The New Normal in China for MNC’s: Attrition

MNC’s To Get a Smaller Share of a Much Bigger Market

Again the organizing concept for MNC’s in China is shifting. Whereas once the focus was on setting up, and quick expansion, now this should move to standard business development. The “land rush” is over, and now to borrow agricultural imagery its time to till the soil and produce good crops. Of course land rushes are far more exiting than farming, so there are complaints that growth is much slower than it used to be, and that some government practices and policies are unfair. At the same time, growth is slower than it was in the boom years around 2004-2010, with current official GDP growth rates at about 7%, and true growth likely even slower than this, in the range of 3-5%. In sum, for some of the shine has some off the China market.

While there may be some reason to complain, the fact is that the most recent 10-15 years represented an ideal period for foreign businesses in China: very fast development combined with relatively open access, and an under-developed set of domestic competitors, depending on the market. In the past several years though, these have all begun to change, with greater focus on compliance, stronger domestic players, and slowing growth. As a result MNCs are in effect being squeezed, with many losing market share in their target industries. Much of this though comes down to the natural progression of China’s development, rather than actions by the Chinese government.

Just because the land rush is over though does not mean that MNC’s should de-emphasize China. In fact it’s probably important now to re-emphasize focus on China, because at some point it will be the world’s largest economy, and the growth here is real. There may be over-capacity and in some key markets such as real estate, but the economy is not a big bubble waiting to be popped. And while it may not be as easy to gain market share, and opportunities may not be as apparent, there will still be a range of opportunities for companies that are able realign their BD strategy to this reality and execute accordingly.

First though let’s review the recent stages of development in China, with a focus on MNC’s, and see how we’ve reached this point. The diagram shows GCiS’ views of this.

Stage of Recent Chinese Development for MNC's - GCiS Market Research

Early 80’s to Mid-1990s: Setting-up (Pioneering)

Certainly to set up in China in the late 1970’s or early 1980s was to be a pioneer. Reform and Opening had just started, and a legacy of state-run everything was difficult to shake. While there were some real transactions to be done- such as selling commercial jets or boilers and MRI machines, the strategic concept was about the potential of China, and laying the ground work to meet this. The key issues at this time were how to enter the market, structure, JV partners, government relations, and manufacturing or sourcing for export. And there was a whole set of soft issues, such as learning to manage a Chinese workforce, understanding Chinese business and general culture, how the government works at all levels, etc.

Furthermore, in the early days of reform and opening and before WTO, not only were markets much smaller but companies had less room to maneuver. MNCs often had to have JV partners, which came with its own set of limitations. Some companies set up with the hope that regulations would turn in their favor, so they could start their operations in earnest. Back in this period, for example, western Telecom operators were preparing for liberalization of fixed and then mobile operations, which would never happen.

In this pioneering period investments were made sometimes without proper research or ROI expectations. Establishing a strong presence, learning the system, and setting things up well in this time were among the most important success factors for MNCs, and the strategic focus. Loss leading was common, most markets very small, and few expected to make much money during this time, especially during the early part of this. But then in the latter part of this period, in the 1990s, growth in the economy accelerated and for many the potential started to become realized.

2002-2013: Rapid Development (Land Rush)

The Land Rush period in China was when companies really started to make serious money in China, including both revenues and profit. While the land rush happened over a period of several years, 2004 is a good marker because this is the year in which passenger auto market in China doubled in a single year, and started its ascent to be the world’s number one market within 7 years, now totaling over 20 Mn autos output annually. The construction boom was also coming into its own then, fueled in part by recent liberalization residential mortgage lending. The businesses of many MNCs are related in some way to these two industries.

And in 2004, China’s GDP was already 20 times larger than in 1984 (nominal), and would be about 70 times larger by the end of this period, meaning a massive new consumer market for foreign businesses. It is notable that consumer products- from shampoo to Ipads- are among the least restricted of China’s markets.

It was in this period that China became a separate line item in reporting, and when it started to account for a very noticeable portion of both growth and revenues of MNCs- not just a footnote. China in this period went from a large potential market to large present market. Near the end of this period, companies started to pay much more attention to the bottom line, cut out loss-leading, and demand positive ROI. And commensurate with such high growth, companies that invested and developed there business widely here could report double-digit annual figures, which prompted many to call China its main growth market. Many APAC headquarters were promptly re-located to China, Shanghai in particular.

With the market growing so fast most every year, building capacity and market share, as well as adding sales and service infrastructure and the like were priorities. The export machine continued to grow, but the focus became more on domestic sales than on exports. And when the RMB appreciated, and with the global financial crisis, exports became less important to the market. With the economy nearly quadrupling during this time, there was room to grow for most. In fact some companies grew by over 10%, gaining praise from HQ, whereas their market in China was growing by 15-20%. Western firms such as GM or Apple saw China become the No. 1 market for their products, whether based on total sales (Apple), or profits (likely GM- not reported).

