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Doing Business in China: The Rules Are Changing
Paul Denlinger

An insider's view of the long-term process required for success in the Chinese market

 

The giant has awakened. China's economy has become the fastest-growing large economy in the past five years. While most North Americans are used to seeing Chinese-made products in their Wal-Marts and other stores, China is rapidly becoming a major consumer market for products and services. Already, the Chinese market is the single largest commodity consumer in many categories. For many Americans and American businesses, this means that Americans will have to shift from being the single largest consumer market to marketing goods and services to a foreign market which seemingly does not follow the same rules that Americans are used to.

Is China a Bubble, or Is This a Tectonic Shift?
For many Americans and Asia watchers, the rise of China bears a similarity to the rise of Japan in the 1980s. During that time, US political observers worried that Japan would snatch the lead from the United States in areas including computing, auto manufacturing and consumer electronics. Books on Japan, such as Lester Thurow's Japan as No. 1, fueled the demand for books on the secrets to Japan's rise in business. But in 1990, the Tokyo stock market and real estate market bubble burst, and for the most part, the Japanese economy has been in a funk ever since.

Meanwhile, the United States recovered. In the mid-1990s, the internet took off, fueling the growth of many startups, mainly in Silicon Valley, but also in other parts of the country. This lasted until the stock market collapsed in 2000. Out of this, though, some leading new companies emerged, including Yahoo!, Google and Amazon. These companies have prospered and have become drivers of innovation in the United States.

 
So now, it is common for many Americans to ask, "Isn't the situation with China now similar to Japan's in the 1980s?" or "Isn't China just a bubble waiting to burst just like Japan?" There are fundamental differences between China in the 2000s and Japan in the 1980s. First of all, Japan's rise was based on mainly exports of consumer electronics and automobiles to the United States. While Chinese exports of consumer electronics to the United States are huge, so far they have been under other brand names because Chinese companies do not yet have their own established international brands and channels as the Japanese did in the 1980s. There are no Chinese Sonys or Panasonics yet. The South Koreans are leaders in this area, establishing Samsung and LG as leading consumer electronics brands. But this is an area into which Chinese companies will expand in the next decade. And fueled by earnings in the huge and highly competitive domestic Chinese market, they will have the cash to spend which aggressive international marketing requires.
 

When this happens, it is most likely that the Chinese will start in the area of mobile phones, an area which did not exist in the 1980s and where they are current leaders. The Chinese are already going one step further than the Japanese, pushing Chinese technology standards for new ways of communications.

Unlike Japan, China has not started to export autos to the United States and other markets. However, the country now has the most modern auto plants in the world, many built and owned by famous leaders such as BMW, Volkswagen, Toyota, Honda, GM and DaimlerChrysler. All of these plants are manufacturing for the Chinese domestic market, and all have plans to begin exporting from their Chinese factories to other international markets. Toyota built its second plant for making the hybrid Prius (the first outside Japan) in Changchun and will begin exports in one to two years.

Since the world's automobile industry is suffering from excess capacity, it is only natural to expect that auto plants in other major markets will be closed, and manufacturing will shift to China. For every manufacturer, China offers tremendous potential as a market and significant cost savings. Not all of these cost savings have to do with China. For the leading American automakers, the savings come from not having to pay into pension funds, as they are required by many of their union agreements in the US home market. When Chinese auto exports start, it is safe to say it will have a very significant impact and, most likely, will put downward pressure on prices and push down profit margins for the manufacturers.

On the social side, the changes which Japan underwent in the 1980s were not as wide and did not spread as far across the range as China's current changes do. The first and most obvious is the population difference. While Japan has a population of 150 million, China has an official population of 1.3 billion (unofficial estimates say it may be as high as 1.8 billion). In economic terms, this means that China has a population whose scale is much larger than either the US or Japanese markets.

China is expanding its infrastructure investment aggressively, especially in the areas of transportation and logistics. A great deal of this is simply to make up for the almost total lack of investment in infrastructure for the period from 1950 to 1980.

Automobile sales in China (January 2000 - October 2004)
Based on figures released by the China Association of Automobile Manufacturers

So, is China a Bubble, And Can It Burst? Without a doubt, there is a huge amount of waste in the Chinese economy. No one can even begin to quantify this waste. Also, a good amount of the growth is dumb growth - investments which are not efficient and do not make economic sense. Chinese businesses, for example, are tremendously wasteful of energy, which is a major factor in the recent rise of oil prices, not to mention pollution and environmental damage and costs. Because the government is the sole importer of oil, it keeps prices artificially low, leading to waste and excess demand.

If there is a bubble and it did burst, it would be safe to say that the whole world economy would be affected. The central banks of the Asian countries are financing the debt of the US economy, and US interest rates would have to go up precipitously to make up for the sudden fall in demand. This would send a catastrophic ripple effect not only through the US economy, but through the whole global economy.

Compared to the 1980s, the global economy is much more tightly interdependent. From an economic point of view, it doesn't even make sense to talk about national economies because the relationships are so deep. It is safe to say that if China's economic growth continues at the current pace, the world's center of growth for economic activity will shift from the United States to China and East Asia in the next decade. The trends show that China has already replaced the United States as Taiwan's, South Korea's and Japan's single largest trading partner.

The Challenge for Non-Chinese Companies
In the mainstream media, it is taken for granted that Chinese companies pirate American, European and Japanese quality goods and sell them at prices much lower than they can compete at. How can non-Chinese companies possibly compete in a market where the rules are unclear and subject to change?

Another great barrier is the culture and language. Most American companies have relied on ethnic Chinese from Taiwan, Hong Kong and China for their local management teams. Now though, China is showing signs of becoming such an important market that it is insufficient that knowledge of China and the Chinese market be confined only to the country management level.

