China Mid Market Innovators

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A new category of competitor — low-price, medium-quality Chinese B2B upstarts — is shaking up the global competitive landscape. These mid-market innovators represent the next stage in China’s transition to becoming an economic superpower — and are a major potential threat to well-established global manufacturers.

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China Mid Market Innovators

  1. 1. strategy+businessforthcoming in issue 67 summer 2012China’s Mid-MarketInnovatorsA new category of competitor — low-price, medium-quality ChineseB2B upstarts — is shaking up the global competitive landscape.by Edward Tse, John Jullens,and Bill Russopreprint
  2. 2. global perspectiveessay global perspective Hang, the company’s chairman and co-CEO. Not bad for a company that began as a low-cost producer in an underserved Chinese B2B sector. Another such company is Shanghai Electric Group, a maker of power generation, transmission, and distribution equipment, along with heavy machinery and public transportation vehicles. Founded in the 19th century, it established itself in the 2000s as a global player in the energy and construction equipment 32 industry. Shanghai Electric’s status as a state-owned company gave it access to China’s domestic market, China’s Mid-Market but the company also developed ca- pabilities for producing reliable, low- Innovators priced equipment around the world. In 2010, for example, the company reached a $10 billion agreement to supply India’s Reliance Power with A new category of competitor — low-price, coal-fired generators. medium-quality Chinese B2B upstarts — is Mindray and Shanghai Electric shaking up the global competitive landscape. are examples of a new type of indus- trial company emerging primarily in China. We call them mid-market in- by Edward Tse, John Jullens, Mindray’s ambitions grew accord- novators, after the burgeoning mid- and Bill Russo ingly; it competed with increasing dle market of Chinese urban and C success in the global medical devices rural businesses and government of- hina’s largest maker of med- market, rapidly gaining market fices, which were their original core ical equipment is Mindray share by offering monitoring and customers. Some mid-market inno- Medical International Ltd. medical imaging systems at prices vators are privately held companies; Based in Shenzhen, the company that were typically 40 percent lower others are state-owned. They are all was founded in 1991 to serve Chi- than those of most incumbents. in intense competition, often with nese hospitals, which, especially in In 2008, Mindray bought the one another, which forces them to rural areas, could not afford many patient monitoring division of the be frugal, nimble, and responsive. basic medical devices. From its earli- Datascope Corporation (based in They sell to customers who have est years as a maker of in vitro diag- New Jersey) for US$209 million. By many choices but who also have nostic processes and patient moni- 2010, the now-global enterprise had their own hypercompetitive pres- toring and life-support systems, this businesses in 140 countries, annual sures, and they are rapidly moving Chinese business-to-business (B2B) revenues of more than $700 million, from their Chinese B2B context out Illustration by Lars Leetaru enterprise strove for a basic level and a portfolio of products approved into the global economic landscape. of acceptable quality and versatil- by the U.S. Food and Drug Admin- ity, and a high level of innovation: istration and other Western regula- A Challenge to Incumbents The company has consistently re- tory bodies. Mindray’s expansion The emergence of mid-market in- invested about 10 percent of its rev- “is part of our long-term strategy novators is a game-changing disrup- enue in R&D every year. As China’s to compete in the most sophisti- tive force. They are rapidly reshap- economy expanded in the 2000s, cated markets in the world,” said Xu ing the dynamics of many industries
  3. 3. essay global perspective— including agriculture, construc- ly developed cities such as those in Global companies will be eagertion, healthcare, and transporta- the Chinese interior or those formed to sell it to them. But by then thetion — but many competitors are on the edge of existing metropoli- mid-market innovators will havestill largely unaware that they exist. tan regions. They tend to begin as built long-standing relationshipsIn aggregate, however, mid-market domestic players, selling to Chinese with those Chinese customers —innovators represent the next stage industrial customers who are look- and their counterparts in India,in China’s transition to becoming ing for goods and services that offer Latin America, Indonesia, Africa, the Middle East, and other coun- tries and regions around the world.Chinese innovators can start to en- Moreover, the financial crisis and resulting pressures on governmentcroach on turf that multinationals spending have led to increased de-have long regarded as their own. mand for low-priced, high-quality tools, devices, construction equip- 33 ment, and machines of all kindsa global economic superpower — a fair level of functionality and qual- — making Chinese industrial prod-and a major potential threat to well- ity at a relatively low price compared ucts competitive even in establishedestablished global manufacturers, with most imports. As Ming Zeng markets like Germany and theone that could jeopardize