The fast-growing Chinese companies have to face fierce challenges ahead in their globalization cause, as the era of easy growth for Chinese companies is coming to a close and multinationals are battling back, said a recent report by The Boston Consulting Group (BCG).
The report is based on 50 fastgrowing Chinese companies with global aspirations and momentum which were selected as the BCG Chinese global challengers.
“To reach the next level, Chinese companies need first to overcome a more challenging economy at home, where the days of relying on low labor costs, price competition, and a giant domestic market to fuel growth are over,” said the report.
The report suggested that to become global leaders, Chinese companies should embrace five strategic initiatives: take advantage of megatrends such as the rise of the middle class; strengthen M&A capabilities; establish capabilities beyond cost leadership; improve productivity; and develop global organization, management, and governance practices.
Chinese companies’globalization
China’s global presence has been on a steady climb over the past ten years. According to the report, between 2002 and 2011, the value of exports rose by 22 percent annually. Foreign direct investments, excluding those in the financial sector, rose by 43 percent annually — reaching $68.6 billion by 2011 — and the value of outbound M&A deals rose by 30 percent annually.
As mature markets continue to struggle with the global slowdown, China’s global role will continue to expand. Foreign direct investments by Chinese companies will likely rise by 15 percent annually between 2010 and 2020, according to the Ministry of Commerce. Chinese companies are also poised to create a few million jobs overseas between 2010 and 2020. In 2010, overseas employment at Chinese companies stood at 780,000.
The report showed that the BCG Chinese global challengers range in size from $180 million to $300 billion in annual sales, with 22 of them falling in the $1 billion to $10 billion range. Nearly one-half of the companies are private, while 26 of them are owned by the state.
Globalization is a work in progress at these companies. 13 of them generate more than one-half of their revenue from overseas, while 14 generate less than 10 percent. The rest of them fall between those extremes.
Over the past ten years, the BCG Chinese global challengers have expanded faster than comparable multinationals based in developed markets. But they have lower levels of profitability, and growth is starting to slow. Challenges ahead
The BCG report indicated that facing slower growth and rising pressure on margins, many of these companies will find it hard to maintain their current valuations. This softening signals that it may be time for Chinese companies to move beyond the advantages that they have historically enjoyed. Aside from ingenuity and ambition, the challengers have bounded to success off of three springboards.
First, the size of the domestic market has enabled companies to acquire scale and, frequently, expertise that companies in other nations can only achieve through overseas expansion. In some heavy-equipment industries, the China market accounts for one-half of global demand.
But this hypergrowth phase of China’s economic development —which may have distracted Chinese companies from opportunities overseas — is over. Real GDP growth in 2012 is likely to settle close to 8 percent, the smallest increase since 1991.
Second, China’s competitive cost position has been a strong point in winning overseas business. This is not just because of low labor costs. Scale advantages driven by the size of the domestic market and the standardization of product offerings help control costs. Chinese coal-powered-equipment companies, for example, have an estimated average cost advantage of 25 percent over established multinationals, half attributable to scale.
The nation’s cost advantage, however, is shrinking, as labor and other input costs rise. Between 2012 and 2016, manufacturing labor costs are expected to rise by at least 10 percent annually, five times as fast as in many developed nations and twice as fast as in developing markets such as Thailand and Vietnam. Unit-labor costs are rising at the same time that the labor market migrates toward higher-wage positions.
Third, while state support is a well-ingrained feature of many national economies, China goes to great lengths to encourage and fortify strategic industries through standard setting, industry consolidation, export support, and financial incentives.
At the same time, however, multinationals are getting better at competing against Chinese companies. In the telecom equipment sector, one of the first advanced industries to fall victim to these advances, Western competitors have battled back.
“The message is clear. The companies aspiring to similar success urgently need to develop novel ways to compete in this new environment,”said the report.
However, few Chinese companies have established world-class capabilities and skills to match their ambition. They need to become more adept at exploiting global opportunities by maximizing the benefits of productivity and scale, developing innovative products tailored to overseas markets, acquiring and integrating companies, creating global organizations and brands, and developing deep talent pipelines, the report suggested. Actions being taken
Fortunately, many of the Chinese global challengers have already started to reorient their strategy, operations, and practices toward the future. At least five strategic initiatives will help these companies become global leaders in their industries as aforementioned, said the BCG report. The report elaborated on the five initiatives as following.
