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Multinational companies and China: What future?

An Economist Intelligence Unit report

Sponsored by:

© The Economist Intelligence Unit Limited 2011 1


Contents

Preface 2

Executive summary 3

Introduction 6

Chapter 1: The big picture 9 Hope, hype and reality 10

Justifiedoptimism? 12

Chapter 2: The consumption story 13

Chapter 3: The perils of success 16 Is it enough 16

Onestrategy,ortwo? 19

Isittoomuch? 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

Atwhatprice? 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 20112


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.

ThefindingsandviewsexpressedherearethoseoftheEIUaloneanddonotnecessarilyreflecttheviews 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 2011

Preface



Executive summary

W 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,

Chinakeepsroaringahead.Whileconsumerselsewhereworryabouttheirjobsandfinancialfuture,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 or otherwise—what does China now mean for multinational companies (MNCs; unless otherwise noted, this termreferstonon-Chinesemultinationals)?AretheybackinguptheirtalkabouttheimportanceofChinawithrealinvestment?Aretheybeingrewardedinreturn?Equallyimportant,andnotunrelated,whatdoMNCsmeanforChina?Willtheybeallowedtorealisetheirdreams?Orwilltheybeheldincheckwhilelocalcompaniesimprovetheircapabilities?

This report, Multinational companies and China: What future?,outlineswhereChinacurrentlyfitsonthe agenda of MNCs and shows how global companies are recalibrating their China operations in reaction tonewrealities.Itsfindingsarebasedonasurveyof328seniorexecutivesconductedinJuneandJuly20111,aswellasin-depthinterviewswithexecutivesofmajorforeignmultinationals,businessscholarsand market analysts.

Amongthekeyfindings:

• Multinationals, large companies in particular, are clearly counting on China to deliver more. Almosthalf(49%)ofallthesurveyrespondentssaidthatthefalloutfromtheglobalfinancialcrisishasraisedtheircompanies’expectationsforChina.Amongthelargercompanies(globalrevenuesofmorethanUS$5bn)thefigureis73%.Butnotallcompaniesareplanningtoinvestmoreinordertoincreasereturns.AmongthelargercompaniescountingonChinatodelivermore,halfarecountingonexistingoperations to bring more growth.

1 The survey covered 328 companies from a range of industries. The respondents came equally from companies headquartered in Europe, North America and Asia-Pacific.Intermsofsize,55%had global revenues of more thanUS$500m,with44%having more than US$1bn in revenues. For more details see appendix.



• While MNCs are bullish, there are signs they are hedging their bets.Theexuberanceofconsumergoodsfirmsaside,Chinaseemstohavestalled,ratherthanrisen,onMNCs’agendas.Amongtherespondents to our survey, the share reporting that their headquarters view China as “critical to global strategy”was37%.Thisisdownfrom53%reportedinasimilarsurveyconductedin2004.2 But this does notmeanthatChinaisnotanimportantmarketformanyfirms.Afurther33%ofrespondentssaidthatwhile it is not critical, it is strategically important.

• Today, China is still a relatively small market for many multinationals, but this is expected to change quickly.Analysisofthefinancialresultsof70MNCs3 showed that in 2010 only ten had China revenuesthataccountedformorethan20%oftheirglobalrevenues.Formorethanhalf,Chinaaccountedforlessthan10%ofglobalrevenues.Companiesdoexpectthistochange.Only8%ofoursurveyrespondentssaidChinaisalreadytheirbiggestmarket,but17%expectittobecomesoinlessthanfiveyears,whileanother21%expectthistohappenin5-10years.

• China’s consumption story is driving MNCs’ strategy. The Chinese government’s drive to raise incomes and shift growth towards domestic consumption is likely to have a profound impact on most companies. Amongsurveyrespondents,58%saidthatthispolicyisthefactorthatwillhavethebiggestimpactontheirChinastrategy,while56%saidthatgrowthprospectsfortheirindustrywasthekeydriveroftheirChinastrategy.

• 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,butiftheydosoinChinatheircompetitorsarelikelytofillthegaps.Overall,59%ofoursurvey respondents remain focused on “improving penetration in wealthier coastal cities/southern region”,andonly33%ofthemare“currentlymovingintosecond-andthird-tiercities”.Atthesametime, companies worry about getting too far ahead of the local competition, lest they attract unwanted attention.ThiscouldexplaintheseeminglylowexpectationsofoursurveyrespondentsintermsofusingacquisitionsasaroutetogrowthinChina:only20%choseacquisitionsasthemostimportantstrategyforgrowthinChina,while63%choseorganicgrowthand46%saidjointventures.

• 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 figuresevenlowerforthesampleasawhole.Human-resourcesconsultanciesreportthatlocaltalentisincreasingly gravitating towards mainland companies.

• China’s policies aimed at encouraging local innovation are causing a great deal of ill will among multinationals.Amongoursurveyrespondents,49%wereconcernedorveryconcernedthattheywould

2 Coming of age? Multinational companies in China, Economist Intelligence Unit, 2004. The demographic for the 2004 survey was similar to the 2011 survey,thoughnearly70%ofthe217respondentsin2004were from corporations with global revenues of US$1bn or more; in the 2011 survey, 44%ofthe328respondentshad US$1bn in revenues or more. Focusing only on the responses of companies with more than US$1bn in globalrevenues,thefigureis still down in the 2011 survey—48%viewthecountryas critical.

3 In compiling our list we examinedInterbrand,S&P100Global,andS&P500companiestofindthosethatdisclosed their China revenues in their latest published annual reports or other reliable sources.



beforcedtogiveuptheirIPinexchangeformarketaccess.Amongbigcompaniesthefigurewas52%.Whilesomeofthemoreobjectionablemeasureshavebeensoftenedbythecentralgovernment,executivesstillworryaboutlocalprotectionism.And46%ofrespondentssaidthatChina’sregulatoryenvironmentandindustrialpolicieswerelikelytohaveabigimpactontheirChinastrategyinthenextfiveyears.

• Multinationals need to reorganise to match the importance being placed on China. Among large companiesrespondingtooursurvey,only8%saidthattheirChinaCEOsitsonthecompanyboard(for45%,theChinaCEOreportsintoregionalheadquarters).However,40%oflargecompaniessaidthattheyhadpostedveryseniorexecutivestogreaterChina,amoveaimedatimprovingunderstandingofChinaandspeeding decision making at headquarters.

• While planning how to win in China, multinationals are beginning to think how they can leverage their relationships there to compete elsewhere in the world. While most arrangements seem to involve cooperativeagreementswithChinesepartnersontheuseofspecificproductsinothermarkets,therearesigns that this could be taken a step further to include joint ventures in third countries.



Introduction

M any foreign multinational companies4 (MNCs) have long viewed China, with its 1.3bn people, as a dream market, with the emphasis on “dream”. With leading economies of the world in

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 elsewhereworryabouttheirjobsandfinancialfuture,butmanyinChinaaregettingrich,andabouttoget 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—whatdoesChinanowmeanforMNCs?AretheybackinguptheirtalkabouttheimportanceofChinawithrealinvestment?Andaretheybeingrewardedinreturn?Equallyimportant,andnotunrelated,whatdoMNCsmeanforChina?Willtheybeallowedtorealisetheirdreams?Orwilltheybeheldincheckwhilelocalcompaniesimprovetheircapabilities?

This report, Multinational companies and China: What future?,assesseswhereChinacurrentlyfitson the agenda of MNCs, and discusses how some are recalibrating their China operations in reaction to newrealities.Itsfindingsarebasedonasurveyof328seniorexecutivesatnon-ChinesemultinationalsconductedinJuneandJuly2011,aswellasin-depthinterviewswithexecutivesofmajorforeignmultinationals,businessscholarsandmarketanalysts,andotherpublishedreportsonspecificindustries.

Multinationals’futureinChinavariesgreatlydependingonindustry,companysizeandindeedonthe 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 ofhigherreturns.Almosthalf(49%)ofallthesurveyrespondentssaidthatthefalloutfromtheglobal

4 Throughout this report, unless otherwise noted, “MNCs” refers to non-Chinese multinational companies.



financialcrisishasraisedtheircompanies’expectationforChina.Butwhile21%are“investingmoreinChinainthehopethatitwillmakeupfordeterioratingmarketselsewhere”,28%are“countingonexistingoperationsinChinatodelivermoreof[their]globalrevenue”.Largercompanies(revenuesofmorethanUS$5bn)aremorewilling—andpresumablyable—tospend:73%arecountingonChinatodelivermore,buttheyarealmostevenlysplitbetweeninvestingmoreandcountingonexistingoperations to deliver growth.

YetChinaisnotascrucialtoforeigncompaniesasmaybeexpected,givenwidespreadhypeaboutitsgrowth. The share of respondents reporting that their headquarters views China as “critical to global strategy”was37%inour2011survey,downfrom53%reportedinasimilarsurveyconductedin2004.5 Although the survey sample from 2004 had a higher percentage of larger companies, when we look only at theresponsesofcompanieswithmorethanUS$1bninglobalrevenues,thefigureisstilldowninthe2011

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.(% respondents)We are counting on our existing operations in China to deliver more of our global revenue

We are investing more in China in the hope that it will make up for deteriorating markets elsewhere

We are postponing further investment in China because of deterioration in our main markets

We are repatriating more profits from China to shore up balance sheets at headquarters

Our expectation has not changed

Source: Economist Intelligence Unit survey

2836

2137

94

21

4022

Big companiesAll respondents

2004 total2011 total 2011 big companies

Critical, or just important?From the perspective of your global headquarters, which statement best describes China?(% respondents)It is critical to global strategy

It is strategically important, but not critical

It is on a par with other emerging markets

We are still exploring the market

It will be a niche market for us

Don’t know

n.a.


3748

52.5

3336

40.6

95

5.5

139

1.4

5

21

5 Coming of age? Multinational companies in China, Economist Intelligence Unit, 2004. The demographic for the 2004 survey was similar to the 2011 survey,thoughnearly70%ofthe217respondentsin2004were from corporations with global revenues of US$1bn or more;inthe2011survey,44%of the 328 respondents had US$1bn in revenues or more.



survey—48%viewthecountryascritical.Still,thatisafairlylargepercentageofcompaniesbankingonChina. And even those for whom China is not critical view it as important.

Indeed,basedonourqualitativeinterviewswithmultinationalexecutivesandserviceprovidersworking 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.EventhosethathavebeenaggressivelyexpandinginthecountryforyearsarerecalibratingtoseizethehistoricopportunitythatChinapresents—thosewithvaluabletechnologyaretryingtofigureout how to do so without losing their shirts. At the same time China is presenting new opportunities in areassuchascapitalraisingandresearchanddevelopment(R&D).

ButChinafromhereonisgoingtobecomemoredifficult(notthatitwasevereasy).Thepost-crisisself-confidenceoftheChinesegovernment,companiesandpeopleissoaringtothepointwhereitstrikesmany 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 toflybelowtheradar,othersfeeltheyarebeingwatchedcarefully.Chinaismakinggreaterdemands—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.

TheimageofChinathatemergesfromthisresearchisacountryofoutsizedpotential,boundlessambitionandincreasingcomplexity.TherelentlessriseoftheChinamarketremainsoneofthemostimportant 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.



Chapter 1: The big pictureThe role China now plays in the world economy is pivotal. But its role in the global revenues of multinational companies is, for the moment, less so.

TheglobalfinancialcrisishasundeniablyraisedChina’sstatureintheworld.Thankstoitsabilitytomaintainneardouble-digitannualGDPgrowththroughthetumultof2008-09,Chinaovertook

Japanastheworld’ssecond-largesteconomyin2010.Beforetheglobalfinancialcrisiserupted,GoldmanSachshadexpectedChinatosurpasstheUSastheworld’sbiggesteconomyaround2041.But now, the Wall Street bank projects that the Chinese economy will overtake that of the US by as earlyas2027.6 The Economist Intelligence Unit (EIU) forecasts that on a purchasing power parity (PPP)basisitwilldosoby2017.

China’s growth prospects look good in the short to medium term as well. During 2012-15 the EIU forecastsChina’sGDPtoexpandbyanannualaverageof8.4%.Thatwouldbeonlymarginallylowerthanthe9%growthexpectedin2011.

This dramatic reversal of fortunes between the West and the rest has transformed the way many MNCslookatChina(aswellasotherlargeemergingmarkets,suchasIndiaandBrazil).Simplyput,itis no longer seen as a major market for the future but a place to make big money now. While it may not becrucialtoallcompanies,Chinacertainlyrankshighlyontheglobalagenda.Inadditiontothe37%ofsurveyrespondentswhosaidtheirheadquartersviewedChinaascritical,another33%vieweditas“strategicallyimportant,butnotcritical”(thoughthisfigurewasalsodownfromthe2004survey,where41%ofrespondentssaidthis).Only13%saidtheywere“stillexploringthemarket”.

