T he story of GOME, China’s largest retailer of home appliances and consumer electronics, is a remarkable tale of rapid rise—and then turbulence and uncertainty. The company’s origins stem from the late 1980s, when founder and CEO Huang Guangyu left his hometown in south China’s Guangdong province to become an itinerant trader. After traveling the length of the country, he opened a market stall in Beijing selling electronic goods. The stall soon became a shop. Relying on factories in his home province to supply him with cut-price products, he turned the shop into a chain.
By 2008, GOME’s 1,300 stores covered every corner of the country. As China’s largest electronic goods retailer, it accounted for 12 percent of all electrical appliances sold according to the company’s own internal estimates. 1 A lot of its growth came from acquisitions, which included taking over its third- and fourth-largest competitors.
Since 2004, the company has had a listing on the Hong Kong stock exchange. Among its investors are Warburg Pincus Asia with 9.71 percent, JP Morgan with 8.88 percent, and Morgan Stanley with 8.17 percent. But Huang, also known by the Cantonese version of his name, Wong Kwong Yu, just forty years old, remains by far the biggest single shareholder, controlling (with his wife) more than 30 percent of the company. Estimates of his wealth fluctuate, but by 2008 it was
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put at around $6.3 billion, enough to make him one of China’s wealthiest people.
Then, toward the end of 2008, Huang’s fortunes changed overnight. In November, he disappeared. Gradually news emerged that he had been detained by the police in Beijing, apparently for “economic crimes” concerning the manipulation of share prices of two companies with ties to GOME. But no one seemed to know for sure. GOME representatives said he could not be contacted. Trading in the company’s shares was halted in Hong Kong. Huang was suspended from his company duties and his wife, Du Juan, resigned as a director. In January, he resigned as company chairman, though he remained the largest shareholder.
As of the time of this writing in mid-2009, Huang remained detained, but trading had resumed in GOME’s shares. Despite the economic slowdown and its legal troubles, the company had remained profitable, earning around $47 million on revenues of $1.4 billion in the first quarter of 2009. And in late June, it was announced that the Asian arm of Bain Capital would invest $417 million in the company. Bain Capital will become GOME’s second-largest shareholder, with a stake of between 9.8 percent and 23.5 percent, assuming the full conversion of the convertible bonds. Through this investment, Bain Capital will also gain the right to nominate three non-executive directors to the board.
Such an investment has to be a gamble. GOME’s future is uncertain; that of its biggest shareholder even more so. For anyone involved with the company—running it, owning it, working for it, or investing in it—nothing can be taken for granted other than it will remain a business in flux. Will Huang remain a shareholder? Could the company be closed down? Could it be forcibly taken over? Or can it continue to operate in the absence of its CEO and founder?
The particulars of the GOME case are extreme but, as we’ve seen throughout this book, this degree of dramatic change and uncertainty can be found everywhere in China. Many decisions are gambles. This will remain true for the foreseeable future. Companies and industries
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will rise in just a handful of years; some will then disappear even faster. Confronted with a multitude of opportunities and threats, businesses will have to be permanently on the lookout for anything that could transform their prospects, for better or worse.
Perpetual vigilance does not mean reacting to everything that happens. It means establishing a framework in which to be able to judge the importance of new events, and so being able to respond appropriately. By developing a mindset that recognizes the force of change and the context it creates for success, companies can best prepare their strategies for the coming decade.
Harvard professor Joseph Nye describes the requisite capability this way: “The most important skill for leaders will be contextual intelligence: a broad political skill that allows them successfully to combine hard and soft power into smart power and to choose the right mix of an inspirational and transactional style according to the needs of followers in different micro contexts.” 2
Nowhere will such a skill be more in demand than doing business in and with China or, for Chinese companies, in and with the rest of the world. It will not be enough for companies to be good at whatever it is they do; they will have to understand how their businesses fit into China’s wider context.