their exis- and Peter J. Williamson point out United States. With their seasonedtence. This may sound overdramat- in their book Dragons at Your Door: knowledge of the middle market’sic, but the possibility is real. Incum- How Chinese Cost Innovation Is Dis- priorities, the Chinese innovatorsbents in capital- and scale-intensive rupting Global Competition (Har- can build scale, add capabilities, andB2B industries, in which consumer vard Business School Press, 2007), start to encroach on turf that globalbranding isn’t important, are par- the mid-market innovators are like multinationals have long regarded asticularly vulnerable. many other Chinese companies, their own. Similar companies could con- competing on price skillfully and re- A good example of the dynamicceivably emerge in other markets, lentlessly. But they also compete on — and the threat — is the construc-such as India, Brazil, or Indonesia, innovation, by continually improv- tion equipment sector. China’s rapidbut they haven’t. They are, so far ing their products, processes, and expansion of buildings and infra-at least, largely Chinese. That’s be- business models, and closing the structure has involved widespreadcause of the unique characteristics of gap in reliability and performance subcontracting, with work on allthe Chinese business environment between themselves and their es- sizable projects shared among aright now: the enormous size and tablished global competitors, some- chain of hundreds or even thou-complexity of its customer base, its times with remarkable speed. At the sands of small businesses. Most offiercely competitive companies and same time, their products remain these Chinese construction sub-rapid-fire innovation culture, its ac- far lower in cost, and, just as impor- contractors think in the short term.cess to low-cost labor, its distinctive tantly, are attuned to Chinese needs. They want equipment that is goodregulatory environment (balancing For example, these companies do enough to do the immediate job,openness and control), and its ex- not target all parts of the country and that will then be written offplosive growth in infrastructure and at once; instead, they recognize that after five years or less. They are notpublic services. All of these combine different regions are developing at interested in expensive, feature-richto give mid-market innovators an different rates, and they concentrate products with a long life span sup-immense platform for growth, pro- on the regions that are ready for their ported by service contracts.tected from outside competitors, particular level of low-cost product. This type of segment is hardwhich don’t have much access to Some Chinese customers who to penetrate for non-Chinese heavythat Chinese business environment buy from mid-market innovators equipment manufacturers, such asor experience with it. today will eventually reach a point Caterpillar (U.S.), Liebherr (Ger- Thousands of new mid-market at which they can afford more reli- many), and Komatsu (Japan). Thesecustomers emerge every year in new- able equipment with more features. manufacturers follow well-estab-
  4. 4. essay global perspective lished business models with buyers of Hunan province — became the and profits are thin, even by their who, supported by long-term fi- world’s largest concrete pump man- standards. nancing, think on a 10- to 15-year ufacturer in 2009; its total revenues Even when global companies time span. Equipment must both in 2010 approached $8 billion. In recognize the threat, many of them last a long time and have the service 2012, Sany announced that it would find it difficult to respond appro- needed to keep it operating with as acquire the second-largest producer, priately. They assume, incorrectly, few interruptions as possible. Meanwhile, upstart construc- tion equipment manufacturers have To a global organization emerged to serve China’s fragment- ed construction industry. They sell headquartered in the U.S. or low-cost machines that typically do not get expensive servicing, but Europe, the emerging mid-market 34 are replaced when they wear out. competitors are barely visible. The manufacturers focus on only a small range of related products, and keep their prices ultracompetitive by the German company Putzmeis- that they have a great deal of time restricting investment only to func- ter, and it has built plants in the to adapt, and that their own prod- tions and features that are strictly U.S., Brazil, India, and Germany, ucts will hold steady as the Chinese needed. Their versions of multina- as well as a major R&D center near market matures. Three of the most tional products might not pass mus- Cologne. Other construction equip- popular strategies for incumbents ter in Canada or Denmark, but they ment manufacturers expanding out- stem from this assumption, and are considered superior in China. side China include ZoomLion (also these strategies have, by and large, Already, some of these mid-mar- based in Changsha), XCMG (a led to poor results. ket construction equipment com- state-owned company headquar- The first strategy is to ignore the panies are becoming global power- tered in Xuzhou), and Shandong risk and avoid competing in China houses. For example, Sany Heavy Heavy Industry Group. They all got altogether. But China’s mid-market Industry Company — founded in their start by selling to China’s frag- is large enough to allow local inno- 1994 in Changsha, the capital city mented construction industry. vators to use it to gain