Buffett’s Chinese electric car company

If you think the American auto industry is in trouble now, just wait until the Chinese learn how to make great cars. And if you doubt that they will learn, check out my cover story about BYD in the new issue of FORTUNE, headed to subscribers and newsstands this week.
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BYD is an amazing company. It was started by a chemist and government researcher named Wang Chuan-Fu in 1995 (same year as Yahoo) to make rechargeable batteries, which it learned to do very well. Within a few years, BYD’s batteries were cheaper and just as reliable as those made by industry giants ony and Sanyo. Then Mr. Wang, as he’s known, got into the automobile business by buying a failing state-owned carmaker. BYD’s conventional gas-powered cars are selling well these days in China, and his electric plug-in electric model looks like it will come to market with a longer range and a lower sticker price than the new Toyota Prius much-hyped Chevy Volt. As if that were not enough, I’m hearing now that BYD is on the verge of a breakthrough in the solar power business and that the company has big plans to make rechargeable batteries at a utility scale to store energy from intermittent, renewable sources like wind and solar. Today, BYD employes 130,000 people in 11 factories, either in China and one each in India, Hungary and Rumania.

That track record—and that potential—is what persuaded Warren Buffett’s company, Berkshire Hathaway, to buy 10% of BYD last fall for $230 million. This could turn out to be one of Buffett’s very best deals. Here’s what Charlie Munger, Buffett’s longtime friend and the vice chairman of Berkshire, told me about Mr. Wang:

This guy is a com-bination of Thomas Edison and Jack Welch—something like Edison in solving technical problems, and something like Welch in getting done what he needs to do. I’ve never seen anything like it.

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Munger, by the way, is a famous curmudgeon, who usually comes up with all kinds of reasons why Buffett’s latest investment idea won’t pan out. Not so this time around.

The other key player in the Berkshire-BYD deal is David Sokol, the chairman of MidAmerican Energy, a utility company owned by Berkshire and an interesting guy in his own right. (I’m going to blog about Sokol later this week—he is a big believer in renewable energy.) Sokol did most of the due diligence on BYD for Berkshire, and he now sits on the BYD board. He, too, was very impressed with Mr. Wang.

Here are three reasons why I think BYD will become an important company in the not too distant future.

1. BYD’s engineering prowess. Depending on whether or not you count trainees, BYD employs between 10,000 and 17,000 engineers and it’s constantly recruiting the best graduates from China’s engineering and technical schools. The Shenzhen manufacturing region, where the company is headquartered, is known for cheap unskilled labor, but BYD’s competitive advantage derives from its cheap skilled labor. “They are the top of the top,” Mr. Wang told me, when I visited BYD last year. This is a company that has already invented new processes (the way it makes batteries) and products (the battery in its electric car) and it is focused on innovation. Innovation appears to be Mr. Wang’s personal passion.

2. BYD’s forward-thinking management. David Sokol is a student of management—he wrote a little book on the subject called “Pleased But Not Satisfied”—and he was impressed with Mr. Wang’s thoughtful and purposeful approach to building his company. So was I. Not many entrepreneurs evolve into effective leaders of global companies with 100,000 or more employees. This fact didn’t make the story, but I was interested to learn that BYD is working with the Hong Kong outpost of Business for Social Responsibility. Unlike some of its domestic competitors, BYD wants to adopt best practices in health and safety as well as find ways to empower its people to improve the company. Jeremy Prepscius, the Asia director for BSR, told me: “What makes them unique is that you have a Chinese company, a big one, that recognizes the value of continuing to evolve its internal culture, and recognizes that it is not just a top-down command-and-control culture…They are somewhere between an old state-owned Chinese enterprise and a modern Japanese company like Toyota.” Sokol told me that Mr. Wang seeks his ideas and criticism whenever they meet. Perhaps surprisingly, many CEOs have the confidence to act that way. On the downside, it’s hard to know whether BYD has a strong bench of managers behind Mr. Wang.

3. China’s commitment to clean energy. Much as I admire the Obama administration’s energy and environment team, there’s no way that the U.S. government is going to help U.S. car companies and battery makers as much as the Chinese government is going to help BYD. As Keith Bradsher of The New York Times reported in a page-one story earlier this month:

Chinese leaders have adopted a plan aimed at turning the country into one of the leading producers of hybrid and all-electric vehicles within three years, and making it the world leader in electric cars and buses after that.

