Danfoss Business Strategy in China

Danfoss Business Strategy in China

Danfoss is a Denmark-based global enterprise having 70 production facilities in 25 countries across the world. As one of the largest industries in Denmark, Danfoss is also a global name in the HVAC industry manufacturing and supplying a diverse range of components such as compressors, radiators, electronic controls, control valves and other fluid handling systems. With 23,000 employees spread globally, Danfoss is a well-established company in the global HVAC industry. [Danfoss] China is one of the fastest growing economies and the development of cities such as Beijing and Shanghai with a number of high raise buildings has increased the demands for air conditioning systems. In general, the increasing dispensable income among the vast middle class Chinese population has created an exploding market for the air-conditioning systems with a market share for a number of national and international companies. Also the nineties witnessed a slowing down of the Japanese economy and this prompted many international industries to focus on China as a prospective market with its fast developing economy and its huge population base that guaranteed enough market for new comers. Furthermore, the growing pressure to cut down the cost of its products in the European market and the availability of cheap labor and land in China created favorable business conditions for Danfoss. All these reasons prompted Danfoss to seriously consider China as its new industrial base. For the Chinese government on the other hand, letting in international companies implied precious foreign exchange investment, which they badly needed for the infrastructural developmental needs of a fast growing economy.

In 1994, Danfoss entered Hong Kong for marketing its products in China and in the very same year it opened an office in Beijing. The fact that Danfoss was allowed to open a wholly owned subsidiary was considered a new and welcome development as the Chinese government only allowed international firms that partnered with local industries (no direct venture was permitted) The company bought 50,000 sq. m of land in Wuqing in 1995 to establish its first factory in China and production of thermostats and expansion valves in the new facility started duly in 1997. However, entry into China was not all rosy for Danfoss, as it had to face several hurdles during the initial phase of its entry in the country. First and foremost was the problem with its suppliers and its employees. The language barrier created significant bottlenecks as suppliers failed to understand the requirements of the company. The lack of adherence to specifications forced Danfoss to import the materials from Europe. The company management also found that the cultural difference between China and Europe had a significant impact. Chinese employees could not easily adjust to working in a team environment and the open management policy of Danfoss did not go well with them. Also Danfoss was not a well-recognized name in the Chinese industrial market. As Jens M. Jepsen, head of the Motion controls division of Danfoss said, 'the clients were very familiar with some big companies such as Eriksson but they had never heard of Danfoss'. [Vinaya Kumar] So it is clear that the initial years presented significant problems for Danfoss that the management had to carefully workout to establish a good foothold in the promising Chinese market.

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During the initial years in China, Danfoss focused only on production of expansion valves in China. By 1998, the company had already shifted the production of 'expansion valves' from its Danish factories completely to China. The availability of cheap labor and material made it a strategically sound initiative to produce the components locally. Also local production would enable Danfoss to successfully compete with the local industries in the price front as European production and import was considerably costlier. The company managed cost savings related to production as much as 40% when the production was shifted to China. Soon after, in 2000, the management decided to transfer the production of line components also to its Chinese factories. The strategic decision makers of Danfoss were already considering shifting almost all of the European production operations to China though the company's European stakeholders did not welcome such a change. As Claus Tonnensen, the production head of Danfoss China said,' It simply is a matter of survival for the company in an increasingly competitive world. However, in the short run, it is affecting the working lives of many people in Denmark and they are obviously hesitant'. [Vinaya Kumar]

For Danfoss, doing business in China offered the promise of a huge market base. The growing Chinese economy and the huge population base with dispensable income was an attractive destination for any industrial enterprise looking forward to expand its global presence. With almost one third of the entire Chinese population (1.3 billion) living in cities and the rapid development of the cities implied a huge and growing demand for HVAC systems in the country. [William G. Sutton]. The meat industry in particular had huge demands for refrigeration and cooling systems. As Joel Haggard, the vice president of Asia specific operations of the USMEF says, "Importers in China who are handling valuable meat and other perishable import products are aware of the importance of the cold chain and most endeavor to control it during importation and distribution," [Jim Herlihy] The Chinese government's plan to build 'Cold food chains' across the country to improve the food storage and distribution systems offered an ideal time for Danfoss to increase its market share. Besides capitalizing on the demands of the local refrigeration and AC markets, Danfoss could also realize considerable gains by the low cost but high quality production in China and exporting it to its European markets. This would ensure that the company is competitive in both the European market as well as the growing Chinese market.

