McKinsey Greater China The leading management consulting firm in Greater China Thu, 17 Apr 2014 04:05:03 +0000 en-US hourly 1 Copyright © McKinsey Greater China 2014 (McKinsey China) (McKinsey China) 1440 McKinsey Greater China 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 no no China In An Hour Mon, 14 Apr 2014 15:19:20 +0000 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 Fri, 11 Apr 2014 15:12:38 +0000 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 Thu, 10 Apr 2014 13:15:07 +0000 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 Wed, 09 Apr 2014 15:22:32 +0000 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 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

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 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   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 Tue, 08 Apr 2014 12:36:37 +0000 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 Sun, 06 Apr 2014 12:29:26 +0000 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) Wed, 02 Apr 2014 12:11:59 +0000 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

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Preparing For China’s Middle Class Challenge (Part 2) Tue, 01 Apr 2014 11:55:42 +0000 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




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

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Preparing For China’s Middle Class Challenge (Part 1) Mon, 31 Mar 2014 13:23:55 +0000 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


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


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


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.


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

Photo: Cathy Yeulet / 123RF Stock Photo

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China’s Civil Society Falls Short Sat, 29 Mar 2014 13:17:27 +0000 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

Photo: philipus / 123RF Stock Photo

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What’s Slowing China’s Growth? Fri, 28 Mar 2014 13:10:44 +0000 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

Photo: tonygers / 123RF Stock Photo

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Why Chinese State-Owned Banks Are Now In the Eye Of The Storm Fri, 28 Mar 2014 02:59:34 +0000 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 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? Wed, 26 Mar 2014 15:14:02 +0000 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


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.


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.



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.


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 Tue, 25 Mar 2014 15:07:15 +0000 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 Sat, 22 Mar 2014 14:46:42 +0000 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 Thu, 20 Mar 2014 14:28:17 +0000 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? Wed, 19 Mar 2014 14:22:27 +0000 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 Fri, 14 Mar 2014 08:14:56 +0000 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 Thu, 13 Mar 2014 01:59:13 +0000 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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Why does China have a thing for bling? Tue, 11 Mar 2014 01:32:27 +0000 In 2013, China’s consumer demand for gold for the first time surpassed India, according the World Gold Council, which has tracked this for many years. These two countries account for almost 55 percent of global consumer demand for gold. In China, a bit over 700 tonnes were used in jewelry, and 400 tonnes for investment in gold bars and coins. In total, that comes to over US$50 billion of spending. Total US consumer demand for gold was about 190 tonnes as a contrast.

Growth in demand for jewelry in China was 29 percent year-on-year, suggesting a robust consumer base. If consumers are willing to spend that much more on (to me at least) discretionary, even luxury products, then they must be feeling reasonably confident in their economic prospects. There are possible, though less likely, alternative interpretations. One could be that the middle class is simply short of places to invest their capital. They own their home and their car, they don’t like the stock market, and wealth management products seem to be more risky. Gold jewelry for them can be seen as part consumption, part investment.

Rising demand for gold bars and bullion suggests that at least part of the population has a different mindset. As does the massive growth in the vault business to store this gold in China. For example, a gold vault that can store 2,000 tonnes (or $80 billion in value), opened in Shanghai owned by Malca-Amit Global Ltd. The Chinese Gold & Silver Exchange Society is preparing to spend at least US$100 million to set up a gold vaulting warehouse in mainland China able to store 1,500 tonnes of gold. Clearly their expectation is that demand for gold storage will rise a lot further.

What does a 42 percent rise in demand for gold bars and coins in China last year imply? Perhaps a large segment of investors are looking for a higher degree of security in their investments than they can get from other sources, that they are not perhaps as positive about economic growth prospects. Or perhaps they simply want to own an asset that is relatively anonymous and easy to transfer ownership to others. It would not come as a surprise if government authorities took an interest, at some point in the future, in who is storing gold in these facilities.

What do you think is driving Chinese consumer preference for gold? Please leave a comment below.

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Where is 7.5% growth going to come from in China? Fri, 07 Mar 2014 04:15:27 +0000 The National People’s Congress, China’s annual parliamentary meeting, is in session this week in Beijing. Observers are parsing Premier Li Keqiang’s announcement, made on the first day of the Congress, that the government will be targeting “around 7.5%” GDP growth in 2014.

7.5% GDP growth? No surprise there. The numbers to do a detailed, bottom-up disaggregation aren’t there yet, but picking on the specific numbers included can give an idea.

Where is 7.5% growth going to come from?

  • For exports, the main statement is to “maintain the basic balance”, with the sum of exports and imports growing 7.5%, meaning exports will be a modest driver of growth.
  • Retail spending is targeted to grow 14.5%, a little higher than last year. This essentially continues the long-term trend of consumers making a modestly larger contribution to GDP growth each year. Again, no step-change here. I did not see any markers for salaries or minimum wages in the remarks so far, but they will need to be in the high single digits to realize this level of retail spending growth.
  • Government spending. With all the attention on government debt levels, and the diminishing availability of land in many cities for governments to sell to finance their expenditures, at best there is no change. The fiscal deficit for the year is targeted at 2.1% of GDP the same as last year, and the Minsitry of Finance forecasts revenue growth of only 8%.

The common theme above is “pretty similar to 2013”, which leaves infrastructure to make up the large remaining balance to get to 7.5% GDP growth yet again.

Let’s hope it’s investment in environmental clean-up, in affordable housing, in transportation systems, and the like, rather than more malls in marginal locations, that will be superceded by e-commerce, or government vanity projects.

On the environment, the statements on the “war on pollution” are good, but probably not great, and reflect the realities of just how much money will need to be spent over an extended period of time. Taking out 27 million tons of high pollution steel production capacity is great, but against production of over 750 million tons, it is at the margin.

Investing in “new” energy is great for Chinese solar and wind manufacturers, but will take years to move the needle on overall energy mix. Tightened building codes are good, but the old codes were already quite stringent – it’s the implementation that counts. More marketization of energy and utility prices is excellent – it will continue the momentum of investing in greater efficiency.

I’m still waiting to get a better sense of how and how fast proposed marketization of China’s state-owned enterprises will unfold.

Where do you think 7.5% growth is going to come from in China this year? Please leave a comment.

This week, Gordon Orr joins 500 global thought leaders as a LinkedIn Influencer. Please follow Gordon on LinkedIn here for more of his views on China.

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A chat with CCTV on China’s challenges in 2014 Wed, 05 Mar 2014 08:10:37 +0000 I just finished an interview with China’s state-run TV network, CCTV, on what business people see as the key challenges in China in 2014. With the Ukrainian coverage, we were cut a little bit short, so below is a summary of the Q&A that we only partly covered:

Q: What are the hot economic topics to be discussed at this year’s National People’s Congress/ Chinese People’s Political Consultative Conference (NPC/CPPCC) meetings?

The pace and nature of state-owned enterprise (SOE) reform, the pace of increasing the “marketization” of non-strategic sectors, is incredibly important to both private Chinese entrepreneurs and multinationals. Many state-owned enterprises are already preparing for expected changes in their governance and ownership. They need this to be confirmed.

It will also be interesting to understand the expected make-up of China’s GDP growth in 2014. There will be little surprise in the overall target number, but how much growth is expected to come from consumption versus investment versus exports? That will reveal quite a lot about how the government is thinking.

Q: What is the biggest challenge for China economically in 2014?

Let me highlight two:

  • At the macro level, it is critical to sustain growth in consumption at levels well above GDP growth. This requires, as always, that consumers have confidence; confidence in their wealth – that the value of assets invested in stock markets, property, wealth management products and the like is secure; confident in their access to the healthcare system and a robust pension; and confidence finally that the affordability gap will shrink – the gap between their income growth and growth in the cost of the assets middle class consumers expect to afford.
  • Businesses are focused squarely on productivity growth. The cost of almost all their inputs – labor, capital, land, utilities – is rising, and their ability to pass this on remains low due to aggressive competition, leading to shrinking margins. Businesses are looking mainly to technology to increase efficiency (e.g. a fifty-fold increase in the size of the market for industrial robots in the last decade) and to reinvent their business model (e.g. the emergence of online only financial institutions) . As I have mentioned elsewhere, it is a great time to be a CIO in China.

Q: What should we expect from the NPC/CPPCC meetings in terms of economic reforms?

The directions were well laid out last year. This year should be about how far and how fast these directions are followed.

Q: What are the differences observed so far between this year’s sessions and previous ones and what does it say about the new government?

Hard to say, but it is planned to be a shorter meeting. Perhaps the government is trying to role model higher productivity? Or alternatively, that with the focus on how rather than what, there is simply less to discuss.

Q: The Chinese currency, the yuan, dropped recently. Analysts say it’s a sign that China is trying to widen the band of trading. Does it mean we are seeing major breakthroughs in financial reforms soon?

I don’t see any automatic linkage between the two. This is not a top issue for business leaders operating in China.

Q: What is the outlook for the property sector outlook in 2014?

As an observer of this market, I have noticed that Chinese property developers are investing more outside China.

For more of my thoughts on China, follow me on Twitter @GordonOrr

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What don’t we know about China? Fri, 28 Feb 2014 13:38:27 +0000 We were asked recently to contribute to a multinational’s top team brainstorming on how to approach the question of global “known unknowns” in politics, business and economics between now and 2019, the sort of things that could materially change the way they think about their business. This business is global and asset-intensive, requiring big long-term capital bets. This was a “just give me your top of head ideas” session, and so was just an opinion-based first-cut. But that also means I’m comfortable sharing the input I gave on China.

If China is 30% of global economic growth, it is more than that in most infrastructure-driven sectors. What could disrupt smooth economic growth, and would this lead to opportunities, or alternatively, a much less attractive marketplace?

As a first cut, I proposed three possible shocks that have the potential to reshape the economy very differently – a poorly handled crisis in the financial system, the sustained reemergence of bird flu and a deterioration of Japan – China relations. All possible, none probable. It’s not good enough to be prepared for volatility; we must anticipate different kinds of volatility.

More specifically:

  • A poorly handled financial crisis could lead to a rapid loss of consumer confidence in the financial system, a desire to hold cash, gold or other physical stores of value. The government might feel it has no option but to bail out investor losses in full to restore confidence and consumer spending. Capital that might otherwise have gone to fund investment in business and infrastructure might be diverted to consumers and delay capital programs.
  • A reemergence of bird flu, particularly if it became endemic in the countryside, would severely restrict individual mobility and likely the flow of agricultural products into cities. As before, stringent restrictions on individual travel between cities would likely be put in place and very quickly the priority would be to focus on limiting food price inflation in cities.
  • Tension between Japan and China, while noisy in the global media and Chinese social media, is likely to affect mainly economic relations between the two countries, with Japanese industrial and consumer companies seeing material drops in sales in China, possibly creating opportunities for others.

