Multinational companies and China: What future?
 

Multinational companies and China: What future?

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This report outlines where China currently fits on the agenda of multinational companies (MNCs) and shows how global companies are recalibrating their China operations in reaction to new realities. ...

This report outlines where China currently fits on the agenda of multinational companies (MNCs) and shows how global companies are recalibrating their China operations in reaction to new realities. Its findings are based on a survey of 328 senior executives conducted in June and July 2011, as well as in-depth interviews with executives of major foreign multinationals, business scholars and market analysts.

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    Multinational companies and China: What future? Multinational companies and China: What future? Document Transcript

    • Multinational companiesand China: What future? An Economist Intelligence Unit report Sponsored by:
    • Multinational companies and China: What future? Contents Preface 2 Executive summary 3 Introduction 6 Chapter 1: The big picture 9 Hope, hype and reality 10 Justified optimism? 12 Chapter 2: The consumption story 13 Chapter 3: The perils of success 16 Is it enough 16 One strategy, or two? 19 Is it too much? 20 Lacoste: Who’s your benchmark? 22 Chapter 4: Whose hubris? 23 Suddenly uncertain 25 Chapter 5: The invisible hand 28 Aiming high 29 The real issue 30 A non-standard approach 32 At what price? 32 High-speed trains: A series of unfortunate events 33 Getting on with it 34 Chapter 6: Honour thy master 36 The renminbi 38 By other means 41 Nissan: According to plan 42 Investing in R&D 43 Chapter 7: Gearing up to play the game 44 Overcoming the fear factor 46 Appendix: Survey results 48© The Economist Intelligence Unit Limited 2011 1
    • Multinational companies and China: What future? Preface Multinational companies and China: What future? is an Economist Intelligence Unit report, sponsored by CICC. The EIU conducted the survey and interviews independently and wrote the report. Gaddi Tam was responsible for layout. The cover design is by Harry Harrison. The findings and views expressed here are those of the EIU alone and do not necessarily reflect the views of the sponsor. Many interviewees for this report have asked to remain anonymous and we have respected their wishes. We would like to thank all interviewees for their time and insights. November 20112 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future?Executive summaryW ith leading economies of the world in dire shape, China now has become a crucial engine of global growth—sooner than anyone had imagined. While developed countries remain in a quagmire,China keeps roaring ahead. While consumers elsewhere worry about their jobs and financial future, manyin China are getting rich, and about to get even more so. Beyond the headlines about China’s growing weight in the world—whether in purchasing power orotherwise—what does China now mean for multinational companies (MNCs; unless otherwise noted, thisterm refers to non-Chinese multinationals)? Are they backing up their talk about the importance of Chinawith real investment? Are they being rewarded in return? Equally important, and not unrelated, what doMNCs mean for China? Will they be allowed to realise their dreams? Or will they be held in check whilelocal companies improve their capabilities? This report, Multinational companies and China: What future?, outlines where China currently fits onthe agenda of MNCs and shows how global companies are recalibrating their China operations in reaction 1 The survey covered 328 companies from a range ofto new realities. Its findings are based on a survey of 328 senior executives conducted in June and July industries. The respondents20111, as well as in-depth interviews with executives of major foreign multinational s, business scholars came equally from companies headquartered in Europe,and market analysts. North America and Asia- Pacific. In terms of size, 55% Among the key findings: had global revenues of more than US$500m, with 44% having more than US$1bn in• Multinationals, large companies in particular, are clearly counting on China to deliver more. revenues. For more details seeAlmost half (49%) of all the survey respondents said that the fallout from the global financial crisis has appendix.raised their companies’ expectations for China. Among the larger companies (global revenues of morethan US$5bn) the figure is 73%. But not all companies are planning to invest more in order to increasereturns. Among the larger companies counting on China to deliver more, half are counting on existingoperations to bring more growth.© The Economist Intelligence Unit Limited 2011 3
    • Multinational companies and China: What future? • While MNCs are bullish, there are signs they are hedging their bets. The exuberance of consumer2 Coming of age? Multinational goods firms aside, China seems to have stalled, rather than risen, on MNCs’ agendas. Among thecompanies in China, EconomistIntelligence Unit, 2004. The respondents to our survey, the share reporting that their headquarters view China as “critical to globaldemographic for the 2004survey was similar to the 2011 strategy” was 37%. This is down from 53% reported in a similar survey conducted in 2004.2 But this doessurvey, though nearly 70% of not mean that China is not an important market for many firms. A further 33% of respondents said thatthe 217 respondents in 2004were from corporations with while it is not critical, it is strategically important.global revenues of US$1bnor more; in the 2011 survey,44% of the 328 respondents • Today, China is still a relatively small market for many multinationals, but this is expected tohad US$1bn in revenuesor more. Focusing only on change quickly. Analysis of the financial results of 70 MNCs3 showed that in 2010 only ten had Chinathe responses of companies revenues that accounted for more than 20% of their global revenues. For more than half, China accountedwith more than US$1bn inglobal revenues, the figure for less than 10% of global revenues. Companies do expect this to change. Only 8% of our surveyis still down in the 2011 respondents said China is already their biggest market, but 17% expect it to become so in less than fivesurvey—48% view the countryas critical. years, while another 21% expect this to happen in 5-10 years.3 In compiling our list weexamined Interbrand, S&P • China’s consumption story is driving MNCs’ strategy. The Chinese government’s drive to raise incomes100 Global, and S&P 500companies to find those that and shift growth towards domestic consumption is likely to have a profound impact on most companies.disclosed their China revenues Among survey respondents, 58% said that this policy is the factor that will have the biggest impact on theirin their latest publishedannual reports or other China strategy, while 56% said that growth prospects for their industry was the key driver of their Chinareliable sources. strategy. • One of the greatest challenges facing multinationals is achieving “China speed”, while maintaining a low profile. Multinational companies tend to want to build more slowly and solidly than their local counterparts, but if they do so in China their competitors are likely to fill the gaps. Overall, 59% of our survey respondents remain focused on “improving penetration in wealthier coastal cities/southern region”, and only 33% of them are “currently moving into second- and third-tier cities”. At the same time, companies worry about getting too far ahead of the local competition, lest they attract unwanted attention. This could explain the seemingly low expectations of our survey respondents in terms of using acquisitions as a route to growth in China: only 20% chose acquisitions as the most important strategy for growth in China, while 63% chose organic growth and 46% said joint ventures. • There are signs that multinationals’ traditional competitive advantages are beginning to erode in China. It is often taken as fact that multinationals have superior technology and better brand management, and hold more appeal for talented workers. There are signs that all of these advantages are beginning to erode in China. Even among the large companies surveyed for this report (global revenues of more than US$5bn), only one-quarter felt they have superior technology or a stronger brand, with these figures even lower for the sample as a whole. Human-resources consultancies report that local talent is increasingly gravitating towards mainland companies. • China’s policies aimed at encouraging local innovation are causing a great deal of ill will among multinationals. Among our survey respondents, 49% were concerned or very concerned that they would4 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future?be forced to give up their IP in exchange for market access. Among big companies the figure was 52%.While some of the more objectionable measures have been softened by the central government, executivesstill worry about local protectionism. And 46% of respondents said that China’s regulatory environmentand industrial policies were likely to have a big impact on their China strategy in the next five years.• Multinationals need to reorganise to match the importance being placed on China. Among largecompanies responding to our survey, only 8% said that their China CEO sits on the company board (for 45%,the China CEO reports into regional headquarters). However, 40% of large companies said that they hadposted very senior executives to greater China, a move aimed at improving understanding of China andspeeding decision making at headquarters.• While planning how to win in China, multinationals are beginning to think how they can leveragetheir relationships there to compete elsewhere in the world. While most arrangements seem to involvecooperative agreements with Chinese partners on the use of specific products in other markets, there aresigns that this could be taken a step further to include joint ventures in third countries.© The Economist Intelligence Unit Limited 2011 5
    • Multinational companies and China: What future? Introduction M any foreign multinational companies4 (MNCs) have long viewed China, with its 1.3bn people,4 Throughout this report,unless otherwise noted,“MNCs” refers to non-Chinese as a dream market, with the emphasis on “dream”. With leading economies of the world inmultinational companies. dire shape, China now has also become a critical engine of global growth—sooner than anyone had imagined. While developed countries remain in a quagmire, China keeps roaring ahead. Consumers elsewhere worry about their jobs and financial future, but many in China are getting rich, and about to get even more so. In many sectors, China is now an emerged, rather than an emerging, market. It is the world’s largest market for cars, air conditioners and LCD-TVs, to name just a few products. No doubt, China will soon be the greatest consumer of a whole host of other goods from medicines to designer handbags. Beyond the headlines about China’s growing weight in the world—whether in purchasing power or otherwise—what does China now mean for MNCs? Are they backing up their talk about the importance of China with real investment? And are they being rewarded in return? Equally important, and not unrelated, what do MNCs mean for China? Will they be allowed to realise their dreams? Or will they be held in check while local companies improve their capabilities? This report, Multinational companies and China: What future?, assesses where China currently fits on the agenda of MNCs, and discusses how some are recalibrating their China operations in reaction to new realities. Its findings are based on a survey of 328 senior executives at non-Chinese multinationals conducted in June and July 2011, as well as in-depth interviews with executives of major foreign multinationals, business scholars and market analysts, and other published reports on specific industries. Multinationals’ future in China varies greatly depending on industry, company size and indeed on the individual company concerned. But some general observations can be made. First, companies are counting on China to deliver more. But not all are planning to plough in more investment in the name of higher returns. Almost half (49%) of all the survey respondents said that the fallout from the global6 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future?financial crisis has raised their companies’ expectation for China. But while 21% are “investing morein China in the hope that it will make up for deteriorating markets elsewhere”, 28% are “counting onexisting operations in China to deliver more of [their] global revenue”. Larger companies (revenuesof more than US$5bn) are more willing—and presumably able—to spend: 73% are counting on Chinato deliver more, but they are almost evenly split between investing more and counting on existingoperations to deliver growth.Counting on ChinaHow has the fallout from the global financial crisis affected your company’s expectation for China?Choose the one answer that best applies. All respondents(% respondents) Big companiesWe are counting on our existing operations in China to deliver more of our global revenue 28 36We are investing more in China in the hope that it will make up for deteriorating markets elsewhere 21 37We are postponing further investment in China because of deterioration in our main markets 9 4We are repatriating more profits from China to shore up balance sheets at headquarters 2 1Our expectation has not changed 40 22Source: Economist Intelligence Unit survey Yet China is not as crucial to foreign companies as may be expected, given widespread hype about itsgrowth. The share of respondents reporting that their headquarters views China as “critical to globalstrategy” was 37% in our 2011 survey, down from 53% reported in a similar survey conducted in 2004.5 5 Coming of age? Multinational companies in China, EconomistAlthough the survey sample from 2004 had a higher percentage of larger companies, when we look only at Intelligence Unit, 2004. Thethe responses of companies with more than US$1bn in global revenues, the figure is still down in the 2011 demographic for the 2004 survey was similar to the 2011 survey, though nearly 70% ofCritical, or just important? the 217 respondents in 2004From the perspective of your global headquarters, which statement best describes China? were from corporations with(% respondents) 2011 total 2011 big companies 2004 total global revenues of US$1bn orIt is critical to global strategy more; in the 2011 survey, 44% 37 of the 328 respondents had 48 US$1bn in revenues or more. 52.5It is strategically important, but not critical 33 36 40.6It is on a par with other emerging markets 9 5 5.5We are still exploring the market 13 91.4It will be a niche market for us 5n.a.Don’t know 21Source: Economist Intelligence Unit survey© The Economist Intelligence Unit Limited 2011 7
    • Multinational companies and China: What future? survey—48% view the country as critical. Still, that is a fairly large percentage of companies banking on China. And even those for whom China is not critical view it as important. Indeed, based on our qualitative interviews with multinational executives and service providers working with them, it seems that foreign companies that have so far only dipped their toes in China are seriously considering taking a headlong dive. Many that had been to China and left in failure are now returning. Even those that have been aggressively expanding in the country for years are recalibrating to seize the historic opportunity that China presents—those with valuable technology are trying to figure out how to do so without losing their shirts. At the same time China is presenting new opportunities in areas such as capital raising and research and development (R&D). But China from here on is going to become more difficult (not that it was ever easy). The post-crisis self-confidence of the Chinese government, companies and people is soaring to the point where it strikes many outsiders as hubristic. Today, some foreign companies in China wonder how long they will be welcome. While smaller foreign consumer-goods makers, retailers and lower-tech companies seem largely to fly below the radar, others feel they are being watched carefully. China is making greater demands— especially on foreign companies with proprietary knowhow and cutting-edge technologies. Competition is already brutal. To build a winning business in China, foreign multinationals must now plan even more meticulously—as well as make tangible contributions to the host country’s continued economic development. The image of China that emerges from this research is a country of outsized potential, boundless ambition and increasing complexity. The relentless rise of the China market remains one of the most important global business stories today. But how this story ends will not be the same for all MNCs. That will depend on how well each company writes its own subplot.8 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future?Chapter 1: The big pictureThe role China now plays in the world economy is pivotal. But its role in the globalrevenues of multinational companies is, for the moment, less so.T he global financial crisis has undeniably raised China’s stature in the world. Thanks to its ability to maintain near double-digit annual GDP growth through the tumult of 2008-09, China overtookJapan as the world’s second-largest economy in 2010. Before the global financial crisis erupted,Goldman Sachs had expected China to surpass the US as the world’s biggest economy around 2041.But now, the Wall Street bank projects that the Chinese economy will overtake that of the US by asearly as 2027.6 The Economist Intelligence Unit (EIU) forecasts that on a purchasing power parity 6 In terms of constant 2007 US dollars. See Goldman(PPP) basis it will do so by 2017. Sachs, “The Long-Term China’s growth prospects look good in the short to medium term as well. During 2012-15 the EIU Outlook for the BRICs and N-11 Post Crisis”, Decemberforecasts China’s GDP to expand by an annual average of 8.4%. That would be only marginally lower than 4th 2009.the 9% growth expected in 2011. This dramatic reversal of fortunes between the West and the rest has transformed the way manyMNCs look at China (as well as other large emerging markets, such as India and Brazil). Simply put, itis no longer seen as a major market for the future but a place to make big money now. While it may notbe crucial to all companies, China certainly ranks highly on the global agenda. In addition to the 37%of survey respondents who said their headquarters viewed China as critical, another 33% viewed itas “strategically important, but not critical” (though this figure was also down from the 2004 survey,where 41% of respondents said this). Only 13% said they were “still exploring the market”. The latest figures for foreign direct investment (FDI) also suggest rising interest. Though in 2009, inthe immediate aftermath of the global financial crisis, inward FDI dropped to US$114bn from US$175bnthe year before, it bounced back to an estimated US$185bn in 2010 as crisis-stricken economies beganto recover. (It is worth noting that these figures may be inflated by private Chinese companies raising© The Economist Intelligence Unit Limited 2011 9
