From'Made in China' to' Made By China'
The wild, wild east
A booming middle class is creating the world’s most dynamic consumer market
· Sep 12th 2015| Economist
Chinas middle class is growing explosively. In 2010 mainstream consumers—those with enough money to buy cars, fridges and phones but not
Rolls Royces—made up less than a tenth of urban households. In a new forecast, McKinsey predicts that by 2020 they will make up well over half. BCG reckons that urban private consumption will rise from $3.2 trillion today to $5.6 trillion in 2020.
Apple expects China soon to become a bigger market for its products than America. In the quarter ending in June, its sales in greater China were 112% up on the same period a year earlier. Six of its ten busiest stores across the globe are in China. At the height of the recent turmoil in the Chinese stockmarkets Apple’s boss, Tim Cook, reassured investors that “I continue to believe China represents an unprecedented opportunity over the long term.” Apple’s shares bounced back.
Where should intrepid marketers go to capitalise on these riches? The wealthy east coast is now widely believed to be saturated, which suggests that firms should head inland. A few inland cities like Chongqing and Chengdu are indeed attractive, but many excellent prospects remain in the east. Obscure but booming cities within reasonable distance of the coast, like Suqian and Xuzhou, are likely to do well, and lucrative niches remain even in well-established magnets such as Beijing, Shanghai, Guangzhou and Shenzhen.
As the middle class expands, so it evolves. Some may grow tired of blingy offerings, but millions of others will try their first Western brand this year. “Every three years a new generation is created here,” explains Charles Hayes of Ideo, a consultancy. Even within cities, consumer groups are highly segmented. Donald Blair of Nike, an American sportswear giant, says his firm maps consumer behaviour here “by shopping district and even by street”, so it can customise offerings and outlets.
A big winner has been China’s e-commerce, a market that is now larger than America’s. Forrester, another consulting firm, expects gross merchandise value in this sector to exceed $1 trillion by 2019. Outside the big cities bricks-and-mortar stores are thinner on the ground, so online shopping is becoming increasingly important. Even where shops are readily accessible, consumers often go “showrooming”, looking at goods in physical outlets but buying them more cheaply online. This is happening the world over, but in China the trend has been accentuated by the ubiquity of smartphones, the reliability of online-payment systems and the spread of same-day delivery services.
Fung Retailing Limited, has over 3,000 outlets, a third of them in China. Victor Fung, its honorary chairman, sees the era of mass production giving way to one of mass customisation. Markets are fragmenting and smartphones are empowering consumers to get “directly involved in what they buy, where it is made and how they buy it”. Zhao Xiande of CEIBS in Shanghai points to Red Collar, a firm that used simply to make and export garments. Now it lets customers the world over design their own shirts online and makes them to order. Another outfit, Home Koo, offers custom-built furniture online.
All this e-commerce is producing some remarkable business-model innovations. Thanks to the convergence of mobile commerce and social media, observes Miles Young, chairman of Ogilvy & Mather, an advertising firm, China is the world’s epicentre of “social commerce”. Studies by BCG show that Chinese consumers are much more likely than American or European ones to interact with brands through social media.
Mr Young believes that China is leading the world in bringing together the “internet of things” (which connects machines to each other) with the internet used by people. Firms such as Suning, an electronics retailer, Haier and Xiaomi are all connecting smart gadgets with consumers through WeChat and other social media. This seems to be happening more quickly in China than in the West.
Are you being served?
Much of this new economy is moving on from supplying goods to providing services. In most rich countries services make up at least three-quarters of GDP, but in China they account for only half. The rising middle class is demanding better services in everything from health care to finance to entertainment. Both foreign and local investors are rushing in to fill the gap.
Two decades ago films made by Walt Disney, an American entertainment giant, were banned on the Chinese mainland, but now China is Disney’s most promising market. The company’s latest “Avengers” film earned over $200m in local theatres in its first two weeks. In May Disney opened its largest-ever retail store in Shanghai. And next year Shanghai Disney, a $5.5 billion theme park, will be ready to receive the crowds. Dalian Wanda, which made its fortune in property, is building a massive $8 billion film studio in Qingdao and will be spending over $30 billion on theme parks across China, confronting Disney head on.
Jean Liu, president of Didi Kuaidi, thinks the sharing economy will allow scarce resources to be used more efficiently. Her ride-sharing firm counts both Tencent and Alibaba as investors. It offers everything from fancy cars and taxis to shuttle buses and car pools—or even someone on a bicycle to drive you home in your own car. It clocks up 6m rides a day, far outpacing Uber.
