The next step in building a China strategy is to set out the path for creating a one world enterprise. The next two questions are designed to help establish fundamental guiding principles for organizing your company’s China operations and integrating your China strategy with those of your other businesses around the world.
Many multinational companies, either through superficial planning for China or by treating the country in isolation from their other plans, suboptimize around narrow objectives. While driving their Chinasourcing programs, for example, procurement managers are usually well aligned with the objectives of manufacturing, logistics, and quality assurance. However, in many companies they fail to work with sales and marketing teams to consider how the total benefits of a presence in China could best help their companies. In other companies, distracted by the promise of selling to potentially hundreds of millions of customers, marketing and sales managers fail to consider how the volume a major sales success in China would create could affect their companies’ global sourcing practices and manufacturing operations.
The most globally successful companies—IBM, Honeywell, and General Electric among them—see China in a global context, as part of an international web of capabilities, including manufacturing, innovation, new business model incubation, and talent development. The leaders of these companies do not think of China as a stand-alone country, but as a part of their global supply chain and overall business. One specific example: In 2009, as it restructured, GM moved its international headquarters to Shanghai and not to Europe, Japan, or elsewhere.
A growing number of companies recognize the value of this sort of one world strategy. A study of manufacturing competitiveness conducted jointly in 2007-2008 by the American Chamber of Commerce in
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Shanghai (AmCham) and Booz & Company found that only a quarter of the survey respondents exhibited the characteristics of a globally integrated company, while half still leveraged only the sourcing operation or the sales operation, and a quarter are hardly in the game of global integration at all. That same year, only 47 percent of the respondents said that their motives for setting up manufacturing bases in China included both cost savings and access to the local sales market. But in 2009, that number rose to 57 percent, and there was a corresponding rise in the number of companies demonstrating global integration in practice, nor have they integrated their export manufacturing operations with their efforts to reach China’s markets. The studies have also found that those who combine their China market and export-oriented operations perform substantially better, with much higher average profit margins (30 percent versus 18 percent in 2008) and an EBIT level on average 8 percent higher. 1
Fortunately, changes taking place in China’s business environment provide an opportunity to leap ahead. Up to now, manufacturing multinationals have tended to build export-oriented factories with abundant, cheap labor and using low levels of technology, assuming that any problems would be offset by the low costs associated with operating in China. This is changing. Due to rising costs, particularly for labor, but also materials, and an appreciation in value of China’s currency, the yuan, against the dollar, both the sourcing and sales models used by many companies in China are coming under pressure. (Although the appreciation of the yuan halted in the second half of 2008, largely due to the effects of the global financial crisis, the long-term trend is likely to be a continued gradual rise in value of the yuan against other major currencies.) There will consequently be more of both an imperative and a means to integrate Chinese operations with those in the rest of the world.
The specific moves to make depend on an in-depth diagnosis of the relationship between your company’s strengths in China and its global strengths. For example:
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THE CHINA STRATEGY
• Where is China relative to your global industry life cycle? How fast will it evolve and in what direction?
• How important is global integration for your China business now? How important will it be in the future?
• What will be the impact to your global competitive position if China cannot be integrated into your global business systems?
• What steps can you take to ensure that integration will be properly designed and executed?
• Who will be overseeing this integration?
All of these diagnostics should be the subject of continuing in-depth discussion between headquarters and China operations. Indeed, a key element in executing your strategy will be the maintenance and management of communications between China operations and global headquarters. Keeping headquarters informed of what’s happening in China can be a challenge, but when it is overlooked, then headquarters executives often fail to understand fully the underlying factors driving developments in China. Paying attention to this relationship is vital. Without good communication, headquarters may find it difficult to react to possibilities and opportunities rapidly enough, and you may even find your burgeoning business in China causing disruptions in other parts of the enterprise thousands of miles away, and with apparently only indirect links to the country. Thus one final subquestion must be addressed:
• How well equipped is your company to manage the relationship between your businesses in China and those in the rest of the world?
A related common error is to let your Chinese businesses operate without benefit of your corporation’s overall knowledge base. Very few multinationals have yet imported the best practices of their operations elsewhere in the world; but as we have seen in earlier chapters, there is good reason to do so.
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VISION
If companies don’t grasp the scope of what is and is not possible in China, they cannot transform their global vision into successful on- the-ground operations in the country. In my experience, the business models of multinational companies fall into one of four categories (see exhibit 6-2):
Type A: Laggards. These companies have neither established China as a low-cost country for sourcing nor entered to pursue sales opportunities. They could benefit from both sales and sourcing opportunities in China, but have not yet gotten around to doing so.
Type B : Sourcing-centric companies. These have well-established China supply bases, but they are primarily designed for export. Their sales operations and capabilities in China are limited or may be nonexistent. Those that have a small sales operation may source in China, complete production in their home country, and then reimport to China. (This approach represents a model of inefficiency.) Companies in this segment include a number of European and American producers of high-end consumer electronics and mobile-communications equipment.
Type C : Sales-centric companies. These have successfully entered the Chinese market, in some cases recording significant sales volumes, but they serve China from home-country operations or small manufacturing operations in China. These companies do not include major exports from China into their global operations. Some of the top-branded European automobile manufacturers fall into this category.