In the rest of this chapter, I will draw a tentative picture of the future and where China is heading over the next decade, and possibly beyond. This is not a forecast—as I have noted before, all forecasts are likely to be proved wrong by events. Rather it is an identification of the key trends that all businesses will have to negotiate: the forces that will inevitably shape the environment.
As China negotiates its way through the fallout of the world’s economic crisis, it is tempting to say that it faces a critical period: that the
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country stands at a crossroads, or some such phrase. Actually, this is anything but the case. China stood at a crossroads in the early 1990s. Then it was unclear, even to China’s leaders, which direction the country should be taking. The decisions to embrace economic reform wholeheartedly, restructure China’s industrial base and banking system, and join the World Trade Organization were momentous ones, and they took it down a path that the country has stayed on ever since.
Today, China’s development, driven by its choices and by the resulting economic growth, has a momentum that it would be hard for anyone to stop, including the Chinese themselves. The country’s broad trajectory for the next decade and beyond is readily discernible. Certainly its leaders will have to make major decisions that are difficult to face and resolve: how to secure energy supplies, reduce environmental depredation, make growth more sustainable, develop more responsive and transparent governance, deal with ethnic conflicts, build a more efficient and resilient financial system, and reduce the problems associated with corruption at all levels of officialdom. But these challenges all concern ways to improve the existing system, not pressure to change it for a new one.
The conclusion this points to, which must be stressed considering the number of pundits and experts predicting China’s imminent collapse, is that the country does not face any systemic threats undermining the foundations of society. Clearly, there will be pressure for official China to make improvements in policy and management; in short, better governance, not different governance. The government already has far better machinery in place to handle its problems than it did a decade ago, thanks to the overhaul of the Communist Party’s organization and membership described in chapter 4. As its efforts to manage environmental pollution and build a renewable energy industry show, it is already handling problems that seemed impossible to manage just a few years ago.
In general, China is now more stable socially and politically than it was in the late 1980s. As mentioned in chapter 4, a 2008 Pew Research
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Center survey found that more than 80 percent of the Chinese population was satisfied with the country’s direction and the general economy. This represented a rise from less than 50 percent satisfaction in a similar poll in 2002, and it far outpaces general satisfaction levels found in any other country. 3 True, some parts of Chinese society have prospered more than others, and unrest in Xinjiang and Tibet points to shortcomings in the country’s treatment of minorities, but the lifting of hundreds of millions of people out of absolute poverty was a direct result of the government’s policies of the last four decades and is recognized as such. Moreover, most people in China believe they can look forward to further improvements in their standard of living in the coming years.
But if China’s overall social and political reform can be safely assumed to continue, this does not mean that companies can be complacent. Its domestic development remains at an early stage, and its international capability at an even earlier one. At home, China is advancing rapidly on many fronts. Structural changes in the economy, the demographics of the population, and the forms of governance are all in progress. An urban middle class has established itself in the wealthiest cities and is growing. Rural development has begun, albeit at a slower pace than its urban equivalent. Change within China will continue at different rates and with different degrees of success for decades to come.
Overseas, however, China’s involvement in global affairs remains nascent. But the extent of its involvement will expand exponentially and at an accelerating rate. Talk of China reaching superpower status is premature in 2010; but it could happen. Even if it doesn’t, China will inevitably play a key role in resolving the major international challenges of the first half of the twenty-first century, above all climate change. To date, the world’s developed countries have been slow to involve China in many global forums; this will change as they find that China has both the economic power and the political influence to sit with them as an equal. There will be a learning process on both sides: Chinese officials will discover how best to exercise the power they have and the leaders of other
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countries will find ways to accommodate Chinese wishes and needs. The path is unlikely to be smooth, but given what is at stake, it will be in everyone’s interests to develop frameworks capable of negotiating agreements aimed at establishing a true community of nations.
In early and mid-2009, most observers predicted that it would take China several years to recover from the drop in external demand caused by recessions in the United States and Europe. It was apparent then that the years are over in which exaggerated American consumer demand could provide the financial base for China’s growth in export industries. But recovery in China was already under way in late 2009. Making up for the shortfall were several factors within China.
