Mao is believed to have said that, “The journey of a thousand miles begins with one step.” Western companies setting up subsidiaries in China may, at times, wish to move fast, but they should appreciate the advisability of expanding carefully, if not step by step, then perhaps later rather than sooner. As these co-authors describe, haste often makes waste when expanding in China.

In the past two decades, China has gone from an enclosed command economy to a major host country for direct foreign investment (FDI). Once in China, managers of multinational corporations often feel the urge to expand rapidly, because of the country’s huge potential as a market and manufacturing base, and because of the general belief in fast action by the business community. But, does it pay to rush once a company has established a base in China? We examined the experience of Japanese direct investments in China from 1980 to 2000 and found that too much haste can result in problems when expanding in China. When companies set up subsidiaries too quickly after the have entered China, the subsidiaries tend to have a lower likelihood of survival, growth, and profitability. This is an important lesson for managers, for as we describe in this article, too much haste can spell trouble when it comes to expanding in China.

Trends in Japanese investment in China

Japan’s earliest direct investments in China can be traced to its activities in what was then known as Manchuria – now the three northeast provinces — between the First and Second World Wars, when the Japanese Imperial Army occupied that area. Investments stopped after World War II and no Japanese expansion in China was possible for the next 40 years or so. China opened up to the outside world again in 1979, but Japanese businesses at that time were engaged in overseas production, mainly in response to the trade restrictions in the U.S. and European countries, as well as the appreciation of the Yen against dollar. Since the 1990s, Japanese investment in China has increased steadily. From 1990 to 1996, investment from Japan amounted to $12 billion, almost five times the amount invested between 1979 and 1987. From 1993 to 1996, Japanese direct investments poured into China, recording double-digit annual growth on a year-onyear basis, before slumping in 1997, when the Asian Crisis broke out. Investment activities in China started to pick up again after 1999. From 2000 to 2002, while world-wide FDI inflows kept declining, FDI in China continued to grow. In October 2002, the United Nations Conference on Trade and Development (UNCTAD) reported that an estimated US$50 billion were invested in China in 2002, and predicted that “China may for the first time overtake the United States to become the largest FDI host country in the world”. In the Japan Bank for International Cooperation’s (JBIC) 12th annual survey of Japanese foreign direct investment (JFDI), China was considered as “the most promising destination for overseas business operations through FDI over the medium-term (next three years)”.

Toyo Keizai (The Oriental Economist) surveys Japanese companies on their foreign investment activities every year. The resulting database offers a historical view of Japanese firms’ overseas expansion. The 2001 version includes 3,416 Japanese subsidiaries that belong to 1,578 parent firms that were established in China between 1980 and 2001. The earliest two subsidiaries in the database were established in 1980. Both were in the business of manufacturing motor vehicles and motor vehicle equipment. One was established by Yamaha Motor in 1980, but it dissolved in 1984. Yamaha waited 10 years before it went back to China on a large scale. In 1994, it established three subsidiaries within one month of each other, and added seven more in the next four years in different areas of China.

About 15 percent of the sample subsidiaries were set up on or before 1990. The majority (about 55 percent) were formed in and after 1995. About three quarters of the investments were made in the manufacturing sectors. The industry that attracted the most subsidiaries was electronic equipment, followed by industrial machinery and apparel.

Japanese parent firms that set up subsidiaries in China include both public companies listed on the Tokyo Stock Exchange and private companies. The variance in the size of the parent firms is considerable, ranging from about CA$334,000 to CA$210 billion in annual sales. About 18 percent of the firms had annual sales levels of less than CA$100 million. The smallest (by sales) was a private textile firm that had nevertheless established four subsidiaries in China since its first entry into China in 1992. This small firm had managed this expansion mainly by entering into joint ventures in which the firm owned 25 to 55 percent of the total equity. In addition to having local partners, it also worked with other Japanese firms in three of the four subsidiaries. All four subsidiaries were profitable in 2001. On the other hand, about 18 percent of the firms had annual sales of more than two billion Canadian dollars. The largest firm was Mitsui, which was a sogo shosha – a general trading company. Its initial entry in China, as an equipment renting facility, was in 1985. Mitsui owned 33 percent of the shares, and the joint venture was subsequently dissolved. Mitsui has since established 41 subsidiaries in China.

In general, public firms tend to be larger in size and richer in both industry and international experience. With richer resources, public firms tend to also have more subsidiaries in China; on average, they set up more than three subsidiaries versus fewer than two for the private firms. However, we see a similar general trend, namely of investing in China, that is shared by both private and public firms.

Speed of expansion in China

About one third of the 1500-plus Japanese firms that entered China during the period expanded their presence there by setting up subsidiaries after their initial entries. Many firms actually have now set up more than five subsidiaries in China since their initial entry. The firm with the most entries in the database was a major general trading company, Itochu, with 64 entries. Firms with multiple entries were significantly larger and more experienced both in their respective industries and in international expansion than the firms with only a single entry.

