PESTEL analysis of the Chinese and German flooring industries

Since 1979, China adopted an export-manufacturing strategy successfully following with Japan, Korea and Hong Kong. The Golden Bridge Co., Ltd is one of the beneficiaries. It was founded in 2007 with flooring as its main products. The product is of high quality by utilizing advanced technology and equipments imported from Germany and Italy. The glue and lacquer materials for production are also imported. In current stage, Golden Bridge has a total capital of 800 million RMB and exported to 35 foreign markets including the U.S., Canada, Japan and Germany. In order to help it to expand the business, our consultancy company attempt to analyze the China business environment and seek a foreign market to relocate the manufacturing of this company with proper entering and competing strategies. This essay first illustrates the business environment of flooring industry in China and German with PESTEL analysis. Then it evaluates the threats in Germany market by following Porter’s five-force model. Later a recommendation would be given on how to properly enter into the targeted country.

PESTEL analysis of china market:

The PESTEL analysis is used to assess the macro environment and identify the challenges Golden Bridge faced with in china market in order to make an appropriate suggestion.

Political:

The Chinese political system characterized as one-party communist dictatorship makes a great contribution to national stability, enabling the economy keep dynamic and sustainable. Nevertheless, when the economic system was deregulated from the command economy to market economy since 1978, the power of economic management was increasingly decentralized, raising the issue of uncoordinated development of regional economy. Currently, though the central government has made effort to alleviate the gap among different areas in terms of developing standards, provinces tend to give a priority to local profits rather than considering the integrated advancement of the whole country. Local protectionism exerts detrimental influences upon market expansion of Golden Bridge Company in nationwide and deters the establishment of a comprehensive distribution channel.

Economical:

China is valued as one of the most vibrant countries in terms of economic development among the world. The reform & opening up in 1978 accelerated China’s GDP growth from 362.4 billion RMB to 30 trillion RMB within a 30-year period. Moreover, in 2010, China has been the second largest economy instead of Japan whilst the value of export accounted for 10% of world. Based on these statistics, judgment can be made that manufactures in China including flooring industry may keep an optimistic attitude to their future prospects in some extent.

Nonetheless, Chinese economy may suffer unpredictable circumstance in the future. Labor resource is one double-edge sword. Once being an advantage of China, abundant labor resource and economical labor price make a great contribution to progress of those labor-intensive manufacturing industries. This is also the primary reason that China flooring industry is quite profitable though China is a net importer of timber. However, as cited by AME info (2005) there is a growth in the minimum wage standard, labor may not be regard as a perpetual advantage of China if this trend continues. In Addition, appreciation of CNY since 2005 against USD may imperil the export of Golden Bridge Company (Goldstein, M. and Lardy, N., 2006).

Social:

It is claimed by Su and Littlefied (2001) that China is an extremely high-context country where people prefer to receive implied messages. For establishing a business in China, strong private-relationships with different stakeholders is the key to success. However, this is extremely time-consuming while the maintenance is also expensive. Potential conflicts in interest may easily erode it.

Besides the “relationship”, corruption is another issue in China. According to the Corruption Perceptions Index, China was positioned 72nd among all 179 countries in 2008. However, damages caused by corruption may be far more hazardous than anticipated, particularly to the economic development. Corruption has been treated as a vital barrier for operating in Chinese market due to enormous back-stage expenditures as well as resulted injustice. For Golden Bridge to gain more import quotas and pay less tariff, costs may be made up of not only normal ingredients such as transporting, but also implied expense for ‘smoothing the network.

Technological:

China wood flooring industry is experiencing a relatively laggard technological standard in its initial stage of development. According to Cheng and Song (2006), the level of timber utilization was 61% in 2004 with a considerable disparity with developed countries (nearly 90%). Additionally, imbalanced technological support aggravates the long-term conflicts between wood supply and demand in Chinese domestic market. In 2004, though the total domestic timber supply is 273.6 million cubic meters and exceeded the total consumption of 241.5 million cubic meters, scarcity of raw material still existed in some parts of timber manufacturing industry.

