Local companies are now the key competitors to beat in carving out a share of China’s rapidly growing market. For foreign multinationals, it’s time to try out some new strategies, because the old ones are running out of steam.
Chinese companies are hitting the headlines. In December 2004, computer-maker Lenovo announced that it was shelling out $1.7 billion to take over IBM’s global PC business. Last year, Chinese consumer-electronics company TCL took a 60 per cent interest in a joint venture that acquired the TV business of Thomson of France; through this deal, TCL gained control of the brand icon of America’s TV business, RCA.
That Chinese corporations are making their presence felt on the international scene should not come as a surprise to those who have seen them battle their multinational rivals inside China-in many cases, coming out on top. The single greatest challenge facing Western corporations is the competitiveness of Chinese corporations on their own turf and their global ambitions in the multinationals’ own backyards.
A decade ago, it seemed unlikely that Chinese companies would pose a serious competitive challenge to Western multinationals in any market. But our research over the past five years reveals that local champions frequently beat out international rivals in the Chinese markets over the past five years, although this phenomenon is far from universal. In industries as different as beer brewing, mobile phone manufacturing and laundry detergent production, Chinese companies-often seeming to appear from nowhere-are forcing multinationals to rethink their strategies and their hopes for explosive growth in the Chinese market.
Reassessing your sources of advantage in China
Multinationals generally start off with clear advantages in two areas: They have better industry-specific technology, know-how and innovation capabilities; and they have a higher level of managerial competence in functions such as marketing and brand building, financial management and IT, which can be used to underpin a strong, well-integrated value chain.
But multinationals also have fundamental handicaps in the race to build competitive advantage in China. A poor support infrastructure often prevents them from exploiting their advantages. Multinationals’ sophisticated marketing and brandbuilding skills, for example, need specialized inputs like detailed market research that are often unavailable or poorly supplied in China. Likewise, the superior attributes of a multinational’s offering might never be communicated to potential customers by a Chinese distribution system that focuses on transport and storage, rather than information provision. Multinationals’ potential advantages in supply-chain management, meanwhile, are often rendered ineffective by the lack of competent local suppliers.
Many multinationals are also required to implement international corporate standards that can put them at a competitive disadvantage in comparison with local rivals who are content to match Chinese norms. Meanwhile, their ability to reap economies of scale and spread high fixed costs is checked by the fragmentation of the market, provincial trade barriers and the protection of local enterprises. In the beer market, for example, several global companies spent money on national or regional advertising campaigns only to find that it was impractical to supply large volumes of beer outside the province in which it was brewed.
Finally, the fact that many markets in China are in an early stage of development (despite the impression conveyed by sophisticated consumers in central Shanghai or Beijing) means that more than one billion of China’s consumers can still only afford products that serve their basic needs. As a result, the superior quality, functionality or service offered by multinationals does not translate into premium prices or higher market share.
None of these drawbacks would matter much if Chinese competitors lacked advantages of their own. After all, Chinese companies also have to deal with insufficient market research, inefficient distribution and inadequate supply chains. The problem is that Chinese companies do have unique competencies.
Chinese competitors enjoy advantages in three areas. First, they have a better understanding of what will work in the local environment. For example, detergent producer Nice has a deep understanding of Chinese consumers. In one of its widely acclaimed advertisements, a young girl is shown helping her mother-who has just been laid off from her job – wash the family’s laundry. The advertisement succeeds because it makes an emotional connection with dongshi, the transition that takes place when a child starts to understand his or her responsibilities to the family and society-a critical part of growing up. Dongshi is one of the most important and satisfying achievements of a Chinese parent, and there is no direct counterpart in Western cultures.
The home appliance market provides another example. Multinationals like Whirlpool introduced large, impressive-looking washing machines, but Haier, the leading Chinese company, produced a machine dubbed “Little Prince” that is capable of handling small loads with very low consumption of electricity. Chinese parents prefer cotton diapers over disposables for their “little princes” (a label that taps into emotions associated with China’s “one child” policy), and the small machines make it easy and inexpensive to do many loads. This is also important for the entire family during the hot Chinese summers, when clothes are washed daily. Little Prince became an instant hit, and millions of units have been sold.
