Robotics & Automation: China on the road to innovation
President Xi is attempting to shift China’s economy from an export-driven model to one led more by domestic consumption and self-sufficiency. Robotics, automation, artificial intelligence and big data are all technologies where the administration has ambition to become a world leader.
The strategy appears sensible, considering the country faces an aging population and an increasingly expensive labor force, and we expect the likelihood of achieving these ambitions at least in part is reasonably high.
However, we expect it will take time and perhaps require regulatory and legal change to achieve. In the meantime, we believe the opportunity to sell robotics and automation systems into China to raise productivity and offset rising labor costs, regardless of whether the robots are made in China or elsewhere, is very significant.
From the outside, given the scale of China’s economy and the world’s dependence on Chinese-made goods, a successful transition to “Made in China 2025” would imply a major shift in the global economic balance of power. Perhaps then, it is not surprising that the US President has been rattling his sabre and threatening a trade war.
Tired of making other people’s technology
In 2010 China became the world’s largest exporter, in 2013 the largest trading nation and in 2014 surpassed the US to become the largest economy1. China has come of age, and has come of age fast. In 1990 the country was largely irrelevant to global manufacturing, producing fewer than 3% of the value of global manufacturing output. By 2017, primarily by making things designed by foreigners and selling them back to foreigners, China had grown to account for almost 30% of global manufacturing. 90% of all PCs, desktops and laptops, are manufactured in China, approximately 80% of air-conditioners and 70% of solar cells. And not just electronic devices: 60% of cement, 60% of shoes, 50% of pork and 50% of coal, et cetera.2
The scale and breadth of this production has spawned large clusters of efficient and competitive suppliers across South East Asia, producing parts and components to feed the manufacturing machine, and in recent years China has absorbed parts of this supply chain too. The World Bank found that the share of imported components inside China’s exported products has fallen from approximately 60% in the 1990s to just 35% today3. At the same time, although not at the same pace, China has shed some of the lower-value parts of the supply chain, allowing countries with cheaper workers to take scraps from the table.
China has in once sense benefited from their push into manufacturing coinciding with the massive expansion in technology scale predicted by “Moore’s Law”. As the power of the computer processor has increased exponentially (with the doubling of the number of transistors on a chip every 2 years since the 1970s) and the cost of technology declined, the size of the global market for electronic devices has expanded massively. To illustrate this shift, take the Sony Walkman as an example, arguably the most iconic electronic product of a generation. Over a 10 year period since its launch in 1979, 50 million units Sony Walkmans were sold. A huge success for Sony. Today however, 50 million, or 5 million units per year would be considered by most as a failure. In 2017 alone 1.47 billion smartphones were shipped, of which 317m were Samsung phones and 216m were iPhones.4 A huge incremental increase in market size and our adoption of and familiarity with technology globally.
Innovation has nothing to do with how many R&D dollars you have. It’s not about the money. It’s about the people you have, how you’re led and how much you ‘get it’.”
Steve Jobs quoted in BusinessWeek, 25 May 1998
A fast growing middle class
In the space of 10 years, China’s GDP per capita expanded hugely, from just USD 6,821 (on a PPP – purchasing power parity - basis) in 2007 to USD 16,600 in 20175. This is an impressive gain, but despite having the largest economy in the world, China’s GDP per capita still only ranks 106th out of the 228 countries listed in the CIA Factbook.6
China’s production base was built primarily on demand from the West, but now as GDP per capita rises, the Chinese consumer is starting to show the same appetite for goods and services. This additional demand will expand China’s massive production infrastructure, developed to supply the export market, even further.
As the economy continues to transform and grow, the old model based on inexpensive migrant workers is starting to crack. Labour costs in China are no longer such a competitive advantage relative to their neighbours. In addition, many young Chinese are choosing not to work in dull and repetitive factory jobs, and despite the easing of the “one-child policy” in 2016, China’s demographics are shifting fast towards an older society, with fewer people able to effectively engage in physical work and with growing pressure on social security and public services. As a result of these 3 dynamics, many businesses in China are facing a growing shortage of labour, in particular cheap labour for factories.
Robotics and Automation
The “Made in China 2025” initiative unveiled by President Xi Jinping’s administration in 2015, directs cities and companies to shift away from low-cost, labor-intensive manufacturing up the value chain to complex, often more technology intensive, value-added production. The initiative sets ambitious targets for the use of Chinese-made robotics and the percentage of technology “content” in electronic devices made in China by 2025. The government has set up a financial war chest of incentives to get the job done, from tax exemptions, to low-interest rate loans and cash subsidies. The city of Guangzhou announced in 2015 that they plan to spend RMB 943 billion (approx. USD 150bn) on encouraging the adoption of robotics and automation, and targets the automation of 80% of manufacturing by 2020.7
China currently accounts for approximately 36% of demand for industrial (factory use) robots and this demand has grown faster than other major countries since 2013. As a result the “density” of robots in factories in China (measured in terms of the number of robots per 1,000 factor workers) has risen rapidly, from 2.5 robots in 2013, to 6.8 robots in 2016. This is likely to expand further thanks to government incentives and the increasing attractive economics of robots compared to the human worker. The IFR forecast that China may account for 45% of global demand for industrial robots in 2019 and APAC as a region may account for 70%.8
Although the growth in China’s use of robots is impressive, there is still a long way to go be on par with the leaders. China’s 6.8 robots per 1,000 workers, stands in contrast to South Korea’s “density” of 63.1 robots per 1,000 workers, and Singapore at 48.8, Germany 30.9, Japan 30.3 and the US 18.9. The government is targeting 15 robots per 1,000 workers by 2020.8
Bringing more robots and automation systems onto the factory floor is helping Chinese manufacturers graduate to the manufacture of higher value-added products and to boost productivity by offsetting the rising cost and increasing shortage of labor. However, this is only one of the two goals of the “Made in China” initiative.