proficiency — and rapidly bring their capabilities Three Challenging Strategies and low prices to the incumbents’ Edward Tse edward.tse@booz.com Many large multinationals have traditional space, as Sany did. is a senior partner with Booz & Company been slow to recognize this threat. The second popular strategy and the firm’s chairman for Greater China, To a global organization headquar- is to continue offering global prod- and is based in Hong Kong and Shanghai. He is the author of The China Strategy: tered in the U.S. or Europe receiving ucts in China, waiting for emerging Harnessing the Power of the World’s Fastest- information through the filter of its markets to catch up to premium de- Growing Economy (Basic Books, 2010). local Chinese sales organization, the mand. For example, a Western con- John Jullens emerging mid-market competitors struction equipment maker might john.jullens@booz.com are barely visible. Many incumbents position itself to sell higher-priced is a partner with Booz & Company, and is based in Shanghai. He specializes in are also held back by their view of vehicles in China — assuming demand-side transformation assignments China’s billions of new urban con- that sooner or later, subcontractors for clients in North America, Europe, and sumers as an increasingly important there will gain scale and access to Asia. source of demand for their products. long-term financing, and start to Bill Russo (See “Competing for the Global buy more expensive, longer-lasting, strategy+business issue 67 bill.russo@booz.com is a senior executive advisor with Booz & Middle Class,” by Edward Tse, Bill higher-quality products. But that Company. Based in Beijing, he has more Russo, and Ronald Haddock, s+b, day is unlikely to come anytime than 20 years of experience in the automo- Autumn 2011.) The mid-market in- soon. Even as China becomes a ma- tive industry, most recently having served as vice president of Chrysler’s business in novators tend to avoid the consumer jor luxury goods market, interest in northeast Asia. sectors, where competition is intense “Mercedes quality” products will
  5. 5. essay global perspectivenot extend to earthmovers, wind- across Asia, Africa, and the Middle For global players, there aremills, and medical devices, not even East are sold as Sitrak. This strategy no easy solutions to the problem ofwith the promise of greater dura- allows MAN to sell two different ve- competition from mid-market in-bility. With its modest barriers to hicles at two different price points to novators. Instead of competing asentry at the lower end of the price two different markets, with separate they are, incumbents facing thisspectrum, China will always have a business models. existential crisis will have to reshapetendency toward excess capacity and The two-tiered strategy, with their entire business model, while re-price-based competition. separate but parallel business mod- maining true to their own identity. Finally, there’s the “good els, can be effective; it is certainlyenough” strategy, popularized by better than ignoring the mid-market Integrated CapabilitiesBain & Company chairman Orit entirely, and it enables companies A small number of global compa-Gadiesh and her partners Philip to compete in mid-markets where nies, seeing the challenge of mid-Leung and Till Vestring. (See “The they otherwise could not. But it is market innovators facing them, haveBattle for China’s Good-Enough extremely difficult to get right. Mar- taken on this kind of comprehensive 35Market,” Harvard Business Review, keting two brands is inherently more approach to change. They are focus-September 2007.) Companies that complex and expensive than mar- ing on developing low-price, as op-follow this strategy remain focused keting one; it can lead companies to posed to low-cost, products. Theyon the upper tier while producing duplicate resources and to create an do this by creating an integrateda lower-priced brand considered incoherent web of joint ventures and capabilities system that approaches“good enough” for mid-market cus- other partnerships, which may be Chinese mid-market customerstomers. They reduce costs for the difficult to unravel later. and Western higher-end custom-value brand by stripping out func- Moreover, it is not a trivial ers as one market, with one grouptions or features, being careful not task for many global producers of of products. This cannot be doneto cannibalize the existing premium industrial equipment to build the overnight; it requires a relentlessproduct line. In effect, this means capabilities needed to sell effec- focus on improving operations andrunning two distinct business mod- tively to mid-market customers in product development together withels, each serving a different market China. They must invest in Chinese regional integration. For example, a company might migrate more parts of its value chain For global players, there are and innovation practice to China no easy solutions to competition and other lower-cost countries — with the intent not of saving labor from mid-market innovators. costs, but of gaining distinctive pro- duction capabilities that can be put in place around the world. Thesesegment. One straightforward way (or equivalent) R&D and product new efforts can specifically targetof doing this is to buy a local com- development, simultaneously inte- the country’s mid-market and usepetitor or work in partnership with a grating their new operations with local engineers and research stafflocal firm whose brand