The future is private
Both the number and the output of China’s SOEs is shrinking, but they remain politically powerful. By gobbling up a disproportionate share of resources, especially credit, they crowd out the private sector. They are also responsible for many of China’s economic excesses, ranging from poor investment decisions to too much leverage. The IMF calculates that the SOEs’ average debt-to-equity ratio rose to roughly 1.6 in 2014, from about 1.3 in 2005; the ratio for private firms in 2005 was also around 1.3, but by last year it had fallen below 0.8.
If Chinese leaders want to put the economy on a sounder footing and develop the private sector’s full potential, they must embrace Ms Dong’s version of SOE reform. That will require an effort on three fronts: first, speeding up financial liberalisation so that credit goes to the most dynamic firms, not the best-connected; second, enforcing the rule of law so that all firms, domestic or foreign, are treated equally; and third, encouraging competition across the economy, including in “strategic” sectors.
The good news is that China’s reformers have, in fits and starts, begun to ease the state’s iron grip on finance. In the past, ordinary Chinese often got negative returns on their savings so that SOEs could enjoy subsidised capital from state banks. Private companies were largely left out. Things are getting better. The authorities are liberalising interest rates and have introduced a useful deposit-insurance scheme. They have encouraged private firms to experiment with online finance. And in August they heeded the IMF’s advice by moving (bumblingly) towards what looks like a more flexible exchange-rate regime. Much more needs to be done, but the outline of a market-based financial sector is emerging.
Competition remains the ugliest aspect of market reform. Extreme competition and none at all exist side by side. Peter Fuhrman of China First Capital, an investment bank, describes competition among private firms as so ruthless that “parts of China may be the most capitalist place on Earth.” At the same time large swathes of the economy controlled by the zombies of the state sector are not subject to any competition at all.
Over 100 big state firms are controlled centrally, and many thousands more are in the hands of provincial and local government. Having observed the looting of Russia’s assets by oligarchs, China’s leaders strongly oppose outright privatisation, and indeed a “big bang” sale of SOEs would probably line the pockets of princelings. Officials have dabbled in partial privatisation, but that has done nothing to boost competition.
Demands for genuine market reform are growing louder. In a report on China’s economy published in August, the IMF noted that the country is making progress on structural reforms, but warned that a huge amount of work remains to be done. Mark Schwartz, the head of Goldman Sachs in Asia, is hopeful about China’s future but thinks progress will take time: “I see this as the beginning of a 30-year historic period of reform.”
The biggest reform needed is a change in mindset. Caixin, an influential Chinese financial magazine, recently ran a striking editorial arguing that, despite official promises, the private sector still suffers legal discrimination in market access, finance and investment. China needs “a transformation” to become more innovative and efficient, it said, which “requires a break from the old practices of a planned economy”.
Double-digit economic growth was never going to be sustainable indefinitely. For an economy that in purchasing-power-parity terms is already the world’s largest, continued growth of even a more modest 5-6% would still mean rapid progress. Thanks to that, and to increasing urbanisation, the middle class, until recently just a small sliver of the population, is expanding fast and will soon make up the majority. Investment-led growth is giving way to growth driven by domestic consumption. And the opening of the long-repressed services sector could represent, on one estimate, a $12 trillion prize in the longer term.
The New Silk Route
AN ENORMOUS MAP of the historic Silk Road hangs on a wall at Wensli, a leading Chinese silk producer. Nearby exhibits put China’s silkmaking tradition into context. The Chinese first encountered silkworms about 6,000 years ago. Two millennia later they built the first silk machine. When France emerged as Europe’s silk centre in the 16th century, it learned techniques from China, then the world’s most advanced economy.
The Chinese love invoking their country’s rich and glorious past, so they lapped up President Xi Jinping’s “One Belt, One Road” plan, announced in late 2013, which aims to restore the country’s old maritime and overland trade routes. Mr Xi hopes to lift the value of trade with more than 40 countries to $2.5 trillion within a decade, spending nearly $1 trillion of government money. SOEs and state financial institutions are being pushed to invest overseas in such areas as infrastructure and construction. According to the EIU, planners see this as an outlet for the vast overcapacity in industries such as steel and heavy equipment. It seems likely to lead to a massive spending binge, but companies should remain wary. Government support will not necessarily ensure success.