Thelatestfiguresforforeigndirectinvestment(FDI)alsosuggestrisinginterest.Thoughin2009,intheimmediateaftermathoftheglobalfinancialcrisis,inwardFDIdroppedtoUS$114bnfromUS$175bnthe year before, it bounced back to an estimated US$185bn in 2010 as crisis-stricken economies began torecover.(ItisworthnotingthatthesefiguresmaybeinflatedbyprivateChinesecompaniesraising

6Intermsofconstant2007US dollars. See Goldman Sachs, “The Long-Term Outlook for the BRICs and N-11 Post Crisis”, December 4th2009.



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%ofrespondentssawlow-costproductionasamajoropportunityinChinainthenextfiveyears,76%pointedtoChinaasagrowingmarketfortheirproducts.ThisviewisevenmorepronouncedforrespondentsbasedinChina—87%seethegrowingmarketasthebiggestopportunity.

Hope, hype and realityJusthowbigisthatopportunity?Perhapsnotasbig as the headlines insist. At least not yet. Our analysisof70multinationalcompanies7 shows that in 2010 only ten had China revenues that accounted formorethan20%oftheirglobalrevenues.Only18countedonChinaformorethan20%oftheirtotal international revenues. Few companies, with thenotableexceptionofsomeautomakerssuchasGeneral Motors and Volkswagen, currently count China as their largest market. But it is clearly a majorsourceofgrowth.Althoughonly8%ofsurveyrespondents said China has already become their company’sbiggestmarket,17%saiditwillbesoinlessthanfiveyearsandanother21%expectedthistohappeninfive-tenyears.

Tiny in the top linePercentage of total revenue from China, analysis of 70 MNCs (% of companies)

0

20

40

60

80

51%+21-50%11-20%0-10%

Source: Economist Intelligence Unit

% of revenue

7 In compiling our list we examinedInterbrand,S&P100Global,andS&P500companiestofindthosethatdisclosed their China revenues in their latest published annual reports or other reliable sources.

Ahead of the packCompanies generating more than 20% of total revenue in China, 2010 (%)Panalpina

Mead Johnson

BHP Billiton

Qualcomm

Cartier (Richemont)

23.1

24.0

25.1Rio Tinto

Nvidia

Yum! Brands

Advanced Micro Devices


Micron Technology

27.8

34.5

29.1

36.5

38.8

46.3

23.7



It’s the growth ...China as % of total revenues 2005 and 2010(%)Adidas

Advanced Micro Devices

BHP Billiton

Boeing Co

Bombardier

Bosch

Carrefour

Corning

DuPont

Intel

LG Electronics

LM Ericsson Telephone Co

Micron Technology

Motorola

Nvidia

Philips

Qualcomm

Siemens

Xilinx

Yum! Brands


20102005

Astra Zeneca

8.33.0

14.5

3.2

12.325.1

4.86.1

1.35.9

8.8

4.72.4

2.4

13.8

15.58.3

7.612.8

15.938.8

13.67.0

16.934.5

9.97.8

7.029.1

4.27.7

10.219.3

13.8636.5

16.5

3.1

4.58.4

12.5

0.8

46.3

It is perhaps telling that the number of companies that make public their China results has more than tripledsince2005.Ofthe70companiesforwhichwewereabletofindresults,only22werereportingthem as far back as 2005. Of these, China’s share of their revenues has in most cases increased by a substantial amount. For Yum! Brands, Qualcomm and several others, the share of revenue coming from China has doubled or even tripled. But for four companies—Boeing, Philips, Motorola and LG—China’s share of their global revenues has actually declined.

Wheredotheygofromhere?Aswediscussincomingchapters,whiletherearetantalizing



opportunities in China, the operating environment is tough and getting tougher. Nearly half of the executivessurveyedsaidtheywereconcernedabout“beingforcedtogiveourIP(intellectualproperty)inexchangeformarketaccess”,withmorethanone-quarter“veryconcerned”.Theshifttoahigher-wage economy will put pressure on business models. Indeed, although surveys by business chambers indicatethatmanycompaniesaremakinghealthyprofitsinChina,someobserversareoftheopinionthatsinceChinaisnolongeran“emerging”marketinmanysectors,thedaysofheftyprofitmargins—intherangeof15-20%—areover.

Onamacrolevel,Chinafacessomeseriousriskstoo.Aninflationratethathasbeenpushedtoathree-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 localgovernmentlevel—anditsownexuberanthousingmarketcouldendinabust,triggeringasharpeconomicslowdowninthenextfewyears.Atimelypolicyresponsecannotbetakenforgranted,sincethegovernmentisincreasinglypreoccupiedwithpoliticalmanoeuvringaheadofthenextleadershiptransition,expectedatthe18thChineseCommunistPartycongressinlate2012.

Justified optimism?MNCexecutivesarenotoverlyconcernedaboutamajorcrisisintheChineseeconomy,buttheyarenotrulingitout.Justunder40%saidtheywereconcerned(18%veryconcerned)aboutacrisis.More—44%—wereconcernedaboutmajorsocialunrest.Butmanydoexpectaslowdowningrowth—40%expectChina’sgrowthratetoslowtomoredevelopedcountrylevels,whichwesuggestedwere3-5%,withinthenextfiveyears.

Ameasureofoptimismmaybejustified,becauseChinahasprovenscepticswrongtimeandagainduring its three-decade-long pursuit of national economic development. It is also important to distinguishbetweeninevitablecyclicaldownturnsthataffectalleconomiesandtheinexorablestructural 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.



Chapter 2: The consumption story China’s determination to make consumption a more important driver of economic growth will have profound implications for many companies. Wage increases are only part of the story. Taken together with policies to provide universal healthcare, to draw more people into cities and to clean up the environment, they create opportunities galore and the potential for explosive growth.

Only 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 always

existedandwassimplywaitingtobefloodedwithsuperiorforeigngoods.Today,thedoubtersareinretreat. Take Arthur Kroeber, who edits the China Economic Quarterly, a publication which he admits has “longpouredscepticalcoldinkonextravagantclaimsthatthequasi-mythicalbeastknownasthe‘Chineseconsumer’ will take over the universe”. He now declares that “as facts change, we change our minds, and the facts now clearly say that the Chinese consumer has arrived”.

Whatarethesenewfacts?Inhislatestanalysis,using2009data,MrKroeberestimatesthatChinanowhasabout100mhouseholds(or300mpeople)withaverageannualhouseholdexpenditureofsomeUS$7,500.IntermsofsizethisarmyofChineseconsumers,withpowertospendattheirdiscretion,rivals that of the US. Of course, the typical American consumer spends far more than his or her Chinese counterpart and will continue to do so for many more years to come. But at an aggregate level, Chinese householdconsumptionisalreadyaboutUS$800bnayear,whichismorethanthecombinedfiguresin South Korea and Taiwan, where per-capita incomes are about twice as high as in China. “Chinese household 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 to rise to just under US$10,000 a year by 2015, more than double the 2010 level of around US$4,500. During2011-15,totaldisposableincomeisexpectedtogrowbywellover10%ayear.Oursurveyrespondentscertainlybelievethatconsumptionissettotakeoff:58%saidthatChina’seffortstoraise



incomes and boost consumption is the factor that would have the biggest impact on their China strategy, and56%saidthatgrowthprospectsfortheirindustrywasthekeydriveroftheirChinastrategy.

Efforts to raise incomes could have a very big impact indeed. The Chinese government is eager to rebalanceeconomicgrowthdriversawayfrominvestmentandexportstowardsconsumption,anditisespeciallykeentoraiseincomesofthelesswell-off.Itplanstoraiseminimumwagesbyatleast13%ayearforthefiveyearscoveredbythegovernment’s12thFive-YearPlan(FYP)for2011-15.Marketforcesarealreadydrivingupwagesatanevenquickerpaceinsomeareas:since2010,30Chineseprovinceshaveraisedtheirminimumwages,byanaverageof23%,andfactoryownersinthePearlRiverDeltaexportbeltsurroundingHongKongareincreasingpaybymuchmorethanthattokeeptheirassemblylinesrunning.In2010theminimumwageinBeijingwentupbyover45%,thankslargelytothegalloping economy and tightening labour supply.

Whilecompaniesareintheshorttermscramblingtofindefficienciestooffsetrisingwages,theyarekeenly aware of the opportunity the creation of a new consumer class represents. This class will not be limitedtothefirst-tiercitiesofBeijingandShanghai,butwillemergeallacrossChinaanddeepintoitspoorerinteriorregions.Bytheendofthegovernment’s12thFYP,theEIUexpectseventhetraditionallybackwater provinces of Henan, Anhui and Sichuan to have disposable incomes per head of over US$3,660(Rmb25,000).TheNielsenCompany,amarketresearchandconsultingfirm,believesthenextbigprizearethe161mhouseholdsinthethird-andfourth-tiercitiesattheprefecturalandcountylevelsin such central and western regions.

In addition to wage rises, China’s galloping urbanisation will help push up consumption and reduce the income gap. It will, in turn, further spur economicgrowthandsupportconsumptionbyexistingcitydwellersandnewmigrants, as well as making it easier to reach more consumers, creating huge potentialopportunitiesfortheworld’sindustrialfirms.Weforecastthatby2025around1bnofChina’spopulation(or70%ofthetotal)willliveincities.Betweennowandthen170newmasstransitsystemsand40bnsquaremetresoffloorspacewillbebuilt.China’scompaniesarenotlikelytobeabletomanage all this on their own.

In the year 2025Forecasts for urbanisation

• Around1bnlivinginChina’scities

• 15citieswith25m+population

• 200+citieswith1m+population

• 170newmasstransitsystemsbuilt

• 40bnsqmoffloorspacebuilt

China urban inflows, 2010-20.

Source:ChinaRegionalForecastingService,EconomistIntelligenceUnit

On the horizonWhich 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

The regulatory environment/industrial policies (eg, indigenous innovation)

Renminbi convertibility, if it happens

Urbanisation

Competition from Chinese companies

58

43

32Improved infrastructure (as a result of stimulus spending)

25

21

Other, please specify


5

46



8 A better life? The wants and worries of China’s consumers, Economist Intelligence Unit, 2010.

Healthcare reform, a key Chinese government initiative, will be vital in unleashing the full potential of the country’s consumption power. With no social safety net, many Chinese households continue to save an inordinate amount of their incomes against medical emergency, or to fund their retirement. Evenrelativelywell-offcitydwellersreportthattheysavemorethan30%oftheirannualhouseholdincome, in part to cover medical emergencies.8 There is an urgent need to overhaul China’s patchy healthcare system to prepare for the coming upsurge in the elderly population, and also to bring a much-neededboosttothequalityoflifeofmanyofitscitizens.Patientsinmanyruralareascurrentlyhave only limited access to clinics, drugs and health insurance. And city dwellers often must cope with overcrowded hospitals and overstretched doctors. Rural and urban residents alike must pay a big portion of medical bills themselves.

The Chinese government is now trying to restore the public healthcare system, after allowing it to decay for most of the modern era of economic reform. With the goal of providing “safe, effective, convenient andaffordable”healthcaretoallcitizensby2020,in2008thegovernmentintroducednationalhealthinsurance.(Thiswasfiveyearsafteritlaunchedaseparateruralcooperativemedicalinsuranceschemethat partially covers healthcare costs.) As Chinese people stop losing sleep over their ability to pay medical bills, 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 the role of the private sector and drug pricing, have yet to be decided or put into place. Moreover, current healthcare insurance rarely covers the cost of the level of care demanded by middle-class consumers. It is 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 the provision of more healthcare facilities across the country will bring more consumers into the system. There are an estimated 13,000 hospitals in China, many of which are likely to need new equipment. Beijing has also announced plans to encourage more foreign investment in this sector, though guidelines have yet to be issued (there are already about 100 foreign-invested clinics and hospitals in China). China is a top-ten market for pharmaceuticals in the world, with US$42bn-worth of drugs sold in 2010 according to IMS, a healthcare consultancy. Though much of the spending was on cheap, domestically made generic drugs, the marketgrewatanannualaverageofaround6%during2006-10.Thispaceisexpectedtocontinuethrough2015, as incomes rise, the government spends more and the ranks of the elderly swell. By then, some forecasters 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 clean up its environment. In a country where studies estimate air pollution kills up to 1.3m people a year9, a potentialbonanzaawaits,forexample,globalcarmakersthatdevelopgreenervehiclesforthemasses.Havingpledgedtoreducethecountry’scarbonintensity(carbonemittedperunitofGDP)by40-45%by2020comparedwiththe2005level,thegovernmentplanstoinvestmorethanRmb100bn(US$15.7bn)inthegreen-vehiclesectorinthecomingdecadetocurbtheexplosiveupsurgeinvehicleemissions.Itsgoal is to turn China into the world’s largest producer of clean-energy cars, with emphasis on electric vehicles (EVs), a category that includes hybrid-electric and battery-powered vehicles.

HowdoMNCsplantocapitaliseonthisconsumptionstory,andwhatobstaclesdotheyface?Perhapsmoreimportantly,howdoesChinaviewtheirsuccess?

9 “The China Greentech Report 2011”, The China Greentech Initiative, 2011.



