Source: The Wall Street Journal                          Date: 18 May, 2011

Growing competition from China is spurring German machinery makers to reassess how to preserve an edge that has made their industry a linchpin of the country's export-driven economy. Chinese rivals are gaining ground in their home market, unnerving German producers about the competitiveness of a sector that accounts for 7% of the German economy. The German companies find themselves up against a state-driven industry growing in large measure through acquisitions and inexpensive labor and building on lessons learned two decades ago in the textile industry.

Mr. Martin Herrenknecht says his tunneling-equipment company entered a joint venture in China, rather than fight for intellectual-property rights. "Germany needs to focus on quality and innovation because when it comes to mass-market machinery, China will soon have the upper hand," says Mr. Bernd Reitmeier, a former member of the German Chamber of Commerce in China.

Many industry experts say Germany's reputation for engineering quality and reliability should help the sector counter Chinese challenges for leadership in high-end machinery, such as drilling and factory equipment, and other engineering sectors. Still, the momentum behind China's companies underscores the long-term obstacles German companies face in maintaining an innovative edge as the supply of home-grown engineers and other skilled workers dwindles.

German companies—mostly small, family-owned enterprises—continue to hold the largest share in the Chinese market for high-end machinery, which is estimated at between roughly USD110 billion and USD120 billion. German exports to China of high-end machinery reached USD21.79 billion last year, up 34% from 2009, according to German government statistics. Though the Chinese and German figures aren't strictly comparable, it appears China's companies are catching up.

The growth of China's machinery industry recalls the country's approach in the 1990s to textiles, an area China now dominates. Both sectors have benefited from governmental financial support. President Hu Jintao in March announced a five-year plan to invest more than USD500 billion in key industries, including machinery. Beijing two years ago unveiled an equipment-manufacturing revitalization plan meant to increase its market share world-wide and to decrease dependence on foreign-owned companies.

Chinese companies also pay lower salaries than their German counterparts, use less expensive parts and receive government subsidies or tax rebates. As a result, Chinese products often cost 10% to 20% less than German ones, analysts say. Chinese programs give away land for free, buildings for free. Many Chinese firms receive tax rebates.

German engineering companies long have worried about Chinese rivals violating intellectual-property rights. Chinese companies also gain access to German expertise through acquisitions, mostly of small, low-profile companies. The value of Chinese acquisitions in Germany rose to USD98 million last year from USD3.6 million in 2006. The total already is USD83.4 million this year, with nearly all the deals involving engineering companies.