|
» China-Business >> View Article
|
|
|
 |
|
 |
| A wait-and-see strategy on China is for losers. |
By:
John Curran |
|
A Director's Guide to China
by John Curran
A wait-and-see strategy on China is for losers. Sure, there are huge risks, including red tape, corruption, and a backward banking system. But the opportunities are even greater, whether you view the country as a place to make things or sell them. Here’s an overview of what a smart board must do now.
Four hundred years ago publishers began putting out erudite tomes on the Middle Kingdom. What’s notable is not that the presses keep rolling, but that China remains a giant riddle wrapped in a mystery inside a (now) rising star. China’s economy is hot, its consumer market is bubbling, and its cost advantages are the talk of the boardroom. If your company isn’t currently in China, odds are that your principal competitor already is, tapping into low labor costs or feeding his bottom line with the power of China’s burgeoning middle class. For corporate overseers in the U.S. today, the wait-and-see strategy on China is fast becoming a losing one.
So how do you turn that around or, if you’re already there, take your China strategy to the next level? The first thing to know is that nothing about China is simple. Any discussion of the country’s promise today would be incomplete without addressing its other reality, characterized by inscrutable government regulation (Chinese call it “market socialism”), widespread corruption, a backward banking system, rampant theft of intellectual property, and pollution that could choke a horse. And that’s before you get to the market, which is distinguished by wildly uneven wealth distribution, cutthroat retail pricing, more than 200 distinct languages, and some 6,000 governmental zones, each with its own difficult-to-decipher rules.
That’s a lot to swallow. But the experience of many American companies says that the risks can largely be contained with planning, due diligence, and the right relationships, or guanxi. Among American companies with major China investments, 68% have wrestled their way to profitability, according to the American Chamber of Commerce in China.
The smart approach for any board member or executive begins with a clear definition of China-related goals. Is your company interested solely in finding a low-cost manufacturing platform for Western markets, the role China has filled for decades? Or are you looking to tap into the country’s rapidly growing domestic market, where a nascent middle class is taking to consumerism with a vengeance?
Increasingly, companies are embracing both strategies. Not only is Wal-Mart China’s biggest single customer, but CEO H. Lee Scott Jr. recently opined that China was the one market where the retailer could replicate its U.S. success. It already has 43 Supercenter stores, three Sam’s Clubs, and two neighborhood markets in China, employing 20,000 people.
At the other end of the spectrum are companies focusing on China’s dirt-cheap unit production costs. Jerry Phlippeau, founder and president of Flipo Group in La Salle, Illinois, first started traveling to China in the early ’90s; he’s been producing consumer items there for more than a decade. His stock-in-trade is body baubles—illuminated belly rings for girls, sold over the QVC Network. He has lately graduated to “pet blinkers,” flashing lights that attach to dogs and cats (don’t laugh—he’s sold over 1.5 million so far at about $8 apiece), all the while gathering China production know-how.
Phlippeau’s first years of China-based production were marked by frequent meetings with Chinese industrial types who would vie for his business and give him tours of their extensive product showrooms. Eventually he discovered that they weren’t factory owners at all, but self-appointed middlemen looking to cut in on his profit. Today he doesn’t just have direct relationships with factory owners, he has a social life with them as well. “They treat me like family,” he says. And that’s important: “If you’re not social with your factory managers, your design plans float out the back door.”
The costs for entrepreneurs like Phlippeau can be as low as one-seventh of those in the U.S., though if you’re using factories anywhere near Hong Kong, your margins are probably shrinking as labor outlays ratchet higher. “My production costs haven’t gone up, but I’ve had to shift production north to Nanjing to keep them down,” Phlippeau says.
For corporations doing large-scale production, costs can be one-twentieth or less of U.S.-based manufacturing costs. A recent multicompany analysis of 2003 global labor expenditures and trends reveals that average hourly compensation for unskilled workers in China was 80 cents (including benefits), versus $21.86 in the U.S. Even America’s productivity edge can’t close that gap. (See the chart at right for how labor costs in various countries stack up.)