name can be their old and managing intellectual accustomed to frugal ways of think-used for lower-tier products. property challenges. They also lack ing. It may not be obvious at first For example, German truck the home advantages that Chinese how particular product lines willmanufacturer MAN SE (Mas- mid-market innovators possess: the be affected, but the new efforts canchinenfabrik Augsburg-Nürnberg), knowledge of their market niche, act as springboards for the kinds ofin a joint venture with China’s Si- access to low-cost production re- ventures that lead to global mid-notruk, has maintained a two-tiered sources, and a deep understanding market prowess.strategy since early 2011. Vehicles of the regulatory and operational Honeywell International Inc.for the Chinese market are sold un- environment. Joint ventures such as has adopted this strategy; its activeder the Shandeka brand name, and MAN’s can help, but they also add R&D centers in China are gearedthose for other emerging markets to complexity and incoherence. not just to products for the Chinese
  6. 6. essay global perspective market, but to an integrated product to take products developed in China markets. Sometimes this can result line that can be sold worldwide. The to other emerging markets. Distri- in simple products of the “good company’s revenues from product bution and marketing are other ar- enough” variety. But many compa- innovations originating in China eas of competitive advantage. Most nies have learned that value in adap- have grown at an average annual rate Chinese manufacturers remain cen- tation need not come from stripping of more than 40 percent in recent tered on production; multinationals out functionality. Rather, the key years. General Motors Company can harness their global experience is offering market-relevant features has a similar approach, with 11 joint in promotion and delivery to offset at a lower price. A footprint with ventures, two wholly owned foreign the better local knowledge of their local innovation can allow com- enterprises, and more than 35,000 domestic competitors. Finally, glob- panies to tailor product develop- employees in China. Working close- al incumbents can use their exper- ment “in country, for country”; ly with the SAIC Motor Corpora- tise in alliances and M&A to forge they can use global resources when tion, a Chinese automaker, GM has partnerships with other companies, appropriate, but design products to 36 successfully positioned its brands to in China and elsewhere, that make meet local conditions and delight lo- cal customers. To many global incumbents, The goal is Mercedes-level the threat of mid-market innova- tors seems remote. But if the trends quality and attractiveness, continue in a plausible fashion, they Toyota-level durability and could move to center stage. If and when that happens, global incum- margins, and Skoda-level prices. bents will be forced to rethink their product portfolios, business models, staff skills, and ingrained mind-sets. suit the diverse needs of the Chinese the most of their combined capa- They will have to stop thinking passenger vehicle market. bilities and aspirations in creating a about what they can bring to China If a company takes this type of single line of products. from elsewhere, and start focusing approach, rather than offering prod- Siemens AG is noteworthy for on what China’s mid-market can of- ucts that are just good enough for the way it integrates its Chinese and fer them. On the upside, this would particular markets, its goal is to cre- global operations. It employs 29,000 allow major global companies to tap ate great products sold everywhere people in China, where it has 65 op- into the same large customer base, — with the right features, better du- erating companies selling industrial, and to develop the same kind of en- rability, more rapid innovation, and transport, energy, and healthcare trepreneurial zeal that mid-market lower prices. Such a company will equipment, with 16 R&D centers. innovators are using right now to develop a capabilities system that, in It has managed data centers for fuel their growth. + its sector, can create products with the Ministry of Railways, supplied Reprint No. 12204 Mercedes-level quality and attrac- high-voltage direct-current power tiveness, Toyota-level durability and transmission systems in Guangdong margins, and Skoda-level prices. province, furnished gear motors for That might seem an unrealistic goal, a bridge at Rizhao port in Shandong but if incumbent multinationals province, and built the baggage han- don’t take it on now, they may find dling systems at Beijing Capital In- themselves facing former Chinese ternational Airport. Siemens’s sales mid-market competitors who have in China were $8.5 billion in fiscal strategy+business issue 67 learned how to do it successfully. year 2011. Global multinationals can tap Global companies are also strengths that their local upstart more experienced with localiza- competitors don’t have. For example, tion, adapting global products to incumbents already have the means meet the varying needs of different
  7. 7. strategy+business magazineis published by Booz & Company Inc.To subscribe, visit strategy-business.comor call 1-855-869-4862.For more information about Booz & Company,visit booz.com• strategy-business.com• facebook.com/strategybusiness• http://twitter.com/stratandbiz101 Park Ave., 18th Floor, New York, NY 10178© 2012 Booz & Company Inc.

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