Not surprisingly, local knowledge also helps companies manage the complex web of relationships that are necessary for operating in China. Such relationships – with state and local governments, buyers, suppliers, and those that control access to infrastructure-are seldom transparent. Paying utility bills on time, for example, may not guarantee that a company will have a consistent power supply; it takes the right relationship to make sure that when power is rationed, your plant is among the priority users. Multinationals with 15-20 years of Chinese operational experience under their belts are very competent networkers, but more recent entrants generally lag their Chinese competitors in the subtle arts of managing relationships. (D. Ahlstrorn and G.D. Bruton, “Learning from Successful Local Private Firms in China: Establishing Legitimacy,” Academy of Management Executive 15, no. 4 (2001): 72.)
A second key advantage of Chinese competitors is that they are often leaner, more flexible and have lower costs. This may seem paradoxical, given the straitjacket effect of a planned economy. But after 20 years of reform, state-owned enterprises now account for only about one-third of China’s GDP, and they are mostly concentrated in heavily regulated industries such as telecommunications and financial services. Many of the most powerful Chinese competitors are run by highly entrepreneurial people who have either built their businesses from the seed of a flexible “township enterprise” (a collective set up by local government outside the centrally controlled state sector), transformed a state-owned enterprise into a joint stock company with strong managerial autonomy, or launched a new private business that continues to be flexible and costconscious despite rapid growth.
A third advantage comes from the existence of open global markets-the same opportunity that multinationals hope to benefit from in China. Open markets allow Chinese companies in many industries to simply buy much of the technology and expertise they need to catch up. Cola marketer Wahaha, for example, was able to build the most modern production lines in the world using imported machinery it bought in volume at a very competitive price. And in white goods, it is easy to buy a production line that incorporates technology capable of matching what multinationals can produce. In the PC market, the latest tools and technologies developed in Silicon Valley now arrive in China within months. This allows DongGuan, a small city in GuangDong province that has the world’s highest concentration of component manufacturers, to provide Chinese PC makers with a ready supply of world-class technology.
These new realities about the strengths and weaknesses of multinationals in China compared with their local competitors means that to succeed in the future, many multinationals will have to refocus their strategies.
Five Strategies for Success
To win against emerging Chinese rivals in the next round of competition for Chinese markets, Western companies should consider acting on some combination of the following five strategies:
1. Expand market coverage. Seeking to exploit their superior technology and brands, most multinationals entered China through the high end of the market. American and European beer companies, for example, positioned their brands at between three and five times the price of low-end Chinese brews, and electronics companies such as Toshiba and Hitachi sought to compete by continuously introducing new, leading-edge products at premium prices. But for two reasons, such a strategy is unlikely to succeed in the future. First, unless multinationals break out of high-end niche markets that generally exist only in major cities, they have little hope of building the localization competencies they need to succeed long-term. Second, unless they expand into the mass market, they will be dangerously exposed as local Chinese firms use their expanding competence base to move aggressively upmarket, financed by massive sales volume in the low end.
Many multinational firms are now starting to move into lower-price, mainstream market segments and into areas beyond China’s more developed coastal strip, to win back the market share they lost to Chinese competitors. A year ago, Hitachi launched a new mini-washing machine directly targeted at Chinese mid-market consumers. Kodak, meanwhile, has a major campaign called “Marching West,” which is extending the company’s coverage into the western provinces of China. And Procter & Gamble has cut the prices of some its leading products by more than 40 per cent, introduced low-priced, small packages for rural consumers, and signed up new distributors to cover even the most remote areas. The result: Its market share is increasing again after declining for three years in a row.
2. Focus on dramatically lowering costs. Multinationals have some valid reasons for having higher costs than their local competitors – such as their need to maintain international standards of environmental and worker safety. But they no longer have the luxury of sustaining the magnitude of cost differentials that often existed in the past. The technology and quality gap is narrowing, and global players will have to reach customers unable to pay premiums for multinationals’ products. After all, despite China’s economic miracle, annual income per capita only passed the $1,000 mark for the first time last year.
Consider how the price premium commanded by foreign brands has declined relative to local brands. For example, five years ago, Japanese brands could charge a premium of about 20 per cent over local products. Today the viable price premium is only 5 per cent. The cost reductions required to respond to this kind of shift in pricing won’t come from incremental changes. Multinationals will need to look at wholesale re-engineering of their business processes in China. And there is no time to lose, because the Chinese aren’t standing still. BYD Batteries, for example, developed its own proprietary process for manufacturing rechargeable batteries. It now has close to a 40 per cent price advantage in the end product market.
