In the second of a two-part interview with Knowledge at Wharton, Utz-Hellmuth Felcht, chairman of the management board at Degussa, the world’s largest specialty chemicals company, discusses his company’s strategy for China. He believes that China represents a larger potential market for Degussa than Western Europe and the U.S. combined. That is why Felcht wants Degussa to be active in China today. As he puts it, “If we want to continue to be the No. 1 specialty chemicals company 10 years from now, we better get going.” (To read the first part of the interview, please click here.)

Knowledge at Wharton: You have a major initiative called Degussa 2008. Why does the company need that, and what are you trying to achieve?

Felcht: We were the new kids on the block when we started in 2001. We had a new company, a new logo, and all that. We had three messages for the employees about what we would do in our first three years. The first was our big divestment project; the second was restructuring the core business; and the third was growth. The first phase was supposed to last until the end of 2004, and it more or less did. Last fall, I sat back and asked what’s next for Degussa. As an organization, were we so embedded and mature that we could lean back for the rest of our life? No, there still were some things that came up during our first three years that we had to emphasize in the next three years in order to have sustainable success. We did not want to stop where we were in 2004; we wanted to improve on our performance.

I discussed these issues with my colleagues, and we came up with four bullet points about areas where we thought the company needed improvement. The first is, “Make China happen.” This means that though we talk a lot about China and are doing a lot in that country, we do not believe we are doing enough there.

Another bullet point involves the way we are trying to differentiate Degussa from other specialty chemical companies with a slogan called Solution to Customers. What is Solution to Customers? Our customers, regardless of their industry, usually have a system, meaning a mixture of materials. And they usually need to stabilize their system or make their system work using products from Degussa. The system may be shampoo, or lipstick, a car tire, or ready-made concrete – because Degussa serves a broad array of markets. We have to know the systems of the customers, as well as the customers. Otherwise we cannot develop products for them. We need to develop solutions to problems that might emerge with their systems. We do not want customers to come to us when there is a problem; then it would be too late. We want our customers to know that we are already thinking of improvements that might affect their systems well ahead of time. That’s typically why we have long-term relationships with our customers. And that is also typically why we do not have only supply relationships but also R&D relationships with our customers. That is how we intend to differentiate ourselves in the market.

Knowledge at Wharton: What are your other priorities?

Felcht: The next bullet point is to reduce the number of sites in Germany; we have too many. We only have 25% of our sales in Germany, but we have 60% of our assets and 60% of our people in Germany. Many of these sites are very old. I want to make sure that we are asking and answering questions such as, “Will that site be around in 10 years or not?” Now this is completely atypical to the normal approach. Normally companies get a consulting firm like McKinsey and say, “We have to cut maintenance costs by 5% in this plant,” and then they throw out a couple of people.

That is not how we approach this issue. To give you an example, we have a site where electricity is the dominant raw material. Electricity costs are rising in Germany, and most likely this plant will not be around in 10 years. Now, I don’t want to wait for nine and a half years to think what will become of those 450 people. If I do that, I will have a problem, and the people will have a problem. I want to know what to do now with them.

So, we looked at that site to see who would be 55 years or older in 10 years. Those people can retire, and socially it’s not an issue. It turned out that 250 of the 450 people would be 55 or older 10 years from now. So we decided that they could stay until the last day and then turn off the lights and go home peacefully.

What should be done about the remaining 200, who would be under 55 in 10 years? Well, we said, slowly but surely, let us put them into other sites. We did not want to wait for nine years to move 200 people; we decided to start now. Moving 200 people over 10 years means moving 20 people a year. That’s a no-brainer. That is the kind of long-term thinking we need to buffer developments that are either positive or negative.

Our fourth and final bullet point is linked with the other three: Encouraging human and corporate excellence. Is our decentralized organization now at its best? Can we still improve in some areas in the interaction between corporate and the businesses, or interaction between the services and the businesses? Those are the questions we ask, and we keep looking at whether there is something we should improve and fine tune.

Knowledge at Wharton: What is your strategy to grow in China?

Felcht: We want to be a multinational company; 75% of our sales are outside of Germany. We want to grow in China. How do we do that? Should we send the young German hot shots there to build and manufacture and run our operations? We have found that this is much too expensive, and in the long term, it is not feasible.

So what are we doing in China now? We are hiring the Chinese, but they have no experience; they are young, because the older generations of Chinese don’t have pre-market expertise. The oldest generations of Chinese with pre-market expertise are roughly 45 years old. If you hire them through a headhunter, you can be sure that in two years, the same headhunter will be around to lure them away with a couple of dollars more. So what do we do? Our strategy is to build plants in China, and I have convinced my people not to send young German hotshots to run the plants for the first four years. No; we are looking for experienced, 55-year-old Germans. Why? Seniority counts in Asia. Secondly, these guys have their own network within the company. Third, these people are willing to go the extra mile because going to China represents the kick of their lives. Many of these people have never spent time outside Germany.

Let me give you one positive example. A man came to me and said, “I don’t have a job any more in Germany.” He had never left Germany in his life. I said, “I don’t have a job for you in Germany, but you can have a job in China.” He turned pale and said, “No, Prof. Felcht, I’ve never been out of Germany. I’ve got to talk to my wife.” He returned later and said, “My wife said no.”

