Chapter 1
This Is What a Business Needs to Succeed in China
Profit growth is a key objective for virtually any company, and geographic expansion can provide that growth. Consider InMobi, a start-up we feature in chapter 7. By 2010, the company had finally become a leader in advertising on mobile devices in its home market of India. Its founder, Naveen Tewari, knew India would remain a small market for mobile advertising for at least a few years. After extending its services to several smaller countries, Tewari was considering expansion to China, a huge potential prize.
The logic of expansion is that an asset developed in one place, such as product or brand, can confer a competitive advantage in another. After all, consumers around the globe share similar needs for food, shelter, communication, entertainment, and transportation. A firm that meets those needs in one part of the world should be able to serve customers in another part. However, the playbook can rarely be copied exactly. Taco Bell’s Cheesy Gordita Crunch, popular with teenagers in Houston, may not appeal to those in Hunan. And the Maytag brand, created more than a hundred years ago in the US Midwest, means nothing to someone shopping for a washing machine in Shenzhen.
This book aims to guide managers like InMobi’s Tewari in assessing their prospects and planning for success. This chapter presents a framework for understanding success in China. We apply the framework to each of our eight cases and, in chapter 11, show how it can be used prospectively. The framework, shown in Figure 1.1, comprises three necessary conditions and five managerial decisions, plus agility and luck. We treat each of these elements in turn.
Three Necessary Conditions
1. Demand
Firms exist to satisfy the needs of customers. In the language of famed Harvard Business School professor Clayton Christensen, customers hire a company to do a job.1 The most fundamental requirement for success in China is that the firm sets out to do a job that lots of Chinese consumers—and the country has an estimated 328 million urban households—need done.
Nearly any need that exists in one’s home market exists in China. For instance, the need to prepare and serve food at home exists in both the United States and China. Yet the need for tools to serve ice cream at home varies dramatically: Americans eat a lot of ice cream at home, the Chinese almost none. One of us (Karl) is a cofounder of a company in the United States, Belle-V, whose best-selling product is an ice cream scoop. Belle-V would face a quixotic challenge entering China to do the job of improving the ease of something few people do. It might fare better with an improved dumpling steamer or wok spatula.
While the ultimate source of demand in society is individual consumers, the business-to-consumer (B2C) companies that cater to end consumers also need goods and services, thus giving rise to B2B firms. Just as consumer needs can vary across geographies, so do the needs of companies. For instance, paper bank checks are used rarely in China, so a company hoping to sell check-processing equipment would likely fail. But, as with consumer needs, if the need is conceived more generally, it likely exists in China. For instance, reframing the need for check processing as the need for payment transmittal results in a job that is indeed real in the Chinese market.
A clear-eyed assessment of what job (or jobs) the company can do and whether there is sufficient demand for that job prefigures any hope of success. Just trying to foist an American offering on Chinese consumers won’t work.
2. Access to the Market
In considering entering the Chinese market, a foreign firm must find out whether the planned activity is permitted by law. Some categories of businesses are closed to foreign companies. However, as of 2019, there were just 40 such categories, each defined quite narrowly.2 Air traffic control systems is one. Some categories require a Chinese partner. For instance, degree-granting higher education requires partnership with a Chinese university and approval from the Ministry of Education. Another example is the internet, where the government often restricts investment. Yet a VIE (variable interest entity) structure can sidestep the restriction. Under a VIE, a foreign company establishes a subsidiary in China. The subsidiary signs a contract with a Chinese company, and the Chinese company invests and operates in the restricted sector. This is the approach Amazon and LinkedIn took.
Despite these restrictions, the vast majority of business categories in China are open to foreign companies, and, in some cases, an industry falls within a category that the government hopes to encourage as part of a major initiative or its Five Year Plan. For these categories, incentives may be available for foreign companies.
Three important caveats are worth noting. First, government policies are dynamic, having changed significantly at least three times since the 1978 opening. Second, policies can vary by province and city, in part because of local political power and in part because of deliberate creation of different zones with different rules for different economic purposes. Third, many policies are deliberately vague, allowing for administrative discretion in interpretation.