The government will make direct grants to automakers (as we do, of course) and also provide “subsidies of up to $8,800 are being offered to taxi fleets and local government agencies in 13 Chinese cities for each hybrid or all-electric vehicle they purchase.”

Finally, there’s a fascinating footnote to this story, and it involves a man named Li Lu, who was born in China in 1966, the same year as Mr. Wang. When I began reporting the story, I wondered how Buffett and Charlie Munger had become aware of BYD. That question led me to Li Lu, who runs an investment firm, in which Munger is an investor, based in Pasadena that owns about 2.5% of BYD. He was the link between Berkshire and BYD.

Li Lu, it turns out, also was a leader of the pro-democracy movement that organized the mass student protests in Tiananmen Square in 1989—20 years ago next month. He fled China after hundreds of demonstrators were killed and appeared on China’s “Twenty-one Most Wanted List.”

Escaping to New York, Li Lu was embraced by the human rights community and wrote a memoir called Moving the Mountain that reads like a movie. His well-educated parents were forced into labor camps during the Cultural Revolution and, as a 10-year-old-boy, he barely survived an earthquake that killed 250,000 in the city of Tangshin.

During the 1990s, Li Lu earned three degrees in six years from Columbia—a B.A. in economics, a law degree and an M.B.A. He worked for Allen & Co. and at Donaldson, Lufkin & Jenrette before starting his investment fund. When David Sokol first flew to China to visit BYD, he stopped at LAX to have dinner with Li Lu, after which they traveled together to Hong Kong. Li Lu is still not permitted to travel freely to China.

Li Lu politely declined to speak with me for my story, telling me that some people in China are still unhappy about his role in the Tianenmen protests. Mr. Wang is not among them. “That’s past history,” he said. “Today, Mr Li and I share the belief that the best way to help China move forward is to make BYD a world-class company.”

Li Lu has agreed to come to FORTUNE’s Brainstorm Green conference next week to talk about BYD. I’m eager to meet him and learn more about this remarkable company. You can read my BYD story here.

Lost in Shenzhen

Half an hour before an interview that I’ve flown 8,000 miles to do, the driver of the Toyota SUV that’s taking me there pulls to the side of a dusty and crowded highway. He’s yelling in Cantonese into his cell phone and madly sketching Chinese characters onto the touch screen of his GPS navigator. The PR woman seated beside me is lost, too. “The GPS isn’t working,” she says. “Too many new roads.”

I can’t blame the driver, the PR woman or the GPS—which, it occurs to me, was probably made nearby, since we are in Shenzhen, the Chinese mega-city that is the hub of the global electronics manufacturing industry. They simply can’t keep up with China’s growth.

You can’t appreciate the scale of a place like Shenzhen until you’ve seen it for yourself. Think of high rises, really high rises, stretching into the distance for as far as the eye can see. Factory after factory, in all directions. Cranes everywhere. Roads too new to have signs. Of course the old roads don’t have signs either.

On the factory gates are the names of companies you’ve probably never heard of: TianMa, NeoPhotonics, TCL, Skyworth, Fangda, Dawning, Tencent, Shima, Microtec, Ohimo Eyewear, Glory Medical, NCBC, Sisemi, Trony. They make things for the companies you know: Apple, Dell, Sony, Hewlett Packard and Nokia.

Shenzhen is a city of about 14 million people, bigger than New York or London, that most of us couldn’t place on a map. The most amazing thing about Shenzjen isn’t its size, though. What’s amazing is how quickly Shenzhen has grown up. Back in 1980, when the city (which is just north of Hong Kong, by the way) was designated as a special economic zone by Deng Xiaoping it was a fishing town of about 30,000 people and the tallest building was a three-story guest house, according to the South China Morning Post, which, by coincidence, published a weeklong series about Shenzhen during my visit.

