Rethinking profitable growth - the productivity imperative for foreign multinationals in china

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After China's decade of economic boom, companies in the nation now need to boost productivity to stay competitive. What must they do to …

After China's decade of economic boom, companies in the nation now need to boost productivity to stay competitive. What must they do to succeed?
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  • 1. Rethinking profitable growth The productivity imperative for foreign multinationals in China September 2012Page 0 Rethinking profitable growth
  • 2. Our view In the business environment that is now emerging in China, companies have an increasingly urgent need to raise productivity if they are to maintain profitable growth. A detailed look at productivity ► Rethinking profitable growth is part of a major program of research on productivity in China ► Ernst & Young and the Economist Intelligence Unit (EIU) surveyed C-suite and senior managers from over 200 foreign multinational corporations in China between March and May 2012Page 1 Rethinking profitable growth
  • 3. Foreign multinationals remain profitable … For the last full financial year, what was your company’s approximate EBITDA margin? • 97 percent of foreign multinationals Overall 3% 49% 39% 9% reported positive profitability Company’s number of years in China • Time in China was a key determinant Less than 5 years 13% 50% 31% 6% of profitability 5% • Services industries 5-10 years 7% 51% 37% proved more profitable, suggesting that theMore than 10 years 48% 41% 11% shift toward a more services-driven By sector growth model has already started to Industrials 3% happen 53% 38% 7% Services 4% 41% 41% 14% Negative Less than 10 percent 10 to 20 percent Over 20 percent Source: Ernst & Young; Economist Intelligence Unit.Page 2 Rethinking profitable growth
  • 4. … but past performance is no guarantee of future success How does your company’s current EBITDA margin compare to two years ago? • 59 percent of respondents in the Manufacturing 59% 24% 18% manufacturing sector reported Information technology 50% 27% 23% decreasing margins compared to two Professional services 45% 36% 18% years ago Chemicals 40% 28% 32% • IT, professional services, and chemicals have Retailing 33% 13% 53% not done well, suggesting a Consumer goods 30% 20% 50% relative decline in overall Telecommunications 27% 33% 40% corporate demand and in industrial activity Healthcare 20% 45% 35% • Retailing is a strong performer, Overall 35% 29% 36% followed closely by consumerThe margin has decreased The margin has stayed roughly the same The margin has increased goods Source: Ernst & Young; Economist Intelligence Unit. Page 3 Rethinking profitable growth
  • 5. What’s different now? • China’s export growth has slowed significantly since 2010 Export growth by geography Europe North America 100% year-on-year growth 80% 60% 40% 20% 0% -20% -40% 2007 2008 2009 2010 2011 2012 2007 2008 2009 2010 2011 2012 Asia Other 100% year-on-year growth 80% 60% 40% 20% 0% -20% -40% 2007 2008 2009 2010 2011 2012 2007 2008 2009 2010 2011 2012 Source: General Administration of Customs, Ernst & Young analysis.Page 4 Rethinking profitable growth
  • 6. What’s different now? • Productivity growth has Accounting for China’s growth fallen16% • Earlier rounds of market liberalization and privatization have largely14% run their course12% • The mass reallocation of labor from low productivity 6.9 agriculture to higher10% 6.8 productivity manufacturing is coming to an end 8% 6.3 0.2 5.6 6.9 • The size of China’s 4.7 6.5 0.2 4.3 6.8 workforce will begin a long- 6% 7.0 0.2 term decline from 2015 0.3 0.3 4% 0.5 0.3 0.2 • Very rapid growth in capital 7.2 0.1 stock without productivity 5.8 0.2 4.8 growth leads to a decine in 2% 3.5 4.1 4.1 3.5 3.3 2.7 capital efficiency, and 2.1 eventually inhibits growth 0% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Total factor productivity Labor Capital GDP growthSource: National Bureau of Statistics; Ernst & Young analysis.Page 5 Rethinking profitable growth