Taking Advantage of Megatrends. At least four prevailing shifts present opportunities for farsighted companies: the rise of the middle class in emerging markets, the building of the “new world” through massive infrastructure projects, the increasing scarcity of natural resources, and the growth of new trade routes through China and other emerging markets.
The Rise of the Middle Class. Over the next 20 years, billions of people will join the middle class in emerging markets. This group will make up 30 percent of the global population by 2020. There will be nearly 1 billion middle-class consumers in China and India by 2020.
Many middle-class citizens still have markedly lower incomes than their counterparts in Europe, Japan, and the U.S. In China, for instance, we define middle-class households as those earning from $7,300 to $23,200 per year in 2010 dollars. But these households have middle-class aspirations, and their growth is fueling demand for previously unattainable products, ranging from home furnishings to health care to financial services.
Many Chinese companies should have a head start in reaching these overseas emerging-market populations. The needs and buying patterns of these consumers are similar to those of the growing middle class in China, which they have served for the past ten years.
Building the “New World.”Emerging-market cities need better housing and infrastructure — including transportation, water, sanitation, and electricity. These needs will require an estimated $30 trillion to $40 trillion in spending by 2030, roughly 60 to 70 percent of the total global investment in infrastructure during that period.
The Scarcity of Natural Resources. A voracious user of energy, China is committed to both acquiring new sources of traditional energy and developing alternative sources to feed its economic growth. Largely through acquisitions, major Chinese energy players are trying to create a global footprint to compete against competitors. In July, for example, the China National Offshore Oil Corporation offered $15 billion for Canada’s Nexen, which has proven reserves in the Gulf of Mexico, the North Sea, and Canada. Sinochem Group has also been completing smaller deals over the past decade. The government wants to increase the share of nonfossil fuel to 11.4 percent of total energy consumption and to reduce carbon dioxide emissions by 17 percent per unit of GDP.
The Development of New Trade Routes. While Europe and North America will continue to be important trade destinations for China, volume to Africa, Latin America, and Southeast Asia is growing more swiftly. Exports to these regions, as a share of total exports, rose 5 percentage points to 19 percent between 2006 and 2011, while exports to mature economies fell. The expansion of these routes provides an opportunity for companies excelling at logistics and other traderelated services.
Strengthening M&A Capabilities. Chinese companies have followed a wide variety of approaches t o b u i l d a global business. Their choices can be placed along two dimensions: whether they initially started expanding in emerging markets or mature markets and whether they have relied primarily on organic growth or M&A transactions. Geely, Goodbaby, and Mindray all entered mature markets first but by different means.
Increasingly, expansionary Chinese companies will need to rely on M&A to achieve some of what they want to accomplish overseas. In many markets, it takes too long to build a business organically because of strong legacy commercial relationships that are difficult to penetrate. And Chinese companies have specific needs for technology and capabilities that M&A can address.
To date, however, few Chinese companies have developed a mastery of the M&A and postmerger integration processes. Executives of many large companies in mature markets understand the typical process or pattern of strategic preparation, execution, and integration required for success. But for many Chinese executives, dealmaking and deal integration are still foreign concepts. Their deals frequently fall short of their original goals.
At least the four following constraints have limited the dealmaking ability of Chinese companies. First, they suffer from a lack of experience. Many Western companies have spent 30 or more years developing capabilities in evaluating, executing, and integrating deals.
Second, cultural differences have impeded Chinese companies in integrating and running foreign companies. English is not spoken widely in the executive suites of most Chinese companies. Many of these companies are unaccustomed to international management practices and have consequently promoted Chinese natives into top positions of their foreign businesses. Third, government approvals in mature markets have prevented some deals proposed by Chinese companies, especially state-owned enterprises. The failure of these deals reflects three realties: the inability of Chinese companies to build respected global brands, the limited trust that policymakers and executives have in Chinese companies, and the failure of Chinese companies to build strong ties with global stakeholders.