    • Multinational companies and China: What future? money through offshore companies and then repatriating the funds back to China as FDI. It is estimated by Dealogic that such funds accounted for US$36bn in the 18 months to end-June 2011.) Surveys by foreign chambers of commerce have for several years pointed out that the bulk of investment is now focused on China’s domestic market, and our own survey underscores this. While 31% of respondents saw low-cost production as a major opportunity in China in the next five years, 76% pointed to China as a growing market for their products. This view is even more pronounced for respondents based in China—87% see the growing market as the biggest opportunity. Hope, hype and reality Just how big is that opportunity? Perhaps not as7 In compiling our list we big as the headlines insist. At least not yet. Our Tiny in the top lineexamined Interbrand, S&P Percentage of total revenue from China, analysis of 70 MNCs100 Global, and S&P 500 analysis of 70 multinational companies7 shows that (% of companies)companies to find those that in 2010 only ten had China revenues that accounted 80disclosed their China revenuesin their latest published for more than 20% of their global revenues. Onlyannual reports or otherreliable sources. 18 counted on China for more than 20% of their 60 total international revenues. Few companies, with the notable exception of some automakers such as 40 General Motors and Volkswagen, currently count China as their largest market. But it is clearly a 20 major source of growth. Although only 8% of survey respondents said China has already become their 0 0-10% 11-20% 21-50% 51%+ company’s biggest market, 17% said it will be so in % of revenue less than five years and another 21% expected this to Source: Economist Intelligence Unit happen in five-ten years. Ahead of the pack Companies generating more than 20% of total revenue in China, 2010 (%) Panalpina 23.1 Mead Johnson 23.7 Cartier (Richemont) 24.0 BHP Billiton 25.1 Rio Tinto 27.8 Qualcomm 29.1 Nvidia 34.5 Yum! Brands 36.5 Micron Technology 38.8 Advanced Micro Devices 46.3 Source: Economist Intelligence Unit10 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future?It’s the growth ...China as % of total revenues 2005 and 2010(%) 2005 2010Adidas 3.0 8.3Advanced Micro Devices 14.5 46.3Astra Zeneca 0.8 3.2BHP Billiton 12.3 25.1Boeing Co 6.1 4.8Bombardier 1.3 5.9Bosch 2.4 8.8Carrefour 2.4 4.7Corning 3.1 12.5DuPont 4.5 8.4Intel 13.8 16.5LG Electronics 15.5 8.3LM Ericsson Telephone Co 7.6 12.8Micron Technology 15.9 38.8Motorola 13.6 7.0Nvidia 16.9 34.5Philips 9.9 7.8Qualcomm 7.0 29.1Siemens 4.2 7.7Xilinx 10.2 19.3Yum! Brands 13.86 36.5Source: Economist Intelligence Unit It is perhaps telling that the number of companies that make public their China results has more thantripled since 2005. Of the 70 companies for which we were able to find results, only 22 were reportingthem as far back as 2005. Of these, China’s share of their revenues has in most cases increased by asubstantial amount. For Yum! Brands, Qualcomm and several others, the share of revenue coming fromChina has doubled or even tripled. But for four companies—Boeing, Philips, Motorola and LG—China’sshare of their global revenues has actually declined. Where do they go from here? As we discuss in coming chapters, while there are tantalizing© The Economist Intelligence Unit Limited 2011 11
    • Multinational companies and China: What future? opportunities in China, the operating environment is tough and getting tougher. Nearly half of the executives surveyed said they were concerned about “being forced to give our IP (intellectual property) in exchange for market access”, with more than one-quarter “very concerned”. The shift to a higher- wage economy will put pressure on business models. Indeed, although surveys by business chambers indicate that many companies are making healthy profits in China, some observers are of the opinion that since China is no longer an “emerging” market in many sectors, the days of hefty profit margins—in the range of 15-20%—are over. On a macro level, China faces some serious risks too. An inflation rate that has been pushed to a three-year high by multiple factors (ample liquidity, booming demand, high commodity prices and upward wage pressures) has become the biggest headache for Chinese policymakers. Rising prices disproportionately affect China’s still-relatively-poor masses, and in the past have triggered social unrest. There is also the growing possibility that China’s huge investment drive—especially at the local government level—and its own exuberant housing market could end in a bust, triggering a sharp economic slowdown in the next few years. A timely policy response cannot be taken for granted, since the government is increasingly preoccupied with political manoeuvring ahead of the next leadership transition, expected at the 18th Chinese Communist Party congress in late 2012. Justified optimism? MNC executives are not overly concerned about a major crisis in the Chinese economy, but they are not ruling it out. Just under 40% said they were concerned (18% very concerned) about a crisis. More— 44%—were concerned about major social unrest. But many do expect a slowdown in growth—40% expect China’s growth rate to slow to more developed country levels, which we suggested were 3-5%, within the next five years. A measure of optimism may be justified, because China has proven sceptics wrong time and again during its three-decade-long pursuit of national economic development. It is also important to distinguish between inevitable cyclical downturns that affect all economies and the inexorable structural upgrading of the Chinese economy. To understand the full implications of the latter, one only has to look at the immense collective purchasing power of Chinese consumers today.12 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future?Chapter 2: The consumption storyChina’s determination to make consumption a more important driver of economic growthwill have profound implications for many companies. Wage increases are only part of thestory. Taken together with policies to provide universal healthcare, to draw more peopleinto cities and to clean up the environment, they create opportunities galore and thepotential for explosive growth.O nly a few years ago, foreign businessmen who scoffed at the notion of China’s “one billion customers” as a headline writers’ fancy were as common as those who believed that such a market has alwaysexisted and was simply waiting to be flooded with superior foreign goods. Today, the doubters are inretreat. Take Arthur Kroeber, who edits the China Economic Quarterly, a publication which he admits has“long poured sceptical cold ink on extravagant claims that the quasi-mythical beast known as the ‘Chineseconsumer’ will take over the universe”. He now declares that “as facts change, we change our minds, andthe facts now clearly say that the Chinese consumer has arrived”. What are these new facts? In his latest analysis, using 2009 data, Mr Kroeber estimates that Chinanow has about 100m households (or 300m people) with average annual household expenditure of someUS$7,500. In terms of size this army of Chinese consumers, with power to spend at their discretion,rivals that of the US. Of course, the typical American consumer spends far more than his or her Chinesecounterpart and will continue to do so for many more years to come. But at an aggregate level, Chinesehousehold consumption is already about US$800bn a year, which is more than the combined figuresin South Korea and Taiwan, where per-capita incomes are about twice as high as in China. “Chinesehousehold consumption has crossed a critical threshold,” Mr Kroeber concludes. His views are supported by the EIU’s macroeconomic forecasts. We project China’s GDP per head torise to just under US$10,000 a year by 2015, more than double the 2010 level of around US$4,500.During 2011-15, total disposable income is expected to grow by well over 10% a year. Our surveyrespondents certainly believe that consumption is set to take off: 58% said that China’s efforts to raise© The Economist Intelligence Unit Limited 2011 13
    • Multinational companies and China: What future? On the horizon Which of the following factors are likely to have the biggest impact on your China strategy in the next five years? Choose up to three. (% respondents) China’s efforts to raise incomes and boost consumption 58 The regulatory environment/industrial policies (eg, indigenous innovation) 46 Competition from Chinese companies 43 Renminbi convertibility, if it happens 32 Improved infrastructure (as a result of stimulus spending) 25 Urbanisation 21 Other, please specify 5 Source: Economist Intelligence Unit survey incomes and boost consumption is the factor that would have the biggest impact on their China strategy, and 56% said that growth prospects for their industry was the key driver of their China strategy. Efforts to raise incomes could have a very big impact indeed. The Chinese government is eager to rebalance economic growth drivers away from investment and exports towards consumption, and it is especially keen to raise incomes of the less well-off. It plans to raise minimum wages by at least 13% a year for the five years covered by the government’s 12th Five-Year Plan (FYP) for 2011-15. Market forces are already driving up wages at an even quicker pace in some areas: since 2010, 30 Chinese provinces have raised their minimum wages, by an average of 23%, and factory owners in the Pearl River Delta export belt surrounding Hong Kong are increasing pay by much more than that to keep their assembly lines running. In 2010 the minimum wage in Beijing went up by over 45%, thanks largely to the galloping economy and tightening labour supply. While companies are in the short term scrambling to find efficiencies to offset rising wages, they are keenly aware of the opportunity the creation of a new consumer class represents. This class will not be limited to the first-tier cities of Beijing and Shanghai, but will emerge all across China and deep into its poorer interior regions. By the end of the government’s 12th FYP, the EIU expects even the traditionally backwater provinces of Henan, Anhui and Sichuan to have disposable incomes per head of over US$3,660 (Rmb25,000). The Nielsen Company, a market research and consulting firm, believes the next big prize are the 161m households in the third- and fourth-tier cities at the prefectural and county levels in such central and western regions. In addition to wage rises, China’s galloping urbanisation will help pushIn the year 2025Forecasts for urbanisation up consumption and reduce the income gap. It will, in turn, further spur • Around 1bn living in China’s cities economic growth and support consumption by existing city dwellers and new • 15 cities with 25m+ population migrants, as well as making it easier to reach more consumers, creating huge • 200+ cities with 1m+ population potential opportunities for the world’s industrial firms. We forecast that by • 170 new mass transit systems built 2025 around 1bn of China’s population (or 70% of the total) will live in cities. • 40bn sq m of floor space built Between now and then 170 new mass transit systems and 40bn square metresChina urban inflows, 2010-20. of floor space will be built. China’s companies are not likely to be able toSource: China Regional Forecasting Service, Economist Intelligence Unit manage all this on their own.14 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future? Healthcare reform, a key Chinese government initiative, will be vital in unleashing the full potentialof the country’s consumption power. With no social safety net, many Chinese households continue tosave an inordinate amount of their incomes against medical emergency, or to fund their retirement.Even relatively well-off city dwellers report that they save more than 30% of their annual householdincome, in part to cover medical emergencies.8 There is an urgent need to overhaul China’s patchy 8 A better life? The wants and worries of China’s consumers,healthcare system to prepare for the coming upsurge in the elderly population, and also to bring a Economist Intelligence Unit,much-needed boost to the quality of life of many of its citizens. Patients in many rural areas currently 2010.have only limited access to clinics, drugs and health insurance. And city dwellers often must cope withovercrowded hospitals and overstretched doctors. Rural and urban residents alike must pay a big portionof medical bills themselves. The Chinese government is now trying to restore the public healthcare system, after allowing it to decayfor most of the modern era of economic reform. With the goal of providing “safe, effective, convenientand affordable” healthcare to all citizens by 2020, in 2008 the government introduced national healthinsurance. (This was five years after it launched a separate rural cooperative medical insurance schemethat partially covers healthcare costs.) As Chinese people stop losing sleep over their ability to pay medicalbills, they are likely to save less and spend more in their daily life, boosting consumption. To be sure, this may still be a distant prospect. Many parts of the healthcare reform plan, such as therole of the private sector and drug pricing, have yet to be decided or put into place. Moreover, currenthealthcare insurance rarely covers the cost of the level of care demanded by middle-class consumers. Itis estimated that about 200m people still have no health insurance at all. Nonetheless, the healthcare market is already huge and can only get bigger. Health insurance and theprovision of more healthcare facilities across the country will bring more consumers into the system. Thereare an estimated 13,000 hospitals in China, many of which are likely to need new equipment. Beijing hasalso announced plans to encourage more foreign investment in this sector, though guidelines have yet tobe issued (there are already about 100 foreign-invested clinics and hospitals in China). China is a top-tenmarket for pharmaceuticals in the world, with US$42bn-worth of drugs sold in 2010 according to IMS, ahealthcare consultancy. Though much of the spending was on cheap, domestically made generic drugs, themarket grew at an annual average of around 6% during 2006-10. This pace is expected to continue through2015, as incomes rise, the government spends more and the ranks of the elderly swell. By then, someforecasters project China to be the world’s second-largest pharmaceutical market, after the US. Another area with seemingly huge implications for consumption is China’s determination to cleanup its environment. In a country where studies estimate air pollution kills up to 1.3m people a year9, a 9 “The China Greentech Report 2011”, The China Greentechpotential bonanza awaits, for example, global carmakers that develop greener vehicles for the masses. Initiative, 2011.Having pledged to reduce the country’s carbon intensity (carbon emitted per unit of GDP) by 40-45% by2020 compared with the 2005 level, the government plans to invest more than Rmb100bn (US$15.7bn)in the green-vehicle sector in the coming decade to curb the explosive upsurge in vehicle emissions. Itsgoal is to turn China into the world’s largest producer of clean-energy cars, with emphasis on electricvehicles (EVs), a category that includes hybrid-electric and battery-powered vehicles. How do MNCs plan to capitalise on this consumption story, and what obstacles do they face? Perhapsmore importantly, how does China view their success?© The Economist Intelligence Unit Limited 2011 15
