When in China, behave as the Chinese do (part 2 of 2)

Chinese strategy and trends to tackle imbalances and reach a sustainable growth

Chinese are very quick to react and adapt to a changing environment. China is hectic, it moves really fast. There are amazing ROI rates: you can recover a capital investment in 2-3 years (Melia Hotel Group recovered a 10 USD million investment in hotel renovation in only one year!).

Yet China has huge imbalances: geographically agriculture is not equally spread, moreover the natural resources are located more in the middle of the country while their use is mainly needed in the East (due to poor domestic connections and moreover to the amount of resources needed for its industries, China has been importing resources). The East now is about 3 times richer than the West: unequal share of income and opportunities creates problems, social and economic.

How is China facing these issues and what are the future strategies and trends?

There are signals China will move away from privatization and reform the SOEs (State Owned Enterprises) because they are not efficient, not competitive. Main goal of SOEs is to secure employment, not to be profitable and reward the shareholders. SOE will take the money of the investors but use it for their purposes and not care about dividends: there are no incentives for shareholders to invest in SOEs.

Talking of SOEs, China had initiated a privatization process in the 1990s but it had kept the largest companies fully owned by the state (example of Baosteel, the steel giant we visited) or the ones in strategic sectors with only the possibility for foreign investors of having a 50% of a Joint Venture (for instance in the automotive industry Volkswagen has a strong presence but only through a JV). Almost worrying to see – as a confirmation to what I knew about the control over the information – how difficult it was to have even basic information (such as the number of employees of a plant) of SOEs or JVs compared to wholly private companies.

Another important aspect is that China is changing the direction of its 5 year growth plan. The general guidelines of the 2010-2015 plan were to boost export and investments but they are shifting towards boosting the domestic consumption, key economic driver for the years coming. Exports and FDI have been central pillars of Chinese fast growth, but these are not working as well anymore. Relying on exports and foreign investments has many downsides: gap rich-poor, dependency from other countries, risk of financial bubbles. For instance the property market in China is a risk: if the bubble bursts it might bring down the whole global economy. But luckily there is a difference with the collapse in the US where people were leveraged, buying houses with loans and mortgages; here they buy mainly by cash.

How to boost domestic consumption?

Increasing the salaries, that are growing up to 15% per year (this fact, and the consequences of the one-child policy that might cause a shortage of workers, determine that China as the factory of the world will not be true anymore).

And pushing for urbanization to provide people with jobs: the National People’s Congress is incentivizing this shift so people have a higher income and can increase the consumption levels. In fact China has experienced amazing urbanization rates: 200 million of people moved to cities between 2010 (650m) and 2012 (850m) – biggest migration ever – and yearly about 70-80 million people are still moving.

The good news for the companies is that urbanization and an increased income brings potential new customers. Very interesting opportunity when considering that in China brand differentiation is at its infancy. People who move to cities have no real knowledge about the brands, once they increase their income they go out and look for the best options. Moreover, low brand awareness translates also in really low loyalty rate to brands (especially true in the countryside): exposed to so many brands, they are like adventurous shoppers who do not know which one is best for them and keep trying out new ones. They rely on the bouche-à-oreille and on the social medias (Renren and Weibo are the Chinese surrogates of Facebook and Twitter that in China are blocked like many thousands of other social and information sites, even Bloomberg has been banned after they published an article in which they mentioned social and political issues to explain economic trends. Something obvious for a Western mentality but not accepted here). Chinese consumers also have a skeptical approach: they don’t know what the real value proposition of a brand is. The final purchasing decision for a notebook for instance could arrive even after 6 months of thinking over and gathering info.

One advantage for foreign brands is that Chinese people have a perception of low quality of the Chinese products (or else a good perception of products of foreign brands and products made abroad), especially for luxury goods and health related products. Also, perception that big large companies are more trustworthy. Interesting to note also that China by 2015 might overtake Japan and become the largest consumer of luxury brands in Asia, 2nd in the world only after the US.

In the case of consumer products, if the companies want to take advantage of these opportunities, when defining the communication and promotion approach it is important to have a strong online presence and a social media strategy, especially if targeting younger demographics who spend most of their free time online and hardly watch television (not allowed in the colleges’ dormitories). Besides, they should identify the local media and tv broadcasts because each province has its own and many consumers prefer to watch regional and local tv (tv still relevant for older people). Worth to mention that China offers many chances for creative and design related jobs: creativity is not part of their DNA.

Talking of products, impossible not to mention the counterfeiting issue. China is the homeland of counterfeiting (if you go to one of the fake-market malls in Shanghai, you get a very good picture of this). For the Chinese imitation is a good strategy. Yet lately there is a lot of pressure from the international arena and also internal pressure to stop this phenomenon because it is starting affecting also local manufactured products sold in China. Now the rules are out there, clear, but the problem is the implementation.

