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Key drivers and success factors for Chinese companies investing abroad
 

Key drivers and success factors for Chinese companies investing abroad

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China’s Outbound Direct Investment (ODI) has been increasing sharply and is likely to continue this trend in the coming year. The ODI structure is concentrated in Asia and is currently oriented ...

China’s Outbound Direct Investment (ODI) has been increasing sharply and is likely to continue this trend in the coming year. The ODI structure is concentrated in Asia and is currently oriented towards natural resources, although there may be some diversification in the future. From a long-term perspective, Chinese companies should consider three key factors when investing in foreign markets: exploit market opportunity; accelerate technical and business skill evolution and improve the overall risk or opportunity profile. Although expanding into new markets is a complex process, there are many lessons that Chinese companies could learn from other countries. This could help them to successfully manage the process by addressing critical issues. By Enrico Lanzavecchia, director, and Claire Zhong, manager at Value Partners, Beijing.

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    Key drivers and success factors for Chinese companies investing abroad Key drivers and success factors for Chinese companies investing abroad Document Transcript

    • PERSPECTIVE Key drivers and success factors for Chinese companies investing abroad China’s Outbound Direct Investment (ODI) has been increasing sharply and is likely to continue Enrico Lanzavecchia this trend in the coming year. The ODI structure is concentrated in Asia and is currently oriented Director towards natural resources, although there may be some diversification in the future. From a long-term perspective, Chinese companies should consider three key factors when investing in foreign markets: exploit market opportunity; accelerate technical and business skill evolution Claire Zhong and improve the overall risk or opportunity profile. Although expanding into new markets is Manager a complex process, there are many lessons that Chinese companies could learn from other countries. This could help them to successfully manage the process by addressing critical issues China’s Outbound Direct Investment (ODI) increases sharply A consistent growth of current account surplus has accumulated huge assets for both foreign currency reserve and outbound investment. Under the macro scenario, that China growth model is changing – and the Chinese government has strongly supported Chinese companies who want to invest internationally through a series of policy incentives. China’s ODI has been increasing sharply, with a narrowing gap between ODI and Foreign Direct Investment (FDI). Chinese Outbound Direct Investment increases sharply China current account surplus evolution China ODI, FDI and outbound M&A evolution ODI CAGR ‘03-’08 US$ billion US$ billion FDI Outbound M&A 100 CAGR ‘03-’08 450 56% 92 426 • Sharp 400 372 75 decrease 80 due to financial 350 66 crisis 61 60 300 253 60 54 52 12% 250 43 200 161 40 27 150 26 21 69 20 78% 100 12 12* 46 6 8 6 50 3 7 3** 3* 121% 0 0 2003 2004 2005 2006 2007 2008 1H2009 2003 2004 2005 2006 2007 2008 % of outbound 17% 45% 53% 39% 24% 50% 22% M&A vs. ODI * 1H2009 ODI data not include outbound investment for financial sectors; M&A data is from Merger Market database ** 2004 Outbound M&A data is calculated based on growth trends between 2003 and 2005 Source: Ministry of Commerce, Sate Administration of Foreign Exchange; Statistic Bureau, Value Partners analysis However, China’s ODI still represents a much smaller fraction of its GDP than in other countries. By 2007, China’s cumulative ODI was only 3% of its GDP, while for the same period, the UK’s ODI was 61.5%, France’s 54.7%, Germany’s 37.3% and the USA’s, 20.2%. Such a low ODI reflects the fact that Chinese companies still rely heavily on the domestic market, as well as on the natural resources sector. Going forward, along with GDP growth and the globalization of Chinese companies, there is huge potential for an increase in Chinese ODI. 1
    • PERSPECTIVE In terms of ODI geographical and industrial structure, Chinese companies used to rely on nearby countries, where they could leverage an established supply chain and familiarity with local markets. A shift to North America and Europe, though, indicates that they are now looking to mature markets for new opportunities and business capabilities. Competing for natural resources has consistently been the main theme of China’s ODI, and this activity has traditionally been conducted by huge state-owned enterprises (SOEs). Since 2006, Chinese financial institutions have started to aggressively purchase overseas assets. This is due to a rapid growth in the financial industry, with huge funding capability following the spin off of Non Performing Loans (NPL). So far a large share of China’S ODI flow has been concentrated geographically in Asia and oriented towards natural resources and commercial services ODI distribution by regions ODI distribution by industry sectors 100% 100% 100% 100% 100% 100% 100% 100% 100% 100% 1% Asia Energy & 1% 2% 2% 3% 5% 4% 2% 1% Latin America* 10% 6% 9% mining 2% 3% 3% 4% 5% 4% Commercial 3% 3% 3% 6% Africa 3% 3% 22% 19% 8% service** 6% Europe 14% 6% 17% Financial 6% North America service 18% Manuafcturing 36% 32% 48% Oceania 53% Other sectors 26% 44% 33% 63% 61% 63% 53% 55% 43% 48% 36% 40% 33% 14% 15% 2003 2004 2005 2006 2007 2003 2004 2005 2006 2007 • Possible over count % of Asia and LA, because companies report the first stop of investment (HK or Tax heaven) instead of destination *: Mostly to Cayman Iland or BVI **: including wholesale& retail trde, transport Source: MOFCOM, Value Partners a nalysis An analysis of the outbound M&As of Chinese companies shows that, since 2005, 85% of