Wharton professors Michael Useem, Harbir Singh and Peter Cappelli discuss their new book on China's fortune makers.

fortune-makers-bookChina has come a long way. In just over 30 years, its economy has evolved from a closed market that is centrally planned to soon becoming the world’s largest. That is an incredible feat considering that it lacked a capitalist system and regulatory framework to support its entrepreneurs. So the Chinese did it their way: bootstrapping their enterprises while continuously learning from their own experiences and the outside world.

This “China Way” is documented through the eyes of Chinese executives in the book, Fortune Makers: The Leaders Creating China’s Great Global Companies, by Wharton professors Michael Useem, Harbir Singh and Peter Cappelli, as well as Liang Neng, management professor at the China Europe International Business School (CEIBS). The Wharton professors recently spoke with Knowledge at Wharton to discuss their book.

An edited transcript of the conversation follows.

Knowledge at Wharton: What is the “China Way” and how is it different from how other countries conduct business?

Michael Useem: We did a book a couple years ago called The India Way, documenting how Indian companies are similar to, in many ways, but also different from, those in the U.S. Taking that analogy back to China, the “China Way,” in some respects, is no different from what we do here. You need a chief executive, you have to have a chief financial officer, you have to get people to perform, you have to manage the supply chain, you have to market. But in other distinctive ways, Chinese companies are run differently.

Harbir Singh: We did a survey of their priorities and what we found was that the first priority was setting strategy. The second was setting the culture and the third was setting the original architecture. Whereas for U.S. executives, the first priority was investors, then it was external communities, and strategy was way down. So, there’s an interesting contrast.

Peter Cappelli: It comes out of Chinese culture, this difference in the way they operate. Part of that I think [is due to a culture that is] very much top down, with an extreme focus on growth — growing really quickly. Some of that I think is the insecurity of being a capitalist in the country and not knowing when are you really secure, so being bigger is probably better for that.

They’re really good at learning. They know that they are behind the West. They spend a lot of time internally trying to figure out how to learn and get better. They look much like small companies in the U.S. — a boss who makes most all of the decisions largely by himself. The difference is they’re pretty big companies and they still manage to operate that way. Part of that has to do with the culture of the employees who follow orders pretty well still, although I think one of the big challenges is they probably are not going to keep following orders as a new generation comes in.

Knowledge at Wharton: In your book, you say that the jury is still out as to whether the “China Way” is actually sustainable without the proper internal controls. Do you think that eventually Chinese companies will develop that, and what will it look like?

“We did a survey of their priorities and what we found was that the first priority was setting strategy. … Whereas for U.S. executives, the first priority was investors.”–Harbir Singh

Cappelli: The most distinctive thing about these companies is that within the small circle of, you might think of as the operating committee, there may be seven or 10 people at the top of the companies. There is a lot of loyalty and there is a great deal of trust. And there is a belief among those people that the boss will not fire them — that if you at least come clean with mistakes and you do it soon, you are not going to lose your job.

As a result, there is a belief that there is an extraordinary degree of transparency there. The executives are not hiding problems and they are not worried about surfacing them. If that is the case, you do not need all the internal control systems that we layer on U.S. companies, a lot of internal accounting or bureaucracy. One of the reasons they can move quickly is because they do not have all that. [It is also] one of the reasons they can be cheaper.

Useem: The early entrepreneurs were like the early global explorers. They had no sense of how to start, how to get going, how to build. And they often discovered that in the early years without laws, for example protecting private property, as a young entrepreneur if they were successful they couldn’t even be sure that at the end of the day they were going to be able to hang on to what they had created.

That said, they have created a learning mentality: We just have to figure out how to do this. Let us look at our experience, learn from what works. If it worked, let us do it. If it does not, let us get rid of it. And they were unburdened by tradition. That was the key point even if they did not have an infrastructure to build on in a broader sense: No business schools, for example, to recruit people from. … We think they can sustain themselves because that learning DNA is just part of who they are.

