McKinsey Greater China http://www.mckinseychina.com The leading management consulting firm in Greater China Fri, 19 Dec 2014 15:41:54 +0000 en-US hourly 1 http://wordpress.org/?v=4.1 Copyright © McKinsey Greater China 2014 china@mckinsey.com (McKinsey China) china@mckinsey.com (McKinsey China) 1440 http://www.mckinseychina.com/wp-content/uploads/2014/10/mckonchina144x144.jpg McKinsey Greater China http://www.mckinseychina.com 144 144 Conversations with McKinsey Partners on the hottest topics affecting the Chinese economy and business. Welcome to the McKinsey on China podcast. In this podcast, consultants from McKinsey’s Greater China Practice delve into the issues and trends shaping business and the economy in this dynamic region. Since we launched the podcast in December 2011, we’ve published over 45 episodes on topics covering the full gamut of critical issues in China, including urbanization, globalization of Chinese companies, energy, consumers, electric vehicles, macroeconomic policy and reform, and more. Your hosts are Nick Leung and Glenn Leibowitz. Nick is the Managing Partner of McKinsey’s Greater China Practice. Glenn heads up McKinsey’s external relations and publishing group in Greater China. Subscribe to the podcast for free on iTunes and listen to it while you’re on the road (or airborne). We’d appreciate if you could write a short review and rate it too. You can also listen to it right here on this website. Suggestions for future topics? Feedback? We’d like to hear from you. mckinsey, china, mckinsey, china, chinese, business, business, economics, chinese, economy, consulting, business McKinsey China McKinsey China china@mckinsey.com no no The Hangzhou Paradox http://www.mckinseychina.com/the-hangzhou-paradox/ http://www.mckinseychina.com/the-hangzhou-paradox/#comments Fri, 12 Dec 2014 01:13:43 +0000 http://www.mckinseychina.com/?p=8135 Hangzhou, home of Alibaba and many other successful Internet ventures, has created a massive wave of millionaires in 2014.

Yet of the 70 cities tracked by the National Bureau of Statistics, Hangzhou has the largest year-on-year decline in house prices at 9.1%.

Why? Is it because citizens of Hangzhou are:

  • Now so wealthy that they aren’t really interested in investing in property anymore and are putting their money elsewhere?
  • Investing in real estate in other cities such as Shanghai and Hong Kong?
  • Haven’t been able to access their paper wealth yet and a boom in house prices is just around the corner?

Or, the real estate market is so over built to swamp any wealth effect from Internet IPOs?

What do you think?

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Looking For Work In China? Check Out Smaller Companies http://www.mckinseychina.com/looking-for-work-in-china-check-out-smaller-companies/ http://www.mckinseychina.com/looking-for-work-in-china-check-out-smaller-companies/#comments Wed, 10 Dec 2014 01:07:49 +0000 http://www.mckinseychina.com/?p=8132 Last weekend a couple of hundred students gathered in a standing room only room at the Saïd Business School at Oxford University to listen and debate on all things China.

A distinctive aspect of the program was that it was not just business, but also foreign policy and culture, which led to some interesting cross-cutting debate. It’s a good format and I encourage the organizers to find a larger venue for next year. Appropriately, I was confined to the business panel.

The panel had a really engaged discussion on “level playing fields”, rule of law, and the future of “national champions”. I see greater and greater transparency, compared to only a few years ago, on what regulations are – cross industry and industry specific (such as pricing in pharma) – and more consistent enforcement on local and international companies.

The students’ view of the business world seemed to lag a bit, perhaps reflecting their time out of China. One student, for example, was explicit that he had access to proprietary information from a corporation that he should not have, and asked a question referring to that information specifically. My fellow panellists, from business and government, were very robust in describing examples of how important it is to know and to follow regulations and laws in China in 2014. I hope he and other students internalized what was said.

My general remarks focused on where the students might find opportunities in business if they move to China upon graduating. As 90% of the audience were Chinese, it seemed a good bet that most would be considering this. I took a bit of a deep dive on IT services and then the food related industries. I pointed out how job creation in state-owned enterprises is now almost non-existent, and that this is not likely to change. I ended by encouraging the students to consider how they can develop entrepreneurial skills, and how they might look for opportunities with private sector SMEs.

Always enjoyable to be in Oxford, even on a wet November weekend.

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9 Ways The Chinese Government Promotes Innovation http://www.mckinseychina.com/9-ways-the-chinese-government-promotes-innovation/ http://www.mckinseychina.com/9-ways-the-chinese-government-promotes-innovation/#comments Mon, 08 Dec 2014 01:00:10 +0000 http://www.mckinseychina.com/?p=8128 In innovation, as in most areas of the economy in China, the government plays a material role, sometimes positive and effective, sometimes not.

A few of the positives include:

  • Expanding higher education from 1 million to 7 million graduates a year over the last 15 years, deepening the available talent pool to work in R&D enormously
  • Encouraging multinationals to set up R&D centers in China in which many Chinese graduates could learn the disciplines needed to innovate and to commercialize innovations at scale
  • Not squashing the Internet. By doing relatively little, by allowing experimentation in business model, by permitting ambiguous legal structures, by not trying to regulate in advance, the government enabled the emergence of Internet champions in China
  • Allowing people to get wealthy. Successful innovation leads to large scale wealth creation. The government has embraced this when it has occurred in the private sector
    Providing access to state funded research teams. For example, many biotech and medical startups have benefited from partnerships with the Chinese Academy of Sciences and leading universities
  • Encouraging the development of the VC and growth capital sectors.Many global and local VC funds have successfully brought to Chinese entrepreneurs not only capital, but also the experience needed to grow and relevant networks
  • Creating competition between local governments. Competition between cities to attract and grow companies has always been intense. This has created the opportunity to play off cities against each other to get the best possible mix of incentives and market access

The impact of this next set of levers has been more mixed

  • Providing capital. The government has made money available in line with their 5-year plans, for indigenous innovation and more. Not always with great results, as seen in solar and semiconductors, areas where capital was perhaps spread too thinly across too many players and was insufficient by itself to create a winning set of companies
  • Imposing industry structure through requiring joint ventures. In some industries, such as high speed rail, the joint ventures between domestic and international companies clearly accelerated the development of stronger domestic companies able to create their own innovation. In other sectors, like passenger cars, the impact has been less significant

Going forward, the government may take on a bigger and more complex role of creating the environment for entirely new industries such as electric vehicles or city-wide health management solutions.

In electric vehicles, for example, the government can subsidize the development of vehicles, the selling price, the installation of charging points and more. Moreover, it is probably one of the few governments that could actually mandate the use of electric vehicles. We will see if it does.

 

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Foreign Investors Show How China’s Economy is Changing http://www.mckinseychina.com/foreign-investors-show-how-chinas-economy-is-changing/ http://www.mckinseychina.com/foreign-investors-show-how-chinas-economy-is-changing/#comments Fri, 28 Nov 2014 05:56:53 +0000 http://www.mckinseychina.com/?p=8116 Foreign investment into China dropped slightly in the first 10 months of 2014, by 1% to $96 billion. That by itself is perhaps a little surprising as China certainly continues to grow, and will likely represent between a quarter and a third of global GDP growth this year.

Within the total number, a major shift is taking place. Investment in services rose 7% to $53 billion. That’s right – more than half of foreign investment into China so far this year is going into services. These companies don’t view China as the factory for the world; they view domestic demand for their services driving their growth.

Yes, you can argue that most foreign companies that were ever going to build factories in China have already done so. But those factories are here, and they are not expanding that much. Maybe gains in productivity can match growth in demand.

Net net though, I believe it is very positive for the Chinese economy to have that much foreign investment coming into many service sectors, to provide new services that will be purchased by Chinese consumers, and to stimulate domestic competition to improve (in the same way that foreign investment has stimulated Chinese manufacturers to improve over the last 20 years).

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Want More Opportunities? Pick Uncertainty Over the Safe Route http://www.mckinseychina.com/want-more-opportunities-pick-uncertainty-over-the-safe-route/ http://www.mckinseychina.com/want-more-opportunities-pick-uncertainty-over-the-safe-route/#comments Tue, 25 Nov 2014 05:50:16 +0000 http://www.mckinseychina.com/?p=8113 I have been in China for over 20 years and with McKinsey for nearly 30. It might seem, therefore, that everything was very linear and that the only major choice I might have had was to leave China, or perhaps to leave McKinsey and stay in China. To me it has been pretty much a no-brainer to stay in China for most of that time frame.

As for doing something else in China, there certainly has not been a shortage of opportunity elsewhere. But the development of so many private Chinese companies continued to create new and varied opportunities for me to serve as a counselor to top management teams. I really didn’t believe I was going to have more impact elsewhere. And as McKinsey became more successful in China, I had the opportunity to spend time in global leadership roles at McKinsey.

But earlier there were choices. They were the choices that got me from a town in the north of England to McKinsey in China. If I had turned left rather than right in any of these four choices, I would likely never have come close to China, let alone spend 20-plus years building an institution in China.

1. Boarding School or Not

When I was 10, the construction workers in the town I was growing up went on an extended strike. I don’t really recall for how long, but it was long enough to prevent the school I was supposed to be going to from being finished. Instead, we had to go for half days to a shared school where the teachers seemed more interested in supporting the striking builders than teaching the students.

After a few months, my parents took me to visit a different school, a boarding school about 30 miles away from home. Did I have any idea whether or not it was better? No, I had no clue. But it was certainly different and on that basis, I decided yes I wanted to go. And so I did. Pretty much the rest of my academic career followed from taking advantage of the opportunities that this decision opened up.

Why did I make this choice? Looking back, I think it’s because I like to do the things I know least about.

2. Engineering or Business

Engineering always seemed a natural career path. I was successful at math and physics. There were lots of industrial companies around where I grew up and lots of people working there seemed to call themselves engineers. My grandfathers and father had studied engineering. To get some experience and to improve my cash flow at university, I sought sponsorship from an engineering company. By working there for 9 months before university (for the grand sum of GBP55 per week) I learned a lot. Most importantly, I learned that if I wanted to run something, to be a decision maker in this kind of business, it was pretty unlikely that I would get there if I became an engineer.

It took me a while to work out what other options might be possible – I was committed to completing an engineering program at that point. In the summer of my second year (on a three-year course), I visited the U.S. and showed up on half a dozen business school campuses to see what they were like. My choice on graduating was to take up a position as an entry-level engineer or to move to the U.S. and study for an MBA (something only one person I knew at that time had ever done).

Taking the option that I understood less but which was truly different – another country and a reboot of what I would study – was the one to take. I barely knew what you studied at business school, but that made it all the more interesting.

3. BCG or McKinsey

After about three months at business school, companies that I had never heard of started showing up and inviting us out for dinner. This was new to me and required me to buy new “non-engineer” suits quickly. For my summer position, I joined BCG in London. Why? They seemed a little edgier, a little more upstart, and Bruce Henderson’s thought leadership struck a chord. The summer taught me the basics of what management consultants did, and I was hooked. It seemed a path to those roles and decisions that engineers rarely got a chance to take.

But McKinsey or BCG? Their offices were a couple of hundred yards apart in London. But I had worked at one, and I had not worked at the other. This decision actually took me awhile, probably longer than all three other choices described here combined. It’s impossible to say how long I would have stayed at BCG had I gone there, but as a result of the choice, I have had the opportunity to grow at McKinsey for nearly 30 years (having had the luck to join London at a time when some of the firm’s greatest talent who went on to lead the firm globally was based there).

Why did I make the choice for McKinsey? Again, I think it was because I knew what BCG was like, and while I thought I knew what McKinsey would be like, I could not be certain.

4. London or China

The point at which I came closest to leaving McKinsey was in 1993, just after I was elected a partner. I had climbed that mountain, and I could not really see what the next one was going to be and why I would get excited by it. I actually picked up the phone when search firms called.

Then by chance, on a recruiting trip to Chicago, I met my former study group member from business school, now a partner at McKinsey in Hong Kong. He described what it was like to be in a tiny office in an enormous geography, where few people knew of consulting, let alone McKinsey. The unknown, and in this case truly unknowable, beckoned again. It took only a few weeks to decide to move to Hong Kong, and then a little while later, on to Beijing. And China has been home ever since.

This worked for me, but I’m not sure it would sell many copies if I tried to turn it into a career planning philosophy and book.

Three common themes:

1. Make a big change only rarely.

2. Pursue what you don’t know, rather than what you do.

3. Don’t agonize, trust your instincts and get on with it.

Read more of my views on my  LinkedIn Influencer blog. And please follow me on Twitter.

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Do Chinese State-Owned Enterprises Innovate? http://www.mckinseychina.com/do-chinese-state-owned-enterprises-innovate/ http://www.mckinseychina.com/do-chinese-state-owned-enterprises-innovate/#comments Tue, 25 Nov 2014 05:47:49 +0000 http://www.mckinseychina.com/?p=8108 Not could they, but do they? “Could” would focus on whether they have the talent and the capital as inputs to conduct innovation. In most cases, they do have lots of great talent and a strong balance sheet.

But do they innovate? Only in a few instances, where it is the only way to keep customers. In most cases, the barriers to innovating are too high. For example:

  • A CEO’s key performance measures (KPIs) may make no mention of innovation and he has no incentive to do anything not directly in his KPIs.
  • There is an implicit requirement at most SOEs that a new business make money in its first year.
  • Consensus-based decision-making is slow and cumbersome and pulls towards the status quo.
  • Regulatory influence may seem an easier path to sustaining performance than innovating new products and services.
  • The pay off from innovation may be beyond the time frame of the CEO and Chairman.

Where innovation has taken place, it has largely been in those sectors where China’s market – power, rail, transmission, etc – has become the largest worldwide, and in which international players are having a real impact in terms of the share they are capturing. State-owned enterprises have upped their game through partnerships and other means. Now they are starting to export and compete globally against the multinationals they spent 20 years learning from in China.

There could be a lot more innovation from the talent in Chinese SOEs, but it’s not likely to happen.

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Chinese Innovation Has Gone Global http://www.mckinseychina.com/chinese-innovation-has-gone-global/ http://www.mckinseychina.com/chinese-innovation-has-gone-global/#comments Tue, 11 Nov 2014 09:33:47 +0000 http://www.mckinseychina.com/?p=8102 More and more Chinese products are finding their way into our lives across a remarkably broad range of sectors, including many we may not realize. Yes, we know that the clothes we buy tend to have “Made in China” on the label. And if we look at the small print on the sticker of our smart phone, tablet and PC, it will most likely say “Assembled or Made in China.”

There is not a lot of innovation associated with that historically. But even in these sectors things are changing. The center of gravity for innovation in fibers and fabrics has in recent years been South Korea. Now, some of the most exciting innovation, especially for creating fibers from recycled products, is happening in China. In PCs, the global market leader is now from China. In smartphones, the buzz today comes from a Chinese company only a few years old and many global telecom operators have made a Chinese handset vendor their supplier of choice.

China’s leading industrial companies are achieving more and more successes internationally, supplying products whose country of origin we might never naturally think much about. Chinese nuclear companies are venturing into the UK. Their high speed rail train producers have a contract in Russia, and hope to land deals in Malaysia and the UK soon. Boston’s public transport system just agreed to purchase Chinese-designed, made in the US vehicles for its renewal. Huawei has been supplying network equipment to telcos in Asia, Africa and Europe for many years. And now, the servers that support the IT operations in many businesses will be made, sold and supported by a Chinese company.

China’s Internet giants are not content to remain domestically focused. Baidu has a Bahasa search engine for South East Asia and is gaining share in several ASEAN markets. Alibaba has local language sites in many markets, has made acquisitions and taken stakes in firms, such as luxury ecommerce site 1stdibs in the US, and is investing in logistics and support services from Singapore to South Korea to Italy. Tencent has invested in a portal in Thailand, a social network in Korea, and continues to gain share as a social media platform in many European markets.

Both behind the scenes and in products and services we use daily as consumers beyond China, Chinese innovators are capturing greater market share.

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Do Joint Venture Boards Do Anything In China? http://www.mckinseychina.com/do-joint-venture-boards-do-anything-in-china/ http://www.mckinseychina.com/do-joint-venture-boards-do-anything-in-china/#comments Thu, 06 Nov 2014 08:58:55 +0000 http://www.mckinseychina.com/?p=8096 I sometimes get asked how to make joint venture boards in China more effective. Generally there are two answers to that question:

  1. If the board is already in place, rather than in the process of being set up, then it is probably too late to do anything much about how it operates – live with it.
  2. Why are you trying to do things through the board anyway?

The board is never the total solution for corporate governance of joint ventures, and in China, it may not be part of the solution at all. There is a whole class of joint ventures which are entirely dominated by one party and the passive partner is along for the ride. These companies tend to be almost run as if they were part of the dominating company with the board meeting as infrequently and briefly as possible to meet legal “must do’s.”

But the board is never the total solution, and generally it is largely more of a ratifier than a decision maker, even for joint ventures where both parties need each other and both make material contributions. Usually the shareholder agreements say who appoints who and how many to the board and management positions. It can simply be management from the joint venture on the board, or someone from the China or even global top team of the multinational.

There is almost never an independent director role. All directors represent one or other shareholder. The exceptions to this can probably be counted on one hand and are there to create a very specific escalation in case of deadlock to a party both partners trust. However, the actual use of the escalation mechanism is very infrequent.

Other types of formal escalation mechanism do exist. There are several examples of joint ventures between a large private sector Chinese company and a large international investor that allow deadlocked decisions to go to the controlling owner of each party.

Boards that work most effectively tend to be ones where the investors know that they need each other and that they are joined at the hip indefinitely for business, not regulatory reasons. These boards tend to have members who stay for an extended period and when they roll off it is because they have been promoted into more senior positions in their corporations. Having former board members in very senior positions at headquarters is great for the long-term relationship between partners and is a characteristic of many of the more successful arrangements.

Net net, expecting to rely on board meetings as a primary forum for dispute resolution in Chinese joint ventures is likely to lead to disappointment and frustration.

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Yes, Chinese Companies Innovate http://www.mckinseychina.com/yes-chinese-companies-innovate/ http://www.mckinseychina.com/yes-chinese-companies-innovate/#comments Mon, 03 Nov 2014 08:53:01 +0000 http://www.mckinseychina.com/?p=8093 Hopefully we are getting beyond the debate on whether Chinese businesses innovate to what the impact of that innovation will be in China and globally. From biotech to the Internet to logistics, I see companies creating new business models, products and services, most of which are informed by their own development work and the needs of the market in China as they see it.

Whether it is a Chinese biotech company creating the world’s first Hepatitis E vaccine, or an innovative new drug for treating lung cancer … the list can go on. Each of these companies has assembled a team of world-class researchers from China and outside, provided them with modern, well-equipped facilities, and given them the space to research.

On the Internet, beyond the famous firms making headlines, I see companies innovating to address issues such as consumer fear of unsafe food products with, for example, QR coded products that are tracked from field to home and delivered within 48 hours.

In financial services, innovative use of data allows one-minute credit assessment for particular needs. In logistics, major companies provide benefits and discounts on services, and spares to their owner-operator drivers, for allowing in-truck monitoring of their driving practices and location.

The value-driven innovation that Chinese companies have pursued for many years continues to be a vibrant source of innovation – from Sany in construction equipment through the myriad of $100 smartphone producers to the companies that have captured a 75% market share of stents in China. This will remain a core part of the strategy of most private sector Chinese companies for years to come.

This strategy means designing and engineering to the quality, durability and functionality needs of the customer exactly, not more than they ask for. And once confident in achieving that level, gradually moving on to serving customers with greater needs, and incrementally improving the performance and cost of the product to do so. In many industrial and electrical sectors today, I see a swathe of Chinese companies starting to make this transition, and to explore serving international, not only local customers.

What is your best (and worst) example of Chinese innovation this year?

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Let’s Eliminate The Frustrations Of Air Travel http://www.mckinseychina.com/lets-eliminate-the-frustrations-of-air-travel/ http://www.mckinseychina.com/lets-eliminate-the-frustrations-of-air-travel/#comments Sat, 01 Nov 2014 08:46:43 +0000 http://www.mckinseychina.com/?p=8089 In the unconstrained world of my imagination, I would like to eliminate all the unnecessary delays, inefficiencies, inconveniences and outright incompetencies associated with air travel.

To calibrate, I fly between maybe 200 times a year, with overnight flights several times a month . I often fall asleep before take-off, and have been known not to wake up until landing. I check luggage maybe once a year. I eat on the plane maybe once a month. (I have often wondered if there shouldn’t be a discount for the no-luggage, no-food segment of travellers…)

1. Start in the air

Install world-class air traffic control systems globally — on all planes, in all airports, in all skies, so that weather-related delays are consigned to history.

2. In the airport

Firstly, departures:

  • Ensure online check-in works everywhere, even Lahore, and works in the same way. This frees up check-in counter staff for those who need them, and makes no-luggage travellers very happy.
  • Once you’ve checked I have a visa, trust that it will still be there the following week when I am making the same trip. Don’t force me to go to the check-in counter for a visa check that you know that I have.
  • One quality security check is enough — I know it may go against the “full employment act” that so many airports seem to adhere to, but check my bags once, my passport once, my boarding pass once. I don’t really care where in the journey from street curb to plane seat it happens, but once is enough. In extreme cases it can be four times in less than 100 yards.
  • Provide information boards that actually have information, and that information is accurate. Why should the information on my smartphone app be different than on the airport information board, or to what the staff at the gate are empowered to share?
  • Have as many shops as you like (I spend a lot in them), but do include a couple of good restaurant options. As the counterpoint of not eating on the plane, I do like to try to eat in the airport.
  • Make the airport Wi-Fi free, or if not, make it really simple to buy a scratch card or electronic equivalent without having to go through a credit card torture test of approvals to spend $10.

Transit:

  • Have enough transit points spread around the terminals that passengers know that they can count on getting off the plane to being in the right departure area in 15 minutes.
  • This is where lounges are important. Two wishes. One: have enough showers, maybe not to meet peak demand, but at least more than one for an entire business class. Two – just because it is lunch time in your time zone doesn’t mean that all passengers want to each lunch. Make allowances for people whose head is in a different time zone.

Arrivals:

  • Land on the runway closest to your terminal, not the one in the next state. Certain airports seem to delight in getting the plane to land as far from the terminal as possible
  • Give passengers a bottle of water as they get off the plane. Almost everyone is slightly dehydrated and somewhat grumpy as a result.
  • Size immigration to maintain a line less than 10 minutes long.
  • Put something interesting on the video screen to distract people waiting in line, not an endless loop of how many sniffer dogs are inspecting your checked luggage right now.
  • Create an app that will guide me to the driver waiting in his car to pick me up.

3. On the plane

  • Minimize the noise pollution. No in-flight announcements about the weather/temperature that we can see if we look out the window, and announcements in three languages maximum.
  • Install a set of buttons on the seat to press that turn on a do-not0disturb light, a no-meal light, etc.
  • Install Wi-Fi on all planes. I will not use it every time, but it’s great to know it’s available.
  • Standardize on one global set of rules for using electronic devices and putting luggage under the seat in front. No more having to remember this airline requires all bags in the overhead, this one does not.

All conceptually doable, but today we move in very, very small step toward my vision.

Read more of my views on my LinkedIn Influencer blog. And please follow me on Twitter.

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Where Next For China’s Chemical Industry? http://www.mckinseychina.com/where-next-for-chinas-chemical-industry/ http://www.mckinseychina.com/where-next-for-chinas-chemical-industry/#comments Fri, 17 Oct 2014 15:08:51 +0000 http://www.mckinseychina.com/?p=8080 In return for sharing some views on China’s macro trends and direction on government policies, I was able to learn a lot recently about the direction of China’s chemical industry from a group of senior executives from a range of chemical companies.

What did they have to say?

  • Asia will generate 70% of global growth in demand for chemicals between 2012 and 2020]
  • China’s demand for chemicals in 2020 will be about 70% of total Asian demand and 8x the demand from Japan.
  • Key priorities for China – Increase self sufficiency through heavy investment in technologies like coal to olefins – Develop own technology and push it to scale through captive domestic demand (pretty similar to many other industries) – Grow strong domestic champions.
  • China’s imports are mainly very basic petrochemicals to which value is added domestically.
  • Scale of domestic capacity build up in recent years has moved China from net short to net long (e.g., PET, PVC, acrylic acid).
  • Private Chinese companies are reaching global scale (e.g. Wanhua, NHU).
  • The Asian chemical industry has changed from one led by Japanese producers to one with leading players in each major market who are in the global top 20 (see below).

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China’s Airlines: Flying Higher http://www.mckinseychina.com/chinas-airlines-flying-higher/ http://www.mckinseychina.com/chinas-airlines-flying-higher/#comments Wed, 15 Oct 2014 06:15:02 +0000 http://www.mckinseychina.com/?p=8049 China’s Big Three state-owned incumbent carriers—Air China, China Eastern Airlines, and China Southern Airlines— and their subsidiary airlines have been a bright spot in the airline industry globally, averaging until recently returns of 15 percent. Their success presents a marked contrast to the industry as a whole, which has averaged returns on capital of under 5 percent in recent years. The industry in Europe and the United States was badly shaken when large traditional carriers were caught off-guard by regulatory changes, and low-cost entrants rapidly captured large market shares. While the forecast market evolution in China does not present as stark a picture, returns have been lately falling off and a number of factors are converging that promise to change the industry landscape.

China is moving ahead with reforms in state-owned enterprises, designed to promote efficiency and profitability. Regulations on new entrant airlines and the speed of growth of private airlines are being relaxed. The effect of the reforms will tend to increase market competition. As latent demand for airline travel is building in China, the stage is set for both market expansion and disruption. With the advantage of hindsight on the experience in Europe and America, Chinese carriers are in a good position to develop effective strategies to ensure that the more competitive environment also creates value.

AIR TRAVEL IN CHINA: SUBSTANTIAL LATENT DEMAND…

Travel in China is an enormous but disproportionately earthbound industry. Thirty-five billion long-distance domestic trips are taken each year on traditional (i.e., not high-speed) trains and motor coaches. Based on benchmarks for travel propensity, we estimate that the number of travelers in China could easily rise by 50 or 60 percent as market conditions relax. The McKinsey Global Institute foresees threefold growth in the number of people in China able to afford airline travel in the next ten years. The upper strata of China’s fast-growing middle class is poised to become the principal engine of consumer spending—including air-travel spending—over the next decade. Combined with China’s newly affluent class, this segment will account for 80 percent of urban consumption by 2022, up from 30 percent in 2012. Outbound international air travel has been historically constrained by relatively tight visa regulations imposed on Chinese travelers by destination countries; these are steadily being relaxed, further stimulating travel demand.

With only 4 percent of the population owning passports, China still overtook the United States and Germany as the world’s leader in international travel in 2012. In 2013 more than 97 million Chinese traveled abroad, spending $129 billion in their destination countries. In 2014 the number of outbound Chinese tourists is expected to exceed 112 million.2 Meanwhile, inland tier-three and four cities have been developing rapidly, with stronger middle-class growth than in the urban strongholds of the eastern seaboard. These growth spots are creating opportunities for new air routes. Today China lags behind Brazil and India in passenger flights serving tier-three and tier-four cities; China’s international connectivity is especially concentrated in a handful of tier-one cities. This picture is about to change dramatically. China’s current five-year plan shows 70 new airports under construction and feasibility studies for 28 more. McKinsey’s research indicates that the availability of air travel will grow all over China, but it will increase 20 percent faster in tier-three and four cities than in tier-one and two cities.

…WITH (SURMOUNTABLE) BARRIERS TO CAPTURING IT

China’s Big Three carriers face significant but surmountable barriers in the coming years. Competition is increasing, putting downward pressure on the price of airline tickets. With yields per kilometer of around 9.5 U.S. cents, China’s domestic fares rival those of the US market, where travelers have more disposable income. This contrasts with carriers in adjacent markets – notably South East Asia – where new entrant low cost carriers are offering very low fares. By offering lower fares on domestic travel, the Chinese incumbents can awaken latent demand, stimulate further consumption, and reduce exposure to any new entrants. Incumbent carriers may have to shift their marketing strategy to handle the new demand. Presently, distribution is disproportionately centered on direct sales and traditional travel agencies, with little e-commerce. Branding similarly remains traditional and out of tune with a new generation of travelers. McKinsey’s research on the Chinese millennial traveler (20- and 30-year-olds) shows a more globally minded generation that is confident, independent, and looking forward to traveling. They are also Internet-savvy: 58 percent of those surveyed reported they were likely to book online.

 

AVERTING A VALUE-DESTROYING SCENARIO

With potential demand building in the Chinese market and greater competition expected, a scenario is developing whereby new entrants could capture much of the latent demand. China is the largest remaining air-transport market without significant penetration from new entrants, including carriers with a low-cost business model. China’s airline regulator, the Civil Aviation Administration of China (CAAC) has recently praised the efficiency of Spring Airlines, one of the few private new entrants. The CAAC has made it easier to set up a new carrier and for existing carriers to expand their fleets. A lesson from the European and American experience with new entrants is that after the market was penetrated by low-cost carriers, traditional carriers fell into losses due to market overcapacity and inflexible cost structures. The latent demand was by and large captured by new entrants. After a competitive shakeout, some of the new entrants survived, including Ryanair in Europe and JetBlue in the United States. Incumbent carriers often went through bankruptcy or tough restructurings. In China today, incumbents do not face so extreme a danger, but they can study the experience of European and American carriers and make corresponding moves to adapt profitably to the changes.

 

FOUR MOVES TO WIN IN A MORE COMPETITIVE ENVIRONMENT

US and European carriers were unable to react fast enough to the new entrants in their markets. Their high cost bases were designed for an era when air travel was a luxury. Chinese incumbents are in a better position to act to counter the risk. Four moves will go a long way to securing a profitable future.

Grow to serve new demand. Latent demand is burgeoning and competition from low-cost entrants is looming. Incumbents can best prepare to capture
this demand by restructuring and adding needed capacity now. They should do this even if it means two or three years of lower profitability, since the prize, in serving the new airports and the new demand in tier-three and four cities, will be large. The new strategy will need to address constraints to growth, including the price sensitivity of the new travelers, the time needed to train pilots, and slot restrictions in major airports. Each airline will have to allocate existing resources efficiently but expand early to serve the new customer segments and geographies, including new airports and existing secondary hubs.

Improve efficiency. We estimate that incumbent Chinese airlines operate at a 30 percent cost disadvantage against new entrant Spring Airlines. The primary reasons are lower daily aircraft utilization and lower-density seat configurations. A typical aircraft in the fleet of a Chinese incumbent will operate for 9 or 10 hours per day, while at Spring, planes operate for 12 hours on average. The incumbents can become competitive with better scheduling for pilots, crew, and aircraft. Similarly, processes both onboard the aircraft and in airports can be streamlined to adapt to the lower fare environment.

Modernize sales and branding. Chinese incumbents can modernize their sales and branding strategies. Incumbents have higher distribution costs because they use traditional travel agency channels and need more staff than low-cost carriers. Brands need revitalizing to ensure appeal to a newer generation of traveler. Incumbents can push for 50 percent Internet distribution, for example, both to reduce costs and to attract new selfdirected customer segments. Last year, Spring Airlines exceeded 90 percent in the share of sales made through e-commerce channels; 24 percent of their individual travelers booked with mobile devices.

Drive other sources of revenue. Internationally, customers have proved to be less sensitive to the pricing of ancillary services (such as baggage, seat selection, and meals) than to the core ticket price. Mindful of the need for lower ticket prices, the Big Three carriers can explore the willingness of their customers to pay for some of these ancillaries. They can also look for other sources of revenue: cross-selling travel products such as hotels, transfers, or tours, and—in recognition of the burgeoning demand from China’s express delivery market—carrying more cargo in the belly of the aircraft.

 

LOW-COST SUBSIDIARIES ARE A DISTRACTION

Some carriers globally have responded to the challenge by setting up their own subsidiary low-cost carriers to compete with new entrants. The philosophy behind this approach is that low-cost carriers serve a different customer segment than do mainline carriers. We believe this is a misconception and that the strategy it supports distracts management attention and company resources from the real solution. For Chinese incumbents, this solution is to expand and improve productivity in their core airlines. The direct route, of improving the existing airline, can be difficult, but we have seen carriers succeed. LAN in Latin America recognized the risk of new entrants capturing latent market demand. The airline underwent a major restructuring and developed from a traditional full-service carrier into a more productive, leaner carrier offering lower fares. The new business approach allowed LAN to capture growing demand for air travel, stimulate new volumes from bus travelers, and cement its leadership position in the market.

***

China’s Big Three carriers are well positioned to understand and surmount the new market challenges. They have a lot to win in capturing China’s large and growing latent demand for air travel. It is only natural, however, that big growth should require big efforts to capture it. The authors acknowledge the contributions to the development of this article made by Peimin Suo, an analyst in the Shanghai office.

 

About the authors
Alex Dichter is a director in McKinsey’s London office and leads the firm’s airline practice globally, Jin Yu and Steve Saxon are principals in the Beijing office, and Mathieu Weber is a specialist in the Luxembourg office.

 

Download a PDF of this report: China’s Airlines – Flying Higher

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Evaluating Our Partners http://www.mckinseychina.com/evaluating-our-partners/ http://www.mckinseychina.com/evaluating-our-partners/#comments Tue, 14 Oct 2014 14:59:15 +0000 http://www.mckinseychina.com/?p=8075 McKinsey is a global partnership of close to 1,500 colleagues based in more than 60 countries around the world. Without successful partners we cannot be a successful firm. One of the key ways in which we maintain our values and connectivity is that we run a single integrated global evaluation process for partners.

Let me bring this to life with my involvement in the process in the spring of this year. I am based in Shanghai and responsible for evaluating our partners in Russia, Ukraine, Poland and the Czech Republic.

Of course, we leverage technology, but the core of the process is the time I invest face to face with these partners. The first step in the process has me receiving a number of documents electronically that detail which colleagues a partner has worked with, which clients the partner has served, and a write up from the partner of his own assessment of his growth as a leader over the last year.

Leadership has multiple relevant dimensions for us – people leadership, entrepreneurial leadership, Firm building leadership, and knowledge leadership, as examples. Based on this, I will conduct interviews with as many of the colleagues a partner has worked with as it takes for me to get comfortable that I have a complete picture of their achievements. This will be a minimum of 15 but could be a lot more. I will also have a lengthy discussion with each partner I am evaluating, sometimes several, each several hours in length. As this was the first year I was evaluating these colleagues, I flew to visit them in their offices so that we could get to know each other better.

With this deep qualitative input from the interviews, I sit down to prepare a structured summary of everything that I have learned, and make a recommendation on rating, but more importantly, on what the key points of feedback should be. I do this by writing a draft of the feedback memo.

Few things are absolute in the process. One element that is, however, is any shortcoming on values. If colleagues have values concerns about a partner, it is impossible for them to be highly rated, and feedback must lead off with this topic.

Armed with my write ups, I set off to spend a week in the McKinsey Learning Center in Kitzbuhel, Austria with 50 partner colleagues that have been making the same preparations. We divide into teams of about a dozen partners from all around the world, and go through a process of challenge on each colleague being reviewed.

I summarize my findings on a specific partner to my team. I am challenged on the thoroughness of my preparation, on the rationale for my findings, and my recommendations for feedback are picked apart and put back together. Once the colleagues in the room are confident we have a full understanding, we vote, and until there is a clear majority on the outcome we will continue the discussion. Indeed, even if there is a clear majority, any individual can reopen the discussion if they feel the majority is missing the importance of some topic. Some days the team will meet long into the evening.

It is always tempting to view the process as done at this point, but in many ways the most important step is yet to come. Giving feedback in writing and verbally is the step that leads to impact and helps our colleagues become more successful in the year ahead. I practice extensively in advance how I am going to communicate the key messages. On the videoconference feedback sessions, I test multiple times to ensure I have really made myself clear. Allowing the feedback conversations to run as long as is helpful for the recipient is part of the plan. Following up a few months later is also.

This is incredibly time intensive for all concerned, and while we add technology to enhance the process, we consider it absolutely essential that this remains a global process. It has been this way throughout my nearly 30 years at McKinsey, and I don’t envision it ever changing.

 

Read more of my views on my LinkedIn Influencer blog. And please follow me on Twitter.

Image credit: Kitzbuhel, Tirol, Austria – geordietyke / Flickr

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A Pocket Guide To Doing Business In China http://www.mckinseychina.com/a-pocket-guide-to-doing-business-in-china/ http://www.mckinseychina.com/a-pocket-guide-to-doing-business-in-china/#comments Fri, 10 Oct 2014 14:17:51 +0000 http://www.mckinseychina.com/?p=8066 China, a $10 trillion economy growing at 7% annually, is a never before seen force reshaping our global economy. Over the last 30 years, the Chinese government has at times opened the door wide for foreign companies to participate in China’s domestic economic growth. At other times, it has kept the door firmly closed. While some global leaders, such as automotive OEMs, have turned China into their single largest source of profits, others, especially in the service sectors, have been challenged to capture a meaningful share of revenue or profits.

In the following post, I summarize some of the trends shaping the next phase of China’s economic growth, which industries might benefit the most, and what could potentially go wrong. I also lay out what I believe it takes to build a successful, large-scale and profitable business in China today as a foreign company.

Trends shaping growth and creating new opportunities in China

As the contributions of net exports and real estate to economic growth diminishes, the focus on infrastructure and domestic consumption, as traditional and new sources of growth for the economy respectively, rises. Whether or not the current growth of the Chinese economy is sustainable depends on the evolution of several trends.

Government policy continues to be the critical shaping force. As the mini stimulus delivered in Q2 2014 demonstrates, the government still possesses levers to push up and down GDP growth rates quite rapidly. In other ongoing government initiatives, the “marketization” of prices for electricity, water, land and capital is having a major impact on the behavior of business, leading to a new focus on productivity, even in state-owned enterprises. Progress in bringing more private capital into state-owned enterprises is slow at the national level, with few scale examples such as the $30 billion partial privatization of Sinopec’s gas stations underway. At the city level, much more momentum is building with local governments selling out of non-core activities such as hotels and many manufacturing businesses. The anti-corruption campaign continues aggressively throughout state-owned enterprises, and government has itself become a material brake on growth. Officials and executives are simply unwilling to make decisions that could possibly be held against them later. President Xi has pursued anti-corruption as a theme for more than a decade; he is not going to back off.

The Chinese middle class, the people who are buying new homes, who today are buying 18 million cars a year (delivering a third of global auto industry profits), and who are starting to spend more on services, are critical. Only if they remain confident in their personal economic future will they continue to increase their spending and become a larger driver of economic growth. By 2022, more than 50% of urban households should be in the middle class (in current $, US$20-40k annual household income), an increase of more than 100 million households over the coming decade.

