousands of people will be flooded with product lines and product models within a few years. The sheep will no longer be just a group, the shepherd will no longer only need one person, and the sheep pen will no longer be limited. Need one, and the cost of complexity creeps into every corner of the company. For example, Hanwang Technology has 37 kinds of electronic paper books, which are deeply involved in high cost and inefficient operation caused by high complexity and cannot extricate themselves. The complexity of products in the mobile phone industry is so great that, in the words of Chang Xiaobing, chairman of China Telecom, there are so many types of mobile phones that people can't even understand their names. However, 73% of the profits of the global mobile phone industry are captured by Apple, and Apple has done a very good job in managing the complexity of products.

This is true for high-volume industries, and even worse for low-volume industries. There is an equipment manufacturer in Europe, and almost every equipment is customized, even for the same customer. Aside from production and procurement, this is also a nightmare for spare parts support: to sell a piece of equipment, you have to have half of the equipment as spare parts. How expensive is this! The availability rate of spare parts is still not guaranteed: due to cost considerations, some very expensive spare parts with very low consumption can only be selected not to be prepared. Not prepared does not mean that they are not needed. The cost is staggering.

The problems brought about by the high complexity are like an avalanche after the company reaches a certain size. It cannot cope with it, and the European company has to sell itself. The company that was bought, which had hoped to successfully enter a new product area, has been paying for complexity for several years, losing more money and earning less.

Complex customized design, inefficient supply chain operation, numerous products and parts, on Zhenhua Heavy Industry, a giant ship with fixed assets of more than 14 billion yuan, sales can be predicted correctly, production can be produced correctly, and procurement can be purchased. How likely is it to be right? basically zero. All kinds of inefficiencies are finally backed up in the form of inventory. Under the economic crisis, the demand is gone, and the inventory backlog is protruding like an iceberg. From 1.6 billion yuan at the end of 2007 to 6.1 billion at the end of 2011, how much expired inventory should there be. After the write-off, not to mention the profit in the next few years, even the accumulated profit of 8.4 billion in the past 10 years is estimated to be little left.

This is also the tragedy of the large-scale equipment industry with high complexity, strong cyclicality and inefficient operation: when business is good, it is impossible to hire people. It is also amazing; as soon as the economic winter arrives, there is a pile of waste materials and excess production capacity, which offset each other, and there is not much left.

Liu Baohong, US Certified Purchasing Manager (CPM), founder of "Supply Chain Management Column" (www.scm-blog.com), Executive Director of CSCS International. He graduated from Arizona State University with an MBA, specializing in Supply Chain Management, and obtained a Six Sigma Black Belt qualification. He currently lives in Silicon Valley and often travels between China and the United States, training local procurement, planning and supply chain management talents, and providing consulting services to help local companies improve their procurement and supply chain management levels. His book "Purchasing and Supply Chain Management: A Practitioner's Perspective" published in China in January topped the sales chart for seven consecutive months.