Finally, a lack of transparency, which is linked to the prior point, creates uncertainty among potential partners and targets in mature markets and leads to increased government scrutiny of large-scale transactions.
Learning from their earlier mistakes, some Chinese companies are starting to take a “leave and learn” approach. They increasingly leave the acquired business alone and try to learn best practices from it.
While the leave-and-learn approach is starting to allow Chinese companies to acquire critical overseas capabilities and outposts, many of them will eventually need to integrate operations in order to garner the benefits of global scale, and reach and leverage their combined advantages. Leave and learn also only works when the target is healthy — it is an expensive tactic when the acquired company is troubled.
Establishing Capabilities Beyond Cost Leadership. China is commonly associated with low costs of both goods and labor. This perception is built on a reality that is quickly fading. While parts of China will continue to have lower labor costs than mature markets for many years, rising wages are eroding China’s advantage as an exporter. The manufacturing of computers and electronics, for example, is already starting to move from China to other low-cost locations.
Looking beyond cost as their primary source of advantage, farsighted companies have started to create strengths in R&D, manufacturing, products, distribution, and branding.
Improving Productivity. Recognizing the limits of low cost as a competitive advantage, many Chinese companies have started to focus on improving productivity through the adoption of lean management and manufacturing practices. There are four critical elements to create a lean organization.
First, companies need to instill lean business requirements, setting the right ambition and operating model, supported by explicit targets.
Second, Chinese companies also need to institute performance governance measures to ensure that overall corporate objectives are met. Third, companies need world-class business processes. These processes will generally support standardization and an end-to-end view of the business.
Finally, productivity depends on employee engagement. Employees are frequently the best source of efficiency ideas. High-performance organizations keep a finger on the pulse of their people, regularly measuring engagement levels and actively managing engagement during reorganization and large-scale change efforts, when it is likely to fall.
Developing Global Policies. A company can have vast overseas operations and still not be a global company. Because of their historical cost-leadership position, many Chinese companies have been able to build overseas sales without creating a global operating model, global organization, and global worldview. They are still rooted in their home market.
Companies from mature markets are struggling with the same challenge, but the Chinese have much further to go. They should be focusing on the following three broad elements that will help unify many ambitious local and regional efforts.
Create a global organization. Organization design can help companies improve execution and achieve strategic goals. A well-designed structure should emphasize what matters most to an organization. It is impossible to accommodate all dimensions (regions, business units, and functions) equally. A company focusing on future performance in key markets, for example, might organize businesses by region rather than channels. Its executives would, then, need to take careful steps to ensure that channels were receiving proper support even though they did not form the dominant axis in the organization.
A corporate center can both help and hinder globalization campaigns. Two extreme patterns of management behavior can upset the balance between the center and overseas units and derail efforts to realize sustained performance.
At one extreme, the center overregulates local operations and fails to adapt to local markets. At the other extreme is the common mistake of overdelegation to local businesses. Between those two extremes lies another misstep that companies often make: an ad hoc approach to each market with no coordinating structure.
Develop a diverse talent pipeline and understand cultural differences. Recruiting and retaining talent have always been a struggle for companies with global aspirations, and today the challenges are larger than ever. As more companies go global, the demand for talent increases at the same time that the retirement of the baby boom generation in the West shrinks supply. With demand rising and supply dwindling, companies are finding that talent, especially in emerging markets, is one of their most critical challenges. Chinese companies will need to raise their investment in talent management, treating human capital with the same rigor as financial capital.
Talent is an especially critical issue for Chinese companies. Language and cultural barriers often steer them toward hiring Chinese natives and promoting from within. They frequently do not exhibit the diversity in talent or delegation of authority needed to manage a complex, global organization, and they often base decision making solely on trust and experience.
Improve corporate citizenship and stakeholder management. As companies grow larger in size, so does their influence over commerce and society. A company is not an island unto itself. Senior leaders need to start managing the business with a longer view, playing a positive role in key industry, economic, and societal issues. In many markets, a galaxy of stakeholders, such as nongovernmental organizations, play a role in business activities.