China is now more than 50% urban, but 10-15 million people a year will still be moving to cities from the countryside. Rural migrants already in the cities need to be better integrated. City governments need to make their cities more livable, more efficient and better able to integrate their migrants. Smart cities is a clichéd term, but China’s cities need everything from more efficient mass transit to water usage. Investment to deliver this will be massive, indicating how the construction of China’s infrastructure is not yet done.

Many businesses are coming under a new level of cost and margin pressure.

  • Margins of industrial state-owned enterprises have fallen by a third over the last four years. Often the industries they compete in, from steel production to telecom network equipment, are simply growing much more slowly. By the standards of China over the last 30 years, they have become mature industries. This leads to three outcomes – initiatives on productivity, diversification and globalization. The latter two are more often conducted on the basis that prior success in one industry in China will automatically lead to success in the next industry and country.
  • Multinationals selling to Chinese consumers often continue to perform extremely well, using their skills in consumer insights, branding and pricing to differentiate from local companies, who while large, are still developing world class functional capabilities. Multinationals selling to government, at the other end of the spectrum, find market access much more challenging.

China is home to some of the world’s largest, most successful and innovative Internet based companies. The pace at which Chinese consumers are embracing the Internet is at the cusp of causing major disruptions to many sectors in China. Perhaps because consumers are still new to our traditional ways of shopping or banking (only having had modern shopping malls for a decade in many cities), consumers are very willing to switch to buying online. When the experience of going into a Chinese bank branch is so poor, it’s not surprising that consumers would rather transact online.

Almost no consumer facing business in China can succeed without an online and off-line strategy today. Mall owners are struggling to find a new economic model. Retailers are trying to bring order to their nationwide distribution chains to exert control over the price at which their products are sold online. Online wealth management products have been able to gather US$100 billion dollars in less than 100 days, forcing traditional banks to increase rates on much of their deposit base. The impact on jobs is just starting to appear, but many millions of sought after white collar jobs will be eliminated in the next few years.

The risks

This growth is not risk-free. Perhaps most critically, Chinese consumers remain relatively unsophisticated. A loss of confidence as a result of a default in a wealth management product, or a decline in housing prices in a specific city, could easily become a nationwide contagion creating a vicious cycle of consumers withdrawing from spending, thereby worsening market conditions. One has to be over 40 to remember a recession in China.

Other risks to growth include geopolitics, especially China’s relationship with Japan, where the government’s credibility depends on being seen to do the right thing by the internet classes. A final and rising risk is the underemployment of graduates. Of seven million graduates each year, maybe only three million find jobs that require a degree. The remainder find their aspirations to join the middle class and own a home and car possibly permanently out of reach. They are a large, dissatisfied and growing segment of society.

Industries with potential for faster growth in the next decade

Many of the industries with the highest growth potential in China over the next decade are in the services sector, but not all. For example, energy and agriculture will have segments with very rapid growth. Below is a very brief snapshot of where we see opportunities.

Etailing: The online share of retail in China, at 8% in 2014, is higher than in the U.S., and is not close to reaching saturation. Increasingly, this is conducted through mobile devices (helping Apple sell more than US$30 billion of devices in China annually). The payments system is in place, logistics are improving, online providers are trusted. Many retailers will adapt, often with far fewer physical locations. Malls will have to become destinations for services beyond retail.

Logistics: Modernization of supply chains is a key enabler of increasing productivity in many sectors in China today. Until recently, most goods were carried by individual truck owner-operators. As express parcels become a US$100 billion industry on the back of etailing, ecommerce companies themselves are investing billions in modern warehouses and trucks. Alibaba alone is committed to spending billions of dollars on its own logistics. Third party carriers such as SF Express are rapidly becoming regional leaders on the back of growth in China. Even in agriculture, massive investment is underway in cold storage and cold carriage to reduce wastage and provide higher quality food products to China’s middle class.

Education: Nearly two-thirds of registered kindergartens in China are privately owned. Private universities are expanding. Traditional and online vocational learning schools are publicly listed multi-billion dollar businesses. Niche businesses, such as preparing children to apply to US, UK and Australian high schools and universities are also flourishing. Chinese willingness to spend on tutoring and support for their children is almost unlimited. As the middle class becomes wealthier, the increased ability to spend will drive market growth.

Healthcare: More than 1,500 new private hospitals opened in China in 2013, a number of which are 100% foreign-owned. The shortcomings of the mainstream public healthcare system in China are not likely to be overcome quickly. Patients are looking for solutions where both cost and quality are more certain, and private and foreign companies are being encouraged to deliver. There is a related boom in supplying equipment to these new facilities.

Tourism: Available hotel rooms in China have tripled over the last decade. Four million mainland Chinese visited South Korea in 2013, four million visited Thailand. China’s middle class expect to take 3-4 weeks of vacation each year and no longer accept visiting the overcrowded, over exploited traditional domestic destinations. Disneyland’s opening in Shanghai in 2015 could trigger a new wave of investment to create higher caliber resorts.

Wealth management: China represents more than 50% of Asia ex Japan growth, with high net-worth (HNW) assets expected to reach US$16 trillion by 2016. The more than 1 million HNW individuals in China remain generally unsophisticated as investors, seeking advice on how to broaden their investment portfolio both onshore and offshore.

Entertainment: China is the second largest movie box office market in the world, despite tickets costing upwards of US$10 and DVDs still being available for $1. In 2013, more than 1000 new theaters opened, yet admissions per capita are less than one-fifth of South Korea.

IT Services: Finding the CIO in a Chinese company is often hard, especially in a state-owned enterprise. Historically regarded as simply a support role for the business, CIOs were pushed 3-4 levels down in the organization and attracted little talent (which went to Internet startups). A typical Chinese company spends only 2% of revenue on IT versus international benchmarks of around 4%. As these companies struggle to bring technology into the core of their operations, they need massive amounts of help to do so. Already the cost of good IT talent is soaring. Most Chinese companies will be unable to solve their technology challenges for themselves.

Clean energy: China already produces the 60% of solar panels and wind turbines for the global economy. Increasingly it is consuming this output domestically. For example, 11GW was installed in large scale solar farms in 2013, and this will grow another 30% in 2014. China is also investing heavily to exploit its shale gas assets and develop cleaner coal technologies.

Agriculture: China does not feed itself today and will be challenged to do so in the future, certainly not with the kind of quality and value-added products that the middle class seek. Continuing food safety crises illustrate the challenge. For many successful technology investors, such as Legend Holdings, agriculture is the new Internet. Chinese companies are investing in agriculture outside China at scale, from Chile to the Ukraine, for China. They also invest in China, especially in value-added products – such as fruit and the production of frozen ready meals.

Doing business effectively in China

Often in China, the fundamental barrier to success is often less about identifying the opportunity, and more about the inability to execute the plan more effectively than others. One’s own management team, the team’s relationship with corporate headquarters, the role of and relationship with joint venture partners – all play a key role. Joint ventures have been part of doing business in China for over 30 years. In many sectors, they remain the only way to participate, often in a mandatory minority position. But there are a number of clear learnings:

Establish the right strategic positioning.

  • If regulations require you to have a joint venture partner and a minority position today, assume it will be that way forever in the core business activities. From automotive to financial services, the lesson is that it won’t change. If that model is not attractive today, do not invest in the hope that it will change.
  • Follow the evolution of government policy and align your stated intent with such policy as far as possible. Using the words from government statements in your statements communicate your commitment to China.
  • Be clear if you are in China for the opportunity in China, or if you are in China for the opportunity that China creates for you in the rest of the world. This can lead to a very different presence in China.

Many likely joint venture partners are highly successful and very large within China, who see international partners as little more than a temporary accelerator of growth.

  • Their mindset is increasingly that there are fewer and fewer things to learn from foreign partners. They don’t need the capital, they can hire the skills, and they have the customer relationships, insights and, most critically, the government relationships. Even state-owned enterprises now hold this mindset.
  • Simply promoting “this is how we do it in America/Germany/Japan” will not win friends. What one can do today is make a long-term commitment to help a Chinese joint venture partner expand internationally. This may well be at a cost to the international partner’s existing business, and needs to be seen as part of the total China investment.
  • Establish from the outset a clear hierarchy of who interacts with whom at the joint venture partner and with relevant government officials. Chinese partners like the certainty this provides. Ensure that the committed executive shows up for board meetings and the like, and don’t delegate.

Place a trusted senior colleague in China with a commitment to have him/her be there for the long term. He or she is your go-to person when things get volatile in China, someone whose viewpoint the global management team will trust, and someone the head of your joint venture partner will also learn to trust. Usually they will be very strong in people development, with skills almost overlapping with a head of HR. And they need to be 100% trusted to enforce compliance and to role model required behaviors. Typically, make this person Chairman of your Asia or China operations, as senior a title as possible.

Talent acquisition and development, at all levels, remains highly time consuming and often frustrating for multinationals. Loyalty to an employer often comes low on an individual’s priority list. Turnover will likely be high and should be planned for.

  • Hiring mid-career executives is increasingly common, and in almost all industries, the available talent pool is deepening. Both Chinese and global search firms have rapidly growing businesses serving local and international companies. It is imperative to do thorough background checks. Getting people to leave quietly in China often involves being silent on the cause of separation.
  • At the entry level, many graduates are available. However, many lack workplace-relevant skills, including even those with MBA qualifications, which are more often bought than earned, and often come with a lack of self-awareness that can lead to a mentality of entitlement. As a result, many corporations hire and then weed out aggressively during the initial probation period. Once on board, retention of high performers often depends on a highly variable compensation structure and dismissing underperformers.
  • While you will likely have to work with “sons and daughters” of government officials as business partners, it does not mean that you have to employ them. Outside of some companies in financial services, few international firms do.

If protecting IP in China is a concern, consider it very hard if that IP needs to actually come to China. Some companies in the technology sector have been very successful, even while not bringing core IP into China. Secondly, consider if the cost of loss of IP could be contained solely in China. Again in technology, multinationals have aggressively and successfully sued Chinese companies outside China that have taken IP from them in China and used it outside China. China is evolving fast on IP protection with more and more Chinese companies suing other Chinese companies. It is increasingly likely that a Chinese partner will recognize the value of IP and be willing to protect IP developed jointly with them. A practical means of making it harder for global IP to leak into China is establishing a standalone IT architecture for China that has no access to servers at headquarters.

China is likely to be a more volatile economy going forward. Taking a through cycle viewpoint rather than a quarterly performance versus plan mindset is key to motivating your China team and convincing them that you are committed to China for the long term. Indeed, downturns in China have proven attractive moments to double down. When partners or government are under stress, new partnerships and licenses can become available to foreign partners who are willing to step up and invest. Even after 30 years, few multinationals have this mindset.

Don’t do anything to compromise your global brand and reputation. If you can’t do business the way you want to, then don’t do it at all. There may be opportunities to make money in the short and medium term, but short cuts will eventually be made transparent. The Chinese government will be well aware of how you are operating and the anti-corruption campaign is not going to go away. Don’t assume that because your suppliers are international companies that they are automatically operating to the global standards you expect; verify that they are.

 

Read more of my views on my  LinkedIn Influencer blog. And please follow me on Twitter.

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This Is How Taipei Can Regain its Mojo http://www.mckinseychina.com/this-is-how-taipei-can-regain-its-mojo/ http://www.mckinseychina.com/this-is-how-taipei-can-regain-its-mojo/#comments Sun, 05 Oct 2014 03:44:34 +0000 http://www.mckinseychina.com/?p=8038 Taipei has many strengths – educated workforce, clean air, great high tech companies, Asia’s leading international schools. And it’s faster to get to downtown Shanghai from downtown Taipei than it is to get to downtown Shanghai from downtown Beijing.

Yet so many conversations with Taiwanese business people are doom-filled diatribes against the government and others for preventing things being as good as they should be. The lack of self-confidence is alarming.

What would I suggest as a few bold initiatives?

  • Play up the connectivity with Shanghai. Encourage people to split their weeks between the two cities, maintain two offices, two homes. Increase the number of flights from Songshan Airport in downtown Taipei to Hongqiao Airport, in downtown Shanghai. Build business parks that are adjacent to each airport. Promote Taiwan as a weekend home destination, the “closest clean air” to Shanghai.
  • Play up the pool of highly productive Mandarin speakers in Taiwan who have lower wage demands than peers in Shanghai for roles from office support to R&D.
  • Build creative industries at scale, learning from South Korea. The film Lucy was certainly creative and it was made in Taiwan. Why not 10 times more of these productions?
  • Get serious about developing medical tourism as an initiative and build it to scale, for everything from health checks to plastic surgery to heart bypass surgery. Partner with the companies insuring wealthy mainland Chinese to accept their insurance programs in Taiwan. Do it now or the opportunity will be taken by others.
  • Build the North Asian “Orlando”, a cluster of theme parks seamlessly connected to and close by Taoyuan Airport, located an hour outside of Taipei. There are many theme park companies around the world who would leap at the opportunity to build within a two-hour flight of tens of millions of middle class Chinese.
  • Green Taipei further. The city is already pretty green. But go even further, and turn it into a role model eco-city. Replace all motorbikes with e-bikes, roll out trams, reclaim and green over empty lots, and create micro parks from spaces that are used as parking lots today.
  • Rebuild and contemporize Taipei’s office and residential buildings. Given their fragmented ownership, this is not easy, but is a must for the city to show a modern face to the world. Allow mainland developers to participate in the rebuilding – most are looking to diversify outside China. Allow the mainland developers to market to mainland buyers.
    These won’t all happen, but they could, and they would make a difference.

 

Read more of my views on my LinkedIn Influencer blog. And please follow me onTwitter.

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Why The Internet Economy Causes So Many Problems For Chinese Officials http://www.mckinseychina.com/why-the-internet-economy-causes-so-many-problems-for-chinese-officials/ http://www.mckinseychina.com/why-the-internet-economy-causes-so-many-problems-for-chinese-officials/#comments Fri, 03 Oct 2014 03:39:38 +0000 http://www.mckinseychina.com/?p=8034 There is something of a panic setting in among the mayors of Chinese cities as they see Internet-related businesses becoming more and more significant. They know they don’t fully understand how it works, but they do know their children, friends and family use it a lot. They see companies with enormous valuations, but they don’t see the jobs. And they see lots of excitement and hype today, but they don’t quite see where it will end up tomorrow, and if the outcome will be good for them and their careers.

In the short term, we see many cities fighting to offer subsidies to attract Internet companies in the same way they fought to attract multinationals in the past. But service companies with a virtual product may not create many jobs locally, and certainly may not create much in the way of tax income. Governments are using tools fit for the last generation of businesses, not the current.

Moreover, the Internet is starting to lead to financial losses for city-owned state-owned enterprises (SOEs). In retail, in food, in consumer goods and electronics, many companies are locally-owned state-owned enterprises. They have been losing share to more dynamic private and multinational companies that embraced online selling and digital marketing more quickly.

More broadly, the increased productivity of Internet businesses, especially in retail and financial services, are leading to job losses, losses of well-paid jobs that are nowhere nearly made up by new jobs in growing sectors such as logistics. Consequently, there will likely be a loss in tax revenues for local government.

And finally, government officials are being encouraged to leverage the Internet for their own activities, to make them more efficient and more transparent. A complex set of challenges for anyone to face, let alone a government official with all the checks and balances they have to deal with.

 

Read more of my views on my LinkedIn Influencer blog. And please follow me onTwitter.

Image credit: “Guarding the wangba (internet cafe)”, Elizabeth Thomsen / Flickr

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Happy 65th Anniversary, China http://www.mckinseychina.com/happy-65th-anniversary-china/ http://www.mckinseychina.com/happy-65th-anniversary-china/#comments Tue, 30 Sep 2014 03:50:37 +0000 http://www.mckinseychina.com/?p=8042 I’m meeting this evening with the Mayor of Shanghai (and many others) to celebrate China’s National Day, the 65th anniversary of the People’s Republic of China. It means that we are in Shanghai and working on one of the quietest days of the year. Few clients and almost no colleagues around. Watching the traffic flows on the highway outside the office, I see there’s less than a third the normal volumes.

If you want to go anywhere over a Chinese national holiday period, you need to leave earlier and earlier to avoid the mad rush for the airports. It also quickly makes you realize how woefully sub-scale China’s tourism infrastructure is. Yes, the airlines and trains may be able to get you there, but they also get so many other people there that the opportunity to enjoy your destination is almost impossible. Try going to Hangzhou to see the lake, or Suzhou to see the gardens. You will really just see the backs of the heads of thousands of other colleagues. It will be fascinating to see who wins when the Disney park opens in Shanghai – will it be the Disney queuing system, or the overwhelming crowds of visitors, that comes out on top?

It makes me realize that my family and I have been living in China for almost a third of these 65 years. No one, least of all I, would have predicted that 20 years ago. We’ve lived in Beijing and Shanghai; downtown, suburbs and now downtown again in an apartment that gives a great view of the strengths and weaknesses of Shanghai today. You can see the physical infrastructure – the roads and the buildings that define the Shanghai skyline today – but you can only see them on a good day when the air is sufficiently clean.

So if the Mayor asks this evening, what would my birthday wish for Shanghai be? The challenges of the city are broad and complex. Selecting just one, I would wish for Shanghai to lead China in a rapid transformation of its education system. A successful, economically vibrant Shanghai will need to have millions of people working in services, in creative industries, and in technology-enabled sectors. It needs to be educating people now in these skills, whether at university, at vocational colleges, or in high school.

The Shanghai government is wealthy enough to fund, in cooperation with the private sector, bold, large-scale experiments that show the rest of China where to follow. The need and opportunity is there, I hope the leadership will be too.

 

Read more of my views on my LinkedIn Influencer blog. And please follow me onTwitter.

Image credit: “Fireworks”, Martin de Witte / Flickr

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Oxford University Focuses On China http://www.mckinseychina.com/oxford-university-focuses-on-china/ http://www.mckinseychina.com/oxford-university-focuses-on-china/#comments Wed, 24 Sep 2014 03:30:28 +0000 http://www.mckinseychina.com/?p=8024 Oxford University opened its brand new China Centre recently amid much fanfare and the presence of royalty. Dickson Poon, from Hong Kong, provided key funding and was present to cut the ribbon. The building is very impressive, a far cry from the run-down engineering facilities I recall as a student. As the building is located on the grounds of one of the colleges, St Hughs, it will readily integrate into student life.

Most importantly, the facility will bring together professors and researchers studying China from across the spectrum of programs in the university – medicine, history, politics, economics, business and more – to allow cross-disciplinary initiatives to develop. Moreover, the Centre should become a focal point for the 900 Chinese students at Oxford and the many hundreds of non-Chinese who are interested in China. Outside of term time, the combination of meeting rooms, social areas and residential accommodation will make the Centre a sought after destination for corporate events.

I was privileged to be asked to talk at the opening. I leveraged some of the research work of the Urban China Initiative, the group that McKinsey co-sponsors with Columbia and Tsinghua Universities to develop solutions to China’s urbanization challenges. I focused on the Urban Sustainability Index, especially its identification of turning points in population density and absolute population, and the geographic mismatch between population and social services in Beijing. I concluded with a discussion on how the development of Internet businesses in China is changing citizens’ needs for what they most need in their local community.

I was also asked to participate in a panel chaired by Andrew Dilnot with Jonathan Fenby, former editor of The South China Morning Post; Rob Gifford, head of the China section of The Economist; and Sun Shuyuan, a filmmaker. A generally upbeat session, although with concerns about the increasingly nationalistic tone of some of the political rhetoric.

Best wishes to Rana Mitter, who leads the Centre, and all those involved.

 

Read more of my views on my LinkedIn Influencer blog. And please follow me on Twitter.

Image credit: University of Oxford

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Is This The End Of The Golden Era For MBA Schools In China? http://www.mckinseychina.com/is-this-the-end-of-the-golden-era-for-mba-schools-in-china/ http://www.mckinseychina.com/is-this-the-end-of-the-golden-era-for-mba-schools-in-china/#comments Fri, 19 Sep 2014 03:21:34 +0000 http://www.mckinseychina.com/?p=8020 A few days ago, something that business schools had been aware of for a while became public – executives from state-owned enterprises or government departments were told they could only attend third party learning programs if they paid themselves. As most of these people don’t officially earn enough to be able to afford this, schools have seen class sizes shrink by up to 50%, especially in their highly profitable EMBA programs.

State-owned enterprise executives were attending these programs in increasing numbers as a perk of their role. The companies were fairly price insensitive and schools knew this. They also knew not to make the course too demanding.

Government officials were given scholarships by the schools to attend. Schools could then market the networking opportunity to private sector executives considering their programs. EMBA programs in China often seemed to attract remarkably high level private sector executives. They also seemed able to attract high level executives from multinationals to give guest lectures or to teach a course. Both may be harder in future.

Potential students will perhaps think much harder about the potential benefits of an MBA – full time or part time. Historically, the qualification came almost automatically as a consequence of paying for the program, which over time has reduced the value of the MBA in the marketplace. Potential students who really want to learn will need to identify courses where plagiarism is not accepted, where attendance at and participation in class is required, and where exams are meaningful. Not all schools have the faculty to ensure these requirements are fulfilled.

The best schools will adjust and thrive. However, many of the mid-tier ones may never have it so good again.

 

Read more of my views on my LinkedIn Influencer blog. And please follow me onTwitter.

Image credit: IOE London / Flickr

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An Essential Strategy for the Essential Drug List http://www.mckinseychina.com/an-essential-strategy-for-the-essential-drug-list/ http://www.mckinseychina.com/an-essential-strategy-for-the-essential-drug-list/#comments Thu, 18 Sep 2014 03:04:55 +0000 http://www.mckinseychina.com/?p=7985 The Essential Drug System (EDS) is one of five priorities that support the government’s overall healthcare reform objective. The impact of EDS on the pharma industry became more prominent with the release of the 2012 version of the Essential Drug List (EDL) and its supporting policies. With their exposure to EDL increasingly significant, and the government signaling an acceleration of the pace of implementation, MNCs can no longer afford to postpone confronting the implications of EDL on their growth potential and market strategy.

In a recent survey of 50 top executives from MNC pharmacos, almost two-thirds of the respondents expect the new EDL to have a negative impact on their business. Why are industry leaders so strongly of this view? Are there any opportunities among the provinces’ diverse implementation approaches? What should pharmacos do to cope with the changes, mitigate their impact, and potentially capture some upside? In this article, we offer our perspectives on the new environment, what it really means, and on the implications for MNCs.

Download the PDF: An Essential Strategy for the Essential Drug List

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Should I Join A Chinese Company As A New Graduate? http://www.mckinseychina.com/should-i-join-a-chinese-company-as-a-new-graduate/ http://www.mckinseychina.com/should-i-join-a-chinese-company-as-a-new-graduate/#comments Sun, 14 Sep 2014 03:11:49 +0000 http://www.mckinseychina.com/?p=8012 You were born and raised outside of China, and you’ve just graduated from a good university. You have done well and you are excited to be joining the workforce. You want to start off well and in a way that allows you to stand out from the crowd. You are thinking about whether joining a Chinese company in China is the way to go. Most likely, that’s not such a good idea.

“Seeking growth opportunities, I’m dynamic and entrepreneurial, committed to Asia, deep expertise to offer, ……..” is the usual opening in the emails I receive asking how to connect with a Chinese company. Some writers are already in Asia, many are not.

A few initial questions you’ll need to answer first, to get calibrated:

  • Just why do you think you have relevant skills? Do you think anyone else will see it the way you do? Given a choice between you and a Chinese candidate, who presumably might be willing to commit long term, why would anyone at this company select you?
  • Do you realize that you are competing against 7 million who graduate from universities in China each year, less than half of whom get a job requiring a degree?
  • Do you realize that skilled blue collar workers get paid more in China than new university graduates? That companies have China pay scales that they are not going to blow up simply because you happen to have attended university outside China, or because you hold a non-Chinese passport?
  • Have you ever worked in a job where you are on call 24×7 – if your boss has an idea you respond, if he wants to meet on Sunday evening you meet? Or where the organization structure, roles and responsibilities are not written down? You need to be comfortable with extremes of flexibility and ambiguity.
  • Have you checked out the cost of accommodation in Chinese cities? You have heard about the real estate boom in China: it translates into new graduates living in dormitory style accommodation.
  • How important is privacy to you? Your colleagues will know everything about you, from how much you get paid, to what you did on the weekend.
  • What will you do when you see behavior that you think might be illegal? Norms are not the same.
  • What are your language skills? If you have a unique skill to offer, then maybe you can be successful with less than fluent Chinese.

If you get through these positively:

What kind of Chinese company to join? Life will be easier if you join a company that already has a good number of non-Chinese employees, a company that competes with and sells to international as well as Chinese customers.

What kind of priorities to set for yourself:

  • Establish clear goals and a timeframe
  • Focus on a single boss and over deliver for him
  • Be humble
  • Do what you can to dispel the image of a “lazy foreigner”

Have you joined a Chinese company in China right out of college? How did it work out for you?

 

Read more of my views on my LinkedIn Influencer blog. And please follow me on Twitter.

Image credit: Penn State / Flickr

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Tianjin Takeaways http://www.mckinseychina.com/tianjin-takeaways/ http://www.mckinseychina.com/tianjin-takeaways/#comments Sat, 13 Sep 2014 03:07:31 +0000 http://www.mckinseychina.com/?p=8008 Having spent the last 2 days in and around the World Economic Forum event in Tianjin, I have time to reflect a bit as I wait for the apparently endlessly delayed flight to Shanghai.

First and foremost, I was struck by the consistency of priorities described by all government speakers, from Premier Li Keqiang’s opening and onwards. In many ways, his speech was a high speed restatement of the priorities from the 3 Plenum and before. Marketization: tick, sustainability: tick, support to SMEs: tick, protect IP: tick… All very forward-looking and upbeat, challenges framed as generic rather than specific, no mention of the real estate market, or of wealth management product defaults.

I was very pleased to hear the emphasis on job creation. Unemployment and underemployment can quickly become corrosive in major cities. It would be only too easy to create GDP growth without job growth in China today as technology enables new levels of productivity in manufacturing, services and agriculture. But that would clearly be unsustainable.

The discussions on how to enable greater entrepreneurship and creativity through education were very positive, although I remain concerned about the slow pace of change. And I still don’t believe anyone has fully embraced the scale of retraining that is going to be needed for individuals joining the workforce today without the needed skills, or for those, such as assembly line workers and bank clerks, who find their current roles eliminated.

As usual, the Forum orchestrated the logistics of a large scale conference very smoothly. This included down to the details of ensuring that in the conference center we could all access Facebook, Twitter and Google services, not something we could do once we stepped outside.

All the tables at the venue also had a small notice reminding us that this was a “green conference”. My suggestion to the organizers on how to push this one step further next year is to stop distributing a 15cm thick book to all attendees with everyone’s profile – the app is just fine – and stop giving us all a logo bag, the vast majority of which simply get left in hotel rooms, and which this year saw a good number have the strap or handle fall off before the end of the conference.

 

Read more of my views on my LinkedIn Influencer blog. And please follow me on Twitter.

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Why China’s Ecommerce Industry Developed So Fast http://www.mckinseychina.com/why-chinas-ecommerce-industry-developed-so-fast/ http://www.mckinseychina.com/why-chinas-ecommerce-industry-developed-so-fast/#comments Sun, 07 Sep 2014 13:14:02 +0000 http://www.mckinseychina.com/?p=8002 I get asked this in almost every country I visit, usually closely followed by the question: “Could the same happen here?” To try to answer, I focus on the following six points:

1. First and foremost, China manufactures too much of almost everything.

This has created an enormous supply of product that manufacturers, distributors and retailers are looking to get rid of at a marginal price, ideally into a part of China that they are not focused on. Chinese mom and pop retailers, distributors and the millions of contract manufacturers have seized this opportunity gratefully.

E-commerce potentially enabled this, with a C2C model with almost no barriers to entry that allowed anyone with as little as a box of T-shirts, legitimate or fake, to set up as an online supplier.

2. There was never a shortage of capital.

China’s investing community has been only too willing to fund ecommerce startups. Take group purchasing, a la Groupon with Chinese characteristics. At one point there were 5,000 startups playing in this space. This enabled Chinese ecommerce players to focus on growth, not profitability, and to wait for a long time before they had to go to the public markets for capital.

3. The consumer had to be ready to spend and in China they were.

By the mid-2000s, China’s middle class was rich enough to be shifting its spending from necessities to optional spend, but still value-driven enough to want to look for a bargain. These consumers had often bought their home and were now looking to purchase items to fill it. Their spending was enhanced from 2008 on by the strategy of the government to push up wages by more than 10% annually. Spending and incomes are highly correlated in China.

4. The Internet and physical infrastructure to join these sellers and buyers needed to be in place.

Thanks to China’s state-owned telcos’ responsiveness to the performance goals set by the government to bring broadband to tens of millions of new homes every year, Internet coverage grew quickly, allowing the middle class to browse online from their homes, rather than having to go to the Internet cafes. E-commerce logistics benefited significantly from the physical infrastructure that China had built over the last 20 years to bring products from factories to ports for export. Much could easily be leveraged to bring product from factory to China’s middle class consumers who were overwhelmingly based in coastal cities.

China had many “subsistence” logistics providers in addition to the state-owned China Post parcel service. These owner-operated truck drivers drove inter-city carriage prices down to almost marginal levels, and an entire new industry of last mile scooter-based delivery agents grew up in cities, earning only a few hundred RMB a month. So costs of getting product to buyers was very low, and even that low cost was absorbed by ecommerce players focused on growth, not profits.

The lack of readiness of several key players meant they neither recognized nor responded to the threat for several years. Large retailers were focused on their own land grab of physical locations and simply didn’t see what was happening. Even if they had, most were more real estate managers than sophisticated retailers, renting space to brand owners. They had no capabilities to move quickly online.

Brand owners themselves had relied on distributors and franchise stores to maximize their China coverage. Their control of the channel was modest. When hundreds of vendors popped up online selling their product, they had limited levers to control. They had perhaps even less control of the factories to which they had outsourced production. If overruns ended up online, what recourse did they have? Private and state-owned mall owners, focused on the expansionist behavior of large retailers, continued their breakneck expansion also, not seeing that some of their key sectors such as electronics and clothing would soon be reducing, not growing, their store footprint.

5. Banks were also unable to anticipate where ecommerce was heading.

They missed the opportunity to move into the online payments space, to capture the trading and financial information on millions of retailers that would have enabled them to better assess risk in lending to China’s SMEs. Instead, the online players were allowed, in a regulatory grey zone, to create their own payment systems. From this, they have built lending and investment businesses, credibly moving now into full service online banking.

6. Sometimes passivity is a key enabler. And it was here.

The government had no grand plan for or against ecommerce, and in its early days, largely stood back and observed whether or not this would turn out to be a positive. As it seemed to be allowing millions of small scale businesses to get established and flourish, the experiment was seen to be a success, even if players had not always sought licenses they might have required, or had ownership structures that may not fully align with regulations.

Will any other country put together this mix of ingredients in the same way? Unlikely.

 

Read more of my views on my LinkedIn Influencer blog. And please follow me onTwitter.

Image credit: Luis / Flickr

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What’s Next For Chip Makers In China? http://www.mckinseychina.com/whats-next-for-chip-makers-in-china/ http://www.mckinseychina.com/whats-next-for-chip-makers-in-china/#comments Wed, 03 Sep 2014 12:57:08 +0000 http://www.mckinseychina.com/?p=7995 (Note: In an earlier post, I talked about development’s in China’s semiconductor industry, including shifts on the policy front. In this post, adapted from a recent article I wrote with my colleague Chris Thomas, I talk about the implications for multinational chip makers.)

China is by far the largest consumer of semiconductors; it accounts for about 45 percent of the worldwide demand for chips, used both in China and for exports. But more than 90 percent of its consumption relies on imported integrated circuits. Integrated-circuit companies in China entered the semiconductor market late—some two decades after the rest of the world—and have been playing catch-up ever since in an industry in which success depends on scale and learning efficiencies. The Chinese government made several attempts to build a local semiconductor industry, but none really took hold. Now, however, things are changing on both the business and policy fronts.

Low-cost smartphones designed in China are flooding the market. For instance, Android phones designed in China now represent more than 50 percent of the global market, compared with their negligible presence five years ago. Lenovo’s significant deals early in 2014—first acquiring IBM’s low-end x86-based server business for $2.3 billion and then buying Motorola from Google for almost $3 billion—further suggest that the customer base for hardware is moving to China.

Multinational corporations in every industry—from automotive to industrial controls to enterprise equipment—increasingly are establishing design centers on the mainland to be closer to customers and benefit from local Chinese talent. McKinsey’s proprietary research indicates that more than 50 percent of PCs, and between 30 and 40 percent of embedded systems (commonly found in automotive, commercial, consumer, industrial, and medical applications), contain content designed in China, either directly by mainland companies or emerging from the Chinese labs of global players. As the migration of design continues, China could soon influence up to 50 percent of hardware designs globally (including phones, wireless devices, and other consumer electronics).

Fabless semiconductor companies are also emerging in China to serve local customers. For instance, Shanghai-based Spreadtrum Communications, which designs chips for mobile phones, and Shenzhen-based HiSilicon Technologies, a captive supplier to Huawei and one of the largest domestic designers of semiconductors in China, are among the local designers that have shown rapid growth over the past few years.

There has been slower but steady progress among local foundries. As global players such as Samsung, Taiwan Semiconductor Manufacturing Company, and Texas Instruments set up shop in China, leading local foundries such as Shanghai Huali Microelectronics Corporation, SMIC, and XMC are poised to benefit from the development of a true technology cluster.

A market-based policy effort

The government, realizing that earlier bureaucrat-led investment initiatives failed to bring the desired results, is now aiming to take a market-based investment approach. In this case, decisions about allocating for-profit investment funds will be managed by professionals but will remain aligned with the government’s policy objectives. Chinese officials have convened a unique task force charged with setting an aggressive growth strategy. This group helped develop a policy framework that is targeting a compound annual growth rate for the industry of 20 percent between now and 2020, with potential financial support from the government of up to 1 trillion renminbi ($170 billion) over the next five to ten years.

To avoid the fragmentation issues of the past, the government will focus on creating national champions—a small set of leaders in each critical segment of the semiconductor market (including design, manufacturing, tools, and assembly and test) and a few provinces in which there is the potential to develop industry clusters.

For instance, Tsinghua Unigroup, a state-owned enterprise, recently bought two of the top four Chinese fabless companies—in 2013, it acquired Spreadtrum for $1.7 billion and RDA Microelectronics for $0.9 billion—and aims to combine them into a single entity. The new policy framework specifically encourages consolidation within China’s assembly-and-test market segment.

Implications for semiconductor players

China released the high-level framework for its new national semiconductor policy in June 2014; the details and the long-term effects of its new approach to developing the industry remain to be seen. Will it lead to a world-class semiconductor industry, or will Chinese semiconductor companies continue to lag behind global players? Three medium-term effects seem likely.

1. Pressure for localization will increase

China’s strong desire for national champions may further tilt the system in favor of local players. According to industry estimates, Chinese original-equipment manufacturers will design more than half of the world’s phones in 2015. Under the national-champions model, they may be encouraged to take advantage of domestic suppliers’ low-cost strategies and strong local technical support.

2. More partnership opportunities will arise for second-tier players

Many of the Chinese government’s previous policies have not offered opportunities for global players to benefit. However, government leaders in China’s semiconductor sector are now beginning to realize that the country needs to partner with global technology companies to improve the local talent base and supply chain. As a result, they are more open than ever to “win–win” engagements between global players and national champions.

3. Chinese companies will become more aggressive in pursuing international mergers and acquisitions

Indeed, it would be quite difficult for Chinese players to build a complete and competitive semiconductor value chain without capitalizing on foreign assets; collaborations between Chinese and global players probably will not be enough to meet the country’s objectives. We should expect China to continue to actively seek opportunities to acquire global intellectual property and expertise, usually with the intent of transferring them back home.

How should multinational players respond?

Most global semiconductor players have invested heavily in their Chinese operations over the years, but many are still operating below their potential, especially in functions beyond sales and marketing. Considering the emerging policy and business trends we’ve just discussed, we believe it’s a good idea for leaders to inventory their company’s current position in China.

This process should start with the most timely and immediate concern—the potential effects of changing Chinese policy. Questions for reflection might include: How will you align your operations with the Chinese government’s new plans? Are your relationships in China strong and deep enough to provide you some warning of potential risk as a result of domestic-policy changes?

Market-level questions might include the following: Given the different buying factors and supplier-management philosophies of Chinese customers, do you still have a winning product road map? Can you respond to the emerging needs of Chinese-based customers as fast as a local company can? Have you followed your global customers as they set up design centers on the mainland?

Capabilities-level questions might include the following: How are you leveraging Chinese manufacturing and design talent to win in China—or to win globally? Are your leaders in China as strong and empowered as they are in your home region? Do your global leaders have enough connections in, experiences with, and insights about the Chinese market? How robust is your talent pipeline in China?

There is no one right answer to any of these questions; depending on its role and standing in the market, every company faces its own unique challenges in China.

 

Read more of my views on my LinkedIn Influencer blog. And please follow me onTwitter.

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When Online Business Meets Government Planners In China http://www.mckinseychina.com/when-online-business-meets-government-planners-in-china/ http://www.mckinseychina.com/when-online-business-meets-government-planners-in-china/#comments Mon, 01 Sep 2014 12:51:15 +0000 http://www.mckinseychina.com/?p=7992 I received a call last week from a group of planners at the National Development and Reform Commission (NDRC), China’s top economic planning body. They had just read our recent report on developments in China’s Internet, and had some questions.

Firstly, they wanted to know how we had done the analysis, and secondly, they wanted us to talk at an event they were hosting later that week for a group of senior government officials from across Asia who were meeting in Beijing.

It was not difficult to address the first question, but as with any interaction with the central government, our response had to be in the form of a structured memo. At the event, we were invited to participate in both panels, joining senior executives from Baidu, Alibaba, Uber and relevant Chinese ministries. My role was largely to synthesize the presentations and Q&A at the end of each discussion.

Positively, business enabled by the Internet was seen by the group as a key driver of innovation, reform and growth, something that had to be embraced and actively managed, not passively allowed to develop around government.

The optimistic saw it as a driver of job creation and an opportunity to catch up if handled well. A cheaper and faster way to growth was certainly the line of the Internet companies themselves.

Government officials were rather more skeptical, highlighting the potential for parallel job destruction. While the pace of technological progress does enable rapid change, this imposes massive challenges on governments as legislators and regulators, where they tend to move at a much more deliberate pace. Indeed, one of the conclusions of the group was to set up a working group for further study on the topic.