Business strategists need to push this very high level thinking to become more specific on how their industries might be affected, and what they could do to mitigate or even take advantage of the situation.

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At London’s Frontline Club Tue, 25 Feb 2014 07:18:58 +0000 While I was in London last week to speak at the China Britain Business Council and at London Business School, I had a free evening which I used to attend a Frontline Club (similar to the Foreign Correspondents’ Club in Hong Kong) session on China. Interesting session on how citizens are evolving how they raise complaints in public in China, and on what subjects. The panel included Jonathan Fenby (Author), Rob Gifford (The Economist), Isabel Hilton (Chinadialog) and Thomas Koenig (European Council on Foreign Relations).

They talked about the difficulty of finding ways to express disagreement in China, and the various eras the country has gone through to reach the current process with its major shortcomings. In short, much of the approach could be described as “defend and deflect”, which has material implications for business leaders going forward.

On business topics, “defend” has increasingly involved buying off local groups of protestors. This is better known around protests against the construction of new factories seen as likely to pollute the local environment, less well-known around factory specific disputes. In these cases, factory owners are frequently pressured to roll over quickly and offer a financial settlement.

Going forward, proactive “deflection” will likely be a bigger issue for businesses. The government is seeking to align itself with consumers against groups that are major sources of concern to consumers, especially to middle class consumers, so as to deflect potential complaints away from themselves. The intent is to be seen to be active in addressing consumer concerns before consumers organize to complain about them. The new consumer law is one tool for this.

We should expect to see much more activist government attacking real and perceived failures in performance by businesses. Larger businesses will in particular be targeted, as it will show the government in a positive light to be taking on the best known brands – and it is easier to go after them. Topics such as genuine product availability, quality and safety of product, behavior in the sales channel, and predatory pricing, are likely issues that the government will pursue.

Multinationals and locals will both be targeted. Businesses should expect greater scrutiny of their operations, not only of their own operations, but also of the end-to-end channel that they use – suppliers, suppliers of suppliers, and so on. Larger businesses will be expected to ensure the quality of smaller businesses in their ecosystem, leading to pressure for vertical integration and the elimination of smaller players in the supply chain.

While consumer goods companies might be most visible targets initially, I suspect a significant number of real estate developers will be targeted for failing to deliver on reasonable expectations of quality in their construction.

Businesses will need to do more than keep their heads down and hope others are targeted.

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Australia for sale – will China buy? Tue, 25 Feb 2014 00:32:39 +0000 Joe Hockey, Treasurer in the Australian government, announced last week that he plans to sell more than US$100 billion of assets the government owns, with details to come in May. Examples of what may be in the sale include airports, roads, rail and ports – not only existing infrastructure but also the right to build major new projects.

Who will buy? Clearly some local Australian companies will be interested, and local and global private equity companies will be sharpening their pencils in anticipation. But what about some of the most enthusiastic builders of infrastructure in the world today, who also have an aggressive international acquisition agenda, specifically companies from China?

Chinese port operators, such as China Merchants, COSCO and Shanghai International Ports, have invested in many existing ports in recent years, including in Belgium, Morocco, Greece, the U.S. and Sri Lanka. Equally, they have been very aggressive in their involvement in the construction of port expansions, with a combination of low cost finance and skills. Part of the financing for the High Speed 2 rail link in the U.K. may come from China. Beijing Construction has committed to invest over US$1 billion in Manchester airports redevelopment. So many precedents exist.

Chinese industrial companies and private equity firms have already invested heavily in Australia, many quietly and successfully. But some investments, especially in mining, have stirred up public and political opinion. Will China’s investors feel sufficiently welcome to make these really long-term investments in infrastructure? It may take a bit of a reboot in China-Australia business relations to create a win-win outcome.

One further area that I could see as a win-win is in automotive. Chinese companies would almost certainly be welcome to invest in automotive production in Australia. In recent months GM, Ford and Toyota have all announced that they are exiting auto manufacture in Australia, leaving the country with no domestic production and an auto supplier industry without any local customers. Why wouldn’t one of China’s leading domestic producers take the opportunity to buy one of the plants scheduled for shut down and launch local production?

The Chinese government is pushing their major automotive companies to expand internationally. This could be a relatively low cost and low risk way to do so. Keeping the suppliers in business would surely attract support from the Australian government. And perhaps the Chinese OEM could introduce hybrid/electric vehicles they have been developing so aggressively to bring something a little different to the Australian market. Not trivial to make all the financials work, but from a big picture perspective, it could be very positive for all involved.

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Where have all the taxis gone? Sat, 22 Feb 2014 00:29:50 +0000 When I am in Shanghai during the week, I take a taxi to the office, normally at around 6:30am. It costs about 18RMB for a ten-minute ride. Until recently, there would have been a line of taxis outside the apartment building, rain or shine, and on the rare day when there was no line, it would not take more than two minutes to walk down the street and find one at the corner with a main road. No longer: there is never a taxi outside the apartment and it can easily take ten minutes to hail a cab on the main road.

The reason is the taxi app war underway in Shanghai between the internet giants Alibaba and Tencent. With financial incentives offered to both taxi drivers and to passengers to use the apps, the market has shifted dramatically. Tencent has partnered with (and invested in) a taxi app called Didi Dache to offer 10RMB to the passenger for booking a taxi through the app, and 10 RMB to the driver also for taking the booking through the app.

Obviously both need to be linked to Tencent’s WeChat and payment system. Alibaba is partnering with (and has invested in) Kuaidi, and is offering 10 RMB to the passenger and 15 RMB to the driver with payments flowing through Alipay. (These numbers are indicative only, as they move around quite a bit as the internet giants skirmish against each other).

Confirmed numbers are a little hard to come by, but the site 36Kr suggests that after one month with the offer in operation, Didi gets 700,000 bookings a day (over 480,000 via WeChat), with a peak of 2.6 million on February 7, of which 2 million were paid through WeChat’s payments system. In one month, incentives paid to riders and drivers totalled more than US$60 million.

This is a “deep pockets” game. These 2 apps now claim to hold more than 80% of the market, with the remaining 50 or so players being rapidly marginalized. It is the winner-takes-all model that we commonly see in internet businesses, but with Chinese characteristics: the large Internet players are leaping in aggressively to shape the outcome, and to use these new markets as a way to gain advantage over each other. I expect that it won’t be long before this is the only effective way to hail a taxi, and the only open question is will there be two vendors or one.

So while each taxi driver is limited to a certain number of subsidized rides per day and likewise passengers, the incentives are changing behavior. Of course this can only really work if penetration of smart phones is high, and in Shanghai it has reached 60%, which is essentially 100% penetration of the taxi using population.

Given the depth of pockets of the protagonists, this could go on for quite some time. I cannot see either really being willing to back down in what is probably just an early skirmish in the competition to come as China’s Internet leaders increasingly compete head-to-head .

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Would you want to be a Chinese university graduate? Wed, 19 Feb 2014 06:48:56 +0000 Not all is rosy in the world of Chinese graduates. Job fairs around the country see tens of thousands lining up to look for better opportunities.

More than 15% of graduates were unemployed 2 months after graduation in 2013. And when they do find a job, it is often not what they had prepared or hoped for. Instead, it is often a fairly prospect-less role in a call center, as a sales agent, or as a receptionist.

To pile misery on misery, wages for graduates have been essentially flat in real terms since 2006, during which the average per square foot price of an apartment, the prerequisite of a middle class lifestyle, has risen 6% in real terms per annum, leaving new graduates with diminished prospects of getting on the real estate ladder.

The relative return of a degree is diminishing as urban salaries of those without university education converge with those that do – the former rising from 40% of the latter in 2006, to over 80% in 2012.

Chinese students must be asking themselves the question: Is university worth it?


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Why governing China is about to become a lot more expensive Tue, 18 Feb 2014 06:47:40 +0000 A recent article in Global Times gave great examples of how turnover of judges in the Chinese court system is rising to unprecedented levels: 17% of judges hired in Beijing between 2008 and 2012 had left already, with a higher proportion in other cities.

The reasons given in interviews with former judges was the growing workload combined with the stagnant pay. Wages might be as low as 2,000 RMB a month for a judge in Shandong and maybe 8,000 RMB a month in first tier cities, certainly much less than the lawyers arguing cases receive, and also less than working in a corporation as a lawyer. To retain the quality of talent that is needed to preside over effective courts, the government will need to pay more, probably a lot more.

If it was only judges that are going to need to be paid more that would not stress the government’s cash flow. But as the clamp down on corruption has shown, many areas of government pay wages that lag far behind corporate sector benchmarks. That doctors are paid less than the sales reps selling drugs to them has been well-documented as a cause of the kick-back problems in that industry. Nurses are paid even less. Teachers supplement their income through tutoring and other means. Policemen do what underpaid policeman do. Government administrators are paid a fraction of the executives who come to them asking for licenses to operate and the like. Even in the renowned science and research academies, prestige is easier to come by than high salaries.

This cannot continue much longer. As the generation that joined these professions because they were prestigious and there were few alternatives, the cost of attracting equivalent talent to replace them is rising fast. For many professions the prestige is less, sullied by the means to which its members go to enhance their income. For those who played with a straight bat, the potential to earn enough to purchase a home is now almost non-existent. The cost of a middle class lifestyle has risen dramatically, but income levels in these professions have not.

In many countries powerful public sectors would bring pressure to bear on government. In China, the fragmentation of workers makes this much harder, allowing the government to underpay for longer that would otherwise be the case.

But this cannot hold for much longer. The available alternatives are becoming increasingly attractive, and the expectations of a rising, middle-class standard of life, are overwhelming for university graduates. Given the high indebtedness of many local governments, the last thing they need is another big demand on their cash flow, but it would not surprise me if their cost per employee rose more than 100% in the next 5 years. Perhaps then, even the government will start to care about labor productivity.

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Passport excess Mon, 17 Feb 2014 06:46:06 +0000 To get my new passport from the British consulate this year, I’ve been asked to bring along a number of my prior passports, which made me think: “Just how many are there?” Turns out there are 20 – see attached picture, basically one for every year I have been in Asia. I am not sure if the UK government makes a profit on issuing passports, but at more than 150 pounds for a 48-page document, I feel they should. If I am at a (very) loose end one day, I might count the number of entry stamps I have by country. I hesitate to offer a guess.