Chapter 3: The perils of successNow 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“doublinginsize”arecommonlyheard,whetherreferringtotheoverallsizeofamarket,

ortoanindividualcompany’srevenueexpectations.Forexample,AkzoNobel,achemicalcompany,planstodoubleitsrevenuetoUS$3bninthenextfiveyears.Ithasploughed€275m(US$383m)intoacomplexinNingbotomakenumerousproductsthatwillbesoldtothebuildingandconstruction,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 2014andsecurea10%marketshareinitssector.Unileverisaimingtoboostsalesfive-foldtoUS$10bnby2020.Volkswagenwillopentwonewplantsby2013(bothtobefinancedbyrevenuesfromitsChinaventures)andFordwillopenthreeby2014.Coca-ColaisjustfinishingupaUS$3bninvestmentprogrammeandisplanningtospendUS$4bnmoreoverthenextthreeyears.Thelistgoeson.

Is it enough?Ironically,amidallthefantasticexpansionplans,oneofthebiggestquestionsfacingmultinationalsis,isitenough?Whilecompaniesareputtingincreasingamountsintomarket-sizingresearchandsqueezingasmuch investment out of headquarters as they can, in interviews for this report some admit that they really arenotveryconfidentintheresults—ifanything,theyworrytheyarebeingtoocautious.

Nissan,whichhasjustunveiledamajorexpansionplan(seeNissan:Accordingtoplan,p42),has



Bricks and mortar aplentyRetail 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(by2015)

Marks&Spencer 16 (12 in HK) 2

McDonald’s 1,300 700(by2013)

Prada 18 10-12 per year

Starbucks 459 1,500 (by 2015)

Tesco 88 80 (by 2016)

Uniqlo 77 923(by2020)

Yum! 3,720(3,200KFC;520PizzaHut) 500 annually between 2011 and 2014

Wal-mart 338 Not disclosed.

Subway 233 600+(by2015)

*Excludesinvestmentsinorotherarrangementsforonlineretailing.

Source:Companyreports,pressreports

A samplingFast-moving consumer goods companies’ expansion plans

Company Planned investment Purpose

Coca-Cola Company US$4bn, 2012-14Addbottlingplants,expandexistingfacilities,initiativesindistribution, 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%stakeinHsuFuChi(awaitingapproval)

Nestle US$600m-1bn* 60%stakeinYinLuFoods

*Market estimates. Not disclosed

Source:Companyannouncements,pressreports

consistently 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, we take it year by year, but I would bet this market will be more than 20m by 2015,” he says (passenger car registrations are forecast by the EIU to hit 15m this year).



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 domesticcompetitorswillfillthegaps—sometimeswiththeforeigncompany’sownproducts.Thisisalready 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,overall59%ofoursurveyrespondentsremainfocusedon“improvingpenetrationinwealthiercoastalcities/southernregion”,andonly33%ofthemare“currentlymovingintosecond-andthird-tiercities”.Thepictureisslightlydifferentamongbiggercompanies—45%reporttheyaremovingintosecond-andthird-tiercities,butonly12%saytheyaremovingbeyond,and44%saytheyareconcentrating 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)We will focus on improving penetration in wealthier coastal cities/southern region

We are currently moving into second- and third-tier cities

We already have a substantial market in second- and third-tier cities and are moving on to fourth tier and beyond


5944

812

3345


Butcompaniestryingtoexpandrapidlyfacesomeveryrealconstraints.“We’reaskingourselves:dowehavetheresources?”saysFrankCancelloni,CEOAsia-PacificofDevanlayAsiaDistribution,whichmanagesLacoste’ssupplychainintheregion(seeLacoste:Who’syourbenchmark?p22).Heismoreconcernedaboutpeoplethancash.“IttookusmorethansixmonthstofindourregionalHRdirector,”he says. “We’ve got 500 sales clerks, and they are the most important people in the company. How do we keepthemiftheothermajorapparelretailersornewbrandsenteringthemarkettrytohirethem?”

Anotherobviouschallengeismaintainingbrandconsistencywhileexpandingatadizzyingpace.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 canexpandwithoutresortingtosomeformoffranchising,giventheresources—bothhumanandotherwise—requiredtoexpandatthepacethatmarketgrowthwoulddictate.

Localcompaniescertainlywillnothesitatetogobig.Forexample,since2004LiNing,aChinesesportswear company, has opened more than 5,000 own-branded retail outlets, bringing its total to 7,915.Itisaimingfor9,400by2013.Adidas,bycontrast,planstoopen500thisyear,bringingitstotalto 6,100, and to add 2,500 more by 2015. That is daunting enough. But then consider that Adidas is also expandingitsfootprintfrom550citiesto1,400.Tobesure,companiesthatexcelinsmall-lotproductionofavarietyofgoods,suchasmanyJapaneseconsumer-goodsfirms,aregoingtostruggleinChina.

The issue of scale is not just for retailers. Caterpillar, a US-based provider of construction equipment,



has been making headlines recently over the new priority it places on China—even factoring in the considerable (and early) investments it has already made in the country. According to analysis from Off-HighwayResearch,aconsultancy,Caterpillar’smarketshareinChinahasfallenfrom11%in2005to7%in2010,despitethefactthatitssaleshavequadrupledinthattime.Themarketshareisnotgoingtoarch-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 consumer needs that at one end of the spectrum are becoming very sophisticated, while at the other remain very basic. As an analyst once quipped, “In China you have both Africa and the EU.” Today, people living in coastal provinces of the eastern and southern seaboards, as well as in some large cities in the interior, are much richer and more discerning than the national average. Rollouts of nationwide distribution networks remain works in progress. But what is more, regional disparities in tastes, preferences and shopping habits, apart from incomes, are simply too great. “If you compare Guangdong in the south and Shandong in the east, less than half of the leading brands are common between the two provinces,” says Karthik Rao, 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, leaving the lower-end to local players, there are signs that they are now reassessing that strategy, with some aiming 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 changing and companies have to stay on top of that. They even have to segment their product line to cater for different tastes as they evolve. That’s what a lot of companies have now realised.”

Thisappliestoeverythingfromdenimjeanstocars.LeviStrauss,forexample,hasdevelopedanewrange of jeans called dENiZEN, which retail for about US$40-60 compared with the US$100 for a regular pairofLevi’s.GMisdevelopingamarquespecificallyforChinatotargettheaspiringcar-ownerwhocannot afford a Chevrolet but wants a lot of the features the brand would offer. The company estimates thatthereare4msuchconsumers.WhyleavethatmarkettolocalmakerslikeCheryorBYD?

The issue will also confront the pharmaceutical industry. China’s growing middle class is willing to pay out of its own pocket for branded Western drugs that they are sure will not harm them. This seems unlikely to change any time soon, given numerous scandals over product quality in China. But at the same time foreign companies will need to align themselves with the Chinese government’s goal of improving access to healthcare for all, including the lowest-income groups. While the government’s ultimate policy on drug pricing remains to be set, it seems a fair bet that price caps will drive the market towards 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 the West,wheredrugsaretooexpensive.Theyneedtodrivecostsdowntothelowestlevel.MostMNCsarenot particularly strong at playing here.”

Most big pharma companies face declining prospects as their major drugs come off patent. Unlike othertypesofconsumergoods,pharmacompaniescannottailorproductstothelowendofthemarket:



they may need to offer the same products at lower cost to poorer segments of society. Can or should they dothis?Thereisnoclearanswerandonlyoneprecedent,whichdoesnotreallyapply:themovesbyfivebigcompaniestoofferAIDSdrugsatlowcostinAfrica.WhilethishadnoramificationsforglobalpricingofAIDSdrugs,thesamecannotbeexpectedfordrugsthathaveawiderapplicationandareproducedinChina, which has problems with cross-border leakages of both real and counterfeit goods.

Is it too much?WhatdoestheChinesegovernmentmakeofthismadscramble?Mostsmallerandlower-profilefirmsfeelthey 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.

“Ioftenjokewithgovernmentofficials—howmanystoresaretoomany?”saysaseniorexecutiveatoneforeignretailer.“Imean,isUS$50bninsalestoomuch?Therecouldbeatippingpointwhentheysay‘toomuch’.Butthemarketisgrowingsofastthatitisnotinconceivablethatourmarketsharecouldeven decline while our business continues to grow enormously.”

This nagging worry about somehow being punished for treading on the local competition could explaintheseeminglylowexpectationsofoursurveyrespondentsintermsofusingacquisitionsasaroutetogrowthinChina:only20%choseacquisitionsasthemostimportantstrategyforgrowthinChina,while63%choseorganicgrowthand46%saidjointventures.

TherehasbeenanairofuncertaintyhangingoverChina’sM&AmarketsinceregulatorsrejectedCoca-

Cola’splannedpurchaseofChinaHuiyuanJuiceforUS$2.3bnin2009overcompetitionconcernsthatwere viewed as questionable. The deal would have boosted Coca-Cola’s share of the fruit and vegetable juicemarkettoaround20%.TheAmericangianthassincegivenuponbuyinganythinginChina.MuhtarKent,chairmanandCEOofCoca-Cola,toldreportersinAugust,“It’s[acquisitions]nolongeronourradar screen because we’re seeing so much potential for organic growth.10“

The Ministry of Commerce has since shown a keenness to improve the transparency of its decisions

10 “Coca-Cola Plans $4bn China Investment”, wsj.com, August19th2011

Putting on weightWhich of the following growth strategies will be most important to your company’s expansion plans in China? Choose up to two.(% respondents)Organic growth

Joint ventures

Acquisitions of Chinese companies

Acquisitions of foreign competitors’ operations

We are not planning to expand

Don’t know


6380

2023

67

93

11

4643




and to be a more sophisticated regulator. But the fact remains that China’s law does allow it to consider non-competition issues, such as security of supply and its own industrial policies, in making its rulings.

Chinahasrecentlyshownsignsthatitwillallowpurchasesinrelativelyhigh-profilelocalcompanies—albeitwithconditions.Forexample,Diageo,aUKdrinksgiant,receivedapprovalthisyeartotakeacontrollingstakeinitsexistingChinesejointventure,SichuanChengduQuangxingGroup,therebygainingindirectcontrolofShuijingfang,ownerofthefamousQuanxingbrandofthelocalspiritbaijiuthataccountsformorethan30%ofChina’salcoholicdrinksmarket.Approvaloftheacquisitionreportedlytook16monthsand,asacondition,ShuijingfanghadtodivesttheQuanxingbrand.Nestléthisyearannounceddealstotake60%stakesintwolocalcompanies,YinLuFoods,amakerofpeanutmilk, and Hsu Fu Chi International, a confectioner. The former has been approved, but the latter is still awaiting 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 the Chinese business target.”



Lacoste: Who’s your benchmark?

Devanlay, which is responsible for the production and distribution of Lacoste brand apparel globally, is illustrative of what is no doubt happening in many companies around the world. Until around 2008 the company paid no special attention to China. Revenues from the countryweregrowingat10-15%ayearanditwasopening20-30newpoints of sale (boutique, a corner within a department store, or a franchise operation) annually. This was fabulous when benchmarked against France or the US. But the company never benchmarked againstotherbrandsinChina.Haditdoneso,itwouldhaverealizedthateven20%growthwasnothingtogetexcitedabout.

Enter a new CEO, Jose Luis Duran, formerly the global head of French hypermarket chain Carrefour. Mr Duran knew China. Suddenly the possibilities became clear. Mr Duran understood the need for higher investment in a market featuring intense competition in the so-called“accessibleluxury”spaceaswellastheneedtomarchforward into second and third-tier cities where no one had ever seen the iconic Lacoste crocodile logo (or at least the real thing).

Since Mr Duran took over Devanlay has beefed up its management in China, including sending a new CFO from Europe. It has been increasing investments in new store openings and renovations and essential infrastructure such as information systems.

DevanlaydoesnotrevealinvestmentfiguresbutFrankCancelloni,thecompany’sAsia-PacificCEO,saysthatcapitalexpenditureforthe region (Japan, China and South Korea) will double in 2011, with China accounting for more than half the total. “We are now growing atabout30%ayear,andIthinkcompoundannualgrowthof30-35%isachievable,”hesays.TodayChinaaccountsforlessthan5%ofLacoste’stotalapparelsalesworldwide,afigurewhichMrCancellonisayscouldriseto10%inthefutureoncurrentgrowthprojections.

Keeping upDevanlay’s current challenge is deciding what it can reasonably do in termsofthepaceofexpansion.“Twoyearsagoweopened20doors[pointsofsale]ayearandnowwe’retalkingabout100-150,”saysMrCancelloni.“Butnowwe’reasking,‘dowehavetheresources?’”Heismost concerned about staff retention and has hired an HR consultancy to survey retail staff on what motivates them to stay with a company. ThecompanyalsospentsixmonthsfindingtherightHRdirector.

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 currently operates 100 points of sale directly in Shanghai, Beijing, ShenzhenandGuangzhou,amixtureofboutiquesandcornerswithindepartment stores, and 250 franchised points of sale. “Franchising ismoreprofitable,thereisnodoubtaboutit,”saysMrCancelloni.“Ifyouopeninacertaincitythenyouhavetosetupanofficeandhiremanagers, etcetera. Again, it’s people. So I think we would rather make sure the people at headquarters are very good at training and working with franchisees.”