Prerequisites for Citizens, Businesses and Government

Current workers, students, the retired, minorities and rural residents all need to be given relevant capabilities to use the Internet – literacy, numeracy and some technological proficiency. They also need to be given opportunity through low cost access to the Internet and, where needed, to financing. Cloud based solutions are essential. The third prerequisite for citizens is the development of trust in the Internet overall and in Internet based businesses. This includes how their personal information is handled, how their payments are handled, and that products and services would be reliably safe and genuine.

Businesses are looking for talent to join them, and the opportunity to experiment. This latter is clearly a source of tension with the role of government to protect as well as enable. Further businesses were looking for the opportunity to scale seamlessly across borders. With each Asian country, and often each region within a country, having its own regulations, this seemed an aspiration more than a prerequisite.

Government officials were looking to learn from each other on how to legislate and regulate. There is much best practice to be shared and the idea of creating a clearing house to do so seemed a very positive step. The role of government in ensuring cities and countryside both have needed infrastructure is critical and also in education, particularly in educating a new generation of citizen entrepreneurs to launch small-scale Internet-based businesses.

Impact on Related Industries

There was excitement and concern about the impact of the Internet on related industries. Excitement for sectors like logistics, but concern for traditional providers of financial services, travel and even taxi services. All could see that large scale change was inevitable, but many were concerned that during the era of transition, more jobs would disappear in the first stage, and it could be many years, if ever, before new jobs were created.

I found the government leaders to be well informed and, probably rightly given their roles, heavily concerned about the possible societal downsides of such rapid change to an overall economy. All had seen cities or regions where traditional industries, such as mining or textile production, had disappeared, and were well aware of the challenges of revitalization that this posed. Businesses were focused more on the micro and the specific, on how they had created jobs themselves rather than the impact on the entire sector or economy.

* * *

It’s great that these dialogues take place, especially on a multinational basis. Also great to see Chinese government officials hosting and fully engaging on the topic.

 

Read more of my views on my LinkedIn Influencer blog. And please follow me on Twitter.

Image credit: Frank Yu / Flickr

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Coming Soon To A Market Near You: Chinese Private Enterprises http://www.mckinseychina.com/coming-soon-to-a-market-near-you-chinese-private-enterprises/ http://www.mckinseychina.com/coming-soon-to-a-market-near-you-chinese-private-enterprises/#comments Wed, 27 Aug 2014 14:00:21 +0000 http://www.mckinseychina.com/?p=7976 It’s a good time to be leading a private enterprise in many sectors in China. We all know about the Internet and consumer electronics, but in many industrial sectors it is also the case. I can’t fully disaggregate how much of this is due to China’s new leadership pulling back some of the advantages state-owned enterprises possessed, and making it at the margin harder for multinationals, rather than this being an on-going trend that is reaching a tipping point.

Certainly in conversations with the heads of multinationals in China, the challenges of a) keeping track of all these focused private sector attackers and b) explaining to global headquarters that these guys are genuinely good at what they do, comes up more and more.

China is creating a new Mittelstand, that core of mid-sized industrial companies (often family-owned) that have been the backbone of the German economy for so many years. Few of these emerging Chinese players are multibillion dollar businesses yet, most have turnover in the hundreds of million or even tens of million, and are fast-growing. They are family-owned, often led by entrepreneurs just entering the midpoint of their career – they plan to be around for a long time.

They are tough competitors – those who survive the intense competition in China are good at whatever it is they focus on. They are competing against a myriad of other private companies, state owned enterprises and global giants. China may be the largest country market for their products worldwide, but it is also the most competitive.

What has changed in recent years? Growth in the domestic market is certainly one factor. Much improved ability to hire talent is for sure another as state-owned enterprises are seen as a less attractive career choice. Banks are finally starting to pay attention to private enterprises allowing them to access debt from the formal banking system for the first time, lowering costs. They have also become much smarter on IP, recognizing its importance and going abroad to buy or license what is needed.

It won’t be long before they get bolder on going international, organically expanding their sales network – southeast Asia, India and Africa are generally high on the list. Acquisitions in more mature economies are also on their list.

Watch out!

Read more of my views on my LinkedIn Influencer blog. And please follow me on Twitter.

Image credit: World Economic Forum / Flickr

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Semiconductors in China: Brave new world or same old story? http://www.mckinseychina.com/semiconductors-in-china-brave-new-world-or-same-old-story/ http://www.mckinseychina.com/semiconductors-in-china-brave-new-world-or-same-old-story/#comments Tue, 26 Aug 2014 09:12:07 +0000 http://www.mckinseychina.com/?p=7962 By Gordon Orr and Christopher Thomas

Executives of global semiconductor companies have had their eyes on China for many years, primarily as a customer-rich end market and a source of innovation. But now they will need to take an even closer look. Government stakeholders in China have been reconsidering the risk posed by the country’s heavy reliance on others for semiconductor components and capabilities, and they are carrying out policy changes that could correct for this dependence. Pair these policy efforts with private-market forces that are slowly but surely strengthening the capabilities of mainland semiconductor companies and multinational chip makers competing in China will likely face a very different operating environment—one with new risks and opportunities.

What’s changing?

China is by far the largest consumer of semiconductors; it accounts for about 45 percent of the worldwide demand for chips, used both in China and for exports. But more than 90 percent of its consumption relies on imported integrated circuits. Integrated-circuit companies in China entered the semiconductor market late—some two decades after the rest of the world—and have been playing catch-up ever since in an industry in which success depends on scale and learning efficiencies. The Chinese government made several attempts to build a local semiconductor industry, but none really took hold. Now, however, things are changing on both the business and policy fronts.

Low-cost smartphones designed in China are flooding the market. For instance, Android phones designed in China now represent more than 50 percent of the global market, compared with their negligible presence five years ago. Lenovo’s significant deals early in 2014—first acquiring IBM’s low-end x86-based server business for $2.3 billion and then buying Motorola from Google for almost $3 billion—further suggest that the customer base for hardware is moving to China. Meanwhile, Beijing and Shenzhen have become innovation hotbeds for wearable devices and other connected consumer electronics. Technology companies in these regions are not trailing others in this area of innovation; they are running neck and neck with other early entrants.

Multinational corporations in every industry—from automotive to industrial controls to enterprise equipment—increasingly are establishing design centers on the mainland to be closer to customers and benefit from local Chinese talent. McKinsey’s proprietary research indicates that more than 50 percent of PCs, and between 30 and 40 percent of embedded systems (commonly found in automotive, commercial, consumer, industrial, and medical applications), contain content designed in China, either directly by mainland companies or emerging from the Chinese labs of global players. As the migration of design continues, China could soon influence up to 50 percent of hardware designs globally (including phones, wireless devices, and other consumer electronics).

Fabless semiconductor companies are also emerging in China to serve local customers. For instance, Shanghai-based Spreadtrum Communications, which designs chips for mobile phones, and Shenzhen-based HiSilicon Technologies, a captive supplier to Huawei and one of the largest domestic designers of semiconductors in China, are among the local designers that have shown rapid growth over the past few years.

There has been slower but steady progress among local foundries. For reasons including costs and scale—and, in some cases, export controls—these players traditionally have been reluctant to invest in cutting-edge technologies, always lagging three or four years behind the industry leaders. But the performance gap is shrinking. As global players such as Samsung, Taiwan Semiconductor Manufacturing Company, and Texas Instruments set up shop in China, leading local foundries such as Shanghai Huali Microelectronics Corporation, SMIC, and XMC are poised to benefit from the development of a true technology cluster. At the same time, fewer and fewer chip designs will be moving to technologies that are 20 nanometers and below; following Moore’s law is becoming too expensive and is of limited benefit to all but a small set of global semiconductor companies. As a result, low-cost, lagging-edge Chinese technology companies will soon be able to address a larger part of the global market.

A market-based policy effort

The Chinese government is now putting significant funding and effort behind new policies relating to the development of the semiconductor industry. The government’s previous attempts to build the industry, dating all the way back to the 1990s, had mixed results because funding plans and incentives were focused more on research and academia than on business. Additionally, investments were fragmented—at one point, the government had invested in 130 fabrication sites across more than 15 provinces, none of which was able to capitalize on the scale and scope of its neighbors’ sites, and supporting industries never materialized.

The government, realizing that earlier bureaucrat-led investment initiatives failed to bring the desired results, is now aiming to take a market-based investment approach. In this case, decisions about allocating for-profit investment funds will be managed by professionals but will remain aligned with the government’s policy objectives. Chinese officials have convened a unique task force charged with setting an aggressive growth strategy (see sidebar, “A different type of task force”). This group helped develop a policy framework that is targeting a compound annual growth rate for the industry of 20 percent between now and 2020, with potential financial support from the government of up to 1 trillion renminbi ($170 billion) over the next five to ten years. Investments will be made by a national investment vehicle (the National Industry Investment Fund) and provincial-level entities. These entities will invest across multiple categories, including project finance and domestic and foreign acquisitions, as well as traditional research and development subsidies and tax credits.

To avoid the fragmentation issues of the past, the government will focus on creating national champions—a small set of leaders in each critical segment of the semiconductor market (including design, manufacturing, tools, and assembly and test) and a few provinces in which there is the potential to develop industry clusters. For instance, SMIC, a leading foundry headquartered in Shanghai, is building a 300-millimeter fab in the Beijing Economic and Technological Development Area. The company signed cooperation agreements with the national and local governments and announced a joint investment of $1.2 billion. Investors include the Beijing Municipal Commission of Economy and Information Technology, the Institute of Microelectronics of Chinese Academy of Sciences, and the Beijing city government.

The Chinese government has actively pursued consolidation to spur the creation of national champions. For instance, Tsinghua Unigroup, a state-owned enterprise, recently bought two of the top four Chinese fabless companies—in 2013, it acquired Spreadtrum for $1.7 billion and RDA Microelectronics for $0.9 billion—and aims to combine them into a single entity. The new policy framework specifically encourages consolidation within China’s assembly-and-test market segment.

Implications for semiconductor players

China released the high-level framework for its new national semiconductor policy in June 2014; the details and the long-term effects of its new approach to developing the industry remain to be seen. Will it lead to a world-class semiconductor industry, or will Chinese semiconductor companies continue to lag behind global players? Three medium-term effects seem likely.

Pressure for localization will increase. China’s strong desire for national champions may further tilt the system in favor of local players. According to industry estimates, Chinese original-equipment manufacturers will design more than half of the world’s phones in 2015.1 Under the national-champions model, they may be encouraged to take advantage of domestic suppliers’ low-cost strategies and strong local technical support. Additionally, in the wake of global data-privacy and security concerns, there has been even more of a push from the Chinese government for state-owned and private enterprises to purchase from local system suppliers (that, in turn, are more likely to source from local semiconductor vendors).

More partnership opportunities will arise for second-tier players. Many of the Chinese government’s previous policies have not offered opportunities for global players to benefit. However, government leaders in China’s semiconductor sector are now beginning to realize that the country needs to partner with global technology companies to improve the local talent base and supply chain. As a result, they are more open than ever to “win–win” engagements between global players and national champions. For their part, top-tier multinational semiconductor companies traditionally have had less incentive to share their intellectual property or transfer technology to China. As such, second-tier players may fare better in this evolving ecosystem since they have less to lose than global giants—and everything to gain. In the winner-takes-all semiconductor markets, these players may benefit from their Chinese partners’ deep pockets, becoming better able to match the investments of market leaders.

Chinese companies will become more aggressive in pursuing international mergers and acquisitions. Indeed, it would be quite difficult for Chinese players to build a complete and competitive semiconductor value chain without capitalizing on foreign assets; collaborations between Chinese and global players probably will not be enough to meet the country’s objectives. We should expect China to continue to actively seek opportunities to acquire global intellectual property and expertise, usually with the intent of transferring them back home. What’s still to be determined, however, is how global governments will react to proposed deals in light of the emerging policy and market changes.

How should multinational players respond?

Most global semiconductor players have invested heavily in their Chinese operations over the years, but many are still operating below their potential, especially in functions beyond sales and marketing. Considering the emerging policy and business trends we’ve just discussed, we believe it’s a good idea for leaders to inventory their company’s current position in China.

This process should start with the most timely and immediate concern—the potential effects of changing Chinese policy. Questions for reflection might include: How will you align your operations with the Chinese government’s new plans? Are your relationships in China strong and deep enough to provide you some warning of potential risk as a result of domestic-policy changes? Do you have an early sense of what those risks might be, and a rapid-response plan to address them? Could you gain advantage by approaching the government with a win–win idea?

For multinational companies operating in China, it is impossible to separate political and regulatory concerns from business—which is why it is also necessary for leaders to take stock of the overall market and the capabilities they bring to the table.

Market-level questions might include the following: Given the different buying factors and supplier-management philosophies of Chinese customers, do you still have a winning product road map? Can you respond to the emerging needs of Chinese-based customers as fast as a local company can? Have you followed your global customers as they set up design centers on the mainland? Which Chinese champions are emerging, and which markets will they attack?

Capabilities-level questions might include the following: How are you leveraging Chinese manufacturing and design talent to win in China—or to win globally? Are your leaders in China as strong and empowered as they are in your home region? Do your global leaders have enough connections in, experiences with, and insights about the Chinese market? How robust is your talent pipeline in China? Can you act as “one company” in the country, or do organizational silos prevent collaboration across the sales, product-development, government-relations, and manufacturing functions?

There is no one right answer to any of these questions; depending on its role and standing in the market, every company faces its own unique challenges in China. Accordingly, we have seen leading semiconductor companies adopt a number of different approaches. Some have taken the initiative to develop R&D capabilities in China, designing chips and applying for patents locally. Others have consolidated all their activities (sales, marketing, and operations, for instance) under a China CEO who reports directly to the global CEO. One company created an advisory board of senior global executives dedicated entirely to coordinating and pushing the China agenda. Other companies have taken a talent-first approach—for instance, promoting a former China head to a global executive position to add China expertise to the boardroom and soliciting personal commitments from the CEO to visit the country every few months to review status and remove organizational barriers.

In China and elsewhere across the globe, government intervention in the semiconductor market has been a mixed bag—some successes, some missed opportunities. Still, the Chinese government is better positioned than most others to make a big policy bet, with its massive customer and installed-manufacturing base, its deep bench of engineering talent, and its financial resources. It can afford to be patient, confident that macroeconomic forces make its hand incrementally stronger every year.

If the government follows through on its policy intent and steers substantial investment and support toward the domestic semiconductor market over the next decade, it will prompt global players to make their own moves—whether forging new and different partnerships with Chinese players, managing overcapacity in critical segments, or developing complementary or competitive policies of their own.

Whether this policy is ultimately effective or not, its impact will be felt across the industry.

About the authors

Gordon Orr is a director in McKinsey’s Shanghai office, and Christopher Thomas is an associate principal in the Beijing office.

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China’s digital transformation http://www.mckinseychina.com/chinas-digital-transformation/ http://www.mckinseychina.com/chinas-digital-transformation/#comments Tue, 26 Aug 2014 03:32:08 +0000 http://www.mckinseychina.com/?p=7951 As individual companies adopt web technologies, they gain the ability to streamline everything from product development and supply-chain management to sales, marketing, and customer interactions. For China’s small enterprises, greater digitization provides an opportunity to boost their labor productivity, collaborate in new ways, and expand their reach via e-commerce. In fact, new applications of the Internet could account for up to 22 percent of China’s labor-productivity growth by 2025.

Yet the Internet is not merely a tool for automation and efficiency; it also expands markets rapidly. Greater adoption of web technologies in China could lead to the introduction of entirely new products and services if government and industry take the right steps to maximize the potential (exhibit). A new report from the McKinsey Global Institute (MGI), China’s digital transformation: The Internet’s impact on productivity and growth, projects that new Internet applications could fuel some 7 to 22 percent of China’s incremental GDP growth through 2025, depending on the rate of adoption. That translates into 4 trillion to 14 trillion renminbi in annual GDP in 2025.

Exhibit

The adoption of new Internet applications may have a substantial economic impact in key sectors of China’s economy.

China's digital transformation - McKinsey China

 

That 10 trillion renminbi gap between the two numbers represents the economic growth at stake. The low end of the projection assumes that the country’s current trajectory continues, with adoption of Internet applications increasing at a moderate pace, under existing constraints. The upper end assumes that China builds a supportive policy environment, individual companies move decisively, and workers adapt to the demands of a more digitized economy.

The MGI report focuses on a set of Internet applications that could penetrate more deeply across key sectors of the country’s economy, including big data; improved demand forecasting, online sourcing, and marketing; Internet banking and payment systems; the Internet of Things; and e-commerce. The six sectors analyzed in the report are already beginning to undergo sweeping changes.

In consumer electronics, for example, the critical factors will be growth in connected devices (such as smart home appliances and Internet TVs) and online media content. China’s fledgling used-car market has enormous room for growth if powered by e-commerce. Chemical companies can use the Internet to enhance their R&D capabilities, enabling collaboration with customers and external experts. In financial services, online money-market funds, discount brokerages, and third-party online marketplaces have already begun to emerge. Chinese home buyers and renters increasingly search online to find the property that’s right for them. More broadly, the Internet is reshaping the market for commercial real estate as e-tailing decreases the need for retail space and increases demand for modern warehousing. And in healthcare, web-based tools such as electronic health records and clinical decision-support systems can elevate the quality of care and play a critical role in making the system more efficient and cost effective.

Increasing digitization is forcing companies across all industries to rethink their operations and become more customer-centric. Owners and CEOs will have to be deeply engaged as they make decisions that can radically affect how their companies do business. Industries will face increasing talent shortages, and larger companies may respond by making targeted acquisitions of tech firms.

From a policy perspective, China’s government faces multiple challenges in harnessing the Internet for economic growth. Building out networks is crucial to bringing more of the population online and facilitating the adoption of new Internet applications, while a balanced set of regulations for data sharing could remove constraints on the adoption of big data. Increased business usage of new Internet applications is likely to have a neutral or slightly positive impact on the total number of jobs—but a more striking effect on the composition of the labor market. The economy will need fewer workers for routine activities that can move online, while demand will increase for workers with digital skills. Government and industry can ease this dislocation by ensuring that training programs are available to help workers continually refresh their skills. China can also adapt school curricula to build digital literacy and create a true education-to-employment pipeline.

Beyond creating economic momentum for China, the Internet will enable growth based on productivity, innovation, and consumption. It will sharply intensify competition, allowing the most efficient enterprises to win out more quickly. The impending shift toward the Internet across key sectors of the economy will pose some risks and disruptions, but it can ultimately support China’s goal of creating a more sustainable model for growth.

Download the executive summary: China’s digital transformation

Download the full report: China’s digital transformation

 

About the authors

Jonathan Woetzel is a director of the McKinsey Global Institute, where Yougang Chen is a principal, Michael Chui is a partner, and Elsie Chang and Jeongmin Seong are senior fellows; Gordon Orr is a director in McKinsey’s Shanghai office; Alan Lau is a director in the Hong Kong office; and Autumn Qiu is a consultant in the Beijing office.

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Where Have All The Expats In China Gone? http://www.mckinseychina.com/where-have-all-the-expats-in-china-gone/ http://www.mckinseychina.com/where-have-all-the-expats-in-china-gone/#comments Sat, 23 Aug 2014 07:29:09 +0000 http://www.mckinseychina.com/?p=7972 It is clearly not a good time to have a business targeted at foreigners in Shanghai. In the last week, our landlord and several other business owners have asked us this question. Our apartment block has gone from 100% to less than 70% full for example.

What’s going on?

Well, if you look out of the window of your apartment on an average day, it’s kind of obvious. It’s the air. Yes, it may be better than Beijing and a host of other Chinese cities, but that doesn’t make it good. And when the grandparents ask what are you doing to their grandchildren’s lungs, they don’t differentiate between cities. This has been a force that just builds and builds. Buying more air filters doesn’t really eliminate the problem, in some ways it just makes you more aware of it.

Multinational companies are localizing more, reflecting the fact that there is more quality local talent available at entry, mid and senior level positions. And if you are going to have expats, see if they can work on a fly-in, fly-out basis, and so avoid the cost of supporting the family move.

More multinationals are focused on performance in China today rather than investing for the future. If current year performance is below plan (as is the case for a good number today), costs have to be reduced. For many multinationals, the sectors in which they compete in China have passed their years of peak growth, and management takes a more mature market mindset to moving in more people.

Shanghai has many schools targeting international students. A number are pretty average in their performance in preparing kids for universities around the world. The reputation of the poorer ones has an impact across all schools, and can lead families to move out of Shanghai as high school approaches for their kids.

The exodus of Japanese executives and their families continues as Japanese businesses feel their growth prospects in China are limited.

The opportunity to get from downtown Taipei to downtown Shanghai in only a touch over 3 hours is leading quite a number of executives to move their family to Taiwan, and spend 4 days a week in Shanghai, 3 back in Taipei.

And finally, a new residential center of gravity is emerging in Shanghai. The developments out beyond the Hongqiao transport hub are lower cost and newer than many of the options in Pudong, and certainly offer more space than in downtown. If your business is in the Hongqiao area or requires frequent domestic travel by plane or train, it makes a ton of sense to live there. And if you do, the number of times you come downtown could easily fall close to zero.

Read more of my views on my LinkedIn Influencer blog. And please follow me on Twitter.

Image credit: Paul Arps / Flickr

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Should I Stay At A State Owned Enterprise? http://www.mckinseychina.com/should-i-stay-at-a-state-owned-enterprise/ http://www.mckinseychina.com/should-i-stay-at-a-state-owned-enterprise/#comments Wed, 20 Aug 2014 07:19:17 +0000 http://www.mckinseychina.com/?p=7968 I was asked this question last week by someone I have got to know through my work with universities in China. This individual was in his mid-30s, a graduate in a technical subject from a leading Chinese university, and has some international exposure.

How did I respond?

First of all, with a review of the prospects for the state owned company (SOE) he worked for and its industry. I generally suggest that the talented and ambitious focus on growth companies in growth industries due to the number of leadership opportunities it creates. You don’t have to wait for senior executives to retire in order to move up.

Was this the case here? Clearly not. His industry has gone through its years of rapid growth, and they are gone and not coming back. The industry has a shocking amount of overcapacity today, many competitors are losing money (even though this specific company is not), and consolidation/shrinking is more on the minds of management.

More broadly, the prospects for SOEs overall seem less bright under China’s current leadership. The SOE-first industrial strategy of the prior leadership is being gradually set aside, with a more level playing field for private Chinese companies emerging. While salaries at leading SOEs remain very attractive, the anti-corruption campaign has reduced the level of associated benefits that a manager at an SOE can expect.

If the broader context is not bright, how did the specifics of this person’s role look? Did they give a promising foundation for at least the next few years of his personal career?

On the positive side, his current boss sounded like an inspirational person, with a broad range of experiences inside and outside state owned enterprises. However, beyond his boss, too many colleagues sounded as though they had joined the company because it appeared to offer a secure job for life, with a good salary and high prestige in the community. This translates day-to-day into a conservatism, a desire to maintain the status quo, and often really not being enormously committed to delivering their best on tasks. But as long as the current boss was there, interesting projects were likely to be available.

Current projects certainly sounded very interesting, with real growth potential. Management has clearly recognized that their current core industry has matured, and they are looking to diversify, committing very large amounts to making acquisitions. This creates great opportunities to learn about these industries and target companies through due diligence, and if an acquisition is made, to move into that new business.

However, this has led to the realization that the decision-making process at the SOE, driven by consensus building, is slow. While slow decision-making can be a strength in some situations, in deciding whether and how much to bid for a company, it is not. So far, all projects have led to offers not accepted. Clearly the frustration of not closing any deals is growing and ultimately was, I think, the driver of having this conversation.

If he were to move to another company, was he well prepared, and where would he go? Potentially, the companies that he is evaluating are an option – they are in fast-growing industries that make use of his technical skills. Maybe a startup, but he needs to be very clear on the personal cash flow implications of moving there from a well-paying SOE – do his life and family commitments permit it?

And multinationals? He had investigated this and found that he was likely to be hired only in an R&D role, which wasn’t really where he wanted to direct his career.

While my friend’s current projects were clearly broadening his skill set beyond technical areas and into broader business topics, I suggested that if he wished to accelerate this, and to have something to show possible future employers about his commitment to general management roles, that he consider some kind of part-time MBA – either online, or by taking classes in the evening.

In the end, I suggested that he set himself a deadline for deciding to stay or go. If by that point no acquisitions had been made, they are probably not going to happen (after the SOE is using up its financial resources to support its declining core business). In the meantime, work to get a qualification that demonstrates commitment to a broader management role, which will make him more attractive if he does decide to move, and also be relevant if he stays.

What would you have said?

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: Steve / Flickr

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Less Than 10% Of China’s Top Cities Meet Clean Air Standards – Now What? http://www.mckinseychina.com/less-than-10-of-chinas-top-cities-meet-clean-air-standards-now-what/ http://www.mckinseychina.com/less-than-10-of-chinas-top-cities-meet-clean-air-standards-now-what/#comments Tue, 12 Aug 2014 06:53:15 +0000 http://www.mckinseychina.com/?p=7941 9 out of 161 cities pass China’s own standards for clean air – is this good news?

If you set expectations low enough, almost anything can seem to be good news. That any of China’s top 161 cities met the Ministry of Environmental Protection’s standards in the first half of 2014 can seem like a win after a year of so many depressing stories of pollution levels in cities across China. This is the case even if a number of the cities that passed are really beach resorts without a factory anywhere to be seen and the bar for passing is not that high.

That the Ministry was willing to publish these statistics, with less than 10% of cities passing, is also for sure good news. Hopefully this creates a precedent for future semi-annual public assessments, and creates pressure on those close to meeting the standard to get their act in gear and do so.

I am not sure that it was a coincidence that China increased its target for installed solar capacity in 2014 back up to 13GW this week. While it makes a tiny difference to the amount of coal consumed, it is a move in the right direction.

If I were in the leadership of one of the 9 cities that met the bar, especially if I were in the leadership of Shenzhen, I would be ecstatic. I would be turning this instantly into a major marketing program to attract service industries and white collar jobs to my city. Shenzhen is much further down the path of becoming a hub of service industries than many realize. Tencent and many other Internet companies are based there, as are the R&D giants Huawei and ZTE and many of China’s most dynamic financial institutions.

Given all the talk of people moving out of Beijing for pollution reasons, being able to say “Come to Shenzhen – the top-tier Chinese city with clean air” is a great pitch. It would not surprise me to see advertisements for Shenzhen popping up in international media in the next few weeks, extolling the green virtues of the city and with testimonials to its clean air.

And this would be another piece of good news: to have Chinese cities competing with each other on the basis of who has cleaner air, rather than who has the fastest GDP growth, has to be a positive development.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: Kalyan Chakravarthy / Flickr

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Why Would Your Corporate Culture Be Embraced In China? http://www.mckinseychina.com/why-would-your-corporate-culture-be-embraced-in-china/ http://www.mckinseychina.com/why-would-your-corporate-culture-be-embraced-in-china/#comments Wed, 06 Aug 2014 02:30:42 +0000 http://www.mckinseychina.com/?p=7932 Corporate cultures don’t get transferred by osmosis. They don’t get transferred through long memos and videos, or by holding the occasional town hall meeting by a fly-in, fly-out senior executive. The less familiar new hires are with the kind of culture you want to instill, the longer it will take, and the harder the work will be. In China, in general, it will be very long and very hard.

This is in part why successful foreign companies are either very small or very big. In small companies, owners who do a bit of everything and treat their business as a full time passion can make their culture what they wish. Larger companies that have the global resources to invest against something they regard as non-negotiable can succeed in instilling culture over time.

Mid-sized companies too often just hope for the best, that their local leader will invest the time to build the right culture, alongside all the million and one other things expected of them. A triumph of hope over reality in many cases.

Some things to consider:

  • Be hands on instilling, talking about, and demonstrating how your values and culture translate into everyday actions. Plan for the time, and plan for the costs on an on-going basis.
  • Document all your policies, make them easily available, and enforce them consistently. It doesn’t matter if it’s your newest salesperson or your head of sales and marketing who is charging his groceries as entertainment expenses – deal with them decisively.
  • If you hired your China head in China and they never worked for you elsewhere, how can they be credible in communicating and reinforcing your culture? Invest in transferring senior and trusted leaders from headquarters who will be based in China.
  • Be sceptical when you hear statements like “We’re better off with a decentralized model”, or “We’re 100% compliant on all that.” Really stress test for yourself so that you are confident what you’re hearing matches reality – don’t accept assertions.
  • Great financial results do not by themselves imply adherence to your corporate culture. Don’t make an exception for China management just because results are good. The faster you are growing your China business, the more challenging it is to educate new colleagues in your core values.

You wouldn’t expect a Chinese corporate culture to be easily embraced outside China. So why should your corporate culture be easily embraced in China? It is hard work to make it happen, but it can be done, and the rewards are real.

You can read more of my views on China on my blog, Gordon’s View. And please follow me on Twitter @gordonorr

Image copyright: sjenner13 / 123RF Stock Photo

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Preparing China’s Graduates For The Next Wave Of Internet Enabled Growth http://www.mckinseychina.com/preparing-chinas-graduates-for-the-next-wave-of-internet-enabled-growth/ http://www.mckinseychina.com/preparing-chinas-graduates-for-the-next-wave-of-internet-enabled-growth/#comments Mon, 28 Jul 2014 02:25:56 +0000 http://www.mckinseychina.com/?p=7928 I just published with my colleagues at the McKinsey Global Institute a new (and lengthy) report on China’s Internet and its potential impact on China’s future growth. We believe that the Internet has the potential to enable China’s economy to grow 1% point faster on average each year between now and 2025. This growth should be enabled by greater Internet based productivity growth, especially in small and medium-sized enterprises (SMEs), greater Internet based consumption, and greater innovation. In combination, these should bring stronger market forces to more and more of China’s economy.

While China’s Internet has been very consumer centered to-date, with the emergence of the largest e-retail sector in the world, over the coming decade business adoption will become a priority. Too few Chinese businesses use cloud services, location-based services, the Internet of Things or related solutions today. Indeed, the average Chinese company spends less than 2% of revenue on IT, only about half of their global peers. Supplying Chinese companies as they invest to catch up will be a massive market opportunity.

Some Chinese companies will be held back in catching up by lack of in-house IT capabilities. CIOs are often not at the top management table and were not always hired for their ability to bring together a business and a technology viewpoint. Quality CIOs are a very scarce resource.

Many winners will emerge from this faster Internet enabled growth. A larger economy should create more wealth and potentially more jobs. Yet there will potentially be losers. Government, business and individuals all need to act now to minimize the impact on those who may lose their current jobs as a result of this transformation, and who may not be well-equipped to find new jobs to replace them.

The chart below shows our analysis of possible job losses and gains. The only overlay I would add is that the losses are somewhere between probable and certain, while the job gains are only possible. And the job losses will likely happen in the early part of the projection period, while the new jobs will emerge at scale somewhat later.

McKinsey China

Government needs to stimulate the creation of low cost vocational retraining at massive scale for those who lose their jobs as a result of Internet enablement, perhaps with a new range of qualifications and certifications that those trained up can obtain as proof of capability. From bank clerks to factory workers, from security workers to call centers, Internet enabled productivity will make many roles obsolete. These workers need to be guided to develop the right new skills.

Employers have an enormous social responsibility here. They cannot and should not simply lay off large numbers of workers; they must help with the retraining of their staff so that as many as practical can be redeployed.

Students and educators need to better anticipate the skills that will be needed. It is clear that universities in China are not equipping graduates with relevant skills for the changing economy. They will have to do better in preparing 7 million graduates a year to enter the workforce.

Individuals will also need to look after themselves. I am convinced that they will seek vocational training in massive numbers. This will also be a very fast growing business opportunity, one which will potentially occupy much of the space in malls given up by retailers who have shifted to selling on the Internet.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image copyright: leungchopan / 123RF Stock Photo

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8 Reasons Why Employers Should Pay You More For Moving To Beijing http://www.mckinseychina.com/8-reasons-why-employers-should-pay-you-more-for-moving-to-beijing/ http://www.mckinseychina.com/8-reasons-why-employers-should-pay-you-more-for-moving-to-beijing/#comments Fri, 25 Jul 2014 06:18:11 +0000 http://www.mckinseychina.com/?p=7924 Some companies are proposing to provide extra pay – including “pollution hazard pay” – for expats living in Beijing. Please!

Made me think about what other reasons one could try to arm-twist an employer for a few dollars more, wherever one might get posted in emerging markets:

1. Eating food in restaurants or perhaps even eating at home. After all, I don’t know how the food has been prepared, if it is past its sell-by date, or if it was sprayed with pesticides?

2. Driving a car. The accident rate must be higher here than whatever benchmark we can get the HR guys to use. It’s not the cost of repairing the car, that’s covered by insurance. The chances of personal injury are higher and I suffer stress just thinking about it.

3. Taking overnight flights on local airlines. Seats that hardly lean back, lights on throughout the flight, being woken up for meals you don’t want, announcements made every 30 minutes during the flight. This leads to serious sleep deprivation.

4. Knowing that my email is being accessed by government security services. Oh wait, sorry, that also happens back where our HQ is, so I can’t really ask for extra for that.

5. Living in an apartment built to local construction standards, or worse. It might fall down.

6. Water. Surely I need to import all the water I use?

7. Clothing allowance. Not only will my clothes be damaged by the air pollution, but at some point the maid will put my suits in the washing machine (this did happen to my colleague a few years ago).

8. Video conferences and conference calls between midnight and 6 a.m. You wouldn’t do this in HQ land – why do I have to? Double compensation for calls on Friday night.

Where do you draw the line? Net net, in my view, before you even get started. If it is the extra money, not the opportunity, that is what determines whether you move or not, I suggest you don’t.

I just don’t see how any of the recently proposed expat allowances (or my more creative suggestions) are anything other than an insult to the talented and committed local colleagues in the city you are thinking of moving to. They breathe the same air, eat the same food, live in the same buildings, travel on the same roads and get on the same middle of the night videoconferences.

Do you really want to be looked at by them, your peers, your direct reports and maybe even your boss, as the guy who has to be paid extra to do what they see as normal?
You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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Who Reads Newspapers In China? http://www.mckinseychina.com/who-reads-newspapers-in-china/ http://www.mckinseychina.com/who-reads-newspapers-in-china/#comments Fri, 25 Jul 2014 05:50:53 +0000 http://www.mckinseychina.com/?p=7921 Despite their influence, relatively few copies of China’s major newspapers are printed every day. For a country of 1.3 billion, that only 3 million copies of People’s Daily are printed daily (source: Danwei) seems pretty low. In comparison, the Sun newspaper in the U.K. (population 60 million) prints 3 million daily, Times of India 4.1 million, Yomiuri Shimbun in Japan 13.5 million, The Wall Street Journal 2.4 million, and The New York Times only 1.9 million*.

This is reinforcement that the vast majority of Chinese citizens receive and consume their media online both from formal news organizations and through social media and from CCTV, with its hundreds of millions of viewers daily. It is not surprising that companies fear an exposé from CCTV more than from print media. Its immediate radiation is so much larger.

Many copies of Chinese newspapers seem to be distributed for free. Their economics cannot be pretty, especially not when they and their peer state-owned enterprises are being asked to become more market-oriented. Consequently, we see the rush to split out parts of their operations that could conceivably be run on a for-profit basis and to promote their listing on local exchanges. The number and nature of visits from Chinese state-owned media to their European peers is growing and changing. Rather than polite exchanges of opinion and commercial arrangements for content sharing, Chinese visitors want to get deep into the business models of how they are funded from public and commercial sources.

A further consequence will be greater economic pressure on journalists, who traditionally have been paid very little, and who supplemented their incomes elsewhere. Newspapers are unlikely to be paying more overall, and indeed, they will likely thin their ranks of journalists. However, they will pay more for stories that generate online views and consequently advertising revenues. Everyone in China understands pay for performance, whether in the private sector or state-owned enterprises. This may also be coming soon to Chinese journalists – a good time to be a great journalist, a bad time to be a general piece writer.

* People’s Daily, Wikipedia, ABC

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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Technology Delivers Safer Food In China http://www.mckinseychina.com/technology-delivers-safer-food-in-china/ http://www.mckinseychina.com/technology-delivers-safer-food-in-china/#comments Wed, 23 Jul 2014 05:47:19 +0000 http://www.mckinseychina.com/?p=7918 Food safety, or the deep felt belief in its absence, is one of the most powerful forces shaping consumer behavior in China. This shows itself in many ways, from the cottage industry of travelers bringing infant milk formula back from every trip abroad, to total contempt for tap water.

Manufacturers are increasingly backward integrating to try to control every step in the food chain that determines what goes into their products. Yet still, retailers and food producers live in fear of adulterated ingredients somehow getting into their products. The government is subsidizing the development of modern cold storage facilities in many cities. Yet consumers remain skeptical and are asking for proof that a product is safe, is as fresh as it claims to be, and was grown where it claims to come from.

Technology is being deployed to do this in a growing number of ways. Below are a few representative examples. If they scale over the next few years, China might be on the verge of finally emerging from its food safety crisis.

  • Joyvio, founded only a few years ago by Legend Holdings, has become one of China’s largest blueberry and kiwi fruit producers. Consumers can track information about their fruit such as farm of origin, product type, planting conditions, quality control steps, and packaging type, by scanning the QR code on the fruit with their smartphone.
  • Metro has traceability scanners in the meat section of their stores where you scan your selection and learn where the animal was raised, where it was slaughtered, how long it has been in transit, and if it has been frozen during the process.
  • Online platforms are becoming increasingly cost competitive for supplying imported foods in China’s major cities. In Shanghai, COFCO reports that 23% of online food sales are of imported foods.
  • Yihaodian, the online only store now controlled by Walmart, has opened a pilot offline store in Shanghai offering pick up and return, as well as home delivery.
  • SF Express, one of the most important providers of logistics services that enables ecommerce in China, is offering subscription based food delivery services, with a time guarantee of 48 hours from farm to home through its SFBest.com online marketplace. JD.com is forming partnerships with specific producers to enhance its own fresh offerings.
  • Sun Art, the hypermarket chain, is working with convenience stores for the stores to serve as pick up and payment points for products ordered on Feiniu.com (their online site).

Lots of experimentation underway to better integrate online and offline and bring greater convenience to the consumer regarding where, when and how they make and receive or collect their orders. I expect the pace of change to be very rapid as retailers play out a new land grab, trying to occupy the best sites in high density residential areas for these new multi-purpose locations – retailer, pick-up point, payment point and more.