Li Jianhua, Wensli’s chief executive, is reviving the Sino-French silk connection, but on its own initiative. Two years ago the company acquired Marc Rozier, an old-established French silk firm. Mr Li says he bought it to find out how the French make the world’s best luxury goods. Wensli’s supply-chain expertise and cash are helping Marc Rozier expand. In turn, the French firm is helping its Chinese owner improve quality and develop a global brand.
Robots and teapots
Many more Chinese firms like Wensli are venturing abroad. Ninebot, a transport-robotics startup backed by Xiaomi and Sequoia Capital, bought Segway of the United States (and its IP) in April. Segway’s products are too pricey and heavy for the mass market; Ninebot has the supply-chain and engineering expertise to change that. Sequoia’s Neil Shen says that “today it’s not just copycats…China will expand, through its own innovations and through acquisitions.”
Chinese firms are also trying to revive old traditions of craftsmanship, which may help them develop authentic brands. Jiang Qiong Er says she founded Shang Xia, with help from Hermès, a French luxury-goods maker, out of a burning desire to prove that it is possible to create a “Chinese brand of excellence”. The firm’s flagship store is on Huai Hai Road, Shanghai’s most elegant shopping promenade. Her luxury boutiques design, make and sell hand-crafted tea sets, jewellery, clothes and furniture from local materials such as bamboo and silk. She has opened a shop in Paris and hopes in time to become a global brand.
Last year Chinese investment overseas almost caught up with foreign direct investment in China (see chart). According to the China Global Investment Tracker, a research service, Chinese investment abroad in the first half of this year amounted to $56 billion, a rise of 14% on a year earlier. Rhodium Group and the Mercator Institute, two other research firms, reckon that the total stock of Chinese direct investment abroad could rise to $2 trillion by 2020, from less than $800 billion at the end of 2014.
Not everyone will be pleased by that prospect, remembering an earlier wave of Chinese globalisation led by SOEs. They made clumsy forays, and enemies, in such places as Africa and Latin America on a quest for oil, agricultural land and other resources. Many deals were politicised and some were corrupt. The resulting backlash was understandable but overdone. In particular, the decision in 2012 by a committee of America’s Congress to blacklist Huawei and ZTE, another big Chinese telecoms firm, on national-security grounds was shameless techno-nationalism. It has given Chinese officials cover for their own misguided attempts to favour firms like Lenovo and Huawei at the expense of IBM, Cisco and other American technology firms.
Fortunately, future Chinese would-be investors abroad are more likely to be market-minded entrepreneurs than national champions. Chinese firms are getting fed up with paying licensing fees and royalties to foreigners. So instead of renting or stealing intellectual property, says Harvard’s William Kirby, they are looking abroad to acquire top talent and technologies. And despite Huawei’s troubles, their favourite target is America.
Earlier Chinese attempts to capture foreign markets and technologies did not go well. In 2004 Shanghai Automotive acquired 49% of SsangYong, a South Korean carmaker, for $500m, hoping that the acquisition would help it enter the American market, but cultural clashes, union troubles and rising oil prices got in the way. In 2009 SsangYong went bust and Shanghai Automotive had to write it off. TCL, a big electronics firm in Guangdong province, bought majority control of the television arm of France’s Thomson in 2004, giving it the Thomson and RCA brands. But TCL’s inexperience and the technological disruption caused by flat-screen technology scuppered the effort, and the venture was shut down.
These examples highlight some of the problems Chinese firms face when going overseas, and explain why many have failed. Chinese firms have few managers with international experience. Their brands and management processes tend to be poorly developed. They are also reluctant to pay outside experts for advice even when they desperately need it.
But Chinese firms are getting better. A study by Claudio Cozza and colleagues published last year by the Bank of Finland looked at Chinese investments in the EU, which went from almost nothing in 2004 to €14 billion ($18 billion) in 2014. They chose Europe because Chinese firms tend to look for new markets and to acquire brands, technologies and knowledge there. Such outbound Chinese investments in the EU, they found, had “a positive effect on [Chinese] firms’ efficiency and performance” and pushed up their overall sales.
That is only the beginning. In “China’s Disruptors”, Edward Tse argues that “China’s entrepreneurial companies will become far more active internationally, entering new markets, acquiring companies and hiring executives.” He believes they will pose an enormous threat to established businesses in many industries. And yet global Chinese entrepreneurs could also be good for the world, as Wanxiang’s example shows.