Crocodile-infested watersLacoste, like many companies operating in China, has its share of problems with counterfeiting. Lacoste’s problems in Asia actually go backtothe1950swhentwobrotherssetupcompaniesinHongKongand Singapore making polo shirts and using a crocodile logo. Lacoste assumesthattheywereexposedtothebrandaftertheyfledChinafollowing the communist revolution and went to Vietnam, which was stillaFrenchcolonyandwhereFrenchexpatriateswouldbewearingLacoste shirts.

Over the years there have been numerous legal disputes with the companies spawned by the brothers, including in China. The battle with Singapore-based Crocodile International, known as Cartelo in China, continues. There are also numerous small groups who make exactcopiesofLacosteproducts,orproductsclearlyinspiredbyLacoste.

Counterfeiting has not prevented Lacoste from growing rapidly in China. According to Jerome Bachasson, regional director for Asia-PacificatLacoste,whooverseestrademarkprotection,brandingandsponsorship,itisunrealistictoexpectthecounterfeitingindustrytogo 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 wholesalers involved in counterfeiting, the only real solution is to stay one step ahead of them.

“Wewillfightcounterfeitingbyhavingfantasticstores,creatingthat gap between us and the locals,” he says. “Consumers want to know how to tell the difference between originals and fakes. In fact I’d say consumers are going faster than the Chinese authorities in dismissing fakes.”



Chapter 4: Whose hubris? It is often taken for granted that multinationals possess superior technology, better brand management and a stronger appeal for talented workers. There are signs that all of these advantages are beginning to erode in China.

A chieving‘Chinaspeed’,asithascometobeknown,isbutonefactorinstayingaheadofthecompetition.“Itisaglobalplayingfieldalmostunlikeanyother,”notesTorstenStocker,a

consultantwithMonitorGroup.Hepointstotheexampleofplasticcontainers,whichinmanycountries around the world are synonymous with Tupperware or Rubbermaid. In China, the market leaderisLock&Lock,aSouthKoreancompanythatisalmostunknownoutsideAsia.

Competition in China comes in many forms. There are foreign companies that have been in the market for years and are now upping their game, as well as new entrants and companies returning to China for a second 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 MNC headquarters.RespondentsbasedinChinarankcompetitionfromlocalfirmsatthetopoftheirlistof 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 their peril.Aformerexecutiveatonemultinationaldisparaginglynotesthatmanagementathisformeremployer would track the market share of the usual global competitors on a weekly basis, ignoring the localcompetition,untilonedaythe“other”categoryexceeded50%.Whoisthis‘other’?theysuddenlywanted to know. By then it was too late.

NimblelocalcompetitorsarechallengingthelikesofP&GandUnilever.Inarecentreport,Booz&Co,aconsultancy,highlightedtheriseoffoursuchcompanies:Wanglaoji(herbaltea);FoshanJingxingHealth(sanitarynapkins);BawangInternational(shampoo)andHangzhouHancaoBiotechnology (non-tobacco cigarettes)11. The authors wrote that for foreign multinationals, “the warningsignsshouldbeapparent”.Theywentontoconclude:“Chinaisgeneratingahostofpowerful

11 “China’s Local Champions”, Booz&Co,2011



Getting in the wayWhat do you see as the biggest operational obstacles standing in the way of seizing opportunities in China? Choose up to three.(% respondents)Lack of intellectual property (IP) protection

Competition from domestic companies

Discrimination against foreign companies

Competition from other foreign companies

Lack of legal protection in general

Lack of available local talent

Risk of trade and economic disputes between China and other countries

Lack of autonomy to make the right decisions for the China market


Respondents based in China

Unpredictable nature of Chinese government

4135

3221

31

Corruption28

29

27

27

23

14

13

15

33

11

813

13

3548

Cleaning upMarket share by retail value for selected consumer goods (%)

0

10

20

30

40

50

OthersWhiteCat

BlueMoon

NafineUnileverP&GLibyNice

Source: Euromonitor 2009 report; Booz & Company

DomesticMNCOther

40

225

91014

18

OthersAmwayReckittBenckiser

KaimiWhiteCat

LohmannHaas

BlueMoon

SCJohnson

47

466671212

Laundry Surface Care

0

10

20

30

40

50

OthersReckittBenckiser

LonkeyNafineAmwayWhiteCat

NiceLiby

24

44510

171719

OthersKaimiReckittBenckiser

Saa LeeLonkeyWhiteCat

BlueMoon

SCJohnson

31

666910

1418

Dishwashing Toilet Care



local champions—and competing against them is the new reality. Close to their customers, focused on developing lower-cost alternatives, marketing and distribution strategies, these businesses are developing new goods and innovative ways of selling them that are well attuned to the needs of Chinese consumers.”

Therisingcompetitivestrengthoflocalcompaniesisalsoreflectedinthetalentmarket.Althoughoursurvey respondents as a whole ranked “lack of available local talent” pretty far down the list of obstacles standing 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 of obstacles (respondents as a whole ranked it eighth).

WithmanyChinesecompaniesflourishingandexpandingatafasterpacethanMNCs,thesamepoolofbilingual and bicultural local talent who can straddle the Chinese and international business worlds are beingchasedbyboth.Forexample,in2010DeutscheBanklostitsChinaheadtoIndustrialandCommercialBankofChina.AfewyearsearlierB&QandMicrosoftsawhigh-profileexecutivesjumptoChinesecompetitors (to Alibaba and Shanda Interactive Entertainment respectively). Ante and Li Ning, the two leading sportswear makers, also have managed to attract talent away from Nike, Adidas and Puma.

HRandexecutive-searchfirmssaythisreverseflowoflocaltalentfromMNCstoChinesecompanieswill increase in the future. According to Manpower Inc, a comparison of its surveys done in 2006 and 2010showsthatjobseekerswhopreferredtoworkforaprivateChinesecompanyjumpedbyfivepercentagepointsduringtheperiod,whilethefigureforthosewhopreferredaforeigncompanydropped by ten percentage points.

The rising attraction of local companies is manifold. Thanks to rapid growth, more of them can match orexceedsalariesatMNCs.Manycompaniesareexpandingoverseas,providingattractivepostings.AndemployeescanexpectquickerpromotionatmanysuccessfulChinesecompanies,whicharelessrigidandformal,allowingmanagerialemployeesmoreflexibilitytodefinetheirresponsibilitiesandworkingconditions.

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 overly confident.Askedtoidentifytheircompany’scompetitiveadvantageinChina,justunder20%ofsurveyrespondents reported that they don’t have an advantage but feel they need to be in the market. Among large companies, only one-quarter felt they have superior technology or a stronger brand, with these figuresevenlowerforthesampleasawhole.

Indeed, the competitive prowess of Chinese companies has surged since our last report in 2004. Then,68%ofsurveyrespondentssawforeign-investedcompaniesasthebiggestcompetitivethreattotheirbusinessinChina,while44%sawathreatfromprivateChinesecompaniesand27%fromstate-ownedenterprises.In2011foreignersdonotseemtoworrymuchabouteachother—only27%pointedtocompetitionfromotherforeignersasathreat,rankingsixthonthelistofobstaclesinthewayofopportunity. Competition from domestic companies, by contrast, ranks second behind IP protection as thebiggestthreat,anditranksfirstamongrespondentsbasedinChina.



Sizing up the competitionWhat is your company’s competitive advantage in China?(% respondents)Long experience in emerging markets/Strong management

Superior/unique technology

Large resources


Strong brand

2424

1625

25

1013

9

We don’t have an advantage but feel we need to be in China19

6

Don’t know2

2

1

23


Big companiesAll responents

Chinesecompaniesarealsoincreasinglyviewedasathreatontheglobalstage.In2004,66%ofsurvey respondents said their Chinese counterparts were not a threat to their business globally. Today, only22%saythesame.Overone-quarterofrespondentsexpectChinesecompanieswillbetheirmajor

... in 2011How 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

Chinese competitors in our industry are already a serious threat to our business globally

Chinese competitors in our industry will be a threat to us globally in five years time

Chinese competitors in our industry are not a threat

Chinese competitors in our industry are the same as other competitors

Source: Economist Intelligence Unit survey, 2011

2631

2022

22

1721

21

155


The view in 2004 ...Are domestic (as opposed to foreign-invested) companies a competitive threat to your business globally? (% respondents)A serious competitive threat

Somewhat of a competitive threat

Not a threat

Other

Source: Economist Intelligence Unit survey, 2004

5.6

28.2

65.7

0.5



globalcompetitorsinfiveyears’time(9%saytheyalreadyare),while47%saytheywillbeseriouscompetitorswithintenyears.Bigcompaniesaresomewhatmoreconfident—only16%expecttheirChinesecounterpartstochallengethemgloballywithinfiveyears(only5%dosonow),withthefigurerisingto38%withintenyears.ButlargercompaniesaremoreconcernedabouttheimpacteventsinChinawillhaveontheirindustry—38%saidthatdevelopmentswillhaveadisruptiveimpactontheirindustrywithinfiveyears,andmorethanhalfexpectthistohappenwithintenyears.Thisthreatismostlikely to come from lower-cost competition on the global stage.

Still,executivesthinkthatChina’seffortstoboostconsumption,andtheuncertainregulatoryenvironment(discussedinthenextchapter),willhaveabiggerimpactthanlocalcompetitionontheirChinastrategyinthenextfiveyears.



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.

Amid all the chatter about China in boardrooms around the world, there are a couple of basic questionsthatexecutivesshouldbeasking:doesChinareallywantMNCs?Andifso,whatexactly

doesitwantfromthem?AtthemomentChina’spoliciestowardsforeigncompaniesinsomesectorsare generating an awful lot of ill will.

Thegovernment’sbroadeconomicagendaisnosecret,althoughitisrathermoredifficulttokeeptrackofallthevariousprioritylists(seep29).Its12thFive-YearPlan(FYP)aimstopursue“scientificdevelopment” 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 valuechainwillcomeattheirexpense.Overthenextfewyearsthestrategicsectorswillbeshoweredwithvariousformsofofficialassistance,frompriorityfundingtotaxbreaks,inordertoensurethattheymeetthegovernmenttargetofgenerating8%ofGDPby2015.Inthepast,similarpreferentialpolicieswere 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 pricesthathasfuelledmarketgrowthintheseindustriesinthefirstinstance.



Aiming high

Sectors in which China hopes to take leadership From the Medium and Long-term Plan for Science and Technology Development (MLP):11 key sectors for employing technology development and innovation to solve China’s problems (with a sampling of the 68 priority areas withclearlydefinedmissions)• Energy,waterandmineralresources(coalliquefactionand

gasification,renewableenergy,explorationandextractiontechnology, power grids, etc)

• Environment(environmentally-friendlyfertilizers,herbicidesandpesticides, waste recycling)

• Agriculture(amoderndairyindustry,geneticallymodifiedcrops)• Manufacturing(robotics)• Transportation(high-speedrailandelectriccars)• Informationandservices• Populationandhealth(drugsandreproductivehealthproducts)• Urbanization(energy-efficientbuidings)• Publicsecurityandnationaldefence

8fieldsoftechnologyinwhich27breakthroughtechnologiesaretobepursued• Biotech(stemcell-basedtissueengineering)• IT(next-generationinternetandsupercomputers)• Advancedmaterials• Advancedmanufacturing• Advancedenergytechnology(fastneutronnucleartechnology)• Marinetechnology(deepseaexploration)• Lasertechnology• Aerospacetechnology

4 basic research programmes• Proteinscience• Nanotechnology

• Quantumphysics• Developmentalandreproductivescience

From the 11th Five-Year Plan for High-Technology Industries (2006-2010)16 Special Projects aimed at import substitution• Coreelectroniccomponents,high-endgeneralusechipsand

basic software products• Large-scaleintegratedcircuitmanufacturingequipmentand

techniques• Newgenerationbroadbandwirelessmobilecommunication

networks• Advancednumeric-controlledmachineryandbasic

manufacturing technology• Large-scaleoilandgasexploration• Largeadvancednuclearreactors• Waterpollutioncontrolandtreatment• Breedingnewvarietiesofgeneticallymodifiedorganisms• Pharmaceuticalinnovationanddevelopment• ControlandtreatmentofAIDS,hepatitisandothermajor

diseases• Largeaircraft• High-definitionearthobservationsystem• Mannedspaceflightandlunarprobe• Threeothersthatremainclassified

From the 12th Five-Year PlanStrategicemergingindustries(whicharetoaccountfor8%ofGDPby2015,upfrom3%today)• Energysavingandenvironmentalprotection• Newgenerationofinformationtechnology• Biotechnology• High-endequipmentmanufacturing• Newenergy• Newmaterial• Newenergyvehicles

Perceived favouritism towards domestic companies is a major sore point with MNCs, which accuse theChinesegovernmentofcreepingprotectionism.Topexecutivesfromthreeoftheworld’sleadingcompanies have been captured on record in the past two years openly questioning China’s intentions12. In its 2011 “American Business in China” white paper, the American Chamber of Commerce in China for thefirsttimehasdedicatedasectiononindustrialpolicyandmarketaccessfocusingonregulatorybarriers. The paper describes a pattern of discrimination created by a host of labyrinthine regulations—including on licensing, government procurement and competition law—as impeding fair competition

12 The heads of Siemens and BASF in 2010 told the Chinese premier, Wen Jiabao, directly in public that they were unhappy with the change in the business climate for foreign companies operating in China, pointing particularly to the issues of forced technology transfer and unfair public-procurement systems.



between American and Chinese companies13. The European Union Chamber of Commerce in China strikes the same note in its 2010/2011 Position Paper14. “More than anything else, European companies wish to have equal access to China’s markets,” it said. “Despite China’s 30 years of reform, it still remains excessivelyregulatedandlessopentocompetitioncomparedtoothermajoreconomies.”Eventhenormally more discreet Japanese chamber began issuing an annual white paper in 2010, citing many of the same complaints15.

