ENFORCING RESEARCH AND DEVELOPMENT:
-- THE IMPORTANT WAY TO GET RID OF THE CURRENT PREDICAMENTS
FOR CHINESE ENTERPRISES
Qifan Wang Xinhua Fu Yin Jin
(School of Management, Fudan University, Shanghai, 200433,China)
ABSTRACT
Business strategy and management decision-making are of prime
importance for enterprises to survive and develop in
competitions. Under the new circumstances of macro economic
adjustment, industrial structure adjustment, and worse operating
micro economic environment in China, it especially shows
overwhilming importance. The paper based on a generic S.D.model
of machinery industry, discusses several problems the
enterprises face, such as_ shortage of working capital, raw
material deficiency and intensive market competition. Those
problems bring many obstacles to enterprises. In rhe paper we
explore a series of solutions concerning technological
transformation and new product development. Then we suggest
several alternative policies. Furthermore, the paper discusses
the effects of technological transformation and new product
development on Chinese enterprises under the new circumstance in
the long-term.
I.Introduction
It has been ten years since China adopted the policy of reform
and opening to the outside world. With the deepening of economic
reforms, some adjustments are usually necessary when the economy
is over hot. Now China is just in the process of adjustment.
The shortage of circulating funds, raw materials, the sluggish
market and fierce competition are the common problems enterprises
have to face at this stage. In the past, the state-run
enterprises, especially those large and medium-sized ones, need
not care about the supply of funds and raw materials secured by
the state. Therefore, when the state reduces or even cancels the
supplies, the enterprises have to face the complicated and
changing market, and deal with the intense competition. Business
strategy and management decision policies then become very
important. When other enterprises are in the same troublesome
situation, to lay emphasis on the study of middle and long-term
strategy of the enterprise and to make bussiness decisions in
advance are the knacks to gain great progress of the enterprise
in the long run. ERF is a supplier of electric equipments for
power and energy industries. It is a medium-sized one and also
one of the three main producers in that line in the country. For
many years with the expansion of the market and state investment
in power and entergy industries the factory made a good record
and became a “second class" enterprise.
The situation began to change in 1986. Though the production
scale and output were still increasing due to the market demand,
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System Dynamics '91 Page 657
the economic returns were going from bad to worse. The profits
before taxation decreased at an annual rate of over 15% for four
years. In the same time the equipments and techologies were
becoming old and backward due to lack of necessary funds to
improve; new products development was slowed down too. The result
was the decrease of market’ share. What is more, working
circulating funds were in short supply because of the country's
tight moneytary policy, which affected the smooth operation of
the. factory as well as the reputation among old customers due to
the delay of the products delivery.
After studying of the data of the factory, we can see that the
main external factors affecting the enterprises' development and
economic benefits at present and in the future are as follows:
1. The total investment of the state in the power and energy
industries. It decides the total demand of the market and is of
vital importance for enterprises to survive and develop. From the
overall tendency of the economy development and the shortage of
power and energy we can expect that the state will. continue to
increase. the investment. So the demand will increase. But the
actual demand will increase slowly as the result of the general
economic policy of the state and the tight moneytary policy.
2. Intense market competition. The slowly increasing market
limits the development of the main enterprises. The factory must
pay more attention to marketing , selling groups have to go to
the customers instead of staying at home waiting for. them. And
the old ways of post services have to be changed. It. can be
predicted that -the selling cost will have a relatively big
increase in.order to guarantee the market share in fierce
competition.
3. The shortage and the expensiveness of raw material. The cost
of raw material makes a big part of the total cost of the
product, and its influence on the benefits of the factory is
serious. From 1986 to 1989, the expenses on raw materials have
increased 150% while the price of products which is strictly
controlied by the state only increase 20%. The proportion of
cost in sales income increased from 40% to nearly 60% with the
average profit decreasing from 30% to 12%. That's to say, the
changes in the price of raw materials exerts a great influence.
4. The loan policy of the state
The monetary policy of the state is a very important factor to
the factory's supply of funds since most of the working capital
of the factory comes from bank loans. When the factory can not
get enough money to keep the production going, it is natural that
the factory's reputation and its relationship with the customers
will be destroyed.