3. Advantage
Given a job to be done in China and a legal charter to operate, the third necessary condition for success is a potential source of competitive advantage. Competition for the Chinese market is intense. The size of its market and its surging growth aren’t secrets to anyone, and Chinese entrepreneurs and multinationals from all over the world are vying for shares. Ultimately all competitive advantage arises from controlling some resource or asset that helps deliver a solution to customers and that cannot readily be acquired by rivals. We call these resources the firm’s alpha assets.3 Alpha assets may include efficient production systems, brands valuable to consumers, or proprietary products. For example, Intel’s chip design and manufacturing technology and Zegna’s brand are both alpha assets. Alpha assets are a firm’s unfair advantage, required to give it a reasonable chance to prevail against local competition. By definition, they’re already possessed by the firm and not easily acquired.
Five Managerial Decisions
If a company has satisfied the three necessary conditions for success (demand, access to the market, and advantage), it’ll next have to make five decisions—all of which are under the control of the parent company. These decisions are made at the outset of the venture and updated as experience plays out.
1. Commitment
With ventures into the unknown, the time and money required for success will usually be greater than expected. In China, the prize is large, and investors have been willing to place large bets. These factors make the commitment required to succeed in China larger than for any other foreign market. In some cases, firms fail to realistically forecast the costs required and lose enthusiasm once reality proves more expensive than their projections. In other cases, the initial commitment of resources is just too stingy, leading to the worst possible outcome: wasting resources with no hope of a payoff. Of course, smart commitments can be contingent and can grow as milestones are achieved.
2. Governance
The structure and administration of the relationship between the China unit and the parent organization is a key managerial decision. On the one hand, the unit could operate mostly independently, like a start-up. On the other, it could operate more like a regional division, little different from other divisions around the world. The full range between these extremes is possible, but most of the companies we studied are somewhere in the middle. Specific governance decisions required include the following:
- To whom does the top manager in China report?
- Which decision rights does that person have? How significant are the decisions that require consultation with headquarters?
- Which resources (e.g., R&D, marketing, finance) are replicated in China, and which are located at headquarters and shared?
These decisions depend on the business context. For instance, Intel is unlikely to replicate the development of semiconductor-fabrication processes in China, because that activity requires deep expertise about the physics of manufacturing, which does not vary by geography and which benefits from a single global center of excellence. In contrast, LinkedIn China would be unlikely to share a marketing department with its US counterpart, because acquiring customers in China differs from acquiring them in the United States. To a large extent, a parent company’s choices on these matters reflect trust and the willingness of the parent to accept the risks associated with trust.
3. Leadership
There is considerable debate and academic research about the extent to which CEOs of large companies really matter.4 There is no such debate about start-up CEOs. Any venture capitalist will tell you that the three most important factors in venture success are the team, the team, and the team. And leading a foreign company’s entry into China more resembles managing a start-up than stewarding a division of a big company in a mature market. Yet managers unfamiliar with the parent company’s culture will struggle to marshal resources they need or win support at headquarters for their plans. The skills needed to excel as a manager within a large firm may even be at odds with those needed in a new venture—savvy corporate politicians are seldom also resourceful pioneers. Add to this mix the need for someone who’s comfortable operating in both China’s business environment and that of the parent company. The number of people who have all these skills is tiny, though growing, and most companies will have to compromise on at least one of these desirable qualities.
4. Strategy
If a firm has a clumsy strategy, it will likely stumble, even when it enters a booming market with a strong commitment and capable leadership. In this context, we intend “strategy” to refer to the top-level plan for entering the market and achieving sustainable success. Typically, this strategy can be described in one or two sentences. For instance, for Hyundai, one of our focal cases, the strategy was this:
Enter China in a 50–50 joint venture with Beijing Automotive Group and offer a highly affordable car for the Chinese middle class using an existing design, an existing component supply chain, and a Chinese assembly plant. Use this approach as a stepping-stone to building the Hyundai brand in China and to offering more upscale models in the future.
Hyundai’s strategic alternatives could have involved different partners, different initial market segments, and different approaches to design and production. Although plans inevitably evolve and companies must adapt, the top-level strategy usually guides the company for the first year or two of its China venture. Getting it right is not a straightforward exercise or a guarantee of success; efforts in China will be buffeted by a host of uncertainties: actions of competitors, macro trends in the market, unexpected decisions from policymakers, and plain dumb luck. Still, trying to enter China without a well-planned local strategy is like trying to hike in a trailless forest without a map and GPS.