Some China-watchers caution that the country’s enormous cost advantage could wither as its standard of living rises in the years ahead. But an analysis of wage trends by the Boston Consulting Group suggests that China’s advantage over Mexico, Europe, and the U.S. will in fact widen rather than shrink. Reason: Even though China’s wages will increase faster than most other countries’ in percentage terms, the gains are on a smaller base (80 cents) than in, say, the U.S., so the dollar gap continues to grow. The report also finds that China’s cost advantage over Eastern Europe (another low-expense production option) will expand for the same reason.
It’s no secret that companies setting up manufacturing operations in China face many risks. These include currency gyrations, the theft of product designs, and supply-chain uncertainties that may keep you from getting your product into America’s stores at the desired time. There’s also the less obvious danger that your end-user country might one day erect trade barriers limiting your ability to import all those low-cost products—not far-fetched, given China’s lopsided trade surpluses with many Western nations. The U.S. already has limits on apparel exports from China. And over the summer, China’s apparel exports to Europe bumped up against quotas and ground to a halt. The prospect of ongoing difficulties in this area recently prompted apparel titan Liz Claiborne to pare plans to shift most of its production to China. (It currently draws about 30% of its production from sources there.)
Of these risks, one often overlooked is the supply chain. It is becoming more common for delays to occur at critical times, like the fall shopping season, at major American and European ports. That’s not a China problem—most of its major commercial ports are state-of-the-art—but it could be your problem if your company misses a major selling season.
A study by the Boston Consulting Group shows how disruptions in the supply chain can batter profitability. Analysts compared the operating profit margins of two sourcing strategies: producing on American soil for U.S. consumption and producing in China for U.S. consumption. They found that the costs of supply-chain volatility for goods made in China—excess inventory that had to be sold at marked-down prices, for example, and lost sales because U.S. stores ran out of stock—could cut an American company’s operating margin by almost 80% from what it would be under ideal inventory conditions. That said, the study also noted that China’s unit production costs are so low, a Chinese product might still yield a better operating margin than the U.S.-produced item. “What’s important is to factor into your early planning the added costs and complexities of the China-based supply chain,” says David Michael, a senior vice president and director of Boston Consulting Group.
Among the biggest changes in recent years is the number of companies looking beyond manufacturing for foreign markets and focusing instead on providing goods and services to China’s 1.3 billion consumers. One by one, business-to-business and individual consumer markets are being opened up—part of the concessions China made as a condition for joining the World Trade Organization, which it did in 2001. And these markets are huge. There are already more than 160 million cell-phone users in China, and that’s in addition to 150 million fixed-line phones. China is now the world’s second-largest Internet market, with roughly 100 million users. In life insurance, annual premiums are expected to exceed $120 billion by 2008, surpassing France and Germany, according to McKinsey & Co.
Even so, such tempting prospects can be a mirage for newcomers who don’t recognize that China is made up of many very different regions. For consumer-products behemoth Procter & Gamble, which entered China in 1988 through a joint venture with Hutchison Whampoa China, an arm of a Hong Kong-based conglomerate, the path to growth has meant constant adaptation to different localities, not just in pricing but in knowing what the customer wants in various parts of the country. P&G found that while the sales of its traditional Western products, such as high-end cosmetics, were strong in China’s prosperous coastal cities, they weren’t right for the rest of the country, where subsistence was more the norm.
Laurent Phillippe, former head of P&G’s Greater China operations, described the challenge in a 2004 McKinsey forum. “In some product categories,” he said, “the cost differential between global or Western technologies and what Chinese consumers need or can afford is so wide that you cannot just make your product cheaper by removing or replacing certain ingredients. The cost gap [with local competitors] is just too big.” Result: P&G now uses its China-based R&D facilities to come up with “value offerings” that are better than those of local competitors but carry an equal or lower manufacturing cost. Daniela Riccardi, P&G’s new president of Greater China, says the lineup now “meets the needs of Chinese consumers across the full spectrum,” with high-end products like Max Factor shampoo sold in more affluent areas and offerings like Rejoice Daily Care Shampoo (about $1.10) aimed at low-income rural customers. In 2004 China was P&G’s sixth-largest market, generating nearly $1.8 billion in sales.