  • 7. Productivity is firmly on the government agenda 12th five-year plan targets 2010 2015 26,810 80.9 10.3% 10,109 7.0% 68.0 2.20 1.75 GDP growth Urban disposable income (CNY) Energy consumption per GDP R&D as percentage of GDP (TCE/CNY millions) 47.0% 43.0% 1,603 8.33 6.91 8.0% 870 3.0% Service sector value-added Minimum wage standard (CNY) Carbon emissions (billion tonnes) Strategic emerging industries as output as percentage of GDP percentage of GDP Growth Labor Resources InnovationGovernment • Lower growth, but more efficient and • Raise urban disposable • Increase carbon and energy • Movement up the value sustainable income efficiency chain for the entire economy • Shift away from capital-intensive • Gradual increase in social • Reduce water and land use industrial production welfare benefits and minimum per unit of GDP • Supported by an increase wage in R&D spending •Companies • Move to targeted, efficient growth • Pressure to boost labor • Pressure to boost resource • Incentives for innovation productivity efficiency Source: National Bureau of Statistics; Ministry of Human Resources and Social Security; Xinhua; Reuters; Ernst & Young analysis. Page 6 Rethinking profitable growth
  • 8. Companies overwhelmingly acknowledge theimportance of productivity Has the importance of improving productivity increased in the past two years? • Nine out of ten respondents said that the importance of Yes 91% improving productivity has increased in the past two No 9% years How important is increasing productivity to your company’s performance in the next 1-3 years? • 84 percent said productivity is either “extremely” or “very” important to business Extremely important 26% performance in the next 1-3 years Very important 58% Somewhat important 16% A little important 0.5% Not at all important 0% Source: Ernst & Young; Economist Intelligence Unit.Page 7 Rethinking profitable growth
  • 9. A focus on profitable growth • Foreign multinationals are focused capturing growth segments in the China market with targeted products and services whilst reducing inputs for every dollar of revenue generated What areas could have the most impact on company profitability in the next 24 months? Introduction of new and better products/services 47% Increased productivity 35% Restructuring of current operations 33% Hiring of new talent/management of existing talent 29% Increased focus on research and development 24% More sophisticated pricing management 23% Better use of outsourcing/subcontracting 21%Geographic expansion into new/more profitable markets 18% Exit from certain less attractive markets 16% Undertaking mergers and acquisitions 8%Respondents were asked to choose up to three. Source: Ernst & Young; Economist Intelligence Unit.Page 8 Rethinking profitable growth
  • 10. Companies are already feeling the pressure What drivers are having the most impact on your company’s overall cost structure and profitability? Labor costs 50% • The current environment is Exchange rate movements 32% characterized by rising cost pressure, Commodity costs 27% intensifying competition, and continuing volatility in Competition from domestic 27% global markets companies Cost of capital 22% Competition from foreign 22% • Foreign multinationals’ companies concerns about labor and commodity costs Energy costs 22% reflect what has been happening in the Regulatory costs 21% market Reduced demand 19% Rising input costs Other, please specify 2% Respondents were asked to choose up to three. Source: Ernst & Young; Economist Intelligence Unit.Page 9 Rethinking profitable growth
  • 11. Companies are already feeling the pressure Weighted cost indices, China domestic (Jan 2007=100%)220% Cost increases200% since 2007180%160% 100% Labor140%120% 77%100% Energy80%60% 19% Metals40%20% 60% 0% Soft commodities 2007 2008 2009 2010 2011 Labor Soft commodities Metals Energy Source: National Bureau of Statistics; National Development and Reform Commission; United States Department of Agriculture; United States Geological Survey; BP Statistical Review of World Energy; Ernst & Young analysis.Page 10 Rethinking profitable growth
  • 12. We expect these cost increases to continue ► The roll out of mandatory employer social welfare contributions, 1 Labor accompanied by government targets to increase the minimum wage, rising expectations from employees, and the increasing cost of living, will undoubtedly put continuous upward pressure on labor costs ► The price of commodities, generally lower in China than globally, will also continue to rise in the medium term as the Chinese government removes 2 Commodities administrative controls. Commodities prices are likely to remain volatile, and will be subject to spikes and sharp corrections depending on global conditions ► Volatility in global markets itself also imposes a significant cost upon 3 Volatility companies, who must hedge against uncertain movements in prices. These costs especially impact on firms that source components and raw materials internationallyPage 11 Rethinking profitable growth