Environment & Legal:

Chinese government proposed the Natural Forest Protection Program (NFPP) nationwide in 1998 to limit exploitation of natural forest resources. The legislation made the supply of domestic natural timber restricted. Between 1997 and 2003, natural timbers supply decreased from 32.05 million cubic meters to 12.145 million cubic meters (Cheng and Song, 2005), which was extremely insufficient to satisfy demands of the highly prosperous timber industry in China. Timer manufacturing companies in China have to depend on importing. Statistics shows that in 1997 the quantity of imported timber only occupied 23.56% of total wood consumption, while the number soared to 53.78% in 2004. The expenditure of imported timber was $33.96 higher per cubic meter compared with the price in 2007, which increased the material coast of Golden Bridge Company.

PESTEL analysis of German market:

Since this essay has analyzed the macro environment of the china flooring market, further looking at the political, economic, social and technological factors of the German can help advance and strength the logic of the whole assessment.

Political factors:

Germany is a home of secure, legal and rewarding investment. The World Economic Forum has rewarded its legal system as the most efficient and this fact has also gained international recognition.

Flooring coverings are categorized according to German and EU laws and building products should be subject to the EU construction products directive and the German construction products law. The directive and law are mainly focused on environmental, health-related, material and usability sectors and most people agree that by considering the environmental restrictions, the EU can be the strictest market. Moreover, with the transnational economic environment, it is predicted by experts that the approval criteria for flooring is likely to decrease and there seems to be a limited permission of eco-labels for flooring products. Further, comprehensive incentives are provided to both home and oversea investors by German government, individual federal states and the EU.

Economic factors

Germany is the largest economy in Europe and in general German is export-oriented. Since 2003, German has been the largest exporter machinery, vehicles, chemicals and household equipment, with an annual export increase of 8%.

However, factors that may prevent Golden Bridge from entering into and developing itself in Germany also exist. They can be excessive dependence on euro currency, tight credit markets and an increasing rate of unemployment. Stimulus and stabilization efforts initiated in 2008 and 2009 and tax cuts introduced in Chancellor Angela MERKEL’s second term will increase Germany’s record budget deficit, which is expected to exceed 5% of GDP in 2010. The EU required Germany to get its consolidated budget deficit below 3% of GDP until 2013. A new constitutional amendment likewise limits the federal government to structural deficits of no more than 0.35% of GDP per annum as of 2016.

Technology factors:

Germany is claimed to be the leading nation in high-tech development and receives high turnover accordingly. In 2007, the high-tech products exported by Germany accounted to a value of RUR 114 billion, ranked first in Europe and third worldwide. More than 27% turnover of German manufacturing factory is generated from high-tech products, compared to a European average of 19%.

Social factors:

Social factors also need consideration. Hofstede’s analysis of Germany shows the emphasis on individualism, masculinity and uncertainty avoidance. Power distance and long-term orientation are both ranked considerably lower than the others. Germany believes in equality and equal opportunity, as well as its ability to change and adapt rapidly. Another arising issue is the social awareness of pollution, which leads Germany to use more environmental-friendly materials.

Abstract for the use of five-force model:

After analyzing the macro-environment of both countries, it is reasonable and necessary to apply Michel Porter’s five-force model in order to provide a thoroughly understanding of the German flooring market before the Golden Bridge company entering into it. According to this model, the competitiveness of an industry is influenced by such five forces and their collective strength and thus determines the ultimate profit potential of this targeting industry. These five forces covered in the analysis are competitive rivalry, supplier power, buyer power, the threat of substitution and the threat of potential new entry. However, the five-forces framework is not a set of principals per se, instead is a tool for systematically use these principals to assess the current status and likely evolution of an industry.

Competitive Rivalry:

The internal competitive rivalry in German flooring market seems high. There are three main reasons. First, the switching cost is low because flooring products are homogenous with little product differentiation. Another reason is that the German flooring market is saturated with a relatively low growth rate. The flooring production in 2008 suffered a 15.1% decline while the total consumption slumped for about 12.19% (FEP, 2008). Also the number of competitive companies in German flooring market and the intensity of rivalry also determine the high threats of rivalry. There are a large number of companies competing in the German flooring market and these companies are divided into three categories, they are Small and Medium Sized Enterprises (SMEs), Domestic Leading Manufacturers (DLMs) and Niche Market Brands (NMBs).