Twenty years ago, 80% of U.S. companies setting up operations in China did what P&G did: organize a joint venture with a Chinese partner. Now more companies entering China do so on their own. China’s laws still require some industries—notably telecommunications, the Internet, and banking—to hook up with local joint-venture partners, but otherwise the preference is shifting to the “wholly foreign-owned enterprise.” Chalk that change up to experience. “Not only are many American companies more familiar with China and willing to go on their own, I also think there was some unhappiness with Chinese partners,” says Jie Chen, a partner at Jun He, a Beijing law firm that lists Microsoft and Exxon Mobil among its clients. “It was the vast cultural differences, as well as the difficulty in making decisions with a very different partner.”
Wholly owned subsidiaries offer the simplicity of one corporate culture and more control over intellectual property—an easy choice for most service industries, whose only real logistical need is office space. It’s a more complicated story for industrial companies that want to build and run a factory, say. For them, critical issues include securing a reliable guarantee of electricity, water, and raw materials. Overarching these challenges is the task of getting all the necessary government approvals, because of an ever-changing political maze that includes four national, or state, zones, followed by less powerful provincial zones, followed by even less powerful municipal zones. To complicate matters, the power relationship among different zones keeps changing. Notes Clarence Kwan, managing partner of the Chinese services group at Deloitte & Touche: “There is definitely a risk for companies that don’t know China and deal with lower-level zones.”
As a general rule, sticking to powerful state zones will get you reliable laws and rulings but less accommodating politicians. Adds Kwan: “They don’t like polluters, but they are very interested in attracting companies with strong reputations, or those in technology.” In other words, going into China’s top coastal zones with production facilities can be more of an admissions process than a selection process.
In a market of 1.3 billion people, one wouldn’t expect finding good local help to be much of an issue. But it is. Says Madelaine Pfau, a managing partner at the executive search firm Heidrick & Struggles International: “There is nowhere near enough senior-level managerial and technical talent to satisfy the demands of all companies hoping to grow in China. And the problem is going to get worse before it gets better.” Pfau notes that China has the world’s fastest-aging population, a result of the nationwide famine of 1959-61 and the country’s one-child policy. The current workforce, she adds, was raised in an environment of limited choice and education by rote: “The missing shell here is creativity, which puts marketing skills in short supply.”
What to do? Rethink staffing, recruitment, and retention strategies. Says Pfau: “Most companies have proved to have a real limited understanding of what ‘good’ looks like to executives in different industries and seniority levels, and even in different regions.” She suggests that U.S. companies conduct tough
self-examination to eliminate overly optimistic assumptions about how good they might look to prospective employees. She also advocates rethinking traditional organizational frameworks: “We’ve already begun to see companies experiment with novel structures in China to help alleviate staffing pressures.” For example, some companies have opted to move China-related finance operations away from the mainland to other countries.
A final tip from Pfau: Don’t treat China like an outpost. “If you’re hoping to retain local talent, it’s important to make them feel like part of the team. Six-month internships at headquarters go a long way toward establishing that bond.”
No matter the industry, the biggest problem is theft of intellectual property. Some 20% of the products coming into the United States from China are counterfeit, according to the U.S. embassy in Beijing. American companies doing business in China ranked the potential loss of intellectual property as their top concern, according to a recent survey by the U.S.-China Business Council. Foreign markets aren’t the only ones affected by piracy. In China’s domestic market, the problem has reached an extreme: 95% of the one billion video DVDs sold there are pirated, according to industry sources.
A year ago the Chinese government introduced tougher criminal sanctions against proven violators of intellectual-property rights, but 39% of respondents to the U.S.-China Business Council survey said the new penalties had done nothing to change the environment. Adds Craig Werner of the U.S. embassy: “They have to do more enforcement before it becomes believable.” That view is increasingly echoed by American CEOs. Time Warner chief executive Richard Parsons told a group of Hong Kong business leaders in October that China’s piracy problem was threatening to give India the advantage in attracting U.S. investment.
Until piracy diminishes significantly, Westerners need to be a lot more cautious about what they disclose. Notes McKinsey consultant Meagan Dietz: “In our experience, some executives are so caught up in the rush to reach the Chinese market that they share technological and business secrets too readily with partners, who subsequently use the information to become competitors.” In other words, loose lips sink ships.
