According to an old Chinese proverb, it is always better to think things over seven times before starting to speak. Executives who want to enter the Asian Giant should keep that advice in mind. Before launching their campaign to conquer China, they should think seven times. China’s population of 1.4 billion people makes it an appetizing target for any company. So does its labor market, where the average worker earns $1 an hour for 1,960 hours a year. According to a report by Roland Berger Strategy Consultants, China is now the second most popular country for offshore operations.
However, executives should not let themselves be blinded by the bright lights of China. Before entering the country, they must analyze if China is really an attractive option for them. “I repeat this phrase often to my students: An opportunity is an opportunity until the entire world has discovered it. During the 1990s, China was truly an opportunity in any sector. However, little by little, foreign and domestic investment in the country has expanded,” says Pedro Nueno, professor at the IESE business school, and executive director of the China Europe International Business School (CEIBS). Nueno urges executives to think hard, and analyze how appealing China can be for their company.
“Over the last 20 years, a lot of companies have invested in China,” Nueno adds. “I don’t want to say that this means there are no opportunities anymore. But you will have to search harder for them, because it is harder to find them. In fact, some executives have gotten burned in China. I wouldn’t be surprised if others are getting burned but they don’t know it yet.” One company that wound up throwing in the towel in China was Chupa-Chups, a Spanish company known for its lollipops.
To avoid the same fate, a study by the Arthur D. Little consultancy recommends analyzing the market in advance and creating joint ventures with local companies. Little advises foreign firms to build a management team that includes Chinese professionals, while introducing quality programs and putting money into R&D investments.
Look Before You Leap
Larry Franklin, former head of investments at Hutchison Whampoa, has broad experience in the Chinese market. He has spent 25 years analyzing operations in China, and he currently works as an adjunct professor at the business school of The Hong Kong University of Science and Technology. Franklin insists that there are many portals for entering the Chinese market but there are only three fundamental recipes.
“First, the fundamental thing is to know local preferences. A product that sells well in your market may not be necessary or appealing in this society. Second, you have to adjust your product to the local market. Occasionally, this affects your packaging, quality, formula and pricing.” Franklin cites the case of Procter & Gamble, the multinational company, which tried to sell shampoo and detergent in China. P&G discovered that the Chinese were willing to pay a little more for “Rejoice” shampoo, but they were not as positive about Tide detergent. “Third, be flexible. You have to be flexible in your plans, and understand the local way of doing business,” he adds.
“The Chinese culture and way of doing business are very different. So it is very important to rely on a local managerial team. More and more executives are convinced that you have to adjust to the characteristics of the country rather than try to change them,” notes a report by Arthur D. Little. The report advises companies to cultivate “guanxi” (relationships). It highlights the fact that many companies have created a department of governmental relations.
For Arthur D. Little, a good case study is British Petroleum’s approach. For several years, the Chinese government has been increasing its investment in electric utilities to guarantee the supply of electricity in China. BP has taken advantage of this to create a $25 million joint venture, 50% owned by Sinopec Zhenhai Refining and Chemical, one of China’s three large oil firms (along with PetroChina and CNOOC). Between them, those three Chinese companies have invested more than $3 billion outside the country over the past two years.
A Smooth Landing
Franklin focuses on two of the five formulas for investing in the country. “These days, the formula that is being used the most is the wholly owned foreign enterprise. In contrast, it is becoming less popular to create companies that have the backing of risk capital, although this continues to be a less common model.” Franklin believes the growing reluctance of multinationals to collaborate with local partners can be explained by cultural differences and different approaches to doing business. “Same bed, different dreams,” he summarizes, colorfully. Franklin cites two examples of the obstacles that can crop up in jointly owned companies. “Board meetings are long, and the distribution channel of the Chinese partner is, quite often, the government. As a result, it is much easier not having a partner.
“I would not make anything in China that I do not make elsewhere,” Franklin adds. “If I invest all by myself in the rest of the world, I don’t know why I would do things differently in China. The only exception would be if the partner offered me something special. However, companies must avoid the mistake of thinking that the partner is going to solve a whole lot of problems, simply because he is there.”
For Nueno, there are four fundamental requirements for a smooth landing in China. “First, you have to do an analysis of the market. You have to ask yourself, ‘Is there a spot for me here?’ At this point, it is essential to analyze both the international and local competition because six or seven years ago, people did not think Chinese competitors were relevant. Now, we are seeing their importance, with operations such as IBM and Lenovo (the Chinese computer manufacturer that purchased IBM’s PC division). The second thing is to be sure you have something to offer. The Chinese need cars, but which cars — big, small, or midsize? Do they need Häagen-Dazs ice cream? That is not clear. The third thing is to ask if it makes sense to go it alone, or under the wing of a local partner. The fourth and final thing is to decide on your team. Sometimes, you look for a partner because you don’t have someone to go in with, and when you are far away, people are the most important thing.”
Arthur D. Little recommends that companies draw up strategies that enable them to recruit the most qualified personnel. This includes special compensation plans, which could include credits, housing, stock options and shares for the corporate team that is helping you build loyalty among your staff. Such companies as General Electric, Motorola and Nokia have already developed career paths for their managers in China. Beyond that, there is also the challenge of creating a good management team. Many companies prefer to hire local personnel, rather than send expatriates. Locals cost less and have more knowledge of the market. One possible solution is to hire Chinese professionals who have earned an MBA in the United States or Europe.
A Complex Market
For Franklin, the secret of success is the entry plan. Where to locate, how much money to spend, and how large a factory you need. My advice is to start on a modest scale. “Begin with about $5 million dollars. Make the mistakes that you need to make. Learn about Chinese culture, day by day, before you invest hundreds of millions,” he advises.
Beyond that, he emphasizes that China is not homogenous. Each province has different levels of buying power, different tastes, and different customs. A Roland Berger study warns that China’s development is creating a social gap between the coast and the interior of the country. China’s cities are also advancing much more rapidly than its towns. Urban residents enjoy three times as much buying power. In addition, 89% of all foreign investment is concentrated in the country’s Eastern provinces.
For Franklin, this pattern suggests that companies are almost obligated to be in Beijing, Shanghai and Guangzhou, the three most developed cities. However, some businesses are much more profitable in other locations. For example, Wal-Mart has 44 stores in China, but not one of them is in Shanghai.