On the subject of travel, I can’t recommend the APEC travel card highly enough. The permission that it brings to bypass long passport control lines on arrival and departure is an incredible benefit. It took a while to get it but very worthwhile. The certainty that this brings in how long it will take to get through formalities combined with online checks, materially reduces how early one needs to safely get to the airport.

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Why are Chinese developers investing outside China? Fri, 14 Feb 2014 06:44:45 +0000 Greenland Group’s purchase this week of a development project in Los Angeles with 1.65 million square feet of residential, hotel and retail space provoked the question, “Why are Chinese developers investing increasing amounts outside China?” After all, Greenland is not alone. Other Chinese developers have recently purchased projects in London, New York, Sydney and many other cities.

Do these developers really believe that returns on projects in major cities are going to be superior to those in China over the coming years? What would this imply about the future of China’s property markets? That housing prices may be set for a long period of stagnation at best? That commercial real estate prices really will be hit in the medium term by the emergence of ecommerce?

Do they believe they bring distinctive capabilities to these international projects that will allow them to earn better returns than local developers in these cities? Locals tend to think not as this article from The Australian highlights. Success in navigating development rules and regulations in China is unlikely to prepare one for the local rules and regulations in a London or New York.

Do they have access to cheaper capital from China than local developers can access? With rates remaining at long-term lows in many markets, this is unlikely unless the Chinese developer is assigning almost a 0% cost to its capital.

Do they have so much capital to deploy that they simply can’t find projects to put it against in China? With many developers in China finding that their ability to draw down committed loans is being restricted with a “come back next month” response, this seems unlikely.

Are they sending an indirect message to Chinese rulers, that if you tighten our access to finance too much and restrict our ability to make money too tightly, we will simply stop investing in China? It is quite possible to believe that some developers will be targeted in coming years for acting against the interests of the vocal middle class, for selling substandard property, or for paying inflated prices for development land.

Do they feel overly concentrated in China and are simply creating some financial security through geographic diversification, just in case there is a downturn in China (not because they believe there will be one), or they find their business under investigation, which restricts their ability to move capital abroad? This seems perhaps the most plausible reason of all, although all of the above may well in part be true?

What do you think?

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When is a loan not a loan in China? Wed, 12 Feb 2014 07:08:22 +0000 When you can’t draw it down.

The Financial Times reported earlier this week that China Development Bank (CDB) and Export-Import Bank of China have asked several foreign clients to delay drawing down lines of credit. This will be worrying not only to foreign clients of these and other Chinese banks, but also worrying to some of China’s most successful exporters who have benefited from the ability to bundle financing from China with the products and services they are selling.

Will their potential customers trust this source of capital going forward? Probably if these delays are short-term and quickly blow over. But sales teams in these exporters must be anxiously wondering if their attractive financial packages for customers will still be available in the future. Their competitors may be wondering if the playing field is about to get a little more level.

Which industries have been most dependent for their international growth on supporting finance from CDB and other banks, and would be most impacted by a pull back? Largely these are players in the infrastructure industries, most often state-owned enterprises – road, rail and infrastructure engineering and construction companies, power generation equipment providers, telecom infrastructure providers, and the like. Some are world-scale and world-class companies with significant influence with their ministries in China. I don’t see them giving up on customer finance as a sales lever without a fight.

I suspect some interesting arguments will rage between the fiscal tighteners in the government and those arguing for export growth for job creation in the months ahead.


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Mass customization comes to China Tue, 04 Feb 2014 07:07:28 +0000 China’s manufacturing industry has the reputation for being able to produce very large quantities of product rapidly and at extremely low cost, but in very few varieties. Innovation in tools such as 3D printers and software to enable flexible production systems – to name only two – are starting to change the game, allowing unprecedented opportunities to offer mass customization, even individual customization, at limited incremental cost.

How is this likely to be embraced in China, where we have lots of fixed and mobile broadband, cheap home delivery, and as a consequence, massive e-retail – but very much “e-retail with Chinese characteristics”, with products sold largely through marketplace platforms?

It’s already clear that 3D printers are being adopted at pace by Chinese manufacturers and innovators for a vast array of weird and wonderful consumer prototypes. Of course it’s not all B2C: industrial companies are starting to distribute 3D printers around their remote branches to substitute for stocks of low-turn inventory.

Why can customization be a game-changer in China?

Even manufacturers with enormous online sales today know little about their customer, and find themselves competing against their own distributors and retailers, and the price inevitably gets driven down. The manufacturer builds no direct connection to the consumer. Mass customization changes this. Customization can only be done by the manufacturer, forcing the consumer to create a direct and hopefully stickier connection.

There is enormous potential benefit to the manufacturer. Smart manufacturers will be aggressively looking for where and how they can cost effectively implement customization – what features can be handed over to the customer to select. Typical Chinese consumers will want to show off their customization to friends and beyond, on the manufacturer’s site and on social media like WeChat.

The Chinese middle class are avid consumers of new technology. Another technology-based innovation that enables customization could link the physical store with the online one, particularly for clothing manufacturers. Retailers can transform a trip to the mall from a chance to check out the latest products, to an experience whereby customers can get a 3D body scan that allows them to view online clothes as they would actually fit, with perhaps some suggestions for customization.

And of course, retailers can turn this experience into a game. Combining Chinese consumers’ passion for creativity with the opportunity to win prizes could be extremely powerful, though the challenge will be to sustain interest over time.

There’s lots of talk about all these directions today, and I’m looking forward to seeing more of them applied. In the meantime, we will see one additional trend for sure, with the possibility of a second. The first is that the flexible production systems to deliver customization cost effectively will be based on capital investment, not people. This will accelerate the broad shift in manufacturing to substitute capital for labor. The second possible trend will be to shift e-retail towards direct relationships between manufacturers and consumes, limiting the market space open to distributors and retailers, and possibly even reducing the power of the marketplace.

Time to experiment.

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The “go private” trend continues for Chinese companies Mon, 03 Feb 2014 07:06:29 +0000 The next U.S.-listed, Chinese technology company to have its controlling shareholder propose to take it private is Shanda Games. With the controlling shareholders holding more than three-quarters of the shares, this seems very likely to succeed. The premium offered to minority investors is at the mid-range of similar transactions at 22% (15% Focus Media, 33% Tom Online, 46% Alibaba), and is at a PE of less than 10 versus expected 2014 earnings. U.S. investors seem to be falling out of love with anything but the largest Chinese technology companies.

The continuing and very public legal wrangles over whether the U.S. affiliates of the Big 4 accounting firms will be allowed to continue to audit the China operations of U.S.-listed companies has not helped to improve investor sentiment. When I meet with U.S. investors today, the conversation seems to focus very much on finding reasons to support the thesis of not investing in Chinese stocks – “this is bad, that is bad, isn’t it”. I suppose in some ways just a balancing out of the over enthusiasm seen in the past.

It is not surprising that boards are deciding to shift their listings to Hong Kong, where they feel they get a more nuanced and balanced assessment from analysts, who visit them regularly in China, and investors.

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China’s e-commerce goes global Fri, 31 Jan 2014 07:05:34 +0000 Last week, Russia’s government announced that it was considering imposing a 30% tax on imports from foreign retailers. I don’t find this surprising, having heard just a few months ago that 40% of small packages coming into Russia originated from Chinese e-commerce companies. Alibaba has very smartly connected to the Russian online payments system to make payments easy – the rest is straightforward. Customers can either go direct to the Chinese sites, or use one of the many non-Chinese language gateway sites.

The root cause of the extraordinary growth is the massive inefficiencies in distribution and retail in the customer’s home market, especially outside the largest cities. By cutting through all of this to the ultra-competitive prices available on Chinese e-commerce sites, consumers are the beneficiaries. But it is easy to see why vested interests could be upset.

This is a precursor of what we are likely to see in many countries, especially those with fragmented physical distribution and retail, a decently developed online infrastructure, and a postal service(!) There are ways to compete, certainly, but more through an “online plus” model. For example, Lazada in Indonesia is seeking to provide higher quality on the ground collection and return services, as well as establishing trust as a local brand, while sourcing aggressively from China.

Over time, though, these features can be matched by the rapidly evolving Chinese e-commerce giants, who have one additional advantage – their staggering size and market capitalization. They grew to be winners in China through supremely aggressive price competition. It will be tough to withstand the fire hose of low cost, low cost, low cost when it is really focused on a specific market.


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China’s next wave of privatization Thu, 30 Jan 2014 06:56:09 +0000 The 2011 data in the chart below brings out the imperative for Xi Jinping to move forward with another round of privatization. Despite the development of so many successful, large scale private enterprises over the last 15 years, the state still dominates many sectors.

Easier sectors to move forward with privatization are likely those industrial sectors with many state-owned participants. These already have some characteristics of markets, especially intense competition as growth slows, but they lack other market disciplines in the allocation and cost of capital, and in the ability to pull all available levers to improve efficiency or to innovate. For CEOs, it is rather like trying to compete with one hand tied behind their back in a market almost designed to create structural overcapacity.

Many of these enterprises need at a minimum to close, some need to consolidate. Lots need to improve their environmental performance. Lots need to improve their capital efficiency, their labor efficiency and their energy efficiency. While it will be good if these are all addressed, it will be painful and likely lead to a lot fewer jobs in these industries. It will be very helpful for government leaders if it is not they who are seen to be making this happen, at least not directly.

Even with privatization, it is unlikely the CEO’s hands will be fully untied. Freedom to acquire and consolidate, freedom to reduce jobs, freedom to change suppliers may well still implicitly be constrained, even if the IPO document says nothing to that effect. But without doubt, given the quality of some of the CEOs, truly successful winners will emerge. The sooner they are allowed to get started the better.


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China’s lead in pork production Wed, 29 Jan 2014 06:51:51 +0000 China continues to dominate global pig production and will for many years to come – close to 50% of all pigs are grown and consumed in China. As demand for higher quality pork rises in China, the need to upgrade the domestic supply chain will go hand in hand with increased imports, rising to US$2.5 billion in 2013 from $1 billion in 2010. I expect these imports to continue to grow.