First, the large stimulus program launched by the government in late 2008 made a difference. This is not simply a consumer support package or a short-term initiative. It will continue for three years, and most of the spending is dedicated toward increasing economic efficiency over the medium term. Of the Rmb 4 trillion (nearly US$600 billion) package announced by the government, 1.5 trillion is being spent on transport and power infrastructure, another trillion on postearthquake reconstruction, 400 billion on public housing and social welfare, 370 billion each on rural development and R&D (technology advancement), 210 billion on sustainable development, and 150 billion on educational and cultural projects, including health care improvement. Many of these investments were chosen for their long-term effects on the quality of life, productivity, and economic momentum of the country. 4
Second, other sources than government expenditure will keep growth coming. Thanks to the restructuring of the financial system, banks can now lend in ways they couldn’t a decade ago, while many companies, particularly large state-owned ones, had put aside a great deal of cash during the 2000s.
Third, after the huge investment of the last several years, industrial consolidation will inevitably occur. Many small and inefficient manufacturers will be taken over or will close down. This process is already taking place in export-oriented regions, particularly Guangdong. Through early 2009, tens of thousands of factories closed across the Pearl River Delta, leading to widespread forecasts of mass unemployment and possible unrest among migrant workers. Most of the companies that are closing are smaller, inefficient businesses. Stronger, more capable companies are surviving. These businesses are already improving their efficiency; they will emerge from the slowdown with larger market shares, leaner and more productive operations, and better quality standards.
The government would like to see a similar process happen in almost every industry. It has placed a three-year moratorium on new projects in the iron and steel sector. Overcapacity persists in the cement sector, and even new industries such as wind power and polysilicon have many redundant projects In short, almost everywhere you look there are many small companies that badly need consolidation to start realizing economies of scale and to create businesses large enough to invest in R&D as well as production.
Fourth, fears of widespread protectionism on the part of China, and consequent drops in growth, are likely to prove ill-founded. A more likely scenario is differentiation: officials will scrutinize merger and acquisition deals closely in terms of what they perceive as China’s best interests. They will encourage takeovers, alliances, and partnerships that lead to improvements in practices and new technologies. Government leaders will also find other ways to reward or help companies that help China overcome its challenges: operating with economic efficiency, meeting environmental needs, increasing productivity, lowering resource usage, and so on.
China’s sense of protectionism could turn out to be strategically defensive. For example, while foreign mergers and acquisitions will be possible, they will not necessarily be easier than they have been to date. The collapse of Chinalco’s offer to buy into Rio Tinto, CNOOC’s
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failure to buy Unocal, and the opposition that led to the Bain-Huawei buyout of 3Com being abandoned have taught Chinese officials that other governments can find regulatory or legal reasons to block deals. They are now putting in place similar regulations or policies to this effect as well.
Finally, the financial sector is likely to remain stable in China, in part because it is so carefully monitored. Since the summer of 2008, Official China’s belief in close oversight of the financial sector has been reinforced. They will continue to stand by their conviction that the state must maintain strong control over the economy’s “strategic heights.” After seeing Western governments scurry to bail out banks and give support to other sectors during the global financial crisis, many Chinese officials felt vindicated: in their refusal to accept liberalization as a universal panacea for economic problems, in their decision to retain control of key aspects of the economy via ownership of China’s very biggest companies, and in their maintenance of a largely nonconvertible currency. They continue to recognize the great value of market mechanisms, but they do not see these mechanisms as an end in themselves. In their view, the financial markets need to be supplemented by appropriate regulation, including capital-adequacy ratios that genuinely reflect the risks banks are undertaking (undistorted by off-balance sheet vehicles). The prime function of banks, in the view of official China, is to promote economic growth by allocating capital appropriately rather than trying to promote their own profitability independent of the “real” economy.