  • 13. Nowhere to pass on costs What percentage of rising costs do you expect your company to be able to pass on to your customers? • 85 percent of None or very little 43% respondents expect they can pass on at Less than 33 percent 42% most a third of rising costs to the final Between 33 to 66 percent 12% customer. There was remarkably little More than 66 percent 3% variation between industries in the extent All 1% to which they could pass on rising costs Source: Ernst & Young; Economist Intelligence Unit. Input/output price growth ratio, manufacturing • In manufacturing, for example, input prices 115.00 have consistently risen 110.00 faster than output prices. The gap 105.00 between the two has increased from an 100.00 average of 4.5 percent in 2009 to 10.0 percent 95.00 in 2011 2008 2009 2010 2011 Source: National Bureau of Statistics, Ernst & Young analysis.Page 12 Rethinking profitable growth
  • 14. Case Study: McDonald’sBalancing rising costs and service standards McDonald’s also monitors the external The cost of food, utilities, and occupancy all environment to gauge customers’ impact McDonald’s profit in China, but it is the expectations around level of service and at cost of labor which has emerged as the what price points. Year-on-year, the company leading consideration. McDonald’s staff have is only able to recover a fraction of rising seen their real wages rise steadily throughout input costs through pricing. Like many of its the past decade, culminating in a 15-17 competitors in the fast food industry, it has percent increase in 2011. had to keep its annual price adjustment to low single digits. For McDonald’s, the balance between rising costs and maintaining standards of customer service lies in productivity improvements. “The main driver of success for us has always been our ability to run our restaurants efficiently – the number of customers served per hour of labor.” -- Dan March, CEO of McDonald’s ChinaPage 13 Rethinking profitable growth
  • 15. Concern about operating model alignment • 64 percent of Please indicate your level of agreement with the following statements. respondents agreedPlease indicate your level of agreement with the following statements. that their company’s operating model Our company’s current operating model impairs our competitiveness. impaired their competitiveness 36% 28% 21% 14% 3% • Productivity should be understood in its widest sense – improving Our company’s operating model does not allow us to keep pace with rapid growth. processes and organization within 23% 37% 21% 16% 4% a business • This requires a competitive We need to overhaul our organizational structure in China to tap new opportunities. operating model suited to the fast 19% 43% 29% 8% 2% pace of the domestic environment in China Strongly agree Agree Neither agree or disagree Disagree Strongly disagree Source: Ernst & Young; Economist Intelligence Unit. Page 14 Rethinking profitable growth
  • 16. More productivity gains will come fromfront office • operations (45 percent), and In your opinion, which functional areas in your company offer the marketing and sales (37 most scope for productivity improvements over the next 24 months? percent) are the two functional areas that offered the most scope for productivity improvements Operations 45% Marketing and sales 37% • These two areas are also traditionally the biggest in Research and terms of cost, where development 23% productivity initiatives usually have the biggest Finance 21% impact. IT 16% • many foreign multinationals have already achieved Customer service 14% gains from back office initiatives, and it seems that HR 6% they are new moving the focus of performance Other, please specify 1% improvement programs to the front office Respondents were asked to choose up to two. Source: Ernst & Young; Economist Intelligence Unit.Page 15 Rethinking profitable growth
  • 17. Case Study: Li & FungMoving the productivity focus to front office Introduced tablet computers to the company’s sales force Shared service center model: to increase their effectiveness centralizing finance, human and efficiency. resources, and IT functions to reduce back office costs per unit of output. Conduct more business Move the productivity online, both for its obvious focus from back cost advantages, and to office to sales and access the vast online marketing. Many support services are population in China. concentrated in Nanjing, where labor costs are relatively cheaper than first tier cities like Beijing or Shanghai. Experiment with selling account services to its existing customers. “For the next few years, technology is what we will focus on, because outsourcing and shared services has been a model which we’ve been using for many years. ” -- Herman So, Executive Vice President of Finance at Li & FungPage 16 Rethinking profitable growth