the large deals have been strategically motivated. Among the strategic outbound M&A deals, 70% are aimed at acquiring natural resources and entering new markets. Up to now, important drivers for Chinese companies going abroad are entering new market and gaining access to natural resources US$ billion, Jan. 2005 - Aug. 2009 No. of outbound M&A with deal size over US$ 10 million • Seems to show that Chinese companies tend to adopt defensive strategy in outbound 122 18 M&As 15% 104 37 30% 100% 34 85% 28% 21 17% 12 10% Total Finance Strategic Access to Access to Access to Access to resources new skill/tech. product markets facilities Deal Value 85.0 8.1 76.9 46.2 11.8 13.2 5.8 Top 3 countries •Hong Kong •Hong Kong •Hong Kong •Australia •Hong Kong •Hong Kong •Hong Kong •Australia •USA •Australia •Canada •Singapore •USA •Canada (by Deal No.) •Indonesia •Canada •Canada •USA •USA •UK •Vietnam Top 3 sectors (by •Energy •Finance •Energy •Energy •Finance •Finance •Mining Deal No.) •Mining •Energy •Mining •Mining •Industrial •Industrial •Consumer •Finance •Media •Industrial •Industrial products products •IT products products •Energy •Telecom Source: Merger Markets, Value Partners analysis 2
    • PERSPECTIVE If the ODI structure of Japan and Korea is compared to that of China, what is apparent is that Japan has shifted away from Asia and now invests more heavily in North America, Europe and Latin America – and that nearly 80% of ODI has been devoted to the financial and manufacturing sectors. Korea also invests considerably in the Middle East and Latin America, and is more focused on manufacturing, trade and mining. Based on this, it is expected that China’s ODI is likely to see greater diversification in both regions and sector structure. Three key drivers to foreign investment for Chinese companies Exploit market opportunities Chinese companies are sustaining a relatively favorable economic performance despite the financial crisis. While developed countries and regions such as the United States and Europe are experiencing negative economic growth, China is expected to maintain a GDP growth rate of 8%. According to a forecast by the International Monetary Fund (IMF), China’s contribution to the rate of global economic growth will increase from 29.9% in 2008 to 46.4% in 2009. The stock market capitalizations of developed countries, affected by the recent economic downturn, have been reduced by more than 15%, compared to pre-crisis figures. Bank credit was reduced by a similar amount. Foreign companies have difficulties in obtaining financing from both capital market and bank loans, leading to a strong need for the injection of capital. Foreign companies are also interested in working with Chinese partners because of their interest in the Chinese market. As Dr. Tadao Kasahara, CEO of MSK, commented about Suntech’s acquisition of MSK, one of Japan’s largest photovoltaic (PV) manufacturers: “As a subsidiary of Suntech, MSK will be able to access Suntech’s support in terms of advanced PV cell/module products and cost competitiveness, financial resources, and distribution channels, as well as have the possibility of pioneering BIPV applications in the Chinese market.’’ Generally speaking, foreign markets are attractive, not least because their consumption expenditure levels are much higher than China’s. If evaluated by consumption expenditure, the Chinese purchase capability per capita is significantly lower than that of developed countries. According to UN statistics, in 2008, Chinese household consumption expenditure per capita was US$ 1,030, while in the same period, American expenditure was US$ 32,564 and Japan’s US$ 21,747. Even taking into account that Chinese first and second tier cities have a higher than average expenditure, there is still a big gap compared to developed countries. This creates significant potential for Chinese companies in terms of both market size and margin. Accelerate technical/business skill evolution If we consider the intellectual property figures of its main industries as a guide to its technological development level, China still has a long way to go to catch up with developed countries. In 2007, for example, the number of effective patents per 100,000 inhabitants for the Chinese mainland was 22, while Korea had 1,170, Japan 968, and the United States, 593. Large Chinese companies have already committed significant technology investment abroad. For example, Huawei has established its R&D centres in Silicon Valley, California, and in Bangalore, India, and hired thousands of local experts in those centres. These decisions have played a crucial role in helping Huawei keep abreast of cutting- edge overseas technologies and product development. This strategy has allowed the company to minimize its time spent catching up with competitors and fully seize the rapidly changing opportunities in international markets. Some Chinese SMEs have leveraged overseas technology investment to upgrade their market positioning. Pearl River Piano acquired, for instance, the R&D centre of Rudisheimer, obtaining its advanced technology in piano manufacturing and gaining a 40% market share of the US vertical pianos segment. It later acquired the R&D centre of Herman Miller in the US and further expanded its market share by leveraging its techniques in baby grand pianos, a piano design in line with modern American furniture styles. For most Chinese enterprises, expanding in the global value chain is a shortcut to gaining complementary business skills. They could obtain an advanced overseas R&D centre, leveraging the local high-tech incubator to accelerate innovation, or develop a global brand to enhance their anti-risk capability and profitability. Similarly, they could 3