The real issueChinahardlyinventedindustrialnationalism,andthiswouldnotbethefirsttimemultinationalshave 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 blueprint for technology theft on a scale the world has never seen before”,16 with the ultimate aim of overtaking the Western world in technology leadership, or a more understandable attempt to bolster China’s capabilities17, albeit with reckless disregard for the impact on foreign companies. Regardless of the intention,theresultisthesame—foreigninvestorsarespooked.Amongoursurveyrespondents,49%wereconcernedorveryconcernedthattheywouldbeforcedtogiveuptheirIPinexchangeformarketaccess.Amongbigcompaniesthefigurewas52%.Whilethegovernment’seffortstoraiseincomesandspur 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 labourcosts,anageingpopulationandunstabledemandfromitstraditionalexportmarkets,forcingitto 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’siPhoneisoftencitedasanexample.OftheUS$500pricetagforaphone,ChinagetsaboutUS$7foritsassemblyjob,whileJapanesecompaniesgetUS$60andGermanfirmsUS$30(Appleitselfmakes US$321).18

Effortstochangeallofthisbeganfiveyearsago,withtheMediumandLong-TermPlanforScienceand Technology Development (MLP), issued by the State Council. It stands at the core of what has becomeknownasthe‘indigenousinnovationpolicy’.TheMLP,towhichfewpaidattentionwhenitwasannounced, was really more of a sweeping mission statement. But subsequent implementing regulations and other policies have been issued seemingly in line with the mission and, as they are now being implemented, the impact is beginning to be felt. Some analysts believe that this confusing labyrinth is a co-ordinated effort.19 Others are doubtful that even the Chinese government could pull together so many moving parts, citing inter-agency battles and what seems to be a diminishing will among provinces andmunicipalitiestofollowthecentralgovernment’sorders.Ifanythingisclear,itistheexpected

16 James McGregor, “China’s Drive for Indigenous Innovation, A Web of Industrial Policies”, American Chamber of Commerce, 2010

17 Dieter Ernst, “China’s Innovation Policy is a Wake-up CallforAmerica”,AsiaPacificIssues, East-West Centre, May 2011

18 Yuqing Xing and Neal Detert, “How the iPhone Widens the United States TradeDeficitwiththePeople’sRepublic of China”, Asian Development Bank Institute, 2010

19 In addition to McGregor’s work cited above, another excellentefforttopulltogether all of the policies into a coherent picture is “ChinavsTheWorld:WhoseTechnologyisit?”byThomasM Hout and Pankaj Ghemawat, Harvard Business Review, December 2010

13 www.amchamchina.org/businessclimate2011

14 www.europeanchamber.com.cn

15www.cjcci.biz/public_html/whitepaper/2011



roleofforeigncompanies.TheMLPdefinesindigenousinnovationas“enhancingoriginalinnovationthrough 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 totoas‘indigenousinnovation’arealreadyhavingasignificantimpactonforeignbusiness.TheAmericanChamberofCommerceinChinareportedinits2011BusinessClimateSurveythat26%ofrespondentswerealreadylosingbusinessand40%expectedtheywouldlosebusinessinfuture.Thepoliciescombinerun-of-the-milltaxbreaksandincentivesforlocalcompaniesinvolvedininnovation,withmoreprotectionistmeasuressuch as requiring state-owned entities to favour locally-developed IP in their purchasing, or for foreign companies to reveal sensitive information in order to sell their products in China. In the background isarenewedemphasis,notalwaysspeltoutinofficialpolicy,onjointventures.Notsurprisingly,theAmerican Chamber’s survey showed that the biggest concern was the loss of sales to state-owned entities.

China has softened some of the more egregious measures, especially where they amounted to outrightprotectionism.Forexample,thegovernmenthadoriginallystatedthatitwouldsupportindigenous innovation by using the public-procurement process to favour products from Chinese companies and containing IP owned by China. It drafted a catalogue of products that would qualify for procurement. But after protests from no less than 34 international trade associations, the requirements on IP ownership were watered down, and in January 2011 the Chinese president, Hu Jintao, vowed to delink indigenous innovation from public procurement altogether.

Yet the US-China Business Council issued a circular in July 2011 stating that 22 provincial- and municipal-level governments (including the Beijing municipal government) had issued their own catalogues, with three being issued since Mr Hu’s statement.20ManycontainexplicitreferencestoIPownership and import substitution.

Thisdevelopmentexplainswhysurveyrespondentsarejustasconcerned—moresointhecaseofbigcompanies—with protectionism at the local level as they are about the national level. There has been a 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 IPR infringements,unauthorisedtaxesandgeneraldirtytricksbycompetitors.“Itisoddandalittlemafia-like, but they are doing the best they can,” notes one consultant.

20 Provincial and Local Indigenous Innovation Catalogues, US-China Business Council, July 2011

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

We are planning to source more materials/components locally

We are shifting some production to other countries

We are undergoing a major cost-cutting exercise

We see no major impact

Source: Economis Intelligence Unit survey

30

15

14

41

23



Somedoubtthattheeliminationofofficialpolicieswouldmakemuchdifference.AccordingtoJohnChiang,aformerITindustryexecutivewhonowteachestechnologymanagementatPekingUniversity, parochialism is an acceptable way of thinking in China, which is still coming off a surge of nationalistpridefollowingtheglobalfinancialcrisis.“Nomatterwhattheofficialpolicyis,MNCswillbehandicapped by this patriotism,” he says.

A non-standard approachChina’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 that these standards will be used as protectionist weapons.21 In many other countries standards are set by industry consensus and then ultimately judged by markets. China’s efforts, however, are being led by the government and are not subject to industry review or market scrutiny.

The most well-known cases involve China’s attempts to set its own wireless networking and 3G standards, known as WAPI and TD-SCDMA respectively. To cut a long story short, most mobile phone users in China today use the international Wi-Fi standard. But mobile phones sold in China today must 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.Foreignfirmsarerarelyallowedtoparticipateinstandards-formingcommitteesand,whentheyare,itisusuallyonlyas“observers”.Askedwhatwastheexcusefornotallowingtheirparticipationin a standards committee, one foreign equipment maker said, “They said it’s only for Chinese companies. Itwasassimpleasthat.We’vefinallymanagedtoget‘observer’statussoweknowabitmorewhat’sgoing 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.Anotherisfarmequipment,wherecompaniesmustmeetthestandards(onwhichonlylocalmanufacturers 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?ForeigncompaniesworryaboutthedegreetowhichtheywillberequiredtoexchangeIPinreturnformarketaccessinChina’s‘strategicemergingindustries’(seep29),whereitplanstospendbillionsnotonly to encourage innovation but to create markets. China’s plan for these strategic industries calls for foreignandChinesecompaniestoworktogetherontechnologystandardizationprojectsinthesesectors,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 way

21 For an account of China’s standards development efforts, see Dieter Ernst, Indigenous Innovation and Globalization, the challenge for China’s Standardization Strategy, UC Institute onGlobalConflictandCooperation and the East-West Center, June 2011.



High-speed trains: A series of unfortunate events

Events surrounding the development of China’s high-speed railways illustratemultinationalcompanies’worstfears:thatChinawillusetechnology and skills learned from them to compete against them in the global marketplace.

At the turn of this century, multinationals such as Germany’s Siemens, France’s Alstom, and Japan’s Kawasaki Heavy Industries controlled about two-thirds of the Chinese market for high-speed rail systems. China tried to launch a competing system, the China Star, using locally-developed technology, but the effort was abandoned after only a couple of years. When China began developing its high-speed rail plans in earnest, it made it clear that it wanted more for domestic companies.

Assumingtheywouldcontinuetoprofitiftheyplayedball,foreigncompanies began what in hindsight was a dangerous journey. For example,in2005SiemensagreedtoworkwithChinaNationalRailway Corporation (CNR) to bid to supply passenger trains for the Beijing-Tianjin high-speed railway. As part of the deal, most of the trains were made in China at CNR’s facilities, and Siemens also offered training for CNR staff. But shortly after the project was completed in 2008, the stakes were suddenly raised. While the German conglomerate announced that it had won a contract to provide 100 trains for the Beijing-Shanghai railway, the Ministry of Railways denied this was the case and announced that the project would use Chinese technology. It then began requiring foreign companies to form joint ventures with CNR or the other state-owned maker, China South Rolling Stock and Locomotive Corporation (CSR). Theywouldbeconfinedto49%equityintheseventures,whichwererequiredtoofferthelatestdesigns,and70%ofthecontentofeachsystem had to be sourced in China.

Today,foreignmakersaccountforonlyanestimated15-20%ofthe high-speed rail market, and there is a concerted drive by China’s rail companies to win contracts in markets overseas. They are already havingsomesuccess.In2009,CNRwonadealtosupplyrollingstockto Australia and New Zealand, and both it and CSR are now gunning for large projects all over the world, including developed markets like

the US. In terms of competitive advantages, the Chinese companies have cost on their side. Not only are their products cheaper but they bringwiththemtheprospectoflow-costfinancingtobeprovidedbyChina’sstate-ownedfinancialinstitutions.

But their march abroad could yet be derailed, if only temporarily. There are widespread suspicions—but as yet no clear proof—that the technology being used by the Chinese companies is not new. Kawasaki Heavy Industries, at least, has threatened to sue if China attempts to patent anything that resembles the technology that it transferred(Chinahasonlyrecentlybegunfilingtraintechnologypatents in several countries around the world and denies that KHI has anything to worry about). Just the threat of a legal quagmire will be enough to put off some potential foreign buyers.

Then there is the corruption and safety scandal that swirls around China’s Beijing-Shanghai high-speed line, which went into operation thisyear.Aformerseniorrailwayofficialhasclaimedthattherailministry covered up technical problems with the trains, putting passengers at risk. The minister responsible for overseeing the building of the line has been arrested on corruption charges. The ministry has since announced that the trains will run at 300km/h rather than 350km/h as originally advertised, but says the reduction is based on economic and environmental concerns, rather than safety issues.

The concerns surrounding the high-speed railways hit the headlines in spectacular fashion on July 23rd, when two trains travellinginbadweathercollidednearWenzhouinZhejiangprovince, killing 40 people and injuring almost 200 others. Investigators initially blamed problems with the track signalling system,butanangrypublicpointedfingersatofficialincompetenceand mismanagement.

Whatcanorwilltheforeigntrainmakersdo?Theyarenotspeaking publicly about their strategies. But their actions speak volumes. In March 2010, Siemens dropped out of the bidding for a rail system in Saudi Arabia and joined a Chinese consortium including CSR and others. In December 2010, GE Transportation announced its intention to form a US-based joint venture with CSR to bid for American high-speed rail projects.



aheadandtrytoprepare.GM,forexample,hasappointeda30-yearcompanyveterantothepositionofexecutivedirectorforelectrificationstrategyforChina,basedinShanghai.Oneofhisjobswillbe 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,possiblyinaminorityposition,andtoproducevehiclesusinglocalbrands.ItisalreadyclearthatforeigncompanieswillnotsucceedsimplybybringingtheirexistingEVmodelsandtechnologies:governmentsubsidiesaimedatspurringdemandforEVs,expectedtobeakeyfactorinthemarket,applyonlytolocally-produced(andpresumablydeveloped)cars.Inanyevent,itisnotclearthatexistingmodels 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 mostlikelythroughaco-developmentexercisegovernedbyalegalagreement.Certaintechnologywould 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 thecaseofChina’shigh-speedraildevelopments(seeHigh-speedtrains:Aseriesofunfortunateevents,p33).

Getting on with itChina’s approach to obtaining technology and encouraging innovation is still unfolding. Hence, it is difficulttopredictwhatwillhappen.