Type D: Global integrators. These companies have integrated their worldwide value and supply chains. They have brought together China sourcing, manufacturing, and selling activities, in addition to innovation activities, and these are integrated, optimized,
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Table captionCHINA AS LOW-COST COUNTRY
THE CHINA STRATEGY
exhibit 6-2 Business models of multinational companies in China
Q Sourcing-Centric | Q Global Supply Chain | |
TJ | Integrators | |
CD r | Well-established China | China sourcing, manufactur- |
co | supply and manufacturing | ing and sales markets are |
JD CO | base, but for export only | integrated, mutually |
CO LU | optimized, and globally leveraged | |
u | Q Laggards | 0 Sales-Centric |
CD -C CO | Yet to establish China | Selling in China, possibly |
5 | either as a low-cost | with partial domestic |
CO -t—' CO | sourcing base or enter | sourcing and/or manufac¬ |
LU | as a sales market | turing, but with no exports |
o z | ||
Not Entered | Entered |
Table captionCHINA AS SALES MARKET
Table captionSource: Booz & Company
and leveraged globally. This is an elite class of companies. Many of its members are smaller or medium-sized companies that, by necessity, had to take an integrated approach early, launching a series of companywide initiatives that the boards of larger organizations might consider risky. Others started out as type B or type C companies, then graduated to an integrated approach. They tend to have a higher level of management capability, especially in understanding and exploiting the opportunities presented by moving major parts of their value chains to China, and they tend to have the resources necessary to act on opportunities much earlier.
Global integrators tend to be adept at transforming their Chinese operations into hubs for their global value chains. They thus make use
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of China’s dual role, as discussed in earlier chapters: a key sales market and a hub for exporting products. They use their Chinese expansion to significantly improve their global economies of scale and their leverage in sourcing; and as they develop their export business from China, they gain competitive advantage by applying superior product designs and standards from elsewhere to the Chinese market.
One globally integrated company is Hansgrohe, a German plumbing products manufacturer that became part of U.S.-based Masco Corporation in 2002. This company operates a dual-mode operation from its base in Shanghai, supporting sales in dozens of cities in China and supplying its global operations network with China-made products that are exported to other countries. The company still imports some high-end products into China, but only when it makes sense. The basic products produced in China are labor intensive, whereas the premium, capital-intensive products from Germany would benefit little from China’s factor-cost advantages.
Another such company is A.O. Smith, the American water heater manufacturer. In the past decade, this manufacturer has built up a management team in China and a sales network that spans across the nation. A.O. Smith has also leveraged its China market experience and production capacity to develop other overseas markets. For example, some water heater designs in China are now being brought back as “new products” to the U.S. market, strengthening the company’s competitiveness in some American market segments. Some of the capacity in China was also used for exporting water heaters to India. Taking advantage of China’s duality has given A.O. Smith China sales in 2007 that were six times its sales in 2001, representing a CAGR (compound annual growth rate) of over 33 percent. Moreover, A.O. Smith leads all foreign brands in Chinese market share for water heaters; it is second only to the local home appliance giant Haier.
Some very sophisticated global integrators are integrating more of their upstream activities, such as R&D and product development, into their China value chains. These include well-known consumer products
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companies such as Coca-Cola and P&G, which are making conscious efforts in R&D activities targeted at the local market. Many of their local products, such as Minute Maid with orange pulp, are effective combinations of local consumer insights and their global brands and platforms. Another example is Sanofi Aventis, a leading pharmaceutical company, which announced in 2008 its plan to expand the company’s R8cD facility in Shanghai, open a new state-of-the-art biometrics center in Beijing, and strengthen its cooperation with the Chinese Academy of Sciences. All these initiatives are expected to improve the company’s capabilities and efficiency for programs ranging from new drug development to late-stage clinical studies.
As you move toward global integration, your current business model represents your starting point. But what business model— sourcing-centric, sales-centric, or global integrator—do you now hope to adopt? Decision makers trying to answer this question should consider three aspects of the country simultaneously:
First, how much of the value chain to move to China. As we have seen, the traditional view of China as a low-cost hub for sourcing and manufacturing bears very little resemblance to what China is today.
Second, how much to sell, and to whom. We have also seen how China’s markets are a complex mosaic of fragmented elements, divided by geography, culture, income, education, skills, and other factors, further complicated by the rate of change they are all undergoing. For a global company to succeed in China, it will have to know the country intimately.
And third, how much to integrate globally. Deciding how far to go down the route of centering your worldwide integration around China calls for figuring out which bits of the local can be accommodated into a global framework, but doing so in a country that is very much a work in progress, with change and discontinuity the one constant.
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Many global integrators, especially those looking to sell a range of goods in China, could end up running two or three of these business models simultaneously. Some product lines will be aimed at capturing the local market; these will have to be differentiated between those aimed at the more developed cities of the coast and the poorer but far more numerous third- and fourth-tier locations dispersed across much of the rest of the country. Other operations will produce higher-end goods for the developed world and China’s wealthiest markets.
One common error is to avoid the lower-tier inexpensive markets. This runs the risk that Chinese companies will establish themselves there, with an eye to building positions from which they can move up to the middle tier. Such an approach also ignores the possibility of missing the revenues from the lower tiers—which, as Honeywell has shown, can be substantial. In addition, producing lower-cost alternatives to those offered by Chinese companies allows a company to tap into the same sources of value that Chinese rivals are using to establish themselves.