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What Chinese citizens are concerned about Mon, 27 Jan 2014 06:48:41 +0000 The chart below drawn from research by Pew highlights which issues are of most concern to Chinese citizens, and which have increased most in importance over the previous year’s survey. In addition to the expected priority given to air pollution, it was interesting to see water pollution moving up so fast.

Historically, certainly there has been little faith in the quality of tap water, even though it is a long time since travelers were recommended to wash their teeth using beer rather than tap water. Consumption of bottled distilled water in urban areas continued to grow robustly at 16% annually over the last 5 years to reach more than US$13 billion in 2013.

It is more surprising to see the large one year increase in concern over water pollution. I suppose that it is driven by people extrapolating from public incidents of industrial pollution poisoning rivers to a fear that incidents have or could occur closer to home without receiving timely publicity.

I look forward to seeing the 2014 snapshot.


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Shanghai’s new road map for air pollution controls Thu, 23 Jan 2014 06:46:52 +0000 Shanghai’s government released a draft plan last week for the actions it will take at different levels of air pollution in the city. It is a four-color system indicating different levels of air quality and suggested/compulsory measures under each level:

Blue (AQI is predicted to be 201-300 for the next 24 hours):

  • The government will give suggestions to local residents.
  • Relevant government departments required to strengthen oversight of local pollution sources.

Yellow (AQI is predicted to be 201-300 for the next 48 hours):

  • Partially close construction sites.
  • Close factories discharging pollutants.
  • Ban vehicles with construction materials from the roads.

Orange (AQI is predicted to be 301-450 for the next 24 hours)

  • Require enterprises in the petrochemical, steel, cement and chemical engineering sectors to suspend operations.
  • Ban fireworks and outdoor straw burning .
  • Ban vehicles carrying construction rubble and yellow label (i.e. high pollution) vehicles other than city buses.
  • Cancel large-scale outdoor sports events.
  • Stop outdoor activities at schools and kindergartens.
  • Halt all outdoor construction work.

Red (when the AQI is predicted to above 450 for the next 24 hours

  • Close primary schools, junior high schools and kindergartens.
  • 50% of official vehicles will be taken off the roads.
  • Cancel large-scale outdoor activities (e.g. outdoor concerts and marketing campaigns).
  • Halt all construction work.

Clearly the core challenge is in the details of implementation. In 2013, the alarm system triggers were seen to be pulled late; will they be pulled more promptly in 2014? How objective will the forecasts be if they are coming in just around the line? Will companies know in advance which lists they are on and what they need to do when a color change is made?

In addition to the new warning system, Shanghai will phase out 500 polluting, hazardous and energy-intensive facilities in 2014, which is excellent. But if pollution is coming into Shanghai from surrounding areas, the city’s ability to restrict these sources remains limited.

Net net, it is great that increased attention to the problem is being sustained. but how much of a difference the new policy makes will depend on pulling the trigger.

For the record, here’s the Shanghai Environmental Protection Bureau’s summary of average daily AQI during 2013:

  • 241 days of AQI below 100
  • 72 days of AQI 101-150
  • 29 days of AQI 151-200
  • 21 days of AQI 201-300 (Yellow days if two consecutively, Blue day otherwise under the new rating)
  • 2 days of AQI over 300 (Orange or Red days under the new rating)
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Chinese investment in soccer Tue, 21 Jan 2014 06:45:20 +0000 In the podcast version of my 2014 forecasts with Nick Leung and Guangyu Li, we debated if Chinese outbound investment into international soccer would happen in 2014 before global investment inbound into Chinese soccer. It looks like the former is now more likely.

There were several reports over the weekend that Wang Jianlin, Chairman of Wanda Group, is looking to take advantage of the current leadership vacuum at Southampton of the English Premier League and buy them for a reported USD300 million.

I’m not in a position to say whether this is a bargain price or not, conceivably it is. Certainly it is consistent with Chairman Wang’s interest in acquiring entertainment and culture businesses outside China, such as AMC cinemas in the U.S.

Wanda also acquired the Sunseeker motor yacht business in the U.K. last year, their first significant investment in the U.K. Sunseeker’s headquarters are just down the coast from Southampton – although there probably is not a lot of synergy with soccer. I cannot see multi-million dollar yachts being advertised on Southampton’s team shirts.

Chairman Wang is certainly familiar with Chinese soccer, having owned the Dalian soccer team for much of the late 1990s, during which time they were the most successful team in China. He sold out in 1999, perhaps due to the challenges that he saw to move to the next level of commercial success. Given the way in which the game has stagnated domestically since then, it was probably a smart move.

Could owning Southampton lead to Chairman Wang reentering the Chinese soccer league and buying another team? Maybe – my guess is that success in developing the Southampton team in England and the Southampton brand commercially in China would lead to a reinvestment in Chinese soccer.

Is Chairman Wang ready for the media and fan pressure that comes with owning an English Premier League team? Vincent Tan (Cardiff) from Malaysia, the Venky’s (Blackburn) from India, Assam Allen (Hull) and even the Glazer family (Manchester United) have all found themselves under severe criticism in the media. There clearly are media management lessons to be learned and I hope that Chairman Wang is aware of the expectations that now fall on him.

(Photo courtesy of Ingy the Wingy via Creative Commons)

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Bullish on China-Britain business Fri, 17 Jan 2014 02:34:24 +0000 Late last year, the U.K. Prime Minister led a large trade delegation to China, which created largely very positive business sentiment in both China and the U.K. This week, London’s preeminent annual event on China business took place, not accidentally at a venue just across the road from the Houses of Parliament. Succeeding in business with China is seen as having many important enablers in policy and direction, ranging from a consistent message on being open to M&A-driven investment, through to the more mundane, but still critical, issue of visas.

Appropriately, Hugo Swire, Foreign Office Minister, kicked off the program. His themes were twofold – celebratory on the scaling of Chinese inbound investment (up 80% year on year) to the U.K. and on the strength of U.K. luxury businesses online and offline in serving Chinese clients (online being larger than the rest of Europe combined). His second theme was on the potential for U.K. services in and related to China. This ranged widely from architecture to pollution reduction, from food safety to low carbon and, of course, London becoming a center for the internationalization of the RMB. He closed with a reaffirmation of the creation of 60 new consulate jobs in China and recommitment to deliver on the “visa service comes to you, not you to the consulate” promise that the Prime Minister made when in China.

The Chinese ambassador, Liu Xiaoming, delivered an upbeat speech in English. He highlighted how the U.K. was outstripping the rest of the EU in its commercial relationships with China: U.K. exports to China up 13% in 2013 versus 2% for the EU overall. Although, taking an anecdote from the BBC’s China correspondent, Zhuang Chen, made later, it seems that part of the growth in UK exports is driven by the fashion for wealthy Chinese to decorate their homes with English antiques. He made clear that the message of openness to Chinese investment in almost all sectors had been well heard in China, highlighting the Chinese infrastructure investments in nuclear power and potentially high speed rail in the U.K. Looking forward, he anticipated further investment in U.K. real estate, finance, culture and advanced manufacturing. With the change in China’s approval processes to make outbound investment easier, I think it is very likely that 2014 will end up a record year for Chinese investment in the U.K.

I missed the session on Chinese consumers to attend a parallel session of the heads of several British industrial and technology companies discussing how to access the China market. Other than Rolls Royce, the panelists were largely from smaller companies with a single distinctive product or focus. The discussion, which quickly involved many from the audience, was very pragmatic. Topics included how to get paid by a state owned enterprise (that’s one I have a lot of experience with also), how to protect IP through using a partner, what does a letter of intent really commit you to and more. The technology enterprises had found it very difficult to attract Chinese talent with the right technology backgrounds – just very short supply. The wrap up created a short list of to-do’s, which I repeat here:

■ Have a distinctive product or don’t bother going to China. If you don’t stand out for the product, there is no reason they will buy from you. This was the “must have” question

■ Align your pitch with national policy and strategic direction

■ Be clear on what you need to adapt to succeed in China

■ Focus on a few potential customers, be patient, be persistent

■ Be serious at every stage in the process. You cannot uninvent a bad meeting or poor impression made

■ Understand the competitive pressures your potential customer faces – labor cost, social cost, over-competition

■ Leverage the experience of others

The China Going Global panel was a highlight (not because I moderated it), with the panel containing 3 young Chinese executives, who had quite early in their careers chosen to get international experience to accelerate their career progression. We heard that being away from HQ was a plus, an opportunity to grow and shine, and not a negative as more senior executives have told us in the past. We also heard of a bias to go to smaller markets first as entry costs less, of the tendency of Chinese companies to follow each other into new markets, and of a tolerance of failure, as long as learnings were incorporated into the next market entry.

The China in Transformation plenary with Rana Mitter, James Kynge, Susan Ning and myself, moderated by Liam Byrne, brought really diverse perspectives. A politician moderating an Oxford professor, the Financial Times’ Emerging Markets editor, a lawyer and a consultant, brought the range of views you would expect. I would happily have sat in the audience to listen to the others.

My notes are incomplete but Rana’s points on being balanced when looking at the China-Asia international relations issues sticks with me, for example, the need to look to the micro and see where Chinese businessmen and tourists are going despite high level political tensions. James focused on the growing economic clout of the migrant workers, asserting their spend is now 1.5 times the entire Indonesian consumer market. Susan showed total mastery of the intricacies of new tax policies and how that might reshape competition in several markets. Liam, a great facilitator, wore appropriately bright red socks. If you have read my other blog posts you will know the kind of topics that I talked to.

The conference was very well attended, around 600 delegates. Not just the number, but the seniority and level of experience on China were very high. And in an important difference from conferences in China, they stayed all day, and it was the business attendees, not the journalists, who asked questions from the floor.

Net net, the event left us with a sense of confidence that there is a strong momentum in U.K.-China trade relations, broadly defined, relative to other European economies, and that the step up from the PM’s year-end visit to China is being sustained.

What do you think about China-Britain trade relations? Leave a comment below.


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Who really benefits from China’s new consumer protection law? Wed, 15 Jan 2014 14:33:30 +0000 On March 15th (China’s Consumer Protection Day), China’s government will implement its first major overhaul of consumer protection law in twenty years. It is remarkable that it has taken so long – twenty years ago not only was there no e-commerce, there was no modern retail to speak of either, and certainly no hypermarkets. Buying consumer electronics back then required taking the product out of the box and plugging it in inside the store to show that it worked. If it failed after that, it was the buyer’s problem. Indeed, it was one of the key enablers of the development of e-retail in China that there was so little regulation, enabling the millions of mom and pop sellers to operate alongside big brand owners.