Less time in transit should mean fresher food with less spoilage; more information should mean greater confidence; more efficiency should mean lower costs. It is more than likely that technology enabled food delivery is the key to a safer food environment for all its citizens.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: Carnie Lewis / Flickr

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Who Depends Most On China For Exports? http://www.mckinseychina.com/who-depends-most-on-china-for-exports/ http://www.mckinseychina.com/who-depends-most-on-china-for-exports/#comments Mon, 21 Jul 2014 05:40:22 +0000 http://www.mckinseychina.com/?p=7909 China’s imports grew only 7% in 2013 over 2012. Which countries are most dependent on China for their exports and so are most impacted by slower growth in imports?

Close neighbor South Korea sends almost 30% of their exports to China, Japan over 20%. From further afield, Australia sends over 35% of their exports to China and Chile nearly 25%*, however this is only 6-7% of their respective GDP. In contrast, many Southeast Asian countries’ exports to China are 8-12% of their GDP in scale.

McKinsey China

The chart also highlights:

  • Growth in exports to China are unlikely to be a major growth driver for the EU, given the current base is only 1.1% of GDP.
  • Russia really does have the opportunity to pivot to the East for its energy exports and achieve significant growth, with only 6.5% of its exports coming to China today.
  • As India’s new government sets a higher growth agenda, debottlenecking India’s exports to China could make a material contribution

By category, instruments and electronics continued to be the fastest growing categories at 20% and 15% respectively. Agriculture was third with a growth rate of 10% and I don’t believe it will be long before it becomes the second fastest growing sector.

*Main source: UBS

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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Shanghai’s Smartest Heading To Oxford http://www.mckinseychina.com/shanghais-smartest-heading-to-oxford/ http://www.mckinseychina.com/shanghais-smartest-heading-to-oxford/#comments Sat, 19 Jul 2014 05:34:53 +0000 http://www.mckinseychina.com/?p=7906 50 of Shanghai’s brightest students gathered last week for an introductory video conference with the administrators from Oxford University. All have places to start at the university in September. All they have to do now is to navigate the visa and financial support processes. Indeed, the conversation during the session and after focused very much on the cost of studying abroad.

While clearly very talented, these students are not from any moneyed elite. Studying abroad is a major financial challenge for them. They are fortunate that the number of scholarships available is rising very fast, ranging from older funds such as the U.K. government’s Chevening Scholarship and the Jardine scholarships, to new funds donated by successful Chinese entrepreneurs. Oxford and other universities realize the challenges that such students face and that the best may simply not apply in future.

Almost all have places in the sciences or engineering, around 60% are women. The skew away from liberal arts is unsurprising. Tackling something like politics, philosophy and economics through the tutorial system in English as a second language is a high bar.

As a pool of talent for multinationals to consider hiring, this is an outstanding group. Ensure that your Oxford recruiters are on the lookout for talent for China, not just London!

It was great to meet these talented students, understand their aspirations and try to ease some of their anxieties as they set out for Oxford. I look forward to remaining in touch with them in the years ahead.

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Enabling The Next Internet Wave In China http://www.mckinseychina.com/enabling-the-next-internet-wave-in-china/ http://www.mckinseychina.com/enabling-the-next-internet-wave-in-china/#comments Thu, 17 Jul 2014 13:14:30 +0000 http://www.mckinseychina.com/?p=7899 The leaders of China’s Internet success stories are rapidly becoming part of China’s establishment, interacting frequently with senior government leaders. Last week, for instance, several China Internet CEOs were part of Xi Jinping’s trip to Seoul. As they have these opportunities to spend time with policymakers, what should they be arguing is necessary for the next era of China’s Internet economy to be as successful as the one they have already profited from so well?

  • Enhancing workforce skills. It should be obvious to all that universities should be graduating students equipped with the technical and business skills to succeed in operating companies. It is, however, entirely obvious today that they are not. Government action to make university curricula relevant for the growth in internet related jobs is.
  • Sustaining openness to international ideas and capital. China has profited greatly from an Internet industry structure that encouraged the development of China relevant business models and local champions to deliver them. Yet often inspiration and stimulation for the business model came from outside China. And today, much of the world is looking to China’s internet leaders for their own inspiration. There is very much a two-way flow of ideas and investments. This benefits everyone.
  • Enhancing data protection for individuals from businesses who are using their data. Many private companies and state-owned enterprises hold vast amounts of information on their customers. While new laws have been passed regarding how they are allowed to use such data, what permissions they should obtain, and the like, consumer confidence in the system is low. It could take only a few high profile breaches of personal information (e.g. from a bank or a telco) to have Chinese citizens pull back from providing their personal data so freely online. It is essential that China’s leading Internet companies are seen to be role models in data protection.
  • Encouraging national markets. Most Internet businesses are born national. Yet regulations at a city or provincial level can hold back the development of efficient national markets that would benefit consumers. Constraints on selling second hand cars across provincial boundaries is one example. Policymakers should roll back regulations that constrain markets to the provincial or city level.
  • IP protection. Increasingly, China’s internet leaders are developing a substantial amount of in-house intellectual property. They want to be certain they can protect this IP in China and internationally as they globalize. Ensuring they can get swift redress when they find their IP being used by others is key. For an Internet player guilty of using someone else’s IP, a small financial fine in 12 months is almost irrelevant when a business is growing at Internet speed. Courts need to decide quickly if a business model is legitimate or not.

Swift action on these levers will place China’s Internet industries in a much stronger position to succeed going forward.

 

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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China Malls Reinvent http://www.mckinseychina.com/china-malls-reinvent/ http://www.mckinseychina.com/china-malls-reinvent/#comments Wed, 16 Jul 2014 13:12:44 +0000 http://www.mckinseychina.com/?p=7895 One of the most notorious failures among many in China’s shopping malls is the New South China Mall in Dongguan. Originally marketed as the largest mall in the world and targeting the entire Pearl River Delta with premium outlets, it quickly fell into disuse and ended up like this.

Now it is reopening under new ownership, focused simply on local residents in Dongguan and with a very different mix of outlets. On its first day back in business last month it claimed 80,000 visitors. (I tried but was not yet able to find a picture of the new crowds). I am sure a lot were visiting out of curiosity, but just maybe they will keep coming back to what in some way is now the largest restaurant in the city. Fully 40% of the space is now given over to food consumption. Conventional retail takes only 30% and is mostly local brands.

The remaining space is for experiences stores, trying to make the mall a destination in which people will remain in for hours. The retail space may shrink further as the mall owners see offices, clinics, opticians, dentists, kindergartens, tutoring for children, and gyms as the next focus of their renovation. What the new owners are doing, on a massive scale, is representative of what is changing in malls across China.

Traditional retail outlets cannot support the economics of most malls; new services are the future if there is one at all. The need to reinvent is high, although hopefully most can avoid bankruptcy as they do so.

 

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: VagabondJourney.com

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China’s Courts Take To The Internet http://www.mckinseychina.com/chinas-courts-take-to-the-internet/ http://www.mckinseychina.com/chinas-courts-take-to-the-internet/#comments Tue, 15 Jul 2014 13:05:39 +0000 http://www.mckinseychina.com/?p=7891 China’s courts may not be world leaders in many regards, but in one area at least, they seem to be innovating in ways that others might follow. Around 200 courts out of 3,100 nationwide have registered as “stores” on Taobao, China’s leading online retailing marketplace. The earliest adopters were in Zhejiang province in East China, where almost 100% of courts now use Taobao.

The courts are using Taobao to sell foreclosed properties, seized and made forfeit as part of the court’s proceedings. Going online allows the courts to list assets for free rather than have to pay someone to advertise and organize local auctions. Clearly, they also reach a much larger pool of potential buyers. Taoabao claims that courts are realizing prices on average 20% above their historic levels and that more assets are being sold at the first time of offering. As a result, creditors are receiving higher and faster pay outs, and the courts are seen to be more transparent.

 

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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Bringing Technology Into Chinese Healthcare http://www.mckinseychina.com/bringing-technology-into-chinese-healthcare/ http://www.mckinseychina.com/bringing-technology-into-chinese-healthcare/#comments Mon, 14 Jul 2014 12:56:10 +0000 http://www.mckinseychina.com/?p=7883 China’s healthcare system is facing massive growth in demand as the urban population grows and the middle class expands. As in so many countries, demand grows at a pace which financial resources do not match. In an effort to get more from less, China’s healthcare administrators, hospitals and patients are exploring how technology can help. In many ways, China’s systems encourage local experimentation with the more successful solutions getting scaled nationwide over time. Some examples include:

  • Telemedicine pilots are scaling across the country. Zhejiang has a telemedicine network connecting 500 community health centers (the entry point into the healthcare system), 150 city hospitals and a dozen provincial level hospitals. By handling thousands of expert interactions and even intensive care cases remotely, inpatient costs fell over 10%, 40% fewer patients needed to be physically transferred to the next level in the healthcare system, and as a side benefit, complaints fell by nearly 30%. Even military hospitals are participating in these networks, with China’s leading 301 military hospital conducting 100 remote consultations a week in 2013.
  • Online “consultancy” platforms connect patients and doctors directly online. One of the leading platforms in China, Chunyuyisheng, has more than 15 million consumers registered along with 10,000 physicians and claims to receive hundreds of thousands of queries a day. While a first question is usually free, these sites successfully charge consumers modest fees. More than 1 million members of the Chunyuyisheng platform are paying $1-2 per month for the opportunity to ask unlimited questions and receive answers within the hour. Some of these platforms connect directly into a hospital’s outpatient scheduling systems and can facilitate consumers making appointments with the right specialist.
  • Neusoft, one of China’s leading providers of healthcare management systems, is running city level pilots, under the Xinkang brand, that combine real time healthcare monitoring of the general populations with in-home monitoring of chronic conditions and hospital consultation.
  • E-cards that hold healthcare related information and which allow patients to make appointments online, check in, record a diagnosis, and pay, have been rolled out to almost all residents in Shanghai’s Minhang district, which has a population of 2.5 million. All healthcare information that was previously held tightly by a single institution is now shared across all facilities in what is called a “Regional Health Information Network”, easing transfer of patients across facilities. The cards even allow an automated warehouse to deliver medicines to a patient who swiped the card without automatically involving a pharmacist.

I expect these pockets of innovation to rapidly scale. The benefits of more efficient use of scarce funds and greater patient satisfaction will rapidly draw later movers to adopt these solutions. One final reason that this will be the case: social media in China today is a great disseminator of consumer-facing innovations. Citizens in cities where they don’t get the new services are quickly aware of them, and are able to push for their delivery.

 

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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Team Building In China http://www.mckinseychina.com/team-building-in-china/ http://www.mckinseychina.com/team-building-in-china/#comments Mon, 07 Jul 2014 05:00:18 +0000 http://www.mckinseychina.com/?p=7877 I have just come out of our Values Day offsite in Shanghai, an annual event for everyone in the office (and in McKinsey offices worldwide) at which we celebrate and discuss our core values. For most of the year we assume that we are instilling our values through role modeling and real-time feedback. Today we explicitly stand back and talk about our values.

With over 500 colleagues in Shanghai, from an enormously wide range of backgrounds and lengths of experience with our firm (from one week to nearly 30 years), the organizing committee always faces the challenge of making the day fresh and relevant. Breaking down the inherently strong hierarchy that is always going to be present in a China-based organization, for example.

This year, the team did a great job by breaking us into small groups to develop a short performance about daily life in our firm, and how we do and don’t live our values. Critically, everyone had to play a role different from that which they take on a day-to-day basis. For example, in my group the analyst was the project manager, the research leader played the client, the assistant was the partner, and I was the assistant. Developing the story line for the role play forced everyone to think out of their usual context and required everyone to make a contribution, with no one sitting silent waiting for the senior person to speak.

We were given a values topic and asked to develop a scenario on stage in front of the entire group, where at first everything was done wrong, and then we repeated the scenario, but this time modeling best practice in living our values. Fun and thought-provoking, and as always, a prize for the best performance – a bit of competition always helps.

Earlier in the day in different groups we had undertaken the “collage exercise”. We were given a random stack of magazines and newspapers and asked to cut images and words from them to stick to a flip chart in a way that communicated our mission and values. This is a great exercise to do at the table as you discuss what a particular word or image means for one individual and see if it also resonates with the group. In the end, the charts can look quite similar so presenting back to the group is perhaps not as interesting. But much is to be gained in developing them and giving everyone at the table, from all roles in the office, the opportunity to describe what our values mean for them individually.

It is particularly important that we do this in China where it is all too easy for hierarchy to become the be all and end all. Regular events like our Values Day, combined with other initiatives through the year, like our charity and volunteer days and sports events, create and reinforce the connections that would not normally develop through daily work. A people-based firm cannot thrive without them.

Beyond just colleagues, team building in China needs to draw in family members to understand what we do all those long hours in the office, often out of town, and with whom. Summer events with children, in-office events to celebrate promotions, and the occasional weekend retreat with spouses, all reinforce connections and commitment. In an environment that is so opportunity-rich in China for the talented colleagues we have in every role, it is not just about living our values, but also smart business practice, to make everyone feel a committed and valued member of the firm.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image: Me and colleagues at our Values Day offsite in Shanghai

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Russian Business Pivots To China http://www.mckinseychina.com/russian-business-pivots-to-china/ http://www.mckinseychina.com/russian-business-pivots-to-china/#comments Fri, 04 Jul 2014 04:55:53 +0000 http://www.mckinseychina.com/?p=7873 Catalyzed by President Putin’s recent visit to China, Russian business leaders have been looking for their own opportunities to invest. Many Russian business leaders were in Harbin this week for a Russia China business summit, others gathered at events in Moscow to consider where the best opportunities lie.

Certainly there is opportunity for an uptick. Just looking at Russia’s exports to China highlights a decline of between 5% and 10% in dollar terms from 2012 to 2013, and China only takes a bit over 6% of Russia’s total exports. Clearly momentum is lacking. It is also clear that Russian business leaders tend to view business opportunities very much through a geopolitical lens.

Where are the best areas for what I might call pragmatic partnership? Areas where it is in the mutual interest of both the Russian and Chinese party to collaborate. I believe there are several:

  • Could China buy more oil and gas from Russia? Certainly the demand is there, the agreement on gas supply just signed hardly covered 10% of China’s expected demand. Now that the reference price has been set, it should be easier to negotiate over further volumes.
  • Could China pre-pay for even more of this oil and gas? China’s energy companies have already prepaid mainly billions of dollars to Russian energy companies, they remain capital rich and have full confidence that the supplies will come. So yes, I could see more prepayment arrangements. CNPC already owns a small stake in Rosneft, perhaps they could acquire a little more?
  • Bottlenecks are more in the infrastructure to carry the oil and gas. Here again Chinese capital can support Russian companies with the rights to operate pipelines.
  • Is there an opportunity to expand capacity on the railroad from Western China through Russia to Europe? Absolutely. Many companies based themselves around Chengdu on the basis that they would be able to ship to Europe by rail only to find that capacity is not reliably available. Demand exists.
  • Could China import more agriculture products from Russia? Today only 13% of Russian exports to China fall into this category and volumes shrank in 2013. Yet China is importing more cereals and more premium foods also. Russia business has a large opportunity. Increasing imports of wheat and other cereals from adjacent countries is attractive for China as an alternative to shipping protein around the world on ships. If Russia could cultivate more of its available land, perhaps in partnership with the private Chinese companies that are now investing to develop agriculture China, we could see a rapid doubling or more in volumes coming to China.

Beyond this, when I attended some of these events, I was asked in great detail about the quality of talent in China, especially of university graduates. Are they well prepared for work? How good is their schooling given how quickly universities have expanded? Where does McKinsey recruit from and why? Do you recruit Party members? It was interesting to debate building strategy from the starting point of whether talent is available.

My visa for Russia expired with this trip, but I am applying for a renewal immediately as there was no doubt that the Russian business leaders I met were 100% committed to growing their businesses in and with China. I will be back soon.

 

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: Derek Harkness / Flickr

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Xi Jinping Visits South Korea http://www.mckinseychina.com/xi-jinping-visits-south-korea/ http://www.mckinseychina.com/xi-jinping-visits-south-korea/#comments Thu, 03 Jul 2014 15:19:43 +0000 http://www.mckinseychina.com/?p=7865 I was in Seoul this week as a number of companies I met with were preparing for President Xi’s upcoming visit. China’s continued economic growth creates an increasing sense of opportunity and threat for many South Korean business leaders. Opportunity, given the relative size and faster growth rate of the Chinese economy. But also threat, given the increased scale and capability of Chinese companies in export markets.

In everything from mobile phones to nuclear power plants, South Korean companies find themselves competing with Chinese producers. The challenge of how to sustain distinctiveness, how to avoid the fate of many Japanese companies, squeezed out of their historic international markets, comes up over and over.

Indeed, many are looking for ways to leverage Chinese capital to stimulate growth in South Korea. South Korean companies often have excellent IP, operating efficiencies in international projects that Chinese companies cannot match, and an established international brand/reputation to go with it. Partnering with Chinese capital and cost structures may well be a good way forward for some.

For the Chinese business leaders coming on the trip, some will be looking for much more than partnership. Outright acquisitions will be on their mind. Real estate, high tech and even healthcare companies may be looking for opportunities to diversify into South Korea. For some of the new private hospitals in China, owning a famous South Korean plastic surgery chain could create significant synergies. Real estate companies have diversified extensively into Jeju island already with good results, and they may be ready to do more.

I also expect announcements on increasing the two-way flow of students between South Korea and China, and on an increase in the number of Chinese cities that you will be able to fly to directly from South Korea.

 

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: US Army Garrison Yongsan / Flickr

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Summer Reading On China http://www.mckinseychina.com/summer-reading-on-china/ http://www.mckinseychina.com/summer-reading-on-china/#comments Thu, 03 Jul 2014 15:10:54 +0000 http://www.mckinseychina.com/?p=7858 At a recent talk in Europe, I was asked during the Q&A by a Chinese member of the audience to suggest an English language reading list on China. Here is what I came up with as old favorites:

  • Caixin magazine (subscribe online)
  • The Party – Richard McGregor
  • Red Capitalism – Carl Walter
  • Capitalism with Chinese Characteristics – Yasheng Huang
  • Avoiding the Fall – Michael Pettis
  • Inside China’s Shadow Banking – Joe Zhang

A couple that are on my to-buy list, but have not yet arrived:

  • China’s Second Continent – Howard French
  • Age of Ambition – Evan Osnos

And below is the remainder of my list from a year ago

  • One Billion Customers – James McGregor
  • The Chinese – Jasper Becker
  • River Town – Peter Hessler
  • Tide Players – Jianying Zha
  • Poorly Made in China – Paul Midler
  • Factory Girls – Leslie Chang
  • Stumbling Giant – Tim Beardson
  • Tiger Head, Snake Tails – Jonathan Fenby
  • On China – Henry Kissinger
  • China’s War with Japan – Rana Mitter

What am I missing that I should use the summer to catch up on?

 

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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Ireland Focuses On China http://www.mckinseychina.com/ireland-focuses-on-china-2/ http://www.mckinseychina.com/ireland-focuses-on-china-2/#comments Wed, 02 Jul 2014 15:02:18 +0000 http://www.mckinseychina.com/?p=7853 I was in Dublin last week for the first time in almost 20 years for a session with the Institute of International and European Affairs, the same week as the 35th anniversary of the establishment of diplomatic relations between China and Ireland. A highly interactive session focused first on the robustness of China’s economy and then on China’s myriad connections with Ireland. I had not realized until I was preparing for my discussion that Ireland is one of very few European countries that runs a trade surplus with China. The open part of the discussion is online here.

In the Q&A, the audience focused on the benefits and risks that rapid development of new and parallel industries online can bring to China, especially the challenges of retail disruption, perhaps in recognition of Ireland’s boom and bust in retail over the last two decades. There were also questions about the impact, sustainability and direction of the anti-corruption campaign.

As expected, a good deal of the business discussion was on the agricultural opportunities, especially in dairy. Here I think there is a real chance for much more growth. China’s demand for milk products is not going to abate and imports will be central long into the future. Attracting Chinese investors and partners to leverage Irish heritage and quality should be a truly winning combination. Further, Chinese drinkers consume spirits from all corners of the world, but I have very rarely seen Irish whisky on sale in China. Surely a missed opportunity?

In the afternoon session, we discussed how to grow Chinese tourism to Ireland. I pointed out that two basic markers were not yet in place. Leading hotels don’t yet all offer Chinese breakfast options, and while it is under discussion, there are still no direct flights. My discussion partners were disappointed that they had been told a flight from Dublin to Beijing would not be allowed. I pointed out how the new BA flight to Chengdu had opened up a whole population to direct flights to the UK and was proving very successful. I think it matters less exactly which city direct flights come from. Indeed, for Ireland, a connection to a major agricultural processing hub might be even more attractive than to one of the tier 1 cities.

I have met many representatives of the Irish government in China over the years. They have tended to impress with their commitment to promoting commercial opportunities for Chinese companies in Ireland. As more and more of China’s private sector leaders move internationally and more of them seek investment opportunities in value added agriculture, this should be a real window of opportunity for Ireland to increase inbound investment and exports at the same time.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: The Institute of International & European Affairs

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Can India Export More To China? http://www.mckinseychina.com/can-india-export-more-to-china/ http://www.mckinseychina.com/can-india-export-more-to-china/#comments Tue, 01 Jul 2014 01:37:29 +0000 http://www.mckinseychina.com/?p=7847 India’s new Minister of Commerce and Industries, Nirmala Sitharaman, recently challenged Indian industry to export more to China and so reduce the current US$30 billion trade deficit. After all, it is only 10 years back that India was running a trade surplus with China.

In 2013, India’s exports to China actually fell by close to 30% from 2011 on the back of iron ore export bans (US$9 billion less exported to China in 2013 versus 2010). Beyond releasing this ban, what else might Indian industries focus on to export to China?

1. Play to strengths – Accelerate growth in sectors where exports to China are already growing

Textiles. India’s exports of textiles to China have doubled to almost $5 billion in the last 3 years. This could absolutely grow much, much further. China is exiting basic textile production just as India is embracing it as a source of urban jobs. It is not unreasonable to expect 20-30% annual export growth.

Gems and Jewellery. India’s exports of gems and pearls to China have also doubled in the last 3 years to nearly $2 billion. Jewellery retail in China continues to grow very strongly and relies heavily on imports. India needs to develop design strengths in the types of jewellery China’s consumers want to capture a greater share

Pharmaceuticals. India’s pharmaceutical giants are world leaders in low cost innovation and production. China’s healthcare industry in total could reach US$1 trillion by 2020. The Chinese government, as so many others, is looking to better control the cost of provision and of drugs. Global pharmaceutical companies have large positions in the China market. There is potential for Indian companies to capture greater share although this may take partnerships and quite some time to develop

2. Focus on growing needs in China

China increasingly needs to import agricultural products in order to feed its citizens in the way they desire. China’s imports of cereals, of meat, of dairy and value added foods are growing rapidly. India is already a leading producer and exporter of wheat and of buffalo meat.

India’s wheat exports may reach 8 million to 10 million tons in 2014-2015 which exceeds the previous record of 6.8 million tons in 2012-2013, U.S. government data shows. Most of the exports go to the Middle East and Southeast Asia. Why could more not go to China?

India produced 3.6 million metric tons of beef in 2012, of which 1.7 million metric tons was exported. India ranks 5th in the world in beef production and 1st in exports. Would it not be possible to expand sales of beef to China?

3. Don’t overlook services

India has the opportunity to attract many millions of Chinese tourists a year, rather than the few thousands that come today. Easier visa processes, more effective marketing and many more direct flights are probably all that it would take to create a major upswing

Net net, the Minister may have been right in her challenge. Indian business could do better in exporting to China.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: Danica / Flickr

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Li Keqiang In The U.K. – Selling Or Buying? http://www.mckinseychina.com/li-keqiang-in-the-u-k-selling-or-buyingor-buying/ http://www.mckinseychina.com/li-keqiang-in-the-u-k-selling-or-buyingor-buying/#comments Fri, 20 Jun 2014 05:25:53 +0000 http://www.mckinseychina.com/?p=7835 Chinese Premier Li Keqiang has just wrapped up his visit to the U.K., during which many business deals were confirmed (or re-confirmed). Many of the deals were positioned as China investing in, buying into the U.K. But in some ways it was just as much about selling, selling the world-leading capabilities of the world-scale companies that some Chinese companies have developed on the back of China’s infrastructure boom over the last 20 years.

Several of these highly successful industries are facing a dilemma. They have become successful solely on the back of tremendous domestic growth. Indeed, the China market that they dominate has represented the majority of the total global market in recent years, for example, in power stations (coal or nuclear), high speed rail, city subway systems and more. But these markets in China are no longer growing at double-digit rates, and a decline in absolute market size in China is foreseeable. The only way to sustain their performance is to sell internationally.

And here Chinese companies face a challenge – their companies are not well known, they have very limited track record internationally. Consequently, government officials on international visits have a big role to play as “salesperson in chief”, lining up a package of not just the industrial companies but also the finance to go with it.

I was able to attend some of the events that were part of the visit, in particular the China Britain Business Council dinner at the Natural History Museum. Premier Li impressed with his ability to adapt his remarks to the venue and to speak without reference to notes, to the extent that the interpreters had a tough time keeping up. In his remarks in response, the UK Chancellor George Osborne told the story of how his mother had studied and spoken Chinese, visiting China in the 1970s.

Expect to see much more aggressive support from China’s political leaders of China’s infrastructure industries as they seek to expand internationally. This is realistically the only way in which they can remain at the scale they have only recently achieved. As an early adopter, perhaps the U.K. got a good deal.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: Propeller TV

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Beijing Blue Sky – Head Or Heart? http://www.mckinseychina.com/beijing-blue-sky-head-or-heart/ http://www.mckinseychina.com/beijing-blue-sky-head-or-heart/#comments Tue, 17 Jun 2014 02:16:54 +0000 http://www.mckinseychina.com/?p=7830 I spent four days in Beijing, all of which were blue sky days. A little bit of rain and by no means low pollution, but so much better than in the recent past. It has to be back during the Olympics that I last experienced that many consecutive blue sky days.

My heart wants to say great, this is an only in China approach to problem-solving. Only here could this type of problem be addresssed so quickly when it is determined to be a major problem. The central government told Beijing’s leader to fix it now or else, and they have responded by throwing vast amounts of money at the problem, buying out and shutting down pollution-generating industrial capacity across Hebei.

The numbers talked about run into the tens of billions of RMB. And if it’s true, does it mean that the pollution has really gone away, or has it just shifted to steel plants in Jiangsu who are now running at closer to full capacity? And their pollution is drifting into Shanghai.

My head says duh, statistics say that eventually there will be four days in a row that look good, and a little bit of rain helped. It was inevitable and doesn’t tell you anything. Moreover, I wonder if we don’t have another type of only in China solution here. Yes, actions can be taken fast: it doesn’t requiring planning, consultation and approvals to get things done. But speed of action doesn’t necessarily lead to a solution that sustains. While the factories in Hebei may currently be closed, will local government keep them closed? Will the production equipment from these factories somehow materialize elsewhere and be put back into use? It’s too soon to say.

But in the meantime, enjoy the blue sky.

 

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: Junyu Wang / Flickr

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Swapping Students http://www.mckinseychina.com/swapping-students/ http://www.mckinseychina.com/swapping-students/#comments Sun, 15 Jun 2014 02:08:50 +0000 http://www.mckinseychina.com/?p=7825 For every 20 Chinese students that come to Britain each year, 1 British student travels to China. Indeed, according to the China Scholarship Council’s most recent figures (2011), there were more students from each of Pakistan and India studying in China than from any western European country. Europe needs to up its game.

The UK government has decided that this is a problem worth fixing and has set a goal of raising the number of students travelling to China for study or work experience 15 fold over the next 7 years. Many universities such as Warwick, Birmingham and Glasgow are establishing exchange partnerships with Chinese universities to lower barriers to sign up. A number of Chinese companies have signed up to offer internships and to fund travel costs. These are excellent initiatives and significantly ahead of many other countries, but I am not sure it will be enough to reach the target.

From my meetings with international students at UK and Chinese universities in recent years, it is clear that they still view the barriers to spending time successfully in China as high – whether it is finding a study place, a work placement, or having the confidence to live in such a different language and cultural context.

Additional actions that might be built into the program, largely focused on lowering these barriers include:

  • Persuading leading UK based companies to offer a number of internships each year where the time spent is 50% in the UK and 50% in China
  • Persuading Chinese companies with significant operations in the UK to do the same, working with the Chinese Embassy in London to do so
  • Leveraging the UK universities that have set up a campus in China
  • Establishing branches of the Confucius Institute on UK university campuses and providing subsidized participation in their language programs in advance of their spending time in China
  • Finding opportunities for students to be part of the many research projects that UK universities are conducting in China, especially in healthcare and medical sciences

 

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: Conor / Flickr

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Why India, Why Now? http://www.mckinseychina.com/why-india-why-now/ http://www.mckinseychina.com/why-india-why-now/#comments Wed, 11 Jun 2014 12:13:08 +0000 http://www.mckinseychina.com/?p=7812 Following up on my recent post on investment opportunities in India for Chinese companies, my colleagues in India have developed a wider ranging piece, presenting the case for why this time its different and India really is open for international business. Take a look and let me know if you agree – Gordon

Time To Act

By Barnik C. Maitra, Anu Madgavkar, Alok Kshirsagar, & Adil Zainulbhai

The burst of economic liberalisation and growth in the first decade of the new millennium was followed by mounting frustration that India’s promise may be fading. Many questioned the ability of 1.25 billion people to work together to rapidly mobilise change, but Indian voters have done precisely that. Last month, the National Democratic Alliance (NDA), led by Mr. Narendra Modi, won overwhelmingly in what is being regarded as a historic Indian general election. Mr. Modi’s Bharatiya Janata Party (BJP) is the first party to win an absolute parliamentary majority since the Congress did in 1984, marking a shift from India’s long experience of fragmented political systems and weak coalition governments.

Over the past few months, the Indian stock market rose by more than 20 per cent, and foreign investment in Indian equities have also risen, in part also due to expectations of a NDA victory in the general elections. While not without challenges, expectations are high that the new government could put India’s economic growth rate back on track, commiserate with its promise and potential.

The next few months will not only be crucial for the new government as they review policies and develop new prescriptions, but also for multinational corporations (MNCs) evaluating growth opportunities or already operating in India, and invested in India’s long-term opportunity. With expectations of an economic revival, several sectors are poised for over 10 per cent growth in the near term. As plans for growth and renewal monopolise the agendas of think tanks, technocrats and bureaucrats, MNCs must also develop a new

agenda to reorient their business models and develop capabilities. This new agenda needs to be crafted in the next few months to shape and capture the imminent spurt of growth over the next 12 to 18 months.

RISING EXPECTATIONS FROM INDIA

Mr. Modi’s victory has raised expectations to incredibly high levels. Aspirations of the country’s social and economic development are turning into convictions, with the new government faced with the task of fixing and reviving the economy, creating an investment-friendly climate, and living up to the expectation of job creation for its youth.

The new government faces challenges in reviving a sputtering economy. From 8.9 per cent in 2010, India’s GDP growth dropped to 4.5 per cent in 2013 and 2014. The industrial sector led the collapse, and the services sector followed, making it a broad-based economic slowdown. A combination of domestic factors drove India’s sluggish performance—large ticket investment projects were blocked due to delays in environmental clearances, production of coal and iron ore declined as mining came to a grinding halt, and new land acquisition laws created uncertainty about the prospects for private investment. India’s fiscal deficit rose, contributing to persistently high inflation of 9 per cent and low real interest rates.

The Reserve Bank of India and the outgoing Finance Minister implemented measures to stem the decline, controlling inflation growth, and tempering current account deficit and fiscal deficit. However, a more fundamental set of reforms is required to get the economy back on track for rapid and broad-based growth. Fiscal spending could be reoriented away from wasteful subsidies to investment and productivity-oriented programs. Underlying supply-side drivers of inflation, including inefficiencies in agricultural production and distribution, could also be addressed. The expectation is that the new government has the intent, because of its political mandate, to do this.

India is poised for new growth on the back of an investment-friendly government. The increase in FII investment indicates that the sentiment for growth is very positive. Most importantly, the new government has promised decisive action, which has implications for the pace of policy approvals and change, project execution, and major growth reform. For example, the new government is likely to fast-track USD 200 to 300 billion of infrastructure projects that are currently stuck in various stages of approval. In the medium-term, with more reform and the government’s stated intent to make bureaucrats more accountable and empowered and break down inter-ministerial silos, several reforms such as tax-code revamps, labour law reform, agricultural productivity missions and transparent auction policies for natural resources could be launched. The new government promises to bring about a more open business climate with less state interference, and improve its international ranking for “ease of doing business.”

Foreign direct investment (FDI) is also likely to rise in most industries, with the expectation that the government will relax FDI limits across several sectors such as aerospace, defence, pharmaceuticals, healthcare, and technology. However given that small traders are important political constituents of the NDA, it is likely that the government may adopt a more cautious approach to expansion of multi-brand retail.

However, living up to the high expectations of immediate job creation will not be easy. The mandate for the new government is widely perceived as one coming from India’s aspiring youth and they are not-quite-middle class; they want the promise of a better life fulfilled quickly. Some 680 million Indians fall below the Empowerment Line, including about 400 million who are not classified as officially poor, but are still unable to meet decent standards of living. (McKinsey Global Institute)

The first and most immediate objective for the government is to manage their expectations. India needs 1 million jobs per month over the next 10 years to absorb its rising labour force. Unfortunately, existing service and manufacturing set-ups will likely create only 70 per cent of the 120 million jobs needed. Through bold policy moves and tight execution, capturing a greater share of manufacturing jobs that are moving out of China (and currently heading to other countries such as Bangladesh, Vietnam and Nigeria) will be critical to delivering on this promise and retaining the widespread public support the new government currently enjoys.

National security and external engagement could in equal measure pose challenges to the growth story and present opportunities for the new government. Mr. Modi’s government could address threats to national security and geopolitical issues with India’s neighbours, particularly Pakistan, while also engaging in constructive attempts to boost trade and investment opportunities with immediate neighbours and further East (notably China and Japan) and with the West. The new Prime Minister demonstrated a desire to constructively engage Pakistan by inviting Pakistan’s Prime Minister Nawaz Sharif to his inauguration, along with other SAARC leaders. On the internal security front, since the election victory, Mr. Modi has emphatically stated that his development platform will address the needs of every Indian irrespective of caste, creed and religion.

On balance, there could be viable near-term and long-term upsides to the India growth story. In fact, analysis suggests (see Exhibit 1) that the near-term GDP growth could rise to 5.3 to 5.5 per cent for FY2014–2015 (as against 4.7 per cent in FY 2013–2014). On a long-term basis from 2015–25, India’s economic rise is likely to move to a Growth Renewal scenario, with the average growth rate for 2014–19 to be around 6.5 per cent to 7 per cent.

This growth momentum could provide the basis to transition into a long-term Growth Renewal scenario whereby the average long-term growth could accelerate to 7.5 per cent to 8 per cent. This case assumes resumption in the investment cycle, a consumption boost and a sharp improvement in investment productivity. The resumption of investment cycle is likely to be triggered by significant increase in capital expenditure by Indian corporates, which declined to 9.9 per cent of GDP in 2013 from a high of 19 per cent of GDP in 2008.

This rise in expenditure coupled with the fiscal prudence could see an increase in investment to GDP ratio of 35 per cent or more in the coming years. Secondly, the consumption boost will be sentiment driven with trickle down benefits apparent from H2 FY2014–2015. Finally, with expected acceleration in project approval and execution, capital productivity increases could drive near-term growth. In particular, ICOR (incremental capital output ratio) for India could move from 8 (in 2013) to the longer-term average of 4.5 to 5.0 providing a strong near-term impetus to growth.

india-exhibit1

OPPORTUNITIES FOR MNCS IN INDIA

MNCs have already established leadership position in India in several sectors notably automotive and FMCG. With the potential improvement business climate and welcoming of foreign direct investment, existing sectors will see accelerated growth and several new opportunities are likely to open up for MNCs over the next 5 years. Here are examples of scale opportunities for MNCs to consider:

Financial Sector: The combination of a higher growth rate and higher investment by FIIs (leading to a 26 per cent increase in the Indian stock market this year in USD terms) will create significant opportunity in all parts of the Financial Services Industry. Investment banking, Global M&A, infrastructure financing, commercial banking could all benefit, in addition to growth in NBFCs, consumer banking, SME lending etc. Raghuram Rajan, the Governor of the Reserve Bank of India has laid out a blueprint of reform, which he is intent on carrying out. This will open up many more sectors to international participation and investment. Specifically, the proposal to treat MNC banks at par with domestic banks if they create a wholly owned subsidiary in India could create significant opportunities for foreign banks interested in India. The proposal to increase FDI in insurance could be another opportunity for MNCs to accelerate their India growth plans.

Consumer and retail sectors: Given the likelihood of improved consumer sentiment, consumer and retail goods is likely to accelerate growth. With the doubling of the middle-class and growing urbanisation, multinational companies need to cover 3x to 7x the number of cities to capture the opportunities beyond the Tier 1/2 cities, which account for the next 25 per cent of urban income. In non-perishables, about 50 per cent of sales for online retailers are from the Tier 2/3 cities. India is likely to have the second largest population of internet users with 350 million subscribers in 2015. The growth of internet penetration will play a significant role in communication, social networking, and in informing and influencing India’s consumers creating interesting business opportunities in categories such as apparel, books, financial services, and travel (where spend is already comparable with that of developed countries and could continue to grow faster). For example, by 2017 India will be home to over 80 million digital cable households and the current industry landscape does yet have a world-class digital cable player. As a result, MNCs with multi-channel (including digital) capabilities and technology experience could be well positioned to capture this growth opportunity in several of these internet and digital industries.

Automotive and heavy equipment: The India auto market (passenger/commercial vehicles, 2/3 wheelers) is set to become a top 3 global markets with 10 to 12 per cent growth forecast over the next 5 years. The investment in auto sector over next 5 years is estimated to be USD 7.5 billion, which can create direct employment for over 2 million people and a significantly larger indirect employment opportunity. India could also potentially service the growing demand for auto in the Middle East and other parts of Asia. In fact, there is an increasing interest among multi-nationals to diversify supply base beyond China. With several OEMs/OESs having already set up shop in India, tapping into the availability of low cost engineers and an existing auto components base, there is a real opportunity to establish India as a “China+1” location.