    • Multinational companies and China: What future? Chapter 3: The perils of success Now that the mythical China consumer has materialised, companies could struggle to keep pace with rising demand. They also worry that too much success will attract unwanted attention. M any multinationals are now turbo-charging their China plans to keep pace with demand. The words “doubling in size” are commonly heard, whether referring to the overall size of a market, or to an individual company’s revenue expectations. For example, AkzoNobel, a chemical company, plans to double its revenue to US$3bn in the next five years. It has ploughed €275m (US$383m) into a complex in Ningbo to make numerous products that will be sold to the building and construction, cleaning and detergents, food preservation, oil, personal care and pulp industries. The company also recently bought a local automotive paint maker. Some companies are even more ambitious. Coach, a premium US accessory maker that saw its sales in China double in 2010 to US$100m, says it aims to raise its revenue in the country to US$500m by 2014 and secure a 10% market share in its sector. Unilever is aiming to boost sales five-fold to US$10bn by 2020. Volkswagen will open two new plants by 2013 (both to be financed by revenues from its China ventures) and Ford will open three by 2014. Coca-Cola is just finishing up a US$3bn investment programme and is planning to spend US$4bn more over the next three years. The list goes on. Is it enough? Ironically, amid all the fantastic expansion plans, one of the biggest questions facing multinationals is, is it enough? While companies are putting increasing amounts into market-sizing research and squeezing as much investment out of headquarters as they can, in interviews for this report some admit that they really are not very confident in the results—if anything, they worry they are being too cautious. Nissan, which has just unveiled a major expansion plan (see Nissan: According to plan, p42), has16 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future? Bricks and mortar aplenty Retail expansion plans* Retailer Current (2010) number of stores Planned expansion Apple 6 25 by end of 2012 Burberry 53 100 over 5 years Carrefour 180 20-25 per year (no timeframe) Coach 44 11 (timeframe unclear) Gap 4 10-15 (fiscal 2011) Gieves & Hawkes 90 10 (in 2011) Guess 113 500 (by 2016) H&M 50 250 (fiscal 2010/11) Zara (Inditex) N/A 42 (by 2012) Ikea 8 17 (by 2015) Marks & Spencer 16 (12 in HK) 2 McDonald’s 1,300 700 (by 2013) Prada 18 10-12 per year Starbucks 459 1,500 (by 2015) Tesco 88 80 (by 2016) Uniqlo 77 923 (by 2020) Yum! 3,720 (3,200 KFC; 520 Pizza Hut) 500 annually between 2011 and 2014 Wal-mart 338 Not disclosed. Subway 233 600+ (by 2015) * Excludes investments in or other arrangements for online retailing. Source: Company reports, press reports A sampling Fast-moving consumer goods companies’ expansion plans Company Planned investment Purpose Add bottling plants, expand existing facilities, initiatives in Coca-Cola Company US$4bn, 2012-14 distribution, marketing and development of new cold drinks PepsiCo US$2.5bn by 2012 New plants (10-12), five new farms, branding Proctor & Gamble US$1bn by end 2015 Unilever US$100m New production facility Nestle US$1.7bn 60% stake in Hsu Fu Chi (awaiting approval) Nestle US$600m-1bn* 60% stake in YinLu Foods *Market estimates. Not disclosed Source: Company announcements, press reportsconsistently under-estimated demand for the past seven years, and the company’s CEO, Carlos Ghosn,sees this as the biggest risk for automakers in the country. “We are very humble in terms of forecast, wetake it year by year, but I would bet this market will be more than 20m by 2015,” he says (passenger carregistrations are forecast by the EIU to hit 15m this year).© The Economist Intelligence Unit Limited 2011 17
    • Multinational companies and China: What future? Foreign companies with strong brands will want to employ their traditional, slower and more meticulous routes to building a sustainable business. But in doing so, they run the risk that their domestic competitors will fill the gaps—sometimes with the foreign company’s own products. This is already happening to some of the world’s more iconic brands such as Apple, Nike, Disney and Ikea, with local entrepreneurs opening unauthorised retail outlets bearing the brand or outlets which closely resemble the original. This seems to be happening largely in the hinterland, where foreign retailers have yet to invest with any great conviction. Indeed, while there has been much media hype about companies moving to third-tier cities and beyond, and FMCG (fast-moving consumer goods) companies certainly are, overall 59% of our survey respondents remain focused on “improving penetration in wealthier coastal cities/southern region”, and only 33% of them are “currently moving into second- and third- tier cities”. The picture is slightly different among bigger companies—45% report they are moving into second- and third-tier cities, but only 12% say they are moving beyond, and 44% say they are concentrating on further penetration of wealthier areas. Going west? How will your company expand geographically in China? Choose the one answer that best describes your situation. (% respondents) All respondents Big companies We will focus on improving penetration in wealthier coastal cities/southern region 59 44 We are currently moving into second- and third-tier cities 33 45 We already have a substantial market in second- and third-tier cities and are moving on to fourth tier and beyond 8 12 Source: Economist Intelligence Unit survey But companies trying to expand rapidly face some very real constraints. “We’re asking ourselves: do we have the resources?” says Frank Cancelloni, CEO Asia-Pacific of Devanlay Asia Distribution, which manages Lacoste’s supply chain in the region (see Lacoste: Who’s your benchmark? p22). He is more concerned about people than cash. “It took us more than six months to find our regional HR director,” he says. “We’ve got 500 sales clerks, and they are the most important people in the company. How do we keep them if the other major apparel retailers or new brands entering the market try to hire them?” Another obvious challenge is maintaining brand consistency while expanding at a dizzying pace. While prominent retailers such as Starbucks and Burberry have bought out their franchisees in order to gain more control over their brands, it is questionable how far those aiming at the mass market can expand without resorting to some form of franchising, given the resources—both human and otherwise—required to expand at the pace that market growth would dictate. Local companies certainly will not hesitate to go big. For example, since 2004 Li Ning, a Chinese sportswear company, has opened more than 5,000 own-branded retail outlets, bringing its total to 7,915. It is aiming for 9,400 by 2013. Adidas, by contrast, plans to open 500 this year, bringing its total to 6,100, and to add 2,500 more by 2015. That is daunting enough. But then consider that Adidas is also expanding its footprint from 550 cities to 1,400. To be sure, companies that excel in small-lot production of a variety of goods, such as many Japanese consumer-goods firms, are going to struggle in China. The issue of scale is not just for retailers. Caterpillar, a US-based provider of construction equipment,18 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future?has been making headlines recently over the new priority it places on China—even factoring in theconsiderable (and early) investments it has already made in the country. According to analysis fromOff-Highway Research, a consultancy, Caterpillar’s market share in China has fallen from 11% in 2005 to7% in 2010, despite the fact that its sales have quadrupled in that time. The market share is not going toarch-rival Komatsu of Japan, but to local players.One strategy, or two?Those on the front-lines of the consumption story are also grappling with how to keep up with consumerneeds that at one end of the spectrum are becoming very sophisticated, while at the other remain verybasic. As an analyst once quipped, “In China you have both Africa and the EU.” Today, people living incoastal provinces of the eastern and southern seaboards, as well as in some large cities in the interior, aremuch richer and more discerning than the national average. Rollouts of nationwide distribution networksremain works in progress. But what is more, regional disparities in tastes, preferences and shoppinghabits, apart from incomes, are simply too great. “If you compare Guangdong in the south and Shandongin the east, less than half of the leading brands are common between the two provinces,” says KarthikRao, managing director for Greater China at Nielsen. While most foreign companies have in the past chosen to play in the higher end of the market, leavingthe lower-end to local players, there are signs that they are now reassessing that strategy, with someaiming to play in the middle, if not the low-end, of the pyramid. “As incomes rise, people become hungry for choice,” notes Mr Rao. “Tastes are constantly changingand companies have to stay on top of that. They even have to segment their product line to cater fordifferent tastes as they evolve. That’s what a lot of companies have now realised.” This applies to everything from denim jeans to cars. Levi Strauss, for example, has developed a newrange of jeans called dENiZEN, which retail for about US$40-60 compared with the US$100 for a regularpair of Levi’s. GM is developing a marque specifically for China to target the aspiring car-owner whocannot afford a Chevrolet but wants a lot of the features the brand would offer. The company estimatesthat there are 4m such consumers. Why leave that market to local makers like Chery or BYD? The issue will also confront the pharmaceutical industry. China’s growing middle class is willing topay out of its own pocket for branded Western drugs that they are sure will not harm them. This seemsunlikely to change any time soon, given numerous scandals over product quality in China. But at thesame time foreign companies will need to align themselves with the Chinese government’s goal ofimproving access to healthcare for all, including the lowest-income groups. While the government’sultimate policy on drug pricing remains to be set, it seems a fair bet that price caps will drive the markettowards generics. In the view of George Baeder, who leads the Asia life science practice of Monitor Group, a consultancy,“The government must meet the needs of 1.3bn people. It can’t just follow the broken models in theWest, where drugs are too expensive. They need to drive costs down to the lowest level. Most MNCs arenot particularly strong at playing here.” Most big pharma companies face declining prospects as their major drugs come off patent. Unlikeother types of consumer goods, pharma companies cannot tailor products to the low end of the market:© The Economist Intelligence Unit Limited 2011 19
    • Multinational companies and China: What future? they may need to offer the same products at lower cost to poorer segments of society. Can or should they do this? There is no clear answer and only one precedent, which does not really apply: the moves by five big companies to offer AIDS drugs at low cost in Africa. While this had no ramifications for global pricing of AIDS drugs, the same cannot be expected for drugs that have a wider application and are produced in China, which has problems with cross-border leakages of both real and counterfeit goods. Is it too much? What does the Chinese government make of this mad scramble? Most smaller and lower-profile firms feel they are too unimportant in China’s overall priorities to warrant much attention. They are probably right. But the larger players are mindful of their steps. “I often joke with government officials—how many stores are too many?” says a senior executive at one foreign retailer. “I mean, is US$50bn in sales too much? There could be a tipping point when they say ‘too much’. But the market is growing so fast that it is not inconceivable that our market share could even decline while our business continues to grow enormously.” This nagging worry about somehow being punished for treading on the local competition could explain the seemingly low expectations of our survey respondents in terms of using acquisitions as a route to growth in China: only 20% chose acquisitions as the most important strategy for growth in China, while 63% chose organic growth and 46% said joint ventures. There has been an air of uncertainty hanging over China’s M&A market since regulators rejected Coca- Putting on weight Which of the following growth strategies will be most important to your company’s expansion plans in China? Choose up to two. (% respondents) All respondents Big companies Organic growth 63 80 Joint ventures 46 43 Acquisitions of Chinese companies 20 23 Acquisitions of foreign competitors’ operations 6 7 We are not planning to expand 9 3 Don’t know 1 1 Source: Economist Intelligence Unit survey Cola’s planned purchase of China Huiyuan Juice for US$2.3bn in 2009 over competition concerns that were viewed as questionable. The deal would have boosted Coca-Cola’s share of the fruit and vegetable juice market to around 20%. The American giant has since given up on buying anything in China. Muhtar Kent, chairman and CEO of Coca-Cola, told reporters in August, “It’s [acquisitions] no longer on our10 “Coca-Cola Plans $4bn radar screen because we’re seeing so much potential for organic growth. 10“China Investment”, wsj.com,August 19th 2011 The Ministry of Commerce has since shown a keenness to improve the transparency of its decisions20 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future?and to be a more sophisticated regulator. But the fact remains that China’s law does allow it to considernon-competition issues, such as security of supply and its own industrial policies, in making its rulings. China has recently shown signs that it will allow purchases in relatively high-profile local companies—albeit with conditions. For example, Diageo, a UK drinks giant, received approval this year to take acontrolling stake in its existing Chinese joint venture, Sichuan Chengdu Quangxing Group, therebygaining indirect control of Shuijingfang, owner of the famous Quanxing brand of the local spiritbaijiu that accounts for more than 30% of China’s alcoholic drinks market. Approval of the acquisitionreportedly took 16 months and, as a condition, Shuijingfang had to divest the Quanxing brand. Nestléthis year announced deals to take 60% stakes in two local companies, YinLu Foods, a maker of peanutmilk, and Hsu Fu Chi International, a confectioner. The former has been approved, but the latter is stillawaiting the green light. It is notable that all of these deals have involved keeping a substantial stake with local shareholders.Indeed, the byword remains caution. “MNCs need to choose targets carefully and manage growth,”says Ninette Dodoo, a lawyer with Clifford Chance in Beijing. “By that we mean, do not overshadow theChinese business target.”© The Economist Intelligence Unit Limited 2011 21
    • Multinational companies and China: What future? Lacoste: Who’s your benchmark? While others in the apparel retail industry are moving towards directly owned stores, Devanlay is likely to continue to use dealers in second and third-tier cities as a means to achieve scale. It Devanlay, which is responsible for the production and distribution currently operates 100 points of sale directly in Shanghai, Beijing, of Lacoste brand apparel globally, is illustrative of what is no doubt Shenzhen and Guangzhou, a mixture of boutiques and corners within happening in many companies around the world. Until around 2008 department stores, and 250 franchised points of sale. “Franchising the company paid no special attention to China. Revenues from the is more profitable, there is no doubt about it,” says Mr Cancelloni. “If country were growing at 10-15% a year and it was opening 20-30 new you open in a certain city then you have to set up an office and hire points of sale (boutique, a corner within a department store, or a managers, etcetera. Again, it’s people. So I think we would rather franchise operation) annually. This was fabulous when benchmarked make sure the people at headquarters are very good at training and against France or the US. But the company never benchmarked working with franchisees.” against other brands in China. Had it done so, it would have realized that even 20% growth was nothing to get excited about. Crocodile-infested waters Enter a new CEO, Jose Luis Duran, formerly the global head of Lacoste, like many companies operating in China, has its share of French hypermarket chain Carrefour. Mr Duran knew China. Suddenly problems with counterfeiting. Lacoste’s problems in Asia actually go the possibilities became clear. Mr Duran understood the need for back to the 1950s when two brothers set up companies in Hong Kong higher investment in a market featuring intense competition in the and Singapore making polo shirts and using a crocodile logo. Lacoste so-called “accessible luxury” space as well as the need to march assumes that they were exposed to the brand after they fled China forward into second and third-tier cities where no one had ever seen following the communist revolution and went to Vietnam, which was the iconic Lacoste crocodile logo (or at least the real thing). still a French colony and where French expatriates would be wearing Since Mr Duran took over Devanlay has beefed up its management Lacoste shirts. in China, including sending a new CFO from Europe. It has been Over the years there have been numerous legal disputes with the increasing investments in new store openings and renovations and companies spawned by the brothers, including in China. The battle essential infrastructure such as information systems. with Singapore-based Crocodile International, known as Cartelo in Devanlay does not reveal investment figures but Frank Cancelloni, China, continues. There are also numerous small groups who make the company’s Asia-Pacific CEO, says that capital expenditure for exact copies of Lacoste products, or products clearly inspired by the region (Japan, China and South Korea) will double in 2011, with Lacoste. China accounting for more than half the total. “We are now growing Counterfeiting has not prevented Lacoste from growing rapidly in at about 30% a year, and I think compound annual growth of 30-35% China. According to Jerome Bachasson, regional director for Asia- is achievable,” he says. Today China accounts for less than 5% of Pacific at Lacoste, who oversees trademark protection, branding and Lacoste’s total apparel sales worldwide, a figure which Mr Cancelloni sponsorship, it is unrealistic to expect the counterfeiting industry to says could rise to 10% in the future on current growth projections. go