So yes, a new law is long overdue, but why specifically now? Certainly it reflects in part the greater activism of the new leadership versus the passivity of the previous administration, especially in its later years. But I think it also reflects the greater savviness of the new leadership in understanding what kinds of actions will be popular with the urban middle class. While it is hard to fix the air pollution issue quickly, while it is tough to ensure food safety standards are followed consistently, it is possible to quickly empower citizens with a new set of rights that the government can be seen to be supporting them against badly behaved big businesses. This is in part a populist quick win, not simply a needed legal evolution.

What does the new law propose? There are some good write ups from legal firms such as K&L Gates or from China Briefing. Many Chinese businesses are only now starting to recognize the implications for them and prepare for the changes. To quote one Internet entrepreneur I met last week “This law could put us out of business” – the changes to business operations and potentially to industry structure are material.

A few of the key changes:

■ Personal data protection. Middle class consumers are increasingly aware that businesses are using and trading their personal data. The new law makes it likely that express consent of the consumer will be required in order to use their personal data.

■ Class action law suits. Class action suits against private parties will be permitted, led by government consumer associations on behalf of affected consumers. If in place over the past few years, this might have been used against milk producers, against automotive OEMs over delayed car recalls, or against companies that offered weaker service and return arrangements in China than elsewhere. One assumes that the probability of a government consumer association winning a case it brings in a Chinese court will be pretty high. Moreover, consumers will now be allowed to claim damages for mental suffering, adding to the potential cost for businesses – this may be challenging to defend against.

■ Right to return. The right of consumers to return products bought online (or from TV shopping channels) without cause within seven days is clearly defined. The one aspect that is less consumer friendly is that consumers will have to pay the return freight fees.

■ Resolving complaints. This must now be done within seven days, which probably requires many businesses to significantly expand their customer service team.

■ Burden of proof: In a dispute over a defective product, the seller has the burden of proof to show that goods were sold without any defect. The consumer claiming the defect is assumed to be in the right.

■ Who to sue? Consumers can sue the platform provider through whom they bought the product or service in many cases. The platform provider then has to seek redress from the seller themselves.

■ Advertising liability. There are at least two challenges. Those carrying advertising (i.e. platform providers) in addition to those creating the advertising are liable for damages if claims made are shown to be false. This creates a burden for the platform provider to understand and verify the claims of all advertising it carries, or to find somehow a way of laying the risk back off on to the seller. Additionally those publicizing claims (e.g. celebrity endorsers) could be held liable for endorsing a product that causes harm to consumers. This may put a damper on a very popular form of advertising.

What are the potential implications?

■ Almost certainly increased costs. There will be more complaints and they will have to be resolved quickly. Simply handling them, even if very few result in a payout, will be costly.

■ Businesses will need to adapt marketing approaches to reflect tighter limits on using consumer data.

■ Ecommerce platform companies will raise the bar on sellers. They have less incentive to deal with small providers who might cut corners or be selling fake products. They have more incentive to deal with and promote the larger brand-owning producers. This may lead to industry consolidation.

■ There may be a new and large opportunity for the insurance industry to sell insurance to consumer-facing companies.

Is your company ready?

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The perils of land transfer in China Tue, 14 Jan 2014 05:13:03 +0000 Cautionary messages from Chen Guangliang, the former Vice Governor of Guangxi province, where he was responsible for the rural population:there will be significant problems if land transfer does not take place – and yes, there will also be significant problems if it does.

At a recent conference on urbanization organized by the Urban China Initiative, he rolled off from memory a long list of statistics on China’s food imports – grain imports up 42% in the first half of 2013 versus last year, 60 million tons of soy bean in 2014, 2.3 million tons of rice, 3.6 million tons of wheat, 5.2 million tons or corn and 3.6million tons of sugar. Whether the goal was to feed China entirely from domestic sources or not was left unsaid, but clearly growing imports at this pace was not seen to be acceptable. Also highlighted was the impact on global market prices, given the internationally traded part of many cereals is very small.

Consolidating farmland to increase outputs through skill-based, capital-based agriculture is the only way to go. But there is an unintended consequence emerging: these larger scale farmers are rationally wanting to grow more value-added products. The Vice Governor gave the example of the creation of China’s largest banana plantation (55,000 mu) in Guangxi. Profit levels are 4-5 times that from growing cereal. Other vegetables and fruits are similarly profitable. Consolidating land may actually lead to less cereal production in China, not more.

The other source of difficulty arises with the former small scale farmers, after they have been bought out. The temptation to simply blow their payment on anything from clothes to gambling is high, and a very material proportion end up a few months later landless and penniless, stuck at the very margins of urban life in the “slum villages”. Methods being considered to address this include phasing of payments over time, and of course, extending social support to more of the population.


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Will 2014 be the Year of the Chinese IPO? Mon, 13 Jan 2014 08:54:32 +0000 2014 looks like it will be a big year for Chinese company IPOs, with a backlog of more than 700 companies seeking to go public. The vast majority will be looking to IPO on domestic stock markets, in part because of the poor performance over the last several years of many of the Chinese companies listed on international markets. We thought it would be timely to do a deep dive into the reasons for this poor performance – rather too much was self inflicted.

Read the full article here: How they fell: The collapse of Chinese cross-border listings. 

What do you think?  Leave a comment below.

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The state of play in China’s private education market Sat, 11 Jan 2014 15:28:32 +0000 My son was telling me over the Christmas vacation about the growing number of mainland Chinese students attending the boarding school he goes to in the U.K. This stimulated me to look into the current state of the private education market in China, which superficially you might think would be non-existent, but in reality is large, robust and growing at almost every stage in the education system.

I am not talking about the market for international schools in China (pretty much a license to print money from a captive market of expat families). My experiences there can be the subject of another post – suffice to say there were highs and some very, very deep lows.

In the Chinese market:

■ In the segment of local kindergartens, private schools outnumber public ones by more than 2 to 1, with chains of hundreds of outlets building strong brands and economies of scale. The number of public kindergartens is shrinking even as the private market grows by double digits annually.

■ Primary schools are state dominated. Only 6% of students attended private primary schools in 2012, although this share is growing from a small base.

■ Private schools play a larger role at the secondary level, rising from less than 3% a decade ago to almost 10% today. This holds across junior, senior and vocational secondary schools and includes about 12,000 schools.

■ Private tertiary education is provided by around 700 institutions and is growing a bit over 10% annually from its current turnover of US$20 billion.

Beyond these, there are many, many private providers of training and certification, vocational training, and test preparation – maybe $30 billion a year and also growing rapidly. And these official sizings almost certainly understate reality significantly as the informal parts of the market, where cash is paid to unlicensed individual providers, is missed.

While the numbers are large and from a societal lens, quite important, it has proven hard for companies to scale. There are success cases of large and profitable players emerging in vocational learning (such as languages) and now in kindergarten, in other areas, fragmentation is the norm. Even as the share of children being educated privately continues to grow and will likely exceed the US within a few years (currently about 10% of pre-K-grade 12 students in the US are privately educated), I believe that the provider industry will remain fragmented.


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Wind power in China blowing hard Thu, 09 Jan 2014 02:27:36 +0000 The wind turbine market in China is a clear example of the virtuous (for China) cycle that China’s industrial policy is sometimes able to deliver. Government-owned generators are the core customer for the turbines. They receive subsidies from the government for installing these turbines. The size of the market in China quickly grows to become the largest in the world. Government policy skews the market towards Chinese producers. And finally, Chinese wind turbine manufacturers are able relatively quickly to churn out product of good enough quality to meet market demand.

In a little more detail:

■ Since 2006, installed wind turbine capacity in China has risen from 3GW to over 90GW – more than a quarter of global capacity – becoming the largest market for new installations every year since 2010. This is still only a tiny fraction of China’s full wind power potential of over 3000GW.

■ 2006 was the trigger year in which the Renewable Energy Law was passed, requiring generators to meet targets for share of renewable energy, providing tax exemptions for doing so, and requiring 70% local content.

■ The share of multinational companies in China fell from 55% in 2006 to under 10% today. Chinese wind turbine manufacturers are increasingly exporting to countries such as the USA, Australia, Ireland and Germany.

However, not all is completely smooth sailing. Wind farms are usually in remote locations. Someone needs to pay to construct the power grid to reach them. This can be very costly, and neither the generator nor the grid company is keen to spend the money. As a result, projects can be completed but sit unconnected for an extended period. And even when connected, the transmission distances from the wind farms to consumers are so great that power losses are very high.

There are solutions – ultra-high voltage lines are on the way to reduce power losses, and offshore wind farms will be built closer to population centers. But this will take time, and the generators will continue to invest. In the meantime, turbine manufacturers gain scale and move along the experience curve, becoming steadily more competitive.


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China’s used car market Wed, 08 Jan 2014 01:59:30 +0000 In China today, for every five new cars sold one used car is sold. Compare that to the U.S., where for every five new cars sold more than twelve second-hand cars are sold! Why is this? The Chinese new car market isn’t small – it is more than 20 million vehicles a year and has been sizeable for quite some time. It has been, after all, many years since I bought my first car in China – a VW Golf locally assembled, for a suitcase of cash exchanged under the third ring road in Beijing.

Among the reasons for the small scale of the used car market are:

1. There are few places to readily source quality used cars. The standard place to go, the OEM dealer, is in China heavily focused on new car sales and takes a very low proportion of trade ins. He doesn’t want to handle used cars as he needs a license to do so and is then forced to pay VAT on the transaction which independent dealers can avoid.

2. Chinese owners keep their cars a long time, typically 5-plus years versus 3-4 years elsewhere.

3. Chinese owners like new cars (as they like new build apartments). There is a negative stigma attached to used cars. With more low-price domestic vehicle models coming to market, options for an inexpensive new car have expanded recently.

4. There is no systematic, trusted pricing system available for consumers to turn to, although online portals are starting to address this. Equally there is a lack of certification of the vehicle’s current status.

5. In many markets it can be a challenge to understand a vehicle’s history. Good luck trying to do so in China.

6. Regulations limit the ability to sell used cars across provincial boundaries due to local entry barriers and licensing requirements.

By 2020, as these constraints erode, the size of the used car market in China could grow from its current 4 million to over 20 million vehicles annually, a very healthy acceleration.


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Join me for a discussion on China Tue, 07 Jan 2014 00:28:12 +0000 My annual forecasts for the year ahead in China were just published, along with a podcast conversation on the topic with myself and two of my colleagues.

