Multinationals Fight For Their Margins in China

Western multinationals are fighting harder to hold on to their margins in China because of overcapacity and an improvement in the quality of Chinese-made products.

Companies including Merck KGaA, United Technologies Corp. and Honeywell International Inc. are responding in myriad ways, from slashing costs to improving customer service. Still, several companies concede margins will stall long-term due to local competition.

"Our margins have been on a downward trend for over five years now," said Philipp Baechtold, general manager at Eftec China Ltd., a Swiss chemicals company that produces glues and coatings for the car industry.

Pharmaceutical company Merck reported net sales of EUR1.35 billion ($1.61 billion) in China last year, around 9% of total net sales of EUR15.02 billion. Still, it suffers from a buildup of local capacity. "The quality of Chinese products has improved," finance chief Marcus Kuhnert said in an interview with CFO Journal. He was referring to Merck's liquid crystals business, an important revenue generator.

Keeping margins of its performance materials unit at about 40% next year will be a challenge, because of an unfavorable business mix and the most recent weakness of the U.S. dollar, Mr. Kuhnert said during an earnings call in early August. Some of his customers now source their liquid crystals from several suppliers, he said, exerting more pressure on price.

The company is stepping up customer support to justify higher prices than its Chinese competitors. A potential sale of the consumer-health business, announced Tuesday, is unrelated to the woes of its liquid crystals business in China, a spokesman said.

Honeywell International, an industrials firm, in recent years also noticed a change in the quality of Chinese products. "Chinese companies are becoming more savvy," said Shane Tedjarati, president of Honeywell's high growth regions unit. "We cannot become complacent. We are benchmarking ourselves against Chinese companies," Mr. Tedjarati said.

Chinese firms have always used price as a lever, said Joe Ngai, managing partner at McKinsey & Co.'s Greater China practice. Even though many Western firms recently reported higher revenues from China, confidence is low because of domestic competition and the glut of production capability in the market.

"Western multinationals are getting more worried about margins," Mr. Ngai said.

According to a recent report by the American Chamber of Commerce in Shanghai, slightly more than 80% of U.S. companies said competition from Chinese firms is one of their most pressing issues. Even more, 93%, cited rising costs--which adversely affects margins--as a challenge.

China-based sales at United Technologies' Otis elevator unit declined 10% in the second quarter, compared with the year-earlier period. "The pricing pressure will continue," said finance chief Akhil Johri during the company's July earnings call.

"There is still overcapacity in the Chinese market, and we've just got to see how it plays out," said Mr. Johri, according to a transcript of the call. The country's elevator production capacity stands at 700,000 units annually, versus demand of around 500,000 to 525,000 units a year, he added.

The company on Monday announced it would buy airplane-parts maker Rockwell Collins Inc., for $23 billion, but didn't cite its China business as one of the reasons for the acquisition.

LafargeHolcim Ltd., a Swiss maker of building materials, is marketing its products as a premium alternative to Chinese cement. Base materials imported from France allow LafargeHolcim to get better prices and attain higher margins, said Ian Riley, head of the company's China business.

France's Faurecia SA, an auto parts maker, has close to 50 plants in China that generate annual sales of EUR2.6 billion and employs roughly 16,000 people. To compete on price, the company is simplifying the specifications for products sold in China. It is also automating manual processes to increase productivity.

"When you have to match a price level that is much lower than yours, you need to scrutinize your specs," said Jean-Michel Vallin, president at Faurecia China. "Chasing costs is part of our daily work," he added.

But for companies like Eftec, time is running out and there are few options. The company has already cut down its product range to save costs. It might have to radically alter it, in a few years from now, Mr. Baechtold said. "We have reinvented ourselves before, " he said, "so we will do it again."

Write to Nina Trentmann at Nina.Trentmann@wsj.com

(END) Dow Jones Newswires

September 07, 2017 04:08 ET (08:08 GMT)