In the past few years, though, several trends have dampened the land rush. The debt and over-capacity in the wake the government’s 2009 stimulus package (in response to the GFC) are still a problem. Inflation is still present, and just as important the labor market has become much more restrictive and expensive, with business in most industries and in the more developed provinces having difficulty in retaining workers. The new leadership in Beijing has also made an impact, with tighter and some would say unfair scrutiny of MNCs, more focus on compliance, and support of state-owned enterprises. There have also been off-and-on attempts to squeeze some of the liquidity out of the market, with higher interest rates. The most important factors are just slower growth, and greater competition.

2014+: Attrition (or Farming)

Now in 2014, the days of very high growth in most markets are over, so we move into the next phase in China’s development: Attrition (or farming, to follow the metaphor). This means that MNCs will have to battle harder to gain or retain market share, retain talent, keep on the good side of the government, and make a profit. Some markets will continue to grow very fast. Automotive is an example here, and there are many smaller markets that will see very fast growth, and new bubbles may form. But the general land rush is coming to a close.

The new strategic focus will be less in investment, M&A, or partnerships, and more on business development and organic growth. Business development here means what it means in the West: developing better products, choosing the right customers to target, and the right channels, selling for a premium. In this limited sense China has become much more of a normal market, and something closer to a developed market- so should be familiar to MNC’s.

Fewer Opportunities for MNC’s?

Does this mean fewer opportunities for MNCs? In some ways, yes. Slower growth and stronger local competition (and in some cases more government protectionism) imply this. The share of MNC’s of this market will be smaller going forward, and some companies will be squeezed out of this market. Costs will be higher, and sales may be more difficult. In some cases Chinese consumers or businesses may have the ability to pay more, but will the price premium may be smaller than expected.

But these depend greatly on the market, and company. In some ways the opportunities will shift. For example, new trends such as Green Building or tighter environmental regulations will offer opportunities for companies in as diverse areas as coatings, HVAC, power generation, and controls. Some opportunities will be fickle. For example, over the past 5 years fire safety regulations went from less strict, then stricter, then less strict. Another high profile fire may shift these back to strict again.

There will be less low-hanging fruit, but even growth of 4% a year means an economy growing significantly faster than most developed countries. It will taking longer to gain or lose market share, but this will still be more fluid than in Western countries. To take advantage of shifting opportunities, MNCs will have to:

Offer Innovative or Distinct Products. Whether it’s a product with real technological superiority, or just one that people want, there is a lot of room here. Chinese firms have improved, but still lag in truly innovative products. A distinct product could be anything from a well designed cookware to premium agricultural products.

Offer Higher Value Products. The China product (or BRICS product) is not a marketing slogan, but a real option for many MNCs.

Develop Better Channels.  Many MNCs have already set up strong channel networks, such as by-passing the more general agents, and focusing on more local distributors in a particular locale or industry.

Have a Better Customer Focus. Demographics in this market are still so large that it’s often hard to keep good customer focus, but this is necessary if sales is to be effective.

Have a Different Regional Focus. This means the shift to Tier 2 and Tier 3 cities as much as East to West. At the consumer level, much growth is taking place in cities such as Wuhan or Chongqing, which are growing faster than Eastern Seaboard cities.

Play the Compliance Game. China is becoming less of a Wild West, and more of a Singapore in this respect, and there is going forward it’s necessary to cross all the t’s, and there will be more t’s to be crossed compared to the local competition.

Much of this comes down to going “deeper” into this market, in terms of local staff, channel partners, customer and market knowledge, products tailored for the local market, and in some cases local production. A marketing focus will be just as important as a sales focus. In some cases this will mean discontinuing a product line or division, if the prospects are not there.

The issue of unfair practice by the Chinese government may have merit, but is typically not the decisive factor in the emergence of strong domestic competitors. Both official and unofficial policies are set up to benefit local companies, though whether these are unfair or illegal is often murky. For example, government-owned SOEs will typically purchase from domestic companies. Sometimes this is because there is an understanding that they must do this, and sometimes because the local products have improved and will meet their needs. Other developing countries have policies that the West deems unfair, such as local content requirements of Brazil, or stringent market entry barriers in India. MNCs have some remedy to this, working with their respective governments, but otherwise one has to work within the existing system.

From the perspective a Western corporate manager, it is understandable to view the China market with less optimism than back in the pioneering days. But well back even before this time there was always a strong element of fantasy about a China market that would bring riches to anyone who showed up. The reality is more difficult and complex. But the upside is that this is now a 60 Trn RMB market, and even if growth is only 4% going forward, then in 10 years this is a 90 Trn RMB economy, or about the same size as the US economy today. Domestic companies will fill much of this space, but not nearly all. And China, unlike say Japan, still has a positive inclination to purchase foreign brands.

So what will come after this phase? We can’t see that far forward, but this phase should go for some time, and companies that are able to properly adjust their approach and execute should find this phase as worthwhile as the last.