  • 18. A failure to capitalize on informationtechnology Has your company adopted any of the following methods to increase productivity? • Given the potential, a Workforce mobility tools 40% surprisingly low number of foreign multinationals have adopted IT initiatives CRM systems 39% to drive productivity. More needs to be done to capitalize on IT Cloud computing services 37% investments already made in core business systems such as Data center capacity 33% enterprise resource planningSupply chain management systems 30% Enterprise resource planning tools 30% • Examples of Information technology enabler: Mobile internet and e- Staff collaboration tools 23% commerce, cloud computing, and data analytics Data analytics 15%Source: Ernst & Young; Economist Intelligence Unit.Page 17 Rethinking profitable growth
  • 19. Case Study: CiscoTime to capitalize on IT The company employs common productivity metrics globally, and tries to limit administrative complexity – for example by simplifying its legal entity structure. TelePresence is a collaboration platform developed by Cisco to It sees great potential in cloud help geographically dispersed computing to raise utilization organizations overcome physical rates while slashing IT costs by barriers, and cut down on 20 percent or more. travelling costs. Capitalize on IT to reduce costs and increase productivity. “Cisco is in the business of selling productivity tools, but we’re also a primary user of the same technology – often before it goes to market.” -- Michael Foy, Finance Director of Cisco ChinaPage 18 Rethinking profitable growth
  • 20. Barriers to improve productivity What barriers are most likely to hamper your organization’s efforts to improve productivity? Shortage of labor or management talent 30% Inappropriate business model 29% Unclear accountability 25% Lack of communication between management and workforce 25% Overly centralized control by home country headquarters 23% Excessive government 20% regulation Lack of access to up-to-date productivity 15% information Incompatible information systems 14% Other 3% Respondents were asked to choose up to three. Source: Ernst & Young; Economist Intelligence Unit.Page 19 Rethinking profitable growth
  • 21. The top 5 productivity initiatives among top-performing MNCs: Has your company adopted any of the following methods to increase productivity? 49% Business unit strategy reviews 32% Improved people development and 48% management 39% 45% Cost reduction programs 29% 38% Enterprise resource planning tools 24% Greater autonomy for regional or 33% country management from global/regional headquarters 18%Source: Ernst & Young; Economist Intelligence Unit. High performers OthersPage 20 Rethinking profitable growth
  • 22. Case Study: FordRaising productivity on many fronts Within each business unit and region, Ford assesses performance against its peers around the world. The company continues to invest in training and development to accelerate labor productivity in its Raise productivity and aim relatively young workforce. for global best practice. Globally consolidated functions work across geographies in a matrix structure. “You have to look at every cost element, to pay attention to every line on the income statement. You need to balance the global capacity to share assets, ideas, and technologies, with an in-depth knowledge of local business and employee practices. ” -- John Lawler, CFO of Ford Asia-Pacific & AfricaPage 21 Rethinking profitable growth
  • 23. Five lessons for foreign multinationals ► Companies should adopt strategic, cross-functional approaches to raise productivity across the organization 1 Productivity as a strategic imperative ► ► A strategy with focus and clarity is needed to avoid complexity and wasted effort Companies should prioritize operational improvement initiatives that drive productivity improvements and allocate resources accordingly ► Local autonomy needs to be balanced with a strong risk and controls framework Operating model 2 ► Companies should pursue opportunities for active mergers and alignment acquisition activities in China in order to increase local market presence ► opportunity to collaborate should be better explored ► Prioritizing locally initiated cost management programs enables management to deliver on bottom line commitments and retain more Proactive cost 3 management ► control Processes ought to be streamlined and non-core functions outsourced, while making sure that core information and expertise is retained ► Increase efficiency and flexibility of core business processes with sophisticated techniques such as identifying cost drivers and using analytics techniques to target cost areasPage 22 Rethinking profitable growth