First of all, SMEs has the largest number in the German flooring market (Roadmap, 2010). These SMEs are often manufacturers provide low-grade flooring with low price. Their marketing strategy is just reverse to Golden Bridge’s. Thus Golden Bridge is suggested to treat them in an abstemious way. However, there are also a few numbers of large flooring manufacturers who operating on European and/or global base. It is suggested by German Timber (2007) that few DLMs account for the majority of the total market share. These companies usually possess strong competencies, highly recognized reputation and well-established brand image. One main rivalry is the Krono Group, who is one of the world leading producers of high-quality flooring. Founded in 1897, it has accumulated years of experience and extensive knowledge know-how. It delivers products to 80 countries worldwide while has its own production-base in 18 countries. In 2004, its production capability of flooring reached 310 million ㎡, took up about 1/3 of the world market share with total sales revenue of 24 billion RMB. It also has an annual R&D investment of 15billion RMB with over 200 scientists doing research in Krono International Laboratory. In addition, there are Niche Market Brands (NMBs) with several well-known brands like Espirt and Kaindl, holding part of the flooring market (FEP, 2007). These companies merely provide certain kinds of flooring to meet the special needs of a group of customers. Furthermore, in order to gaining competitive strength, the NMBs together with some foreign brands such as Balterio from Belgian and Vito from Austria have formed a conglomerate named Beamy International, a commercial platform allowing them to compete on both domestic and global markets (FEP, 2008).

As the competition is fierce in German flooring market, Golden Bridge is suggested to adopt a niche strategy and doing effective promotion after entering the market. To explain, the original German wood flooring manufacturers already gains economy of scales and undeniably enjoy a cost advantage. Advanced distribution channel comparing with those new entrants also allows them first mover advantages. Cost disadvantage and lacking reliable cooperators are main barriers for Golden Bridge to survive in German market. Insufficient in capital determines that an aggressive expansion strategy is also irrational. However, one advantage Golden Bridge occupies is that it has been doing export business within German importers for couple of years and its products did have certain reputation in this highly competitive market. By offering additional value, Golden Bridge can efficiently differentiate itself among the rivals with a brand image of ‘reliability, valuable, and symbol of statuses. This may help obtain sustainable brand loyalty among German customers.

Threat of Substitutes:

The threat of substitution refers to the extent to which different products used in place of a company’s products or offered by other industrials. Flooring is not restricted on only wood but other materials such as textile and stone/ceramics are also widely used. For instance, in German market in 2008, textile took the largest raw material market share (i.e. about 37.4%) for making flooring. This is followed by stone/ceramics of 28.6%. Comparably, the laminate only had a market share of 13.9%, ranked in the third place.

In terms of switching cost, the result can be distinct regarding to different objects of study. To individual consumers, there is almost no switching cost exists because choose one kind of material instead of another is just a matter of personal taste. However, this can be criticized in depth for the reasons that wood-made flooring has its own characteristics and functions that other materials may not have. To some extent and to specific customer groups, for instance, those who have fixed-decoration style, the switching cost can be relatively high.

However, to large wholesalers (e.g. Beamy International) who previously dedicated in wood-made flooring, the switching cost would be extremely high, as they may lose the stable distribution channels with their current wholesalers or retailers, and also the price advantage provided by the long-term cooperative producers. This means the substitution threat is less considerable because their past investment in developing stable distribution channels with retailers and producers offers them an advantage in current market and this may make them unwilling to undertake risks of operating and competing in a new and highly competitive market.

Summing up the above, it is the end-user customers that Golden Bridge should pay close attention to. First of all, it is advised that a regular customer survey to be conducted to make a comprehension of customers’ preferences and what they really appreciate. The company should also emphasize the exclusiveness and unique utilities of their products, making it cost more for the customers to switching to other substitutes. In the meantime, though as mentioned the future trend seems favor wood flooring industry, Golden Bridge should cause enough value that the technology development is always indeterminate. Thus in order to avoid sudden shock of new technologies that brings in comparable substitutes, Golden Bridge should invest continuously in Research and Development to keep pace with the times.

Threat of New Entrants:

Threat of new entrants is moderate. As put by European Commission (2001), the main barriers to enter German market include certification approval and the quality standards and label, while the incentive to enter German market depends mainly on its impeccable infrastructure system.

The extensive unified intensification, which has been mentioned before in PEST Analysis of German, increase the starting investment of new entry, accordingly has negative effect on new entrants to the market. There are totally fourteen member countries of European Federation of the Parquet Industry (FEP). Under the Single European Market policy, twelve of them have reached an agreement on moving goods, service and capital freely internally, giving companies in these markets strong mobility. To put it simpler, a flooring company located in Germany for example, can either choose to develop domestically or entre into either of the other 11 member countries of EFP, in support of the unified system. Once entering into the consolidated FEP, the new members deserve this privilege with little hindrance, however, the legal entry requirement, especially for flooring companies’ compliance with environmental protection, is said to be quite strict in European Market, which is especially true in Germany. Thus it can be expected that in order to harmonize to European standards, a large quality of funds will be needed to invest in order to fulfilling the standards ranging from environmental protection to individual healthcare.