Many Japanese firms seem to have chosen a fast pace in setting up subsequent subsidiaries after their entry into China We gauge how fast these firms expand by measuring the time gap between the date each subsequent subsidiary was founded and the date an earlier entry was installed. In other words, how briskly each step of expansion was made. The mean time gap between an initial entry and setting up the first subsidiary is about 1.4 year. The median is only 0.58 year, meaning that half of the 1,887 subsequent subsidiaries were established only seven months after the initial entry. About 40 percent of them were established within three months of an earlier entry. These Japanese firms seemed to have rushed to expand in China.

It is interesting to observe which kind of companies tend to move faster. Arguably, the pace of expansion is related to firms’ prior resource base. We found that private firms, which were usually smaller and less experienced in international business, tend to wait longer before expanding after their initial entry. They also tend to set up fewer subsidiaries and do so at a slower pace than the larger, public firms. Firms’ strategic choices regarding their first entries into China also influence how fast they will further expand. The timing of their first entries, for instance, has some impact on how soon and how fast firms will set up subsidiaries. The early entrants, defined as those which made the first 10 percent of entries in China in their competitive group, averaged more than six subsidiaries by 2001, while the later entrants had fewer than three.

The choice of entry mode in the first entries also has an impact on how firms expand post initial entry. The mode of entry quite often reflects a firm’s resource commitment to a subsidiary, in that a wholly- owned subsidiary (WOS) often implies that there has been more input in financial and human capital than a joint venture (JV) . Our data revealed that those firms that first entered China with a joint venture ended up making subsequent entries sooner and faster, and were likely to have more subsidiaries established by 2001. Those that first entered China via a joint venture, on average waited 1.5 year before they started making additional investments, and averaged about 3 entries in total by 2001. Those that went it alone from the very beginning with a wholly-owned-subsidiary waited close to two years before they expanded further, and totaled fewer than two entries. This seems to suggest that cooperative strategies may help firms move faster in a foreign market. By partnering with (often) local firms, the foreign company can, arguably, learn about the host country’s business environment, establish the necessary connections, and develop the required capability of managing local operations faster.

Performance implications for the subsidiaries

As shown in the previous section, Japanese firms seem to believe in a fast expansion strategy; a majority of their subsidiaries in China were formed within a very short time of each other. This, then, begs the question: Has the faster pace been beneficial to the performance of their subsidiaries? We divided all 1,887 subsequent subsidiaries into four categories — those that were set up less than one month after an earlier entry, those that were set up between one and seven months after, between seven months and 27 months after, and 27 months or more after an earlier entry. Each category represented about 25 percent of all the subsequent entries. We then examined and compared their performance on the basis of three things: survival, 5-year sales growth, and profitability.

In general, better performing subsidiaries tend to be those that were established later rather than sooner after initial entry. This is especially conspicuous in the case of surviving versus non-surviving subsidiaries. For those subsidiaries set up within one month of a previous entry, more than 40 percent were later dissolved. When the time gap goes up to more than one month but less than seven months, about 32 percent failed to survive.. In the next two categories the non-surviving percentage goes down first to 22 percent, then to 17 percent. On average, the surviving entries were formed more than 15 months after their predecessors, while the nonsurviving ones were formed much sooner – a bit over eight months.. The set-up date presents a similar relationship to subsidiary profitability, in that the more that time passes between a subsequent subsidiary set-up and an earlier entry, the more likely it will be profitable.

The average annual sales growth rate in the five years following the establishment of a subsidiary does not move in a straight line as the time gap widens. Subsidiaries that were set up within one month of an earlier entry experienced the lowest average 5-year sales-growth rate. The sales-growth rate increased for those that were established more than 1 month but less than 7 months after an earlier entry; it was highest for those that were established more than 7 months but less than 27 months after an earlier entry. The average 5-year growth rate dropped again for those subsidiaries that were established more than 27 months after a previous entry.

This suggests an inverted “U” relationship between when a subsidiary was installed and its growth rate five years later. Subsidiaries established in too much haste can not really enjoy faster sales growth. However, if companies waited too long before they set up subsidiaries, they could also hurt the subsidiaries’ potential for growth. A moderate pace would be the best for these subsidiaries to realize high growth.

Japanese companies’ experience in China from 1980 to 2001 suggests that there might be disadvantages–at least for the subsidiaries–to moving too fast in that rapidly growing market. This seems to go against what the popular business press often advocates, namely that speed is crucial. However, when it comes to venturing into a foreign market, a more cautious pace can sometimes make more sense. There are three reasons why it pays to be cautious.

First of all, foreign expansion needs to be supported not only by financial resources, but also with managerial (human) capital. To manage a foreign subsidiary successfully, a manager would have to have knowledge about the strategy, systems, and structures of its parent company (or companies), as well as knowledge about the local market. Such managers can not be trained and developed instantaneously. Since China is a relatively new market, and it takes time to develop expatriate managers, most companies do not have a ready supply of qualified managers.

Second, learning takes time. Companies need to take into account the fact that they cannot develop the required capability to successfully compete in an unfamiliar foreign market by compressing time. Finally, since China is still an economy in transition, the market remained unfamiliar and uncertain to many incoming foreign companies. An overly speedy expansion will expose a company to unnecessary risks. Therefore, companies should pace their subsequent expansions in a market like China in a more cautious manner, and increase their commitments as they develop a better understanding of the local competition and as the market uncertainty declines over time.