The above mentioned are some external factors that influence
the business management of the factory and the factory usually
can do nothing about them, especially in a short period of time.
That is to say, all the business affairs have to be dealted
basing on the facts mentioned above. So the only solution is to
Page 658 ‘System Dynamics '91
do something to change the internal structure and functions of
the factory and improve the management.
The following are some internal factors concerning benefits of
the enterprises.
1. Because of the tightness of money and the lack of motivation
to develop new products under the central planing economy, the
enterprises are not active in technological innovation, and thus
the product substitution is slow. The main reasons for that are
the shortage of junds and the lack of motivation to develop new
products. Facing the competitive market, factories now are more
interested .in the development and sales of new products in order
to attract customers but the funds for that are still not
adequate.
2. Technological transformation and progress
The fixed capitals of the factory underwent a great expansion
in the past decade but the expansion is only in scale not in
technical progress. The relatively backward technology has at
least two restrictive effects on the development of the factory.
One is on the raising of productivity and the production cost,
and the other is on the development of new products since new
products usually need advanced equipments, which means more
investment in equipments.
3. Poor management and serious waste
More attention has been paid to business management in = recent
years. The larger the factory is, the harder it is to coordinate
with the functional department;. Management problems lie in
consciousness field and “the sense of responsibility The
consciousness of the people changes with the progress of the
time. The people's ideas change when the factory is facing
trouble and crisis. This leads to a good trend to rationalize the
functional structure. And the distribution of personal waste is
very common in. the enterprises in our country. Backward
technology is one reason for that but to a great extent, it is
attributed to poor management and high unit consumption of raw
materials is another reason. These lead to the low economic
benefits. To enforce basic management and more business reforms
are the major solutions to this problem.
The above are some internal factors concerning enterprises
benefits. Next we will analyze and discuss these problems using
S.D. theory and methods. We will analyse the influences of the
internal factors on the long term development of the factory at
first, and then try to find a solution to the problems the
enterprises face.
We create a model SDGMDM to aid the business decision-making.
The following is a stretch drawing of the main structure of the
model according to the micro business mechanism and priblems_ to
be solved.
III. The analysis of the foundamental operation
We first have a test of the basic model according to the
present situation of the business operation in the factory when
no extra measures are taken including R&D new product development
System Dynamics '91 Page 659
and technological transformation. We begin from 1989 with the
collected statistic data. The result is shown in Figure 2.
The profits of the factory will drop from 5 million in 1989 to
102 million in 1999. With the prices of raw materials rising at
an annual rate of 9--10% while the product price can only have a
20% rise in all. And the profit rate from capital will drop from
18% in 1989 to 6% in 1999. The factory will grow to some extent
but ‘the comprehensive production capacity will begin to decline
around 1995, due to the decrease in profit from capital revenue.
But when we take into account the tight moneytary policy and
intense market competition, * the profits and capital revenue will
drop to zero. The demand will be small due to the tight moneytary
policy. The sales expanse will increase due to the. competition.
These unfavorable factors lead the factory into a very difficult
position.
IV. An analysis of the results of policy test
From the fundamental operation we can see that some other
measures must be taken in order to achieve a great development
under today's unfavorable conditions such as -enforcing R&D,
speeding, up product innovation, strengthening the competitive
ability of the factory. So we introduce the exploration of
production and sales of new products into the model. According to
the current cost, new products will have a rising cost of 2.5%
with price rise of 60% or more.
The simulation results show that new products ‘bring a much
larger benefits to the factory. The new products make up 40% of
the sales income, but the profits it makes can reach 10 million
yuan and keep the rate of capital revenue at 35--40% in 1995 or
so. The fixed capital can be doubled in 10 yuans. The actual
production capacity may be tripled with additional technological
transformation and follow-up investment. This can make the
capital per capita reach a reasonable level.
Therefore enforcing R&D to strengthen new product development
is away out. It is worth while to have a further study of its
effects and potentiality.
The following are some typical policy tests.
1. The prices of raw materials rise at 9.6% annually; The factory
can get 50% of the capital it needs from banks; The monthly
investment in R&D and new product development is 15.000 because
of the fierce competition, and the insane capital has to be used
in 8 million yuans from 1989 to 30% in 1994. Then it will drop
again because of the accumilation of price rises in the past
years . In the same time the rate of capital revenue will also
drop from 60% in1989 to 30% in 1994. The fixed capital have been
doubled and the annual production capacity tripled.