Take a deep breath
A sexy electric roadster is parked outside A123 Systems, a battery firm in Michigan. It is made by Fisker Automotive, a failed American firm acquired by Wanxiang, and it is meant to inspire. Jason Forcier, A123’s boss, says his firm would not be there except for Mr Lu’s dream about solving China’s pollution problem. Wanxiang bought the company at a bankruptcy auction in 2012 for about $250m and imposed strategic focus and cost discipline on the free-spending startup. Mr Forcier expects a profit this year.
Wanxiang has come to America to learn how to make China, and maybe the world, a cleaner place to live in. It has built a solar plant outside Chicago and invested in coal-to-natural-gas technology in Massachusetts. Back in China, it is accumulating the in-house expertise and alliances needed to make affordable electric vehicles for the mass market.
Mr Lu’s quest is not as Quixotic as it seems. China is the world’s best place to scale up clean technologies, wherever they are invented. His effort is just a tiny fraction of the $2.5 trillion that the UN expects to be invested in clean energy in China by 2030. In future, says the green billionaire, Chinese firms “will contribute more merit and value to the world”.
China’s best firms are standing ready to go global. As Thomas Hout and David Michael write in a recent issue of the Harvard Business Review: “If there’s a business equivalent to the Cambrian period of explosion and extinction of species, China from 1991 to the present is it.” Many have failed, but the survivors are straining at the leash.
Manufacturing
Still made in China
Chinese manufacturing remains second to none
AMID ALL THE excitement about high tech and the push into services, it is easy to forget that China’s modern economy was built on the strength of a solid and often low-tech manufacturing sector. Now manufacturing is widely thought to be in trouble. Factories are squeezed, labour costs are rising and jobs are being reshored to America. Competitors such as Germany are said to be leaving China behind by using robotics.
Chinese officials have responded in the only way they know. In May the State Council, China’s ruling body, approved “Made in China 2025”, a costly scheme that will use mandates, subsidies and other methods to persuade manufacturers to upgrade their factories. The plan is for China to become a green and innovative “world manufacturing power” by 2025.
China is already the world’s largest manufacturer, accounting for nearly a quarter of global value added in this sector. Research by Morris Cohen of the Wharton Business School finds that the country leads in many industries and that “reshoring to the developed economies is not happening on a large scale.” Even though some production is moving to countries nearer its consumers, China remains at the heart of a network known as Factory Asia. It has an excellent infrastructure and an enormous, hard-working and skilled workforce. Though wages are rising, its labour productivity is far higher than that of India, Vietnam and other rivals, and is forecast to keep growing at 6-7% a year to 2025.
Manufacturing is almost entirely controlled by private firms, both Chinese and foreign, which unlike SOEs will not be pushed by bureaucrats into making unprofitable investments. Marjorie Yang, Esquel’s boss, says that subsidies may feel good but distort investment decisions: “The government loves to fund flashy hardware and robotics, but there’s no money for the software and data analytics needed to make proper use of it.” And in any case most of these private firms are already innovating at a cracking pace without prompting from government.
Manufacturing is almost entirely controlled by private firms, both Chinese and foreign
Michael McNamara, the boss of Flex, a big American contract manufacturer, says product cycles have become much faster. Factories in China used to serve export markets, but are now reorganising to concentrate on the booming local market. They are sensibly investing in automation, worker training and new methods. In the process, he says, China is “moving from work engine of the world to genuine innovator”.
Kirk Yang of Barclays, a bank, believes the manufacturing sector is moving from “Made in China” to “Made by China”. In the 1980s and 1990s most factories were owned by firms from Taiwan (like Foxconn) or the West (like Flex). Increasingly, he predicts, the sector will be run by Chinese firms. Taiwan used to dominate the market for upmarket electronics components, but he thinks many Chinese parts-suppliers—like BYDE, an arm of the electric-car firm BYD—are now excellent.
In many industries China is still learning from the world, say the engineers, but its electronics manufacturing is so advanced that “the world is learning from China.”
Terry Gou, Foxconn’s boss, claims that within five years the 30% of his labour force doing the most tedious work will be replaced by robots, releasing them to do something more valuable. The highly inventive firm, which holds
We have a plan
What about the government’s “Made in China 2025” plan? It might succeed on its more modest goals, says Stephen Dyer of Bain, a consulting firm. Its immediate aims are to improve quality, productivity and digitisation, and to expand the use of numerically controlled machines. All these things, he notes, are already in common use by world-class manufacturers in other countries. A push to invest might well help Chinese laggards catch up.
Comments
Post a Comment