China and Network Theory

When I took my first trip to Hong Kong in January 1989 it didn’t occur to me that I was amongst the vanguard of U.S. merchants in search of the next cheap source of consumer products. At the time, Hong Kong was a British territory and many overseas buyers relied upon Hong Kong trading companies as their source for Chinese made goods. Buyers, such as myself, didn’t have the resources to develop our own products but were relying on the trading companies to “knock-off” the more popular U.S. made items.

The trip to China was an attempt to bypass the U.S. based agents who had been the previous wave of intrepid explorers to take advantage of the cheap labor and lower production costs provided by Chinese and Hong Kong based manufacturers. These agents had followed on the heels of companies such as Mattel and Hasbro (I was working for a chain of stores that sold toys) who were producing Barbie dolls and Cabbage Patch dolls in China.

The agents were taking advantage of the Chinese penchant for parallel development” by creating lines of faux Barbie dolls and cabbage patch-like dolls that they could sell to U.S. toy stores for considerably less money than the originals. The U.S. retailers made very little money on the Barbies and Cabbage Patch dolls due to the increasingly common practice of large retailers such as Toys R Us to use these wildly popular items as loss leaders to bring in store traffic.

Smaller retailers found that they could buy the knock-offs, sell them for less than the originals, and actually make money. Now, however, retailers such as myself found that even the knock-offs were priced too high to purchase domestically and hence began our quest to get as close as possible to the fountainhead of the supply chain. The problem was, the further you strayed from the path of the U.S. based agents, the more risk you faced in terms of product quality, delivery problems, and other sources of miscommunication.

I found that there were different strata of manufacturers all vying to sell the same type of products. At the top level there were the manufacturers working directly under the auspices of MNCs such as Matttel, Hasbro, Playmobil, and Lego. At the next level, overseas Chinese from Taiwan, Hong Kong, and Singapore, who had extensive family connections in China as well as an understanding of the quality level of products U.S. buyers were seeking, were producing for second tier toymakers as well as U.S. agents and distributors looking to sell quality knock-offs. The bottom level consisted of wholly owned and run Chinese facilities under the full control of local Chinese. Prices at this level were extremely competitive but there were also possible problems not encountered at the other two levels. For instance, making the Chinese producer understand that Barbie needed to have western eyes, not Chinese eyes could be problematic and ultimately disastrous if your shipment of 3000 dolls all arrived looking distinctly Chinese.

As I traveled to Hong Kong year after year, and eventually to China, I became fascinated with the process of sourcing and importing. One year their might be talk amongst the buyers that the Phillipines, or Bangkok would be the next great source of a certain type of toy, but eventually most buyers stopped looking elsewhere for the ‘next cheapest source’.
Suppliers who had been hedging their bets with factories in Taiwan and Bangkok eventually consolidated all of their sourcing in China. The numbers show the incredible growth of Chinese exports and the concomitant slowing of exports from other Asian countries, but what accounts for the way this trade pattern developed?

Over the years I became fascinated by the steady migration of domestic U.S. producers and manufacturers into China. I have seen the frustration of manufacturers struggling to keep their U.S. factories running in the face of the onslaught of Chinese competitors and U.S. competitors, some of whom had been their former customers. I have watched the U.S. based companies preach quality advantages year after year, even after these advantages slowly vanished as Chinese quality steadily improved.

The U.S. based manufacturers placed their faith in their belief that U.S. consumers would be loyal to U.S. made products and U.S. based companies. They placed their faith in their belief that good old American know how would rule the day. What they didn’t count on was the fact that good old American know how was working against them. If they had been listening, they would have heard the marching feet as the big box retailers; Kmart, Wal-Mart, Sears, and others, made their way to Chinese factories in search of cheaper versions of the items being produced in U.S. factories.

Toys, appliances, furniture, auto parts, computers, shoes, and clothing were all being produced in Chinese factories. And U.S. consumers were purchasing these items in droves. Eventually U.S. factories had no alternative but to either close their doors or move their production overseas. While all of this was happening there were consumer advocates, free trade opponents, and others urging us to “Buy American”. In fact, we were buying American. We were buying from Sears and Kmart and Wal-Mart and Target. We were buying from Mattel and Hasbro and GE and Motorola. We were buying lots of Chinese made, U.S. endorsed products. Studies were being conducted that showed Americans were not favorably impressed by products made in China, but every year we bought more and every year more U.S. manufacturers shuttered their doors.

There were two constants I was aware of during this period. The first, which I have just described, was that U.S. based suppliers were sourcing as much as they could from China. The second constant was that, almost every supplier I came in contact with in China, wanted to sell their products to Wal-Mart. Wal-Mart was the Holy Grail. Selling Wal-mart was like winning the lottery.