Knowledge at Wharton: Early on when Chinese entrepreneurs were starting out, they did not have much infrastructure support or regulatory support. Do you feel that that has changed on the part of the Chinese government? Are they more supportive? Are regulations coming along?

Cappelli: There’s an up and down to that. In the early days, the government was hostile to capitalists and they were hostile to a lot of these companies that were starting up. It was quite challenging for the companies to do anything. So it was not that they did not have support; they were actually under attack.

Then there were, for some companies, opportunities that the government did give them: funding through the state-owned enterprises, keeping out foreign competitors to some extent. The local governments in China are the big story with respect to this, not the central government per se. In order to generate jobs, many of these companies got a lot of breaks. They got free land. They got roads, infrastructure — things to get started.

But our sense from interviewing these folks now is that in this later stage, once they are up and running, they just want to stay away from the government. They are like U.S. companies. “I’m here to help,” the government says. And they do not want to have anything to do with them. They understand it is very important to get along with the government and they work to do that and to pay attention to what the government wants.

But they are not expecting help from the government and they do not want to do too much from the government. I would say at this point for the companies that are already up and running, they are probably not getting a lot of help from the government. They are pretty much doing it by themselves now.

Singh: In terms of the stock market, actually the Hong Kong stock exchange has very similar transparency requirements as the New York Stock Exchange. For public listings, they recognize that they have to have a high degree of transparency, follow the globally accepted rules of accounting, and so on. But I did want to mention also that in the area of M&A, I think there is a lot of variation in terms of their understanding of how capital markets work. And in that area, you will see a lot of heterogeneity.

Useem: It is hard to imagine, if you are an entrepreneur in the U.S., surviving if you could not hire more than six people. But at one point that was the policy in China. Hard to imagine a start up in Silicon Valley that does not provide for incentive compensation, but for a while you could not provide incentive compensation in China. All of those restrictions, of course, are gone.

But the effect was to force those who were struggling to get going fast when Deng Xiaoping opened up this small crack for private enterprise. … [To survive,] they had to be really feisty, determined to get through these incredible points of resistance. One result of all that is you have people who are still running these enterprises, who still remember the days when everything was arrayed against them. And thus, that has given them a kind of resilience that is unusual in some other countries.

“They are really good at learning. They know that they are behind the West. They spend a lot of time internally trying to figure out how to learn and get better.”–Peter Cappelli

That said, a state-owned enterprise is a state-owned enterprise. They are protected unequivocally by the government; their interests are advanced. Our focus, though, in talking with the people who run Lenovo, Alibaba and other non-state owned companies is on how they operate when you are not officially government-owned. We thought this might be one of the distinctive elements of operating in China.

Knowledge at Wharton: I was wondering if Chinese companies compensate their employees differently from those in American companies. And also, maybe corporate governance practices, how different are they? And do they have CEO succession plans? Or are these mostly family owned enterprises?

Cappelli: One of the things that was quite surprising is that I do not think we heard from any of the executives or leaders that they expected their family to play a role in their companies. They had moved past that. They understood these are big, complicated businesses and that they needed professionals, and in many cases they need professionals who would come from outside. … They are not family-dominated, they are not family run, they are not intending to go in that direction in the future.

Some of the companies have started to pay their top people stock options and leverage compensation, but I would say they are kind of unique in the extent to which that is not the case — the founders are astonishingly wealthy and the people around them, often the people that helped build the company, are not. This is not like Silicon Valley companies where if you were in at the beginning of a company like Alibaba or Vanke or something, you would expect to be extraordinarily wealthy. Unless you were the founder, you are not that wealthy.

Singh: Governance has multiple dimensions. There is the issue of independent directors versus CEOs and how they set strategy. Then there is the whole issue about the shareholders versus managers — and then shareholders versus other stakeholders. So one of the things we see is that these leaders, they seem to view investors quite far down the set of priorities, which is interesting. Maybe because they themselves are investors. But there seems to be less of this analyst pressure that we see in the U.S. That is an important point. Governance there is different in that sense.