Thus, while the global financial crisis has affected China, it is not changing it; certainly not in the way it is reworking the United States and Europe. China will emerge from the crisis with a stronger, more efficient and more resilient economy: one that will rely as much on domestic as on foreign demand and that will be poised not just for continued growth but for more sustainable growth. And not only will it be more competitive, but it will also have a substantially larger share of the total world economy.
Despite these prospects, growth will probably not permanently return to the 10-percent-plus average annual rates that the country experienced before 2008. In the short term, such a figure may be reached, but over the coming years a rate of one or two percentage points less is likely as the economy matures. There will be some pluses in this. Wage pressures at the lower end of the scale are likely to ease. (Demand for experienced managerial and professional staff will remain intense.) Growth should also be less resource intensive. A huge share of the country’s industrial expansion since 2000 took place in heavy industry, with the demand for steel, aluminum, chemicals, and other raw materials to supply the country’s construction, automotive, and other manufacturing sectors. Most of these industries are in need of consolidation, with most of the smaller, more inefficient plants set either to close down or be taken over. More attention will be paid to developing a “green” economy through an emphasis on environmentally friendly practices and energy saving. This in turn should relieve some of China’s resource and power needs, ending, for example, the electricity shortages that have affected most of the country since the mid-2000s.
But while overall the economy is likely to be more stable due to its more moderate growth rate, competition will intensify. Companies will have to get more out of their workforces, putting a greater emphasis on the use of better management and best practices. They will also find themselves gradually subjected to stronger regulation, with stricter enforcement of regulations already on China’s statute books, for environmental protection, labor rights, intellectual property, and taxation.
The realization of all this has sunk in at some global companies. Many corporate leaders would like to increase their investment in China, because of its market growth prospects relative to the rest of the world. A survey of more than one hundred leading manufacturers conducted in late 2008 by Booz 8c Company found that more than half the respondents intended to commit further investment to China in the coming two years. 5
But this money won’t simply be spent adding capacity: many of these business leaders said they would be concentrating on improving their operations by raising standards and quality. 6 For the short run, these companies have accepted that weaker demand in China has made it impossible to offset shortfalls in exports immediately, but more than three- quarters of them said they felt that investing in China-based production now would bring better access to local consumers in the future.
Beyond the economic crisis, a new set of pressures and opportunities will matter to companies doing business in China. They will fall into three broad categories: those arising from market forces, the government, and the demographic evolution of the Chinese population.
Pressures arising from market forces will include land and labor costs. These may not rise much in 2009 or early 2010, due to the impact of the global financial crisis. But they will rise before long, as both the global economy and China’s export sector recover. In the longer term, the cost of capital for Chinese companies will also inevitably increase.
There will also be corporate reforms, induced in part by the Chinese government and in part by businesses themselves, that will boost consumption and business development. Regulations are being introduced in 2009 to allow the establishment of consumer finance companies, and the big banks are all establishing small- and medium-sized lending arms. By the end of 2009, the Shenzhen stock market should have launched a market aimed at smaller companies, the Growth Enterprise Board. And it appears only to be a matter of time before farmers are allowed to use their land as security for mortgages; if this change goes ahead on a large scale, it will create an enormous potential pool of capital for rural businesses.
Pressures that stem more directly from the government will include tighter enforcement of environmental and other laws; stronger staff
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rights, as seen in the labor contract law, and increased costs for inputs. In many key areas, such as environmental restrictions and intellectual property, China already has a substantial body of law and supporting regulations in place, often with regulatory regimes as strong as those of many developed countries. But many multinationals are often cynical about Chinese attitudes, due to the weak or selective enforcement of many of its laws, most notably those protecting intellectual property and restricting pollution. Some foreign companies have striven to introduce global best practices in their manufacturing operations, only to see their domestic Chinese rivals either ignoring laws and failing to be punished, or bribing officials to overlook breaches of the law. The 2008 financial crisis exacerbated the problem, with local governments in particular becoming even laxer in their oversight of companies rather than doing anything that might result in a loss of jobs.