  • 24. Five lessons for foreign multinationals(continued) ► Management should do more to capitalize on information technology investments Driving business value 4 from information technology ► ► Improve the level of compliance, ensuring workarounds are minimized and all users are using the IT system as they are supposed to leverage the data generated by the IT system through the use of business analytics and customer relationship management (CRM) tools to improve their operational efficiency, more closely target customers, and better predict outcomes and risks ► Boost the productivity of their employees through innovative ways to 5 Enhancing people incentivize staff, and transforming process flows so as to reduce physical development and technical barriers between employees ► Effective managers should possess balanced management skills and sales ability, as well as the ability to manage every aspect of the P&L. ► The focus of training programs ought to put a greater emphasis on productivity topics such as reengineering business processes, reducing costs, and improving sales effectivenessPage 23 Rethinking profitable growth
  • 25. Questions for management ► How well are you doing against industry and internal peers? ► Do you know how the major drivers of margin are trending in your industry ► What actions are you taking to boost productivity? ► Are there any short term cost reduction initiatives? ► Have you started to think about the longer term operational improvements that can be made? ► Does your company have the governance structures in place to enable productivity improvement? ► Does your company have the capability for sustained productivity gains to match long-term cost increases?Page 24 Rethinking profitable growth
  • 26. Appendix
  • 27. Survey respondent demographics Global revenues Headquarters by country 17% $500 million or less 10% 41% Europe $500 million to $1 billion 24% $1 billion to $5 billion 11% $5 billion to $10 billion 31% North America 37% $10 billion or more 27% Asia-Pacific 1% OtherPage 26 Rethinking profitable growth
  • 28. Survey respondent demographics Industry Job title 5% Board member 13% Chemicals 11% CEO Manufacturing 29% President Managing Director 11% Information technology 5% CFO/Treasurer 10% Consumer goods 4% Other C-level executive 10% Healthcare, pharmaceuticals and biotechnology 7% Professional services 40% Senior Vice President 7% Retailing Vice President 7% Director Telecommunications 7% Construction and real estate 6% Energy and natural resources 4% Head of business unit 4% Financial services Head of department 6% 12% OtherPage 27 Rethinking profitable growth
  • 29. China still has a long way to go when it comes to productivity World technological frontier, 2010 90 80 United States Japan 70 60thousands USD/worker United Kingdom Labor productivity Inset France Germany 8 50 Australia 7 Peru Colombia Canada Italy 40 6 Egypt Romani a Morocco South Korea 5 Thailand 30 Philippines Spain 4 Indonesi China, 2010 Poland Argentina 3 a India 20 Malaysia Turkey 2 Mexico China, 2001 Venezuela, RB 1 10 Vietnam Brazil 0 Bangladesh South Africa China 0 5 10 15 20 0 0 50 100 150 200 250 Capital intensity (K/L) Source: World Bank, Ernst & Young analysis. thousands USD/worker Page 28 Rethinking profitable growth
  • 30. Ernst & Young Assurance | Tax | Transactions | Advisory About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 167,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit www.ey.com. © 2012 Ernst & Young (China) Advisory Limited All Rights Reserved. FEA no. 03002101 This presentation contains information in summary form and is therefore intended for general guidance only. It is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither Ernst & Young (China) Advisory Limited nor any other member of the global Ernst & Young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor. www.ey.com/chinaPage 29 Rethinking profitable growth