Manufacturing (labour-intensive and assembly): Manufacturing accounts for only 14 per cent of the GDP whereas for developing economies the share of manufacturing should be 25 per cent of GDP. Given the priority of the new government to create new jobs, business opportunities will emerge in chemicals, electronics, garments and leather. The government is likely to drive creation and scaling up of industrial clusters. At the same time, several of these clusters could also service regional demand allowing MNCs to manufacture and assemble products and goods for India and neighboring countries. MNCs can bring unique skills, technology and productivity practices to make these clusters competitive regionally

Defence: There is a substantial domestic demand in India, with potential defence spending estimated at USD150 billion through 2017. The offset potential is expected to be at USD 10 to 20 billion from setting up India-based defence manufacturing. The July 2012 amendments to India’s defence procurement program (DPP) encourage suppliers and contractors to bank their offset credits. At the same time with the potential increase in FDI cap in defence, several multinationals could have a competitive advantage in the defence sector and would bring the capabilities and state-of-the art technology to develop and propel the local industry.

Agriculture and food processing: Despite being self-sufficient in food grain since the mid-1990s and being the world’s third largest agricultural producer (behind China and the United States), Indian agriculture is far from realising its true potential. In years to come, India is set to increase its overall food consumption by 4 per cent annually with food expenditure more than doubling from USD 245 billion in 2010 to potentially USD 510 billion by 2030. The growth in demand creates opportunities for India to produce and export high-value produce. Several high-value food categories such as fruits (banana, mango), vegetables (potato, soya), and poultry are likely to grow at 8 to 10 per cent annually. Food processing output is also likely to triple from USD 20 billion to USD 120 billion by 2030 (growing at 9.5 per cent annually).

Infrastructure: The Indian infrastructure build-out requires over USD 1 trillion of investments over the next 5 years. In addition to clearance of existing projects, the new government is likely to make significant push towards building big infrastructure corridors (e.g., Delhi-Mumbai, Delhi-Kolkata) and new cities (the BJP manifesto talks of creating 100 new cities). In addition, water resources is likely to be new focus area for the government with a renewed impetus to 24×7 water supply, drainage and sanitation, river cleanup (notably for the Ganga) and inter-linking of rivers. Roads, ports, power generation, transmission and oil and gas are attractive sub-sectors for MNCs to bring technical expertise and project delivery capabilities. In fact, a lot of these projects will need international financing and government is likely to institute new measures (e.g., exchange rate stability fund, removal of withholding tax on FII in long-term infra bonds and relaxing RBI restrictions on refinancing by ECBs) to attract foreign capital to address the potential 15 to 20 per cent shortfall in financing.

Energy: The government has listed the energy sector as a priority to fix since it underpins so much of the economy. They have put Power and Coal and Renewable Energy under the same minister, and will take a fundamental look at the policy for oil and natural gas also. This is likely to open up many parts of the industry to international investment and welcoming MNCs to participate more deeply in several areas potential starting with renewable energy.

MNC IMPERATIVES

The potential surge in India’s growth rate and the likely change in policies on Foreign Direct Investment and improvements in business climate require some rethinking of the strategies for MNCs who are in India already or are thinking about India. This may include fundamentally revisiting the granularity in existing strategy, the nature of investment and potential mergers and acquisitions. MNCs should consider taking the following actions:

1. Re-evaluate business model, bring in global teams to build a winning position in India: This is an appropriate time to launch a quick re-evaluation of the India strategy, so that the company can examine whether the business is potentially ready to take advantage of the opportunities available. McKinsey has developed a short self-diagnostic survey that the company can take to test its readiness (see Exhibit 2). This could also be a great opportunity, for example, to bring together people who built a company’s business in emerging markets (China, Africa, Latin America) and see what lessons they can share with the people in India.

2. Develop strategies for different scenarios and for different triggers: MNCs should be prepared to act decisively on the 4–5 most important triggers for their business. Companies must challenge their India leadership team; ask them what it would take (internally and externally) to be 3x of current plans for 2019. These could be linked to the economy overall or to specific regulatory or policy changes. In particular, MNCs should watch for specific triggers on project approval, policy announcement that could forecast a stronger growth and better environment. MNCs would do well to create a basis for upping their game and agreeing upon what triggers would lead to what actions.

3. Plan to be 2–3x the current plan for India: MNCs would do well to prioritise India as top 3 growth market and initiate the necessary internal processes to reallocate capital and senior management attention. Companies should consider bringing the board to India; nothing beats persuading the board that things have changed. As the economy starts picking up, there will be shortages of leadership, people, critical supplies and attractive inorganic investment opportunities. MNC could proactively allocate investment budgets, complete growth diagnostics to be first movers in sectors poised for growth. Taking the board, for example, on a visit to the top 3 economic zones in which their industry is clustering (e.g., automobiles in Chennai) could help speed-up decision making.

4. Meet the new Government as they are more accessible: MNC business owners and corporate leaders could approach and shape policy more proactively with the government and to show their support for the growth of India’s economy. Mr. Narendra Modi was open and receptive to MNCs during his days as the Gujarat Chief Minister. MNCs must meet with them, share the top 10 wish list—not just in Delhi but also in one or two of the most business ready states.

5. Empower the local leadership to succeed: MNCs could strive to have visible committed leadership at corporate level and in India and provide the necessary operational freedoms to their operating teams for the granularity and business model customisation needed to win in India. At the same time, empowering the local leadership to make bold decisions through a visible shortening and simplification of investment plans could set up India units for medium-term success. Organisationally, MNCs could consider asking themselves a few questions, such as, is it time to have India report direct to the CEO; or is it time to put their senior, trusted “top 5” executives to run India. At the same time, MNCs should re-assess the need to rapidly improve their on the ground engines (direct sales, channel) to prepare for the growth.

india-exhibit2

***

As is so often the case in India, its potential is enormous and so are its challenges. With the new government and its decisive mandate, India may be at the cusp of its next economic renaissance. MNCs can become important players in the Indian market if they are sufficiently agile during the next year or two enabled by decisive actions in the next few months.

The authors are current and former colleagues of McKinsey’s India offices.

 

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: Tiberio Frascari / Flickr

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Russia Can Feed China. Will It? http://www.mckinseychina.com/russia-can-feed-china-will-it/ http://www.mckinseychina.com/russia-can-feed-china-will-it/#comments Tue, 10 Jun 2014 12:07:47 +0000 http://www.mckinseychina.com/?p=7807 I talked earlier about China’s increasing need for agricultural imports. Russia has the potential to be a key player in this. Currently Russia has 67 million hectares of arable land under cultivation, with 2.5 million hectares dedicated to producing 9 million tons of corn.

By 2025, Russia plans to double the area planted with corn to a total of 5.1 million hectares in response to rising commodity prices. They also aim to raise yields significantly due to the adoption of GM seeds from 2014 on and by scaling farms. This could result in additional production of 30 million tons of corn annually, which would address a major part of China’s expected grain shortfall. This would require China to accept GM products, which is not the case today.

Beyond this plan, Russia could produce a wider range of China’s agricultural needs. Russia has over 90 million hectares of potential arable land available. However, exploiting it will need large scale capital investment and the willingness of people to develop farms in these remote areas.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: Image courtesy of Idaho National Laboratory (INL) Bioenergy Program

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China Outbound Moving Into Services http://www.mckinseychina.com/china-outbound-moving-into-services/ http://www.mckinseychina.com/china-outbound-moving-into-services/#comments Sat, 07 Jun 2014 10:29:32 +0000 http://www.mckinseychina.com/?p=7803 Much of what we generally hear about Chinese outbound investment focuses on acquisitions in basic materials and energy. And when it isn’t, that it is about manufacturing companies buying companies for their market access, their technology or their brands.

But now an additional theme is emerging of Chinese companies making acquisitions in services, in areas where many companies thought they might not see Chinese international expansion for many years. A few examples include:

  • Fosun investing in Club Med, with plans to develop all inclusive destination resorts for Chinese tourists going overseas
  • Wanda investing in AMC cinemas in the US
  • Tencent investing in gaming and social media companies in Korea
  • Alibaba investing in Singapore’s Postal Service
  • Blue Focus, China’s largest PR company, investing in Huntsworth of the UK and acquiring We Are Social.
  • China Mobile scaling up its investment in Pakistan’s mobile services sector with a US$500 million investment in spectrum

Most of the acquirers are private companies; all are investing in people-driven businesses. The investments are really global, driven by the needs of their businesses. It is a sign of the growing internationalization of the top management teams in these businesses that they feel ready to make these moves.

Expect a lot more.

 

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: Elliott Brown / Flickr

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Surviving The 2 A.M. Video Conference http://www.mckinseychina.com/surviving-the-2-a-m-video-conference/ http://www.mckinseychina.com/surviving-the-2-a-m-video-conference/#comments Fri, 06 Jun 2014 10:17:56 +0000 http://www.mckinseychina.com/?p=7798 This may well be one of my less lucid posts, coming just after my 5 hour videoconference which started at 2 a.m. this morning. My fault that I had the VC – I was supposed to show up in the U.S. for the meeting, but events kept me here in China. And I wasn’t already messed up on time zones as I’ve been in East Asia for a week.

Preparation involved getting home by 10 and trying for 2 hours of sleep from 11 to 1. Largely successful. Three alarm clocks just in case I’m subliminally minded to set the alarms for a more reasonable time. When awake, I follow the normal morning routine, shower, shave, put on work clothes, etc etc. Take breakfast products from the fridge. Try to kid the body it’s morning. Double check you have the keys before closing the door.

Given the choice of doing the VC from home on the tablet or at the office on a large screen, I chose the office. To stay focused or even just stay awake I need to be in a work environment with minimal potential for distractions.

Drive to the office. Taxis must be three quarters of the cars on the road. Good to know the chance of people drinking and driving mid-week in Shanghai looks to be pretty low.

In the office – the air conditioning is on, so I’m not going to have to sweat my way through the call. Miracles do happen. Eat first cup of yogurt – easy to digest, not filling – and drink first coffee. Put in eye drops so there is a chance of focusing on the people on the screen

Video starts – they even start early! Minimize distractions – no tablet, no PC, just the screen and the presentations. Sit really close to the screen so you’ll seem more present to the folks at the other end (also means I can use my reading glasses throughout the VC, no need to switch back and forward between glasses).

Speak a lot early on so they know you are there and then speak at least once every 20 minutes thereafter. Plan ahead what you are going to say. Take lots of notes (about the VC subject), it helps to keep you focused.

At about 5:30 energy levels running low, drink a carton of milk and a cup of apple sauce. Immediate burst of energy – throw in a couple of closing comments about what to do in the next meeting.

Finish the VC and realize that you’ve still got energy. Send out the follow up emails from the VC. Then go get a decently unhealthy egg and toast breakfast.

Then you can declare success (until the next time).

 

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Copyright: rido / 123RF Stock Photo

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China’s Growing Economic Impact On Asia: Part 2 http://www.mckinseychina.com/chinas-growing-economic-impact-on-asia-part-2/ http://www.mckinseychina.com/chinas-growing-economic-impact-on-asia-part-2/#comments Thu, 05 Jun 2014 10:10:59 +0000 http://www.mckinseychina.com/?p=7794 In the first part of this post, I discussed the drivers of China’s expanding economic impact on Asia. In the following post, I discuss specific business opportunities in several key industry sectors.

Basic Materials and Energy

In basic materials and energy, China continues its push to develop additional energy suppliers closer to home. Central Asia and eastern Russia are becoming very important sources of gas, with China funding much of the infrastructure needed to carry the gas to China. As I wrote earlier, Putin’s visit to Beijing in May was a milestone in China’s pivot to sourcing energy from its neighbors, with the signing of a supply contract of potentially US$400 billion in size.

Alongside Australia, Indonesia is becoming an increasingly important source of coal and minerals for China, with CIC recently committing more than US$1 billion to infrastructure to enable mines to transport their output to China. Many more of these investments are minority stakes. There has been much learning from investments in Africa that controlling ownership is not needed and may often be a disadvantage. Increasingly, China’s state-owned enterprises, who make most of these investments, prefer to invest in Asia over Africa as they find the context more familiar.

In coming years, China is likely to become a much larger exporter of energy technology to the rest of Asia. China’s nuclear power industry is actively seeking opportunities to sell power stations in Asia. Chinese manufacturers have enormous scale in solar panels and are leaders in parts of the wind turbine industry. As Asian countries ramp up their investment in solar and wind generation, they will be buying product produced in China. For example, as India’s new government is committing several billion dollars to expand deployment of solar, Indian companies are turning to China for supply.

Agriculture

Investment in agriculture across Asia to meet growing demand in China is a well-worn investment theme pursued today both by corporations and private equity funds, but it is still only in the first stage of its development. China’s potential demand for imports over the next decade could rise to levels that exceed the total current cross border global trade today in certain products. Demand exists for a very broad range of products from many countries.

New Zealand is seeing its exports to China growing 35% annually on the back of milk sales, India is supplying growing volumes of beef, rice is coming from Thailand, wheat from Russia and Australia, fish from Indonesia and Malaysia. Future growth will be driven by several factors – the growing demand for protein in China, growing demand for quality food, loss of land to farm on, relatively high yields already achieved and many of China’s food imports today come from beyond Asia. Supply from closer by is seen as more secure.

Infrastructure and Real Estate

China’s investments in infrastructure are shifting from Africa to Asia. Perhaps the best example is Xi Jinping’s commitment in October 2013 to provide nearly $30 billion of infrastructure to Indonesia over the next 5 years. Investments will range from public transport systems to railways and ports, and will mostly be delivered by state-owned enterprises. Similarly, Pakistan will see a new public transport system built in Lahore and a new airport in Gwadar to go with the existing port and pipeline investments. Sri Lanka has received nearly $4 billion to expand Colombo’s port. Indochina has other examples. Most of these projects have an economic objective, for the receiving country and for China, a shift away from the “vanity projects” sometimes seen in Africa. Chinese banks, especially China Development Bank, play a key role both in funding these public sector projects but also in private sector projects with APP and Reliance.

In contrast, China’s fast growing real estate investments in Asia are largely by private sector. Projects are visible from Sydney to Kuala Lumpur to Hyderabad. In Malaysia, for example, Country Garden, R&F and others have invested over US$3 billion in residential projects that they market to mainland Chinese customers, who recognize the brand and who are very keen to diversify their investments internationally. Individual Chinese buyers have bought tens of billions of dollars of property internationally in the last 5 years as it has become much easier for them to take money out of the country. The impact on Hong Kong, Sydney and Singapore is often discussed, the growing impact in Thailand, Malaysia and Japan less so.

Digital

The coming growth of China’s digital industry leaders across Asia could become a highly disruptive factor for local retail industries . We are just at the start of this change with early indicators visible – the majority of small packages going into Russia today are already from Taobao vendors and has led to the introduction of new taxes. Alibaba has launched dedicated sites for Southeast Asia, is investing in the Singaporean Postal Service and is partnering with local banks to simplify payment by local consumers. Tencent has offices in Malaysia and Singapore and has invested in a Thai portal and a Korean social network and gaming company. Baidu has an R&D hub in Singapore for Asian language processing. In ecommerce, the China “giants” have the potential to substantially undercut local retailers, big and small. It is not clear that local businesses and government will let this happen. The financial scale of the “giants” also means they, theoretically, could buy any local players that start to scale.

People moving

This deepening of business and investment connections between China and the rest of Asia requires a corresponding growth in people movement between countries. Outbound travellers from China to Asia are growing 20% annually, with more than 3 million to Thailand and 4 million to South Korea in 2012. However, inbound travellers from South Korea and Japan have been flat for 5 years and there are some obvious gaps in where people are moving to and from – in 2012 more outbound travellers from China visited New Zealand than India. There are more than 85,000 flights a year between China and South Korea. This compares to 8,000 with Indonesia and 4,000 with India.

There are more than 90,000 Chinese students in Australia (25% of all international students in Australia) and, in a quiet development, 80,000 Chinese students in Japan (60% of all international students in Japan and a great source of talent for McKinsey). China hosts 60,000 students from South Korea, 15,000 from Indonesia and even 9,000 from India (mainly in medical areas).

Looking forward

The deepening of business connections between China and the rest of Asia will accelerate. Chinese manufacturers will increasingly have a fuller presence in many Asian markets going beyond sales to include marketing, manufacturing and even R&D. India is in some ways the biggest market opportunity, but Chinese companies are starting so far behind there it is not certain they will catch up. China will continue to support the development of infrastructure across Asia and will create demand for Asian agricultural output that could drive up prices over time across the region. The impact of China’s digital champions across Asia could be enormous but they will need to tread carefully to avoid a local backlash. Growth in people flows is an incredibly important underpinning to these business connections – the emergence of a new generation of Asians with experiences in multiple Asian countries is an essential talent pool for the new generation of multinational Chinese businesses.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: Miles Willis

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China’s Growing Economic Impact On Asia: Part 1 http://www.mckinseychina.com/chinas-growing-economic-impact-on-asia-part-1/ http://www.mckinseychina.com/chinas-growing-economic-impact-on-asia-part-1/#comments Tue, 03 Jun 2014 08:28:12 +0000 http://www.mckinseychina.com/?p=7789 In this first of a two-part post, I share some observations on the drivers of China’s growing economic impact on the rest of Asia.

I recently had the opportunity to address a joint Asia House and China Britain Business Council event on this topic. It was great timing with the Indian election results just announced, Putin visiting Beijing and the tensions with Vietnam and the Philippines – multiple reasons the topic was relevant. Through the clients I work with I see more and more of a swing to Asia in the geographies that Asian companies prioritize. Also more and more private sector involvement, less need to take absolute control, more interest in a wider range of Asian countries – generally signs of a maturing economic interest and the increased relative attractiveness of Asian markets over other regions for Chinese businesses.

What is driving this? Yes, there is still government encouragement – and that might account for moves like China Mobile’s US$500 million investment in Pakistan’s 3/4G licenses – but mostly it is more mundane business reasons. Domestic markets are maturing, competition is intensifying, and costs are rising. With greater scale and capabilities, Chinese companies find many Asian markets in particular looking attractive – higher prices and less competition than at home – and believe that their experience in selling to customers as an economy evolves from low to middle income is very relevant in many Asian markets.

China’s economic involvement in Asia is evolving from an era where the dominant sound bite focused on trade flows, imports and exports, and state-sponsored investment in basic materials, to a much more diverse set of business models. These include:

  • The evolution of China’s export-only businesses to having marketing operations, manufacturing and R&D in local markets
  • The shifting locus of Chinese investment into basic materials and infrastructure into Asia from Africa
  • Corporate and personal investment from China into Asian real estate
  • Investment in all stages of the Asian agriculture industry chain for consumption in China
  • The very recent emergence of Chinese “digital” leaders as shapers in Asian markets
  • We also see changing people flows to match – of business travellers, tourists and students.

Beyond Exports

On exports and imports, the interdependence of many Asian countries with China is well understood: 35% of Australian exports, 26% of Korean exports, 20 % of Japanese exports come to China. For most Asian countries, China provides 15-20% of their imports today. As a result, China runs a trade deficit with many Asian countries, a position that is likely to change over the next few years. Why? China’s role as an assembler has led it to import many electronic components from Asia for assembly into products exported to the US and Europe, or increasingly for domestic consumption. As China manufactures more and more of these components domestically, from semiconductors to LCD screens, imports will diminish. Also the unit value of exports will grow as Chinese companies build brands in Asian markets and export mid-range branded items, no longer just no-name, low cost items.

In essence, we are seeing a shift from manufacturing in China for the world, to manufacturing in China for China and adjacent Asian markets, served most cost effectively from China. There are patterns of who is moving manufacturing out of China. Asian companies are most likely to move first. Taiwanese, Korean, and Japanese firms have had a particular focus on Vietnam and Bangladesh in recent years. Current disruptions are likely to be a blip rather than a trend change. Western multinationals are more focused on diversifying production than shifting existing manufacturing from China into Asia. Indonesian and Indian markets are reaching critical mass and so justify local manufacturing. An exception may be made for products that multinationals have developed in China for China, which continue to be produced in China and are now exported as well to Asia.

Chinese companies have moved the least amount of manufacturing out of China to date, which is unsurprising. Lenovo’s factory in Pondicherry is much more the exception than the norm. Other examples are SAIC and Great Wall, with factories in Thailand to be part of the auto cluster there and to be inside ASEAN, and Comtec Solar in Malaysia. However, the intention to add capacity in other markets, following the example of multinationals, is clearly growing, especially for private Chinese companies who see the cost and flexibility arguments for doing so, but they remain concerned about their weak managerial capabilities to run international businesses. Chinese companies with R&D operations in Asia outside China are even rarer. Huawei has a large center in Bangalore. Lenovo acquired an R&D center in Japan when it purchased IBM’s PC business back in 2005.

However, Chinese companies are aggressively building up customer facing functions internationally. Having real marketing capabilities in Asian countries is now the norm. More Chinese companies are now just as sophisticated on segmenting and understanding the customer as their multinational competition. The way Xiaomi creates buzz to sell out its product in Singapore, the way Haier targets first time buyers in Indonesia, the way Lenovo sells PCs in India, each is an example of more sophisticated marketing and segmentation.

Where might manufacturing investments from China go next? India makes theoretical sense with the current economic discontinuity, the size of the market and the fit of many Chinese products to Indian needs. Japanese and Korean firms have already bet big on India, Chinese companies lag. For example, Japanese FDI in India exceeds US$16 billion, while Chinese FDI is only $400 million. When I visit Chennai it sometimes feels like Yantai, the number of Korean factories and Korean business men is so high. Indonesia is also on the list, especially for the size of the emerging consumer market and, for similar reasons, Pakistan could also become attractive to Chinese companies in the next few years.

(Please check back here for part 2 of this post)

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: Miles Willis

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Pakistan Business Embraces China http://www.mckinseychina.com/pakistan-business-embraces-china/ http://www.mckinseychina.com/pakistan-business-embraces-china/#comments Sun, 01 Jun 2014 09:23:44 +0000 http://www.mckinseychina.com/?p=7786 One of my major take-aways from a visit to Pakistan this week was just how positively China is regarded. Chinese business, Chinese investment, Chinese products, Chinese leaders all seen in a very positive light. As the consumption levels (some estimates of GDP that I heard were 3x the official numbers) and quality of infrastructure exceeded my expectations in this country of 180 million-plus people, I return to China with the perspective that there might well be a lot of commercial upside for Chinese business in the years to come.

Beyond the investment in developing Gwadar port as a point to offload oil to be piped on to China, China has committed around a further US$35 billion over the next 5 years to developing infrastructure. Addressing the critical power shortage with expanded generation capacity is at the center of this, with 1.3GW well underway at the industrial park in Faisalabad already (selling directly to industrial users is a very smart move as it bypasses the distribution companies where much of the commercial losses are incurred). China is also committed to invest in highways, a new airport by Gwadar, and fiber optic backbone. After the Chief Minister’s trip to Beijing last week, a commitment to fund the second mass transit line (“Orange Line”) was made.

China Mobile has just paid US$500 million upfront for 3G/4G spectrum, to build on their small position in the 2G market today. If China Mobile invests to build a network in Pakistan as it has done in China, the Pakistani consumer will certainly benefit. It may, however, be tough for other operators to compete. Pakistan is a perfect market for the $75-100 smartphones in which Chinese manufacturers excel. With only 2G network today, it is one of the few markets where you still hear the Nokia ring tone on a frequent basis. Soon it’s likely to be Xiaomi, Lenovo, Huawei and more from China. Chinese consumer electronics manufacturers in general may find strong demand for their value oriented products.

The Chinese I met in the hotels seemed mainly to be from the consumer industries. Yet they must have been keen to make the trip. There are few direct flights for them to take – Chengdu to Karachi 9 times a month, Beijing to Islamabad the same, and Urumqi to Islamabad slightly more frequently.

What might be additional opportunities?

  • Certainly expanding the airports and direct flights to go with them
  • Building a dominant presence with Pakistani consumers for Chinese brands
  • Exporting beef from Pakistan to China. Chinese beef imports grew 400% last year versus 2012. Pakistan could be a major supplier.
  • Installing chefs in the Chinese restaurants in the hotels who prepare food that is recognizably Chinese.

The potential for trade to flourish is there.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: Anne Rigby, AusAid / Flickr

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What Else Got Signed When Putin Was In Beijing http://www.mckinseychina.com/what-else-got-signed-when-putin-was-in-beijing/ http://www.mckinseychina.com/what-else-got-signed-when-putin-was-in-beijing/#comments Wed, 28 May 2014 09:10:53 +0000 http://www.mckinseychina.com/?p=7782 All the headlines focused on the gas supply agreement when Putin was in Beijing earlier in the month. But more than 40 further agreements were signed. Some were regional government to regional government and may not amount to that much. Others were business to business (some between state controlled companies) and indicate how much more seriously Russia’s business leaders are taking opportunities in or with China.

These ranged from nuclear power to agriculture, and included railways, coal, power, aircraft, automotive and real estate. China Development Bank also agreed to finance a significant number of projects. If these all do move forward, not only will it lead to billions of dollars of shared investment, it will commit Chinese and Russian business leaders to work much more closely together.

The full list is below.

Documents signed during the official visit of Russian President Vladimir Putin to China – informal translation from the Russian President’s website

1. Joint Statement of the Russian Federation and the People’s Republic of China on a new phase of comprehensive partnership and strategic cooperation

2. Protocol to the Agreement between the Government of the Russian Federation and the Government of the People’s Republic of China on the establishment and organization of regular meetings of the heads of governments of Russia and China, dated June 27, 1997

3. Memorandum of Understanding between the Ministry of Education and Science of the Russian Federation and the Ministry of Education of the People’s Republic of China on cooperation on the project of a Russian-Chinese University created by Lomonosov Moscow State University and Beijing University of Technology

4. Memorandum of Interregional and Cross-Border Cooperation between the Ministry of Regional Development of the Russian Federation and the National Development and Reform Commission of the People’s Republic of China

5. Memorandum of Understanding on Trademark Protection between the Federal Intellectual Property Service of the Russian Federation and the State Administration for Industry and Commerce of the People’s Republic of China

6. Memorandum of Understanding between the regions of the Volga Federal District of the Russian Federation and the middle and upper reaches of the Yangtze River of the People’s Republic of China on the development of trade, economic and humanitarian cooperation

7. Agreement of Friendship and Cooperation between the Republic of Bashkortostan and Jiangsu

8. Agreement of Friendship and Cooperation between the Perm region and the Chinese province of Jiangxi

9. Agreement of Friendship and Cooperation between the Republic of Tatarstan and the Chinese province of Hunan

10. Memorandum of Understanding between the State Atomic Energy Corporation Rosatom and China Atomic Energy Authority on cooperation in the construction of floating nuclear power plants

11. Contract of sale of liquefied natural gas under Yamal LNG project between JSC NOVATEK and China National Petroleum Corporation

12. Memorandum of Understanding between the China Development Bank, the State Corporation Bank for Development and Foreign Economic Affairs (Vnesheconombank), JSC Gazprombank and JSC Yamal LNG on funding for the Yamal LNG project

13. Tianjin Refinery Commissioning Schedule and Crude Oil Deliveries for Refining at Tianjin between JSC Rosneft and China National Petroleum Corporation

14. Letter of Intent between Summa Group and Chinese province of Jilin

15. Strategic Partnership Agreement between JSC Russian Railways and China Railway Corporation

16. Agreement on Research and Development Cooperation between JSC Russian Railways and Huawei

17. Agreement between Inter RAO Group and China Huaneng Group Corporation on intents for strategic cooperation in the power sector

18. Framework Agreement on Strategic Partnership between JSC Gazprombank and the The China Development Bank

19. Agreement on Cooperation between En+ Group and Shenhua Group Corporation for the joint development of Zashulansky coal deposits

20. Memorandum of Cooperation between Russian Machines LLC and NORINCO Corporation

21. Memorandum of Understanding between JSC United Aircraft Corporation and Commercial Aircraft Corporation of China

22. Cooperation Agreement between JSC VTB Bank and Bank of China

23. Agreement on Credit Cooperation between Vnesheconombank and the Export-Import Bank of China

24. Framework Agreement on Cooperation in Finance Lease Projects between JSC VEB Leasing and the Export-Import Bank of China

25. Memorandum between the Moscow Government, China Railway Construction Corporation Limited and International Fund for China

26. Tripartite Agreement on Cooperation in the Implementation of the Investment Project “Construction of a Car Factory Including Stamping, Welding, Painting, Assembly, and Parts Manufacturing Shops” in Tula region between the Government of the Tula Region, JSC Tula Regional Corporation of Public-Private Partnership and Great Wall

27. Memorandum of Understanding between the Russian-Chinese Investment Fund and Vcanland for the establishment of a fund to invest in the real estate for the elderly population and tourism

28. Memorandum of Understanding between the Russian-Chinese Investment Fund and HOPU Investments for investments in the development of logistics infrastructure in China and Russia

29. Cooperation Agreement between JSC UralVagonZavod Research and Production Corporation and Jizhou Zhongyi FRP Co. Ltd.

30. Strategic Partnership Agreement between JSC RusHydro and POWERCHINA

31. Memorandum between Baikal Mining Company LLC and HOPU Investments within the framework of the Udokan Copper Project

32. Agreement between JSC RAO Energy System of East and China Dongfang Electric Corporation on cooperation within the framework of joint projects in the Russian Far East

33. Strategic Partnership Agreement between JSC Russian Grids and the State Grid Corporation of China

34. Agreement between JSC Sibur Holding and Sinopec on establishment of a joint venture for the production of butadiene nitrile rubbers

35. Cooperation Agreement between JSC Sibur Holding and Sinopec

36. Contract between Eurocement Group and China CAMC Engineering for the construction of a new production line with the capacity of 6,200 tons of clinker a day on the basis of CJSC Pikalevsky Cement in the Leningrad region

37. Contract between Eurocement Group and China CAMC Engineering for the construction of a new production line with the capacity of 3,500 tons of clinker a day on the basis of CJSC Savinsky Cement Plant in the Arkhangelsk region

38. Contract between Eurocement Group and China CAMC Engineering for the construction of a new production line with the capacity of 5,000 tons of clinker a day on the basis of CJSC Zhigulevskie Materials in the Samara region

39. Contract between Eurocement Group and China Triumph International Engineering for the construction of two new production lines with a total capacity of 10,000 tons of clinker a day on the basis of CJSC Maltsovsky Portland Cement in the Bryansk region

40. Contract between Eurocement Group and China Triumph International Engineering for the construction of a new production line with the capacity of 6,200 tons of clinker a day on the basis of CJSC Ulyanovskcement in the Ulyanovsk region

41. Contract between Eurocement Group and SINOMA International Engineering for the construction of a new production line with the capacity of 10,000 tons of clinker a day on the basis of CJSC Mikhailovcement in the Ryazan region

42. Partnership Agreement between JSC Rostelecom and Huawei on advanced telecommunication services within the framework of a national program for elimination of the digital divide

43. Supplementary Agreement to the Agreement on Cooperation in the Financing of Projects in the Far East of the Russian Federation between the Far East Development Ministry of the Russian Federation and the China Development Bank

44. Cooperation Agreement between the All Russia Non-Governmental Organization Delovaya Rossiya (Business Russia) and the China Federation of Industrial Economics

45. Contract for the supply of CKD kits for the full cycle assembly of cars between Derways Automobile Company and Hawtai Automotive Corporation

46. Memorandum of Cooperation between Volga Group and China Port Construction Company

 

You can read more of my views on China on my LinkedIn Influencer blog.  And please follow me on Twitter @gordonorr

Image credit: Sebastien Wiertz / Flickr

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Where Is The Best Place To Be A Mother? http://www.mckinseychina.com/where-is-the-best-place-to-be-a-mother/ http://www.mckinseychina.com/where-is-the-best-place-to-be-a-mother/#comments Tue, 27 May 2014 09:00:32 +0000 http://www.mckinseychina.com/?p=7775 The Save the Children Fund just released its 2014 ranking of the best and worst places to be a mother. European countries dominate the top 30 slots, South Korea is the highest ranked north Asian country at number 30. China comes in at 61.

I took a look at the factors used to create the index and compared China to the United States, Russia, India and the rating leader, Finland. While the answer is clearly skewed by the factors the survey designers use, it is still interesting to compare at the specific criteria level.

On the criteria of educational status and maternal wellbeing, China scores comparably to the US and Russia. On children’s wellbeing, China lags but is still far ahead of India. On economic status, where GDP per capita is used, China clearly lags materially behind the US and Russia, but on political status (where the metric is the % of women in national government) China is ahead of both.

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Click here for the full survey.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: J B / Flickr

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Time To Get Your Visa For India http://www.mckinseychina.com/time-to-get-your-visa-for-india/ http://www.mckinseychina.com/time-to-get-your-visa-for-india/#comments Thu, 22 May 2014 14:24:46 +0000 http://www.mckinseychina.com/?p=7768 I was in India several days last week as the results of the election were announced. The enthusiasm among business leaders for the new leadership and what they might deliver in terms of opening markets up and accelerating economic growth was remarkable. If half of it comes into being, the opportunities for Chinese companies could also be large. It is time to explore, build a presence and potentially make some big bets.

While a small number of Chinese companies have succeeded in India, their collective scale lags far behind that of Korean and Japanese companies. Japan’s FDI into India exceeds US$16 billion, while China’s remains less than US$1 billion. Three of the most successful MNCs in India are Korean – Samsung, Hyundai and LG.

From China, several providers of industrial equipment have sold successfully into the power and telecom industries, often with China Development Bank support. Huawei has a well regarded R&D center in Bangalore, Lenovo has a factory in Pondicherry. Many other Chinese companies export to India, often as white label products that Indian companies then brand.

India as a consequence remains a market that is not well understood by the average Chinese exporter. In 2012, only 170,000 Chinese visited India, less than visited New Zealand, and less than 5,000 direct flights, a quarter the number between China and Malaysia. With a little collaboration from relevant ministries in both countries, we could easily see flights double or triple, directly connecting more city pairs and adding flights that depart at times that business people actually want to travel.

Stronger economic growth in India could lead to opportunities in selling to consumers, especially in consumer electronics, and to business, such as construction equipment, power generation equipment, port, road and rail construction. Equally the potential exists, should India’s central and local governments adopt the right policies, for India to become a center of manufacturing for export. India has many ports that could be upgraded with land adjacent to them that could be used by manufacturers, especially in Andhra Pradesh and Tamil Nadu.

I expect Korean and Taiwanese companies to push hard to capture these opportunities. Chinese companies could also benefit as they seek to diversify their manufacturing base. One further area of opportunity comes in the digital world. India’s largest internet based businesses today are a fraction of the size of the largest in China. In a few years they could potentially be of similar scale. If Chinese companies move quickly now and build models of operation tailored to India and draw in their scale experiences from China, they could become leaders in a market that is almost certain to grow very very fast over the next few years.

Standing back from the specifics, it is remarkable to reflect on how much Indian attitudes towards China have evolved. From my first visits to India, when I would be lectured on how then fundamentals in India were so much stronger than in China, to today, where people in India express a genuine interest to understand what actions and policies have enabled growth and a willingness to discuss how these experiences could be adapted and applied in India. Last week, I was talking at the India School of Business in Hyderabad specifically on this topic with a very engaged audience of business leaders and bureaucrats. The new priority given to job creation was striking.

Yet this may not happen. The new Indian government, despite its majority, may prove unable to cut away the red tape holding back growth. And unless the Indian embassy and consulates in China change their operating model, it still won’t be easy to get a visa to travel to India. But the odds are good that growth will accelerate and that new very large opportunities will open up. It is time to go explore the potential.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: Marco Belluci / Flickr

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China Real Estate Is Now Like Dubai Before The Crash http://www.mckinseychina.com/china-real-estate-is-now-like-dubai-before-the-crash/ http://www.mckinseychina.com/china-real-estate-is-now-like-dubai-before-the-crash/#comments Thu, 22 May 2014 04:40:22 +0000 http://www.mckinseychina.com/?p=7756 There has been an eerie calm in Chinese real estate for the past couple months. People have noticed that real estate developers are cutting prices. They have noticed that banks are pulling back on lending. They have noticed that China’s first bond defaults since 1997 have occurred. It’s like everyone has stopped (or at least slowed) the real estate game they have been happily playing for the past decade and are quietly re-assessing the situation.

In October 2008, those of us in Dubai noticed a similar calm. For six years, we had enjoyed a housing boom. And we had all become well-versed in the rationalizations for why the housing bubble wouldn’t collapse (i.e., “it hasn’t crashed so far”, “the government wouldn’t allow it”). That had all ended the month before when housing prices unexpectedly began to fall. And what followed was a similar eerie quiet, like everyone was rethinking and holding their breath.

By December 2008, prices for new Dubai developments had dropped 40%. Real estate stock prices were in free fall. And publications such as the Economist were leading with headlines like “Has the Bubble Burst?” The calm was over and everyone was starting to take action.

In January 2009, foreigners began to leave the country in droves, abandoning their leased cars at the airport by the thousands. State-backed real estate companies began to realize they were facing massive lay-offs. Many real estate developers realized they weren’t going to be able to survive their debts at current housing prices. And the overall government debt at 150% of GDP suddenly went from a theoretical to a very real problem.

By July 2009, Dubai was a ghost town. The roads were no longer congested. It no longer took an hour to get across town. The restaurants and malls were spooky-quiet. Hotels were 50% cheaper than the year before. And apartment prices continued to drop by a cumulative total of 60% over the next year. The city would subsequently spend the next 3-4 years working out its debt and housing supply situations.

China today has some important similarities to that initial calm period in Dubai in October 2008.

First, everyone is re-thinking the situation– and market psychology matters.

People have now accepted that the Chinese real estate market, or at least parts of it, could actually collapse. It’s no longer a theoretical idea. Commercial banks have woken up to the fact that they could be stuck with non-performing loans. Developers are slowing their land acquisitions. Home owners are realizing they could lose money. And the overhang in construction is likely to plague the building trades with overcapacity for years to come.

Psychology is a big part of what is going on right now. Irrational exuberance can easily tip into fear in moments like this. And if people become too afraid to buy it will cause real decreases in home pricing. Whether people slow down versus run for the door, like Dubai, is going to matter.

Second, this is mostly about Dubai-like second-tier cities

Dubai collapsed but Abu Dhabi, Doha and Riyadh did not. It was a real estate bubble in a specific second-tier city. China’s situation is mostly the same. The housing markets of specific second tier cities could collapse due to oversupply relative to local demand. But Shanghai, Beijing and the overall country-wide market are less likely to be greatly impacted. Much of China’s housing problem is a demand and supply imbalance in certain isolated and unsexy second tier cities.

China is not “Dubai times 1,000” as some have claimed. China is a huge country with 10-20 potential Dubai’s in it.

Third, the quasi-sovereign guarantee for debt is being curtailed.