Nonetheless, the government is very serious about improving legal compliance across the board. For example, spurred by the high number of deaths in the mining industry, it set about closing small mines where safety rules are often ignored and most accidents take place. It has recognized how instances of pollution have affected both the economy and popular sentiment. The State Environmental Protection Administration has estimated the total cost of environmental pollution at around 10 percent of GDP; in 2008, a chemical plant at Xiamen on the Fujian coast was relocated following widespread protests the previous year.
At some point, the government will get serious and crack down on the smaller companies that either ignore the rules or cannot afford to get the equipment they need to comply with environmental regulations. When will this happen? When China has the resources. This is less a question of money and more of having people with the requisite experience. It takes a long time to put in place the training and oversight needed to develop skilled environmental inspection teams and enable them to work.
Foreign companies in particular will have to be vigilant about changes. For both political and financial reasons they are likely to be
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among the first targets of inspections. Evidence for this comes from another area where China is stepping up enforcement: taxation. In chapter 4,1 noted how tax officials are scrutinizing the transfer pricing practices of only one hundred companies a year. These are mainly large multinationals. While their executives may complain that it’s unfair to pick on them first, from China’s point of view they are good targets for a host of reasons. First, these are high-profile businesses; finding and punishing just one foreign corporate lawbreaker would encourage many others to comply. Second, the amount of tax revenue involved is large, especially if businesses are spiriting money out of the country via their internal pricing practices. Third, these companies are already deeply experienced in handling transfer pricing issues: officials can expect them to know what is going on and behave appropriately. Fourth, these companies are not going to go away, unlike small Hong Kong or Taiwanese controlled plants, which could shut up shop overnight and whose owners could vanish without a trace. And, finally, it is far less likely that such companies would try and evade payments by offering bribes.
Other pressures stem from demographic factors, including the huge number of people moving to urban centers. This will lead to great increases in consumption in the coming decade: urban residents, with work commitments that cut back their time at home, tend to buy many more household products, packaged foods, and local services. In addition, starting around 2015, China will face a very different demographic challenge: that of an aging society. The number of people over the working age will grow fast. The pool of young workers that has driven growth in the last twenty years will begin to shrink, putting pressure on wages, and the number of retired dependents will rise. Currently, every one hundred people of working age have to support around forty dependents, either children or retirees. By 2040, that figure will have risen to sixty. As this happens, growth will inevitably slow.
To overcome the problems this will create, the government will have to place an even greater emphasis on education than it has already. (This is one reason China has increased its spending on schools so much in
the last decade.) Companies will have to emphasize education, too. Currently, there are still benefits to be gained from looking to hire large numbers of unskilled young staff, but that won’t hold true for much longer. Companies will have to look at ways of retaining older staff, possibly beyond retirement age. The upside will be a workforce that, though shrinking, will grow in ability. Throw in China’s cultural proclivity in favor of education, and the result will be a transformation of the country’s human resources in less than a generation, from a nation of farmers to a nation of educated, urban knowledge workers.
Finally, there are emerging government-driven imperatives on energy efficiency and autonomous business development. These will provide opportunties for both local and foreign investors and businesses—to help create wind power and electric vehicle innovation, for example, as well as strategic technical alliances and upgraded industrial processes.
All of these factors will put pressure on companies to improve their efficiency. Companies that have grown by adding scale will need to pay far more attention to increasing their productivity. Doing this will represent a particular challenge for Chinese companies, but foreign companies will also have to manage it deliberately. They will bring their best global management practices into the country. They will boost their marketing efforts, as sales to the Chinese markets start to grow in importance compared with exports. And they will continue to need to look for executives who can combine deep China experience with broad knowledge of business and management.
Handling what happens in China will only be half the story. In the late 1980s, Kenichi Ohmae and other business experts argued that Japan was different from the West, and therefore that Western companies wanting to do business there needed to adapt and develop new ways of working. This turned out to be correct. But it will not be the same with China.