This year I highlight, among a dozen or so topics, in particular an emerging reprioritization on jobs over growth, the imperative to grow productivity on all inputs and interlinked with these first two, the increasingly disruptive impact of technology.i

I would welcome a conversation on this topic. Please leave a comment below, and let’s see where this takes us…

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What could happen in China in 2014? Mon, 06 Jan 2014 23:41:35 +0000 The year ahead could see companies focus on driving productivity, CIOs becoming a hot commodity, shopping malls going bankrupt, and European soccer clubs finally investing in Chinese ones. McKinsey director Gordon Orr makes his annual predictions.

January 2014 | by Gordon Orr

1. Two phrases will be important for 2014: ‘productivity growth’ and ‘technological disruption’

China’s labor costs continue to rise by more than 10 percent a year, land costs are pricing offices out of city centers, the cost of energy and water is growing so much that they may be rationed in some geographies, and the cost of capital is higher, especially for state-owned enterprises. Basically, all major input costs are growing, while intense competition and, often, overcapacity make it incredibly hard to pass price increases onto customers. China’s solution? Higher productivity. Companies will adopt global best practices from wherever they can be found, which explains why recent international field trips of Chinese executives have taken on a much more serious, substantive tone.

This productivity focus will extend beyond manufacturing. In agriculture, the pace at which larger farms emerge should accelerate, spurring mechanization and more efficient irrigation and giving farmers the ability to finance the purchase of higher-quality seeds. Services will also be affected: for companies where labor is now the fastest-growing cost, a sustained edge in productivity may make all the difference. And in industry after industry, companies will feel the disruptive impact of technology, which will help them generate more from less and potentially spawn entirely new business models. Consider China’s banking sector, where bricks-and-mortar scale has been a critical differentiator for the past two decades. If private bank start-ups were allowed, could we see a digital-only model, offering comprehensive services without high physical costs? Will Chinese consumers be willing to bank online? Absolutely—if their willingness to shop online is any guide.

2. CIOs become a hot commodity

There is a paradox when it comes to technology in China. On the one hand, the country excels in consumer-oriented tech services and products, and it boasts the world’s largest e-commerce market and a very vibrant Internet and social-media ecosystem. On the other hand, it has been a laggard in applying business technology in an effective way. As one of our surveys1 recently showed, Chinese companies widely regard the IT function as strong at helping to run the business, not at helping it to grow. Indeed, simply trying to find the CIO in many Chinese state-owned enterprises is akin to hunting for a needle in a haystack.

Yet the CIOs’ day is coming. The productivity imperative is making technology a top-team priority for the first time in many enterprises. Everything is on the table: digitizing existing processes and eliminating labor, reaching consumers directly through the Internet, transforming the supply chain, reinventing the business model. The problem is that China sorely lacks the business-savvy, technology-capable talent to lead this effort. Strong CIOs should expect large compensation increases—they are the key executives in everything from aligning IT and business strategies to building stronger internal IT teams and adopting new technologies, such as cloud computing or big data.

3. The government focuses on jobs, not growth

Expect the Chinese government’s rhetoric and focus to shift from economic growth to job creation. The paradox of rising input costs (including wages), the productivity push, and technological disruption is that they collectively undermine job growth, at the very time China needs more jobs. Millions and millions of them. While few companies are shifting manufacturing operations out of the country, they are putting incremental production capacity elsewhere and investing heavily in automation.

For example, Foxconn usually hires the bulk of its workers for a given 12-month span just after the Chinese New Year. Yet at the beginning of last year, the company announced that it wouldn’t hire any entry-level workers, as automation and better employee retention had reduced its needs. Although upswings in the company’s hiring still occur (as with last year’s iPhone 5S and 5C release), the gradual rollout of robots will probably reduce demand for factory workers going forward. In short, many manufacturers—both multinational and Chinese—are producing more with less.

So as technology enables massive disruptions in service industries and sales forces, what happens to millions of retail jobs when sales move online? To millions of insurance sales agents? Millions of bank clerks? Even business-to-business sales folks may find themselves partially disintermediated by technology, and rising numbers of graduates will have fewer and fewer jobs that meet their expectations. They will not be happy about this and may not be passive. Finally, while state-owned enterprises will feel pressure to improve their performance, to use capital more efficiently, and to deal with market forces, they are likely, at the same time, to face pressure to hire and retain staff they may not really need. The government and the leaders of these enterprises have long argued that such jobs are among the most secure. They will find it very hard to declare them expendable.

4. There will be more M&A in logistics

As everyone pushes for greater productivity, logistics is a rich source of potential gains. State-owned enterprises dominate in capital expenditure–intensive logistics, such as shipping, ports, toll roads, rail, and airports; small mom-and-pop entrepreneurs are the norm in segments such as road transportation. This sector costs businesses in China way more than it should. With upward of $500 billion in annual revenues, logistics is an industry ripe for massive infusions of capital, operational best practices, and consolidation. Driven by the pressure to increase productivity, that’s already happening at a rapid pace in areas such as express delivery, warehousing, and cold chain. Private and foreign participation is increasingly encouraged in many parts of the sector, and its competitive intensity is likely to rise.

5. Crumbling buildings get much-needed attention

While China’s flagship buildings are architectural wonders built to the highest global standards of quality and energy efficiency, they are unfortunately the exception, not the rule. Much of the residential and office construction in China over the past 30 years used low-quality methods, as well as materials that are aging badly. Some cities are reaching a tipping point: clusters of buildings barely 20 years old are visibly decaying. Many will need to be renovated thoroughly, others to be knocked down and rebuilt. Who will pay for this? What will happen if residential buildings filled with private owners who sank their life savings into an apartment now find it declining in value and, perhaps, unsellable? Alongside a wave of reconstruction, prepare for a wave of local protests against developers and, in some cases, local governments too.

6. The country doubles down on high-speed rail

When China inaugurated its high-speed rail lines, seven years ago, many observers declared them another 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, fuelled partly by aggressive ticket prices. Demand was simply underestimated. Now that trains run as often as every 15 minutes on the Shanghai–Nanjing line, business and retail clusters are merging and people are making weekly day-trips rather than monthly two-day visits. The turnaround of ideas is faster; market visibility is better; and many people come to Shanghai for the day to browse and shop. There are already more than 9,000 kilometers (5,592 miles) of operational lines—and that’s set to double by 2015. If the “market decides” framing of China’s Third Plenum applies here, much of the investment should switch from building brand-new lines to increasing capacity on routes that are already proven successes.

7. Solar industry survivors flourish

Many solar stocks, while nowhere near their all-time highs, more than tripled in value in 2013. For the entire industry, and specifically for Chinese players, it was a year of much-needed relief. By November, ten of the Chinese solar-panel manufacturers that lost money in 2012 reported third-quarter profits, driven by demand from Japan in the wake of the Fukushima disaster. (Japan’s installed capacity quadrupled, from 1.7 gigawatts in 2012 to more than 6 gigawatts by the end of 2013.) Domestic demand also picked up as the State Grid Corporation of China allowed some small-scale distributed solar-power plants to be connected to the grid, while a State Council subsidy program even prompted panel manufacturers to invest in building and operating solar farms—an initiative that will ramp up further.

This year is likely to see even stronger demand. Aided by international organizations, including the World Bank, an increasing number of developing countries (such as India) regard scaling up distributed power as a way of improving access to electricity. In addition, solar-energy prices continue to fall rapidly, driven down by technological innovations and a focus on operational efficiency. While I’m on green topics, I’ll point out that the coming months are also likely to see another effort to create a real Chinese electric-vehicle market. The push will be centered on the launch of the first vehicle from Shenzhen BYD Daimler New Technology.

8. Mall developers go bankrupt—especially state-owned ones

Shopping malls are losing ground to the online marketplace. While overall retail sales are growing, e-retail sales jumped by 50 percent in 2013. Although the rate of growth may slow in 2014, it will be significant. Yet developers have already announced plans to increase China’s shopping-mall capacity by 50 percent during the next three years. For an industry that generates a significant portion of its returns from a percentage of the sales of retailers in its malls, this looks rash indeed. If clothing and electronics stores are pulling back on the number of outlets, what will fill these malls? Certainly, more restaurants, cinemas, health clinics, and dental and optical providers. But banks and financial-service advisers are moving online, as are tutorial and other education services.

I expect malls in weaker locations to suffer disproportionately. These are often owned by smaller developers that can’t afford better locations or by city-sponsored state-owned developers that are expanding into new cities. The weak will get weaker, and while they may be able to consolidate, it’s more likely they will go out of business.

9. The Shanghai Free Trade Zone will be fairly quiet

In early October, there was much speculation about the size of the opportunity after the State Council issued the Overall Plan for the China (Shanghai) Pilot Free Trade Zone (FTZ), and the Shanghai municipality issued its “negative list” of restricted and prohibited projects just a few days later at the end of September. For the FTZ, the only change so far appears to be that companies allowed to invest in it will not have to go through an approval process. As for the negative list, while there’s a possibility that Shanghai will ease the limitations, for the moment the list very much matches the categories for restricted and prohibited projects in the government’s fifth Catalog of Industries for Guiding Foreign Investment. This ambiguous situation gives the authorities, as usual, full freedom to maintain the status quo or to pursue bolder liberalization in the FTZ in 2014 if they see a need for a stimulus of some kind. On balance, I’d say this is relatively unlikely to happen.

10. European soccer teams invest in the Chinese Super League

I know, I know—I’m making exactly the same prediction I did a year ago. True, Chinese football has battled both corruption and a lack of long-term vision. It’s also true that the Chinese Super League still trails Spain’s La Liga and the English Premier League in television ratings. That’s in spite of roping in stars such as Nicolas Anelka and Didier Drogba (who both returned to Europe this year) and even David Beckham (as an “ambassador”).

At least this year some things started to improve. After all, Guangzhou Evergrande just won Asia’s premier club competition—the AFC Champions League—a year after hiring Italy’s seasoned coach Marcelo Lippi. This international success could be temporary, but there is a shared sense in China that something has to change because there is so much underleveraged potential. Maybe Rupert Murdoch’s decision to invest in the Indian football league will precipitate more openness among Chinese football administrators? Perhaps the catalyst will be the news that the Qatari investors in Manchester City also invested in a New York City soccer franchise? An era of cross-border synergies from the development and branding of sister soccer teams is coming closer.