One of the problems with state capitalism is that it creates the belief that commercial projects enjoy quasi-sovereign guarantees. Investors, banks and others assume that if things go wrong the government will help them out. This is usually through state-owned companies, banks, and local governments. That expectations problem exists in both Dubai and China.

In China, the line between commercial and government debt is being re-clarified. This is similar to Abu Dhabi’s response to Dubai’s 2008-2009 crisis. In both cases, the government publicly withdrew the implicit guarantee on debt, if ever there was one.

The ultimate difference between China and Dubai is Dubai had debts that exceeded their cash. The real estate problem did not have to trigger a Lehman-type financial freeze. The real estate debt was enough to bankrupt the city on its own and Dubai had to go to Abu Dhabi for a bail-out. China, in contrast, has a closed capital account with trillions in cash.

In the press, there has been ongoing speculation that China has finally reached its “Lehman Brothers moment”. But the right analogy is that many second-tier Chinese cities are reaching their “Dubai moment”.

You can read more about Chinese real estate in our #1 best-seller the One Hour China Book. Now available on Amazon for the price of a medium latte. Visit www.onehourchina.com.

 

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Russia’s Wish List In China http://www.mckinseychina.com/russias-wish-list-in-china/ http://www.mckinseychina.com/russias-wish-list-in-china/#comments Wed, 21 May 2014 14:19:33 +0000 http://www.mckinseychina.com/?p=7763 President Putin is shortly to visit China. Expectations are high in China that game changing announcements may be made, opening large parts of the Russian economy up to Chinese investment for the first time.

What might be on the wish list? Could there be benefits for both countries as a result?

Below are a few thoughts on areas that might be on the table for discussion.

Energy and Basic Materials

Any opportunity to increase energy security with long term, large scale contracts will be seized aggressively, supported by capital commitments to build the infrastructure to bring the energy to China. Reduced dependence on Middle East supplies is an explicit goal.

Moving one step up the value chain, China Inc (and in these sectors it is very much China Inc, almost entirely state-owned enterprises) would take opportunities to undertake value added processing in Russia. Russia has the cheap energy and abundant water that China lacks to do this cost effectively.

Accessing mining opportunities in Siberia directly, under a more attractive foreign investment scheme than exists today. After all, some of these minerals are never going to be cost effectively extracted if they are targeted at Western markets. Chinese miners see the need, have the capital and the skills to operate there. There are international precedents – Russia can learn from the experiences of Australia and Latin America in allowing Chinese investment in mining.

Manufacturing

Free trade zones to simplify manufacturing in Russia. Maybe on the border, maybe around Vladivostok, create a “mini Shenzhen” with unique degrees of flexibility to create manufacturing operations in Russia. Almost uniformly, Chinese manufacturers find operating in Russia today incredibly challenging. This holds back investments that could create tens if not hundreds of thousands of jobs.

Infrastructure

China’s builders of railways and other infrastructure would be delighted to have the opportunity to work in Russia and it is hard to argue that they are not well equipped to do so, having built more high speed and conventional rail capacity in the last 2 decades than the rest of the world combined, often in very challenging terrain.

Agriculture

China is on track to need to import more than 50 million tons of cereal within a few years. Can more of Eastern Russia be opened up to Chinese investment in large scale cereal production? Alternatives to having to ship cereal around the world would be attractive.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: Ryan Hyde / Flickr

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How Connected Is China? http://www.mckinseychina.com/how-connected-is-china/ http://www.mckinseychina.com/how-connected-is-china/#comments Thu, 15 May 2014 13:32:36 +0000 http://www.mckinseychina.com/?p=7741 The McKinsey Global Institute recently published the results of their research into global flows of goods, services, capital, people and all things digital. Beyond the obvious – the flows are big and growing, what does the report have to say, particularly about China?

The team has created an index that ranks countries on their level of connectedness across these 5 flows. Germany comes top, China down at 25, perhaps lower than I might intuitively have expected.

Overall messages

The report highlights the following key messages:

  • Flows of goods, services and finance are 36% of global GDP in 2012, 1.5x their level in 1990.
  • Growth in flows contributes 15-25% of global GDP growth annually. Without doubt it is a very meaningful force for global economic growth.
  • Knowledge intensive global flows are the fastest growing segment. For example, knowledge intensive goods flows growing 1.3x labor intensive goods flows.
  • Digitization transforms and enriches flows through creation of digital only goods and services and “wrapping” value onto physical goods.
  • Flows are increasingly between emerging economies with China as the hub.

Why is China low on the list?

After all, on the value of total flows of goods, services and capital inbound and outbound has China at #2 using this 2012 data. This year it will probably be #1.

The ranking combines two measures.

  1. The first is a measure of flow intensity, which measures flows relative to the size of an economy, which ranks China (at 62%) low relative to many smaller mature economies (e.g. Netherlands 157%) but well above the US (35%).
  2. The second assesses a country’s share of global share of flows in each of the flow types. In these, China’s performance is highly varied:
  • Goods flows: China ranks high at #5, behind Hong Kong, Singapore, Germany and Belgium.
  • Service flows: China ranks #21, not surprising given the less developed nature of many of China’s service economies
  • Financial flows: China ranks #6 behind Luxembourg, Hong Kong, United States and Singapore. Perhaps higher than I would have expected given China’s closed capital account but probably driven by trade finance on the back of goods flows and China being a leading destination for FDI
  • People flows: China ranks #93 behind the United States (#1), Russia (#2) and many others. Seems superficially surprising as we think of China becoming the #1 source of international students in many countries, the #1 international buyer of property in many cities and the #1 source of tourists in many more. I need to find time to kick the tires a bit more on this with the report’s authors.
  • Digital and communication flows: China ranks #33. Given the preponderance of Chinese language usage on the Internet in China, this is not surprising

In absolute terms, China is already #2 on knowledge intensive inflows and outflows (chart), highlighting just how much the economy has shifted away from low value export categories.

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In several of the rankings, city states come out very high. I couldn’t help wonder how Shanghai would rank if it were treated as “country” for purposes of the analysis.

I also wondered if a different metric for people connectivity would provide a very different outcome. Including migration as they do now, captures a very long term indicator of connectivity (decisions made 50-60 years ago often) as well as short term “shock” disruptions – wouldn’t Syria be ranking very high today on a migration metric?

Closing thought

Whether cause or effect, greater flows and greater opportunities for Chinese entrepreneurs go hand in hand. Chinese entrepreneurs are able to participate at ever greater scale and reach in the global economy and smaller, less entrepreneurial economies face the challenges of dealing with intensely competitive global scale attackers. For many businesses and governments, this will prove very tough.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: Wolfgang Staudt / Flickr

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Good Time To Be A Farmer In China? http://www.mckinseychina.com/good-time-to-be-a-farmer-in-china/ http://www.mckinseychina.com/good-time-to-be-a-farmer-in-china/#comments Wed, 14 May 2014 13:18:41 +0000 http://www.mckinseychina.com/?p=7733 I am very encouraged by the practical market-driven changes underway that enable farmers to grow their incomes with lower volatility from year to year.

One tool that is helping a lot is agricultural insurance. Hundreds of millions of farmers are buying heavily subsidized insurance (up to 80% of the premium covered by the government) against loss of income due to weather damage to crops. The intent of the subsidy is to reduce the barriers to adoption as much as possible while still making the farmer feel that there is a personal cost to him. Indeed so large has this become that China is now the second largest agricultural insurance market worldwide. Insurance companies have incentives to train farmers how to mitigate losses from abnormal weather patterns.

China’s agricultural insurance covered 73 million hectares of crops in 2013, accounting for 45% of the total planting acreage, according to the China Insurance Regulatory Commission, and paid out US$3.4 billion in compensation across 33 million households. The goal is to cover 60% of planted land by 2020. Once the insurance market is fully established and farmers have learned the benefits, subsidy levels should be gradually rolled back. This insurance initiative comes on top of other positive changes, some of which I have mentioned previously in posts.

  • Land consolidation is being aggressively supported in many provinces, allowing the creation of scale farms that justify investment in mechanization, in irrigation systems and more. Larger farms also have the opportunity to switch from subsistence cereal crops to more value-added fruits and vegetables, leading to higher incomes per hectare.
  • Banks are making more financing available to enable land consolidation and investment in farm related equipment.
  • Investment not just in road and rail infrastructure but in storage facilities, especially cold storage facilities, has increased the proportion of product that reaches processors or end consumers without wastage.
  • Many multinational companies are reaching far back up the chain to provide training to farmers and to contract directly with them for output. The benefits then radiate to other farmers in a neighborhood.

One area of uncertainty and a place where the government is going to need to make choices in the next few years is in deploying GM seeds. As land, water and fertilizer is used more efficiently, as infrastructure reduces losses on the way to market, as food processors ensure quality is maintained throughout the chain, the one obvious remaining lever to increase agricultural production (and so address China’s food security goals) is through deploying GM seeds. Should the government go in this direction, it will be an interesting challenge to convince the general urban public that this is the right move to take. In the end, though, I expect that they will accept it.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: leniners / Flickr

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E-commerce Comes to Car Buying China http://www.mckinseychina.com/e-commerce-comes-to-car-buying-china/ http://www.mckinseychina.com/e-commerce-comes-to-car-buying-china/#comments Tue, 13 May 2014 09:57:27 +0000 http://www.mckinseychina.com/?p=7726 Cars have been sold through TV shopping channels in China for a long time. China also has very successful online automotive sites, such BitAuto and AutoHome, that have largely provided auto related information to consumers and generated income from advertising and referral fees from dealers. AutoHome listed in New York earlier this year with a multibillion dollar valuation.

BitAuto announced last week that it is taking the next step directly into e-commerce and in doing so, changing its relationship with dealers. They launched HuiMaiChe, an ecommerce platform based on a dealer bidding system. It works in the following way:

Potential buyers specify the car they want, place the order, and pay a fully refundable deposit to the platform. Once the deposit is received, BitAuto publishes the order information to the company’s local dealer-members. The dealers then make bids for the order. Customers select the dealer that offers the most favorable price. BitAuto then sends a confirmation to the customer, allowing them to purchase the car from the dealer at a price no greater than its bid price. The service currently is piloting in three cities including Beijing, Shanghai and Zhengzhou.

How this platform succeeds in the market will say a lot about where the economic power lies in the auto industry in China today.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: Ford Asia Pacific / Flickr

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Where Are Chinese Banks When It Comes To Outbound Investment? http://www.mckinseychina.com/where-are-chinese-banks-when-it-comes-to-outbound-investment/ http://www.mckinseychina.com/where-are-chinese-banks-when-it-comes-to-outbound-investment/#comments Mon, 12 May 2014 09:49:00 +0000 http://www.mckinseychina.com/?p=7721 The announcement of ICBC’s proposed investment of US$316 million to acquire 76% of Tekstilbank in Turkey provoked me to consider how far and fast China’s banks are globalizing. ICBC’s latest move builds on investments made in markets including South Africa, Argentina, Canada as well as Hong Kong over the last 5 years. And earlier in 2014, ICBC also announced that it would buy control of Standard Bank’s London-based markets unit for about $765 million to expand in trading businesses.

Despite this activity by ICBC and, to a lesser extent, by other major Chinese banks, progress seems much less than it could be for institutions of their size and whose owners are encouraging globalization. Even in the geographically adjacent markets of South East Asia, cross border acquisitions, consolidation and inbound investment are the order of the day, but more from Japan than China.

In some ways I can see why. It’s not that the major Chinese banks don’t have lots of challenges and opportunities at home, working out whether they really have a large bad debt problem, dealing with a growing margin squeeze and determining how to compete against nimble online competitors. And the size of some of South East Asian markets must seem remarkably small after the numbers in China.

But still there are interesting segments that Chinese banks could and probably should serve, leveraging their undoubted scale and experience serving similar customers in China. Some segments could be served through organic development; some may require M&A as with ICBC in Turkey. So rather than just saying that the investment is in support of the globalization of the yuan, they could propose and then execute on a real synergy.

For example:

  • Supporting Chinese businesses as they expand their manufacturing, and not just their trading operations. Becoming the natural provider of RMB based services in particular to these enterprises is a no-brainer. Becoming a trusted provider of in-country services in local currency may be harder, but is a skill worth acquiring.
  • Supporting Chinese individuals, both those who move to work outside China and those, part of the long-term diaspora who have been outside China for generations. Provide services ranging from smooth funds transfer to access to unique investment products in China.
  • Lender to the next billion: There are hundreds of millions of under-banked or unbanked people in emerging markets. Chinese banks know very well how to attract individuals and very small enterprises into the banking system through physical branches and online offerings.
  • Manager of new found wealth at scale. Chinese banks have had to develop the capabilities to support tens of millions of new middle class customers who have investable income for the first time. They could find millions more in emerging economies.
  • Investor in infrastructure. For better or worse, Chinese banks have as much experience in investing in infrastructure as any banks worldwide. While they have not always applied commercial criteria to making such loans, they certainly know the characteristics of loans that pay back, and loans that won’t. Developing economies around the world need infrastructure and the finance to support it

Chinese banks will internationalize in the coming years, likely with an increasing focus on middle income economies. And when they do, they will find that they have relevant capabilities to go with the investments in technologies and customer relationships. Learning how to leverage such strengths may be better done close to home in mid-sized markets. South East Asian markets will, sooner or later, become a priority for Chinese banks.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: Brian Yap / Flickr

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Chinese Nurses Go Global http://www.mckinseychina.com/chinese-nurses-go-global/ http://www.mckinseychina.com/chinese-nurses-go-global/#comments Thu, 08 May 2014 09:42:49 +0000 http://www.mckinseychina.com/?p=7716 The Chinese Ministry of Health’s Guanghua Nurse Fund (GNF) is launching an initiative to send to selected universities in Europe, primarily the UK, 2,000 full time students from Chinese universities majoring in nursing or health. They will transfer to programs at a Bachelor’s degree level, or to postgraduate programs for a Master’s degree, to top-up their training.

The intent is to ensure that standards to be met by trainee nurses are equivalent to those that prevail internationally and appropriate to the needs of the Chinese Government’s 12th Five Year Plan. All well and good in intention.

I fear the reality is that a large number of these students, like many in the Chinese nursing profession before them, will take the opportunity to find a job outside China and not return home. The differentials in not only pay but also in respect for the profession between China and a number of other countries is too wide. Nurses are at the front line of the all too common threats of physical violence from patients and their families in China today. Even though there are 2.5 million nurses today, that only gives a ratio of 1.8 nurses per doctor, versus an international average of closer to 4, too few nurses to deliver the expected nursing responsibilities. Many simply leave the profession.

There are programs in place for Chinese nurses to work in many countries globally, Australia, Germany, Singapore, Japan and Canada to name a few. I expect more Chinese nurses, especially from the 10-15% that join the profession with a full university degree, to take advantage of this opportunity to work internationally, even if it means learning a new language in addition to a new health care system and country to live in.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: yuliang11 / 123RF Stock Photo

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The Secret To Catching Your Flight On Time In Beijing http://www.mckinseychina.com/the-secret-to-catching-your-flight-on-time-in-beijing/ http://www.mckinseychina.com/the-secret-to-catching-your-flight-on-time-in-beijing/#comments Mon, 05 May 2014 03:19:01 +0000 http://www.mckinseychina.com/?p=7702 I experienced firsthand recently one of the areas where Chinese services can be incredibly efficient. I arrived at Beijing Terminal 3 at 16:03 for an international flight that was departing on time at 16:30. I was pretty skeptical that it was even worth trying, but my assistant made clear that she couldn’t (or maybe wouldn’t) find a seat on a later flight as all were booked due to the public holiday.

I stepped on the plane at 16:25 and could have been there a couple of minutes earlier, if I had not shown impatience at security, leading to a second cycle of pat down.

How did this work? Four elements:

  1. No luggage to check of course
  2. Online check in. Beijing airport lets you go straight to immigration with self-printed boarding pass. The only constraint is an electronic gate that you have to go through to get to the train to get to the international departure building. This gate requires you to scan your boarding pass and it does not seem to mind if the flight is leaving at the time of scanning. The train to the terminal runs every 2 minutes so no delay there.
  3. APEC travel card. This card gives you access to a dedicated line, which is almost always empty, as it was that day. The APEC card has become a great stress reducer for me, knowing that long arrival or departure lines will not mean I miss meetings. The security line however remains a lottery: on that day the line was of moderate length.
  4. The terminal is large, so finding one of the courtesy electric vehicles saves another few minutes. Fortunately they seem to cruise around just beyond security for this reason.

Always embarrassing to be the last person on the plane – so apologies to my fellow passengers, but we did arrive at our destination 15 minutes ahead of schedule.

But (there has to be a but) why was I so late in getting to the airport in the first place? I’m after all usually obsessively early. The reason was the counter-example of how Beijing can consume massive amounts of your time inefficiently. It took more than 90 minutes to travel 30 km from a meeting to the airport.

At least on that day, the gains counterbalanced the losses.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Image credit: gyn9037 / 123RF Stock Photo

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China’s Auto Industry Puts The Pedal To The Metal http://www.mckinseychina.com/chinas-auto-industry-puts-the-pedal-to-the-metal/ http://www.mckinseychina.com/chinas-auto-industry-puts-the-pedal-to-the-metal/#comments Fri, 02 May 2014 03:10:39 +0000 http://www.mckinseychina.com/?p=7698 As the automotive industry winds down from another spectacular show in Beijing, attended by global CEOs from around the world showcasing a multitude of new models they plan to roll out in China in the near future, it is worth standing back to reflect on how the industry is performing, and the critical role that the China market now plays for the worldwide auto industry.

First of all, for many of the global auto producers, growth is still very very strong in China. Neither the slowdown in GDP growth nor the anti-corruption campaign have had a big impact to-date. For example, at the luxury end of the market, BMW and Audi both grew at over 20% in the first quarter of 2014 versus last year, and Mercedes at close to 50%. More broadly, growth in demand for cars in China is expected to represent 40% or so of total global demand growth between now and 2020. So not only is China already the largest single passenger car market in the world, it will soon be larger than the entire European market.

The only participants who might not be as thrilled by this continued growth might be the Chinese OEMs, who saw their sales fall 20% in the first 2 months of the year with their market share declining to only 23%, proving again that designing and producing cars that integrate such a broad range of technologies with consistently high quality and low cost is a really hard thing to do. Most of the Chinese OEMs have been in joint ventures with their global peers for 20 years and they still cannot translate the learnings from these partnerships into a successful standalone business.

But China is not just important because it is big and because foreign manufacturers are able to hold a leading share through their joint ventures. Our analysis, shared at the Beijing Auto Show, is that China provides roughly one-third of the global industry profit pool, on the back of a little over 20% of global revenue. It will be no surprise to anyone who spends time in China and sees the extent to which the roads hold so many premium passenger cars that China generates well over 40% of global profits in this segment. Cash flow from China is funding a large part of the global automotive industry.

Which all leads to the “what if” question. When playing out hypothetical scenarios in China and addressing the question, what industries would be hardest hit if there was a sudden slowdown in China, my answer is two – real estate (which is largely a domestic industry) and automotive (which is clearly global). Global OEMs are all planning aggressive capacity-building and new product launches in China, and these investments all require significant lead time, sometimes 2-3 years. Unless they take a lean approach to these investments and build-in enough flexibility in their expansion plan, they could end up with under-utilized facilities, declining profitability due to lower transaction prices for cars, and a heavier debt burden. That would impact the industry globally.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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China Gives Semiconductors Another Try http://www.mckinseychina.com/china-gives-semiconductors-another-try/ http://www.mckinseychina.com/china-gives-semiconductors-another-try/#comments Thu, 01 May 2014 04:22:39 +0000 http://www.mckinseychina.com/?p=7692 My visit to Silicon Valley this week reminded me that in semiconductors, China’s performance still lags far behind its aspirations. While China consumes more than 40% of all global semiconductor production, its role in producing silicon wafers, in chip design, in manufacture, and also in the equipment used to manufacture it, plays a pretty minor role still. Indeed, China was a net importer of semiconductors last year, a deficit of more than US$200 billion, larger than net imports of oil.

Why is this still the case?

China came late to the market, 1-2 decades after current leaders, and has to catch up. But semiconductor is a scale and learning efficiencies market, very hard for late comers to develop know-how and scale. As a result, IC selection has historically been made by foreign players who use non-PRC vendors. Furthermore, lack of IP protection has been a barrier to technology transfer.

The government’s approach to supporting the industry did not work. The government did not provide enough money to cover the entire value chain, nor was it able to play an influential role as a customer. Investment was not concentrated, resulting in too many sub-scale foundries and fabs (i.e. the classic Chinese government approach of back many and see who wins was exactly the wrong approach here). And geographically, fabs were too spread out and lacked a full value chain in city clusters.

Chinese companies chose to compete opportunistically at the lagging edge and stay profitable, a rational and lower risk strategy.

What happens next? Will things change?

In design, the glass half full view says the China market is growing fast, 20% plus per annum reaching nearly US$6 billion in 2013. Yet the top 10 Chinese players combined in size still lag the global #4. Quite rationally, the Chinese fabless designers are focusing on consumer applications like phones and tablets that have high local consumption. These Chinese designers are starting to have a real influence on the foundry industry, making up close to 10% of foundry demand this year. These designers source from the best available suppliers and so purchase the majority of their foundry services from non-mainland Chinese foundries.

Chinese foundries continue to face the challenges posed by their smaller scale and the need to catch up. Most are caught in a vicious cycle of focusing on trailing edge technologies that sell at lower prices which generate lower cash flows to reinvest. However, when they do invest, they generally are buying from global tool vendors. Chinese tool vendors are tiny in size and with real limitations in development capabilities. At the moment, global tool vendors don’t have to do anything special to win in China, they remain so far ahead.

The global semiconductor leaders are deepening their presence in China. Most generate more than 40% of their revenue in China, some close to 50%. They are all expanding their design team in China to be closer to their customers and to take advantage of the steadily increasing level of talent in China.

So on a “continue as is” basis, incremental change only.

What the Government might do next

Whether for national security reasons, for balance of payment reasons, or simply to be a global leader in an industry which enables so many others, incremental catch up is not good enough for the Chinese government. Since 1998 there have been many policies, strategic investments in Chinese champions, tax breaks for foreign investors and more. Yet the scattergun approach really did not work, spreading an already small investment amount compared to that spent by global leaders around numerous smaller Chinese players.

So 2014 sees another policy reset. Its objectives are believed to be 20% plus growth for each of the design, assembly and test, fab and tools sectors in China to reach a total of US$65 billion in revenue by 2018, supported by up to US$18 billion a year of government investment. This money will support national champions not only in their domestic investment but also to go out and make leap frog acquisitions internationally (although finding targets may be hard).

Will this lead to a step change? In all probability, no. Will it increase the pace of incremental change? Probably yes. Will China stop investing to develop an indigenous end-to-end semiconductor industry chain? Not until it is seen as a competitive world leader in the sector. It may just take some time.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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Where To Live In China? http://www.mckinseychina.com/where-to-live-in-china/ http://www.mckinseychina.com/where-to-live-in-china/#comments Wed, 30 Apr 2014 04:15:05 +0000 http://www.mckinseychina.com/?p=7685 The Urban China Initiative (a think tank focused on urbanization challenges in China and supported by McKinsey & Company) just published its most recent ranking of Chinese cities based on its own proprietary sustainability index. Take a look to find where your city ranks on the list.

What are the key messages?

  1. Overall, China’s cities are becoming more, not less, sustainable.
  2. Richer cities tend to perform better on the index and so most of them tend to be in the east or on the coast of China.
  3. Greater sustainability correlates with size up to a point, that point being around 4.5 million people. After this, size doesn’t matter.
  4. Greater sustainability correlates with increased population density up to a point, that point being around 8,000 people per square kilometer. After that, higher density doesn’t lead to higher sustainability.
  5. Five Chinese cities have already crossed these thresholds and 11 more are likely to do so soon, representing more than 20% of China’s population.
  6. Improving sustainability in these cities requires new forms of action, which have proven successful in peer cities globally. These include many actions that are not hard to describe, but are hard to implement consistently, whether it is in energy savings and emissions reduction, tighter supervision of polluters, pricing resources to create rational usage, smart planning of and incentives to use public transport. Implementation, not conception, makes all the difference in China.

Please read the full report for the charts which illustrate this more fully.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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Small World Of English Boarding Schools And Chinese Parents http://www.mckinseychina.com/small-world-of-english-boarding-schools-and-chinese-parents/ http://www.mckinseychina.com/small-world-of-english-boarding-schools-and-chinese-parents/#comments Tue, 29 Apr 2014 06:49:54 +0000 http://www.mckinseychina.com/?p=7681 I got an email from a colleague based in our Beijing office recently. The essence of it was to say that he and his family were on a post-offer, pre-acceptance tour of a well-known English boarding school for girls. On this tour with them was another family that he and I both knew well, formerly of Shanghai, now living in the UK. And the tour was being conducted by my niece who is a student at the school. What are the odds of that?

While low, probably not as low as you might think given how few girls’ boarding schools there are in the UK and the high level of interest from wealthy Chinese parents in such schools. Also, the parents who tend to be interested in sending their children to the UK are likely to socialize with and have an extended network of friends with similar intentions.

We end up at dinners on a quite regular basis where the planned topic of conversation is UK or US boarding schools, with parents who already have children in these schools being quizzed by those just embarking on the journey, and for whom the phrase “common entrance exam” is still deeply mysterious.

I will concede that having my niece show them around was exceedingly unlikely. After all, I do only have one niece.

You can read more of my views on China on my blog, Gordon’s View. And please follow me on Twitter @gordonorr

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China Poised To Invest Big In Russia http://www.mckinseychina.com/china-poised-to-invest-big-in-russia/ http://www.mckinseychina.com/china-poised-to-invest-big-in-russia/#comments Mon, 28 Apr 2014 06:40:23 +0000 http://www.mckinseychina.com/?p=7677 Just back from several days in Moscow.

With the Putin visit to China coming up in only a few weeks, clearly China is rising high up the agenda. Lots of efforts underway to sign long term commercial agreements on gas (maybe 40 billion m annually) to go with the long term oil supply agreement already signed.

But China may find willing partners for much more than supply agreements. This could be a fantastic time for China Inc to put bold investment proposals on the table in basic materials and agriculture. After all, China’s investment dollars in these sectors have become less welcome in traditional destinations such as Africa and Australia in recent years, and Russia needs new sources of investment, especially from partners with a downstream demand for the materials.

For example, I got the sense that there is a new willingness to accept Chinese investment in exploiting new mines in Siberia and the Russian Far East, with a list of priority opportunities being drawn up to share on Putin’s trip.

But the opportunity list should not stop there. Agricultural opportunities should be high on the list. China’s imports of agricultural products continue to grow, from Latin America, the United States and Australia in particular. A source of cereal supply closer by, and in which Chinese farmers might be permitted to operate the farms (even if they don’t own the underlying land), could be very attractive. There is much underexploited agricultural land in the Russian Far East. Timber supply could also provide interesting opportunities.

Chinese manufacturers should also be looking for opportunities. Russia is an attractive but hard to penetrate market for many Chinese companies. This may be an opportunity to create agreements to short circuit burdensome import regulations or to be able to set up assembly or R&D operations in Russia on a very preferential basis.

Finally, China’s e-commerce players might look to have the duties imposed on small packages (i.e. their goods) shipped from China to Russia rolled back for a period.

Net net, the commercial agenda for the Putin visit could be very rich.

In closing, a couple of perspectives on Russia:

  • A very high level of frustration that needed reforms to the economy are not being made. Expected growth among people I spoke to seemed to be 0% for 2014. Changes to enable productivity growth, to encourage capital investment outside oil and gas, especially in infrastructure and manufacturing, are high on the list.
  • Several Russian banks have suddenly become very flush with cash due to the recent repatriations from Western Europe.

 

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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The China Urban Sustainability Index 2013 http://www.mckinseychina.com/the-china-urban-sustainability-index-2013/ http://www.mckinseychina.com/the-china-urban-sustainability-index-2013/#comments Mon, 28 Apr 2014 04:35:31 +0000 http://www.mckinseychina.com/?p=7659 The China Urban Sustainability Index (USI) 2013 builds upon the work carried out in USI 2011. USI 2013 has expanded and upgraded the indicators used in USI 2011. The analysis deploys 23 metrics, which cover four categories: economy, society, resources and environment.

We ranked 185 cities, of varying sizes and at different stages of development, by their level of sustainability from 2005 to 2011. To ensure data was available, as well as to reflect the full landscape of Chinese cities, our sample includes all levels of cities from municipalities directly under the central government, to county-level cities with populations ranging from 200,000 to 20 million.

Our study also benchmarks sample Chinese cities against advanced global cities. We studied the basic principles affecting the development of urban sustainability in order to identify closely-related features. Our aim is to understand how China’s sustainability drive is evolving, and to provide an international reference for Chinese cities during this process.

The indicator system serves as a quantifiable scoring tool to evaluate cities urban development. With this tool, Chinese cities can identify models for urban development both within China and abroad, based on their own stage of development. Depending on how they scored in each category and their overall score, Chinese cities can also identify their advantages and disadvantages, craft development strategies, and evaluate the potential impact and effectiveness of development policies.

Key findings of the research include the following:

1. Most of China’s cities have improved their level of sustainability in recent years, primarily in the social and environment sub-categories. This reflects both strong underlying progress driven by healthy economic growth and a renewed emphasis on delivering social and environmental benefits.

2. The top 10 cities with best overall sustainability performance are located mostly in the coastal or eastern regions. Cities in the east showed the strongest level of overall sustainability, followed by cities in central and western China. The same is true of city performance in the economic, social and environmental subcategories studied. From 2008 to 2011, the gap between western and central cities was somewhat widened, with central cities gradually catching up with eastern cities. Situated in geographic locations favorable to trade and investment opportunities, Eastern cities were early beneficiaries of China’s economic liberalization policies. However, since each city is at a different stage of economic development, the strongest economic performers are not necessarily those cities with the fastest improvement in sustainability.

3. In the long term, the sustainability of China’s cities is positively correlated to economic strength, population size, and density, FDI, and migration. However, our sample cities show there are clear turning points at which a city’s sustainability potentially slows down, or stalls. This becomes especially evident when a city with a population size of more than 4.5 million, population density of more than 8000 people per square kilometer, FDI of more than USD 3 billion, or with a more than 30% share of migrants. Most developed Chinese cities are positioned at such sustainability turning points: Shanghai, Beijing, Shenzhen, Guangzhou, Hangzhou, Tianjin, Chengdu, Nanjing, Shenyang, Wuhan and Chongqing.

4. The gap with global benchmark cities is closing slowly. Over the past few years, most Chinese cities are closing in on benchmark cities such as Tokyo, Seoul and London. But unlike the Chinese cities sampled, benchmark international cities are able to improve their levels of sustainability, whether or not they reach turning points in their development. Leading cities make better use of the economic advantages that high population density brings. They are able to deliver security, social stability and efficient allocation and utilization of resources at the same time. Many Chinese cities, especially those that have passed through the turning points, will have their potential for growth limited if they continue to follow existing models of development. A blind pursuit of economic growth, population expansion, and an increase in population density will prevent sustainable progress. Policy-makers in these cities must learn from leading international cities by seeking out new growth models. These include the construction of smart and low-carbon cities, a strategy that would strengthen the urban capacity of these cities. Policy-makers must also improve city planning, construction and management, in the hope that these cities will able to leapfrog development.

5. Bigger improvements in sustainability are possible for cities at earlier stages of economic development. Increases in productivity (GDP per capita), the rise in scale (population and density), and external factors such as FDI and migration demonstrate a much bigger impact on sustainability for cities at earlier stages of economic development, than when they are at a more mature stage of development.

6. Cities can determine their own future; their fate is not determined by GDP, population size or density. Cities can, at any time in their development, make improvements by leveraging inherent strengths, comparative natural advantage or policy instruments. No uniform laws were identified, from our sample of 185 cities, to interpret short-term changes in a city’s sustainability using only changes in macro variables.

7. When a city’s economy reaches a certain level of maturity, imbalance emerges between the economy and the social and environmental aspects. Some rich and large cities are developing at the cost of social and environmental deterioration. Population and economic size expansion cannot help them further without social and environmental sacrifice as they lack advanced city management capabilities.

8. During the transformation from small cities to large ones, small cities should better integrate with cluster cities. This would enable them to leverage the advantages of the cluster while contributing their strengths to the entire cluster.

Download The China Sustainability Index 2013 report here.

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Weighing China’s Economic Scale Vs. Its Neighbors http://www.mckinseychina.com/weighing-chinas-economic-scale-vs-its-neighbors/ http://www.mckinseychina.com/weighing-chinas-economic-scale-vs-its-neighbors/#comments Fri, 25 Apr 2014 06:31:35 +0000 http://www.mckinseychina.com/?p=7669 By the end of the first quarter of the year, institutions like the IMF have usually published their summary of economic data for the year just passed. I took a moment this week to look at their data on GDP and GDP per capita for 2013. (I accept this may be a post of interest to fewer than my typical posts)

What I noticed:

  • Japan only ranks 24 on GDP per capita after the depreciation of the yen, behind even the UK. Tokyo continues to feel vibrant and wealthy when I visit, reinforcing the view of there being “2 Japans” – Tokyo and the rest of the country, in a similar way to there being “2 UKs” – London and the rest of the country
  • China still only ranks 83 but is ahead and growing further ahead of most ASEAN countries on a GDP per capita basis. This still comes as surprise to many Chinese tourists when they visit these countries. These tourists tend to come from the wealthiest parts of China, where the GDP per capita could easily be 2x the national average and they don’t realise how poor parts of ASEAN remain
  • China’s GDP per capita has reached 4.5 times that of India. If ever there was a time when manufacturing industries had the potential to move from China to India, this theoretically would be the time. Twenty years ago the gap was less than 2 times but China’s GDP has grown faster than India each year.
  • China’s nominal GDP is greater than the sum of Japan, India, South Korea and Indonesia’s GDP. Wow!
  • China’s nominal GDP is more than 30 times that of Malaysia.
  • North Asia’s GDP is roughly the same size as the GDP of the US or the EU

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You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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All you need to know about business in China http://www.mckinseychina.com/all-you-need-to-know-about-business-in-china/ http://www.mckinseychina.com/all-you-need-to-know-about-business-in-china/#comments Wed, 23 Apr 2014 07:35:48 +0000 http://www.mckinseychina.com/?p=7646 Six big trends are shaping the country’s future, as investor Jeffrey Towson and McKinsey’s Jonathan Woetzel explain in this excerpt from The One Hour China Book.

April 2014 | byJeffrey Towson and Jonathan Woetzel

A lot of people view China business as mysterious. Relax. Consumers behave pretty much the same everywhere. Competition is pretty much the same everywhere. You just need to ignore the hype and focus on the basic fact that in China today, there are six big trends (exhibit). That’s it. Six trends shape most of the country’s industries and drive much of China’s impact on the Western world. They are like tectonic plates moving underneath the surface. If you can understand them, the chaotic flurry of activity on the surface becomes a lot more understandable—and even predictable.

These trends move businesses on a daily basis. They’re revenue or cost drivers that show up in income statements. Deals, newspaper headlines, political statements, and the rising and falling wealth of companies are mostly manifestations of these six trends, which aren’t typically studied by economists and political analysts. In fact, we happen to think that Chinese politics or political economics are wildly overemphasized by some Westerners in China. So let’s tell a story about each of these megatrends, with some important caveats. They’re not necessarily good things. They’re not necessarily sustainable. For every one of them, we can argue a bull and a bear case. Most lead to profits or at least revenue. Some may be stable. Some lead to bubbles that may or may not collapse. We are only arguing that they are big, they are driving economic activity on a very large scale, and understanding them is critical to understanding China and where it’s headed.

 

Exhibit

onehourchina-exhibit

Urbanizing a billion people

Urbanization is arguably the most important phenomenon shaping modern China. More than 300 million people have moved from the country to cities in the past 30 years, and an additional 350 million are on the way. China has 160 cities with populations of more than one million and 14 with more than five million. Increasingly, these cities are becoming linked, creating urban areas with 30 million people or more—the size of many European countries. Before long, there will be one billion city dwellers in China, placing intense demands on infrastructure such as transportation and public services, as well as on critical resources like clean drinking water. Already, a staggering 40 percent of Chinese rivers are seriously polluted and unfit for use. In an attempt to reverse that, China will invest $636 billion in water-related projects through 2020.

At the same time, urbanization is creating a great deal of wealth. Some 350 million people have moved out of poverty since 1990 in China, with disposable income per capita rising 300 percent during that period. Perhaps the clearest illustration of wealth generation is in real estate, where investment rose to $980 billion in 2011 from just $120 billion in 2003. In fact, by focusing on building basic modern apartments for China’s rising middle class, the country’s leading developer, China Vanke, built some 80,000 apartments in more than 25 cities in 2012—and recorded annual sales topping 97 billion renminbi (about $16 billion).

Huge manufacturing scale

China is the world’s largest manufacturer, with more than $2.2 trillion in manufacturing value added. It makes 80 percent of the world’s air-conditioners, 90 percent of the world’s personal computers, roughly 70 percent of the world’s solar panels, 90 percent of the world’s mobile phones, and some 65 percent of the world’s shoes. Manufacturing makes up 40 percent of the Chinese economy and directly employs 130 million people. But its traditionally low labor costs are rising, and there is aggressive movement from low-tech assembly to high-tech manufacturing, as well as from the more expensive coastal areas into cheaper central and western China. In addition, Chinese companies’ strategy of building big and selling cheap may not be enough to win in Western markets against companies with both established market share and brand equity, which is the primary barrier preventing Chinese manufacturing scale.

Yet it’s perilous to underestimate Chinese manufacturers and the benefits of scale. Perhaps the most global Chinese company today is telecommunications giant Huawei Technologies, which grew rapidly by developing lower-priced equipment for second- and third-tier cities and avoiding competition from global manufacturers in major markets. When Huawei expanded abroad, it targeted less-developed areas in Southeast Asia, Africa, and Eastern Europe that had been neglected by major global players. By the time Huawei became the world’s top telecommunications-equipment company in 2012, it was earning more than two-thirds of its $36 billion in revenue outside of China. And at home, its scale has allowed it to make more sophisticated products and move into first-tier cities.

Rising Chinese consumers

The American middle class was the world economy’s growth engine throughout the 20th century. Now, the engine is the Asia–Pacific region, which will account for two-thirds of the world’s middle class by 2030. While Chinese consumers’ focus on “value for money” has driven the rise of companies such as apartment builder China Vanke and Tingyi Holding Company—the business behind China’s dominant instant-noodle brand—buying habits are changing. As urbanization accelerates, consumer spending is becoming more like that of the West’s middle class. Urban Chinese are shopping to meet emotional needs, driving a skyrocketing demand for middle-class goods, food, and entertainment.

