Zongshen Group

Chongqing, a city in central southwestern China, had a heritage in heavy manufacturing, as it was one of the centers of the Chinese defense industry, especially for vehicles. In 1980s, when the Cold War slowed, the central government wanted to reduce defense expenditure and asked some of the state owned enterprises (SOEs) to begin manufacturing civilian products. At the beginning only SOEs could get license for the business but government permitted people to go into business for themselves but they could only work as individual business operators and could not set up companies.

Many of the SOEs turned to parts production.

Zuo Zongshen, being a former motorcycle repairer, decided to open a motorcycle repair business in 1982 with the present condition in China. Almost all of the motorcycle industry was producing imitations of Japan motorcycles at first as they could not afford any investments for research and development. By 1992, the regulations had changed and individuals were permitted to set up private companies, so Zuo quickly set up a company to assemble motorcycle engines from purchased parts which was capitalized at CNY500,000.

The parts that were manufactured by SOEs were the copies of Japanese engines. There were several hundred of these suppliers and assemblers had to figure out how to select the right ones. Being a former motorcycle repairman, Zuo knew which factories made the good ones and what were the good brands.

After 3 years of assembling, Zuo was dissatisfied with the approach as it was not easy to get parts from manufacturers as they were mainly responsive to large scale SOEs.

He used to use his network and sometimes “red envelopes” to get the parts. With the experience he had, he has started to make core components in house and increased the number of the components in house production as his capabilities improved. He classifies the necessity to do this in three drivers; to make a differentitation, to guarantee the supply and also to upgrade the parts as a good start for innovation. In order to improve quality and reliability of parts that it produced as well as to reduce production costs, Zongshen started applying advanced technology tools such as computer aided design and computer aided manufacturing to its product development. Besides, Zongshen also sought manufacturing consultant from former Honda employees and visited its competitors and prospective partners like Harley-Davidson in the United State. As a result, Zongshen was stood out in the common manufacturers throughout the country.

In 2000, Zuo decided to build up the company group structure. They splitted the responsibilities between the departments. Then they decided that they should tap into capital markets. Becoming a world class competitor would require a lot of capital, if the company could float its stock, it would have a source of equity capital. The technique that Zongshen used to raise its financial capital is very artful. Instead of following the tradition method which is through an initial public offering (IPO), Zongshen used another technique called “Reverse Merger” or “Backdoor Merger”. The technique can be described in detail that Zongshen had a target list of companies which had an existing list but lack of assets or liabilities. Once Zongshen could attain one from the list, it would merge its assets into. This technique is very critical for the success of Zongshen. In fact, when it became the largest shareholder of a Chengdu company, it divested the assets of the original company and inserted its own assets from the engine company. As the result, it turned into the largest engine manufacturer in the Chinese motorcycle industry.

In 2004, Zongshen added its 3rd business, another listed company in Canada. Buying PEM Technologies through Norstar Venture in Canada led Zongshen to be able to control the technology manufacturing proton exchange membranes, a key element in producing hydrogen fuel cell. Having this technology, Zongshen became very successful in manufacturing and selling e-bikes. In fact, its two subsidiaries could produce 350,000 units of e-bike a year. Its sale volume increased dramatically from 50,000 units in 2007 to 220,000 units in 2008.

Moreover, Zongshen enhanced its effectiveness by collaborating with other established firms. Piaggio, for instance, became its partner in exploring rural markets. The corporation set up a new company and planned to manufacture 100,000 scooters a year. As a part of the new joint venture agreement, Zongshen would supply the company with a significant amount of parts. In fact, by 2005, Zongshen provided 35% of accessories and components of the scooter. It was expectedly increased by 50% in 2006. In 2005 the Chinese motorcycle industry still had too many manufacturers, and they were introducing undifferentiated products to the same customers. As a result the margins were too low. Zuo studied W.Chan Kim and Renee Maugorgne’s book about “Blue Ocean Strategy” which argued that firms should go after uncontested “blue ocean” market, and look for some new demand instead of chasing existind demand in hyper competitive “red ocean” markets.

Zuo decided not to produce imitations; instead Zongshen launched the cyclone project to develop products with technology in order to introduce differentiated products. The original production facility was converted to a R&D center and Zongshen contracted with Nova design to assist with new product designs. After spending CNY300 million, they launched first Cyclone products in 2007 and 2008. But in the markets that change was not succesfull. Consumers and retailers had doubt that Zongshen could make such good products and the blue ocean products failed. So they decided to launch “Purple Ocean” products with a higher quality than red ocean products and of course with higher prices, but still lower than blue ocean products. The “Purple Ocean” products coincided sharp rebound in profitability. Improved quality and styling helped products such as ZS250 to gain popularity.

One key change for the company was implementing a new performance evaluation and incentive scheme that linked all employees’ base salary to the breakeven point of the company. For the e-bike market, traditionally lead acid batteries were used. While inexpensive and mature technology, lead acid batteries were heavy and had alimited lifetime to deep discharge cycles. Zongshen PEM was using either lead acid or lithium ion batteries. The latter gave the e-bike longer range and stronger climbing capability. As there were many entrants to the market it is easily seen that the base skills for e-bike were not hard to develop but Zonghsen was determined not to compete in high volume, so the question was differentiation. The key differentiators in e-bike industry were in several categories, and the challenge was to have required skills. The company launched a tool called “Master Apprentice agreement” with about 40 key personnel and managerial positions. Zuo was personally taking care of those personnel and helping them to build skills and giving gifts. Also there was a career development plan for those employees.

While talent had always been a challenge for Zhongsen, it is now very critical as they want to transform to e-bikes.  How did Zongshen acquire the capabilities to produce motorcycles? As noted above, Zou was a motorcycle repairer in the past. As many of the SOEs turned into manufacturing of civilian products, with the change of the laws and permissions he first became an individual business operator. After 1992, the regulations has changed and indivuduals were permitted to set up companies so Zuo set up the company. As he had experience and and was not coming from the trenches, he knew to select the best parts and Zongshen became a good assembler. After some years of assembling he decided to produce some critical parts in house and gradually he has started to manufacture more parts. He classifies the necessity to do this in three drivers; to make a differentitation, to guarantee the supply and also to upgrade the parts as a good start for innovation. Zongshen also adopted the computer aided design relatively earlier than the others.