What is more, the sophisticated infrastructures that Germany possesses nationwide make the market considerably attractive to those adventurous entrepreneurs. As known to all, Germany lays in the center of the Western Europe, with large-scale transportation centers such as International airport in Frankfurt and seaport in Hamburg (ELA, 2010). Centering in a fast and efficient logistic network covering almost all the main markets in Europe, flooring companies in Germany can procure raw materials namely timber on a global scale, and reach the external markets with relatively lower transportation costs.

Therefore the threats of new entrants would be moderate in German flooring market. For Golden Bridge, the corporate should create a marketing and brand image and keep customers’ loyalty, tie up to both suppliers and distributors. More important, it should sign a patent to protect the intellectual property of their high-tech products.

Buyer Power:

Buyer power, which is determined by the individual customers’ ability in negotiating purchase prices with suppliers, is at an intermediate level in German market basing on four crucial reasons. Firstly, according to the previous analysis, competition in the wood flooring manufacturing is largely intensified by a large amount of incumbents. Hence, purchasers are more unrestricted in choosing their suppliers with considering competitive advantages of products, and price may be a decisive factor for some customers. However, it is important to note that Wholesalers have more bargaining power than individuals. Being the large-volume buyers, they are not only main customers where companies earn profits from, but also controllers of dominant distribution channels. By stark contrast, individual customers with smaller purchase volume may be positioned less vitally in suppliers’ minds. Secondly, the buyer power is attenuated by the availability of substitutes of wood flooring in German market. Except for this category of flooring, more choices are supplied on the market.

Despite competition reinforces customers’ bargaining power, the phenomena of demand surplus in German wood flooring alleviates this circumstance. According to the research of European Federation of the Parquet Industry (FEP), the consumption of German wood flooring is about 17.88 million square meters, while the production of German wood flooring is only about 11.04 million square meters (Slides Stats 2008). In additionally, German culture also plays a significant role in lessening customers’ bargaining power. The spirit of the nation, such prudence and fixation lead to a fairly strict standardization in both work and life. Germans are used to calculating a precise price based on all dimensions. Hence, they dislike dealing with situations out of their planning, enabling bargaining become very difficult. Ten percentage cut in price is the biggest range they will agree in they dealing with foreign buyers. (LeMont Schmidt, 2001).

Supplier Power:

Supplier Power refers the power of suppliers to drive up the prices of raw materials, supplies, equipment or inputs. Your company purchases the glue, paint and equipment, and employs labors from Germany and imports the wood from Russia.

There are some crucial factors performing low supplier power of your company. Firstly, German is not used to bargaining, which is mentioned in Buyer power. Hence, it is meaningless for German suppliers to drive up the price of material and equipment. Negotiating power is weak in Russia as well. Although the nation is one of the largest wood producers, there are a large number of wood suppliers¼Œwhich provide a strongly competitive circumstance in Russia. Admittedly wood is a kind of nature product so that customers are sensitive to the price of wood. Because of high standard of transparency, the switching cost is low in Russia. On the other hand, many substitutes with lower expenditures are becoming increasingly prevalent such as marble, carpet, plastic flooring. High standard of substitutes’ threat can restrict the suppliers to drive up the price and reduce the power of suppliers.

However, high labor cost strengthens the supplier power. The German labor cost is one of the highest in world. According to Common Protocol of Salary, Labor wage need be determined by the negotiation between wood flooring industry and backwards industry (Fact about Germany, 1996). Therefore, the security of labor force is quite completed. Unions are powerful to argue with unfair wage or welfare. For example, Michael Sommer, the head of the trade union federation(DGB) , claimed that is necessary to increase labors wage with the upturn of economy in 2010( Guardian¼Œ2010).