    • PERSPECTIVE leverage a local distribution network to effectively penetrate local markets, or acquire local expertise, which is crucial for Chinese enterprises building global competitiveness. Chinese companies could strengthen their skills portfolio through overseas investment Assessment of Chinese companies positioning along global value chain Industry R&D Raw material Manufacture Brand Distribution Customer services Home appliances  Lack of high-  Improved  Own brand and  Some end product sharply, while OEM coexist , enterprises has industrial crafts  Lack in set up his own gap still exists worldwide outbound advanced player distribution Plastics  Imitation  Large  Mostly own brand  Mostly  Limited production  Lack in wholesale investment in capacity and worldwide R&D low price advanced player Clothing   Mainly imitate  The raw for  Large production  Mainly OEM  Few players  Lack in design advanced capacity and low Lack of own set up their own and innovation products need price brands especially distribution to be imported in high-end network market worldwide Consumer goods-  Improving  Large production  Mainly OEM  Few players rapidly while capacity and low  Lack of set up their own Electrics advanced price worldwide distribution know-how is brand network limited worldwide Toys and  Weak design  The raw for  Overcapacity in  Mainly OEM  Few players children's traditional  Lack of own set up their own capability in advanced products high-end products need products while brand distribution products to be imported lack in high-end network ones worldwide Source: Industry research, Value Partners analysis Improve the overall risk or opportunity profile Although China is the largest country in terms of population, and is growing fast, in many leading industries, the Chinese market still accounts for a limited share of global demand and will continue to do so for the near future. For example, China’s market values as a percentage of the global market are lower than 10% for the banking, construction, chemical and telecom industries. In many industries, the domestic market experiences significant, though temporary, fluctuation, and companies that have diversified their business in secondary markets could be better positioned to offset the impact of a downturn. Considering that several industry sectors already face the risk of a short-term saturation or slow down, it is important for companies not to invest exclusively in local markets. 4
    • PERSPECTIVE Chinese companies could strengthen their skills portfolio through overseas investment China %, growth rate world Growth of Auto industry Growth of chemical industry 40% 20% 20% 0% 10% 2001 2003 2005 2007 -20% 0% -40% 2004 2005 2006 2007 Growth of construction industry Growth of consumer good* industry 30% 20% 20% 10% 10% 0% 2002 2004 2006 2008 0% 2001 2003 2005 2007 2009 2011 2013 -10% * Consumer good without food market value Source: Global Insight's Global Construction Outlook 2008, Datamonitor , Euromonitor, EIU; Value Partners analysis Lessons and experiences developed by other countries For Chinese companies, moving into foreign markets seems to be a complicated process, due to a lack of international experience. A study of instances in which Chinese companies failed to succeed in foreign environments suggests that these companies have some key weaknesses. For example, they have a limited knowledge of international markets, including market situation, regulations and customer base. There is also a limited availability of managers who can operate in an international context, with sufficient language proficiency, foreign culture understanding and an established social network. Last but not least, they seem to lack systematic process, for instance in strategy definition, roadmap development and execution. By examining the experience of companies who have already invested in developed countries, Chinese firms could prepare for some unavoidable issues: • Culture clash: generally speaking, English proficiency is limited for the Chinese, and the Chinese “vague” communication style is different from the direct style of western business practices. The Chinese work-life balance is also quite different to that seen in Europe; • Higher uncertainty in a global context: rapid changes in global social, environmental, technological and business trends could lead to systematic risks, such as financial crises or regional conflicts; • Lack of availability of many professional managers who have solid overseas business experiences and local background; • Stronger social tension: needing to manage a multinational environment in-house, while externally needing to deal with local government, communities, partners, etc Developed countries have accumulated many overseas investment experiences to tackle these basic problems, which could be valuable references for Chinese companies. First and foremost, they need to build a dedicated team that focuses on international expansion, including recruiting local professional managers with international business experience, seeking help from third-party professionals such as consulting firms, lawyers, PR agencies, and lobbyists, and get training on culture difference management and international communication. It is critical to develop an effective model of international governance. One method would be to choose an appropriate governance model based on the target country’s business climate. This would mean caution in shareholding investment in emerging countries, for instance, due to the high risk of partner default, and flexibility during transition periods. 5