While the first goal is progressing well driven by the increasingly attractive economics of robotics, the second goal, to ensure more of the technology content is Chinese, is more challenging. Currently 90% of robots installed in Chinese factories are foreign (non-Chinese) and the 10% which are Chinese-made tend to be simple 2 to 4-axis robots, used for basic tasks of lifting heavy objects, not the sophisticated 6 to 16 axis robots used for more complex assembly. In fact, although China claims to have more than 800 companies involved in the robotics industry (including component makers and system integrators) it is estimated that 88% of these are system integrators.9 On the components side too, the critical elements in a robot such as the control system, speed-reduction gears, servo-motors, inverters and machine vision tend to be bought in from foreign makers in Japan, Germany and the US.
Based on numerous comments from Western companies doing business in China it appears that for the last 20 years China has been in “cut & paste” mode, replicating foreign technology, reproducing it in large volume at low cost and gradually working to improve quality and reliability. This pattern is familiar to and a highly successful component of the post war model ofeconomic development in both Japan and South Korea10. Furthermore, considering the size of the Chinese manufacturing sector and the current lack of penetration of robotics, it also appears to be a sensible strategy. A number of now listed Chinese companies have grown fast and large on the back of this strategy, selling almost entirely into the lower-end of the domestic market, where the customer does not need the most reliable system or highest feature set robot, but can still realize healthy returns on investment in simple robotic solutions.
As a strategy this is fine while the market remains under penetrated and as long as their neighbors do not flood the market with excess supply at even lower prices. But a more sustainable model and one which should ensure greater local technology content in Chinese robots, is likely to require a greater level of genuine innovation from the Chinese companies.
Innovation is often difficult. It takes time and needs to be carefully nurtured under the right conditions. Brute force economics (pouring money into R&D) often fails to produce innovative solutions. Ironically the loose environment surrounding intellectual property protection, which arguably has enabled the cut & paste model, would need to be tightened up for the simple reason that the value of innovation is much greater if the innovator is guaranteed some rights of exclusivity. Without IP protection there is little motivation to invest time or resources into attempting to innovate.
No surprise then that President Xi has started to emphasize the importance of IP protection. The US Chamber of Commerce manages an “International IP Index” to gauge the level of commitment to fostering and protecting innovation across 50 countries. In this index China ranks 25th out of 50 (the US is 1st, the UK 2nd, Sweden and France 3rd and 4th), but in the notes the Chamber of Commerce give credit to the China’s, “Growing recognition and upholding of IP rights across different levels of government and enforcement agencies.”11
China on the road to innovation
We believe it is likely to be several years before China starts to lead the way in terms of technology innovation and specifically technology leadership in robotics and automation. However, given how far the country has come in 30 years, the scale of their manufacturing base and the power of their central government, we expect that over time China will become competitive at the leading edge of technology innovation.
Away from the manufacturing sector and robotics, many of China’s internet companies such as Baidu, Alibaba and Tencent, sheltered from foreign competition have already become innovators in their respective fields. One of the areas they are pushing into, and another area of focus in the “Made in China” initiative, is artificial intelligence (A.I.) and big data. Over time, these technologies designed for consumer applications, e-commerce and logistics are likely to be adopted more broadly by the manufacturing sector and specifically by robotics companies. Alibaba uses A.I. enabled chat-bots to help customers make shopping decisions and an automated warehouse operated by Cainiao Network Co, near Shenzhen, uses 200 logistics robots to process up to 1 million shipments per day12. JD.com is experimenting with drone delivery innovations and Hikvision, the domestic leader in video surveillance equipment, recently announced it is investing in “machine vision” technologies for factory automation and autonomous vehicles.
China has some natural advantages in developing A.I., in the sheer number of its internet users (approx. 751 million in July 2017)13, the relative freedom in the use of data generated by digital devices and the restrictions placed on foreign internet companies operating in the Chinese domestic market. However, given the expected size of the market opportunity for artificial intelligence, China is of course not alone in its ambition to establish itself as a leader in this new technology field. A large number of countries in the Middle East, but also Canada, the UK, Singapore, Hong Kong and India are all regularly making media headlines, staking their claim to A.I. credentials and soaking up both public and private funds to build A.I. focused research labs. Against most of these would-be rivals however, China has the advantage of scale, data volume and relative freedom to use that data.
Although China has the largest installed base of industrial robots, it is still underpenetrated relative to peers and to the size of its manufacturing labor force. Since the country faces a growing shortage of labor, the opportunity for companies to sell robotics and automation into China is massive. Currently most of the systems sold are foreign, but we expect to see more domestic Chinese robotics at the lower end of the market and over time if the government can better protect intellectual property, then we can expect Chinese companies will move to innovate and compete higher up the value chain in the technology market.
As technology advances and processing power increases, the automation systems used will become smarter, more intuitive, self-healing and ultimately more useful. They will also become cheaper, and as the cost of robotic systems falls, the number of systems in use in factories in China and the rest of the world is likely to expand. In fact, ever smarter and more versatile robotic systems will likely be deployed more broadly not just in factories, but also in our homes, offices, hospitals, and infrastructure and transport systems. Automation and artificial intelligence are increasingly delivering cost efficient solutions to improve quality of life, increase productivity and perform dirty, dangerous or dull tasks.
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