away soon given that so many livelihoods in China still depend on it. While it is important to take legal action against the factories or Keeping up wholesalers involved in counterfeiting, the only real solution is to stay Devanlay’s current challenge is deciding what it can reasonably do in one step ahead of them. terms of the pace of expansion. “Two years ago we opened 20 doors “We will fight counterfeiting by having fantastic stores, creating [points of sale] a year and now we’re talking about 100-150,” says Mr that gap between us and the locals,” he says. “Consumers want to Cancelloni. “But now we’re asking, ‘do we have the resources?’” He is know how to tell the difference between originals and fakes. In fact most concerned about staff retention and has hired an HR consultancy I’d say consumers are going faster than the Chinese authorities in to survey retail staff on what motivates them to stay with a company. dismissing fakes.” The company also spent six months finding the right HR director.22 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future?Chapter 4: Whose hubris?It is often taken for granted that multinationals possess superior technology, betterbrand management and a stronger appeal for talented workers. There are signs that all ofthese advantages are beginning to erode in China.A chieving ‘China speed’, as it has come to be known, is but one factor in staying ahead of the competition. “It is a global playing field almost unlike any other,” notes Torsten Stocker, aconsultant with Monitor Group. He points to the example of plastic containers, which in manycountries around the world are synonymous with Tupperware or Rubbermaid. In China, the marketleader is Lock & Lock, a South Korean company that is almost unknown outside Asia. Competition in China comes in many forms. There are foreign companies that have been in the marketfor years and are now upping their game, as well as new entrants and companies returning to China for asecond time. Then there are the locals, who by all accounts are rapidly improving in many segments. Our survey suggests that competition from local companies is perhaps being underestimated by MNCheadquarters. Respondents based in China rank competition from local firms at the top of their listof obstacles, while the sample as a whole ranked it second, behind IPR (intellectual-property rights)protection. Studies suggest that foreign companies ignore the threat of local competition at theirperil. A former executive at one multinational disparagingly notes that management at his formeremployer would track the market share of the usual global competitors on a weekly basis, ignoring thelocal competition, until one day the “other” category exceeded 50%. Who is this ‘other’? they suddenlywanted to know. By then it was too late. Nimble local competitors are challenging the likes of P&G and Unilever. In a recent report, Booz& Co, a consultancy, highlighted the rise of four such companies: Wanglaoji (herbal tea); FoshanJingxing Health (sanitary napkins); Bawang International (shampoo) and Hangzhou Hancao 11 “China’s Local Champions”,Biotechnology (non-tobacco cigarettes) 11. The authors wrote that for foreign multinationals, “the Booz & Co, 2011warning signs should be apparent”. They went on to conclude: “China is generating a host of powerful© The Economist Intelligence Unit Limited 2011 23
    • Multinational companies and China: What future? Getting in the way What do you see as the biggest operational obstacles standing in the way of seizing opportunities in China? Choose up to three. (% respondents) Respondents based in China Lack of intellectual property (IP) protection 41 35 Competition from domestic companies 35 48 Unpredictable nature of Chinese government 32 21 Discrimination against foreign companies 31 29 Corruption 28 27 Competition from other foreign companies 27 15 Lack of legal protection in general 23 13 Lack of available local talent 14 33 Risk of trade and economic disputes between China and other countries 11 13 Lack of autonomy to make the right decisions for the China market 8 13 Source: Economist Intelligence Unit survey Cleaning up Market share by retail value for selected consumer goods Domestic (%) MNC Other 50 Laundry Surface Care 47 40 40 30 20 18 14 12 12 10 10 9 7 6 6 6 5 4 2 2 0 Nice Liby P&G Unilever Nafine Blue White Others SC Blue Lohmann White Kaimi Reckitt Amway Others Moon Cat Johnson Moon Haas Cat Benckiser 50 Dishwashing Toilet Care 40 30 31 24 20 19 18 17 17 14 10 10 10 9 5 6 6 6 4 4 0 Liby Nice White Amway Nafine Lonkey Reckitt Others SC Blue White Lonkey Saa Lee Reckitt Kaimi Others Cat Benckiser Johnson Moon Cat Benckiser Source: Euromonitor 2009 report; Booz & Company24 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future?local champions—and competing against them is the new reality. Close to their customers, focusedon developing lower-cost alternatives, marketing and distribution strategies, these businesses aredeveloping new goods and innovative ways of selling them that are well attuned to the needs of Chineseconsumers.” The rising competitive strength of local companies is also reflected in the talent market. Although oursurvey respondents as a whole ranked “lack of available local talent” pretty far down the list of obstaclesstanding in the way of market success, a mounting array of evidence suggests they should be concerned.Those on the ground already are—respondents from China ranked the lack of talent third on their list ofobstacles (respondents as a whole ranked it eighth). With many Chinese companies flourishing and expanding at a faster pace than MNCs, the same pool ofbilingual and bicultural local talent who can straddle the Chinese and international business worlds arebeing chased by both. For example, in 2010 Deutsche Bank lost its China head to Industrial and CommercialBank of China. A few years earlier B&Q and Microsoft saw high-profile executives jump to Chinesecompetitors (to Alibaba and Shanda Interactive Entertainment respectively). Ante and Li Ning, the twoleading sportswear makers, also have managed to attract talent away from Nike, Adidas and Puma. HR and executive-search firms say this reverse flow of local talent from MNCs to Chinese companieswill increase in the future. According to Manpower Inc, a comparison of its surveys done in 2006 and2010 shows that job seekers who preferred to work for a private Chinese company jumped by fivepercentage points during the period, while the figure for those who preferred a foreign companydropped by ten percentage points. The rising attraction of local companies is manifold. Thanks to rapid growth, more of them can matchor exceed salaries at MNCs. Many companies are expanding overseas, providing attractive postings. Andemployees can expect quicker promotion at many successful Chinese companies, which are less rigidand formal, allowing managerial employees more flexibility to define their responsibilities and workingconditions.Suddenly uncertainEven though headquarters may be underestimating the power of local brands and Chinese companies’growing attractiveness to the country’s shallow pool of talent, multinationals do not seem overlyconfident. Asked to identify their company’s competitive advantage in China, just under 20% of surveyrespondents reported that they don’t have an advantage but feel they need to be in the market. Amonglarge companies, only one-quarter felt they have superior technology or a stronger brand, with thesefigures even lower for the sample as a whole. Indeed, the competitive prowess of Chinese companies has surged since our last report in 2004.Then, 68% of survey respondents saw foreign-invested companies as the biggest competitive threat totheir business in China, while 44% saw a threat from private Chinese companies and 27% from state-owned enterprises. In 2011 foreigners do not seem to worry much about each other—only 27% pointedto competition from other foreigners as a threat, ranking sixth on the list of obstacles in the way ofopportunity. Competition from domestic companies, by contrast, ranks second behind IP protection asthe biggest threat, and it ranks first among respondents based in China.© The Economist Intelligence Unit Limited 2011 25
    • Multinational companies and China: What future? Sizing up the competition What is your company’s competitive advantage in China? (% respondents) All responents Big companies Long experience in emerging markets/Strong management 24 24 Superior/unique technology 23 25 Strong brand 16 25 Large resources 10 13 We don’t have an advantage but feel we need to be in China 19 9 Other, please specify 6 2 Don’t know 2 1 Source: Economist Intelligence Unit survey The view in 2004 ... Are domestic (as opposed to foreign-invested) companies a competitive threat to your business globally? (% respondents) A serious competitive threat 5.6 Somewhat of a competitive threat 28.2 Not a threat 65.7 Other 0.5 Source: Economist Intelligence Unit survey, 2004 ... in 2011 How would you describe the competitive strengths of domestic Chinese companies in your sector? Choose the one that best applies. (% respondents) All respondents Big companies Chinese competitors in our industry are already a serious threat to our business in China 26 31 Chinese competitors in our industry are already a serious threat to our business globally 15 5 Chinese competitors in our industry will be a threat to us globally in five years time 20 22 Chinese competitors in our industry are not a threat 22 21 Chinese competitors in our industry are the same as other competitors 17 21 Source: Economist Intelligence Unit survey, 2011 Chinese companies are also increasingly viewed as a threat on the global stage. In 2004, 66% of survey respondents said their Chinese counterparts were not a threat to their business globally. Today, only 22% say the same. Over one-quarter of respondents expect Chinese companies will be their major26 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future?global competitors in five years’ time (9% say they already are), while 47% say they will be seriouscompetitors within ten years. Big companies are somewhat more confident—only 16% expect theirChinese counterparts to challenge them globally within five years (only 5% do so now), with the figurerising to 38% within ten years. But larger companies are more concerned about the impact events inChina will have on their industry—38% said that developments will have a disruptive impact on theirindustry within five years, and more than half expect this to happen within ten years. This threat is mostlikely to come from lower-cost competition on the global stage. Still, executives think that China’s efforts to boost consumption, and the uncertain regulatoryenvironment (discussed in the next chapter), will have a bigger impact than local competition on theirChina strategy in the next five years.© The Economist Intelligence Unit Limited 2011 27
    • Multinational companies and China: What future? Chapter 5: The invisible hand China’s use of protectionism as a means of encouraging innovation is causing a great deal of ill will among technology-rich multinationals. The role of vested interests is as much, if not more, of a problem than policy. Rather than counting on an official solution, companies are probably better off seeking a way to work around the risks. A mid all the chatter about China in boardrooms around the world, there are a couple of basic questions that executives should be asking: does China really want MNCs? And if so, what exactly does it want from them? At the moment China’s policies towards foreign companies in some sectors are generating an awful lot of ill will. The government’s broad economic agenda is no secret, although it is rather more difficult to keep track of all the various priority lists (see p29). Its 12th Five-Year Plan (FYP) aims to pursue “scientific development” as a top priority by fostering “strategic emerging industries” with a view to upgrading the Chinese economy from low-cost manufacturing to higher-value-added industries and services. Foreign companies worry that China’s emphasis on having local companies lead the charge up the value chain will come at their expense. Over the next few years the strategic sectors will be showered with various forms of official assistance, from priority funding to tax breaks, in order to ensure that they meet the government target of generating 8% of GDP by 2015. In the past, similar preferential policies were deployed to nurture a group of domestic corporate powerhouses in such sectors as railways and telecoms. China is determined to create more such “national champions” in other industries—especially in newly emerging sectors where no country has much of a head start and where there is a real chance to take the lead. In the previous FYP, the government targeted solar and wind energy, and in both sectors Chinese companies now lead the markets globally. This lead has been based more on low costs than technological prowess. Some observers point out that it is Chinese companies’ ability to drive down prices that has fuelled market growth in these industries in the first instance.28 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future? Aiming high • Quantum physics • Developmental and reproductive science Sectors in which China hopes to take leadership From the 11th Five-Year Plan for High-Technology Industries From the Medium and Long-term Plan for Science and (2006-2010) Technology Development (MLP): 16 Special Projects aimed at import substitution 11 key sectors for employing technology development and innovation • Core electronic components, high-end general use chips and to solve China’s problems (with a sampling of the 68 priority areas basic software products with clearly defined missions) • Large-scale integrated circuit manufacturing equipment and • Energy, water and mineral resources (coal liquefaction and techniques gasification, renewable energy, exploration and extraction • New generation broadband wireless mobile communication technology, power grids, etc) networks • Environment (environmentally-friendly fertilizers, herbicides and • Advanced numeric-controlled machinery and basic pesticides, waste recycling) manufacturing technology • Agriculture (a modern dairy industry, genetically modified crops) • Large-scale oil and gas exploration • Manufacturing (robotics) • Large advanced nuclear reactors • Transportation (high-speed rail and electric cars) • Water pollution control and treatment • Information and services • Breeding new varieties of genetically modified organisms • Population and health (drugs and reproductive health products) • Pharmaceutical innovation and development • Urbanization (energy-efficient buidings) • Control and treatment of AIDS, hepatitis and other major • Public security and national defence diseases • Large aircraft 8 fields of technology in which 27 breakthrough technologies are to be • High-definition earth observation system pursued • Manned spaceflight and lunar probe • Biotech (stem cell-based tissue engineering) • Three others that remain classified • IT (next-generation internet and supercomputers) • Advanced materials From the 12th Five-Year Plan • Advanced manufacturing Strategic emerging industries (which are to account for 8% of GDP by • Advanced energy technology (fast neutron nuclear technology) 2015, up from 3% today) • Marine technology (deep sea exploration) • Energy saving and environmental protection • Laser technology • New generation of information technology • Aerospace technology • Biotechnology • High-end equipment manufacturing 4 basic research programmes • New energy • Protein science • New material • Nanotechnology • New energy vehicles Perceived favouritism towards domestic companies is a major sore point with MNCs, which accuse 12 The heads of Siemens and BASF in 2010 told thethe Chinese government of creeping protectionism. Top executives from three of the world’s leading Chinese premier, Wen Jiabao,companies have been captured on record in the past two years openly questioning China’s intentions12. directly in public that they were unhappy with the changeIn its 2011 “American Business in China” white paper, the American Chamber of Commerce in China for in the business climate for foreign companies operating inthe first time has dedicated a section on industrial policy and market access focusing on regulatory China, pointing particularly tobarriers. The paper describes a pattern of discrimination created by a host of labyrinthine regulations— the issues of forced technology transfer and unfair public-including on licensing, government procurement and competition law—as impeding fair competition procurement systems.© The Economist Intelligence Unit Limited 2011 29
