July 18, 2010

Entering China: Survival of the Most Strategic

With Goldman Sachs projecting that its economy will grow by more than 11% in 2010 and its top 500 companies already outperforming American ones, China is set to surpass the U.S. as the world’s largest economy faster than predicted. Foreign investors in general and Middle East investors in particular must therefore enter what is arguably today’s most complicated and competitive market. To do so successfully they must develop a new 4 c strategy: a China strategy.

While many other countries have slipped into an economic coma, China is humming along, with Goldman Sachs projecting that the economy will grow by more than 11% in 2010. On the other hand, these are not happy times for many foreign investors. The clash between Google and the Chinese government, along with the ongoing vulnerability of intellectual property rights and continuing restrictions on foreign ownership in China, makes CEOs wonder if a presence there is worth the risks. There’s also a growing perception that the Chinese government has hardened its attitude toward the outside world, blaming the United States for creating the global financial crisis, and favoring local companies over foreign ones. Leaders of companies that don’t already have operations in China today are bound to feel handicapped, but they shouldn’t make the mistake of thinking they have been left too far behind to enter this growing market. China’s integration with the global economy is increasing, and the changes the country is undergoing have created a bewildering array of possibilities.

China Today and in the Future

Few Western companies were prepared for the speed of China’s recovery; fewer still are ready to handle the fact that China will soon be the world’s growth engine in terms of output and consumption. China surpassed the United States as the world’s largest automotive market in 2009. According to a September 2009 report from the China Enterprise Confederation and the China Enterprise Directors Association, the top 500 Chinese companies’ net profits were $170.6 billion in the first half of 2009, exceeding for the first time the net profits reported by the top 500 American companies, which were $98.9 billion for that period.

“Not only will China replace the U.S. as the world’s largest economy faster than predicted, but China’s (and India’s) growth may make Asia the source of about 50% of the world’s gross domestic product by 2030,” said Edward Tse, a senior partner with Booz & Company.

A Battle for Survival

Although the Chinese government began freeing the economy from controls in 1978, it has always wielded strong oversight over business, balancing the need for economic growth—and the entrepreneurship that demands—with its overriding desire to maintain political and social stability. The government still prevents foreign companies from entering core sectors such as telecommunications and media.

The number of private companies in China shot up from 140,000 in 1992 to 6.6 million by the end of 2008, even as the number of foreign corporations grew to 435,000. Of the Fortune 500 companies, about 480 are already in China, according to its government. This makes for a marketplace in which Chinese and foreign companies battle for survival.

The China Context: A 4C Context

“Executives usually consider three C’s when formulating strategy: Customers, Competitors, and the Company. For China, they must add one more C: Context. That’s easier said than done; three factors keep changing the context in China”, commented Hatem Samman, the Director of The Ideation Center—Booz & Company’s Middle East think tank.

Official China. Despite recent controversy over the Chinese government’s attitude toward foreign companies, economic liberalization will continue. Growth generates confidence in China’s government and promotes social stability. However, the Chinese government will continue to determine the pace at which it frees the economy from controls. Companies that wish to do business in China must understand the government’s priorities and modify their strategies accordingly.

Competitive China. “Many executives take for granted that China—compared with, say, Russia and India, or even Japan and South Korea—has an open marketplace. Unlike Asia’s other economies, China opened its markets to foreign companies when its economic reforms began and has opened them wider ever since” said Tse. Large investments and cheap labor have propelled economic growth until now, leading to enormous waste and environmental damage. Over the next decade government policy will drive a switch to efficiency and conservation. Companies in China will have to reduce their consumption of raw materials, mitigate the environmental impact of their operations, radically improve quality, and hone their management skills. That will make them even more competitive than they are today.

Consumer China. The money generated by China’s growth has created a substantial middle class. As a result, no other country—not even Japan or the United States—has as many products and brands as China does. This has resulted in a lack of brand loyalty and quick shifts in market share.

Five Questions for Shaping a China Strategy—Survival of the Most Strategic

To fashion a China strategy that can ride these forces, executives must answer five questions.

How open is—and will be—our industry in China? The Chinese government imposes legal restrictions on both the nature of corporate ownership and the products and services that companies may offer. Although the state is opening up more industries to competition, it doesn’t follow a timetable. Companies must monitor the extent to which—and the pace at which—the government frees industries from controls

What business models should we use? Foreign companies’ business models fall into two categories: sourcing-centric and sales-centric. Enterprises using the former, particularly in sectors such as consumer electronics and mobile communications, have established export bases in China, but their local marketing and sales capabilities are limited. Those deploying the latter, particularly in the fast-moving consumer goods and automotive industries, focus on the Chinese market. Smart companies combine the two models as they expand

Can we live with China’s uncertainties? The pace of change, lack of data, and high executive turnover in China render decision making hard for foreign companies. Nevertheless, it’s better to be approximately right than precisely wrong. Anticipating specific changes is impossible, but leaders should be ready to act when opportunities or new constraints appear.

How can we integrate our China operations with our businesses elsewhere in the world? The stand-alone business models that many multinational companies have been using in China are coming under pressure from rising costs—particularly those of labor and raw materials—as well as the Yuan’s appreciation. The rise of the Yuan stopped in the second half of 2008, largely because of the global financial crisis, but its value is bound to increase in the future. In order to keep costs down, companies will have to integrate their China operations with their businesses elsewhere—for instance, by developing products in China and manufacturing them in other Asian countries—and vice versa.

Can we move more parts of our value chain to China? China’s increased R&D and its development of global value chains, favor enterprises that locate each element—from research, through manufacturing, sourcing, and procurement, to distribution and marketing—in the most appropriate place. “Such one-world companies can take advantage of China’s growing markets, its increasing dominance of parts of the value chain, its talent pools, and its integration with global communications and transport networks. They will protect themselves against intellectual property theft by developing highly innovative product designs, keeping some of their operations closely guarded, and providing customer service of a quality that is difficult to imitate”, said Samman.

A New Strategy

Doing business in China doesn’t mean what it used to. Many companies believe they have figured out how to operate there, but the scale and intensity of change in the Chinese economy is rendering even successful strategies inadequate. It is no longer sufficient to develop a freestanding business in the country. In most industries, China is becoming a game changer, with companies’ operations there altering the basis of competition the world over. Companies must therefore develop a new China strategy—one that isn’t simply a plan for selling in or sourcing from China. They must integrate the China business with their operations elsewhere, so that China can provide them with a global competitive advantage.

Making the transition will be difficult even for companies that have operated in China for decades. But those that don’t make the shift will be pushed aside by rivals, old and new, that are already using China to transform their competitive positions. In the meantime, latecomers can set up globally integrated businesses from the outset, which will transform them worldwide. In fact, that’s an opportunity they are best placed to exploit.