3. Streamline distribution channels. Until recently, multinationals have been handicapped by regulations that effectively prohibit their direct involvement in distribution and retailing activities. Canon, for example, has historically had to use its Hong Kong office as the primary sales arm in servicing China because of regulatory constraints on mainland sales and distribution. But the removal of these restrictions as part of China’s deal to join the WTO is opening up new opportunities for multinationals to streamline their channels. One option is to emulate the Chinese practice of building dedicated distribution networks that can be used to smooth the supply chain, get closer to customers, and gain better control of marketing and communications through to the point of sale.
A second option is to take advantage of the fact that China’s excessively fragmented retailing sector is consolidating fast – driven by the aggressive expansion of retailers like France’s Carrefour, America’s Wal-Mart and Britain’s Tesco, along with emerging local chains such as N-Mart. By working closely with the rapidly emerging retail chains, multinationals can expand their market coverage, improve distribution efficiency, and make sure superior product quality and performance is communicated effectively to end customers. This will enable them to avoid having poorly performing distributors destroy much of the differentiation a multinational has to offer.
4. Localize R&D. In the past, most multinationals have viewed their China operations as importers of the results of their R&D conducted elsewhere. But there are good reasons for localizing more R&D in China. For one thing, it would improve the chances of meeting local customer needs and increasing speed to market. In addition, given China’s vast supply of cheap and talented scientists and engineers, localizing R&D could substantially reduce costs. Lastly, transferring R&D to China would do a lot to help sweeten relations with governments at every level, and could provide a powerful bargaining chip for winning official support for other parts of a company’s China business.
Of course, the questions of intellectual property rights (IPR) associated with local R&D need to be carefully managed, especially in joint ventures where Chinese partners may look to apply new technologies to related businesses outside the venture. And there are risks of IPR leakage if turnover of personnel cannot be contained. But leading multinationals in China are recognizing the potential of China as an important R&D base. Over the last few years, more than 100 global R&D centres have been established by such companies as HP, Microsoft and Motorola.
5. Drive industry consolidation. Many Chinese industries are highly fragmented by world standards. While fragmentation persists, economies of scale will be undermined, excess capacity and cutthroat price competition will remain endemic, and even fundamentally sound companies will struggle to make adequate returns. Until recently it has been difficult for companies to do much about this problem, given China’s regulatory restrictions on takeovers. Only 5 per cent of foreign direct investment takes place through acquisitions in China.
Opportunities to drive industry consolidation, however, are opening up. Kodak has been a pioneer: In 1998, it negotiated a deal with the Chinese government to take over three large state-owned photographic enterprises and integrate them into a holding company with Kodak’s existing operations. It has since bought up several other Chinese players; in October 2003, Kodak acquired a 20 per cent share of China’s largest local film producer, Lucky Film Corp, for $45 million (U.S.) and a package of new filmmaking technology.
Other multinationals are following Kodak’s lead. The French-based food and beverage company Danone, for example, has acquired large shareholdings in China’s drinking-water market, driving consolidation and becoming the leading supplier.
To succeed with some combination of these five strategies, foreign-owned organizations in China will have to become smarter and more flexible. The China-based management team will have to educate corporate headquarters about the company’s competencies vis-à-vis the competition in, and about their need for enough autonomy to respond to nimble Chinese competitors. For example, the head of China operations for companies such as P&G, Microsoft and Motorola now report directly to global CEOs. The seniority of China heads has also risen dramatically: The president of Samsung China, for example, is one of three key decision makers back at headquarters.
Multinationals must face the fact that their superior technologies, products and systems are not enough to win in China. They must also master the complexities of distribution, sales and service in China’s secondary cities and rural heartland, and learn how to more sensitively adapt everything from products and processes to marketing messages in ways that will suit the peculiarities of the Chinese market-competencies in which their local competitors are currently far ahead. These strategies will help Western companies to carve out a bigger share of the Chinese market, and prepare your company for the day when Chinese companies arrive in the global market as multinationals in their own right.