What kind of check and balance do they have? We have a whole chapter entitled “The Big Boss” and the idea is that there is a tremendous amount of authority that senior management has. That is good and bad, right? The negative side of that is there is not as much dialogue as there should be — the quality of discourse is relatively one-sided. Then we have the issue of shareholders versus stakeholders. On that, there seems to be variation. It is what their sense of responsibility is to society. Some people actually do have a sense of mission. But I think the shareholder versus manager — there is a very big difference.

Cappelli: There is this belief many people have that as soon as they enter western finance markets, they are going to change. We heard people say the same thing about the Indian companies too and it is not true. One of the things that we forget in the U.S. is that it is not so much the rules of public funding that change the way the companies operate, it is the way they respond to the incentives that are created by that and the culture around that. …

The Indian companies that were listed in the U.S. did not seem to change the way they operated at all. My sense for [Chinese] companies is that they are not going to change that much either.

Useem: Chinese company ownership — these are private companies, of course — is still very much concentrated in a few hands. If you take General Motors or Proctor & Gamble, the biggest stockholder probably at most has 2% or 3% of the shares of those companies. The biggest these days are obviously major institutions: BlackRock, Vanguard or Fidelity. In China … the number one stockholder is often not at 3% but at 30% or 40%.

“The early entrepreneurs were like the early global explorers. They had no sense of how to start, how to get going, how to build.”–Michael Useem

Take that fact, and then add in the ‘Big Boss’ model that Peter and Harbir have alluded to or described, and you have the makings of a board that is there, but maybe not all that influential in the way that American boards have become very independent – they are there to monitor management; keep management on the straight and narrow.

But turning it upside down, some Chinese companies — our favorite example again is Lenovo but it is evident elsewhere — the big boss at the top working with other people in senior management have moved to put really strong people on the board, not to keep an eye on management for monitoring reasons because they are not going to do much of that, but to have great ideas in the boardroom, and thus the board has often become like an advisor, in effect a strategic advisor, a strategic partner if you take it pretty far along with top management.

That gets back to the fundamental question of governance — for what? And the most striking element is that in contrast to the West where shareholder value is the mantra – it is the focus — the criterion for success, the consideration in picking a new CEO, it is just not there. So what is there? … It really is not about delivering more value to the owners, it is about growing. Maybe to grow now before it gets too late. Maybe to grow now because we just want to do a great job. Whatever it is, it is just a different drum beat. We want to grow. We want to get bigger. We want to deliver great services and products.

Cappelli: The other thing that is surprising about these CEOs, these founders, is that they have, for the most part a pretty small social footprint. They are not showing off, buying huge estates and things. In the context of living in a Communist country that is probably not surprising. But they also are not very much involved in civil society, and maybe that is not too surprising either because there is not a lot of civil society in a Communist country.

You do not see a lot of philanthropy, for example, very little really. And again, maybe that is a context of the particular culture. Maybe it is an age effect of these founders. Even in the U.S., the Andrew Carnegies, Rockefellers and Fords and their foundations did not come until the founders died — Carnegie a little before then — but it came at the end of their careers. So maybe it will happen there in China. But so far, lots of incredibly rich founders do not operate outside their firm the way we see founders operate here. There is no Bill Gates equivalent in China.

Singh: The goal probably is the name on the door — we want to be the biggest company in this industry. We want to have the highest prestige. In the U.S., I think people have traveled down that road and realized that that can come at a price. But I think for them, the name on the door is really important.

The other issue is that in their lifetimes, they have seen so much growth and there still is this sense of urgency and this growth [mindset because] they never thought that they would get it when they were young. So there is probably a sense of obsession with the business and not thinking beyond that. I think that is very much a part of what we are seeing.

Knowledge at Wharton: Can each of you share a favorite Chinese CEO story or Chinese company story?

Singh: Jack Ma from Alibaba. One of the very interesting things he did was to always keep the Chinese consumer top of mind. EBay was already very strong in China when he had the ambition to build his company. One of the differentiating factors that allowed them to essentially win against eBay was that they played off the idea that Chinese consumers want to verify goods when they buy online and they want to negotiate if possible.

