Why are Foreign Companies Growing Slower in China?

Weakness in One Sector in Particular Provides Part of the Answer

A recent finding from the GCiS Research Data Set shows that over the past 4 years, starting in 2008, domestic Chinese companies have grown significantly faster than foreign-invested companies. This includes both private as well as state owned Chinese firms (SOEs). Heading into 2012, FEI’s (foreign invested companies, including WOFE and JV) were growing significantly slower than Chinese companies.

One reads almost daily how much this or that MNC is having record sales in China, though it bears keeping in mind that in many cases this is not because the company has gained market share in China, but because the economy has grown so fast over the past 10-15 years. Just since the year 2000, China has added over RMB 40 trn in GDP (nominal), or nearly USD 7 trillion at current exchange rates. Certainly some foreign companies have had great success in China above and beyond GDP growth- GM and Apple come to mind. Though in many cases this has been momentum growth, with growth actually below GDP or sector rates. The chart shows that at the start of the period FEI’s were growing at about average (for industrial markets), though this has slowed by 2%, while the rate of Chinese firms has increased.

Figure 1: Real Industrial Growth Rate by Ownership (2008-2011) – RDS Data

Real Industrial Growth Rate by Ownership - GCiS China Market Research
Source: GCiS Research Data Set

A quick note on definitions: this is original data that comes from a pool of original GCiS research with hundreds of companies, including FEI, private and SOE firms. As GCiS is a B to B specialist, the pool of companies is weighed heavily by industrial firms, in markets such as chemicals, oil & gas, building & construction, power, and other industrial.

Underlying Reasons

The last year shows an up-tick in growth, though the gap is still large. What are the reasons for this slower growth? This is difficult to isolate, but several can be identified:

  • Low cost preference. In most markets in China, the preference is for lower priced goods, and foreign companies are always more expensive. In addition, many domestic companies have made gains in quality, so can satisfy a larger swath of customers.
  • The Government as a Customer. Where the government is a customer, which is many markets in China from power to petrochem, domestic firms are favored and sell more. These companies benefited particularly well in the 2009-2010 stimulus program.
  • Flexibility. FEI’s in China are much less flexible in what they can offer, whereas domestic firms are able to enter new markets much quicker to take advantage of opportunities. And sometimes these markets are very different. Just an example: Wuhan Broad, which started in HVAC, is now a developer and construction firm.
  • Local Ways. Local companies always have an advantage in terms of sales networks, market knowledge, vendor base, etc.

Each of these reasons could be further discussed, though there is another important factor that deserves particular focus. This is that foreign suppliers have had limited involvement in the biggest single growth industry in China in the past 15 years: construction, including infrastructure. Below we look at the details behind this, and first look at the recent impact of this industry in China.


Impact of Construction Industry on Chinese Economy

The construction industry in China now comprises 26% of the China economy, up from 13% in 2000, as shown in the below chart. In this time it has added RMB 71 Trn to the economy cumulative. In terms of growth, no other sector can compare to this, other than automotive. Furthermore, while the construction industry has not grown as fast as previous, growth in the past 4 years has still averaged over 20% per year, compared less than 9% for total GDP. While the central government has taken steps to slow growth in the real estate market, significant investment still flows into this industry. Moreover the market is far from saturated, with most of the Tier 3-5 cities yet to be built out, and still lots of activity in China’s larger cities. And the trend to urbanization will likewise give momentum to this trend, with China expected to attain 70% urbanization by 2035, up from 50% in 2012.

In sum the dynamics outlined here point to continued strong growth in construction, and construction increasing as a component of the total economy.

Figure 2: Revenues for Construction Industry & Total GDP by Year

Revenues for Construction Industry & Total GDP by Year - GCiS China Market Research

Source: China MoC

Statistics also show that most of this growth is not coming from large projects- in fact over 60% of the added space- 2 bil sq m in 2010 and 1.7 bn in 2011 is for residential buildings. Add another 15-17% for industrial applications by sq m, and a smaller number for other buildings. As hundreds of millions of Chinese move into cities, the demand for new housing should remain strong.

Figure 3: 2012 Real Estate Construction by Million Sq m

Real Estate Construction by Area - GCiS China Market Research

Source: China MoC

Not only does the building of all these apartments and hotels and bridges have a large impact on the economy, but this creates huge demand for upstream goods, as shown in the next chart.