    • Multinational companies and China: What future?13 www.amchamchina.org/ between American and Chinese companies13. The European Union Chamber of Commerce in China strikesbusinessclimate2011 the same note in its 2010/2011 Position Paper14. “More than anything else, European companies wish14 www.europeanchamber. to have equal access to China’s markets,” it said. “Despite China’s 30 years of reform, it still remainscom.cn excessively regulated and less open to competition compared to other major economies.” Even the15 www.cjcci.biz/public_html/whitepaper/2011 normally more discreet Japanese chamber began issuing an annual white paper in 2010, citing many of the same complaints15. The real issue China hardly invented industrial nationalism, and this would not be the first time multinationals have encountered it. But China’s attempt to link access to its markets with requirements that foreign investors share more of their intellectual property—including developing and registering it in China—is something new. Depending on which analysis one subscribes to, China’s policies are either “a blueprint16 James McGregor, “China’s for technology theft on a scale the world has never seen before”,16 with the ultimate aim of overtakingDrive for IndigenousInnovation, A Web of the Western world in technology leadership, or a more understandable attempt to bolster China’sIndustrial Policies”, American capabilities17, albeit with reckless disregard for the impact on foreign companies. Regardless of theChamber of Commerce, 2010 intention, the result is the same—foreign investors are spooked. Among our survey respondents, 49%17 Dieter Ernst, “China’sInnovation Policy is a Wake-up were concerned or very concerned that they would be forced to give up their IP in exchange for marketCall for America”, AsiaPacific access. Among big companies the figure was 52%. While the government’s efforts to raise incomes andIssues, East-West Centre, May2011 spur consumption were seen by respondents as having the biggest impact on their China strategy, the regulatory environment and industrial policies ranked second. The reason China is demanding more from technology-rich foreign companies is not hard to fathom. What was initially a desire to move up the value chain has suddenly become a need, as China faces rising labour costs, an ageing population and unstable demand from its traditional export markets, forcing it to keep growth going with fewer resources and to stoke demand in its own domestic market. Yet previous policies aimed at improving technological prowess have produced little. While a handful of companies has become globally competitive—Huawei, a telecoms-equipment maker, is universally held up as the poster child—in the main Chinese manufacturers have remained low-end assemblers in the global supply chain. Apple’s iPhone is often cited as an example. Of the US$500 price tag for a phone, China gets about18 Yuqing Xing and Neal US$7 for its assembly job, while Japanese companies get US$60 and German firms US$30 (Apple itselfDetert, “How the iPhoneWidens the United States makes US$321).18Trade Deficit with the People’sRepublic of China”, Asian Efforts to change all of this began five years ago, with the Medium and Long-Term Plan for ScienceDevelopment Bank Institute, and Technology Development (MLP), issued by the State Council. It stands at the core of what has2010 become known as the ‘indigenous innovation policy’. The MLP, to which few paid attention when it was19 In addition to McGregor’swork cited above, another announced, was really more of a sweeping mission statement. But subsequent implementing regulationsexcellent effort to pull and other policies have been issued seemingly in line with the mission and, as they are now beingtogether all of the policiesinto a coherent picture is implemented, the impact is beginning to be felt. Some analysts believe that this confusing labyrinth is“China vs The World: WhoseTechnology is it?” by Thomas a co-ordinated effort.19 Others are doubtful that even the Chinese government could pull together soM Hout and Pankaj Ghemawat, many moving parts, citing inter-agency battles and what seems to be a diminishing will among provincesHarvard Business Review,December 2010 and municipalities to follow the central government’s orders. If anything is clear, it is the expected30 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future?role of foreign companies. The MLP defines indigenous innovation as “enhancing original innovationthrough co-innovation and re-innovation based on the assimilation of imported technologies”. Co-ordinated or not, the policies that are now commonly referred to in toto as ‘indigenous innovation’are already having a significant impact on foreign business. The American Chamber of Commercein China reported in its 2011 Business Climate Survey that 26% of respondents were already losingbusiness and 40% expected they would lose business in future. The policies combine run-of-the-milltax breaks and incentives for local companies involved in innovation, with more protectionist measuressuch as requiring state-owned entities to favour locally-developed IP in their purchasing, or for foreigncompanies to reveal sensitive information in order to sell their products in China. In the backgroundis a renewed emphasis, not always spelt out in official policy, on joint ventures. Not surprisingly, theAmerican Chamber’s survey showed that the biggest concern was the loss of sales to state-ownedentities. China has softened some of the more egregious measures, especially where they amounted tooutright protectionism. For example, the government had originally stated that it would supportindigenous innovation by using the public-procurement process to favour products from Chinesecompanies and containing IP owned by China. It drafted a catalogue of products that would qualify forprocurement. But after protests from no less than 34 international trade associations, the requirementson IP ownership were watered down, and in January 2011 the Chinese president, Hu Jintao, vowed todelink indigenous innovation from public procurement altogether. Yet the US-China Business Council issued a circular in July 2011 stating that 22 provincial- andmunicipal-level governments (including the Beijing municipal government) had issued their owncatalogues, with three being issued since Mr Hu’s statement.20 Many contain explicit references to IP 20 Provincial and Local Indigenous Innovationownership and import substitution. Catalogues, US-China Business This development explains why survey respondents are just as concerned—more so in the case of big Council, July 2011companies—with protectionism at the local level as they are about the national level. There has beena discernable trend in recent years for multinationals to align more closely with local governments,making themselves indispensible to the local administration by providing investments in infrastructure,education and so on. In return, the local administration helps them to deal with issues like IPRinfringements, unauthorised taxes and general dirty tricks by competitors. “It is odd and a little mafia-like, but they are doing the best they can,” notes one consultant.Who cares about the yuan?How will the reminbi’s appreciation affect your China strategy? Choose all that apply.(% respondents)We see more opportunity to export to China 30We are planning to source more materials/components locally 23We are shifting some production to other countries 15We are undergoing a major cost-cutting exercise 14We see no major impact 41Source: Economis Intelligence Unit survey© The Economist Intelligence Unit Limited 2011 31
    • Multinational companies and China: What future? Some doubt that the elimination of official policies would make much difference. According to John Chiang, a former IT industry executive who now teaches technology management at Peking University, parochialism is an acceptable way of thinking in China, which is still coming off a surge of nationalist pride following the global financial crisis. “No matter what the official policy is, MNCs will be handicapped by this patriotism,” he says. A non-standard approach China’s efforts to develop its own industrial standards are also related to the indigenous innovation strategy. While the development of proprietary standards is understandable, the way in which China is going about it, and the lack of transparency in its approach, has led foreign companies to believe that21 For an account of China’s these standards will be used as protectionist weapons.21 In many other countries standards are set bystandards developmentefforts, see Dieter Ernst, industry consensus and then ultimately judged by markets. China’s efforts, however, are being led by theIndigenous Innovation and government and are not subject to industry review or market scrutiny.Globalization, the challengefor China’s Standardization The most well-known cases involve China’s attempts to set its own wireless networking and 3GStrategy, UC Instituteon Global Conflict and standards, known as WAPI and TD-SCDMA respectively. To cut a long story short, most mobile phoneCooperation and the East- users in China today use the international Wi-Fi standard. But mobile phones sold in China today mustWest Center, June 2011. still support WAPI, the Chinese standard, and their makers such as Nokia must pay a royalty to WAPI’s creators. TD-SCDMA is also in use, by China Mobile, though it is reportedly still plagued by bugs. Other operators rely on the international-standard CDMA. Even without government direction, the standards-setting process is all too often hijacked by vested interests and used to keep out of the market foreign products with which Chinese producers cannot compete. Foreign firms are rarely allowed to participate in standards-forming committees and, when they are, it is usually only as “observers”. Asked what was the excuse for not allowing their participation in a standards committee, one foreign equipment maker said, “They said it’s only for Chinese companies. It was as simple as that. We’ve finally managed to get ‘observer’ status so we know a bit more what’s going on. We used to have cases where we were knocked off the list because we weren’t informed of the requirements.” Many standards are what has come to be known as “voluntary, yet compulsory”. WAPI is a classic example. Another is farm equipment, where companies must meet the standards (on which only local manufacturers have input) or be left off the list for government subsidies for equipment purchase, which are the key driver of the market. At what price? Foreign companies worry about the degree to which they will be required to exchange IP in return for market access in China’s ‘strategic emerging industries’ (see p29), where it plans to spend billions not only to encourage innovation but to create markets. China’s plan for these strategic industries calls for foreign and Chinese companies to work together on technology standardization projects in these sectors, but there have been no details of these projects, which are to be funded by the Chinese government. Meanwhile, in strategic industries such as electric vehicles, players await further signals of the way32 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future? High-speed trains: A series of unfortunate events the US. In terms of competitive advantages, the Chinese companies have cost on their side. Not only are their products cheaper but they bring with them the prospect of low-cost financing to be provided by Events surrounding the development of China’s high-speed railways China’s state-owned financial institutions. illustrate multinational companies’ worst fears: that China will use But their march abroad could yet be derailed, if only temporarily. technology and skills learned from them to compete against them in There are widespread suspicions—but as yet no clear proof—that the global marketplace. the technology being used by the Chinese companies is not new. At the turn of this century, multinationals such as Germany’s Kawasaki Heavy Industries, at least, has threatened to sue if China Siemens, France’s Alstom, and Japan’s Kawasaki Heavy Industries attempts to patent anything that resembles the technology that it controlled about two-thirds of the Chinese market for high-speed rail transferred (China has only recently begun filing train technology systems. China tried to launch a competing system, the China Star, patents in several countries around the world and denies that KHI using locally-developed technology, but the effort was abandoned has anything to worry about). Just the threat of a legal quagmire will after only a couple of years. When China began developing its high- be enough to put off some potential foreign buyers. speed rail plans in earnest, it made it clear that it wanted more for Then there is the corruption and safety scandal that swirls around domestic companies. China’s Beijing-Shanghai high-speed line, which went into operation Assuming they would continue to profit if they played ball, foreign this year. A former senior railway official has claimed that the rail companies began what in hindsight was a dangerous journey. For ministry covered up technical problems with the trains, putting example, in 2005 Siemens agreed to work with China National passengers at risk. The minister responsible for overseeing the Railway Corporation (CNR) to bid to supply passenger trains for building of the line has been arrested on corruption charges. The the Beijing-Tianjin high-speed railway. As part of the deal, most ministry has since announced that the trains will run at 300km/h of the trains were made in China at CNR’s facilities, and Siemens rather than 350km/h as originally advertised, but says the reduction also offered training for CNR staff. But shortly after the project is based on economic and environmental concerns, rather than was completed in 2008, the stakes were suddenly raised. While the safety issues. German conglomerate announced that it had won a contract to The concerns surrounding the high-speed railways hit the provide 100 trains for the Beijing-Shanghai railway, the Ministry of headlines in spectacular fashion on July 23rd, when two trains Railways denied this was the case and announced that the project travelling in bad weather collided near Wenzhou in Zhejiang would use Chinese technology. It then began requiring foreign province, killing 40 people and injuring almost 200 others. companies to form joint ventures with CNR or the other state-owned Investigators initially blamed problems with the track signalling maker, China South Rolling Stock and Locomotive Corporation (CSR). system, but an angry public pointed fingers at official incompetence They would be confined to 49% equity in these ventures, which were and mismanagement. required to offer the latest designs, and 70% of the content of each What can or will the foreign train makers do? They are not system had to be sourced in China. speaking publicly about their strategies. But their actions speak Today, foreign makers account for only an estimated 15-20% of volumes. In March 2010, Siemens dropped out of the bidding for the high-speed rail market, and there is a concerted drive by China’s a rail system in Saudi Arabia and joined a Chinese consortium rail companies to win contracts in markets overseas. They are already including CSR and others. In December 2010, GE Transportation having some success. In 2009, CNR won a deal to supply rolling stock announced its intention to form a US-based joint venture with CSR to to Australia and New Zealand, and both it and CSR are now gunning bid for American high-speed rail projects. for large projects all over the world, including developed markets like© The Economist Intelligence Unit Limited 2011 33
    • Multinational companies and China: What future? ahead and try to prepare. GM, for example, has appointed a 30-year company veteran to the position of executive director for electrification strategy for China, based in Shanghai. One of his jobs will be to work with standards committees. While regulations and nuances are constantly evolving, the government looks likely to require foreign carmakers and EV components makers to form JVs with local firms, possibly in a minority position, and to produce vehicles using local brands. It is already clear that foreign companies will not succeed simply by bringing their existing EV models and technologies: government subsidies aimed at spurring demand for EVs, expected to be a key factor in the market, apply only to locally-produced (and presumably developed) cars. In any event, it is not clear that existing models would be appropriate. Nor is it clear that technology need be at risk. GM is planning to work with its partner, SAIC, to develop batteries and vehicles that are less costly to produce so that more Chinese consumers can afford to buy them. The development work will not be conducted in a joint venture but most likely through a co-development exercise governed by a legal agreement. Certain technology would be jointly owned and some would be separate. GM and SAIC have used similar arrangements to develop an engine and dual-clutch transmission. The risks of JVs have always been the same—particularly the risk that the partner will walk away with technology or trade secrets—and they have been borne out in numerous cases, not only in China. But the stakes today seem ever higher given China’s determination to become a global player in many industries. What was previously a localised risk is now a global one. This risk is most clearly illustrated in the case of China’s high-speed rail developments (see High-speed trains: A series of unfortunate events, p33). Getting on with it China’s approach to obtaining technology and encouraging innovation is still unfolding. Hence, it is difficult to predict what will happen. Could pressure from foreign governments result in further dismantling of the most feared policies? This seems the least likely source of relief. American and European governments are waking up to the realities and, in some instances, have investigated the legality of policies such as those on public procurement under World Trade Organisation (WTO) rules. There are, however, too many policies to tackle all at once, and it is not at all clear if many are in contravention of anything. Moreover, the real problem often lies not in the national policies themselves but the way in which they are hijacked by vested interests and local governments. There is some belief—and certainly a lot of hope—that Chinese leaders will eventually realise that the innovation race is not a zero-sum game, and that in many areas it still needs foreign multinationals. These range from some obviously critical products such as semiconductors, to less-recognised soft knowledge such as the ability to manage a complex business across borders or how to develop and manage a brand. Pragmatism, a quality that most foreign businessmen agree the Chinese government doesn’t lack, is more likely to get it what it wants. There is also hope that with the current emphasis on developing their own IP, Chinese companies will now push hard for proper IP protection at home, and leaders will recognize the connection between lack of protection and lack of innovation. “Entrepreneurs in China want to get rich quick,” notes an American34 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future?businessman with long years of experience in China. “Under the current environment, intellectualproperty is no way to get rich because it is stolen immediately. It is better to put your money in realestate.” A few foreign companies are thinking that by aligning themselves more closely with Chinese partnerson the global stage through joint ventures they will give the partner a vested interest in helping themmake their way in China. This is not charity—in some cases Chinese companies have technologies thatare applicable in other emerging markets, and even in emerged ones (see Chapter 7). With the newemphasis on R&D and technology transfer, chances are very high that they will develop even moretechnologies that foreign companies will want to access. On the policy level, no major changes are expected in the near term. China is about to make aleadership transition in 2012, and as a result there will undoubtedly be a shifting of key players andrealignment of agencies and ministries. In the meantime, it will be up to MNCs to figure out what theycan offer that China wants, and how they can safeguard their interests in doing so.© The Economist Intelligence Unit Limited 2011 35