As an example, China consumed more than 13 million tons of chicken in 2012—more than the United States. Tyson Foods’s China operations has facilities able to process more than three million chickens per week, and Chinese chicken consumption, which grew by 54 percent from 2005 to 2010, is expected to grow an additional 18 percent annually during the next five years. For additional evidence, look no further than the fact that the largest Chinese acquisition of a US company had nothing to do with technology, cars, or energy. In 2013, Chinese Shuanghui International spent $7.1 billion to buy American Smithfield, the world’s largest pork producer and processor. It’s not surprising, then, that agribusiness is one of China’s hottest new industries.

Almost every aspect needs to be improved, from land and water use to logistics and retail. Legend Holdings, the parent company of Lenovo, now lists modern agriculture as one of its five core areas, with a portfolio that includes kiwi and blueberry farming.

Money—and lots of it

China has more than $15 trillion in bank deposits, and that figure grows by $2 trillion every year. Foreign-exchange reserves total $3.5 trillion. China is the single largest foreign purchaser of US government debt. And its yearly trade surplus with the United States has grown from $10 million in 1985 to more than $300 billion in 2012. China’s banking and financial ecosystem is moving large amounts of money with increasing efficiency and sophistication—but it may not be stable. The financial-services sector is a great churning mass of high finance, state capitalism, and one-party rule. The Big Four banks can and do function as an arm of the government, pumping lending into big state-owned enterprises and local governments rather than the small and midsize enterprises that employ 80 percent of the Chinese workforce. And this mismatch is driving a surge in the shadow banking system.

In 2003, bank lending accounted for 88 percent of Chinese finance; in 2012, it was 55 percent. A large lending market outside the formal banking system has emerged, complete with underground finance, off-balance-sheet lending, and wealth-management products that pool investors’ money and invest it in various projects. However, most of these wealth-management products do not specify where funds are used. This situation creates risks and affects the dynamics of the Chinese banking sector. Banking is dominated by government regulation while shadow banking is not, which is giving it a competitive edge. And this comes as lending in China has skyrocketed. Central and local governments have financed an estimated $1.8 trillion in debt for projects, but no one really knows how much debt China actually has.

The brainpower behemoth

Manufacturing isn’t the only thing that’s happening at large scale in China. The number of college graduates has surged from 1 million in 1998 to 7.5 million in 2012, turning Chinese brainpower into another game-changing phenomenon. There is an explosion in research-and-development investment: in 1993, China accounted for just 2.2 percent of the world’s R&D spending; by 2009, the figure was 12.8 percent and well ahead of most European countries. In 2011, China surpassed Japan and is now second only to the United States. China’s manufacturing giants have massive scale, deep pockets, and access to large numbers of skilled professionals. For example, Huawei has a workforce of 150,000, of whom 68,000 are in R&D; Cisco has 66,000 employees but only 21,000 in R&D.

That’s the good news. The not-so-good news is that there is a substantial disconnect between education, employment, and other markers of Chinese brainpower. One-quarter of the students who graduated college in 2012 failed to land a job by year’s end. Patent filings have surged, but few of China’s patents are of a quality comparable with those in Japan or the West. And even companies focused on cost innovation are not immune to market forces or competition: solar-panel maker Suntech rose rapidly—and fell from the world stage just as quickly.

The Chinese Internet

The Internet is a recent phenomenon in China. About 60 percent of the 618 million Chinese now online have only begun using the Internet in the past three to four years, and overall penetration remains at just 40 percent of the population, compared with approximately 80 percent in the United States. The potential for further growth is underlined by another fact: Internet users in China spend five to six more hours online per week than Americans do. Yet user behavior is also different. While search and e-mail dominate online activities elsewhere, in China, users have gravitated to instant messaging and online video. That online behavior shows no sign of changing, even though gaming and social networking have become popular.

Consider, then, the growth of Tencent. Founded in 1998, it now has more than 700 million accounts for its instant-message service QQ. Over the years, it has added service after service to become, one observer has noted, an amalgam of AOL, Facebook, Gmail, Norton, Skype, Twitter, and Yahoo!, with a market capitalization of nearly $100 billion. In 2013, cofounder Ma Huateng—known as Pony Ma—was ranked China’s third-richest person, with a net worth of $13 billion, according to the Bloomberg Billionaires Index. The company is now spending heavily to expand overseas, particularly in gaming. It bought a majority stake in Los Angeles–based Riot Games in 2011 and a minority stake in Epic Games the next year; it also has partnerships with both Activision Blizzard and Electronic Arts. Tencent has, according to Dean Takahashi of VentureBeat, “the market power to acquire just about every major video-game company in the US.”

China is developing so rapidly and on such a vast divider scale that instability and chaos are natural by-products. It is experiencing regular booms and busts across its economy in the same way a rocket ship experiences turbulence. Yet underlying this volatility are powerful economic and demographic megatrends that are broad and long term. They did not change last year, will not change this year, and will remain the driver of most of China’s daily business and economic activity—for better or for worse.

About the authors

Jeffrey Towson is a managing partner of the investment firm Towson Capital, and Jonathan Woetzel is a director in McKinsey’s Shanghai office. They are both professors at Peking University’s Guanghua School of Management in Beijing.

This is an edited excerpt from The One Hour China Book: Two Peking University Professors Explain All of China Business in Six Short Stories (Towson Group, January 2014). For more details about the book, visit onehourchina.com.

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Digital China On The Rise http://www.mckinseychina.com/digital-china-on-the-rise/ http://www.mckinseychina.com/digital-china-on-the-rise/#comments Wed, 23 Apr 2014 01:19:56 +0000 http://www.mckinseychina.com/?p=7652 I recently spoke to a large group of Fudan University students in Shanghai about what to expect as they graduate from college and start their working careers, given the technological forces at work today. I started at the level of global trends, then discussed the impact on specific industries and then on specific roles. I closed with a check list of the skills – digital and non-digital – that will be required as the foundation for successful careers that are starting today. The University videotaped the event, and they attached a transcript on their website as well.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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Is Competition Really About To Come To Telecom Services In China? http://www.mckinseychina.com/is-competition-really-about-to-come-to-telecom-services-in-china/ http://www.mckinseychina.com/is-competition-really-about-to-come-to-telecom-services-in-china/#comments Thu, 17 Apr 2014 08:06:08 +0000 http://www.mckinseychina.com/?p=7643 Over the next month, the first of the mobile virtual network operators (MVNOs) licensed at the end of 2013 will launch their services. Close to 30 licenses have been issued to companies from many industries to allow them to resell the networks of the existing mobile network operators.

Initially as a consumer, you may be hard pressed to notice that new competition has arrived. Commercial terms between the network operators and the MVNOs are deeply unattractive. The wholesale price for voice is basically the same as the current post discount retail price. The wholesale price for data may in some instances be even higher than the post discount retail price.

To offer any price advantage MVNOs will need to sell at a loss. As a result, none are putting a lot of investment behind the launch right now, even though several of them have very interesting bundling opportunities to offer to customers. Surely this is not what the regulator intended as the long term outcome. I expect we will see these terms gradually changed over time to favor new entrants

For example, among the MVNO license holders are the largest sellers of mobile phones such as Gomei, Suning and JD. Could they offer a bundled service package with handset sales over time? Likely yes.

Also among MVNO license holders are China’s online giants who have their own payment systems in place and connections with hundreds of millions of customers. Their main goal is likely not just to sell minutes but to enhance their total offering to buyers, sellers and partners. For example, they might offer free calls between buyers and sellers, or free data when on their site, And even, over time, free calls between anyone who holds an account with them, merging their social media offerings seamlessly into a bundled voice offer.

Like Amazon in the US, they might easily offer their own branded phone with operating system and apps tailored to using their service. These players are wealthy enough that they could offer loss leader packages for a while, but even they would have to be careful of what they wish for. Even for their deep pockets, success could lead to investment levels they could not sustain – this is not the same as subsidizing taxi rides for a few RMB a day.

The incumbent network operators are in a tough position over time. While they still have much spare capacity on their 3G networks, they are being pushed to upgrade to 4G now and invest billions of dollars in doing so. Moreover, they are not popular with their customers – seen as difficult to deal with, not particularly customer-friendly compared to the internet companies. They could easily see a rapid exodus of customers to MVNOs, if the latter had attractive pricing plans.

Launching MVNOs is a way for the government to create a commercial lever to influence the behavior of the big three operators, a surprisingly populist lever as the result is likely more choice and lower cost for customers over time. However, it is likely to be a one way lever: if packages and services emerge that consumers really like and move to in their tens of millions, it will be very hard to pull back.

Watch what happens closely, don’t expect much in Q2 but by Q4 we could see some really dramatic shifts in the telecom services market.

 

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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China Steps Up From Industrial Parks To Knowledge Cities http://www.mckinseychina.com/china-steps-up-from-industrial-parks-to-knowledge-cities/ http://www.mckinseychina.com/china-steps-up-from-industrial-parks-to-knowledge-cities/#comments Wed, 16 Apr 2014 08:00:24 +0000 http://www.mckinseychina.com/?p=7636 Twenty years ago, Singapore Inc’s investment in an industrial park in Suzhou was held up as a symbol of the direction of China’s economic development. Today, a new collaboration in Guangzhou could become a symbol of the direction of China’s development into the 2020s. I had a chance to learn about Guangzhou Knowledge City (GKC) when I spoke at a leading university recently.

GKC offers the kind of incentives to multinational companies to create research and creativity-based jobs that used to be on offer to companies building factories. Incentives are available (as you would expect) for pretty much all the research priorities laid out in the 12 Five Year Plan. The incentives are even on offer to universities and foreign government institutions.

As with the industrial parks, the owners have thought through what kind of services need to be collocated. But instead of worker dorms and services to hire hundreds or thousands of migrant workers, GKC will have a branch of the State Intellectual Property Office, the agency responsible for approving patent applications in China, and an international high school for the children of international researchers. Adjacency to Guangzhou’s international airport should be a plus, as is the relative proximity to Hong Kong.

Whereas in the past incentives were negotiated somewhat ambiguously on a case-by-case basis, GKC’s brochure has an appendix with incentives detailed for industries from biotech to creative. (I’m not so naive to believe all deal-making has been eliminated, but it is at least a standardized starting point.)

As a green-field development, GKC hopes to deploy technologies developed locally as a practical demonstration or showcases for the investing companies who own them. This could be in smart grid, smart sensors, smart traffic and more.

Certainly, multinationals are showing interest. The zone’s administrators described investments from European industrial solution companies as well as US software and technology companies. Universities from the UK and the US are establishing hubs, with a focus on medical and biotech.

The intended scale is vast – 250,000 high value added jobs on 60 sq km of developable land. Whether or not the GKC meets its founders’ expectations is probably not the most important outcome for China’s overall development, although I’m sure the investors would like to see a return. In reality, barriers to others copying this model are relatively low. What is important is that others observe and learn what it takes to create a successful knowledge cluster – what soft and hard infrastructure to provide, what kinds of incentives really matter, who the best foundational business and academic tenants are. Then we can have a new era of healthy competition between knowledge zones across China, drawing in research and knowledge jobs from multinational companies.

After all, the industrial park in Suzhou was not a great success during the era of Singaporean investment; it really only took off after their stake was sold back to the Chinese partner. Yet it always was a flagship that other industrial zones across China learned from. Let’s hope that the GKC can be a win-win-win for its investors, its tenants and for competing zones across China.

Hope it is more successful than the Suzhou park.

 

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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China In An Hour http://www.mckinseychina.com/china-in-an-hour/ http://www.mckinseychina.com/china-in-an-hour/#comments Mon, 14 Apr 2014 15:19:20 +0000 http://www.mckinseychina.com/?p=7619 My colleague, Jonathan Woetzel, has written a book with Jeffrey Towson, a private equity investor, that boils their decades of experience in China down to a one-hour “speed read” – China in an hour. (Full disclosure: I did give input on an early iteration of the book).

I gave the book to my Economist-reading son last week when he was back in China during a break from school, and can confirm that it does what it says on the cover. It took him about an hour to get through. Highlights for him were the examples.

The blurb argues this book is for everyone. Perhaps a slight stretch, but certainly at $4.00 for the e-version it can help lots of people, especially those who need to put together a clear macro paper or presentation on China, and also anyone who wants to stand back a bit from the daily noise of news stories to view the longer term trends.

In the spirit of if you can’t beat them, join them (with permission), here is the five-minute version of China in One Hour:

1. 1 billion Chinese living in cities – that’s a lot of apartments

“Urbanization is arguably the most important phenomenon shaping modern China. More than 300 million people have moved from the countryside to cities in the past 30 years, and another 350 million are on the way. China has 160 cities with populations of more than one million and 14 with more than five million. Increasingly, these cities are becoming linked, creating urban areas with 30 million people or more—the size of many European countries.”

“Before long, there will be one billion city dwellers in China, placing intense demands on infrastructure such as transportation and public services, as well as critical resources like clean drinking water. Already, a staggering 40 percent of Chinese rivers are seriously polluted and unfit for use. In an attempt to reverse that, China will invest $636 billion in water-related projects through 2020.”

2. China manufacturing is big and here to stay

“China is the world’s largest manufacturer, with more than $2.2 trillion in manufacturing value-added. It makes 80 percent of the world’s air-conditioners, 90 percent of the world’s personal computers, roughly 70 percent of the world’s solar panels, 90 percent of the world’s mobile phones, and some 65 percent of the world’s shoes.”

“Manufacturing makes up 40 percent of the Chinese economy and directly employs 130 million people. But its traditionally low labor costs are rising, and there is aggressive movement from low-tech assembly to high-tech manufacturing, as well as from the more expensive coastal areas into cheaper central and western China. In addition, Chinese companies’ strategy of building big and selling cheap may not be enough to win in Western markets against companies with both established market share and brand equity, which is the primary barrier preventing Chinese manufacturing scale.”

3. Chinese consumers eating more and better

“The American middle class was the world economy’s growth engine throughout the 20th century. Now, the engine is the Asia–Pacific region, which will account for two-thirds of the world’s middle class by 2030. As an example, China consumed more than 13 million tons of chicken in 2012—more than the United States. Tyson Foods’ China operations have facilities able to process more than three million chickens per week, and Chinese chicken consumption, which grew by 54 percent from 2005 to 2010, is expected to grow an additional 18 percent annually during the next five years.”

“For further evidence, look no further than the fact that the largest Chinese acquisition of a US company had nothing to do with technology, cars, or energy. In 2013, Chinese Shuanghui International spent $7.1 billion to buy American Smithfield, the world’s largest pork producer and processor.”

My comment: One of the big trends within Chinese private equity firms is to invest in the agricultural industry outside China to bring quality products to Chinese consumers.

4. Lots of Chinese talent available

“The number of college graduates has surged from 1 million in 1998 to 7.5 million in 2012, turning Chinese brainpower into another game-changing phenomenon. There is an explosion in research and development investment: in 1993, China accounted for just 2.2 percent of the world’s R&D spending; by 2009, the figure was 12.8 percent and well ahead of most European countries. In 2011, China surpassed Japan and is now second only to the United States. China’s manufacturing giants have massive scale, deep pockets, and access to large numbers of skilled professionals. For example, Huawei has a workforce of 150,000, of whom 68,000 are in R&D; Cisco has 66,000 employees but only 21,000 in R&D.”

My comment: Yes, but… Of those 7.5 million graduates, their starting salaries were no higher in real terms than in 2007, close to 20% had no job at all 6 months after graduation, and many others were in jobs that did not require a graduate degree. Universities need to provide life and technical skills that employers want.

5. The Internet is now mostly in Chinese

“The Internet is a recent phenomenon in China. About 60 percent of the 618 million Chinese now online have only begun using the Internet in the past three to four years, and overall penetration remains at just 40 percent of the population, compared with approximately 80 percent in the United States. The potential for further growth is underlined by another fact: Internet users in China spend five to six more hours online per week than Americans. Yet user behavior is also different. While search and e-mail dominate online activities elsewhere, in China, users have gravitated to instant messaging and online video. That online behavior shows no sign of changing, even though gaming and social networking have become popular.”

My comment: Important to get the e-version of the book as I suspect the Internet chapter will need updating almost quarterly given the fantastic pace of innovation and industry realignment we are seeing. Indeed one of the key things I think the authors can do is to update all the chapters on a rolling basis with new examples and updated data for the trends – turning the book into a new kind of living document that we go back to and find fresh each time.

Clearly the examples and the stories are lost in this abbreviation – go to the book for these.

If you like the topic but don’t like the idea of reading more than this blog, the authors have recorded a podcast on iTunes and a video on Youtube:

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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Even Chinese SOEs Are Getting Media Savvy http://www.mckinseychina.com/even-chinese-soes-are-getting-media-savvy/ http://www.mckinseychina.com/even-chinese-soes-are-getting-media-savvy/#comments Fri, 11 Apr 2014 15:12:38 +0000 http://www.mckinseychina.com/?p=7613 At the end of March, I attended the launch of China-US Insurance Advisory Co. Ltd., the joint-venture agency distribution company between PICC Group and American International Group, in Beijing. Not that unusual, I get invited to a fair number of such events.

What this one in particular did make me reflect on was the transformation in sophistication of how Chinese state-owned enterprises represent themselves. It wasn’t just the caliber of executives, their international mindset, and the excitement that they had about the launch. It was also in how they ran the event, what they emphasized, and how they brought the services they offer to life – and just how different this was from the past.

I recall state-owned insurance company announcements as being completely dire in the past. A large semi-lit room, partly filled. Executives sitting at a desk reading a script they didn’t care about to an audience who didn’t really want to be there other than for the drinks available at the end. And always running late.

The new version involved floor to ceiling LCD screens, which projected what was on the screen of the sales agent’s iPad on the stage as she demonstrated an actual sale in real time during the event. The speeches were concise, on time, and delivered with enthusiasm. The back of the room had further iPads so that the journalists could try (and film themselves doing so) the apps.

It really felt like a commercial entity was driving the event.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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Coming To A Factory Near You: Chinese Robots http://www.mckinseychina.com/coming-to-a-factory-near-you-chinese-robots/ http://www.mckinseychina.com/coming-to-a-factory-near-you-chinese-robots/#comments Thu, 10 Apr 2014 13:15:07 +0000 http://www.mckinseychina.com/?p=7594 World Robotics recently published their annual update on the industry. It captures very clearly the trend in China towards higher value added production and towards substituting capital for labor. They believe global sales of multipurpose industrial robots last year was around 162,000, of which 25,000 were sold in China, slightly fewer than were sold in North America or Japan. By only 2016, they forecast that China will be consuming 38,000 robots, 20% more than either Japan or North America is expected to buy.

However that won’t mean that China’s installed base of industrial robots has yet caught up. With only 120,000 in use in 2013 versus 310,000 in Japan and 215,000 in North America, that will take a number more years, but China will most likely overtake Germany’s installed base by 2016.

In many ways this is not surprising: after all, around 40% of these robots end up in the automotive industry. China’s automotive factories look as capital intensive as those in Europe or the Americas, and are producing more cars than any other country worldwide.

There is a “but” in this, which is that Chinese robot producers are not part of this global industry association, and so robots produced in China for use in China don’t get counted in the global statistics. So if you thought the numbers above were small, you were correct. Foxconn’s in-house production of robots are excluded, as are the sales of the several hundred Chinese robot producers that a quick search on Alibaba throws up. In fact, China could easily be 40% of the global market today.

China could easily be 40% of the global market today

Net net, this is like so many other industrial sectors. China is for a period a massive net importer. Over time, Chinese companies see the market and look for opportunities to enter. We will have over competition, focused on the low-end, and gradually winners who start to develop their own IP will emerge. My sense is that we are about at that stage in China today, and that Chinese manufacturers will gain domestic market share quite rapidly in the mid-market.

Unlike in some other sectors, exports by Chinese companies may be harder to come by. The largest international markets – Japan, USA and Germany – represent more than 50% of the non-China market, and all have strong domestic industrial robot industries closely tied to their customers in the defense and automotive sectors. Displacing them will be hard. I suspect that there will be more international growth through M&A by the Chinese manufacturers than through organic expansion.

Don’t come to China for cheap labor, come to China for cheap robots for your factory instead.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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The 5 Drivers Of China’s Internet Deal Frenzy http://www.mckinseychina.com/the-5-drivers-of-chinas-internet-deal-frenzy/ http://www.mckinseychina.com/the-5-drivers-of-chinas-internet-deal-frenzy/#comments Wed, 09 Apr 2014 15:22:32 +0000 http://www.mckinseychina.com/?p=7562 You can’t go a week without hearing of a new acquisition by Baidu, Alibaba or Tencent. While China’s Internet giants have been doing acquisitions for years, the last three months can best be described as a frenzy.

Tencent’s recent announcements have been impressive – including:

  • They are buying 15% of Leju, an online property agency, for $180 million.
  • They are buying 15% of e-commerce website JD.com for $215 million.
  • They are buying 28% South Korean mobile game developer CJ Games for $500 million.
  • They have paid $448 million for 36% of search engine Sogou.
  • They have bought about 20% of review website Dianping.

And in the last few days, Chinese media has been reporting that Tencent is buying 20% of online video site Youku Tudou for approximately $300 million.

Alibaba’s recent moves have arguably been even more ambitious.

  • They invested $215 million in mobile messaging app-maker Tango, a competitor to WeChat.
  • They have announced plans to take control of China’s leading mobile mapping service, AutoNavi.
  • They are investing $804 million for a controlling stake in ChinaVision Media, which has a library of movies, TV shows and sports broadcasts including some Chinese rights for the English Premier League soccer.
  • They have moved into Internet finance in a large way with Yu’e Bao.
  • They have launched an entertainment investment fund called Yu Le Bao which lets people invest small amounts of money in TV and movie productions.
  • They are investing $360M in a logistics joint venture with the Haier Group, China’s largest maker of appliances.
  • And they have an agreement with Midea Group to sell the first intelligent air conditioners on Tmall.com.

Baidu has also made recent announcements:

  • They are buying Chinese app distributor 91 Wireless for $1.9 billion.
  • They are buying majority ownership of group buying platform Nuomi.com for $160 million.

Overall, the recent deal frenzy is pretty impressive in its speed and scale. And there are lots of explanations floating around for what is going on. That this is because Internet use is moving from PCs to smartphones. That this is mostly about competition between Tencent and Alibaba. That this is mostly about all the cash sloshing around. And so on.

In fact, such surges in M&A are fairly common. And this surge of mostly-strategic deals is quite similar to the one that took place in the US in the 1990’s when the Internet first emerged. It is actually also quite similar to a strategic merger wave that occurred around 1900 as America’s industrial economy first emerged.

In all three situations (there are others), large existing businesses were confronted with a fundamental shift in the business environment. At the start of the industrial age. At the start of the Internet age. And now at the start of a new, but not yet named, age in China.

Then, like now, the leading companies are scrambling to find a new business model for a still changing landscape. And strategic mergers and acquisitions are how big companies evolve quickly when they need to. It is also how entrepreneurs, venture capitalists and investment bankers take advantage of the situation.

Per American M&A guru Bruce Wasserstein, such deal waves are typically driven by one or more of five drivers. In China today, it looks like all five are happening at once. They are:

  1. Technological change
  2. The need for scale
  3. Fluctuations in the financial markets
  4. Regulatory change
  5. The role of leadership

 

Technological change (#1) is the biggest driver here.

There is an acute awareness that mobile phones and e-commerce are technological changes that are fundamentally changing the Chinese economic landscape. And not just in online business. It is also changing significant sections of China’s offline economy. Financial services, entertainment, retail, logistics, transportation and many other sectors are being changed. The Internet economy is both driving productivity and creating new markets.

Against this technological change, the Internet giants are attempting to protect their current businesses from new threats – but are also rushing after the new opportunities. A lot of these deals are a “land grab” for the best new opportunities.

The need for scale (#2) is the second big driver.

Alibaba’s activity is driving Tencent to act and vice versa. If your competitor becomes twice your size in a service, you are likely at risk and growing organically will not be enough. So you need acquisitions. The race for size often leads to a competitive panic – and all this leads to deals.

Fluctuations in the financial markets (#3) also frequently lead to deal sprees (both financial and strategic). The emergence of junk bonds in the 1980’s and securitization of mortgages in the 2000’s gave rise to the LBO and mortgage deal frenzies of the same periods. Similarly, the new wealth of China’s Internet giants is enabling them to be big buyers. Cash rich Internet companies and the efficiency with which capital is deployed in China’s Internet sector are important parts of the current phenomenon.

Regulatory change (#4) also creates deal opportunities. For example, the creation and later ending of the Glass-Steagall Act started waves of divestiture and later consolidation.

In this case, there is an interesting contrast between the lack of regulation in China’s online businesses and the tight regulations of many offline industries. This has created a tempting situation where the Internet companies can operate with a regulatory advantage in many situations. It appears to be prompting entrances into more regulated industries, such as Alibaba’s move into Internet finance.

Finally there is the role of leadership (#5). This is the most interesting factor.

Deals are ultimately done by individuals. And some business leaders are more aggressive than others. Some people are empire-builders. Some are visionaries. Some are speculators. And the leaders of China’s Internet companies are a highly aggressive and highly competitive group. They are seasoned entrepreneurs and risk-takers in their primes.

So the current Internet deal spree has a lot to do with the individual personalities of Jack Ma, Martin Lau and Robin Li.

We are seeing all five drivers at once right now. It’s impressive. But it is also people are only logical to a point. Sometimes people just do deals to do deals – and frenzies can take on a life of their own.

Our take is that most Chinese companies today, Internet-based or not, have little idea how the new landscape will look in a few years. They mostly do not know what will be the winning business model. And they do not yet know what they need to be in order to survive and / or thrive.

What has happened in previous episodes of transformation (and frenzied deal-making) is that one or two companies figured it out first. They are later called the “Steve Jobs” of the situation for their prescience.

But most of the companies are just doing deals and trying to figure it out as they go. Everyone is running but only a few have a clear picture of the destination. It will be interesting to see in a few years who was actually pursuing the winning strategy and who is the Steve Jobs of this transformation.

This article first appeared on The One Hour China blog on SCMP.com.   Jeffrey Towson is Managing Partner of Towson Capital, an investment advisory firm specializing in US-emerging market healthcare. Jonathan Woetzel is a Director in McKinsey & Company’s Shanghai office, and the Director of the McKinsey Global Institute in Asia. They are Professors at Peking University’s Guanghua School of Management, and are the authors of the best-selling One Hour China Book, now available on Amazon.

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Chinese Talent Taking on America http://www.mckinseychina.com/chinese-talent-taking-on-america/ http://www.mckinseychina.com/chinese-talent-taking-on-america/#comments Tue, 08 Apr 2014 12:36:37 +0000 http://www.mckinseychina.com/?p=7591 Yang Song, Vice-President of Sales and Marketing at Dongfeng Nissan, Nissan’s successful joint venture in China, is being promoted to run the West Region of Nissan’s US operations. So says China’s social media.

This is recognition not only of the size and importance of the Chinese auto market but also of the talent that is being developed in the intense competition that exists in China. Nissan sells more cars in China than the US and is growing faster. It would not be surprising at all that a successful executive from this market would be taken to shake up another region. But this is one of the first times that it has been a Chinese executive and moreover an executive that came out of a joint venture rather than the parent company.

Very exciting as a milestone and one of the first cracks in the glass ceiling for “proven in China” Chinese executives working in multinationals. Congratulations to Nissan.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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The UK Rolls Out The Red Carpet For Chinese Investors http://www.mckinseychina.com/the-uk-rolls-out-the-red-carpet-for-chinese-investors/ http://www.mckinseychina.com/the-uk-rolls-out-the-red-carpet-for-chinese-investors/#comments Sun, 06 Apr 2014 12:29:26 +0000 http://www.mckinseychina.com/?p=7588 Earlier this month, the National Development and Reform Commission (NDRC), China’s chief economic planning agency, issued a 70-page guide to Chinese businesses on how to invest in the UK.

It is a great practical example of the Chinese government’s commitment to increasing outbound investment and potentially a big boost to the U.K. government’s drive to increase inbound investment. The materials describe the support provided by Chinese and UK government agencies, including financial assistance, for companies making these investments. Perhaps most usefully, the document gives case examples from many industries of Chinese companies that have invested in the U.K. that readers might reach out to for more insights.

The report describes how business relations are in many ways already quite robust. Excluding Hong Kong, the U.K. is already the #3 destination for Chinese FDI after the U.S. and Kazakhstan, with 500 Chinese businesses invested in the UK and 700-plus new projects in 2012 alone. The trend of Chinese companies investing out is not new, only the larger scale of the projects is. Large-scale investments in real estate, in financial services, or in infrastructure would not have happened 5 years ago. Today, they feel quite normal.

I thought that some non-Chinese business and government readers might be interested in the report, so I’ve attached a very rough unofficial translation as an example of what kind of document could be created through collaboration between the NDRC and inbound investment agencies. Please go to the original Chinese version for confirmation of any data quoted.

If I were to suggest a few additions for the next edition of this material beyond the usual updating of the cases, I would propose the following:

1. A section on the attractiveness and ease of listing on the London Stock Exchange, either as a primary or secondary listing. Whether it is the lower cost of listing, or the depth of analyst expertise in sectors like mining and financial services, London has a lot to offer.

2. A section explicitly on the role of London as a regional HQ for Asian companies, highlighting how for earlier Asian movers, the UK has proven a very successful base.

3. A section on collaboration between Chinese companies and UK universities on research topics and perhaps on the UK as an R&D center more broadly. In biotech, in medical research more broadly, and in Internet-based innovation, there is much overseas investment into the UK, but less than might be expected from China.

4. And perhaps a sidebar on the UK’s education sector as after all, many of the children of the Chinese businessmen making these investments are, or will be, at school in the UK at some point.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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Preparing For China’s Middle Class Challenge (Part 3) http://www.mckinseychina.com/preparing-for-chinas-middle-class-challenge-part-3/ http://www.mckinseychina.com/preparing-for-chinas-middle-class-challenge-part-3/#comments Wed, 02 Apr 2014 12:11:59 +0000 http://www.mckinseychina.com/?p=7581 This is the third of three chapters from my China Development forum paper on the future of China’s middle class. In it I propose a number of actions that business and government could take to address these pressures.

Actions required now to move towards a highly-skilled, well-employed middle class

China’s government understands the need to adapt education and training to the needs of the modern economy. The National Plan for Medium and Long Term Education Reform and Development highlighted the need to expand vocational education and provides a foundation for change. Beyond this, the government needs to help graduates adjust their expectations regarding the kinds of jobs they should aspire to, and accelerate changes in the academic system to develop the skills they need to find those jobs. In parallel, large employers must play their part by investing in helping students to develop “future ready” skills. An effective combination of government and employer actions can help move China towards a German-style model of low graduate unemployment and a middle class that fulfills its potential to become the engine of China’s economy.

Government actions

Government plays a central role. A few critical actions are detailed below.

Embrace the inevitable. Technology that can be deployed will be deployed. Sufficient sectors in China operate on the basis of vigorous competition between companies for this to be inevitable. Whether it is a private sector domestic company, a multinational corporation, or a state-owned enterprise, they all have a growth objective, a market share objective, and in most cases, a profitability objective as a listed company. If technology can give them a competitive edge through greater efficiency, lower costs, or better customer service, they will look for best practices globally, adapt it for China, and invest behind it. Government’s role should be to support the transition with at-scale retraining and redeployment programs for workers who are affected, rather than subsidizing companies to retain workers they no longer need.

Boost SMEs. Globally, the OECD reports that 60-70% of all new jobs are created by small and mid-sized enterprises (SMEs). The European Union believes that within the EU, this proportion is as high as 85%. Much of China’s future job creation must likewise come from SMEs. The government must accelerate its actions to eliminate barriers to developing SMEs. The World Bank’s 2014 report ranks China 158 out of 189 on ease of starting a business – an issue that has the biggest impact on small-scale entrepreneurs. A second big challenge for SMEs is access to capital. As China’s banks become more market-driven, they will seek out opportunities to lend more to SMEs, but they will need to develop new risk assessment skills. Government should focus banks on this priority. In the meantime, online commerce marketplaces such as Alibaba are able to fill part of the current gap with working capital loans, but banks must step up.

Develop new skills for new roles. Research by The McKinsey Global Institute in 2013 using China National Bureau of Statistics data forecasts that the three largest sectors for graduate job growth in the decade ahead will be health and social services, high-end manufacturing (as graduates are required to operate the more sophisticated equipment in factories) and education, not financial services. Students entering university need to be steered towards these opportunities with courses designed specifically with these roles in mind.

Change mindsets. A 2011 Tsinghua university survey showed that two-thirds of graduates sought to join state-owned enterprises as their first choice. Only 11% wished to join small enterprises. More of China’s top talent needs to become excited by the opportunity to be a successful entrepreneur. In the future, state-owned enterprises will provide few new jobs for life. The government needs to celebrate successful small-scale entrepreneurs that can serve as a role model to others.

What companies need to do

Companies have a responsibility to engage with government to ensure students are prepared for the middle class jobs that the future economy will provide. For example:

Engage next generation employees early. When new skills are needed, industry should connect with the next generation while they are still in high school. Industry-led programs can expose youths to particular professions during secondary school. For example, South Africa’s Go for Gold is an industry-wide effort led by 20 engineering and construction companies that seeks to attract young people into the field. The program identifies students while they are still in high school and provides tutoring in math, science, and life skills. The UK’s Higher Apprenticeship program allows talented students to join the work force directly from high school and earn a degree equivalent qualification while working with a company. In 2013, 13,000 students joined this program, a 100% increase on the year before.

Create your own talent pipeline. Since 1978, the China National Petroleum Company (CNPC) has run the China Petroleum Pipeline College, a vocational school to train CNPC employees, as well to provide one-off courses for other companies. The school has an enrollment of about 5,000 students who do everything from university-level courses to general vocational education, all related to pipeline construction and service. China South Locomotive and Rolling Stock Corporation established a post-secondary vocational school in 2012 to train its own employees and those of its clients. It aims to enroll 1,000 students a year. Short skill-based programs, on the order of 8 to 12 weeks, that focus on the small set of particular skills that matter the most for the profession in question, can be very effective to establish and refresh skills. Wipro, the Indian information-technology powerhouse, fills 15,000 engineering positions per year. The 30 percent of its recruits that do not have engineering degrees go through a 12-week intensive training program to get them to a productivity level that is close to that of those who do.

Share the investment: Small- and medium-size enterprises often struggle to develop effective training, a deficiency that has consequences for their competitiveness. One trend is for large companies to give SMEs access to their training programs. For example, SK Telecom, a leading telecom player in South Korea, has allowed 300 of its suppliers to participate in more than 100 technical and soft-skills training programs. By helping to improve the skills of its suppliers, SK Telecom gets better goods and services down the line. In China, privately-held China Vocational Training Holdings provides training to 100,000 students a year through partnerships with almost 2,000 companies in the automotive sector.

* * * * *

A large, successful and confident upper middle class is fundamental to China’s future economic success. While current economic momentum is strongly moving China in this direction, technological disruptions could shift the country quickly towards a different outcome. Government and business must work together to understand the impact of technology on China’s economic growth, the types of jobs it will (and will not) need as a result, and the graduate and vocational training the students of tomorrow will need for a prosperous future.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Photo: ryanking999 / 123RF Stock Photo

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Preparing For China’s Middle Class Challenge (Part 2) http://www.mckinseychina.com/preparing-for-chinas-middle-class-challenge-part-2/ http://www.mckinseychina.com/preparing-for-chinas-middle-class-challenge-part-2/#comments Tue, 01 Apr 2014 11:55:42 +0000 http://www.mckinseychina.com/?p=7570 This is the second of three chapters from my China Development Forum paper on the future of China’s middle class. In it I lay out the trends reducing opportunities for China’s new graduates and the implications this has.

The rise of “Generation 2” consumers

A new generation of middle class consumers born after the mid-1980s is emerging. While their parents lived through many years of a shortage economy,and are primarily concerned about building economic security for their families, members of “Generation 2”, (G2) were born and raised in relative material abundance. With a stronger sense ofsecurity, the emerging G2 consumers are more interestedin “living it”. Most of them are also the only child in their family due to the strict enforcement of the one-child policy. They have high expectations for job satisfaction and income growth.

McKinsey research has found that G2 consumers are more confident than their parents, and are more willing to pay a premium; indeed, they regard expensive products as better products. They are eager to try new products and experience new technologies. Compared with their parents,they are more loyal to the brands they trust, and prefer niche brands. Importantly, they seek more sources of information prior to making a purchase than the previous generation, and they rely heavily on the internet for product information.This generation is becoming a crucial consumer group for the Chinese economy. In 2020, 35% of total consumption in China is expected to come from these G2 consumers, who will be major purchasers of personal care, leisure, and travel services.

Too many graduates chasing too few jobs

If they hope to make their entry into the middle class, today’s graduates will need to find well-paying jobs. For a growing number, however, this goal is becoming increasingly elusive. There are signs that this problem is rapidly becoming a serious one. According to the Chinese Academy of Social Sciences, 17.6% of newly minted graduates were reported to be unemployed in September 2013. In the segment of graduates aged 20 to 29 in 2013, 12.5% were unemployed[2]. Universities themselves report that only 50% of their students are finding a job before graduation, and a survey conducted by the Chinese Academy of Sciences/Mycos shows that nearly half of all graduates feel they are underemployed versus their potential and expectations.

Our analysis of National Bureau of Labor statistics suggests that this mismatch has led to real wages for graduates rising only 3% annually over the last decade, versus 11% annually for vocationally qualified workers (Exhibit 4). Jobs that facilitate entry into the middle class exist, but enough jobs to take the next step up the ladder into the upper middle class may not. The labor market is hardly clearing today. With China likely to have over 115 million graduates by 2020, this issue alone could materially depress wages and weaken the collective spending power of the emerging middle class.

 

Exhibit 4

Exhibit 4

 

 

There is a crisis of graduate unemployment and under-employment in many countries, dragging down middle class income and confidence in the future. Some of this was triggered by the global financial crisis of 2008, but not all. The overarching secular trend in developed economies is for technology to eliminate the well-paying middle class jobs that graduates aspired to, and which paid for the lifestyles that are just emerging in China.

Look at Europe, where graduate unemployment in the 15-24 age band is over 17%, ranging from 50% in Greece to 4% in Germany (Exhibit 5). In the UK in 2012, the Higher Education Statistics Agency records that not only were 10% of graduates unemployed after 6 months, but 50% were working in jobs that did not require a degree, and 5% were working in jobs that did not require a high school diploma. And yet many employers still report they cannot hire people with the skills fit for the jobs available.