Finally, something that’s less a prediction than a request. Can we declare the end of the “BRICs”? When the acronym came into common use, a decade ago, the BRIC countries—Brazil, Russia, India, and China—contributed roughly 20 percent of global economic growth. Although China was already the heavyweight, it did not yet dominate: in 2004, the country contributed 13 percent of global growth in gross domestic product, while Brazil, Russia, and India combined contributed 9 percent, with similar growth rates. Compare that with the experience of the past two years. China accounted for 26 percent of global economic growth in 2012 and for 29 percent in 2013. The collective share of Brazil, Russia, and India has shrunk to just 7 percent. It’s time to let BRIC sink.

In this podcast, author Gordon Orr discusses some of his predictions for the coming year in China with fellow McKinsey directors Nick Leung and Guangyu Li.

Download a PDF of this article

About the author

Gordon Orr is a director in McKinsey’s Shanghai office. For more from him on issues of relevance to business leaders in Asia, visit his blog, Gordon’s View.

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China’s teachers seeking better pay Mon, 06 Jan 2014 08:55:52 +0000 Stress in the teaching profession in China has been growing for years, in some ways a quite similar development to the medical profession. In the era before there were many high-paying jobs for the middle classes in China, the prestige of being a teacher was a significant reward. But over the last 20 years, the relative prestige of the profession has fallen and the relative pay has fallen even faster.

With the state as a monopoly employer it is hard to push back and demand higher wages. This has led to widespread gifting and payment of fees to teachers for a variety of explicit reasons, but implicitly to shift their incomes to a level more commensurate with private sector roles. All well and good in cities where parents have the income levels to afford to do this. In poorer cities, the pressure valve is now becoming industrial action. For example, at the end of 2013, teachers in Huanggang city, Hubei province, reportedly went on strike to claim higher wages and unpaid benefits.

More broadly, the differential between wealthier and poorer areas is amplifying. From official yearbook data, Shanghai teachers earn more than twice what those in Guizhou earn. Teachers in Shanghai have classes that are 40% or so smaller. And on average, they are a decade younger, reflecting the difficulties of attracting young teachers into poorer towns and rural areas. Even in Shanghai, average teacher age appears to be in the late 30s. How adaptive are such teachers going to be to the rapid and radical changes in available education technology? Little wonder that spending on private tuition is growing so fast.

One reason that local government spending on personnel needs to rise (hopefully at the expense of some of the spending on infrastructure) is to lift teacher incomes to the level at which it becomes attractive for quality graduates from the younger generation to enter – and remain – in the profession.


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Public holidays in China Fri, 03 Jan 2014 06:49:41 +0000 The General Office of the State Council finally got around to confirming the public holiday schedule for 2014 in mid-December, less than 8 weeks before the biggest holiday of the year. Most of it was predictable – the long mandated holidays with make-up work days on the weekend could largely be guessed – but it remains odd that they have to be guessed and are not laid out several years in advance.

One change that was not anticipated was to abolish the public holiday on Lunar New Year’s Eve. An understatement to call this unpopular as it will make it very difficult for many if they have to work the full day before travelling home, in town or elsewhere, for the traditional family dinner.

Beyond this specific issue, there is the increasingly urgent question of how long the current system of mandated nationwide extended vacations can continue. Originally created for good reasons, primarily to ensure that workers, especially factory workers, did indeed get vacation, and secondarily, to seek to stimulate spending, they are becoming less effective or even necessary. The swamping of transport and vacation facilities that result from the concentration of travel is increasingly putting off those who might travel and imposing enormous strains on the system. As more and more of urban China enters the middle class, their expectations for more flexible vacation arrangements only rises.

It would be a further sign of a maturing of the Chinese economy and of growth in services industries, which lend themselves to more flexible vacation schedules, if the government shifted its focus from mandating public holidays towards increasing the mandatory minimum vacation dates that employers must provide, and then spend its time ensuring that regulations are adhered to. For manufacturing enterprises, there could be a shift towards the model previously used in Europe of staggering some of the vacation periods, with companies in one region having mandated vacation periods that do not overlap with those in an adjacent region or city.

An optimistic reading of the lack of a long term schedule for public holidays is that some of this change is being readied for 2015.


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How they fell: The collapse of Chinese cross-border listings Thu, 26 Dec 2013 07:18:58 +0000 As the China–US IPO pipeline restarts, recent history offers lessons for companies, investors, and regulators.

December 2013 | by David Cogman and Gordon Orr

Amid the frenzy around Twitter’s $1.8 billion IPO on November 7, it would have been easy to miss a pair of small Chinese IPOs in New York a week earlier. Qunar, the Chinese travel-booking service, raised $167 million on November 1, with share prices rising 89 percent above the initial offering. The day before,—a Chinese version of Craigslist—raised $187 million, exceeding the initial offering by 47 percent.

Do these IPOs—and three others this year—mark a broader return of Chinese cross-border listings in the United States? It’s too early to tell; after all, Qunar’s listing was the second from a reputable company in a well-understood industry.1 And fit neatly into the sweet spot of US tech-industry analysts. These are among the first major Chinese listings in the United States after more than 100 Chinese companies were delisted or suspended from trading on the New York Stock Exchange in 2011 and 2012 as a result of fraud and accounting scandals. The fallout of that episode, which destroyed more than $40 billion in value, continues to reverberate through the investment community and in subsequent lawsuits.

Cross-border listings play an increasingly important and valuable role for companies and investors in an ever-more-global economy—and they do promote the mobility of capital, competition between exchanges, and greater strategic flexibility for companies. But if they are picking up again, understanding the episode and its lessons is important for both executives and investors if we are to avoid a repeat.

The story behind the story

Many observers at the time viewed the massive loss of value as a simple story: the companies never should have listed in the United States in the first place, and investors were drunk on China’s vigorous growth during the early years of the new millennium.

The real story was more complex. Primary responsibility falls on the companies whose malfeasance precipitated such a strong reaction from investors. Yet in many ways, the process also got ahead of itself: companies and their managers were ill prepared to meet the expectations of foreign markets, and the infrastructure was unprepared to supervise cross-border listings adequately. Even in the 1990s, such listings were mostly limited to a few accidents of corporate history, where a company had roots in more than one region. As the stock exchanges consolidated and sought global scale, companies found themselves able to choose overseas exchanges based on the characteristics of the market, the availability of capital, and the sophistication of investors. Regulators were—and still are—structurally incapable of enforcing policy across borders. And investors themselves were unaware of the fragility and weakness of their protections in cross-border listings.

Three waves of listings

When Chinese companies began to list in the United States, they came in three waves between 1990 and 2010. The first arrived in the 1990s, after privatization and at the direction of Chinese regulators, who recognized that the largest and most prestigious Chinese companies would benefit from the capital and governance standards that nascent domestic markets could not provide. Their hope was that listing in Hong Kong or New York would compel the companies’ transition from government departments into fully functional corporations—by forming boards, imposing corporate-governance standards, and creating management infrastructure for statutory reporting, for example. New York at the time was the most highly regarded listing location, with the highest governance standards, and it conferred a stature befitting the companies to be listed.

The second wave of listings included more state-owned giants, as well as an increasing number of private companies, many from China’s burgeoning technology sector, including Baidu, Tencent, and Youku. These companies felt that US capital markets offered an environment best suited to their needs, given their concentration of analysts and experience with technology listings. Combined, these first two waves comprised around 100 companies with an average market capitalization of $24 billion as of 2013, representing 48 percent of the total value of Chinese companies listed in New York.

The third wave of listings was larger by number—around 500 companies—though the companies themselves were much smaller, with an average market cap of less than $5 billion. Unable or unwilling to compete for capital in the domestic stock markets with the larger private and state-owned enterprises, many of them looked instead to New York. There, they found ready access to US capital markets and investors who had grown comfortable with US-listed Chinese companies and had considerable appetite for the China growth story.

New York also still held the prestige and brand that had attracted the first wave of listings—and now there was an infrastructure in place to support these IPOs. All major US law firms and banks had a presence in China, as did a group of smaller advisory firms specializing in reverse-merger listings, where an unlisted company acquires a shell that is already listed and registered with the US Securities and Exchange Commission (SEC), bypassing the more rigorous scrutiny of a standard IPO. These tended to be much smaller: as the crisis hit, companies listed by reverse merger had an average market capitalization of only $68 million and represented less than 1 percent of total market capitalization of all New York–listed Chinese companies. As it would turn out, this 1 percent would cause a disproportionate amount of trouble.

The turning point

By early 2011, a series of scandals had developed around companies from the latest wave of listings. Many involved fraud with features that presented particular problems for investors. Almost all involved misrepresentations in financial reporting that would have been missed by a standard audit. Many involved falsification of the underlying documents on which audits relied, particularly commercial banks’ transaction records. This could be detected by a fraud audit or detailed hands-on due diligence, but these are only conducted by exception.2 And while fraud in the most egregious cases was more visible, such as false claims about customers or manufacturing facilities, it was not common for investors to perform this kind of diligence.3

Many of the scandals involved companies that had listed by reverse merger. By June, the SEC had issued an investor bulletin discussing the risks of reverse mergers,4 citing six enforcement actions taken in the preceding months, all against Chinese companies. A mere three months later, the median New York–listed Chinese firm had already lost two-thirds of its value.

The market reacts

Many market observers—as well as the companies themselves—viewed the sell-off as an indiscriminate backlash by the market against any and all Chinese companies. In reality it was anything but. Investors clearly distinguished between small and midcap companies—those with market capitalization below $200 million—and the larger, better-established ones, with market capitalization over $20 billion. Indeed, while median small and midcap companies underperformed the S&P 500 by 40 percent between 2011 and 2013, the median large-cap company outperformed the index by around 15 percent (exhibit).


The collapse of Chinese cross-border listings

Beyond size, other systematic factors such as industry or geographic revenue mix played almost no role in the change in valuations. Moreover, a number of companies performed significantly better or worse than their size would suggest, as investors differentiated among them based on concrete company-specific news, such as major acquisitions, credit downgrades, new-product launches, or patent approvals. In effect, the market decided that the size and reputation of the major companies was the only currency they would accept.

Chinese companies listed on other foreign exchanges were not immune. In spite of the preference for New York listings, many had also listed elsewhere. Of the 160 Chinese companies listed in Singapore, for example, nearly one in ten was delisted between 2011 and 2013, collectively valued at $27 billion, or around 5 percent of the exchange’s capitalization.