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Businesses cannot treat China like a Japan in the 1980s and 1990s, as a place very different from everywhere else, where everything had to be tailored to Japanese needs. The reason for this is that China is integrating with the rest of the world in a way that Japan never managed to do.
This integration will be reinforced by the deepest aspects of Chinese culture. To be sure, outside its borders many people still see China as a kind of opposite culture to the West. But much of this impression stems from the impression left by 170 years of isolationism during the nineteenth and twentieth centuries, and especially the years of the Great Leap Forward and the Cultural Revolution. But these periods were not typical of the country’s history. In general, the Chinese culture should not be seen as only, or even primarily, inward looking; the nation’s history involves many long episodes of close integration with the rest of the world.
Already, the new phase of integration is taking place much faster and deeper, and on a much broader scale, than most people understand and appreciate. Having made it through the nineteenth and twentieth centuries, the Chinese want to say to the rest of the world, “Look, we’re back.” Their goal isn’t the recreation of the old empire, or any empire, but a country that is and is treated as the equal of any other on the planet, and that through its achievements has earned the respect it deserves. Notions such as decoupling , a word used during the early part of the 2008 global financial crisis to suggest that the Chinese economy would continue to grow strongly despite the downturn elsewhere, underestimated the degree of integration that already existed. China was already dependent on the global economy, and most Chinese people were glad of that. They don’t want to be isolated from the world; they want the world to know and respect them. And while China (and India) will continue to grow at a much faster economic rate than the developed economies, this will undoubtedly serve to integrate them further into the global economy, not to separate them.
Multinational companies will find Chinese companies to be extremely fast learners. Those operating in liberalized industries face
more intense competition in their home markets than most multinationals do. They will struggle with some challenges: a lack of sophistication in planning and a lack of precision in their operations. But they also have strengths that can be easily adapted from China’s turbulent markets, especially the abilities to operate in environments that are less than transparent and to make fast decisions.
A particularly important factor driving Chinese companies overseas will be the need to access capabilities and market knowledge. For Japanese companies, operating at a time when the pace of globalization was a lot slower than it now is, it was possible to delay starting overseas operations until the requisite technology or expertise had been acquired at home, and then to grow at a slow pace when starting up in a new market. Chinese companies do not have this luxury; their home market is not protected as Japan’s was, and almost all markets around the world are far more open to competition than they were three decades ago.
To compensate, many Chinese companies will seek to learn through mergers and acquisitions. This will be relatively easy for them in the wake of the global financial crisis, when the opportunities for acquisition are great. In 2009, Lou Jiwei, the chairman and CEO of China’s sovereign wealth fund, China Investment Corporation, spoke at the Boao Forum, a gathering of political and business leaders aimed at being an Asian equivalent of the Davos summit held annually in Switzerland. He told how, whereas a year before, investment opportunities, particularly in Europe, had always had many strings attached, now his fund was seen as a “lovable force,” and he was hearing little talk of investment restrictions.
Recent examples of acquisitions aimed at meeting very specific needs were carmaker Geely’s $40 million purchase of Australian company Drivetrain Systems International to strengthen its gearbox expertise and Bank of China’s acquisition of Singapore Aircraft Leasing for its specialized know-how, in an area that the bank had yet to tackle. With much of the automotive industry in Europe and America in deep
trouble, Chinese companies look highly likely to make some strategic purchases. Probably the most interesting possibility, at the time of this writing, is the potential purchase of GM’s Hummer business by a privately owned machinery maker, Tenzhong, in the Sichuan province. Just as many foreign companies first gained experience of China by teaming up with a Chinese business, so Chinese companies are finding that buying a foreign company can both give them a foothold in a new market and an opportunity to discover different customer needs and ways of operating. When the goal is to build capabilities rather than scale, companies can focus on smaller deals, which are easier to handle and integrate with an existing business in China, a particularly important factor for companies with little knowledge of international business.
