Lenovo Group, China’s largest personal computer manufacturer, gained a great deal of attention when it acquired IBM’s PC unit in 2004. The company has encountered some serious challenges since then, but co-founder Liu Chuanzhi — who returned to his position as chairman at the beginning of this year, after stepping down following the IBM deal — is confident that Lenovo can turn the situation around.

In a keynote speech delivered at the Wharton Global Alumni Forum in Beijing in June, Liu highlighted several principles for building a healthy company, including knowing your industry thoroughly, responding to market changes, and building a strong team and corporate culture. He also discussed the landmark year of 1994, when the groundwork was laid for Lenovo’s later success.

Following are edited excerpts from Liu’s speech:

A strong, healthy man won’t be hit easily by the flu.  It is the same with business: A healthy business will not be hit easily by a crisis.

Lenovo has gone a long way to build itself from a start-up in a small room into a multinational company with some impact on the global stage. In my speech [today], I would like to talk about how to build a healthy company. 

So, what makes a company healthy? The first question [to ask] is: Do you have a thorough understanding of your industry?

Take the PC industry as an example. In 1994, China’s PC industry was at a crucial turning point. Before the 1990s, in order to protect the domestic PC industry, our government prohibited PC imports by adopting high tariffs and a difficult approval system. Consequently, the quality of China-made computers was really bad; meanwhile, there were no imported products [to compete with them]. In 1991 and 1992, China’s government wisely lowered the tariffs and abolished the approval system, which resulted in a big inflow of computers made by foreign companies like Compaq, AST Computer and IBM, but their price was very high.

The other consequence of opening the door was that China’s own computer business was heavily beaten. The biggest national PC brand at that time was Great Wall, but it disappeared after 1994 and became a factory for IBM. [At that time, Lenovo was] not a completely state-owned company, and we were the fourth largest in China, with PC sales of only around 20,000 that year.

We were standing at a crossroads. Our capital, management, technology and talent levels were obviously in a disadvantageous position compared with those of the big foreign brands. It was a choice for us whether to continue our own brand or to be an OEM (original equipment manufacturer) for foreign companies. We held many meetings to discuss our future direction. During the meetings, we listed all our advantages and disadvantages. We concluded that we had many big problems. For example, our gross profit margin stood at 25% — relatively high in the industry — but our costs were also very high.

Know Your Industry

Eventually, our decision in 1994 was to restructure the organization, reform our business model and hire Yang Yuanqing (now the CEO of Lenovo Group), who was then 29 years old, to be the general manager of the business unit. I stepped down from the CEO position between 1994 and 2000. The average growth rate of Lenovo’s revenues and profit reached 100% during that period.

Why did we have such a high growth rate? One of the reasons is that we did thorough research and tried to understand the industry. For example, we analyzed our cost structure in 1996. Cosmetic companies have advertising as their biggest cost, and for software companies, human capital is the biggest. But for us, the biggest cost was components, comprising 84%. What’s more, those basic components changed constantly, with CPUs (central processing units) undergoing continuous upgrades, from 286 to 386 and 486 processor chips. The price of the components, including the hard disk, was continuously dropping, which makes the computer almost like fresh fruit that cannot be preserved. You have to sell it quickly, otherwise its value will be drastically reduced.

A very impressive memory for me is that in July 1996, we bought one piece of a chip for US$16, but the price dropped to US$2 by September. For each computer, which comprises eight chips, the price difference was US$200 [lower], based on the cost of chips alone, within a few months.

We began to realize that the biggest challenge was to compress the turnover of our inventory, and to build up a cost-efficient supply chain. We began vigorous efforts to reshape the supply chain. It was hard for us because we had little negotiating power in talks with suppliers like Intel. But we tried every means to place orders week by week and to reduce our inventory turnover time. Our efforts were quite effective. In 1996 alone, we cut our price six times, which caused the media to become very concerned. They worried that we were going to kill [the company] and sell everything before closing down. But the truth was we had unprecedented profit at the end of that year because we sold much more than before.

At that time, most local Chinese companies were not thinking about cost structures and supply chain issues as actively as we were. They were thinking more about how to lower the import tariff or how to counteract foreign exchange risks and so on. But we really spent a lot of effort on our supply system.

Another example concerns technology. When Lenovo gained [a certain level of] recognition in the market and from society, many people asked us to do more core technology, which was the most profitable item in the value chain and was controlled by companies in developed countries. After [conducting] thorough research, we determined not to do that, because Lenovo was still a young company and we didn’t have that much capital. Intel had invested heavily for many years; it had become the standard-setter for the chip industry and would be very hard to challenge. A very small company challenging the core technology giant [seemed] almost like suicide.

Respond to the Changing Market

But we did manage to attempt one thing: integrating product technology. We first learned this strategy from the [television manufacturing] industry. In the early 1990s, Japanese TVs were everywhere in Chinese families. From the mid-1990s, Chinese local companies like Changhong, Haier and TCL were gaining market share. Why? Because they are good at integration.

Due to the difference in voltage between Japan and China, Japanese products were not ideally suited to an unstable electrical source environment like China. So some local companies made some improvements that soon helped them gain market share.