    • Multinational companies and China: What future? Chapter 6: Honour thy master In addition to pleasing their customers, multinationals must also do their part to please the Chinese government. G earing up the organisation and exploring new opportunities are only part of the story of what the more high-profile foreign MNCs will need to do to succeed in China. The companies we spoke to are keenly aware of what China wants from them, and they try to be seen to be cooperating with China’s development objectives. Many companies, however, report a rather unseemly focus on their technology with which they struggle to abide. According to a senior executive at an equipment maker, even local governments are now judging investments by the degree of technology they bring, particularly whether it is energy-saving or otherwise environmentally friendly. “It is more challenging for MNCs,” the executive notes. “Are you bringing what they want? We have our own business plans, and these may not be aligned with those of the government.” Officials are particularly unimpressed with “backward” technology that is no longer used in the developed world, says the executive at the equipment maker. “But it is a balance between the technology and the reality of the market…We have research that the market doesn’t want some kinds of advanced technology, but the government insists it is the right technology for the market.” Others report that when speaking with potential local partners they are bluntly asked: How much does it cost to license? Larger companies, however, report an increased willingness to consider the bigger picture, including how two companies can work together on the global stage. More and more it seems that multinationals are seeing little choice but to work with Chinese partners, even though regulations may not clearly state that they need to do so. GE, for example, has in the past two years announced numerous joint ventures in airplane technology, coal gasification, wind turbines and other energy sectors. It is showing a new flexibility in forming these arrangements. For ventures36 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future?based in China, it is willing to accept a minority position, although for ventures abroad (which are still inthe pipeline), where it has more expertise than its partners, it will seek a majority stake. Noting the Chinese government’s intentions to develop its own jet airliner, John Rice, vice-chairmanof GE, told The New York Times: “We can participate in that or sit on the sidelines. We’re not about sittingon the sidelines.” Its JV partner is Aviation Industry Corporation of China (Avic) which has supplied itwith parts for years. “This isn’t something we were forced into,” Mr Rice noted.22 22 “G.E. to Share Jet Technology With China in Pundits, particularly America’s right wing, fear that GE is giving away American technology and jobs, New Joint Venture”, New Yorkand stands to suffer the same fate as high-speed train makers (see p29). Of course, the issue is doubly Times, Jan 17th 2011sensitive for GE, whose CEO, Jeffery Immelt, is US President Barack Obama’s jobs czar. But while MrImmelt is at one minute urging US companies to hire more engineers in order to boost competitiveness,he is at the same time unapologetic about GE’s plans for China. Regarding the JV with Avic, he toldreporters: “This is about creating a new competitor [to Boeing and Airbus] and it’s about an Americancompany looking for strategic opportunity to develop a new platform.”23 23 Ed Crooks, “GE sets its sights high in Chinese tie-up”, Mr Immelt noted that GE will supply more content to China’s first commercial airliner, the C919, Financial Times, January 20ththan it has to any other plane in history. “This is more about trying to play offence in a win-win setting 2011than ‘under threat of death we gave our technology’...[That’s] just not true,” he said.24 Of course for 24 Jeremy Lemer, “GE chief urges companies to addtechnology-rich conglomerates such as GE and GM, it is rather easy to take a gamble with what is really a engineers”, Financial Times,small part of the empire. July 14th 2011 With China’s renewed emphasis on innovation, multinational R&D centres now seem to be flavourof the month. Zinnov, a management consultancy, says that during the worst of the financial crisisbetween 2009 and March 2011, MNCs set up 200 new R&D centres in China, in addition to the 1,100that were already in existence25. The trend is driven by several factors. The biggest, perhaps, is public 25 “MNC R&D Landscape: A China Perspective”, Zinnovrelations. The second is a need to more closely tailor products to suit the growing and increasingly Management Consultingsophisticated market. The third is the need to meet local standards—indeed, some claim thatincremental innovations to existing products made in China, qualifying them as Chinese innovations,will be enough to satisfy the government’s drive for indigenous innovation (which is being measuredwith, among other things, strict quotas on patent filings). Last but not least is the need to drive downcosts—for R&D, components and other supplies—in order to compete and expand in the mass market. Inareas such as pharmaceuticals trials in particular, cost savings are estimated to be as much as 20%. Sceptics question how many of the R&D centres are engaged in “real” R&D work, as opposed tothe labour-intensive kind that is routinely required to test and certify products, or to make minoradjustments to existing products. There is no hard data to determine the answer, although a recentstudy of the top ten technology companies suggests that half of them are not doing any significant R&Dwork in China and that Indian labs are far ahead in generating patents.26 While there has been much 26 Anil K Gupta and Wang Haiyan, “How Beijing Ishype about “reverse innovation”—the development of products in emerging markets which are then sold Stifling Chinese Innovation”,in developed countries—this seems to be overplayed. Indeed, only 22% of our survey respondents said wsj.com, September 1st 2011they saw China as a “source of innovation for global products” in the next five years. Many more, however, see China as a source of business model and process innovation. Honeywell, forexample, talks of its operations in China having “Chinese DNA” and using the company it has developedthere to compete in other emerging markets. Companies in some sectors also see China as a source of© The Economist Intelligence Unit Limited 2011 37
    • Multinational companies and China: What future? talent, acknowledging the vast potential China has to be an R&D power in the future. In pharmaceuticals and healthcare, 52% of respondents saw this as a major opportunity for their companies (compared with 32% for the survey respondents as a whole), while the figure for IT/technology was 49%. In both industries, China’s talent was cited as second only to the growing market as the biggest opportunity. While companies agreeing to set up R&D operations in China may benefit from skills availability and lower costs, whether there is any direct payback in terms of favourable treatment from authorities is another matter for scepticism. Microsoft is in the vanguard of R&D investment in China, having first set up a lab in Beijing in the mid 1990s. According to research, China has played a part in 6.5% of the27 Erik Sherman, “Microsoft patents granted to Microsoft in the US since 2005.27 Despite this, and Hu Jintao’s reference to MicrosoftNeeds China: 6.5% of Its U.S.Patents Have Roots There”, Chairman Bill Gates as “a friend of China”, software piracy remains rampant and Microsoft’s ChinaFebruary 26th 2010 revenues are less than those it gets from the Netherlands—an especially galling statistic given that China is now the world’s largest market for PCs. Steve Ballmer, the company’s CEO, made clear the impact28 “Ballmer Bares China in May this year when he came to Beijing to open a new US$400m Asia R&D campus.28 One can onlyTravails”, wsj.com, May 26th2011 surmise that China has talents Microsoft cannot do without. One industry where investment in R&D centres is having an acknowledged impact is in pharmaceuticals. Companies are realising that by opening serious R&D labs, they are able to attract Chinese PhDs working overseas to return home. While China’s several thousand local drugs makers (largely manufacturers and distributors) have shown little inclination to develop blockbuster drugs, many industry players suggest that the research ecosystem being created by big pharma and the flourishing population of clinical research organisations (CROs) is laying the groundwork for them to do29 George Baeder and Michael so one day.29Zielenziger, “China, The LifeSciences Leader of 2020”, The biggest concern for companies setting up R&D facilities in China is, of course, IPR protection.Monitor Group, 2010 The mantra is still, “if you can’t afford to lose it, don’t bring it”. Without doubt MNCs are keeping their core R&D at home. Some will restrict their R&D activities to products aimed at the local market. Others will seek to integrate their China facilities into a global network which divides R&D work between several facilities and hence lessens the risk of IP loss. Still, some are catering for China’s desire to have more patents filed in the country. For example BASF’s polyurethanes division R&D centre in Shanghai completed development of Elastollan Soft, a thermoplastic polyurethane with potential applications in various industries ranging from footwear to construction, and launched it globally in 2010. The idea was generated in Japan but the development patent was filed in China. GM, meanwhile, has worked with its joint venture partner, Shanghai Automotive Industry Corp (SAIC), to develop an engine and a transmission under a co-development exercise with a separate legal agreement, rather than a joint venture (see previous chapter). The renminbi Another way in which multinationals can impress China’s leaders is by showing support for its efforts to internationalise the renminbi and to attract famous global names to list on the so-called international board of the Shanghai Stock Exchange—the launch timing of which is still unclear. Since 2010, China has increasingly allowed renminbi bonds to be issued in Hong Kong and the currency to be used for trade settlement. There have been a few high-profile bond issues, notably by38 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future?Unilever, McDonald’s, Yum! Brands and Caterpillar. McDonald’s and Unilever planned to use the proceedsfor working capital in China, while Caterpillar plans to use the funds to offer financing for the purchaseof its equipment. The attractions of issuing renminbi bonds are manifold: the cost of financing can belower, it provides a chance to manage currency risk, and an opportunity to broaden the investor base.But perhaps more importantly, it is a smart PR move. The Chinese government has signalled its intentionto internationalise the renminbi, and bankers are of the opinion that corporate issues, rather than thoseby financial institutions, will give the market more credibility. The downside, as ever with China, is uncertainty. Companies are not automatically allowed torepatriate the funds to the mainland, and though McDonald’s and Caterpillar have been able to do so,approvals were slow in coming. This no doubt helps explain why our survey respondents did not showmuch interest in such fund-raising. Only 9% of respondents reported any plans by their company toissue renminbi bonds, whether in Hong Kong or China. Among big companies, the figure was only 5%.According to a spokesperson for BASF, a German conglomerate with large investments in China, “Theattractiveness of these markets increases with the maturity level achieved by regulatory frameworks. Forthe time being, however, we are not considering tapping these markets ourselves.” As for the prospect of listing in China (either a dual listing or listing of a China subsidiary), the resultsare largely the same. Despite some big names such as HSBC, Standard Chartered, Unilever and Coca-Colaexpressing interest in a dual listing on the Shanghai exchange—and some of these actively discussingthe finer points with regulators—fewer than 10% of survey respondents thought their company would belikely to go down this route. Again, lack of clarity no doubt has a bearing on enthusiasm. Plans to launch the international boardin Shanghai were first announced back in 2007. Despite suggestions that the board would be up andrunning by the end of 2011 it seems no closer to fruition. Just what is holding it up is unclear, thoughthe subject of much speculation. It is commonly believed that the major reason for the delay is China’scurrency policy—to entice companies to list, the government would need to introduce full capitalaccount convertibility, thereby giving up one of the major instruments by which it controls the economy.However, China is expected to simply make rules on convertibility and repatriation for companieslisted on the board. This in itself, if introduced without limits, could be politically sensitive. Somecommentators have conjured the image of foreign companies using China as an ATM machine, takingthe proceeds from their higher valuations in China and using them to buy back their own shares on otherbourses at a lower price 30. Others think this a non-issue as many listing companies are more likely to 30 “The Shanghai International Board:keep ploughing money back into China, rather than taking it out, at least in the near term. From MNCs’ Challenges andviewpoint, convertibility is no longer as big a deal as it once was. Only about one-quarter of our survey Opportunities”, Trusted Sources, June 2010respondents said that lack of convertibility had an adverse impact on their China strategy. It is understood that most of the technical details of the basic rules for listing have been thoroughlydiscussed and rules drafted. They are now awaiting sign off by senior leaders. While the comingleadership change may delay the launch, it is believed that it will still go ahead, with timing dependenton market conditions and China’s relations with major trading partners. As with many other new policies in China, the launch of the international board is expected to begradual. The number of companies allowed to list initially will be limited, probably to less than five and© The Economist Intelligence Unit Limited 2011 39