While smaller companies may be able to fend off intellectual-property pirates by means of patent registration and strong social relationships with those who work in their plants, the defense for larger high-tech companies must be far more advanced. In general, it’s best to transport to China either low-tech production that uses nonproprietary techniques or high-tech production that is constantly evolving. That way, stolen plans are likely to be outdated before they can trigger mass production.
Further, unless you’re serving the China market, think twice about moving advanced production there. “China’s big production advantage is low labor costs, so if you’re moving labor-efficient operations to China, you’d better have a good reason,” notes Deloitte’s Clarence Kwan. Such reasons might include the availability of low-cost R&D—China graduates 350,000 engineers each year—or proximity to final markets. Dell, for example, has production facilities in China, but only to supply the China market. An added protection for the company: “Our made-to-order production is near impossible to copy,” says a spokesperson.
Better still, understand that your business partners—your distributors, for instance—want to make money. If the distributors can turn a better profit by copying your product—they call it “reverse engineering”—they will be sorely tempted to do so. Many of China’s entrepreneurs are far more interested in near-term profits than in relationship-building, says Jun Zhao, principal and co-founder of JJ Wellesley Group in Diamond Bar, California, a firm that shepherds midsize U.S. companies into the China market. Thus, if a product they are distributing is not selling well, they’ll be tempted to copy the product and sell it at a cut rate.
So, says Zhao, “the No. 1 issue for Western companies selling in China is this: You’ve got to get your price points right.” To keep its China pricing on target, P&G uses a constant reality check, focusing not on the value share (share of category revenues) of a particular product, but on the volume share (share of category unit volume). Its reasoning: A high value share may be the result of low volume and overpricing—a sign of trouble. Of P&G’s product categories in China, it is the market leader in hair care (Rejoice), facial moisturizers (Olay), personal cleansing (Safeguard), baby care (Pampers), and feminine care (Whisper). P&G’s Tide is the second-best-selling detergent after Diaopai, a Chinese domestic brand.
The newest frontier for many companies is the inner cities of the mainland. “Companies that have been selling successfully to China’s big coastal cities now realize that if they want to keep growing, they have to go inland,” says David Michael of the Boston Consulting Group. But that calls for a different strategy. “The two or three distributors who served you along the coast are not the ones who will be right for distributing your product inland. You may need 100 distributors, or even 500,” Michael says. And don’t expect to find them in a directory: “In some areas, they don’t even exist.” Michael adds that meeting this challenge is increasingly what separates the winners from the losers in China. “It’s all about getting your product on the shelf before competitors do,” he says.
Whether it’s distribution or finance or workforce issues, China is undergoing a massive change, and the pace is quickening. This isn’t a challenge only for foreign companies; Beijing has to think differently too. The reform of the country’s inefficient state-owned enterprises, for example, is casting five million Chinese workers a year into unemployment. At this stage, there’s little to cushion that fall. Consumerism is beginning to take root in the rural communities, but it’s hard to pay 48 cents for a bar of P&G soap if you’re making less than a dollar a day, as 60% of China’s peasants—more than half a billion people—still are. Of growing concern to business, foreign and Chinese, these inequities are beginning to stir protest. In 2005 there were 78,000 instances of social unrest, according to China’s government—a sharp rise from the prior year and a warning shot across Beijing’s bow. In response, China’s leaders are scrambling to put a social safety net in place, and the government recently announced new commitments to foster consumer spending across China. Both efforts will take time.
But within this risk lies yet another opportunity. As a result of the economic dislocations, more Chinese will head from the country to big cities, looking for work. By one estimate, 100 million people will migrate to the coastal cities over the next five years. The opportunity for companies is huge. Says Michael: “These people will need housing, sewage, education, mass transit, you name it.”
Risk, opportunity, and an ever-changing reality. That’s always been China’s story. The brand-new question: Can you keep up?
http://www.boardmember.com/
Corporate Board Member | the magazine for the Directors of Public companies. |
|
|
 |
 |
 |
 |
|
Check Out Discount Hotel Prices In China:
|
