Doing Business in China

China is the fourth largest country in terms of size and the largest in terms of population.  Driven by domestic demand and supported by World Trade Organization accession, China economy should continue to grow robustly over the next 2 years.The total value of goods and services has been growing at a double digit rate for over 20 years. Although growth figures are now in the single digits (about 7.3 %), this is a large market that cannot be ignored. The World Bank estimates by the year 2025 China's economy will account for 25% of the total World Economy. WTO entry was certainly a watershed in China's commercial   relationships with the international community. Broadly speaking, China has adhered to its WTO commitments on time in lowering import taxes and removing formal trade barriers. Where there have been trade disputes, notably with the US and the EU, established WTO dispute procedures have been followed. As most observers expected, the main fall-out on China's economy has been steadily increasing exports, imports of raw materials and capital equipment and even more foreign direct investment which has stimulated both industrial production and consumption further. However, it would be misleading to say that there was a causal effect between WTO entry and China's robust economic growth. The infrastructure of China's industrial sectors was already embedded and the economy has grown strongly without serious downturns for more than twenty years. Where WTO membership has been instrumental in China's more recent economic and commercial development has been the opening up of the domestic market, in particular retailing and financial services, to foreign investors. However, WTO membership can take some credit for the greater urgency in the restructure and reform of China's banking system and in the more recent drive to expel corruption from state-owned industries and business generally.

Ehancing Profitability in China

Lenovo, TCL, and Huawei are well-known examples of Chinese high-tech companies that have established a global footprint. Beyond these headline-making brands, however, scores of high-tech companies—largely unknown outside China—are rapidly assuming market leadership within the mainland while quietly building the capabilities to go global.

China's high-tech sector is growing at an impressive pace. Over the past three years, revenues of its 100 largest high-tech companies grew by 26 percent annually, more than twice the overall market growth rate of 12 percent and nearly four times the annual global rate of 7 percent. Of these, nearly 20 midsize and large companies have grown at 50 percent or more a year—a remarkable pace for businesses of that size.

The rise of Chinese companies comes at a challenging time for the high-tech sector in the rest of the world. Slowing core markets and pressure from investors to increase earnings are forcing companies to turn toward China. Depending on the product category, 30 to 75 percent of future growth in the global high-tech industry will come from emerging markets, with China expected to generate a significant portion.

Foreign high-tech companies in China find themselves up against a host of challenges: limited demand growth in high-end product segments, where they tend to compete and in which they are increasingly under attack from Chinese players; severe pricing pressure; a tendency to overinvest, leading to excess capacity; high turnover of qualified local management talent; and difficulty managing joint venture partners.

Many foreign CEOs seem convinced they are doing the right thing. In addition to utilizing expatriate managers, they have local managers on the ground, source and manufacture components in China, and visit the country three or four times a year to check on the business.

These actions, though necessary, will not be enough to win in China. By applying their tried-and-true product and business models, foreign high-tech companies are unlikely to earn the level of profits—not only from hardware, but also from after-sales parts, services, and software—in China that they do elsewhere. In mature markets, for example, printer makers earn as much from the sales of cartridges, ink, paper, and services as they do from the printer itself. In China, this model does not work as well, since consumers would rather refill an old cartridge or purchase a new, low-cost copycat one. Many local companies are available to provide maintenance services at a fraction of the price that a foreign group would charge.

A different set of dynamics is at work in China, requiring foreign high-tech companies to rethink how they compete. First, they will need to reduce costs severely—by 30 to 50 percent—to bring themselves in line with Chinese competitors. Many foreign players believe they are getting a good deal on components sourced in China, yet they often pay 10 to 20 percent more than local companies. Foreign companies in China often rely on a single, more expensive overseas supplier for a particular component because Chinese suppliers cannot meet the design specifications. To reduce costs, foreign companies will need to design products that local Chinese suppliers can manufacture.

But cutting costs is only part of the equation. Since many foreign high-tech corporations may never be able to reach cost parity with their Chinese rivals, they will have to think of other ways to create value. One way is to rethink their distribution system in China. In Europe and the United States, consumer electronics goods are distributed mostly through large retail chains. But these channels do not have the same scale or reach in China. To get around this problem, Sony distributes its notebook PCs through hundreds of stand-alone shops and sales counters in consumer electronics malls. Setting up its own distribution network has helped Sony boost its share of the Chinese notebook PC market from just 1 percent in 2002 to more than 8 percent today.

Foreign companies should also leverage their global brands and marketing muscle in China, especially given how brand conscious Chinese consumers appear to be.

Most foreign companies operate at the high end of the market, conceding the midrange and low-end segments to Chinese competitors. But if multinationals want to build large businesses on the mainland, they will have to figure out how to operate in these much bigger segments without eroding their brand image. Motorola and Nokia have succeeded in this area and continue to enjoy strong brands while occupying leading positions in China's mobile-handset market, with phones priced from 400 renminbi to 9,000 renminbi ($50 to $1,120).

Whatever strategy they pursue, the world's high-tech companies will need to think differently when doing business in China or risk losing out on the biggest growth opportunity of the century.

Back