    • Multinational companies and China: What future? even as few as two or three. This will be based on the market’s capacity to absorb the issues more than anything else. The companies most likely to list will be seeking to raise Rmb10-30bn each (through IPOs), while total fundraising on the Shanghai exchange in 2010 was just Rmb515bn, according to Dealogic (the amount was down to Rmb22bn in the first ten months of 2011). Regulators will also be concerned about any potential negative impact on local share prices or local companies’ abilities to raise funds. Convertibility and repatriation aside, the biggest concerns for foreign investors are rules on corporate governance and accounting standards. Having to comply with a new set of standards would add to the cost of listing and lessen the appeal. According to a source close to the regulators, foreign investors will be subject to their home market rules in terms of governance issues such as board structure and operation. Accounting standards are less clear but it seems likely that EU companies will be allowed to use their existing IFRS. US companies will be allowed to report under US GAAP but may need to reconcile major items with Chinese accounting standards. The attractions of a Shanghai listing for multinationals are not hard to fathom. Valuations are on average much higher in China, and it would make sense for companies planning to make major investments in China to raise the funds in local currency. There is the PR benefit of having one’s name splashed daily in the media in the run-up to listing (and no doubt there are a few companies desperate to ensure they are listed before their competitors). Perhaps more importantly, a listing, it is felt, could offer them some protection from whimsical bureaucrats, who may think twice about making an example of a company with several hundred thousand local shareholders. For companies with a decidedly poor reputation locally, such as global resources players, who are widely perceived to be profiting unfairly from China’s dependence on them, it would no doubt help them to allow some Chinese citizens to share in their profits. Where there are opportunities, however, there must also be risks. These are not entirely clear at this early stage, but analysts point to two issues. The first is the fate of the international board once currency No big deal Does the lack of capital account convertibility of the renminbi have an adverse effect on your China strategy? (% respondents) Yes 26 No 51 Not sure 23 Source: Economist Intelligence Unit survey Please indicate your level of agreement with the following statements. Rate on a scale of 1 to 5, where 1 = Strongly agree and 5 = Strongly disagree. (% respondents) Strongly agree 1 2 3 4 Strongly disagree 5 Repatriation of funds remains difficult, making us more conservative in our push into China 35 33 21 7 4 We still need to rely on more open financial centres such as Hong Kong or Singapore to run regional finances 35 35 21 6 4 Lack of convertibility is preventing us from moving our Asia headquarters to China 21 23 21 18 17 Source: Economist Intelligence Unit survey40 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future?controls are eventually lifted and Chinese punters allowed direct access to international markets. Theworriers point to the experience of Tokyo, where many of the foreign multinationals so keen to list inthe 1980s have since withdrawn due to the poor performance of their shares, which was blamed in parton Japan’s open capital account. The optimists counter that Tokyo’s experience may not be relevantbecause companies that seek dual listings do so based on their expectations of growth in the countryconcerned and its importance to their global strategy. While multinationals were bullish on Japan atthe time, most would agree that expectations of China are in an entirely different league. The secondpotential risk is an over-dependence on China. This is particularly true for sectors like luxury goods,where China is rapidly coming to account for a large share of their global revenues. For all its growthChina is still facing some difficult and risky economic and social transitions. To become overly reliant onit for both sales and fundraising may not be prudent.By other meansPleasing the Chinese government is not all about R&D labs and bond issues. Many multinationalshave some sort of corporate social responsibility programme in China, often linked to education orenvironmental management. But some are coming to the conclusion that this is not enough. One largeconsumer goods company, for example, has decided that what its regulatory masters are truly in want ofat the moment is sharing of knowledge that can help Chinese companies in their expansion abroad. So thecompany is bringing in senior global executives to train managers from China’s state-owned enterprises(SOEs), largely in the resources sector, on how to undertake global M&A. “What we have are our brand andyears of experience running a global company and doing successful mergers and acquisitions,” notes theexecutive. “These are things that China is keen to have for its own companies.” Given that there are noSOEs in the FMCG industry, there is no danger that the foreign company is helping competitors.© The Economist Intelligence Unit Limited 2011 41
    • Multinational companies and China: What future? Nissan: According to plan 80,000 in 2015. Its main export markets are South America, Russia, the Middle East, and South Asia. Given its concerns about being able to keep pace with demand for passenger cars (it exceeded its goal For Nissan, like GM and Volkswagen, China is already its largest single for 2010 by 300,000 units), exports will remain skewed towards market, accounting for nearly one quarter of its global sales. With commercial vehicles. the Chinese government targeting vehicle sales of 30m by 2015, • Expand production, increase local content. DLF will open three Nissan, like others, is now scrambling to expand fast enough to new plants in the next two years, one each for passenger vehicles, keep pace with demand, worrying that if it doesn’t it will lose market light commercial vehicles and medium to heavy commercial vehicles, share. It achieved the sales target of its previous mid-term plan two as well as a new engine plant. years ahead of schedule. It is now aiming for 10% of what it believes • R&D. In line with China’s desire to increase the amount of R&D will be a 20m-unit vehicle market by 2015, up from 6% of today’s done in the country, DLF will increase the number of R&D employees market. It plans to achieve this by, among other things, introducing from 3,500 to 6,000 by 2015. around 30 new products, including a locally developed electric • Electric vehicles. Though Nissan already produces its own fully vehicle (EV), catering for the increasingly diverse needs of the China electric vehicle, the Leaf, it will develop a new electric model under market. the Venucia brand, which it plans to launch in 2015. The medium-term plan of its 50:50 joint venture with Dongfeng There is much scepticism that demand for EVs can be stoked to the Group, known as DFL, sounds like a page right out of China’s 12th extent necessary to justify such investments—the main argument Five-Year Plan. When the partners presented it to a press conference being that first-time buyers, who are driving the car market in in July, they made careful reference to what was expected of the China, are more likely to go for affordability and style, rather than auto sector in the plan and what they were doing to meet those environmental consciousness. But automakers seem to have a degree expectations. The JV plans to spend Rmb50bn (US$7.8bn), focusing of blind faith in the Chinese government’s ability to create demand. on the following: They are, however, not very sure of the how, when and how many. • Indigenous brands. The Five-Year Plan calls for indigenous brands As Carlos Ghosn, president and CEO of Nissan Motor notes, EV to account for 50% of domestic passenger car sales by 2015. Hence pilot schemes are currently running in only six cities, and they are DLF will introduce the new Venucia brand of vehicles, which will be restricted to local brands. “When the market will take off is hard to designed in China from start to finish. The company is also targeting tell because there are not that many EV offerings yet,” he says. “But 100% local content by 2015 (though it is not clear if this will come China says, to expand in this country, you need to bring in new- from local suppliers or subsidiaries of Japanese suppliers). energy cars. So more foreign producers will bring in new-energy • Exports. The Five-Year Plan calls for the auto industry to export cars.” 10% of its total volume. DLF plans to raise exports (mostly of commercial vehicles) from 19,000 in 2010, to 40,000 in 2012, and42 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future? Investing in R&D healthcare group, hopes to double its revenues in China to €6bn by 2015 from €2.9bn in 2010. To help achieve this goal, the company plans to conduct its R&D closer to its customers. In June this year China is already the third-largest market in the world for both BASF Bayer MaterialScience started the third-phase expansion of its and Bayer, German industrial behemoths that arrived in China Polymer Research & Development Center (PRDC) in Shanghai. When as early as the late 19th century. On top of their huge existing it is completed in the second half of 2012, the PRDC will double the investments in China—BASF has invested €3.8bn (US$5.1bn) in number of employees to almost 260 and will have a full range of R&D China since 1990—both are spending billions more euros to expand expertise befitting a global innovation center. The material science their production capacities. Both companies are also spending division has also moved the headquarters of the polycarbonates serious money on beefing up their local research-and-development business unit to Shanghai (R&D) capabilities—in lockstep with the Chinese government’s push Bayer HealthCare is following a similar path. The company for more home-grown innovation. this year announced that it would move its general medicine In December 2010, BASF, a chemical company with nearly 7,000 headquarters to Beijing. Earlier, in February 2009, Bayer Schering employees in China, broke ground on a €55m (US$74m) regional R&D Pharma unveiled plans for a €100m global R&D center in Beijing. centre in Pudong, Shanghai, which is scheduled to open in the first The company’s head of global development and chief medical half of 2012 with some 450 scientific and technical professionals. officer, Kemal Malik, said in a statement at the time: “Our goal is to This “Innovation Campus” will focus on developing new products build a world class organization here in Beijing that will lead drug and solutions for the construction, automotive, footwear, and development not only for China but also for other Asian countries. cosmetic industries in the Asia-Pacific region. BASF currently has Our aim is to systematically include Asian patients earlier in global major local R&D facilities in Shanghai, Nansha (Guangdong province) drug development, breaking the tradition of ‘US and EU first’.” and Beijing. The expansion of R&D capabilities in China is aimed at Since then, the company has also begun a collaborative supporting BASF’s objective of manufacturing 70% of what it sells in arrangement with Tsinghua University in Beijing—the Bayer- Asia-Pacific locally by 2020. The company says its Pudong centre— Tsinghua Research Center of Innovative Drug Discovery—focusing which will also house the company’s Greater China head office—will on oncology research, and has formed a strategic partnership with ultimately become one of the largest BASF sites outside Germany, the General Hospital of the People’s Liberation Army (301 Hospital), with more than 2,000 employees. one of the largest hospitals in Beijing, to jointly study gynecological Meanwhile, Bayer, a high-tech materials, crop science and diseases.© The Economist Intelligence Unit Limited 2011 43
    • Multinational companies and China: What future? Chapter 7: Gearing up to play the game To succeed in China, multinationals will need to reorganise to reflect the country’s importance to them, to be flexible in their thinking, and ultimately to think beyond China. T he picture of China that we have painted in this report is a fast-changing market that is about to be transformed again. The good news for foreign multinationals is that the long wait for the country’s enormous and long-heralded consumer market to fulfil its potential is nearly over. The bad news is that it will be fought over by many businesses, both foreign and Chinese, that are looking to grow—which is to say all businesses. What is more, for MNCs that possess valuable technology, China is shaping up to be an increasingly risky market. No business can avoid competition and risk, of course. In that sense, the China market is becoming more normal than in earlier years of its economic reforms. Back then, many MNCs’ strategies amounted to not much more than just showing up. But many MNCs still need to take China more seriously. That means, for one thing, the need to reorganise to ensure that China gets the attention it deserves at the highest levels within the company. According to our survey, companies are only beginning to do so. Among large companies, only 8% said that their China CEO sits on the company board (for 45%, the China CEO reports into regional headquarters). However, 40% of these companies said that they had moved very senior executives to greater China. For example, in late 2010 GE relocated John Rice, one of its vice-chairmen, to Hong Kong to ensure GE is well placed to capture the huge opportunities in China’s power, transport and healthcare sectors. In January of this year Caterpillar moved its group president, Richard Lavin, to Hong Kong from the US. Then in May Intel, a computer chipmaker, announced that one of its most senior executives and a future contender for CEO, Sean Maloney, had been appointed as the company’s first China chairman based in Beijing. But all three were months behind Ford, which moved its Asia Pacific headquarters from Bangkok to Shanghai in 2009.44 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future? This may be the beginning of a move toward greater autonomy for China teams: 49% of largecompanies said that the autonomy of their China operations had increased in the past three years. Thiswill undoubtedly be the way of the future for industrial giants. “Many companies have US or Europeanheadquarters which are obsolete in terms of their ability to do much to help in China,” says ThomasHout, adjunct senior lecturer at the Fletcher School of Law and Diplomacy at Tufts University. “The smartones have a China CEO reporting to the global CEO. If China is your future, that’s what you’ve got to do.” Efforts at integration flow the other way as well—42% of survey respondents at big companies saidthey are bringing more Chinese executives to global headquarters, either for postings or for executivedevelopment programmes. And 12% reported that they have moved the global headquarters of somedivisions to China. Somewhat surprisingly, given the amount of grousing heard on the ground in China, the majority ofsurvey respondents felt that the views of headquarters and operations in China were aligned in terms ofstrategy. Among large companies, 14% felt they were out of sync and the major area on which they weremisaligned was on the need to be innovative in business structures, such as taking minority stakes injoint ventures in China (though China-based respondents said the need for speed was the bigger issue).Among respondents based in China, 27% say they are misaligned, mainly on the need for speed. That the China market requires flexibility is well illustrated in the pharmaceutical sector. As notedearlier, it is highly likely that price caps will drive the market towards generic drugs. Here the name ofthe game will be speed and scale, where local companies have the advantage. In an ideal world, fromthe cash-rich multinationals’ viewpoint, they would buy up local players to expand. Though foreigncompanies are looking, it seems unlikely to be so simple. Local companies are well aware of the potentialgold mine on which they are sitting and are seeking high prices. Many are unwilling to sell completely,even if such deals would be approved (China’s anti-monopoly law is not well tested in this industry).And then there is the issue of whether local firms can meet quality standards in this highly regulatedindustry. All of this means that multinationals will need to change their typical approach. “To tap this, youneed to be fast, innovative and aggressive—or you will miss out,” says Simon Benjamin of Ernst &Young, an accounting and consulting firm. “I think all of big pharma recognises this now.” According toMr Benjamin, although there have not been enough deals to really call it a trend, anecdotal evidencesuggests that minority stakes in local drug makers for foreigners will be the way of the future. Fonterra, a New Zealand dairy group, is a good example of an MNC with a flexible approach for theChina market. It is investing in its own farms in China even though it has 4m cows producing some 15bnlitres of milk annually at home, much of it for export. With demand for dairy products growing rapidly inChina, it is prudent to begin both replacing imports with local supplies and helping the country improvefood security. The move is also in line with the government’s desire to develop its agriculture sector andimprove food safety. Fonterra is understandbly keen to control its supply chain. Its Chinese partner,Sanlu, played a central role in a scandal in which industrial chemical-tainted milk sickened tens ofthousands of babies (six of whom died) in 2008.© The Economist Intelligence Unit Limited 2011 45
    • Multinational companies and China: What future? Overcoming the fear factor The ultimate flexibility will be needed in figuring out how to co-exist with Chinese competitors outside China. While many companies—and countries—fear the rise of competition from China, an increasing number of companies, particularly carmakers, are trying to exploit what they have developed in China to tackle other emerging markets through co-operative arrangements with their Chinese partners. Two of the world’s largest corporations are going a step further and officially partnering with their Chinese counterparts in other markets. GM has teamed up with its Chinese joint-venture partner Shanghai Automotive Industry Corporation (SAIC) in a new 50:50 JV in India, a market GM entered in 2000 and has struggled with since. Analysts have speculated that the Indian venture stake was a trade-off, with GM getting an increased share in its SAIC-GM-Wuling venture, the world’s largest producer of minivans, in return. But Kevin Wale, managing director of GM China, says this was not the case. Rather, the deal was done purely on its own merits. “There is a tremendous opportunity in India and other markets which are poised at where China was about ten years ago,” he says. “Their product needs are very similar and the best way to win is to transfer some of the business models and products from our China business.” That China business is only partially owned by GM. Shanghai GM is currently 51% owned by SAIC following the sale of a controlling 1% stake to the Chinese company in 2010, a move that was made to allow SAIC to consolidate the venture’s earnings on its books. GM now owns 44% of GM-SAIC-Wuling. “SAIC has the same interests as us to exploit the India market,” says Mr Wale. “We have advantages in terms of international experience and they have advantages in terms of products and resources— physical products, low-cost manufacturing techniques, lots of things along the full supply chain. There are lots of assets that have been developed through our joint ventures that are relevant in India and elsewhere.” Another example is GE, which in December 2010 announced its intention to form a US-based joint venture with China South Rolling Stock and Locomotive Corporation (CSR) to bid for American rail projects, notably the high-speed rail corridors planned for Florida and California. The fate of the JV, however, could be in doubt following China’s recent rail disaster (see the box p33). But prior to these difficulties emerging, it made a great deal of sense. According to one consultant: “They know the future is a joint effort. The US has the systems, the customer contacts, the innovation pipeline. China has the big heavy parts where cost matters. They have the construction and engineering companies who can install things.” Both GM and GE are probably better off working with the competition than against it. “They’ve got a good flow of orders for their factories, and it is a good way to avoid getting caught up in international conflict,” says the same consultant. “If you end up in a WTO hearing or protracted action or in court, you have lost because nothing gets done. And this is a game of speed and going with the market.” For the Chinese side, the GE-CSR deal represents everything it could ever hope for: access to an area of the American market that would otherwise undoubtedly be politically difficult to enter and the opportunity to learn from a world leader.46 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future? Still, given concerns about China’s rising power among the general public in many Western countries,companies need to play such arrangements carefully. In its announcement of the JV with CSR, GE Transportwas at pains to point out that local content would be maximised to meet “Buy America” requirements andthat the venture would sustain several thousand high-tech manufacturing jobs in the US. Other multinationals will be watching the outcome of these ventures closely. Those with extensiveinternational operations will be hard-pressed to make a case for partnering with Chinese companies whoare in comparison neophytes in the global market. But looking to the next frontiers for business—thelikes of India, Indonesia, Africa and the Middle East—the idea might not seem so unsound. Theseare markets in which lower prices will create and drive markets. Where will multinationals find thewherewithal to compete on that basis? The answer is likely to be China.© The Economist Intelligence Unit Limited 2011 47