However, doing business in China would imply that Danfoss has to carefully assess the local market and the cultural differences and adjust to the requirements of the local culture. Also, the favorable production climate and high market demand has attracted countless other international brands into the country and it would not be all that smooth and easy for Danfoss in China. It would have to compete with both the established local industries as well as international competition. Failure to assimilate the local business processes would prove to be a costly misadventure for any foreign company interested in expanding its business in China. For instance by 2005 already 33 out of the 66 brands in the air conditioning segment had already exited China. [Vinaya Kumar] Another problem that Danfoss had to face in China was the surge of duplicate products. The company learned of counterfeit products that were sold at low prices and eventually with the help of the police the culprit company was traced. However, dealing with such counterfeits would continue to be problem for Danfoss as the Chinese market is flooded with such counterfeits. [Vinaya Kumar]

Danfoss' China strategy was well assessed and phased out. At first, the company used a leased production facility mainly for making expansion valves but later it developed its own production facility in Wuqing, which started production by December 2002. The factory soon started production and export of refrigeration and air conditioning components. By 2004, most of the production catered to the local markets that included major companies such as Gree. Thus by using a well calculated and phased out production strategy, Danfoss had stabilized itself in the local market and by 2002 started to realize profits from its Chinese operation. Also in the following years Danfoss revamped its strategy to include the low-end segment of the Chinese market, an area which it had for so long ignored. In 2005, Danfoss acquired 'Holip', one of the major players in the frequency converter markets which promises competitive edge in the field that has the potential for a 25% annual growth. [Danfoss] Danfoss' China strategy has been a success and I would endorse its policy of gradual and well phased out market penetration and its flexibility. Understanding the market dynamics is very critical for sustained growth in a huge but competitive market like china. The low-end market in China would definitely be a highly profitable segment for Danfoss and hence I would strongly recommend the strategic decision makers of the company to seriously consider this segment along with the high-end markets.

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The cultural difference between western and eastern worlds was evidenced in Danfoss' Chinese ventures. Initially the Danfoss management was disappointed with the performance of the Chinese employees who were used to the hierarchical setup. The management found out that the Chinese employees were more individually focused and were less eager to work in a team. In the open western culture of work, teamwork was very much a natural part of the job and employees were expected to openly discuss the issues that they face. However, the Chinese employees were reluctant to open discussions and were more self-centered and just did what they were asked to without much of an active cooperation that is involved in a team-oriented approach. Danfoss HR managers had to understand these cultural clashes and devised extensive employee training programs and personality development seminars. The management also devised a platform to address employee grievances. It is necessary to conduct such seminars and employee training programs to provide the Chinese employees the cultural orientation to equip them with the skills necessary for working in a global concern. Danfoss management has learnt from its initial experience the importance of understanding and appreciating the cultural differences involved in globalization. The human resource department of the Chinese subsidiary focuses on bridging the gap and promoting a more efficient working platform, which would contribute to the overall profitability of the company. As one of the Supply chain managers at Danfoss put it ' adapt to the Chinese way on the outside and doing things our own way inside the company'. [Jonathan Story]

As discussed above Danfoss has huge market potential in China, which is emerging as a fast growing economy with huge demands for its products. China offers a business proposal, which would be a dream for any business venture. It has a large and expanding market base, it offers cheap land and labor, and the entry of China into the WTO has further facilitated the business operations for foreign companies. By acquiring material locally and by producing the components locally, Danfoss was able to compete both with the local companies as well as make products cheaper for its western customers where there is increasing demand for reducing prices. Furthermore, western markets are more or less saturated in the HVAC product segment and are not as lucrative as the emerging markets such as China, which is poised to grow at a significant pace with huge growth in this segment that Danfoss caters to.

The implications for Danfoss are immense. China offers great promise but it also demands meticulous planning and strategic thinking in order to reap the benefits. The Chinese market is also intensely competitive and therefore a hasty or unplanned venture would only backfire as can be witnessed in the exit of several multinational firms in the HVAC sector in the last couple of years in China. As one of the early birds in the Chinese market, Danfoss has a good foothold and is well poised to realize the Chinese dream. On the other hand, Danfoss also has to deal with a huge outcry in Denmark and its other facilities in Europe as its Chinese expansion has affected the employees and the employment prospects across Europe. China attracts more foreign direct investment than India, Russia and Brazil put together. With Israel being the third largest trading partner of China it is only natural for many Israeli firms to venture into China. [Deloitte] Thus Israeli firms which have plans to enter into China would do well to take Danfoss as an example and study how an effective and well formulated strategy would contribute to stable and steady business prospects in the growing Chinese market economy. In particular, cultural considerations have to be thoroughly understood and cultural orientation is key to better employee contribution. Also, companies should focus on low-end segment as well as they contribute a huge market base.

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Harmony, hierarchy, responsibility are Confucian elements of Chinese culture. Chinese management principles include these Confucian values of mutual obligation, hierarchy and harmony. [Huibert de Man] Danfoss did well to consider these traditional Chinese ideals and applied them effectively. For instance the Danfoss was very intent on maintaining excellent relationship with the Chinese government officials (Guanxi) and made it a point to invite the top officials for every important strategic event. For instance, for the opening of its manufacturing plants Danfoss invited important government officials. This according to Danfoss management 'indicated to the local people and corporates that the government supported the company and its products'. [Vinaya Kumar] Danfoss also made it a point to invite government officials to its plants in Europe. Danfoss also proclaimed its business strategy of making China its 'Second home market'. These initiatives were aimed at improving and maintaining good relations with the Chinese government and to obtain the support and confidence of the Chinese public.