However, so far, American companies have been slow to adapt to globalization, and most company boards have comparatively little international experience on the operational level. Compared to Europeans, who have much experience dealing with different languages and cultures, American businesses are at a disadvantage. Add to this the climate of fear, especially with regard to "foreign" things, engendered in the United States after 9/11, and one gets the picture that many US companies and individuals have chosen to withdraw into their own cocoons, instead of engaging the world.

Added to this are worrying economic trends which do not work to the advantage of the United States. The current US trade policy is unclear and lacks a clear focus. While Chinese companies have been aggressively moving up the ladder from low-quality, low-cost products, most US efforts have focused on the protection of intellectual property rights for the main US entertainment firms. These companies are facing a dying business model in the United States, having largely failed to find a new way of making money with the arrival of internet distribution and digitization.

And what is the single largest economic category which the United States sells to China by value? Soybeans. In contrast, the single largest category of products which China sells to the United States is electronic products. You don't need to be an economist to see that there is something wrong with this picture. How can the United States, which has the single largest economy in the world, have soybeans as its single largest commodity for export to China? There are other economies which sell soybeans to China, including Brazil, Argentina, Canada and Australia. Obviously, something is going to have to change.

In the quest to cut costs and increase profit margins, the US government and many American businesses have outsourced manufacturing - and now many services - to China. Outsourced manufacturing has helped the Chinese to improve their manufacturing skills and to update their plants, which are now the most modern in the world. This, in turn, has raised the Chinese standard of living and led to the growth of China's domestic market as investment money has flowed into the country.

But it leaves a huge, gaping question: "What are Americans good at, and how do American products and services create value for Americans?" Compared to China, the US economy is much more dependent on services. Traditional economic theory tells us that a country goes through three different stages of development: first agricultural, then manufacturing and then services.

We are becoming a globalized economy where national boundaries are blurred (witness the European Union) - which means, at its most basic, that there is no difference between domestic and international economies. When the difference between a domestic and international (overseas) economy blurs, the only significant differences are in language and culture. Right now, this is where US businesses are at a significant disadvantage - but it can be changed, and it must change.

What does this mean for non-Chinese suppliers of services to China? What opportunities are there? Is it possible for them to survive against notoriously price-aggressive Chinese companies? The good news is yes. It is possible, but it is going to be hard work. For Americans and American companies especially, it calls for a new way of thinking. For many American companies, which like quick fixes and easy solutions, the bad news is that there aren't any. This is a long-term process which will require considerable investment.

The American consumer and economy have been the engine of worldwide economic expansion since the end of World War II. Because of the tremendous power, strength and vitality of the US economy, American companies have been largely able to dictate how business was done. The same was true of the American consumer, whose spending habits and tastes have been so influential worldwide. That phase has come to an end. With the consolidation and expansion of the European Union and the rise of China, global business rules and consumer tastes will be much more varied and dynamic.

For American companies, it means that they will no longer be able to take it for granted that business is done "the American way." For large multinationals which are used to selling their products and services in many different markets and which employ the best and the brightest from all over the world, this is no big deal. But now the challenge is also faced by small and medium-sized companies. These have quickly found that because of new trade regulations from the World Trade Organization and the enabling technologies of the internet, all of a sudden they need to compete on a worldwide basis.

There are major Chinese trends which companies can capitalize on to establish a foothold in the Chinese market. Here are a few:

China is going through a rapid urbanization phase. The Chinese government is moving more Chinese from the countryside into cities, adding more than two million persons every month to the urban population. These people need all the things which city people anywhere need.

Education is the key to social success. Chinese view education as the key to success in society. Combined with China's one-child policy, this means that the Chinese educational system is the largest and most competitive educational system in the world. Parents are willing to spend anything to make sure that their child makes it to the top.

The Chinese government wants Chinese companies to go global. While Chinese products can be found anywhere at reasonable prices, that is not enough. The Chinese government is encouraging Chinese companies to build successful international brands. So far, Chinese companies are not there yet.

 


Chinese private companies want to go global. The private sector in China now produces more than Chinese state-owned enterprises. Starting from a Chinese base, these new firms need to establish a presence in international markets, but don't know how.

The service sector needs to grow. Chinese manufacturing capability leads the world in price and quality, but the service sector is still comparatively weak and undeveloped. This sector will show the fastest growth in the next decade. The urbanization and education trend will mean that there will be more demand for sophisticated services.

Competition will intensify. The growth of the Chinese economy has caught the world's attention, and more companies will see success in the Chinese market as key to global success. Already the most competitive market in many sectors, this competition will intensify even more, putting downward pressure on margins as companies seek to dominate in the marketplace.

Compared to buyers in other economies, Chinese buyers are comparatively high-touch, meaning that a local presence and frequent face-to-face meetings are important. The good news is that Chinese are generally more generous about giving face time than many western companies are.

The companies which do the best are those which are able to put on a Chinese face by using seasoned and well-trained executives who know Chinese well or are of Chinese extraction and are western-trained.

Most importantly, Chinese society and the Chinese economy are undergoing a period of rapid change, and most events are not reported in the western media. In order to succeed, executives need to be able to make quick adjustments and exploit new opportunities. The most successful companies and individuals are those that are comfortable living and working in a rapidly changing fluid situation and know Chinese. This means that local knowledge and decision-making capabilities are important.

Success in the Chinese market is challenging and requires a long commitment. The companies and individuals that stick it out, learn and succeed will become the business leaders of tomorrow.

 
Reprinted from MultiLingual magazine (2006, #72 Volume 16 Issue 4) with permission from Multilingual Computing, Inc., www.multilingual.com.
 
Paul Denlinger is the CEO of China Business Strategy, which helps companies identify partners and enter the Chinese market and advises Chinese companies going global.