Shenzhen is the creation of an economic miracle. The government invited in capitalists, cleared land for factories, brought in masses of rural migrants and housed them in vast dormitories. Their jobs pay $200 a month or less but they are so desirable that the authorities built a wire fence, 85 kilometers long, to keep out illegal immigrants. From the factories sprung other opportunities. Today, there are enough middle managers, engineers, shopkeepers, developers and entrepreneurs so that the average per capita income in Shenzhen has grown $10,628 a year, the highest of any city in China. The city has its own vast shopping malls, theme parks, luxury hotels and a stock exchange.

“Pursuit of money has pushed aside Maoist principles,” said one headline in the newspaper series. You don’t say! Still, there was a wistful tone to some of the coverage. An early settler named Fang Xioa, who worked as a salesclerk at a state-owned department store and then got rich trading IPOs, said that her husband, who also made money in the market, then left her for a young mistress:

We have been overwhelmed by numerous unexpected freedoms and opportunities since the economic reform launched. But many have also lost their inner peace and traditional values amid dazzling fortunes.

Right now, there are more pressing concerns than the loss of inner peace in Shenzhen and the rest of Pearl River Delta. No. 1 is the global recession. China’s growth is slowing, and several people told me during my brief visit that they are worried about the stresses that a downturn will place on the ruling Communist Party, as workers lost their jobs and become disgruntled.

Over lunch one day at the Hong Kong Jockey Club, one of the city’s most prominent PR women drew the Chinese characters for the word harmony on a scrap of paper. Turns out that one of the characters represents “grain” and the other represents “mouth.” So long as people are fed, she explained, there will be harmony in China. But already hundreds of thousands of people in the Pearl River Delta have lost their jobs because global demand for electronics, cars and toys is declining. Taxi drivers and bus drivers have gone on strike, and thousands of people in one city (elsewhere in China) attacked government offices and burned cars to protest the confiscation of their land.

The Chinese government is responding with a carrot, a stick and, most interestingly, some small steps towards openness.

The national and provincial governments are rolling out economic stimulus packages. The government is holding down fuel prices, helping the newly-employed collect back pay and putting off wage increases to keep more people on the job. That’s the carrot.

The government is also demanding law and order. “We have to strengthen public security forces in rural areas, carry out crackdowns on crimes in high-risk places and punish those who endanger our social stability,” said a top party official. That’s the stick.

As for the openness, the state-owned media is reporting more on land, labor and social problems because acknowledging bad news is a way to contain it, according to Reuters:

Propaganda authorities have issued a writ authorizing news organizations to report on unrest, rather than allow rumours to take hold among a public worried about the impact of the global financial crisis on the country’s economy.

This partly reflects the difficulty of suppressing negative news as rumors spread quickly across the Internet. China’s digital media businesses are flourishing.

I asked a young marketing executive for a Chinese company whether the country needed to become more open, to deal with corruption, debate the government’s economic policy or, for that matter, learn from experiences in the private sector. He responded that he thought it would be difficult to take China’s companies to the next level so long as the society that stifles argument and dissent. Marketing, he added, is one area where China’s companies lag well behind because the state-run education system discourages creativity or thinking outside the box.

Big companies, he noted, have been built in China but the economy has yet to create a global brand. I thought about that for a moment, recalled all those unfamiliar names on the factory gates, and realized he was right. (No, Lenovo is not a global brand.)

By the way, after 40 minutes of driving around and a couple of fruitless attempts to ask people for directions—apparently no one can keep up–I made it to the interview. Given the slowdown, maybe the government should hire some people to put up street signs.

P.S. I had an email after this posted letting me know that Ritz Carlton is opening a hotel in Shenzhen next year.

Helping companies fight sweatshops

On a 15-hour flight from Chicago to Hong Kong (in coach), it helps to have some distractions. The movie Get Smart? Nah. Instead, I spent time talking with Dan Viederman, the leader of an NGO called Verite, who I’ve gotten to know in recent years because he works with U.S. companies that want to improve conditions in factories in poor countries where their products are made.

Dan, who is 45, happens to be an old China hand. He first traveled to China in 1985, after college, to spend a couple of years teaching English. “I was one of 50 foreigners in a city of 9 million people and 30 of them were Korean,” he tells me. He also lived in China during the 1990s, first as a development worker with Catholic Relief Services and then as the director of World Wildlife Fund’s offices in Beijing. He’s been back many times since.