Figure 4: Key Upstream Materials- China Construction Market

Key Upstream Materials- China Construction Market

WC= Weight Cases. Source:China MoC

Used in Construction Industry %, 2012
Plate Glass 72%
Steel 75%
Cement 87%
Related Output (2012)
Elevators 500,000 Units
Arch Coatings 4.5 Mn tons
HVAC Units 1.3 Mn Units*
* Not including wall units

Not only are these industries massive- the steel output here accounts for half the steel produced in the world- but much of the production is used directly or indirectly in the construction industry. Rebar and cement are obvious, though there are also products such as copper used in HVAC, which is then used in apartments or offices. Or take construction equipment, for which China is the world’s largest producer. Nearly a million of these machines, from excavators, to cranes, to smaller backhoes were produced in China in 2012, mostly for domestic use, and mainly for use in construction. Over 500,000 sets of elevator sets were produced in China in 2012, and 4.5 Mn tons of architectural coatings, most these for use in buildings.

While the construction statistics will include basic materials such as rebar and cement, based on MoC statistics these do not include many of the ancillary products such as HVAC or decorative products and services. As such the total sector is in fact even larger than 26% of the economy, and likely closer to 30%.


By Company, the Story is not Uniform

One reason growth of foreign suppliers in China may have slowed in recent years is their limited involvement in the construction sector. There are certainly some big players in the market, including La Farge in cement and gypsum, BASF and Henkel in chemicals such as adhesives, Owens Corning in insulation such as XPS, or Carrier and Trane in HVAC. These companies have good sales in these segments in China, though in general these segments are not among the largest components of the sector by revenues.

For example, the 2012 market in China for silicone sealants, one of the top construction chemicals, is about USD 600 Mn. Foreign suppliers such as Dow Corning and Momentive play a big role in this market, though this market represents less than 0.3% of the China construction market. In the cement market, on the other hand, just the top 5 suppliers in the market have combined sales of nearly USD 25 Bn, mainly in construction. A list of China’s largest cement companies, developers, and construction equipment companies are noted in the table below (that is- produced in China). Of these 30 companies, only two, Komatsu and Kobelco, are foreign.

In the China construction sector, foreign companies are typically limited to certain product sectors, most of which are niche relative to the total industry, and/or have small roles in larger markets. And importantly, there are large sections of the sector that foreign companies are essentially shut out of- such as construction services, as developers, and upstream metals- all of which represent very large markets.

Unlike other industries such as automotive, or fine chemicals, the foreign suppliers' role is not generally limited by state intervention. The fact is that in general, foreign suppliers are typically not competitive in this industry, including the industries that feed into it such as steel and cement. For a typical residential or commercial building, foreign construction companies have no distinct advantage. Most of these markets- such as cement or construction- are relatively low tech or relying on lower labor costs. Foreign construction firms such as Fluor or Lendlease are typically involved in more complex projects, such as a chemicals plant, or for foreign clients.

Figure 5: Top 10 Companies in China by Key Construction-Related Market

Top 10 Cement Co’s Top 10 Developers Top 10 Construction Equipment Co’s
Conch China Vanke XCMG
BBMG Corporation Greenland Group Zoomlion
China Resources Cement Holding China Poly Group Corporation Sany Group
Sunnsy Group COHL SCM
JIDD Evergrande Group Liugong Group
Huaxin Cement Dalian Wanda Group Changlin Company
Yatai Group Greentown Real Estate Group Komatsu
China Tianrui Group Cement China Resources Land Limited Kobelco
Sinoma Country Garden Holdings Longking
Tongli Cement Shimao Property Holdings Limited XGMA

Source:China MoC. Foreign companies in bold.


Going Forward for Foreign Suppliers

The China construction industry may no longer grow as fast as the red hot days of the 2000’s, though the basic drivers are enough to ensure strong growth going forward. Can foreign suppliers increase their share of this market? This is unlikely, as a range of leading domestic companies have improved their offering, and should take some of the market away from foreign suppliers. Just as an example, Chinese TiO2 suppliers are now competitive in the architectural coatings market, selling to companies like ICI and Nippon, whereas 5 years ago these companies only purchased from foreign suppliers.

However, if this sector continues to expand then opportunities will still be there. Even a modest 12% compound growth will mean a sector worth over RMB 30 Trn by 2020. And just as important, new markets and opportunities within this sector will open up, often instigated by new products from foreign suppliers. PCM, advanced roofing membranes, and waterborne coatings are a few examples of incipient markets that may add new opportunities in this sector in the coming years.