Couldpressurefromforeigngovernmentsresultinfurtherdismantlingofthemostfearedpolicies?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 theinnovationraceisnotazero-sumgame,andthatinmanyareasitstillneedsforeignmultinationals.These range from some obviously critical products such as semiconductors, to less-recognised soft knowledgesuchastheabilitytomanageacomplexbusinessacrossbordersorhowtodevelopandmanage 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 nowpushhardforproperIPprotectionathome,andleaderswillrecognizetheconnectionbetweenlackof protection and lack of innovation. “Entrepreneurs in China want to get rich quick,” notes an American



businessmanwithlongyearsofexperienceinChina.“Underthecurrentenvironment,intellectualproperty is no way to get rich because it is stolen immediately. It is better to put your money in real estate.”

A few foreign companies are thinking that by aligning themselves more closely with Chinese partners on the global stage through joint ventures they will give the partner a vested interest in helping them make their way in China. This is not charity—in some cases Chinese companies have technologies that areapplicableinotheremergingmarkets,andeveninemergedones(seeChapter7).WiththenewemphasisonR&Dandtechnologytransfer,chancesareveryhighthattheywilldevelopevenmoretechnologies that foreign companies will want to access.

Onthepolicylevel,nomajorchangesareexpectedinthenearterm.Chinaisabouttomakealeadership transition in 2012, and as a result there will undoubtedly be a shifting of key players and realignmentofagenciesandministries.Inthemeantime,itwillbeuptoMNCstofigureoutwhattheycan offer that China wants, and how they can safeguard their interests in doing so.



Chapter 6: Honour thy masterIn addition to pleasing their customers, multinationals must also do their part to please the Chinese government.

G earinguptheorganisationandexploringnewopportunitiesareonlypartofthestoryofwhatthemorehigh-profileforeignMNCswillneedtodotosucceedinChina.Thecompanieswespoke

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.

Accordingtoaseniorexecutiveatanequipmentmaker,evenlocalgovernmentsarenowjudginginvestments by the degree of technology they bring, particularly whether it is energy-saving or otherwiseenvironmentallyfriendly.“ItismorechallengingforMNCs,”theexecutivenotes.“Areyoubringingwhattheywant?Wehaveourownbusinessplans,andthesemaynotbealignedwiththoseofthe government.”

Officialsareparticularlyunimpressedwith“backward”technologythatisnolongerusedinthedevelopedworld,saystheexecutiveattheequipmentmaker.“Butitisabalancebetweenthetechnology 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 reportthatwhenspeakingwithpotentiallocalpartnerstheyarebluntlyasked:Howmuchdoesitcosttolicense?Largercompanies,however,reportanincreasedwillingnesstoconsiderthebiggerpicture,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, eventhoughregulationsmaynotclearlystatethattheyneedtodoso.GE,forexample,hasinthepasttwoyearsannouncednumerousjointventuresinairplanetechnology,coalgasification,windturbinesandotherenergysectors.Itisshowinganewflexibilityinformingthesearrangements.Forventures



based in China, it is willing to accept a minority position, although for ventures abroad (which are still in thepipeline),whereithasmoreexpertisethanitspartners,itwillseekamajoritystake.

Noting the Chinese government’s intentions to develop its own jet airliner, John Rice, vice-chairman of GE, told The New York Times:“Wecanparticipateinthatorsitonthesidelines.We’renotaboutsittingon the sidelines.” Its JV partner is Aviation Industry Corporation of China (Avic) which has supplied it with parts for years. “This isn’t something we were forced into,” Mr Rice noted.22

Pundits, particularly America’s right wing, fear that GE is giving away American technology and jobs, andstandstosufferthesamefateashigh-speedtrainmakers(seep29).Ofcourse,theissueisdoublysensitiveforGE,whoseCEO,JefferyImmelt,isUSPresidentBarackObama’sjobsczar.ButwhileMrImmelt 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 told reporters:“Thisisaboutcreatinganewcompetitor[toBoeingandAirbus]andit’saboutanAmericancompany looking for strategic opportunity to develop a new platform.”23

MrImmeltnotedthatGEwillsupplymorecontenttoChina’sfirstcommercialairliner,theC919,than it has to any other plane in history. “This is more about trying to play offence in a win-win setting than‘underthreatofdeathwegaveourtechnology’...[That’s]justnottrue,”hesaid.24 Of course for technology-rich conglomerates such as GE and GM, it is rather easy to take a gamble with what is really a small part of the empire.

WithChina’srenewedemphasisoninnovation,multinationalR&Dcentresnowseemtobeflavourofthemonth.Zinnov,amanagementconsultancy,saysthatduringtheworstofthefinancialcrisisbetween2009andMarch2011,MNCssetup200newR&DcentresinChina,inadditiontothe1,100thatwerealreadyinexistence25. The trend is driven by several factors. The biggest, perhaps, is public relations. The second is a need to more closely tailor products to suit the growing and increasingly sophisticated market. The third is the need to meet local standards—indeed, some claim that incrementalinnovationstoexistingproductsmadeinChina,qualifyingthemasChineseinnovations,will be enough to satisfy the government’s drive for indigenous innovation (which is being measured with,amongotherthings,strictquotasonpatentfilings).Lastbutnotleastistheneedtodrivedowncosts—forR&D,componentsandothersupplies—inordertocompeteandexpandinthemassmarket.Inareassuchaspharmaceuticalstrialsinparticular,costsavingsareestimatedtobeasmuchas20%.

ScepticsquestionhowmanyoftheR&Dcentresareengagedin“real”R&Dwork,asopposedtothe labour-intensive kind that is routinely required to test and certify products, or to make minor adjustmentstoexistingproducts.Thereisnoharddatatodeterminetheanswer,althougharecentstudyofthetoptentechnologycompaniessuggeststhathalfofthemarenotdoinganysignificantR&Dwork in China and that Indian labs are far ahead in generating patents.26 While there has been much hype about “reverse innovation”—the development of products in emerging markets which are then sold indevelopedcountries—thisseemstobeoverplayed.Indeed,only22%ofoursurveyrespondentssaidtheysawChinaasa“sourceofinnovationforglobalproducts”inthenextfiveyears.

Many more, however, see China as a source of business model and process innovation. Honeywell, for example,talksofitsoperationsinChinahaving“ChineseDNA”andusingthecompanyithasdevelopedthere to compete in other emerging markets. Companies in some sectors also see China as a source of

22 “G.E. to Share Jet Technology With China in New Joint Venture”, New York Times,Jan17th2011

23 Ed Crooks, “GE sets its sights high in Chinese tie-up”, Financial Times, January 20th 2011

24 Jeremy Lemer, “GE chief urges companies to add engineers”, Financial Times, July 14th 2011

25“MNCR&DLandscape:AChina Perspective”, Zinnov Management Consulting

26 Anil K Gupta and Wang Haiyan, “How Beijing Is StiflingChineseInnovation”,wsj.com, September 1st 2011



talent,acknowledgingthevastpotentialChinahastobeanR&Dpowerinthefuture.Inpharmaceuticalsandhealthcare,52%ofrespondentssawthisasamajoropportunityfortheircompanies(comparedwith32%forthesurveyrespondentsasawhole),whilethefigureforIT/technologywas49%.Inbothindustries, China’s talent was cited as second only to the growing market as the biggest opportunity.

WhilecompaniesagreeingtosetupR&DoperationsinChinamaybenefitfromskillsavailabilityandlower costs, whether there is any direct payback in terms of favourable treatment from authorities is anothermatterforscepticism.MicrosoftisinthevanguardofR&DinvestmentinChina,havingfirstsetupalabinBeijinginthemid1990s.Accordingtoresearch,Chinahasplayedapartin6.5%ofthepatents granted to Microsoft in the US since 2005.27 Despite this, and Hu Jintao’s reference to Microsoft Chairman Bill Gates as “a friend of China”, software piracy remains rampant and Microsoft’s China 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 impact inMaythisyearwhenhecametoBeijingtoopenanewUS$400mAsiaR&Dcampus.28 One can only surmise that China has talents Microsoft cannot do without.

OneindustrywhereinvestmentinR&Dcentresishavinganacknowledgedimpactisinpharmaceuticals.CompaniesarerealisingthatbyopeningseriousR&Dlabs,theyareabletoattractChinese 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 flourishingpopulationofclinicalresearchorganisations(CROs)islayingthegroundworkforthemtodoso one day.29

ThebiggestconcernforcompaniessettingupR&DfacilitiesinChinais,ofcourse,IPRprotection.The mantra is still, “if you can’t afford to lose it, don’t bring it”. Without doubt MNCs are keeping their coreR&Dathome.SomewillrestricttheirR&Dactivitiestoproductsaimedatthelocalmarket.OtherswillseektointegratetheirChinafacilitiesintoaglobalnetworkwhichdividesR&Dworkbetweenseveral facilities and hence lessens the risk of IP loss. Still, some are catering for China’s desire to have morepatentsfiledinthecountry.ForexampleBASF’spolyurethanesdivisionR&DcentreinShanghaicompleted 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 wasgeneratedinJapanbutthedevelopmentpatentwasfiledinChina.GM,meanwhile,hasworkedwith its joint venture partner, Shanghai Automotive Industry Corp (SAIC), to develop an engine and atransmissionunderaco-developmentexercisewithaseparatelegalagreement,ratherthanajointventure (see previous chapter).

The renminbiAnother 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 boardoftheShanghaiStockExchange—thelaunchtimingofwhichisstillunclear.

Since 2010, China has increasingly allowed renminbi bonds to be issued in Hong Kong and the currencytobeusedfortradesettlement.Therehavebeenafewhigh-profilebondissues,notablyby

27 Erik Sherman, “Microsoft NeedsChina:6.5%ofItsU.S.Patents Have Roots There”, February 26th 2010

28 “Ballmer Bares China Travails”, wsj.com, May 26th 2011

29 George Baeder and Michael Zielenziger,“China,TheLifeSciences Leader of 2020”, Monitor Group, 2010



Unilever, McDonald’s, Yum! Brands and Caterpillar. McDonald’s and Unilever planned to use the proceeds forworkingcapitalinChina,whileCaterpillarplanstousethefundstoofferfinancingforthepurchaseofitsequipment.Theattractionsofissuingrenminbibondsaremanifold:thecostoffinancingcanbelower, 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 intention to internationalise the renminbi, and bankers are of the opinion that corporate issues, rather than those byfinancialinstitutions,willgivethemarketmorecredibility.

The downside, as ever with China, is uncertainty. Companies are not automatically allowed to repatriate the funds to the mainland, and though McDonald’s and Caterpillar have been able to do so, approvalswereslowincoming.Thisnodoubthelpsexplainwhyoursurveyrespondentsdidnotshowmuchinterestinsuchfund-raising.Only9%ofrespondentsreportedanyplansbytheircompanytoissuerenminbibonds,whetherinHongKongorChina.Amongbigcompanies,thefigurewasonly5%.According to a spokesperson for BASF, a German conglomerate with large investments in China, “The attractiveness of these markets increases with the maturity level achieved by regulatory frameworks. For the 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 results are largely the same. Despite some big names such as HSBC, Standard Chartered, Unilever and Coca-Cola expressinginterestinaduallistingontheShanghaiexchange—andsomeoftheseactivelydiscussingthefinerpointswithregulators—fewerthan10%ofsurveyrespondentsthoughttheircompanywouldbelikely to go down this route.

Again, lack of clarity no doubt has a bearing on enthusiasm. Plans to launch the international board inShanghaiwerefirstannouncedbackin2007.Despitesuggestionsthattheboardwouldbeupandrunning by the end of 2011 it seems no closer to fruition. Just what is holding it up is unclear, though the subject of much speculation. It is commonly believed that the major reason for the delay is China’s currency policy—to entice companies to list, the government would need to introduce full capital account convertibility, thereby giving up one of the major instruments by which it controls the economy. However,Chinaisexpectedtosimplymakerulesonconvertibilityandrepatriationforcompanieslisted on the board. This in itself, if introduced without limits, could be politically sensitive. Some commentators have conjured the image of foreign companies using China as an ATM machine, taking the proceeds from their higher valuations in China and using them to buy back their own shares on other bourses at a lower price30. Others think this a non-issue as many listing companies are more likely to keep ploughing money back into China, rather than taking it out, at least in the near term. From MNCs’ viewpoint, convertibility is no longer as big a deal as it once was. Only about one-quarter of our survey respondents 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 thoroughly discussed and rules drafted. They are now awaiting sign off by senior leaders. While the coming leadership change may delay the launch, it is believed that it will still go ahead, with timing dependent on market conditions and China’s relations with major trading partners.

AswithmanyothernewpoliciesinChina,thelaunchoftheinternationalboardisexpectedtobegradual.Thenumberofcompaniesallowedtolistinitiallywillbelimited,probablytolessthanfiveand

30 “The Shanghai InternationalBoard:Challenges and Opportunities”, Trusted Sources, June 2010



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),whiletotalfundraisingontheShanghaiexchangein2010wasjustRmb515bn,accordingtoDealogic(theamountwasdowntoRmb22bninthefirsttenmonthsof2011).Regulatorswillalsobeconcerned 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 beallowedtousetheirexistingIFRS.UScompanieswillbeallowedtoreportunderUSGAAPbutmayneed 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 investmentsinChinatoraisethefundsinlocalcurrency.ThereisthePRbenefitofhavingone’snamesplashed 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 offerthemsomeprotectionfromwhimsicalbureaucrats,whomaythinktwiceaboutmakinganexampleof a company with several hundred thousand local shareholders. For companies with a decidedly poor reputationlocally,suchasglobalresourcesplayers,whoarewidelyperceivedtobeprofitingunfairlyfromChina’sdependenceonthem,itwouldnodoubthelpthemtoallowsomeChinesecitizenstoshareintheirprofits.