Supplier power and buyer power, which exert a moderate threat on Golden Bridge’s development in German, can be alleviated through several ways. From one aspect, to limit bargaining power of large-volume wholesalers, the company should give priority to building up a distribution network itself by developing new franchisers rather than depending on the primary channels of wholesalers. In terms of individual customers as well as challenges from substitutes, enhancing the products’ benefits would be the most efficient way to reduce their bargaining desire as most of affluent people value quality more important than price. From the other aspects, labor relationship, the most considerable barrier in lessening German supplier power, should be harmonized through affording sufficient welfare to employees, as well as building a relative democratic organizational culture by the company. Moreover, it is supposed that importing a few skilled workers from China would benefit the company not only by more economical labor cost, but also reducing the significant dependence on the German labor market.

Limitation of the 5-forces:

Porter’s five-force model is not perfect but based on the assumption that from the view of any one firm, all the other firms no matter whether they are supplier, competitor or buyer are threats to the profitability. However, according to Brandenberger and Nalebuff’s value net theory, interactions among firms can sometimes enhance profits. Thus critics raised and attentions on cooperation are much more paid. The cooperation between the Golden Bridge Company and other foreign flooring companies will be analyzed and evaluated in the later recommendation part.

Recommendation

By illustrating the German macroeconomic environment and its circumstance of flooring industry, it is thought that the most recommended strategy for Golden Bridge is to build a joint venture with one or several German covering floor manufacturing enterprises, whilst maintaining the manufacturing section and primary market system in China. Joint venture can be explained as a collaborative formation among companies that each party invests parts capabilities to constitute a new enterprise, thereafter determining the distribution of ownership according to corresponding contributions. Nevertheless, two preconditions should be taken into consideration before making an alliance with German incumbents. Firstly, as a dominant barrier in Chinese market, capital insufficiency would also limit the investment ability of Golden Bridge in German to a large extent. Consequently, small-to-medium incumbents are more desirable as cooperators rather than large-scale companies in terms of ensuring a relatively high proportion of ownership of Golden Bridge in the new joint venture. Moreover, it is imperative to illustrate compatibility of potential partners based on a number of philosophic criteria, including similar experience, common principles and agreed future target as well (Kanter, 1994).

Where extremely intensive competition takes place, German market would tend to pose more threats than opportunities on the Golden Bridge if the company attempts to entirely entry the market alone. In comparison, cooperating and aligning with local companies would be a much safer and efficient measure from two aspects. First, by giving joint ventures preferential treatment, the Golden Bridge gains a good opportunity to penetrate the German market in a relatively short period with minimum risks as the company is unnecessary to expose abundant long-term investments to gain market shares in German wood flooring industry. Instead, it can utilize those important strategic assets of local cooperators such as complete distribution channels, customer relationships and brand loyalty. Moreover, Golden Bridge is still deficient at technology and management comparing with the local German companies. Through setting up a joint venture, advanced technology and managerial know-how can be more easily accessible by Golden Bridge, which is beneficial to its development in China market as well.

Nevertheless, possible issues relating to joint venture cannot be neglected by the Golden Bridge. First, operational dissimilarities caused by political and economic divergence between China and German may be a vital problem for Golden Bridge. For instance, blind spots in law or financial systems will damage the corporate profits at initial stage. Additionally, cultural and managerial difference may be difficult to consolidate as different authority, reporting and decision-making patterns (Kanter, 1994), therefore leading to possible mistrust and misunderstanding between Golden Bridge and its partners. It has been widely recognized that German managers are prudent and rigid in dealing with regulations and rarely consider the influences of the ‘network relationship’, which is fairly distinct from Chinese managers’ conceptions.

Conclusion:

In conclusion, according to the PESTEL analysis, there are a number of challenges in China. These challenges can be the unbalanced market condition in china because of local protectionism and insufficient infrastructures, under-developed technology and managerial skill led to the low efficiency of timber industry in China, Natural Forest Protection Program limits the domestic nature timbers supply as well as the increasing labor cost in flooring industry due to China’s economy prosperous. The complexity of interrelationship of different parties involved in the business environment also cannot be neglected. The PESTEL analysis of German market was further conducted to make the assessment more comprehensive. Later the consultants use five-force model to assess threat of entering the German flooring market. For instance, the competitive rivalry and threat of entry in German flooring market is extremely high. In terms of threat of substitution, it is much more complex. The supplier power and buyer power are both at an intermediate level. However, Porter’s model is criticized for lacking of corporation with other market players. Thus, a recommendation is made by our consultancy company for Golden Bridge to organize a joint venture and thus with other reliable and competitive companies for instance, the Beamy International.

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