This said, there is also another point of view when talking of counterfeiting of luxury goods. On one hand the counterfeiters make money and the government does not have to subsidize them; on the other hand counterfeiting is not seen as bad from brands, not affecting them: sometimes from the companies point of view counterfeiting make products affordable to more people and “keep the brand dream alive”. You know you are successful if your products are imitated: it means a stronger desire for that brand. But a fake good does not provide the same status. So in a country where the “face” and the appearance are so important, people will buy the real product as soon as they can afford it.

To introduce the next two trends I want to highlight, it is very interesting to see the role of the Chinese fiscal policy as a tool to push the geographical development in some provinces or supercities (Go West trend) or to drive the investments towards certain sectors of the economy (high technology trend).

Based on its Western Development program started more than 10 years ago, China has been investing a lot in infrastructure in the West and now incentivizes investments to make companies “Go West”. From the business point of view, now the West provides more opportunities (for instance Chongqing within the Sichuan Province is the new developing supercity whose growth is stimulated and incentivized by the central government policies) but there are more challenges as there are less clear regulations. West can already be a good option for large sized companies but it is still complicated (risky, far away) for small ones.

Another trend is the switch to services and higher added value products / high technology, pushed by fiscal incentives as mentioned above. Until 2008 there has been a push on attracting foreign investments for manufacturing options (2 years tax holiday, then half taxes). Then various reforms to push for capital investments (for instance they made representative offices more difficult and expensive, because they do not bring capital expenses) and offer a lower income tax rate for enterprises with new/high technology. This shift is nothing new though, it’s a world path toward success, look at Japan after WW2, or Korea more recently: depreciate currency to boost export, get cash, and move up the value chain from cheap to high value added products.

Internationalization is the next trend I would like to highlight, and it comes as a consequence of this switch towards higher added value products: China needs to create local brand champions and to do this the only way in a globalized economy is to play internationally. China incentivizes acquisition of foreign companies and brands to get technology, brand reputation and heritage. Examples of acquisitions are: Volvo by Geely, Weetabix by China’s Bright Food ($1.2 billion deal), Smithfield Foods’ bacon by China’s Shuanghui International ($4.7 billion deal).

China is also signing commercial treaties with other Asian countries to favour the trade. Some companies are already taking advantage of this, take the examples of Piaggio that set up a manufacturing plant in Vietnam to export to China and to the rest of Asia; and Ducati who is trying to do the same in Thailand.

Finally, what are the impacts of all these trends? Growth for growth’s sake does not work for a long time as rich gets richer, it gives room to speculation and increases the pollution (which is an environmental and social problem). Pollution is actually the element that could bring to protests and create problems to the Government (main concerns of people in China are pollution and children’s health and education). That’s why the new policies also dedicate relevancy to anti-pollution measures.

The current President of the People’s Republic of China, Xi Jinping (since March 2013) aims at the completion of becoming a “moderately prosperous society”. China should slow down its growth (big challenge for the current president) to make it sustainable but in a way it needs to grow (how to create jobs for the 8 million graduates out of college each year?).

In this amazing path of economic growth in China many companies have made lots of money, even if many players in the same sectors: until now the lower cost of labour and the high demand enabled most of the players to be successful and profitable. There was room for everyone. Yet, looking ahead, there will be many M&A (Mergers and Acquisitions) and only the companies that are looking outside of China, that are better structured, managed and organized, only the ones that are trying to diversify and implement practices for environment and social issues will survive and succeed. That’s why we could already see in large companies (such as Wolkswagen Shanghai and Mann+Hummel) a good level of respect of quality controls and EHS policies (Environment Health and Safety) and the first steps of CSR practices.

These practices are also a tool for the companies to create a brand culture, to try to retain employees and thus tackle the high turnover ratio (consultants say employee turnover is about 20% but the managers say it can go up to 110%). With salaries growing up to 15% per year, it’s not always possible to offer too much more than market prices to be competitive they said at Mann+Hummel. In Mondragón they manage to provide salaries 15% higher than the minimum set by law (it changes by province) but they leverage also on better working conditions (in Orbea warmer areas, music… More responsibility and engagement: in the assembly line every employee in charge of one bike, no production chain; for the frame finishing, each one is responsible of the quality of his/her product).

We saw that compromises are an imperative in the negotiations. Will China be able to find a compromise itself to solve its imbalances? Will the competition rules of a global market (which China, even if it is a socialist country, has to comply with) really succeed in bringing environment and social topics at the top of the companies and government’s agenda?

With the size of this country and the importance of its economy, I really hope so.

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