Where there are opportunities, however, there must also be risks. These are not entirely clear at this earlystage,butanalystspointtotwoissues.Thefirstisthefateoftheinternationalboardoncecurrency

No big dealDoes the lack of capital account convertibility of the renminbi have an adverse effect on your China strategy?(% respondents)Yes

No

Not sure


26

23

51

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)

Repatriation of funds remains difficult, making us more conservative in our push into China

We still need to rely on more open financial centres such as Hong Kong or Singapore to run regional finances

Lack of convertibility is preventing us from moving our Asia headquarters to China


213335 7 4

3535 4621

2321 171821

Strongly agree 1 2 3 4 Strongly disagree 5



controls are eventually lifted and Chinese punters allowed direct access to international markets. The worrierspointtotheexperienceofTokyo,wheremanyoftheforeignmultinationalssokeentolistinthe1980shavesincewithdrawnduetothepoorperformanceoftheirshares,whichwasblamedinpartonJapan’sopencapitalaccount.TheoptimistscounterthatTokyo’sexperiencemaynotberelevantbecausecompaniesthatseekduallistingsdosobasedontheirexpectationsofgrowthinthecountryconcerned and its importance to their global strategy. While multinationals were bullish on Japan at thetime,mostwouldagreethatexpectationsofChinaareinanentirelydifferentleague.Thesecondpotentialriskisanover-dependenceonChina.Thisisparticularlytrueforsectorslikeluxurygoods,where China is rapidly coming to account for a large share of their global revenues. For all its growth Chinaisstillfacingsomedifficultandriskyeconomicandsocialtransitions.Tobecomeoverlyreliantonit for both sales and fundraising may not be prudent.

By other meansPleasingtheChinesegovernmentisnotallaboutR&Dlabsandbondissues.Manymultinationalshave some sort of corporate social responsibility programme in China, often linked to education or environmental management. But some are coming to the conclusion that this is not enough. One large consumergoodscompany,forexample,hasdecidedthatwhatitsregulatorymastersaretrulyinwantofatthemomentissharingofknowledgethatcanhelpChinesecompaniesintheirexpansionabroad.SothecompanyisbringinginseniorglobalexecutivestotrainmanagersfromChina’sstate-ownedenterprises(SOEs),largelyintheresourcessector,onhowtoundertakeglobalM&A.“Whatwehaveareourbrandandyearsofexperiencerunningaglobalcompanyanddoingsuccessfulmergersandacquisitions,”notestheexecutive.“ThesearethingsthatChinaiskeentohaveforitsowncompanies.”GiventhattherearenoSOEs in the FMCG industry, there is no danger that the foreign company is helping competitors.



Nissan: According to plan

For Nissan, like GM and Volkswagen, China is already its largest single market, accounting for nearly one quarter of its global sales. With the Chinese government targeting vehicle sales of 30m by 2015, Nissan,likeothers,isnowscramblingtoexpandfastenoughtokeep pace with demand, worrying that if it doesn’t it will lose market share. It achieved the sales target of its previous mid-term plan two yearsaheadofschedule.Itisnowaimingfor10%ofwhatitbelieveswillbea20m-unitvehiclemarketby2015,upfrom6%oftoday’smarket. It plans to achieve this by, among other things, introducing around 30 new products, including a locally developed electric vehicle (EV), catering for the increasingly diverse needs of the China market.

Themedium-termplanofits50:50jointventurewithDongfengGroup, known as DFL, sounds like a page right out of China’s 12th Five-Year Plan. When the partners presented it to a press conference inJuly,theymadecarefulreferencetowhatwasexpectedoftheauto sector in the plan and what they were doing to meet those expectations.TheJVplanstospendRmb50bn(US$7.8bn),focusingonthefollowing:• Indigenous brands. The Five-Year Plan calls for indigenous brands toaccountfor50%ofdomesticpassengercarsalesby2015.HenceDLF will introduce the new Venucia brand of vehicles, which will be designedinChinafromstarttofinish.Thecompanyisalsotargeting100%localcontentby2015(thoughitisnotclearifthiswillcomefrom local suppliers or subsidiaries of Japanese suppliers).• Exports.TheFive-YearPlancallsfortheautoindustrytoexport10%ofitstotalvolume.DLFplanstoraiseexports(mostlyofcommercialvehicles)from19,000in2010,to40,000in2012,and

80,000in2015.ItsmainexportmarketsareSouthAmerica,Russia,the Middle East, and South Asia. Given its concerns about being able tokeeppacewithdemandforpassengercars(itexceededitsgoalfor2010by300,000units),exportswillremainskewedtowardscommercial vehicles.• Expand production, increase local content. DLF will open three newplantsinthenexttwoyears,oneeachforpassengervehicles,light commercial vehicles and medium to heavy commercial vehicles, as well as a new engine plant. • R&D.InlinewithChina’sdesiretoincreasetheamountofR&Ddoneinthecountry,DLFwillincreasethenumberofR&Demployeesfrom 3,500 to 6,000 by 2015. • Electric vehicles. Though Nissan already produces its own fully electric vehicle, the Leaf, it will develop a new electric model under the Venucia brand, which it plans to launch in 2015.

There is much scepticism that demand for EVs can be stoked to the extentnecessarytojustifysuchinvestments—themainargumentbeingthatfirst-timebuyers,whoaredrivingthecarmarketinChina, are more likely to go for affordability and style, rather than environmental consciousness. But automakers seem to have a degree of blind faith in the Chinese government’s ability to create demand. They are, however, not very sure of the how, when and how many.

As Carlos Ghosn, president and CEO of Nissan Motor notes, EV pilotschemesarecurrentlyrunninginonlysixcities,andtheyarerestricted to local brands. “When the market will take off is hard to tell because there are not that many EV offerings yet,” he says. “But Chinasays,toexpandinthiscountry,youneedtobringinnew-energy cars. So more foreign producers will bring in new-energy cars.”



Investing in R&D

China is already the third-largest market in the world for both BASF and Bayer, German industrial behemoths that arrived in China asearlyasthelate19thcentury.OntopoftheirhugeexistinginvestmentsinChina—BASFhasinvested€3.8bn(US$5.1bn)inChinasince1990—botharespendingbillionsmoreeurostoexpandtheir production capacities. Both companies are also spending seriousmoneyonbeefinguptheirlocalresearch-and-development(R&D)capabilities—inlockstepwiththeChinesegovernment’spushfor more home-grown innovation.

InDecember2010,BASF,achemicalcompanywithnearly7,000employeesinChina,brokegroundona€55m(US$74m)regionalR&DcentreinPudong,Shanghai,whichisscheduledtoopeninthefirsthalfof2012withsome450scientificandtechnicalprofessionals.This “Innovation Campus” will focus on developing new products and solutions for the construction, automotive, footwear, and cosmeticindustriesintheAsia-Pacificregion.BASFcurrentlyhasmajorlocalR&DfacilitiesinShanghai,Nansha(Guangdongprovince)andBeijing.TheexpansionofR&DcapabilitiesinChinaisaimedatsupportingBASF’sobjectiveofmanufacturing70%ofwhatitsellsinAsia-Pacificlocallyby2020.ThecompanysaysitsPudongcentre—whichwillalsohousethecompany’sGreaterChinaheadoffice—willultimately become one of the largest BASF sites outside Germany, with more than 2,000 employees.

Meanwhile, Bayer, a high-tech materials, crop science and

healthcaregroup,hopestodoubleitsrevenuesinChinato€6bnby2015from€2.9bnin2010.Tohelpachievethisgoal,thecompanyplanstoconductitsR&Dclosertoitscustomers.InJunethisyearBayerMaterialSciencestartedthethird-phaseexpansionofitsPolymerResearch&DevelopmentCenter(PRDC)inShanghai.Whenit is completed in the second half of 2012, the PRDC will double the numberofemployeestoalmost260andwillhaveafullrangeofR&Dexpertisebefittingaglobalinnovationcenter.Thematerialsciencedivision has also moved the headquarters of the polycarbonates business unit to Shanghai

Bayer HealthCare is following a similar path. The company this year announced that it would move its general medicine headquarterstoBeijing.Earlier,inFebruary2009,BayerScheringPharmaunveiledplansfora€100mglobalR&DcenterinBeijing.The company’s head of global development and chief medical officer,KemalMalik,saidinastatementatthetime:“OurgoalistobuildaworldclassorganizationhereinBeijingthatwillleaddrugdevelopment not only for China but also for other Asian countries. Our aim is to systematically include Asian patients earlier in global drugdevelopment,breakingthetraditionof‘USandEUfirst’.”

Since then, the company has also begun a collaborative arrangement with Tsinghua University in Beijing—the Bayer-Tsinghua Research Center of Innovative Drug Discovery—focusing on oncology research, and has formed a strategic partnership with the General Hospital of the People’s Liberation Army (301 Hospital), one of the largest hospitals in Beijing, to jointly study gynecological diseases.



Chapter 7: Gearing up to play the gameTo 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.

The 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’senormousandlong-heraldedconsumermarkettofulfilitspotentialisnearlyover.Thebadnews 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.

Accordingtooursurvey,companiesareonlybeginningtodoso.Amonglargecompanies,only8%saidthattheirChinaCEOsitsonthecompanyboard(for45%,theChinaCEOreportsintoregionalheadquarters).However,40%ofthesecompaniessaidthattheyhadmovedveryseniorexecutivestogreaterChina.Forexample,inlate2010GErelocatedJohnRice,oneofitsvice-chairmen,toHongKongto 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 theUS.TheninMayIntel,acomputerchipmaker,announcedthatoneofitsmostseniorexecutivesandafuturecontenderforCEO,SeanMaloney,hadbeenappointedasthecompany’sfirstChinachairmanbasedinBeijing.ButallthreeweremonthsbehindFord,whichmoveditsAsiaPacificheadquartersfromBangkoktoShanghaiin2009.



ThismaybethebeginningofamovetowardgreaterautonomyforChinateams:49%oflargecompanies said that the autonomy of their China operations had increased in the past three years. This will undoubtedly be the way of the future for industrial giants. “Many companies have US or European headquarters which are obsolete in terms of their ability to do much to help in China,” says Thomas Hout, adjunct senior lecturer at the Fletcher School of Law and Diplomacy at Tufts University. “The smart ones have a China CEO reporting to the global CEO. If China is your future, that’s what you’ve got to do.”

Effortsatintegrationflowtheotherwayaswell—42%ofsurveyrespondentsatbigcompaniessaidtheyarebringingmoreChineseexecutivestoglobalheadquarters,eitherforpostingsorforexecutivedevelopmentprogrammes.And12%reportedthattheyhavemovedtheglobalheadquartersofsomedivisions to China.

Somewhat surprisingly, given the amount of grousing heard on the ground in China, the majority of survey respondents felt that the views of headquarters and operations in China were aligned in terms of strategy.Amonglargecompanies,14%felttheywereoutofsyncandthemajorareaonwhichtheyweremisaligned was on the need to be innovative in business structures, such as taking minority stakes in joint ventures in China (though China-based respondents said the need for speed was the bigger issue). AmongrespondentsbasedinChina,27%saytheyaremisaligned,mainlyontheneedforspeed.

ThattheChinamarketrequiresflexibilityiswellillustratedinthepharmaceuticalsector.Asnotedearlier, it is highly likely that price caps will drive the market towards generic drugs. Here the name of the game will be speed and scale, where local companies have the advantage. In an ideal world, from thecash-richmultinationals’viewpoint,theywouldbuyuplocalplayerstoexpand.Thoughforeigncompanies are looking, it seems unlikely to be so simple. Local companies are well aware of the potential gold 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). Andthenthereistheissueofwhetherlocalfirmscanmeetqualitystandardsinthishighlyregulatedindustry.

All of this means that multinationals will need to change their typical approach. “To tap this, you needtobefast,innovativeandaggressive—oryouwillmissout,”saysSimonBenjaminofErnst&Young,anaccountingandconsultingfirm.“Ithinkallofbigpharmarecognisesthisnow.”AccordingtoMr Benjamin, although there have not been enough deals to really call it a trend, anecdotal evidence suggests that minority stakes in local drug makers for foreigners will be the way of the future.

Fonterra,aNewZealanddairygroup,isagoodexampleofanMNCwithaflexibleapproachfortheChina market. It is investing in its own farms in China even though it has 4m cows producing some 15bn litresofmilkannuallyathome,muchofitforexport.WithdemandfordairyproductsgrowingrapidlyinChina, it is prudent to begin both replacing imports with local supplies and helping the country improve food security. The move is also in line with the government’s desire to develop its agriculture sector and improve 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 of thousandsofbabies(sixofwhomdied)in2008.