5. Product
For a given job to be done, various solutions might be offered. Consider the need for clean clothing each day. You might buy a washing machine, tote dirty clothes to a laundromat, or even rent outfits, as has long been done with tuxedos and is now an option with expensive designer outfits. A company achieves product-market fit when its solution is preferred by the consumers it aims to serve. In practice, this fit can be influenced by consumers’ price sensitivity, their cultural norms and preferences, and their alternatives. For instance, in the United States, clothing washers and dryers are almost always separate appliances. In Europe, given much smaller homes, they’re often combined into a single unit. But in China, which also has small homes and high energy prices vis-à-vis most families’ budgets, apartments often have a semi-enclosed porch or a balcony on which clothing is hung to dry. A plan to sell full-size washers and dryers in China would almost certainly fail.
In B2C markets, most solutions require significant adaptation to meet the needs of the Chinese consumer. But there are instances of nearly identical solutions working globally. These are often technical or narrow in their scope, such as with microprocessors or industrial adhesives. But in a few interesting cases, a product’s main benefit may be its foreignness, as seems to be true of Starbucks. In most cases, the needs, preferences, and tastes of Chinese consumers vary enough that firms hoping to succeed in China must adapt their offerings. Most companies have the capability to do this, so doing it is mostly a question of willingness to localize and expend the cost and effort required.
Emergent Factor: Agility
Managers of foreign companies in China cited one factor more often than any other in our discussions: agility. The Chinese market operates at the speed of an online marketplace, with offerings, prices, and even vendors changing constantly. Established companies are more accustomed to markets that function like shopping malls, where change happens more slowly and someone can’t just rush in, set up a kiosk, and start selling something new. In China, competitors respond to opportunity in days, not months or quarters, and start-ups backed by abundant venture capital sprout up. Established firms, even in their home markets, tend to be cautious. Add to that the complexities of coordination across oceans, time zones, and organizational boundaries, and they are considered sloths in comparison with China’s cheetahs. Unfortunately, agility is not itself a single managerial decision. Rather, it emerges from other managerial choices, particularly the governance of the China unit, its leaders, and the autonomy they’re granted.
A central tension limits agility for foreign companies in China. The greatest agility would arise from appointing an entrepreneurial leader and giving that person complete autonomy. But that structure would then mirror an independent start-up, leaving little, besides perhaps funding, for the parent to contribute. The premise of foreign investment in China is that the foreign firm brings alpha assets. Tapping into those assets requires coordination with headquarters.
Luck: What You Can’t Control
Economists don’t like the word “luck.” They lump it into a category they call “exogenous factors,” which basically means everything outside your control that affects you. No matter which word you choose, the reality of randomness can’t be changed, but it can be prepared for. The first step is acknowledging that exogenous factors can be divided into known unknowns (e.g., the precise level of the exchange rate between the renminbi [RMB] and the US dollar over the next five years) and the unknown unknowns. By definition, the “unk-unks” aren’t listed in advance, but retrospectively most companies would identify the arrival of the novel coronavirus in 2019 in China as an unk-unk. To some extent, firms can prepare contingency plans or at least calculate the chance of success with some assumptions about the likelihood of the known unknowns. For a start-up, the timing and nature of competition is a known uncertainty, for which responses can be planned in advance for a reasonably small number of scenarios. But the unk-unks are different; scientific breakthroughs, terrorist acts, social movements, and macroeconomic crises are in most cases scenarios so unexpected that trying to articulate and plan for every one of them is not a productive use of managerial attention.
Every Success Factor Brings a Potential Failure
For every success factor, there is a complementary way for a firm to fail in China. For example, a company can mistakenly believe that its global brand will entice Chinese consumers. In these kinds of cases, the failure may have been avoided by a more realistic assessment of consumer tastes and the market. We hope to provide a diagnostic instrument for such assessments in chapter 11.
Other failures stem from missteps and can be avoided through better managerial practices. Bias and arrogance can be mitigated with a deeper knowledge of China and its challenges. Missing key needs of customers can be mitigated with more careful and honest research into the job the firm hopes to do. Delivering a solution that meets its customers’ needs can be achieved by adapting global products for the Chinese market or designing new products specifically for that market. Errors in execution can be avoided through a clear-eyed assessment of the resources needed to win and by putting in place skilled executives with the autonomy to act with agility. Our case studies in the rest of the book illuminate both pitfalls and their costs, as well as some of the ways in which successful companies have recognized and managed these risks.