    • Appendix Multinational companies and China: What future?Survey results Appendix: Survey results Note: Percentages may not total 100 due to rounding or the selection of multiple answers. Are you familiar with your company’s China strategy? (% respondents) Yes 100 1. How has the fallout from the global financial crisis affected your company’s expectation for China? Choose the one answer that best applies. (% respondents) 37 We are counting on our existing operations in China to deliver more of our global revenue 28 We are investing more in China in the hope that it will make up for deteriorating markets elsewhere 21 We are postponing further investment in China because of deterioration in our main markets 9 We are repatriating more profits from China to shore up balance sheets at headquarters 2 Our expectation has not changed 40 2. From the perspective of your global headquarters, which statement best describes China? (% respondents) It is critical to global strategy 37 It is strategically important, but not critical 33 It is on a par with other emerging markets 9 We are still exploring the market 13 It will be a niche market for us 5 Don’t know 248 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future? Appendix Survey results3. What is driving your company’s China strategy? Choose one. (% respondents)Growth prospects for our industry in China 56Belief that China’s unique characteristics (eg, population) will have a major impact on our industry 19Need to serve our customers 10Need to monitor Chinese competitors 7Falling revenues in other markets 2Other, please specify 4Not sure 24. What is your company’s competitive advantage in China? (% respondents)Long experience in emerging markets/strong management 24Superior/unique technology 23Strong brand 16Large resources 10We don’t have an advantage but feel we need to be in China 19Other, please specify 6Don’t know 25. What are your company’s key assumptions for China over the coming years? Please indicate when you expect each of the following events to happen. This year/has already happened In less than 5 years In between 5 and 10 years (% respondents) In between 10 and 20 years Not in foreseeable futureGrowth will slow to more developed market rates (eg, 3-5%) 10 29 29 21 11The renminbi will be made fully convertible1 31 41 16 11China will succeed in shifting its growth model away from exports and investment and toward domestic consumption 7 32 39 15 6China will become our biggest market 8 17 21 17 37Our major competitors globally will be Chinese 9 17 21 19 35Developments in the China market will have a disruptive impact on our industry 14 18 19 13 36 © The Economist Intelligence Unit Limited 2011 49
    • Appendix Multinational companies and China: What future?Survey results 6. Which of the following factors are likely to have the biggest impact on your China strategy in the next five years? Choose up to three. (% respondents) China’s efforts to raise incomes and boost consumption 58 The regulatory environment/industrial policies (eg, indigenous innovation) 46 Competition from Chinese companies 43 Renminbi convertibility, if it happens 32 Improved infrastructure (as a result of stimulus spending) 25 Urbanisation 21 Other, please specify 5 7. What do you see as the major opportunities for your company in China in the medium term (ie, next five years)? Choose up to three. (% respondents) Growing market for our products 76 Source of skills/talent 32 Source of low-cost production 31 Key market for our technology 27 Source of innovation for global products 22 Source of capital 19 8. What do you see as the biggest operational obstacles standing in the way of seizing these opportunities? Choose up to three. (% respondents) Lack of intellectual property (IP) protection 41 Competition from domestic companies 35 Unpredictable nature of Chinese government 32 Discrimination against foreign companies 31 Corruption 28 Competition from other foreign companies 27 Lack of legal protection in general 23 Lack of available local talent 14 Risk of trade and economic disputes between China and other countries 11 Lack of autonomy to make the right decisions for the China market 850 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future? Appendix Survey results9. How has the autonomy given to the China operations of your company by headquarters changed in the past three years? (% respondents)It has increased 36It has decreased 9No change 5510. Would you say that the views of headquarters and the views of the China operation are in alignment with regard to your China strategy? (% respondents)Yes 73No 12Don’t know 1510a. What impact has this misalignment had on your operations? Choose all that apply. (% respondents)We have lost opportunities because we were not flexible in our thinking 45Global decisions (eg, divestiture of product lines) were not the right ones for China 45We have lost opportunities because decisions could not be made quickly enough 39We have lost opportunities because we could not get the investment required 21Our products do not meet local market needs 18Key executives have quit in frustration 13Other, please specify 510b. What are the key areas in which views are misaligned? Choose up to three. (% respondents)The need to move quickly 32The need to be innovative in our business structures in China (eg, accept minority stakes in JVs) 29The need to adapt product/pricing to local market conditions 24Need for long-term investment 21The threat posed by local competitors 21Risk assessment 18Returns on investment 13View of China’s potential 11Resources for investment 11 © The Economist Intelligence Unit Limited 2011 51
    • Appendix Multinational companies and China: What future?Survey results 11. Which of the following growth strategies will be most important to your company’s expansion plans in China? Choose up to two. (% respondents) Organic growth 63 Joint ventures 46 Acquisitions of Chinese companies 20 Acquisitions of foreign competitors’ operations 6 We are not planning to expand 9 Don’t know 1 12. How will your company expand geographically in China? Choose the one answer that best describes your situation. (% respondents) We will focus on improving penetration in wealthier coastal cities/southern region 59 We are currently moving into second and third-tier cities 33 We already have a substantial market in second and third-tier cities and are moving on to fourth tier and beyond 8 13. Is your company planning to issue bonds in Renminbi? (% respondents) Yes, our parent company is planning to do so in Hong Kong 3 Yes, our parent company is planning to do so in China 3 Yes, our China subsidiary is planning to do so in Hong Kong 2 Yes, our China subsidiary is planning to do so in China 11 No, we have no plans to do so 76 Don’t know 15 14. Please rate how likely your company would be to do the following in the next five years. Rate on a scale of 1 to 5, where 1 = Highly likely and 5 = Not likely at all. (% respondents) Highly likely 1 2 3 4 Not likely at all 5 Raise bonds in Renminbi 5 4 10 11 70 Pursue a secondary listing on the Shanghai Stock Exchange (if permitted) 2 6 11 11 70 List China subsidiary on a mainland stock exchange (if permitted) 3 5 10 14 68 List China subsidiary on the Hong Kong stock exchange 2 7 11 13 67 Sell a stake in your company to a Chinese competitor 2 7 14 16 61 Sell a stake in your company to a minority investor as a means of raising capital and gaining local expertise (eg, Chinese private equity or financial institution) 1 10 21 17 51 Acquire a Chinese company 11 23 25 18 2452 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future? Appendix Survey results15. Does the lack of capital account convertibility of the Renminbi have an adverse effect on your China strategy? (% respondents)Yes 26No 51Not sure 2315a. Please indicate your level of agreement with the following statements. Rate on a scale of 1 to 5, where 1 = Strongly agree and 5 = Strongly disagree. (% respondents) Strongly agree 1 2 3 4 Strongly disagree 5Repatriation of funds remains difficult, making us more conservative in our push into China 35 33 21 7 4We still need to rely on more open financial centres such as Hong Kong or Singapore to run regional finances 35 35 21 6 4Lack of convertibility is preventing us from moving our Asia headquarters to China 21 23 21 18 1716. How will the Reminbi’s appreciation affect your China strategy? Choose all that apply. (% respondents)We see more opportunity to export to China 30We are planning to source more materials/components locally 23We are shifting some production to other countries 15We are undergoing a major cost-cutting exercise 14We see no major impact 4117. Which initiatives is your company undertaking to try to integrate China more closely into global operations? Choose all that apply. (% respondents)Senior executives from headquarters are travelling to China more frequently 58We are putting senior Chinese staff onto our global talent development programme and are bringing more Chinese staff to positions at headquarters 29We have moved very senior global executives to China/the region 22We have appointed executives from China to our global board 15We’re moving or have moved our Asia Pacific headquarters to China 13We have moved global headquarters of some divisions to China 7Our efforts are minimal—we send senior executives to China a few times a year 33 © The Economist Intelligence Unit Limited 2011 53
    • Appendix Multinational companies and China: What future?Survey results 18. How does your company manage China at the board level? Choose all that apply. (% respondents) Our company has a China specific plan that is reviewed and approved by the board annually 43 Our company treats China the same as any other emerging market, with the CEO reporting into a regional head 39 Our company has independent directors/a China advisory committee to oversee and support our operations in China 16 Our company has external board members with China experience and/or board members that live in Greater China 14 Our China CEO sits on the global board 13 Don’t know 14 19. Please indicate the degree of concern at your company regarding the following. Rate on a scale of 1 to 5, where 1 = Very concerned and 5 = Not at all concerned. (% respondents) Very concerned 1 2 3 4 Not at all concerned 5 A major crisis in the Chinese economy 18 25 31 20 6 Major social unrest in China 13 31 29 19 9 China’s bilateral relations with your company’s home country 9 25 26 24 16 Human rights incidents such as the detention of foreign executives 10 22 31 22 15 Protectionism in China at the national level 19 32 28 15 6 Protectionism in China at the provincial/local level 17 32 27 16 7 Protectionism in your company’s home country 6 12 27 30 24 China’s proposed foreign investment review board 6 18 41 23 13 China’s lack of press and internet freedom 12 23 32 23 11 Being forced to give our IP in return for market access 26 23 28 14 9 20. How would you describe the competitive strengths of domestic Chinese companies in your sector? Choose the one that best applies. (% respondents) Chinese competitors in our industry are already a serious threat to our business in China 26 Chinese competitors in our industry are already a serious threat to our business globally 15 Chinese competitors in our industry will be a threat to us globally in five years time 20 Chinese competitors in our industry are not a threat 22 Chinese competitors in our industry are the same as other competitors 1754 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future? Appendix Survey results20a. If Chinese companies in your industry are a threat to your company globally, what do you believe have been the most important factors in their competitive strength? Rate on a scale of 1 to 5, where 1 = Very important and 5 = Not important. (% respondents) Very important 1 2 3 4 Not important 5Entrepreneurial drive 24 35 24 16 1Cost advantage 35 35 24 5 1Government support (eg, low-cost financing) 35 33 23 7 3They have absorbed technology from foreign partners in China 29 40 19 6 5They have developed competing technology 9 27 36 21 721. How has the overseas expansion of Chinese companies affected your company? Choose all that apply. (% respondents)Chinese companies have driven down prices in other markets 30Chinese companies have become competitors for acquisition targets 23Our partners in China have become our competitors in other markets 14No impact 42Other, please specify 322. Has your company changed its China strategy in response to the overseas expansion of Chinese competitors? (% respondents)Yes 24No 68Don’t know 7 © The Economist Intelligence Unit Limited 2011 55
    • Appendix Multinational companies and China: What future?Survey results In which country is your company headquartered? (% respondents) US 29 Germany 8 India 7 Singapore 7 UK 6 Hong Kong 6 Canada 4 Netherlands 3 Australia 3 China 3 France 3 Switzerland 3 Spain 2 Italy 2 Japan 2 Malaysia 2 Philippines 1 Denmark 1 Ireland 1 Thailand 1 Austria 1 Belgium 1 Cyprus 1 New Zealand 1 Poland 1 Portugal 1 Sweden 1 Taiwan 1 In which region is your company headquartered? (% respondents) North America 33 Western Europe 33 Asia-Pacific 33 Eastern Europe 156 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future? Appendix Survey resultsIn which country are you personally located?(% respondents)US 17China 16India 9Singapore 9UK 7Germany 5Canada 5Hong Kong 5Australia 4Italy 3Malaysia 2Spain 2France 2Switzerland 2Philippines 1 2Ireland 1 2Japan 1Poland 1Portugal 1Thailand 1Czech Republic 1Denmark 1Hungary 1Indonesia 1Vietnam 1In which region/country are you personally located?(% respondents)Asia-Pacific excluding China 35Western Europe 26North America 21China 16Eastern Europe 2 © The Economist Intelligence Unit Limited 2011 57
    • Appendix Multinational companies and China: What future?Survey results How long has your company been in China? (% respondents) <5 years 37 5-10 years 27 >10 years 36 What is your primary industry? (% respondents) Manufacturing 14 IT and technology 13 Professional services 13 Financial services 12 Healthcare, pharmaceuticals and biotechnology 6 Chemicals 5 Construction and real estate 5 Consumer goods 5 Education 4 Automotive 4 Energy and natural resources 4 Transportation, travel and tourism 4 Telecommunications 3 Aerospace/Defence 2 Entertainment, media and publishing 2 Retailing 2 Logistics and distribution 2 Agriculture and agribusiness 1 Government/Public sector 1 What are your organisations global annual revenues in US dollars? (% respondents) $500m or less 45 $500m to $1bn 12 $1bn to $5bn 15 $5bn to $10bn 12 $10bn or more 1758 © The Economist Intelligence Unit Limited 2011
    • Multinational companies and China: What future? Appendix Survey resultsWhich of the following best describes your title?(% respondents)Board member 5CEO/President/Managing director 24CFO/Treasurer/Comptroller 9CIO/Technology director 3Other C-level executive 6SVP/VP/Director 18Head of business unit 7Head of department 10Manager 14Other 2What are your main functional roles? Choose up to three.(% respondents)Strategy and business development 46General management 45Marketing and sales 25Finance 24Operations and production 16IT 11R&D 9Risk 9Customer service 8Information and research 5Human resources 4Legal 4Supply-chain management 4Procurement 3Other 1 © The Economist Intelligence Unit Limited 2011 59
    • Appendix Multinational companies and China: What future?Survey results60 © The Economist Intelligence Unit Limited 2011
    • Whilst every effort has been taken to verify the accuracyof this information, neither The Economist IntelligenceUnit Ltd. nor the sponsor of this report can accept anyresponsibility or liability for reliance by any person on thisreport or any of the information, opinions or conclusionsset out herein.Cover image - Harry Harrison
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