Exhibit 5

Exhibit 5

 

The impact of technology must be built into projections of employment and wages in all countries. China is no exception. The China of tomorrow will deploy technology aggressively to substitute for labor, and will require a new range of skills from successful graduates if they are to obtain rewarding jobs. In manufacturing, capital intensity has risen for a decade. Domestic output of computer numerically controlled (CNC) machine tools rose 15x between 2000 and 2012, and the market for industrial robots rose by 55x over the same period.

The impact of technology is now starting to be felt in services. How many millions of existing jobs might disappear as sales of insurance and banking services move online (a single large insurance company may have more than half a million sales agents today), and as retail moves even further online in the next 5 years? Based on international comparisons, 30-50% of insurance sales could shift from agents to online. Today, more than 5% of all retail sales are conducted online, and clothing and consumer electronics chains are closing stores. How many additional retail positions will be lost if 15% of retail moves online? Already 25% of airline and 6% of train tickets are sold online. Based on international benchmarks, this could rise to 50%, eliminating the need for agents and travel advisors.

Even these international benchmarks may be too low for China, where the adoption of online commerce is faster than in almost any other major international economy. China’s share of online retail sales is already higher than the United States (Exhibit 6). Many of these “disappearing” jobs pay above the urban average (e.g. financial services pay 2.2x the city average in Shanghai[3]). So not only are major sources of middle class jobs likely to disappear, but sources of well-paying jobs as well.

Exhibit 6

Slide6

 

Notes:

2. China Employment Statistics

3. Shanghai government statistics, CEIC

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

Photo: Cathy Yeulet / 123RF Stock Photo

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Preparing For China’s Middle Class Challenge (Part 1) http://www.mckinseychina.com/preparing-for-chinas-middle-class-challenge-part-1/ http://www.mckinseychina.com/preparing-for-chinas-middle-class-challenge-part-1/#comments Mon, 31 Mar 2014 13:23:55 +0000 http://www.mckinseychina.com/?p=7546 In recent months, I have become increasingly concerned about the next stage of development for China’s middle class. We have witnessed the tremendous transformation as hundreds of millions have moved into the middle class over the last 25 years, and in many families, now we have a younger generation born into the middle class with high expectations for further growth in their standard of living.

We have seen the projections of what this would look like, and the analysis of why it is important for China’s rebalancing to a consumption-driven, from an investment-driven economy. And while this can happen, my discussions with students at universities made me wonder if it automatically will, or whether we need a change of direction.

Students seem quite pessimistic about their future: wages upon graduation have not risen in real terms in 6 years, and many of the 7 million new graduates each year have a hard time finding a job. While graduates are only a small segment of China’s middle class, they are an important one, one that perhaps over time sets the trend for the rest of the middle class. I have concluded that this is indeed an issue, and that government and business action is required to address it.

So in the following three posts taken from a paper I prepared for the China Development Forum (an annual government-hosted forum to discuss ideas and potential policy solutions to China’s biggest economic issues) this month, I have set out to do the following:

  1. Describe the importance and impact of China having a successful and prosperous-feeling middle class.
  2. Lay out the trends reducing opportunities for China’s new graduates and the implications this has.
  3. Propose a number of actions that business and government could take to address these pressures.

 

Preparing For China’s Middle Class Challenge (Part 1)

The explosive growth of China’s middle class has brought sweeping economic change and social transformation to China. In this essay, we explore how the middle class could become economic drivers of China’s continued growth, but also caution that this may not happen without significant intervention to reshape how China’s youth are prepared to meet the needs of future, not past, middle class jobs.

The potential of the Chinese middle class

As recently as 2000, only 4% of urban households in China was middle class [1]; by 2012, that share had soared to 68%. Today, urbanites account for 52% of the entire Chinese population; by 2022, their share is likely to rise to 63%, with 170 million new urban residents. By then, China’s middle class could number 630 million – that is, 76% of urban Chinese households and 45% of the entire population.China is fast becoming a middle class nation. Central to this huge surge in middle class consumers has been the country’s urbanization, and with it, the creation of higher paying jobs.

The expanding urban middle class is increasingly made up of skilled white-collar workers who deliver higher productivity and earn higher wages. Their productivity is enabled both by ‘hard’ benefits in the form of infrastructure development, and ‘soft’ benefits through improved provision of, for instance, education and healthcare. The enormous growth in China’s urban infrastructure is well-known. Perhaps less appreciated, however, is the investment the government is putting into the soft enablers that unleash the economic potential of the middle class. Take insurance, for example: as recently as 2005, fewer than 150 million people had basic medical insurance in China; today, this figure has mushroomed to more than 95% of the population. In the case of those urban citizens that have insurance, their out-of-pocket expenditure ratio has fallen from 59% to 35%. This is an example of the Chinese government recognizing that the quality of middle class development is as important as the number of middle class citizens.

The ‘upper middle class’ should become the new mainstream

We divided the Chinese middle class into two segments: the mass middle class – those earning annual household income of RMB60,000 to RMB106,000, equivalent to US$9,000 to US$16,000– comprising 54% of all urban households in 2012. And the upper middle class – with household income of RMB106,000 to RMB229,000,equivalent to US$16,000 to US$34,000 – accounting for 14 % of urban households in that year.

The upper middle class punches above its weight in terms of consumption, accounting for 20% of China’s urban private consumption (Exhibit 1). This structure should look very different by 2022, when the upper middle class could comprise 54% of total urban households and 56% of urban private consumption by 2022,compared with around 13% in the case of the mass middle class. But this will only happen if household incomes continue to grow across the middle class.

Exhibit 1

Slide1

A successful shift towards the upper middle class will lead to a more mature and attractive market for businesses. Relative to the mass middle class, upper-middle class consumers are already more willing to pay a premium for quality products, have a higher level of trust in well-known brands, and spend more of their income on discretionary products and services (Exhibit 2). They are also much more international in their outlook, open to – and even eager for – international brands.

 

Exhibit 2

Slide2

China’s upper middle class consumers are becoming more mature. They decreasingly perceive shopping as a desirable family activity, spending significantly more time on leisure activities and travel than they did a decade ago. As a reflection of this trend, China’s hotel room capacity quadrupled between 2000 and 2012, and since 2010, the annual growth rate of cinema ticket receipts has exceeded 30%, with more than 1,000 new cinemas opening in 2013 alone.

Powered by higher incomes, upper middle class shoppers buy a wider range of products and at higher price points than their compatriotsin the mass middle segment. Nearly 60% of upper middle class consumers have bought digital cameras, compared with just 40% of mass middle class consumers. In the case of laptops, 51% of upper middle class consumers bought this item, compared with only 32% of the mass middle class. A similar pattern is evident in purchases of laundry softeners, where 56% of the upper middle class bought this product compared with 36% of the mass middle class (Exhibit 2).

Stark disparities exist between the two segments with regard to what products they consider attractive.Basic functional benefits appeal to mass middle class consumers, two-thirds of whom mention ‘durability’as one of their top five buying factors for a washing machine, compared with less than half of upper middle class consumers citing this factor. In the case of smartphones, 62% of mass middle class consumers cited durability in their top five considerations,compared with only 36% of upper middle class consumers.

Emotional and social benefits are increasingly important to upper middle class consumers, who are more than 50% more likely than mass consumers to cite considerations such as‘showing my taste’ and ‘makes me feel that my family is living a better life’, when purchasing products such as shampoo or mobile phones.

China’s expanding upper middle class is much more outward-looking than the broad swath of Chinese citizens—a dramatic break from the past that has broad implications for their consumption behavior. This group is much more willing to buy foreign brands. Foreign-branded food and beverages are favored by 34% of upper-middle class urbanites compared with 24% of all city dwellers. The upper middle class is also much more likely to travel abroad—in 2012, 10%of the urban middle class travelled overseas,compared with 3% of all urban Chinese.

This international outlook reflects a number of factors. Upper middle class citizens are better educated and more likely to speak a foreign language – 34% of the upper middle class holds a bachelor’s degree or above, and 26% can speak and understand English. They have, as a result, been the beneficiaries of the newly created, higher paying jobs in financial services, professional services, and the travel industry.

Widespread adoption of the internet is another important ingredient in this internationalism; the upper middle class are more likely to buy online and spend a higher proportion of their income online. The Chinese market will continue to retain its own unique characteristics, but if the upper middle class becomes the new mainstream, we should expect it to bear an increasing resemblance to mature international markets.

The geographic center of middle class growth is shifting

Businesses looking to serve these consumers will need a granular understanding of where the greatest growth in middle class numbers will. While China’s middle class expansion is largely happening in cities and will continue there, it will become much more evenly spread geographically.

In 2002, 40% of China’s urban middle class livedin the tier 1 megacities of Beijing, Shanghai,Guangzhou and Shenzhen. However, this share is expected to decline to 16% in 2022, while the share will rise in tier 2 and tier 3 cities. Tier 3 cities hosted only 15% of China’s middle class households in 2002; by 2022, that share should reach 31% (Exhibit 3). This shift in the weight of the middle class households from megacities to medium-sized cities means that there is also a movement from the huge urban centers of the coast to urban areas inland. In 2002, only 13% of the urban middle class lived in inland provinces, but that number is expected to rise to 39% in 2022.

Exhibit 3

Slide3

Examples of two small cities illustrate this shift. Jiaohe in Jilin province is a northern inland tier 4 city, which is growing quickly due to its position as a transportation center. It has abundant natural resources such as Chinese forest herbs and edible fungi, and is China’s most important production base for grape and rice wine. In 2000, fewer than 900 households out of 70,000 were middle class; by 2022, the city is expected to grow to 160,000 households, and about 90,000, or nearly 60%, are predicted to be middle class.

Another city, Wuwei in Gansu province, is an inland tier 4 city with the advantages of being within the Jinchang-Wuwei regional development zone. It possesses rich sources of minerals, with its nearby ilmenite (the most important ore in the manufacture of titanium) reserves ranking among the largest in the nation. Wuwei is also conveniently located at the junction of major railways and several highways. In 2000, less than 900 of 87,000 households were middle class. By 2022, the city is expected to grow to 650,000 households, of which around 390,000, or 60%, will be middle class.

Geographic remoteness matters less and less in shaping consumer needs and purchases. When China inaugurated its high-speed rail lines seven years ago, many observers declared them an infrastructure boondoggle that would never be used at capacity. How wrong they were: daily ridership soared from 250,000 in 2007 to 1.3 million last year. Demand was simply underestimated. Now that trains run as often as every 15 minutes on the Shanghai–Nanjing line, business and retail clusters are emerging, and middle class consumers are making weekly day-trips to work and shop, rather than monthly overnight visits. There are already more than 9,000 kilometers of operational lines—and that figure is set to double within the next few years.

Another factor making geographic location less relevant is the fact that internet retail is “born national”. All products available in Shanghai can also be delivered in Wuwei. Physical retailers have a tough time competing and may now choose to never establish anything beyond a few flagship locations in third tier cities. In some segments like B2C apparel, where online sales almost doubled in 2013 over 2012, internet retail is rapidly becoming the mainstream channel.

In tier-3 cities, online contributed to 14% of luxury goods sales in 2012, compared to almost nothing in 2010. Chinese consumers already spend 55% of their media time online, compared to 38% for their U.S. counterparts. This is driving new behaviors which will shape the Chinese middle class of the 2020s, such as shopping through social media platforms like WeChat, or visiting malls primarily as a leisure and entertainment activity, instead of for purely shopping.

Notes:

1. We have defined ‘middle class’ as those with annual household disposable income of between RMB60,000 and RMB229,000, a range that – in purchasing power parity terms – is between the average income of Brazil and Italy. These consumers would spend less than 50% on necessities and demonstrate distinctive consumption behavior compared with other classes of consumers.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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China’s Civil Society Falls Short http://www.mckinseychina.com/chinas-civil-society-falls-short/ http://www.mckinseychina.com/chinas-civil-society-falls-short/#comments Sat, 29 Mar 2014 13:17:27 +0000 http://www.mckinseychina.com/?p=7543 You occasionally hear stories about foreigners being exploited at the scene of an accident in China, being required to make payments to a counterparty, even if they themselves were clearly the victim of the accident. A friend’s recent experience brought this home.

She was riding a bicycle along the quiet streets by the consulates in Shanghai. She stopped at a traffic light and a motor cycle ran into the back of her bike while she was stationary. The motorcycle spilled its groceries onto the street, but otherwise no harm done. Indeed, my friend could simply have ridden off.

Instead, she helped to pick up the groceries. My friend was wearing a helmet and sunglasses and spoke to the lady riding the motorcycle in Chinese. All was calm until my friend removed her sunglasses, at which point it was clear to the motorcycle rider that she was not Chinese. The motorcycle rider started screaming and shouting that her neck hurt and her arm hurt. People gathered around, including a few policemen who wanted nothing other than silence to return to the neighborhood.

The motorcycle rider became so excited that she started pointing with her supposedly damaged arm at the policeman, an action which caused some Chinese in the crowd to remark loudly that there was nothing wrong with her arm. Eventually, a second policeman suggested to my friend that she just ride off, there was nothing to do. She declined to do so out of concern that the motorcycle lady would continue to follow her home and harass her again. After a long time, the police persuaded the motorcyclist to leave, and calm returned to the neighborhood. My friend will not be stopping to help out again anytime soon.

The broader points that are often discussed after this kind of incident are the ones about the nature of civil society in China today. Of how the scale and pace of societal dislocation with urbanization, and the shift of hundreds of millions from poverty to the middle class, leads to a lack of roots, and a deep insecurity about the potential for falling back, falling behind others.

Of how this is exacerbated by the government’s three-decade promotion of the overarching goal to make China wealthy and its citizens wealthy along the way. Of how, for many, self-interest becomes a paramount driving force, whether demonstrated in these types of incidents, in the acceptance of plagiarism in exams, of faking qualifications to get jobs, or a lack of belief in due process.

Only nationalism seems to come close as a competing force in shaping individuals’ mindsets. This deserves a longer piece that I will come back to later.

 

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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What’s Slowing China’s Growth? http://www.mckinseychina.com/whats-slowing-chinas-growth/ http://www.mckinseychina.com/whats-slowing-chinas-growth/#comments Fri, 28 Mar 2014 13:10:44 +0000 http://www.mckinseychina.com/?p=7539 China’s macroeconomic statistics have not been strong so far in 2014. Some analysts are questioning whether the government can achieve its growth target of 7.5% without a stimulus. Exports are not as robust as hoped. Consumer spending, while still growing in double digits, is less than in 2013. And investment is also somewhat weaker.

We could dive into the details of what underlies all of this, but that is for another post. Today, I wanted to focus on a factor that I believe is starting to having a material impact on growth, but which is not much talked about, and it is behavioral.

The anti-corruption campaign launched last year has undoubtedly had impact in the way that was intended. We all hear about the decline in performance of luxury restaurants, luxury alcohol companies, and of companies reliant for sales on gifting. But there were bound to be second order consequences, and I believe we are seeing one now in a reluctance to approve new projects.

Both government officials and leaders of state-owned enterprises are simply avoiding making decisions to start projects, or delaying them by requiring extra hoops of approval from as many people as possible. “No one will ever be accused of corruption for not approving something” seems to be the logic. Better to do nothing than to run the risk of approving a project and having people point fingers at you later. Some officials seem simply scared to make a “go” decision right now.

A second shift is occurring in the mindset of successful Chinese entrepreneurs. While there have always been some who, on the back of their initial success, switched swiftly from wealth creation to preservation, the proportion seems to have grown significantly in the last 12 months. Investment outside China is just one symptom of this, particularly when the investment is into projects that are clearly going to earn a lower return than is still available in China.

It will take more than verbal encouragement from government leaders to turnaround these two factors.

You can read more of my views on China on my LinkedIn Influencer blog. And please follow me on Twitter @gordonorr

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Why Chinese State-Owned Banks Are Now In the Eye Of The Storm http://www.mckinseychina.com/chinese-state-owned-banks-are-now-in-the-eye-of-the-storm/ http://www.mckinseychina.com/chinese-state-owned-banks-are-now-in-the-eye-of-the-storm/#comments Fri, 28 Mar 2014 02:59:34 +0000 http://www.mckinseychina.com/?p=7493 This week, China’s big four state-owned banks are set to announce their 2013 financial results. And the numbers, if predictions are accurate, should show a significant slowing in earnings growth across the board. Likely 11% year over year growth for a combined net income of approximately $130 billion. So solid growth in a very big number, but also their lowest growth rate since the 2008 financial crisis.

This big drop-off is a good symbol of the myriad forces that are currently buffeting Chinese state-owned banks. Chinese banks, more than at any time in the past twenty years, are in the eye of a very big storm.

A quick look at the forces they are dealing with right now is daunting:

  • The People’s Bank of China is pulling back from the credit-led investment surge of the last several years. Interbank rates are being raised and the country is weaning itself off the debt-fueled GDP growth that saw itself through the financial crisis. This pull-back directly impacts the state-owned banks, which have been the primary mechanism of this lending. Loan growth shrunk to 14% in 2013, the lowest level seen since 2005.
  • Additionally, the interest rate caps which have created impressive profitability on bank deposits are now being loosened. This, combined with the lending pull-back, is a fairly fundamental change to the profit engine that has fueled state-owned banks for the past decade.
  • Meanwhile, shadow banking continues to grow, offering higher investment returns and creating increasing competition for deposits. State-owned banks have seen their share of Chinese household savings drop from 55% to 50% in the past year.
  • The recent free-for-all in credit going out the door is also starting to come home to roost as NPL rates start to rise, especially on single project local government financing vehicles.
  • Another type of competitor is also taking the field. The Chinese Banking Regulatory Commission (CBRC) has recently given approval for five private banks to be set up. These trial banks are being created with the announced goal of increasing competition in the sector (i.e., for the state-owned banks)..
  • Finally, we have government policy reforms that accept a slower growth rate and focus on shifting away from an export and investment-led model. This shift away from “growth at all costs” will slow bank growth and lending.

So state-owned banks are dealing with a change in their traditional profit engine, a decrease in lending, increased risk, increasing competition on two fronts, and a slowing overall GDP. Suddenly, an 11% increase in earnings last year seems pretty impressive.

And finally, there is the wild card of the Internet giants moving into online banking. These companies are proving to the great disruptors in industry after industry in China. Their sudden launch of online products in 2013 was a surprise and their aggressive adoption by Chinese consumers has knocked the state-owned banks back on their heels. They quickly followed this with the introduction of credit cards, which was quickly halted. The Internet companies are the wild card in the banking sector and should likely provide some surprises for the banks in 2014.

Does this spell disaster? No – with over 100 trillion renminbi in deposits, the Chinese banking system faces no funding stress. And earnings remain collectively over US$100 billion per year, which is healthy and well ahead of the US$80 billion generated by the four leading international banks. But they are definitely in the eye of a very big and interesting storm.

This article first appeared on the author’s new One Hour China blog on SCMP.com. Jeffrey Towson is Managing Partner of Towson Capital, an investment advisory firm specializing in US-emerging market healthcare. Jonathan Woetzel is a Director in McKinsey & Company’s Shanghai office, and the Director of the McKinsey Global Institute in Asia. They are Professors at Peking University’s Guanghua School of Management, and are the authors of the best-selling One Hour China Book, now available on Amazon.

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Is China’s healthcare industry on the road to recovery? http://www.mckinseychina.com/is-chinas-healthcare-industry-on-the-road-to-recovery/ http://www.mckinseychina.com/is-chinas-healthcare-industry-on-the-road-to-recovery/#comments Wed, 26 Mar 2014 15:14:02 +0000 http://www.mckinseychina.com/?p=7516 I attended a session recently where my colleagues who focus on China’s healthcare sector hosted around 40 private equity investors for a discussion on investment opportunities. Despite its recent rapid growth, China’s spending on healthcare is still only 5% of GDP compared with 7.2% in Korea and 9.3% in Japan (and of course, way less than the 17.9% in the US).

Perhaps an even bigger difference is that in China, services account for only 30% of spending versus over 70% in Japan and the US. China has to converge towards other countries’ share of spending on services over time, and that is where many opportunities will lie. The government still pays for around 55% of all healthcare expenditures, private insurance only 3%, and out-of-pocket spending by individuals covers most of the rest.

In some ways, China’s healthcare spending has been remarkably effective. The profile of diseases that its citizens suffer from is not that of a developing country – it is very similar to that of a wealthy country, as exhibit 1 shows.

exhibit 1

Private equity and venture capital firms have been very active in the sector already. We tracked over 180 investments made in 2013, totaling over US$5 billion and $1.8 billion of exits made. Investments are getting larger, with over 8% exceeding US$100 million, and across multiple sub-sectors. More than 50 investments were in pharmaceutical firms, nearly 40 into biotech, 60 into services and 30 into devices. Chinese firms themselves have become active acquirers internationally, led by companies like Fosun, Mindray and Microport.

exhibit 2

Pharmaceuticals

Growth in the pharmaceuticals sector is driven by several factors including continued macro-economic growth, demographic trends that are expanding unmet needs, and increased patient accessibility as a result of improved affordability and infrastructure. For example, the government is expanding major disease coverage through a series of regional pilots – in Qingdao, 8 “expensive therapy” drugs are on the approved list. They are including more diseases in the nationwide reimbursement schemes – chronic therapies for diabetes, hypertension and oncology are getting on the lists. In parallel, government investment in upgrading facilities is improving rural access to healthcare.

Yet the government clearly has limits on its willingness to spend on drugs. The National Development Reform Commission (NDRC) continues to announce aggressive annual price cuts across all therapeutic areas. This comes with an increased focus on off-patent drug providers. Indian market leaders in this space have taken notice, and are seeking to build their presence in China for the first time.

Local Chinese pharmaceutical companies are bringing new molecules to market and forming a range of R&D joint ventures with multinationals, proving their potential to be credible innovators. For example, Simcere has developed Iguaratimod Tablets for rheumatoid arthritis and Betapharm has an anti-cancer drug, Conamana. In R&D, BMS is partnering with Simcere, Merck with Beigene, Amgen with Betapharm. Such partnerships are becoming common and often extend beyond R&D.

Slide3

So where might investment opportunities be found in Chinese pharmaceuticals? A few ideas came up:

  • Local pharma companies with a strong portfolio in specialty therapeutic areas (e.g. oncology) or lower-priced alternatives to existing multinational products.
  • Local pharma companies starting to develop first-to-market generics and high quality generics for export.
  • Local leaders in developing innovative molecules and in biosimilars.
  • Local leaders in OTC, as the market doubles to US$60 billion to 2020.

 

Services

As in so many areas, the scale of China’s medical services industry is vast, with over 21,000 hospitals and another 20,000 health centers. The scale of private participation in the services sector is already very significant and expanding fast. Private providers own and operate around 23% of all hospitals, with the number of private hospitals growing 18% annually in recent years versus an annual decline of 2% in the number of public hospitals.

As private medical insurance expands among China’s middle class, demand for private hospital services will like rise even further. The government is targeting for 20% of all patient flow to be into private hospitals by 2015, and has supported this with changes in regulation to allow 100% foreign-owned hospitals and favorable tax treatment.

Middle class expansion is not just stimulating investment in private hospitals but also in dental services, cosmetic specialties, rehabilitation services and elderly care. Spending that would previously have been seen as a luxury item is becoming a standard cost of living for the middle class.

The constraint on even faster growth in private hospitals is not demand or capital, which is also abundant, but availability of doctors. A free market for medical talent in China does not exist yet. Prior to 2009, doctors would lose their professional title and ranking if they worked at a private hospital. Even today, when regulations have changed to allow doctors to be employed in more than hospital, many are reluctant to make the shift. A tipping point will come as doctors become more comfortable that the private sector is here to stay, and are swayed by the financial (and possibly even safety) benefits of working in a private hospital.

Private equity capital is already widely deployed into many specialist private hospitals in China, with over 30 investments in the last 4 years mainly focused in tier 1 cities, where the depth of ability to pay for private services is highest. Looking forward, we see the likelihood of more investment from international hospital operators:

  • Some will likely go 100% owned, building a new greenfield hospital under their own brand.
  • Others will joint venture with an established Chinese hospital to operate a branch hospital that may focus in a particular specialty, leveraging the Chinese hospital’s patient flow and the international operators IP in process and technology.
  • Others may simply buy existing hospitals and upgrade them. It is certain that many cash-strapped local governments would be interested in this.
  • A final option would be to separate asset ownership from management and simply take on a contract to run a hospital.

We will likely see all four of these models put to use.

Devices

The devices market will reach US$30 billion this year and should continue to grow robustly at 15-20% annually, in coming years. One of the most important trends in the sector is the rising share of Chinese manufacturers and how their products are increasingly bought internationally, not just in China. For example, in coronary stents, Chinese manufacturers have a 75% share of industry revenues; in molecular diagnosis 70%; in trauma 70%; and in hematology analysis 50%.

Exhibit 4

Most of the Chinese companies in this sector are still of modest scale with revenues of between U$200 and $600 million. There have been more than a dozen investments providing growth capital to these firms in the last couple of years, with a disproportionate share coming from domestic funds. Perhaps international funds have been slightly more risk averse, holding back until the companies develop to a scale that they can be confident that quality and safety standards are what they need to be.

Areas that we can see additional investment going into include:

  • Local leaders in sectors (e.g. pacemakers) that still have relatively low penetration from local Chinese companies.
  • Local leaders that are ready to expand into adjacent medical device sectors. However, in some cases this may lead to over competition and lower industry margins.
  • Local leaders following in Microport’s wake and expanding internationally.
  • Local leaders who are truly innovating in their global field (e.g. personal gene testing).

* * *

Net net, it was an upbeat session on the sector overall, featuring numerous opportunities to invest. Something of a contrast to many recent conversations on the overall state of the Chinese economy, highlighting once again that the Chinese economy is too large and too diverse to simply look at macro top-down statistics in determining how a particular industry is performing.

You can read more of my views on China on LinkedIn. And please follow me on Twitter @gordonorr

Photo: 123RF Stock Photo

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When an international school in Shanghai goes belly up http://www.mckinseychina.com/when-an-international-school-in-shanghai-goes-belly-up/ http://www.mckinseychina.com/when-an-international-school-in-shanghai-goes-belly-up/#comments Tue, 25 Mar 2014 15:07:15 +0000 http://www.mckinseychina.com/?p=7513 There are some sectors in China where you tend to think that a license to operate is truly a license to print money. One niche example is international schools in China, particularly international schools that follow the U.K. or U.S. curriculum, which attract not only families of these nationalities, but of many others also.

The market is very price insensitive – you can even get parents to pay several years fees in advance. You may get a sweetheart deal from the local government for the land, as they want to attract many international schools. And the supply of teachers is very high – the opportunity to live and work in a new geography for several years attracts very high performing teachers.

But events at Rego International School in Shanghai over the last few years prove that even with all these advantages, owners can drive a school to closure, and local government education officials have limited ability to remediate issues. (Disclosure: My son attended this school until 18 months ago, leaving in part because of some of the events I describe). A school that used to have hundreds of students now has only a dozen; teachers have been unpaid for months (as was the case last year also); their utility and rental bills have also gone unpaid. The school caterers, electricity providers, and even bus drivers have not been paid, and have cut off the school.

This is the culmination of events that have built up over several years. City Weekend ran a piece in 2012 on how teachers at the school were unable to get work visas and were even back that not being regularly paid.

The operating costs of a well-attended international school are well below the fees that would be paid. Fees paid in advance provide a capital base from which interest can fund capital. In China, however, there is no requirement to ring fence such payments to ensure they are used towards the school’s budget. Noone is sharing today where the cash flow went and what the balance of the schools budget was over time, and I don’t expect that they ever will.

Very distressing for students, teachers and parents. Seemingly less distressing for the owners, who appear to have successful businesses running in parallel to this singular failure.

You can read more of my views on China on LinkedIn. And please follow me on Twitter @gordonorr

Photo: 123RF Stock Photo

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China says “no” to virtual credit cards http://www.mckinseychina.com/china-says-no-to-virtual-credit-cards/ http://www.mckinseychina.com/china-says-no-to-virtual-credit-cards/#comments Sat, 22 Mar 2014 14:46:42 +0000 http://www.mckinseychina.com/?p=7487 The end of last week saw the Chinese central bank intervene to shut-down an innovative online service of virtual credit cards, launched by Tencent and Alibaba, in conjunction with Citic Bank. This move came the day after the services were launched, which seemed a little odd – why did they allow something to go to market rather than intervene to halt the services before they could be launched?

The answer lies in a combination of the absence of regulation or policy in some parts of the banking sector, and the willingness of the large Internet players to take the absence of prohibition to mean permission, so that they have largely been pushing into financial services with a logic of “if enough scale with enough satisfied customers can be reached quickly”, then it’s too late for the regulator to shut them down. These virtual credit cards, which would have bypassed the state-owned quasi monopoly, China UnionPay, was another move in this direction.

Unlike with online wealth management products, the government intervened fast when it learned of the launch of the credit cards. Now, perhaps, the regulators can say they have caught on to the tip of the tail of the dragon that is innovation in Chinese financial services today, and going forward, it will be seeking to impose more classic banking-style regulation on the new, online private Chinese banks.

Yet sustaining a balance that works for all will be incredibly hard – investors clearly love the online options – more than 80 million have signed up in less than a year, and according to reports, 3% of Chinese deposits have shifted to their products in one month in 2014. Incumbent state-owned banks have deeply rigid fixed cost structures, meaning that even if they do offer identical online services, they will be at higher cost. Being a financial services industry regulator in China today may be one of the hardest jobs around.

With all the turbulence in China’s banking sector, I took a look at the share price trend of the big 4 banks. Bank of China (BOC) and Industrial and Commercial Bank of China (ICBC) were listed back in 2006; China Construction Bank (CCB) in 2007; and Agricultural Bank of China (ABC) in 2010. Today, only ICBC’s share price is above its listing price – and that by a slight 2%. BOC is down by 27%, CCB by 54% and ABC by 15%.

Much of the decline has come in the last few years on the back of investors’ concerns over how these mammoth state-owned institutions could reinvent themselves as their industry changed. Firstly, they had to face up to the reduction in spread between lending and deposit-taking as rate setting has gradually shifted to the market. Secondly, the market sees the banks as the deep pockets likely to be called on if more trust products get into trouble.

And thirdly, the impact of Alibaba and Tencent, with their ability to attract billions of dollars of deposits and tens of millions of clients in only a few months, and to innovate seemingly at will, leaves investors looking at the big 4 as legacy banks with legacy fixed assets and people that make it very hard to reinvent themselves into the kind of financial institutions that Chinese consumers clearly want to deal with today.

You can read more of my views on China on LinkedIn. And please follow me on Twitter @gordonorr

Photo: 123RF Stock Photo

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10 questions university grads should ask about getting a job in the digital economy http://www.mckinseychina.com/10-questions-university-grads-should-ask-about-getting-a-job-in-the-digital-economy/ http://www.mckinseychina.com/10-questions-university-grads-should-ask-about-getting-a-job-in-the-digital-economy/#comments Thu, 20 Mar 2014 14:28:17 +0000 http://www.mckinseychina.com/?p=7478 I gave a speech to several hundred students at Fudan University in Shanghai this past week. Fudan is considered one of China’s top universities (and incidentally, this week they are hosting Twitter’s CEO, Dick Costolo, on his first trip to China).

The students were kind enough to give up a part of their Friday evening to attend. It was a two-part talk: in the first part I spoke on behalf of the British Council about my experience in the U.K.’s education system, and how my going through it had helped prepare me for a career at McKinsey. Rather different and more personal than my usual speeches.

The second half was more typical of my presentations, but closed with a section that I hope is very relevant for students as they make their first career choices. I spoke first about the digital economy and its impact. I moved on to describe how businesses are embracing technology – to get closer to their customers, to improve their decision-making, to automate existing activities and to innovate their business model. I argued that China is actually a very fertile place in which to innovate aggressively on the back of new technologies, as often regulations that might constrain innovation are simply absent, and private sector entrepreneurs are taking advantage of new opportunities with vigor.

My final section focused on the individual starting a career in an economy that is suddenly much more volatile as a result of the impact of technology. I started by highlighting how the life expectancy of even the largest companies is becoming shorter and shorter, and how specific jobs that we might only 10 years ago have expected to provide a full career no longer will. I laid out a set of digital and broader life skills that I believe are foundational to a successful career starting in 2014 or 2015, and that will almost certainly require more role changes and more skill renewal than any of us have experienced in our own careers.

I then posed a set of 10 questions that I suggest students consider as they select an industry, a company and a role as they launch their careers. I have condensed these questions down onto one graphic, which is below.

10 questions university grads should ask about getting a job in the digital economy

Do these questions feel right to you?

You can read more of my views on China on LinkedIn. And please follow me on Twitter @gordonorr

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Can China turn garbage into gold? http://www.mckinseychina.com/can-china-turn-garbage-into-gold/ http://www.mckinseychina.com/can-china-turn-garbage-into-gold/#comments Wed, 19 Mar 2014 14:22:27 +0000 http://www.mckinseychina.com/?p=7472 Beijing Capital, one of the largest diversified conglomerates owned by the Beijing city government, bought New Zealand’s largest waste management company this month for almost US$1 billion. This follows on Hong Kong-based Cheung Kong buying New Zealand’s second largest waste management company for US$400 million.

For Beijing Capital, which is very domestically focused and has a reputation for being conservative, this is a bold move. Even though Li Keqiang, China’s Premier, announced in his 2014 work plan that his goal for outbound investment by Chinese enterprises was US$99 billion, and large Chinese enterprises would want to be seen to support his goal, this is a big step. Outside of basic materials – oil, gas, mining, chemicals, etc – there have been few examples of state-owned enterprises making an acquisition as large as this.

What could be the drivers behind the acquisition? Certainly, China’s waste management industry standards will continue to rise over time and New Zealand’s policies and practices offer things that Beijing Capital could apply in its domestic waste management operations. But surely these lessons could have been learned without spending US$1 billion? Perhaps they really are seeking to role model the outbound investment the government is seeking and this is the first step in a multi-country expansion?

Or perhaps it is preparation for another of the central government’s flagship policies, the “marketization” of more state-owned enterprises. Our conversations with leaders of state-owned enterprises, especially those owned at the city level, have focused very much on their preparations for this change. They anticipate greater independence of action along with possibly some forced industry consolidation. They also anticipate the state reducing its ownership stake, selling to private Chinese or international investors.

State-owned enterprise leaders are considering how this will change their governance: Will the board composition and operation be changed? Will management’s freedom to appoint, promote and fire executives be changed? They are also considering what they can do to make themselves more attractive to private capital, domestic or foreign.

It is just possible that in this instance, the leadership of Beijing Capital believes that owning a quality foreign asset will make them a more attractive investment for foreign capital. We will see.

You can read more of my views on China on LinkedIn. And please follow me on Twitter @gordonorr

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Shanghai thanks its biggest taxpayers http://www.mckinseychina.com/shanghai-thanks-its-biggest-taxpayers/ http://www.mckinseychina.com/shanghai-thanks-its-biggest-taxpayers/#comments Fri, 14 Mar 2014 08:14:56 +0000 http://www.mckinseychina.com/?p=7446 I spent yesterday afternoon representing McKinsey at a very important annual event. The occasion was the annual celebration by the Huangpu district (think Manhattan of Shanghai) of its top “contributors to economic development”, whom they define as their 100 biggest corporate taxpayers.

About 500 business leaders and 50 government officials gather in a hotel ballroom. There are the obligatory speeches from the officials about the district’s achievements in the past year, its goals for the coming year, and some pot shots at other districts in Shanghai for not being as successful. Then a glitzy video showcasing successful companies in the district – well done in the sense that almost every company present would have said “they highlighted us” even if only for a second.

Then every company has a representative go up on stage to receive a plaque registering their rank as a taxpayer, starting with #100 through to #1. The metric used is the sum of corporate tax, VAT and individual income tax paid by employees, which is a pretty enlightened way of thinking about the total tax burden on corporations (unlike the simplistic focus on corporate tax in some Western economies). We ranked in the top 25 this year, which I like to think is a sign of our success in building a practice of scale and relevance in and around Shanghai.

The plaque giving is not the end of the event. After everyone is seated again, a government official comes around to each table with a sealed brown envelope. This contains a sheet of paper communicating the tax rebate that is being given for the past year. There is no ranking for this. Indeed, there is both science and subjectivity in coming up with size of the rebate, based on additional softer factors such as longevity in the community, broader contributions made to priority government initiatives, and possibly even the seniority of the leader sent to represent a firm at this kind of event.

Net net, it is about communicating you are important to us, and we are important to you, in a very tangible and visible fashion. Globally, other cities and districts could benefit from adopting some elements of this approach.

What kind of approaches would you like to see cities take to recognize their corporate citizens?

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When your workers in China walk out http://www.mckinseychina.com/when-your-workers-in-china-walk-out/ http://www.mckinseychina.com/when-your-workers-in-china-walk-out/#comments Thu, 13 Mar 2014 01:59:13 +0000 http://www.mckinseychina.com/?p=7438 Are Chinese workers getting more strike prone? In the absence of solid statistics on this, my qualitative sense is yes. The number of strikes during an acquisition certainly seems to be rising. The strike at the IBM factory due to its transfer to Lenovo as part of their acquisition of IBM’s low-end server business is the most recent case.

Also very recent has been action at Pepsi’s bottling plants in China as they shift ownership to Tingyi. Earlier, there was the high-profile strike at Cooper Tires factories in China. All three of these are related to change of ownership of the business operating the factories in question.

In one instance, an Indian company was seeking to take over from an American owner. In another, a Taiwanese company is seeking to take over from an American company. And in the third, a mainland Chinese company is again seeking to take over from an American company.

Is it that American owners are uniquely popular among Chinese factory workers? It is certainly possible that there might be a perception that terms and conditions at American firms might be more generous, although I have not seen any surveys to back this idea up.

Two other factors are more likely to be leading to strikes during acquisitions. The first is that change of ownership will generally mean change of contract for the workers, with the expectation that owners will take this opportunity to reduce the attractiveness of the overall package offered. The second, and I think most common, is that change of ownership is seen as an opportunity for a one-time bonus payment to workers for facilitating a smooth transition (This is also common in South Korea).

I believe this is likely to become the norm. Acquirers of businesses in China need to be on the front foot to preempt strike action. Be ready even before the deal is public to communicate on contract arrangements, and build into the transition costs a one-time payment for workers. And don’t assume that workers cannot organize across plants. As the Pepsi case has highlighted, in a world of $100 smartphones, coordinated action across plants has become much easier.

Expect more frequent bottom-up worker mobilization as this becomes a new, expected “entitlement” for factory workers.

How do you think managers should prepare for a potential strike in China?

I’m now blogging on LinkedIn as well. Please follow me.

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