In the immediate future, most Chinese companies venturing overseas will concentrate on emerging markets. They may follow the models of deals such as that of China Mobile Pakistan, a wholly owned subsidiary of China Mobile, which teamed up with Alcatel-Lucent in early 2009 in a $53 million deal to provide mobile-phone services in northern Pakistan. Likewise, Industrial and Commercial Bank of China’s acquisition of a 20 percent stake in Standard Bank of South Africa will provide a platform to support other Chinese companies looking to expand in southern Africa.
Another important rationale for acquisitions will be to secure stable supplies of commodities. Ownership or minority shareholdings of resource companies will provide both a source of profit when commodity prices recover and better ways of securing materials than buying them in spot markets. Such investments also prepare the way for future cooperation, increasing the familiarity and strengthening the relationships of different stakeholders and market participants, and bringing information and insight into the dynamics of strategically important markets. Already the global oil industry is familiar with China’s largest players, Sinopec, PetroChina, and CNOOC; a host of other companies are following in their wake. ChemChina, a state-
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owned chemicals company, spent some $1.4 billion in 2006 buying a series of overseas companies that could supply it with materials; it is now looking for more strategic investments to strengthen its specialty chemicals and life-sciences arms. Minmetals, another state-controlled company, spent just under $1.4 billion to buy a large part of Australia’s Oz Minerals in 2009. And other companies are looking for similar deals.
Activity in mature markets will be less visible, but it will occur, especially for Chinese businesses with strong cash positions. Huawei continues to look for ways to establish itself in the United States, in March 2009 agreeing to a partnership with T-Mobile USA for the distribution of Huawei’s 3G data cards. Haier is also planning to increase its sales forces in Japan, to allow it to take advantage of the economic downturn to boost sales by 30 percent within a year by pushing its range of inexpensive products.
To make acquisitions work, in both emerging and mature markets, Chinese companies have a great deal to learn. Today, they rely primarily on “hard” power, as political scientist Joseph Nye calls it: they get what they want through sheer financial muscle, scale, and relative strength. But Chinese companies often lack “soft” power: the ability to influence through diplomacy and the raising of mutual interests. This is evident in the failure of several high-profile acquisition bids, such as CNOOC’s attempt to buy Unocal in 2005 and Chinalco’s bid for Rio Tinto in 2009. For successful acquisitions, Chinese companies, and the officials who support them, need to develop the capabilities to attract, inspire, and persuade all the different stakeholders that are involved. This means not just at the companies being targeted, but in governments where official approval is needed and in the media, so arguments and voices supporting a deal can be heard.
Moreover, postmerger integration problems have beset some of those companies that went ahead. Chinese companies are still learning to manage the process of an acquisition effectively, from retaining customers and key staff to navigating a foreign and usually unfamiliar
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regulatory and social environment. Li Rongrong, the head of the state- owned Assets Supervision and Administration Commission, the body that holds and manages the government’s stakes in the country’s largest state-owned enterprises, has long argued that most Chinese companies do not understand the legal risks of foreign acquisitions. Nonetheless, these skills are learnable, and Chinese companies may develop the capabilities of sustaining an acquisition more rapidly than many observers expect.
China’s power, as we have seen, stems from the combination of scale and intensity. When that power is moved onto the world stage, the global impact will be immense. Consequently, in an ever-increasing number of industries, China will be a game changer; its presence will fundamentally shift the prevailing business models and basis of competition within those industries.
Only a few companies, such as Huawei and ZTE in the telecommunications equipment-making sector, have demonstrated this potential so far. But more are coming. In the passenger car sector, some independent car firms are proving themselves far quicker at penetrating the domestic market and moving into overseas markets than the massive government-backed companies and their joint ventures with foreign carmakers. Chery Automobile, which was set up in 1997, took less than a decade to make itself China’s third-bestselling carmaker. By the end of 2007, it was also the country’s leading car exporter, selling 120,000 of its vehicles overseas.