Lenovo began to think in that direction. For example, in 1998 and 1999, the Internet became hot. But in reality, it was very inconvenient for a user to visit the Internet, because for computers at that time you needed to buy a modem, install other software and even register with the telecom department of the government. So, we launched a product with a function called “one key online,” which soon became a hot seller in the market.

That year, our market share grew from 9% to 18%, which made us number one in China’s PC market. Since then, we have been very much focused on the invention and development of product technology to respond to market demands. Among them is today’s very common “one key recovery” and others.

What was the result? In 1995 and 1996, while our competitors’ gross profit margins were at 9% to 10% and dropping, ours stabilized at 14% to 15%. In addition, our costs were kept low due to rigorous cost management, and our net profit was good as well. In the computer industry, most of the players are not really making money, so you have to be very careful about managing your business and [make a] huge effort to control your costs.

Even if you understand your industry well, is that enough to make your company into a sustainable winner? Certainly not. The world is changing, the industry is changing, your competitors are changing and the national economic environment is changing. Your company will not survive if you don’t respond to these changes.

A typical case is the [photographic] film industry. Around 2000, I was invited to give a television interview with a friend from Lucky Film Company, a famous local photo film company. [Shortly after that], Lucky Film was hit hard by the arrival of the digital camera. As a business leader, if you do not observe market trends and revise your strategy beforehand, you will be killed.

Build Management Basics

At Lenovo, we set up our management basics according to three [principles]. First, set up a top management team. Second, shape the strategy. Third, lead the team — which means building a capable, competitive and efficient employee team.

A company should have a vision. But vision alone is not enough; you also have to set a mid-term target. After that, the most important thing will be [to determine] the strategies for reaching this target.

In my own experience, strategies are very important. At the time we started the company, we only had 200,000 yuan in investment capital. Our strategy at the beginning was to do OEM for foreign companies like Hewlett-Packard. We learned finance, marketing and sales from them. Meanwhile, we were also observing how companies like Intel and Microsoft designed their strategies and we learned from them.

In Silicon Valley, many companies [develop] a certain technology first, and then find investors, and then trade. But our course was “trade-manufacture-technology,” which was controversial at that time. But that was based on our own situation, which does not apply as a rule to other companies. Every company has to find its own course based on its own conditions.

Another [strategy] lesson [involved] the real estate frenzy [beginning in] 1993, which attracted the investments of many companies from various industries. We began to discuss internally whether should we buy land here and there. But we didn’t feel good about that strategy. So we held meetings internally, and asked [ourselves] what is our target, what do we really want to do, and what should we do? The conclusion was that we should focus on computers.

There were always too many temptations. Minsheng Bank was talking to me, asking for investment at the very beginning. If I had invested in Minsheng Bank, I would have made hundreds of billions today. But I think our decision at that time was right. Even if I would have made billions in Minsheng Bank, I might have lost more than that in other investments.

We are happy that although we haven’t done everything, we have accomplished some things that we wanted to do. [Having] clear strategies made us focused.

Around 1997, as we had good performance in China, we began thinking about going abroad. I took our executive team to visit Taiwan at that time. All of the Taiwanese computer companies were bigger and stronger than us in terms of technology and business capability. But they didn’t have their own brands, and even branded companies like Acer were frustrated in international market. Why can they only be OEMs? One important reason was that they didn’t have a big enough local market. If you go abroad, you have to be a strong brand.

I then realized that it is really valuable that we have such a big market in China and such high growth in the local market. So we decided not to go abroad, and we concentrated on the domestic market. Later, our market share reached 30%, beat some brands in China and also laid a foundation for us to shift our strategy in 2004.

The key to implementation is people. In a war, even you have a good fighting strategy, history tells us that having soldiers who are brave enough, with skills in shooting and fighting, is what makes the difference.

Lenovo divided “lead the team” into three [elements]. First, how can you get your soldiers to love fighting? That translates into: How can you get your employees to love the company? Second, how can you make your soldiers skillful in fighting? Third, how [can you do all of this] in an orderly fashion? And there are other questions: What organizational structure is the most efficient? What will be the incentives? Both material incentives and cultural incentives play very important roles.

‘On the Edge of a Cliff’

Today, we all know that Lenovo has had difficulties. It is expected. The global financial crisis brought shocks to our big clients — the main consumers of our Thinkpad products overseas. To respond to the crisis, one of the first things they do is cut their budgets for computers.

But on a deeper level, we have had many problems exposed. In acquiring IBM’s PC unit, we anticipated three major risks. The first was the brand risk — whether our brand would be recognized by the market after we bought Thinkpad. This looks successful today. Second, whether previous employees would be willing stay with us — and we overcame this challenge, too. The third issue, which was the biggest, was the difference in mindset between management and the board of directors. I can’t say too much because it’s a company secret. [Some colleagues have told me] we are “standing on the edge of a cliff.” I say yes, it’s the edge of a cliff, but it’s an important turning point for Lenovo as well. And things will be clearer in a year or two….

But overall, I am very confident. Why? As I just mentioned, we have a good management system, and we put lots of effort into shaping our strategy. So whether a company can respond to the crisis is mainly determined by whether it’s healthy enough. But on the other hand, if an earthquake comes, even a very strong man will not stand it…. [Meanwhile, we can] try our best to do something beneficial for society, which is good for every one of us.