So they created an algorithm in the software to allow consumers to actually inspect goods and create an escrow account. EBay did not essentially do the same at the same pace because they were using the U.S. model. And that was one differentiator that allowed Alibaba to gain on eBay.

Useem: [Lenovo founder] Liu Chuanzhi … left a very promising career as an engineer doing research on hardware and software in computers at the Chinese Academy of Sciences [to start his business in the 1980s]. He had himself and one other employee.

… Because they had no roadmap, no textbook, no business school background, no tradition of how you manage or run anything, he would sit down and do a weekly after-action review.

“For public listings, they recognize that they have to have a high degree of transparency, follow the globally accepted rules of accounting and so on.”–Harbir Singh

[They would ask themselves,] “We got through a whole week. We are not bankrupt. What did we do right? Where did we blow it this week? And with the answers to those first two questions, let us be better next week.” It is symptomatic of this learning pathway they have all been on because they had no [business] background. … The founder of Lenovo had one employee back in 1982 and today it is the world’s largest provider of personal computers.

Cappelli: Let me tell three anecdotes about three different CEOs and just roll them into one since they are all quite similar. One hires a student from Peking University every year just to read business books for him and summarize them. Another says that a quarter of his time is spent reading, and not reading things about the company, but just reading in general.

A third requires all the top executives in the operating circle to prepare book reports on the most important books they have read and send them to the CEO. So the idea of the company as a school that actually looks like a university is pretty profound.

Knowledge at Wharton: When foreign companies set up shop in China, to what extent should they adopt the Chinese way of management?

Cappelli: It is extremely difficult to do it if you don’t have a Chinese CEO and you do not have Chinese employees and Chinese management, and if you have ties back to your home country that impose requirements around you. … The point is really to understand what your competitors are doing in China, and maybe your partners there as well. However, there are a few things you can learn from China that you probably could adopt in the U.S. I think for me the important one would be this question of trust and the benefits — if you really had trust at the top of the organization — that could accrue to you

Singh: This book can inform people about what is the model of doing business in China and the history of the evolution of these companies, which I think is really important, including making up their own ideas as they go along. Of course, now we have lots of business schools that are very good there, and so on. But if you think about how companies manage global operations, maybe they can be integrated on technology and so on, but organizationally it seems that being differentiated or allowing different operations in China to operate in a way that works for them is going to be important. I think interfering or getting a hybrid model or imposing a model is probably going to be disruptive and may not result in good outcomes.

Useem: It’s a really good question to end on because much of the motivation for us to take on the book — and we did 75 interviews with people who are out there like Jack Ma, building companies like Alibaba — is to help people in the West, including ourselves, better appreciate how companies do operate in China and how they are going to operate when they are over here.

Back to The India Way, our earlier book, one thing that we noticed as we did a similar methodology with over 100 Indian CEOs is that Indian top executives are very committed about giving back to the community and [this mindset] is carried through to their company. If there is not a hospital, they will build a hospital, for example. Now American companies going into India are not going to be doing that. But it is really important to know that your competitors are because Indian consumers are going to wonder, “well, your competitor, an Indian indigenous company, is helping build roads and provide public health,” and it is a bit odd that as an American company we do not do that.

Back to China. Two of the accounts that we do reference in the book … refer to the fact that a couple of very well-known U.S. companies have had a go of it in China — eBay and Uber. And they were both defeated by very able competitors. The competitors in some respects simply could outgrow them.

There’s a Chinese Uber equivalent [Didi]. Uber just threw the towel in recently when the competitor was willing to take losses for longer in the interest of just getting big. In the case of eBay, it is up against Alibaba, and Alibaba in some respects had a better operating model. But it also had a deeper commitment to building without worrying about quarterly returns. American companies in China have to worry about that — it is who we are. It is how we operate. But it is good to know what you are up against when you are in China. That is partly why we wrote the book.