Chery’s cars, and those of its rival, Geely, compete almost entirely on price. Chery’s bestselling model, the QQ, can be bought for less than $4,500. Geely’s cheapest car costs a little less. GM’s Chevrolet Spark costs one-third more, and Volkswagen’s cheapest model costs nearly double (though it has started to bring car models from its low-
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cost Czech-based subsidiary, Skoda, to its Shanghai factory, intending to recapture some of the market share it has lost).
Offering goods at a lower price is only one tactic. As I discussed in chapter 3 with the examination of the shan zhai or “bandit” practices used by many new businesses, Chinese companies know that they cannot establish themselves on the same ground as existing multinationals, so they have to change the nature of the game. The best way they have found of doing this is to find and produce goods that cause large- scale market disruption.
In its mobile-phone handset business, Huawei took an apparent weakness—its lack of a recognized consumer brand name—to do exactly that. The division’s largest deal to date was a five-year agreement to supply 3G phones to the telecommunications services company Vodafone. These phones would only have Vodafone’s logo, not the Huawei name alongside it. This made it an unpalatable deal for other leading mobile handset makers such as Nokia, Sony Ericsson, or Samsung, as it undermined their strategy of charging a premium for branded products. But it allowed Huawei to change the business model, and it gave the Chinese company an opportunity to gain experience working with Vodafone, giving it a better understanding of how international companies operate.
Another example of a disruptive strategy is creating new consumers where previously there were none. Both Chery and Geely have concentrated on being able to get cars to market extremely fast. Such lower-tier markets are natural targets for Chery and Geely’s inexpensive models. Similarly, BYD, the battery and automobile company, minimizes costs with a semiautomatic manufacturing system featuring low fixed investment and high labor content that takes advantage of China’s low staff costs. In addition, it has developed a unique backward-vertical integration model by streamlining its production line and developing key high- cost parts (including chassis, air conditioning, and engine) in-house.
Since BYD began manufacturing cars it has invested heavily in R&D, focusing in particular on car battery and dual gasoline-electric
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drivetrain systems. If its efforts in these areas prove successful, BYD will have created a key platform to be a leader in the potentially hugely lucrative electric-auto market. If this happens, it could turn out to be one of the most disruptive of all Chinese companies worldwide.
It is also worth noting that China has the largest known reserves of rare earth metals, which are a key ingredient in cc new energy” vehicles such as hybrid and electric cars. This represents a competitive advantage for Chinese companies and may be a deciding factor in changing the game for the global automotive industry.
Beyond cars, what about aircraft? This would seem a big leap for a developing nation’s economy. But it is official government policy to develop large passenger aircraft and eventually compete with Boeing and Airbus. Given its record over the last couple of decades of establishing a presence in industries previously deemed too technologically advanced for developing countries, it seems clear that this could well be successful. It could also happen within a few years—far less time than the two decades it took Airbus to launch its first commercial aircraft after the French, British, and German governments formally agreed in 1967 to launch the project.
Chinese manufacturers are entering this market in the same way they develop their presence in every industry. First they make components, then sell them at low prices to claim market share; then they acquire competitors. This gives them access to further know-how and expertise, allowing them to move up the value chain and claim areas beyond that of the initial component they made, eventually allowing them to reach a point where entire products can be made.
In 2007, Airbus sourced $60-million worth of components from China; by 2015, it expects that value to have risen to $400 million. 7 In the city of Tianjin, the company’s A320 aircraft are being assembled, with the first one completed in June 2009. A separate runway has been built at the city’s airport specifically to handle test flights for the aircraft.
Of course, this industry could have a natural advantage with the burgeoning Chinese airline industry, particularly if the market for air
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travel within China expands. Currently, the industry is expected to need 3,000 passenger and freight aircraft in the two decades up to 2025, with an estimated value of just under $290 billion. 8 Like automobile and telecommunications companies before them, aircraft makers will discover that they cannot avoid building production facilities in China because of the combination of lower costs and better access to China’s markets. The challenge for these companies will be to get the balance right: to position themselves for maximum gain while minimizing risk.