    • PERSPECTIVE It is necessary to engage in comprehensive planning to fully understand local context and possible changing factors and to reduce setback risks. ,It is advisable not only to prepare a contingency plan – after thoroughly considering all the possible risks in strategy, social environment, and economy – but also to have a proper exit plan. Being committed to developing local networks is also important – for example, by hiring a key relationships contact person who could operate effectively in the local business community and apply a PR approach to promoting the company’s commitments and contributions to the local community. Chinese companies have many possibilities on the spectrum that fall between resisting overseas investment and duplicating domestic models. The first approach could be to form an alliance with peers or strong players to share the resources and risks. For example, a large SOE could build partnerships with other sizeable players in some negotiations, so as to avoid internal competition and to get a lower price. SMEs could form a consortium with other SMEs, or work with large players as their suppliers, service providers, or distribution partners. Target areas might be the ones where a company has already done business in the past, or even the regions where many Chinese communities exist. The firms could set up a joint venture with a local partner, leveraging their local resources and learning about the local market and culture. It is important to focus on a niche market in which the company has its core expertise – identifying those markets that have a good return and less competition, thereby avoiding having to compete in the mass market. This unique expertise should be strengthened, and differentiated products and services should be provided to local customers. As for organization and HR, it is best to build through practice. Organization formats could be structured as sales agent-sales subsidiary-manufacturing facility-full operation, which creates the right governance structure. Chinese talent should be trained on the job, and local talent should be motivated from a long-term perspective. It is also essential to adapt to the local rules of the game, fitting in to the community and building business models that are a win-win for both parties, by maintaining certain levels of local employment, instead of just acquiring a small expert team while dismissing all manufacturing labourers. Finally, it could be helpful to assess the critical issues in each step of foreign investment. Focusing on four steps in particular, the main critical issues could be: • Defining the objective: - What is the main investment target – for market, technology, skills, or profits? - What is the minimum target? - What is the time frame for the target? - How much funding is needed, considering both the whole investment cycle and the contingency scenario? - What are the main risks and how can we reduce or migrate them? • Preparing to go: - What are the top three criteria to evaluate targets and investment results? - Who are the right people to join a dedicated international expansion team? - What external resources could be leveraged, in order to understand the feasibility and the risks of targets, and also to grant support, so as to make things happen? • Manage the process: - Which is the appropriate governance model? - How is it possible to communicate proactively with all stakeholders? - How could a positive image of the company be promoted and how could branding be established in local communities? 6
    • PERSPECTIVE • Integrate effectively: - What is the integration blueprint, with specific milestones, timelines, and key actions? - What is the integration plan and the governance structure during the transition period? - What is the new business model and how should it be implemented? - Who should be appointed to the board? - How can company culture be rapidly integrated and communication efficiency improved? About Value Partners Value Partners Management local financial institutions and For more information on the issues Consulting has been present in telecom industry players in raised in this note please contact China since 2005, and has long strategy definition, organization claire.zhong@valuepartners.com or term commitment to China market optimization and operation enrico.lanzavecchia@valuepartners. and its sustainable economy improvement areas. com or one of our offices below. Find growth. Our 40 professionals all the contacts details on www. based in Beijing, Shanghai and Founded in 1993, Value Partners valuepartners.com Hong Kong offices has supported is a global management local companies and international consulting firm that works with Milan companies who considering to multinational corporations and Rome grow in China market with our high-potential entrepreneurial London solid experiences. Value Partners businesses to identify and pursue Munich provides comprehensive value enhancement initiatives Helsinki consulting services, ranging from across innovation, international Istanbul Strategy to Organization, and expansion, and operational Dubai from Operation Improvement effectiveness. It comprises two São Paulo and International development sister companies: Value Partners Rio de Janeiro to Technology support. We have Management Consulting and Buenos Aires assisted many multi-national Value Team IT Consulting and Mumbai companies successfully develop Solutions. Beijing China business, providing Strategy Hong Kong development, M&A, local support With 14 offices across Europe, Singapore and sourcing consulting. In the Asia, South America and past years, we have supported MENA, Value Partners expertise operation of Luxury and FMCG spans corporate strategy and companies, as well as Energy and financial business planning, cost Environmental areas. transformation and organizational development, commercial Value Partners has strong global planning, technology decisions, functional practices, particularly in and change management. Its TMT (Telecom, Media, Technology) 3,000 professionals from 25 and Financial Institutions. In China nations, combine methodological we have successfully supported approach and analytical international banks and Financial frameworks with hands-on Groups to develop China market attitude and practical industry entry strategy and M&A, and we experience developed in executive also help top Telecom Operators capacity within their sectors of to define channel strategy and focus: media, telecoms and IT, improve operation. Nowadays luxury goods, financial Value Partners are working with services, energy, manufacturing more and more China and hi-tech. 7