An interesting relationship developed between Wal-Mart and the suppliers who wished to sell them. It was something I was able to experience first hand as I visited various showrooms and factories. There were items in these showrooms that would never make it to store shelves. No matter how interested a small buyer such as myself might be in that item, unless Wal-Mart decided to buy it, the manufacturer couldn’t afford to produce it. They priced the item low enough to attract Wal-Mart’s attention, but without Wal-Mart’s support they wouldn’t achieve an economy of scale that would allow the item to be profitable.

This practice wasn’t new. Manufacturers were always showing new products and waiting for the buyers to react and placed orders prior to production. The new part was that these items were being specifically targeted to Wal-mart. In the past, a good reaction from a mix of buyers would be sufficient prompt the manufacturer to add an item to their catalog. Now there was only one arbiteur of success or failure.

What began to intrigue me was the evolving dynamic between U.S. based suppliers, Chinese manufacturers, large U.S. retailers ( read Wal-mart), and the end consumer. Two of the loudest cries to be heard were; “China is taking all our jobs!”, and “Wal-mart is destroying all of the smaller retailers!” My personal axe to grind was that, in search of lower and lower prices, Wal-Mart initiated a process whereby all the personality and quality was removed from products just to achieve the lowest possible price points.

The bottom line was; U.S. companies imported more and more from China, Wal-Mart continued to grow in dominance, and, as long as the price was right, consumers didn’t seem to be complaining about where the products were made. As I tried to analyze this situation from a theoretical perspective I found myself frustrated by the limited scope of extant articles. Much of the literature showed that the country of origin was an important cue to consumers as they made buying decisions. Other literature illustrated that, as the amount of information a consumer received increased, the more they relied on overarching cues such as brand identity. Other articles, trying to account for the increased bifurcation between the country where the brand originated and the country where the item was produced, disaggregated the country of origin cues into as many as 5 separate parts.

The more closely these processes were being examined, the farther the inquiries strayed from what I felt was the essence of the problem. When I tried to determine how to statistically analyze the interactions between China, Wal-mart, and the U.S. consumers, some suggested that China and Wal-Mart were outliers.

In 2004, frustrated with my inability to formulate the right question, I drew a diagram on the back of a handout I had received in statistics class. On the paper I drew 3 large circles to represent U.S. imports, Chinese exports, and Wal-Mart respectively. I then drew lines linking these circles. I showed the paper to my, then, advisor, stabbed at the circles and declared “this is what I want to look at!”.

Complex Adaptive Systems
Part of the problem with trying to model the interdependent behavioral patterns that exist with regard to Wal-Mart, China, and other global trading partners is that the predominant statistical methods don’t allow for the real world interactions that are taking place. In “The Organization of Organizations” Mackenzie asks:

“Is it possible that we simply have been working on the wrong problems? related to this is the methodological argument that, if the organization of organizations is interdependence, perhaps our research methods, based as they are on statistical methods, predicated on independence-dependence relationships, are fundamentally and irredeemably inappropriate to the phenomena. In a metaphorical sense we may be trying to measure distance by using thermometers” (Mackensie 2001).

In “Adventures in Complexity: An Essay in Dynamic Open Complex Adaptive Systems, Butterfly Effects, Self-Organizing Order, Coevolution, the Ecological Perspective, Fitness Landscapes, Market Spaces, Emergent Beauty at the End of Chaos, and All That Jazz” Morris Holbrook states,

“chaos refers to the phenomenon wherein systems composed of inter-related parts or interdependent agents- each of which follows very simple, highly regular rules of behavior- generate outcomes that reflect these interactions and feedback effects in ways that are inherently nonlinear and intractably unpredictable…Potentially systems can spin toward various sorts of attractor states- stable equilibria, recurrent cycles, out of control explosions, or (somewhere between the latter two) strange attractors. Mapping the regions between these possibilities in phase space creates exquisitely beautiful fractal patterns that reveal mind-bogglingly infinite levels of reflexivity, self-embeddedness, or self-similarity. When such insights are applied to real-world systems- whether ant colonies, evolutionary biology, business organizations, or brand-positioning strategies- they shed light on dynamic processes of adaptation and survival. A business comes to be regarded as a dynamic open complex adaptive system (DOCAS), composed of interrelated parts, interacting with its environment, subject to resulting feedback effects, evolving over time adaptively to fit the pressures imposed on it, perhaps attaining sustainable advantage and in the process generating emergent phenomenon. Especially relevant to those with an interest in marketing, various DOCAS-related spatial metaphors bear directly on the issue of attaining competitive or differential advantage by successfully positioning the company or brand at a favorable location in the market space.”

So if our traditional, statistical methodologies are inappropriate to measuring complex adaptive systems how do we examine these issues? Fast forward to 2006. I am reading “Linked” by Albert Barabasi and he is addressing this very problem. Science has spent hundreds of years learning how to take things apart and study the pieces, he says, but has yet to learn how to put it all back together. Barabasi discusses recent developments in network theory and asserts that everything is connected and, by studying the interactions, we can actually see the processes that are occurring. As I read, my diagram with the three circles appears in my mind and I see that I finally have a framework with which to study the interactive processes I have been trying to describe.