The new products make 40% ofthe total production in 1990, it
will reach 60-70% 3 or 4 years later. So we can see that the
tight moneytary policy has more effects on the old products
which cost more and take more time to produce. Although funds are
still in short supply, the factory is in a better situation just
because of the introduction of new products. That shows that,
facing the above problems the factories at least have a way to
Page 660 System Dynamics '91
overcome the troubles ensuring a_ continuous and lasting
development, that is to invest more in R&D, change the products
structure as soon as possible so as to gain a relatively superior
position in the market.
2. The conditions are the same as item 1 with an extra market
competition being introduced. A relative competition index is
referred to as we take 1.5 is assumed for it in the test, and the
result is shown is Figure 3.
The result. shows that between 90--94. The factory gains some
superiority in the market, the capital revenue rate rises and
then remains at 46% or so. The annual profit gradually reaches 40
million yuan gradually although the sales expense rises due to
the competition.
But after 1994 the profits will drop and in 1999 fall to 2
million yuan because the prices of raw materials will rise while
the prices of the products can not catch up with it. This
indicates that the price-rising of the materials must be
controlled macroscopically. To keep a rational ratio between the
price of products and the price of materials is not just for the
interest of enterprises but also for the fundamental interest of
the country.
3. The. conditions are the same with Test 2 and the new products
of the opponent factories increase at’ 10% annually.
The increase of new products of other factories may reduce the
orders and production of the factory especially when the money is
in short supply and the market is in fierce competition. The new
products show their vital importance . The result see Figure 3.
The result shows that during the first 5 years the annual
profit of the factory will drop slightly, remaining around 3
million yuan , capital revenue rate keeps at about 40% in the
first 3 years while in the later two years at about 25% due to
the competition of other new products. Between 1996--1999 the
capital revenue rate will keep at 20%. But owing to the
uncontrolled expense in raw materials the accumulative effects of
the opponent factories on new products and the rise in management
overhead, the actual profit will drop to zero or even in
deficit. It again indicates that although R&D and new product
development may bring good results even under the compound
effects of some unfavorable factors, if the price rises in raw
materials are not shown in the price of products, the problem
will not be able to be solved thoroughtly.
4. Comprehensive test
After a careful study of the above tests, we propose a plan
which includes some possible measures. The following policies are
supposed in the test.
- The annual price rise of raw materials is 9.6%
- Technological and management measures are taken to reduce 10%
of the unit consumption of raw materials.
- Production period for old products decreases by 20%, for new
product by 15%
- 60% of the capital the factory needs is ensured
--New products of opponent factories increase 10% annually
System Dynamics '91 Page 661
The result of the test.is in Figure 4.
The result of the comprehensive test is: in the first six years
the annual profits increase evenly from:20- million yuan in 1990
to 36 million yuan in 1995, keeping at 40%. In the sixth year and
after, the profits and capital revenue rate will drop because the
compound effects of many unfavorable factors, esp. the limits on
products price adjustment capital revenue rate will drop from 40%
in 1995 to 24% in 1997 and then to 12% in 1999. The profits in
1999 will be 1.2 million only.
The fixed capitals increase by 50%, and the actual production
capacity increases by 100% in ten years.
The above test is a comprehensive plan including some favorable
and infavorable factors. Though the result can hardly be said
excellent it is realistic and easy to realize.
V. Conclusions
To summarize the tests we find that under the serious business
situation, enterprises are facing many touchy problems. Since an
enterprise is unable to change the external factors, it is very
important for it to take some unique measures such as_ enforcing
R&D and developing new products which we have just discussed to
save the enterprise out of the troublesome state which all the
other enterprises are in.
References
1. Qifan Wang, “System Dynamics", 1988, Tsing Hua University
Press.
2. Qifan Wang, et al., "Theory and Application of System
Dynamics", New Time Press, Beijin.
3. Jay W. Forrester, 1961, “Industrial Dynamics:, Cambridge,
Mass.,The MIT Press.
Page 662 System Dynamics '91
VOLUME =o!
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Page 663
System Dynamics '91
RCP SI
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