Large and growing ICG markets in the YRD and the PRD

The spectacular rise in China's manufacturing and export activities have been matched by a rising demand for intermediate and capital goods (ICGs). In particular, the need to maintain competitiveness will spur the demand for quality ICGs in China.

The aggregate market size of ICGs for five selected industrial groups¹ in the Pearl River Delta (PRD) and the Yangtze River Delta (YRD) is estimated to be US$114-122 billion. Over 50% of the surveyed companies there are planning to increase their spending on ICGs. It is estimated that the market for intermediate goods (IGs) will grow by 13%, while capital goods (CGs) will grow by 11-12% over the next three years.

From a geographic perspective, the YRD accounted for an estimated 58% of the aggregated market size of ICGs for the five industrial groups. Electronics and telecommunications equipment accounted for the largest share (36%) of the ICG market, followed by electrical machinery.

Sourcing pattern of end-user companies

A majority of the end-users in the PRD and the YRD are purchasing their CGs mainly from abroad since China is unable to produce certain technology-intensive components and capital equipment. In the case of IGs, nearly 40% of surveyed companies also mainly source from abroad. While PRD-based end-users are more evenly split between purchasing IGs domestically and overseas, 70% of surveyed YRD-based companies purchase IGs mainly domestically.

Partly reflecting suppliers' emphasis on supply lead time, flexibility and familiarity of suppliers, when purchasing ICGs domestically, end-users mainly source from their respective base region: 81% of the interviewed PRD-based companies source mainly from the PRD, while almost three-quarters of YRD-based companies mainly buy in the YRD.

However, PRD-based end-users seem more receptive to cross-region sourcing than their YRD counterparts. The reason for this pattern may be due to the higher concentration of upper-stream industries in the YRD and its greater output of capital equipment.

End-users assess their suppliers by a variety of parameters. Survey results showed that the most important characteristics that manufacturers consider are (in order of importance): quality, price, lead time and stability of supply. More than 70% of the respondents considered these criteria to be of primary importance. Other important aspects include the ability to provide value-added services (VAS), level of technology, and functions of the product.

Currently a majority of suppliers already supply some form of VAS, but only 35% of the interviewed end-users indicated that they pay separately for VAS. Going forward, half of all respondents intend to increase purchases of VAS.

About half of the interviewed end-user companies use trading agencies. On average, 22% of these companies' annual procurement is purchased through trading agencies. When using a trading agency, end-users mainly use Chinese trading companies, followed by Hong Kong companies with representative offices in China. Hong Kong trading companies, both with and without representative offices in China are significantly more popular among PRD-based end-users compared to YRD-based end-users.

Hong Kong is an important sourcing hub for ICGs

When purchasing ICGs from abroad, the Asia-Pacific region is the leading sourcing region while Hong Kong is the second most important source. Nineteen percent of the interviewed end-users mainly source their IGs from Hong Kong and 14% source their CGs mainly from Hong Kong. Particularly in the PRD, 60% of the interviewed end-users have previously "imported"² ICGs from Hong Kong.

Extensive discussions with end-users in the PRD and YRD indicate that Hong Kong ICG suppliers in general offer products that are of high quality and have good stability. Hong Kong suppliers are in general fast and flexible in responding to client requests, highly efficient in various business activities, and very professional in offering on-site or off-site services. In addition, Hong Kong suppliers in general have strong business integrity and are very good in honouring contracts.

Foreign suppliers can take advantage of Hong Kong in setting up regional offices

Apart from indigenous companies, Hong Kong is also a preferred place for international ICG suppliers to locate their sales office for the Chinese market. The high density of international ICG suppliers and traders in Hong Kong allows end-users a convenient platform for sourcing a wide range of ICG supplies. There are several major advantages for international ICG suppliers in setting up regional offices in Hong Kong:

• Given the extensive involvement of Hong Kong-based companies in manufacturing on the mainland, international suppliers can network with a large number of major manufacturers headquartered in Hong Kong.
  
  
• A large cluster of trading companies in Hong Kong, which typically have extensive end-user networks on the mainland, can easily extend their customer base and have an enlarged catchment area in the mainland.
  
  
• Advanced business infrastructure and a high level of professionalism in Hong Kong allow international suppliers to set up and operate their regional offices easily and efficiently.
  
  
• Compared with the Chinese mainland, the transparent business environment and well-established legal system in Hong Kong provides better protection in the implementation of contracts.
  
  
• Hong Kong's free and mature financial market is convenient for international suppliers in settling their transactions at low cost. Hong Kong also offers readily accessible offshore financing to international companies.
  
  
• Hong Kong has a significant pool of human resources (at both middle to senior management levels) who are highly experienced in manufacturing production in China. They offer in-depth market knowledge as well as a customer network.

Furthermore, given Hong Kong's sophisticated infrastructure, advanced service sector and business-friendly investment environment, it can act as a manufacturing service and controlling centre. A key enabling factor for Hong Kong in acting as a manufacturing controlling and service centre for China's ICG market is the advanced IT infrastructure and the experienced IT solution providers available in Hong Kong. Given that there are a large number of companies with controlling and headquarter functions located in Hong Kong and production facilities in China, an effective remote / on-line monitoring system is critical to maintaining smooth operations.

Hong Kong as a centre of equipment leasing complements its sourcing hub role

Hong Kong has long been an important location for manufacturers in the PRD and the YRD to obtain financing for purchasing capital goods (particularly in the form of equipment leasing). The leasing industry in Hong Kong is advanced and mature. There are a significant number of independent leasing companies in Hong Kong. Besides, more and more banks and financial institutions have entered the leasing market in the last 5 to 10 years.

Cross-border equipment leasing to China is a major market focus of the leasing industry in Hong Kong. It is estimated that the amount of cross-border equipment leasing reached at least HK$ 6 billion in 2003.

Moving forward, as the manufacturing sectors in the PRD and the YRD continue to grow, there is an increasing demand for capital financing and equipment leasing. While state-owned enterprises have relatively easy access to capital from major Chinese banks, private enterprises (particularly small and medium-sized companies) may have more difficulties meeting their financial needs. Expanding to domestic private enterprises will be a new business area, but has higher risks.

Currently there are domestic leasing companies operating in China, but industry sources indicate that Hong Kong equipment financing capabilities are well ahead of the mainland. Hong Kong equipment leasing companies, for example, excel at managing default risk. Hong Kong lessors can offer more international exposure and vendor networks for domestic private manufacturers, and can offer more flexible financing options and better financial strength. Hong Kong lessors also have decades of experience and involvement in China's manufacturing sector and possess more in-depth local industry knowledge.

Hong Kong should move towards a one-stop shop for Chinese manufacturers

Hong Kong has traditionally been the preferred location for international ICG suppliers in setting up their offices and leading Greater China sales functions. With the presence of such a wide array of international suppliers, Hong Kong can attract Chinese manufacturers in setting up procurement offices in the city.

In Hong Kong, end-users can also benefit from up-to-date market information, as well as better communications with suppliers and traders, compared with the Chinese mainland. Hence, in recent years more and more Chinese manufacturers have set up procurement offices in Hong Kong, or have procurement functions located in their Hong Kong sales offices. Along with such developments, Hong Kong should position itself as a one-stop shop, where Chinese manufacturers are able to source conveniently in one place for all their ICG needs from around the world.

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