We ran into each other by chance, but we were both headed for the Pearl River Delta area of southern China, the world’s biggest manufacturing hub, where many millions of mostly young workers make the clothes, shoes, furniture and electronics we use every day. (I’m typing this blogpost on a MacBook Air; odds are some or all of it was made here. Same with the Gap jeans and shirt I’m wearing.) These huge facilities—with dormitories for the production workers, apartments or homes for middle managers, cafeterias and restaurants, stores and athletic facilities—are more like company towns than mere workplaces.

Consider: Shenzhen, which is just north of Hong Kong, was a fishing town of about 30,000 people when “paramount leader Deng Xiao-ping” (as he’s called in this morning’s South China Morning Post) designated the area as a “Special Economic Zone” to promote foreign trade in 1980. Today, Shenzhen is bigger than New York or Paris, with about 14 million people, and it’s one of China’s wealthiest cities.

This has been a boon to U.S. companies and consumers. But it has also led to scandals around sweatshop labor that embarrassed Nike and Kathie Lee Gifford and Disney and Wal-Mart, most in the 1990s, some more recent. Since then, U.S. companies have been looking for ways to stay out of that particular spotlight. Many have written labor standards and codes of conduct that they impose on their suppliers, after which they hire inspectors to monitor factory conditions. These U.S. and European brands function, informally and imperfectly, as the Department of Labor in China, which has pretty good labor laws on the books but enforces them erratically at best.

As executive director of Verite since 2004, Dan has tried to improve that system. He has worked with a host of companies – Timberland, Disney, Gap, Apple, a coalition of firms called the Electronics Industry Citizenship Coalition and others—around labor practices in the developing world. Verite does auditing, training, worker empowerment programs, research and investigations. Verite also has contracts with the U.S. government (labor and state) to look at issues like migrant labor and slave labor, and it’s part of a chocolate industry effort to do something about child labor in the cocoa industry in West Africa. The NGO is headquartered in Amherst, MA, with offices in China and Manila.

No one who knows anything about this system of factory monitoring, inspection and compliance will tell you that it is ideal but in China, at least, it’s about all we’ve got. Dan’s job is to make it better, and he says the obstacles are many—suppliers keep two sets of books to fool auditors, they monkey around with workers’ pay stubs by deducting funds for housing or uniforms, they track hours poorly or don’t pay overtime, etc. “There’s built-in underpayment of wages,” Dan says. Besides that, some auditors who work for U.S. brands may not be fully committed to the task—they are paid, after all, by the companies, and they may not know or care how to do inspections right. Think of how Arthur Anderson “audited” Enron.

As a nonprofit, Verite’s loyalty is to the workers, and its credibility is key. That’s one reason why Dan is refreshingly honest about the flaws of the system. “We don’t really believe you can certify a factory as complaint,” he says, because conditions change all the time as new orders come in. A more sustainable approach would be to educate workers to look out for their own rights—Timberland hired Verite to try that at some factories a few years ago, and Reebok has taken similar steps. But the Chinese government permits only one trade union, and Dan tells me that the government-controlled All China Federation of Trade Unions has never, as far as he can recall, organized a strike or fought hard for its members.

Despite all the problems, there’s little doubt that the massive industrialization of China has been good for its people. Hundreds of millions have lifted themselves out of poverty through factory work—more than in any other place at any other time. This is the upside of globalization.

“By almost any measure, except maybe environmental quality, China’s a better country for most people than it was in 1985,” Dan says. “I think that has a lot to do with its openness to the world and its role in the global economy.”

What’s more, before we smugly assume a position of moral superiority when it comes to cheap labor in China, we should remembering that it wasn’t all that long ago that rapid industrialization and unfettered capitalism created terrible factory conditions in American cities. (The Triangle Shirtwaist factory fire caused the death of 146 garment workers in 1911.) It took a robust union movement, aided by progressive politicians, to protect American workers from exploitation.

Something similar will have to happen in China before we can feel entirely comfortable when we pay “bargain” prices for laptops or jeans. Interestingly, the Chinese government has been more willing to allow dissent and permit the growth of vibrant NGOs in the environmental arena—where the problems are dire—than it has been to promote independent labor unions.

“In the long run, things will change because the society demands change,” Dan says. “This can’t be the responsibility of business alone.”