I said, “I am not going to accept that. Here are two tickets for a 10-day trip to China. You and your wife can go there, and when you come back, you can give me your answer. Your house is paid for; your kids are out of the house; this could be the ultimate challenge of your life. This is your chance to do something exciting and new for yourself, a major challenge to overcome before you retire.” So he went to China, and when he came back, he said, “My wife has agreed to go to China.” This is a true story.

One year later, I ran into him in Shanghai. His wife already spoke basic Chinese in order to get around and drive a car. He had gotten rid of his old gray suit and gray tie. He was wearing a straw hat, no tie, rubber boots, running around on the construction site, talking to the Chinese people, and he was accepted as a boss.

That example shows what we want to do in China. This man represents the kind of executive whom you can charge with the goal, “When you leave China in four years, I want you to have educated two young Chinese managers as your potential successors.” For him, the young Chinese do not represent competition. But for the young German hotshot, they do. The young German would rather not educate the young Chinese, because he is afraid that when he goes back to Germany, the Chinese might do the job better.

Knowledge at Wharton: This is fascinating. Considering the kind of business you are in, specialty chemicals, how do you leverage China as part of your global strategy? In order to take advantage of China’s low labor costs, have you had to resort to less capital-intensive manufacturing methods than you might use in other countries?

Felcht: No, we have not. We have at the moment a holding company in China with 18 subsidiaries, of which 12 are already manufacturing and six are joint ventures. Our strategy is, if we need to partner in China for the local market, we build the manufacturing site at the partner site. If we don’t, we have leased land in a chemical industrial park, near Shanghai, that we built ourselves.

We have not done any projects because of the low labor cost. We have to go to China because of the size of the potential market. There are 650 million Chinese who are potential customers for Degussa. Those are more customers for Degussa than we have in Western Europe and in the U.S. combined. So, we have to go there. If we want to continue to be No. 1 in specialty chemicals 10 years from now, we better get going. That’s exactly what we have to do. We have calculated that in order to be there in the year 2010, and be the market leader with most of our products, we need roughly 100 million euros of investment a year.

Knowledge at Wharton: Are you worried about the security of your intellectual property?

Felcht: A little bit, but not enough to not go.

Knowledge at Wharton: How do you protect yourself? How do you mitigate your risk?

Felcht: You cannot mitigate the risk, because any Chinese employee can steal your technology and run away with it. But so what? Do you think the Chinese only have old technology, and they are just waiting for our technology? I’ll tell you a completely different story. We got a call from a Chinese biotechnology company. Their executives said, “Come by and visit us. We want to see if we can do business with you.” So somebody drove up and saw that they had the latest, state-of-the-art fermentation plant. They showed us examples of three products, which are Degussa products, which they can make by fermentation. And they said, “We don’t have a sales organization. Can we have a joint-venture with you, because we need a sales organization like the one Degussa has?” It turns out that the three owners all studied biotechnology on the West Coast of the U.S. They all had degrees from Stanford. They had raised money from a Chinese businessman in Hong Kong — roughly $60 million — and they built the most modern biotechnology fermentation plant.

So who is losing what now? I think the issue of risk is enormously overestimated, at least in the chemical industry. I believe three things. First, if you know the basics of a process, it still doesn’t mean you can scale it up completely or easily. Second, if you are good at scaling up and process engineering, then you don’t need the western power. The Chinese are smart enough. And third, for one German chemistry student, there are 1,500 Chinese chemistry students. Who would be arrogant enough to believe that this one German student is better than 1,500 Chinese students? I think we have to look at the intellectual property rights issue in a little bit more relaxed manner. If somebody wants to steal something, they will do it anyway.

Knowledge at Wharton: One of the things you have been talking about is the importance of planning ahead, looking ahead, whether it’s placing workers in different plants, closing plants, or finding new opportunities in China. Why don’t more CEOs do that? Why do most of them plan for the short run? Is it because of compensation concerns? Do they want to spike their performance so they get their bonus? What’s their motivation?

Felcht: If I optimize my thinking so that I get a bonus, I should be fired. A bonus cannot be the driving force of my decisions. My decisions are based within a framework that is like a triangle. On one corner is social responsibility; on the other corner is economic good sense; and on the third corner is ecological sense. I have to stay within that triangle. Those are my ethics.

If you are within this triangle and go too much to one side, then you will end up making a mistake on the other side. If you optimize every decision with social and ecological concerns, you will make everyone happy and keep the environment completely clean, but you will probably go bankrupt. On the other hand, if you optimize only on the economic side, do you think you will have a good workforce, good people? And do you think the customers will congratulate you because you pollute all the rivers around your plant? That doesn’t make business sense either. The framework of the triangle does not exist for me because I am nice and soft. I think that this triangle is a business must. Take a simple example: Nowadays, if your customer asks, “Do you use child labor somewhere in the world?” and if you cannot be 100% sure and say no…well, then you will lose business. That is why staying within this triangle makes a lot of business sense. As I said, those are my ethics.