Overcoming the fear factorTheultimateflexibilitywillbeneededinfiguringouthowtoco-existwithChinesecompetitorsoutsideChina. While many companies—and countries—fear the rise of competition from China, an increasing numberofcompanies,particularlycarmakers,aretryingtoexploitwhattheyhavedevelopedinChinato tackle other emerging markets through co-operative arrangements with their Chinese partners. Two oftheworld’slargestcorporationsaregoingastepfurtherandofficiallypartneringwiththeirChinesecounterparts in other markets.

GM has teamed up with its Chinese joint-venture partner Shanghai Automotive Industry Corporation (SAIC)inanew50:50JVinIndia,amarketGMenteredin2000andhasstruggledwithsince.Analystshave 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.”

ThatChinabusinessisonlypartiallyownedbyGM.ShanghaiGMiscurrently51%ownedbySAICfollowingthesaleofacontrolling1%staketotheChinesecompanyin2010,amovethatwasmadetoallowSAICtoconsolidatetheventure’searningsonitsbooks.GMnowowns44%ofGM-SAIC-Wuling.“SAIChasthesameinterestsasustoexploittheIndiamarket,”saysMrWale.“Wehaveadvantagesintermsofinternationalexperienceandtheyhaveadvantagesintermsofproductsandresources—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.”

AnotherexampleisGE,whichinDecember2010announceditsintentiontoformaUS-basedjointventure 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,couldbeindoubtfollowingChina’srecentraildisaster(seetheboxp33).Butpriortothesedifficultiesemerging,itmadeagreatdealofsense.Accordingtooneconsultant:“Theyknowthefutureis 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’vegotagoodflowofordersfortheirfactories,anditisagoodwaytoavoidgettingcaughtupininternationalconflict,”saysthesameconsultant.“IfyouendupinaWTOhearingorprotractedactionor in court, you have lost because nothing gets done. And this is a game of speed and going with the market.”

FortheChineseside,theGE-CSRdealrepresentseverythingitcouldeverhopefor:accesstoanareaoftheAmericanmarketthatwouldotherwiseundoubtedlybepoliticallydifficulttoenterandtheopportunity to learn from a world leader.



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 Transport wasatpainstopointoutthatlocalcontentwouldbemaximisedtomeet“BuyAmerica”requirementsandthat the venture would sustain several thousand high-tech manufacturing jobs in the US.

Othermultinationalswillbewatchingtheoutcomeoftheseventuresclosely.Thosewithextensiveinternational operations will be hard-pressed to make a case for partnering with Chinese companies who areincomparisonneophytesintheglobalmarket.Butlookingtothenextfrontiersforbusiness—thelikes of India, Indonesia, Africa and the Middle East—the idea might not seem so unsound. These aremarketsinwhichlowerpriceswillcreateanddrivemarkets.Wherewillmultinationalsfindthewherewithaltocompeteonthatbasis?TheanswerislikelytobeChina.

48 © The Economist Intelligence Unit Limited 2011

AppendixSurvey results


Appendix: Survey resultsNote:Percentagesmaynottotal100duetoroundingortheselectionofmultipleanswers.

Are you familiar with your company’s China strategy?(% respondents)

Yes100

37

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)We are counting on our existing operations in China to deliver more of our global revenue

We are investing more in China in the hope that it will make up for deteriorating markets elsewhere

We are postponing further investment in China because of deterioration in our main markets

We are repatriating more profits from China to shore up balance sheets at headquarters

Our expectation has not changed

28

21

9

2

40

2. From the perspective of your global headquarters, which statement best describes China? (% respondents)It is critical to global strategy

It is strategically important, but not critical

It is on a par with other emerging markets

We are still exploring the market

It will be a niche market for us

Don’t know

37

33

9

13

5

2

49© The Economist Intelligence Unit Limited 2011



3. What is driving your company’s China strategy? Choose one. (% respondents)Growth prospects for our industry in China

Belief that China’s unique characteristics (eg, population) will have a major impact on our industry

Need to monitor Chinese competitors


Need to serve our customers

56

10

7

Falling revenues in other markets2

4

Not sure2

19

4. What is your company’s competitive advantage in China? (% respondents)Long experience in emerging markets/strong management

Superior/unique technology

Large resources


Strong brand

24

16

10

We don’t have an advantage but feel we need to be in China19

6

Don’t know2

23

5. 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. (% respondents)

Growth will slow to more developed market rates (eg, 3-5%)

This year/has already happened In less than 5 years In between 5 and 10 years

In between 10 and 20 years

The renminbi will be made fully convertible

China will succeed in shifting its growth model away from exports and investment and toward domestic consumption

China will become our biggest market

292910 21 11

311 111641

327 61539

21178 3717

Our major competitors globally will be Chinese21179 3519

Developments in the China market will have a disruptive impact on our industry191814 3613

Not in foreseeable future




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

The regulatory environment/industrial policies (eg, indigenous innovation)

Renminbi convertibility, if it happens

Urbanisation

Competition from Chinese companies

58

43

32

Improved infrastructure (as a result of stimulus spending)25

21

Other, please specify5

46

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

Source of skills/talent

Key market for our technology

Source of capital

Source of low-cost production

76

31

27

Source of innovation for global products22

19

32

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

Competition from domestic companies

Discrimination against foreign companies

Competition from other foreign companies

Lack of legal protection in general

Lack of available local talent

Risk of trade and economic disputes between China and other countries

Lack of autonomy to make the right decisions for the China market

Unpredictable nature of Chinese government

41

32

31

Corruption28

27

23

14

11

8

35




9. How has the autonomy given to the China operations of your company by headquarters changed in the past three years? (% respondents)It has increased

It has decreased

No change

36

55

9

10. 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

No

Don’t know

73

15

12

10a. 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

Global decisions (eg, divestiture of product lines) were not the right ones for China

We have lost opportunities because decisions could not be made quickly enough

We have lost opportunities because we could not get the investment required

Our products do not meet local market needs

Key executives have quit in frustration


45

39

21

18

13

5

45

10b. What are the key areas in which views are misaligned? Choose up to three. (% respondents)The need to move quickly

The need to be innovative in our business structures in China (eg, accept minority stakes in JVs)

The need to adapt product/pricing to local market conditions

Need for long-term investment

The threat posed by local competitors

Risk assessment

Returns on investment

View of China’s potential

Resources for investment

32

24

21

21

18

13

11

11

29




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

Joint ventures

Acquisitions of Chinese companies

Acquisitions of foreign competitors’ operations

We are not planning to expand

Don’t know

63

20

6

9

1

46

13. Is your company planning to issue bonds in Renminbi? (% respondents)Yes, our parent company is planning to do so in Hong Kong

Yes, our parent company is planning to do so in China

Yes, our China subsidiary is planning to do so in Hong Kong

Yes, our China subsidiary is planning to do so in China

No, we have no plans to do so

Don’t know

3

2

11

76

15

3

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

We are currently moving into second and third-tier cities

We already have a substantial market in second and third-tier cities and are moving on to fourth tier and beyond

59

8

33

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)

Raise bonds in Renminbi

Pursue a secondary listing on the Shanghai Stock Exchange (if permitted)

List China subsidiary on a mainland stock exchange (if permitted)

List China subsidiary on the Hong Kong stock exchange

1045 11 70

62 701111

53 681410

1172 6713

Sell a stake in your company to a Chinese competitor

Acquire a Chinese company

1472 6116

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)21101 51

2418252311

17

Highly likely 1 2 3 4 Not likely at all 5




15. Does the lack of capital account convertibility of the Renminbi have an adverse effect on your China strategy? (% respondents)Yes

No

Not sure

26

23

51

15a. 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)

Repatriation of funds remains difficult, making us more conservative in our push into China

We still need to rely on more open financial centres such as Hong Kong or Singapore to run regional finances

Lack of convertibility is preventing us from moving our Asia headquarters to China

213335 7 4

3535 4621

2321 171821

Strongly agree 1 2 3 4 Strongly disagree 5

16. How will the Reminbi’s appreciation affect your China strategy? Choose all that apply. (% respondents)We see more opportunity to export to China

We are planning to source more materials/components locally

We are shifting some production to other countries

We are undergoing a major cost-cutting exercise

We see no major impact

30

15

14

41

23

17. 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

We are putting senior Chinese staff onto our global talent development programme and are bringing more Chinese staff to positions at headquarters

We have moved very senior global executives to China/the region

We have appointed executives from China to our global board

We’re moving or have moved our Asia Pacific headquarters to China

We have moved global headquarters of some divisions to China

Our efforts are minimal—we send senior executives to China a few times a year

58

22

15

13

7

33

29




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)

A major crisis in the Chinese economy

Major social unrest in China

China’s bilateral relations with your company’s home country

312518 20 6

3113 91929

259 162426

Human rights incidents such as the detention of foreign executives

2210 152231

Protectionism in China at the national level

3219 61528

Protectionism in China at the provincial/local level

3217 71627

Protectionism in your company’s home country

126 243027

China’s proposed foreign investment review board

186 132341

China’s lack of press and internet freedom

2312 112332

Being forced to give our IP in return for market access

2326 91428

Very concerned 1 2 3 4 Not at all concerned 5

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

Our company treats China the same as any other emerging market, with the CEO reporting into a regional head

Our company has independent directors/a China advisory committee to oversee and support our operations in China

Our company has external board members with China experience and/or board members that live in Greater China

Our China CEO sits on the global board

Don’t know

43

16

14

13

14

39

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

Chinese competitors in our industry are already a serious threat to our business globally

Chinese competitors in our industry will be a threat to us globally in five years time

Chinese competitors in our industry are not a threat

Chinese competitors in our industry are the same as other competitors

26

20

22

17

15




20a. 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)

Entrepreneurial drive

Cost advantage

Government support (eg, low-cost financing)

243524 16 1

3535 1524

3335 3723

They have absorbed technology from foreign partners in China

4029 5619

They have developed competing technology

279 72136

Very important 1 2 3 4 Not important 5

21. 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

Chinese companies have become competitors for acquisition targets

Our partners in China have become our competitors in other markets

No impact


30

14

42

3

23

22. Has your company changed its China strategy in response to the overseas expansion of Chinese competitors? (% respondents)Yes

No

Don’t know

24

7

68




In which region is your company headquartered?(% respondents)North America

Western Europe

Asia-Pacific

Eastern Europe

33

33

33

1

In which country is your company headquartered?(% respondents)US

Germany

Singapore

Hong Kong

Spain

Italy

Japan

Malaysia

Philippines

Belgium

Cyprus

Taiwan

Portugal

Sweden

Poland

New Zealand

Austria

Thailand

Ireland

Denmark

Switzerland

France

China

Australia

Netherlands

Canada

UK

India

29

7

7

6

6

4

3

3

3

3

3

2

2

2

2

1

1

1

1

1

1

1

1

1

1

1

1

8




In which country are you personally located?(% respondents)US

China

Singapore

Germany

France

Switzerland

Philippines

Ireland

Japan

Denmark

Hungary

Vietnam

Indonesia

Czech Republic

Thailand

Portugal

Poland

Spain

Malaysia

Italy

Australia

Hong Kong

Canada

UK

India

17

9

9

7

5

5

5

4

3

2

2

2

2

2

2

1

1

1

1

1

1

1

1

1

1

1

16

In which region/country are you personally located?(% respondents)Asia-Pacific excluding China

Western Europe

North America

China

Eastern Europe

21

26

35

16

2




What are your organisation's global annual revenues in US dollars?(% respondents)$500m or less

$500m to $1bn

$1bn to $5bn

$5bn to $10bn

$10bn or more

15

12

45

12

17

What is your primary industry?(% respondents)Manufacturing

IT and technology

Professional services

Financial services

Healthcare, pharmaceuticals and biotechnology

Chemicals

Construction and real estate

Consumer goods

Education

Automotive

Energy and natural resources

Transportation, travel and tourism

Telecommunications

Aerospace/Defence

Entertainment, media and publishing

Retailing

Logistics and distribution

Agriculture and agribusiness

Government/Public sector

14

12

6

5

5

5

4

4

4

4

3

2

2

2

2

1

1

13

13

How long has your company been in China?(% respondents)<5 years

5-10 years

>10 years36

27

37




Which of the following best describes your title?(% respondents)Board member

CEO/President/Managing director

CFO/Treasurer/Comptroller

CIO/Technology director

Other C-level executive

SVP/VP/Director

Head of business unit

Head of department

Manager

Other

9

24

5

3

6

18

7

10

14

2

What are your main functional roles? Choose up to three.(% respondents)Strategy and business development

General management

Marketing and sales

Finance

Operations and production

IT

R&D

Risk

Customer service

Human resources

Legal

Supply-chain management

Procurement

Other

Information and research

25

45

46

24

16

11

9

9

8

5

4

4

4

3

1

Whilst every effort has been taken to verify the accuracy of this information, neither The Economist Intelligence Unit Ltd. nor the sponsor of this report can accept any responsibility or liability for reliance by any person on this report or any of the information, opinions or conclusions set out herein.

Cover image - Harry Harrison

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