Hong Kong was a notable exception. Mainland Chinese companies there represented 42 percent of the exchange’s total capitalization, with an aggregate market capitalization of $1.1 trillion.5 Yet the decline in Hong Kong’s “red chips” was only 40 percent as big as that for US-listed mainland companies.6 Why? First, reverse-merger listings are relatively uncommon there, with only one in the past five years, and so most companies go through the heightened scrutiny of an IPO. Second, the city’s securities industry—including its brokerage, equity analysis, accounting, legal, and banking sectors—developed around listings from mainland China and has decades of experience in them. The investment community also has a much stronger network there and is better able than the US investment community to spot leading indicators of problems.

Regulators step in

Regulatory protections failed to prevent this crisis from happening, and once it happened, they failed to remedy it—though through no fault of their own. While the exchanges in question promptly suspended companies’ listings when evidence of fraud emerged, US securities regulators could not themselves take action against the companies or their executives, whose assets were typically in mainland China. Suits against them would end up in Chinese court, where judgments would be hard to enforce.

Instead, regulators focused on the advisers who allegedly misled US investors—auditors in Hong Kong and the United States. Here, too, their hands were tied. Like most countries, China restricts provision of professional services to companies incorporated and licensed locally, which typically means that US-listed Chinese companies are audited by the Chinese subsidiaries of the Big Four US audit firms. These subsidiaries are licensed and supervised by the Chinese, not by a US-based accounting-oversight board whose authority doesn’t extend to foreign audit firms. These subsidiaries resisted releasing their working papers for audits on delisted companies, maintaining that they were covered by China’s extremely broad state-secrets laws.7

They also asserted that Chinese regulators— who have long resisted any form of supervision by foreign regulators—instructed them not to cooperate and that doing so would invite severe criminal penalties.

In July 2013, China’s regulators offered to release audit working papers to the SEC on a case-by-case basis. This is an improvement, but it’s a small one. It enables the SEC to prosecute long after the event—and only after negotiating to get the materials it needs. It does not give the SEC any automatic rights to inspect the auditors’ work, to take action against them without regulators’ support, or to take effective legal action against the companies or their officers.

Companies react

In the aftermath, few companies saw their valuations recover quickly, despite efforts to convince investors of their honesty. Some tried to bolster their share prices with more frequent, more comprehensive investor communications, but no amount of communicating could assuage the market’s wariness. Others explored bringing in a credible new strategic investor whose extensive diligence, managers hoped, would demonstrate reliability. One such deal was successful—Pearson’s acquisition of Global Education and Technology—but other strategic investors remained largely aloof. Still others opted for take-private deals, announcing or completing 27 of them in 2012 and 12 through November 2013—though most were led by second-tier private-equity firms.

Comments from the Chinese executives of delisted companies are revealing. Even before the sell-off, many Chinese executives we spoke to felt US investors didn’t understand them—they were too distant to fully grasp China’s risks and opportunities. Others felt US investors’ analysis was too colored by their familiarity with mature companies in the same sectors at home, where the drivers of growth and profitability were often radically different. After the sell-off, most also felt that, in retrospect, they as a group had been poorly prepared for listing in New York to begin with.8 Many professed to have had little awareness of the regulatory burden it would carry or the challenges of investor relations in the face of a crisis.

Although most of the people we spoke to said their companies had no immediate need for fresh capital, all planned eventually to relist—preferably in China, either on Shanghai’s A-share market or in Hong Kong if they needed foreign capital. This preference was partly economic, but they also felt that investors and analysts there would better understand and be able to value them. Many also expressed a desire to participate more closely in their home market and to see their successes enrich local investors rather than to be at the mercy of foreign investors.

Lessons learned

For such listings to work, there needs to be a regulatory framework that provides transparency and protects investors, a professional-services ecosystem that provides effective quality control for listings, and an investor base with the knowledge and capabilities to understand the businesses properly. If regulators and investors are serious about avoiding similar crises in the future—involving companies from China or elsewhere—there are several lessons to learn.

An equity market is more than just an exchange. Investors rely on a broad ecosystem of professional advisers, equity analysts, brokers, and regulators who perform quality control on the companies that list there. The dangers come when the ecosystem takes on issues that it is not prepared to evaluate. In the major global equity markets, investors take the high standards of this ecosystem for granted, when in fact relying on audited financials and company representations is insufficient in many markets.

The companies involved in this case happened to be Chinese, but the elements that led to fraud there are visible in many other emerging markets, as well as in some developed ones. The lack of quality control is especially concerning with regard to companies originally listed by reverse merger, since this route to market continues to be used. Indeed, on US exchanges, there have been nearly as many reverse mergers per year involving companies after January 2011 as in the preceding five years. That there were far fewer Chinese companies should give investors little reassurance. They need to be aware of the shortcomings of reporting and find ways to fill the gaps, whether through informal channels or through analysts doing investigative diligence.

Gaps in regulatory supervision must be closed. The SEC doesn’t face a problem just with Chinese audit firms but potentially with any audit firm outside its regulatory purview. And the SEC is not the only regulatory agency facing this problem, since every other major capital market could face the same experience, particularly given the growing competition among stock exchanges.

To close the gap between US and Chinese regulations satisfactorily, the countries’ two regulatory agencies must collaborate; both sides urgently need this to happen. The solution offered by the Chinese regulators falls far short of genuine cross-jurisdiction cooperation and to date has not been fully tested. Hence US investors are still forced to take on faith the content of audit reports, and neither they nor regulators have timely mechanisms to take action against frauds.

A company’s choice of listing location must be more thoughtful. It’s a strategic decision that most companies will only make once. They and their advisers must be less driven by emotive factors and prestige and more by economics and an appropriate fit between issuer and location. Although the top-tier equity markets are increasingly similar on liquidity, costs, and valuations, significant differences remain in specialization and ability to understand different types of companies. Just as expertise in mainland Chinese companies is disproportionately concentrated in Hong Kong, for example, Toronto has a concentration of experts in junior miners, London in large resource companies, and the United States in technology companies. US markets are still comfortable with larger and better-known Chinese companies, many of which are significant on a global level, but they are not confident with smaller, less-well-known ones, and valuations reflect this.

Cross-border listings will continue to be valuable for companies, investors, and exchanges alike. The lesson of the Chinese delisting debacle is that each must be more circumspect in their approach and take concrete steps to avoid a repeat.

Download a PDF of this article.

About the authors

David Cogman is a principal in McKinsey’s Shanghai office, where Gordon Orr is a director.



1. Qunar’s parent company, Baidu, has been listed in New York for several years and is extensively covered by US equity analysts.

2. For a more detailed review of this, see David Cogman, “Due diligence in China: Art, science, and self-defense,” July 2013.

3. These events spawned a small industry of analysts and investigators that do this kind of research: it is increasingly becoming a standard feature of diligence in China, even for public-market investors.

4. See Investor Bulletin: Reverse Mergers, US Securities and Exchange Commission, June 9, 2011,

5. H-shares—the Hong Kong listing of mainland-incorporated companies—account for around 21 percent of Hong Kong Stock Exchange capitalization. The red chips, or overseas-incorporated companies controlled by state-owned enterprises, account for an additional 20 percent.

6. Calculated from median decline in P/E ratios in Hong Kong red chips versus US-listed Chinese companies.

7. China’s state-secrets laws cover an extremely broad range of economic information: this includes, for instance, the financial reports for key state-owned companies. While these laws tend to be used only for genuine secrets—nonpublic information with national-security implications—some have been prosecuted for releasing less sensitive information.

8. The majority of delisted companies were, for legal reasons, unable to comment on their situation, and those still trading in the US were similarly unable to discuss their future plans openly.

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Recent reading on China Tue, 24 Dec 2013 12:59:29 +0000 Not sure that too many of us still read books in any format, but committed authors still keep writing. I was looking at my bookcase and then my Kindle this weekend to see what, new and old, books on China I had been referring to recently. In no particular order they were the following. (And no this is not a sponsored post)

  • The Party – Richard McGregor
  • 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
  • Red Capitalism – Carl Walter (How the Chinese stock market works)
  • Stumbling Giant – Tim Beardson
  • Capitalism with Chinese Characteristics – Yasheng Huang
  • Tiger Head, Snake Tails – Jonathan Fenby
  • On China – Henry Kissinger
  • China’s War with Japan – Rana Mitter
  • The Tragedy of Liberation – Frank Dikotter

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


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Japan Inc. rethinks China Mon, 23 Dec 2013 12:09:21 +0000 I just returned back to Shanghai from several days in Japan. For the first time in a very long time the plane was packed. Maybe it was just a holiday season anomaly, but hopefully it was a sign that commercial and tourism links may be turning the corner.

My conversations with Japanese executives as usual focused largely on China. The sense I got from these was of a more purposeful intent to rebuild position, a shift away from the “nothing is going to work” attitude of earlier in the year. They are realizing that the exchange rate shift has made a material difference in their competitiveness in China, and are becoming more specific on which market segments they can access and how.

Consumer companies are becoming more sophisticated, especially when it comes to online marketing. They are promoting company heritage more than national heritage, and focusing on categories, such as air filters, where quality clearly trumps cost as a buying criteria. They are leveraging online sales channels much more aggressively.

Business-focused companies are looking much more seriously at the private sector, particularly areas such as health, tourism and other service sectors, as priority customers.

In Japan, as I mentioned in an earlier post, there is increased interest in recruiting Chinese talent out of Japanese universities. There is also more understanding of the need to design products specifically for the China market, and of the opportunity to sell such product in many other markets internationally. Whether it’s called “Design for China”, “Design to Value”, or simply “Lower Cost Product”, Japanese companies are seeking to expand beyond the high-end markets that have been their natural home.

While politics may always intervene, the intent of businesses seems to be more positive for 2014.


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Chinese students become more visible (and successful) in Japan Fri, 20 Dec 2013 11:35:35 +0000 Chinese students are not only highly present at US universities – with more than 230,000 officially studying this year, an increase of over 20% from a year ago – but they are also increasingly visibly in Japan. At one of Japan’s top university’s advanced management program, a majority of the top students this year were Chinese. It has been common practice for many years for middle-tier Japanese universities to recruit from top Chinese high schools. The practice is now more common at leading universities.

These Japanese-speaking, Chinese high performers are also spreading further afield as they graduate. And giving away a small secret, these students are becoming a great talent source for us at McKinsey. In our recent recruiting trip to the US, we were very excited by a concentration of Chinese who completed undergraduate studies in Japan and were now completing science and engineering PhDs in Boston.


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Oxford University in Shanghai: How to enable future cities Thu, 19 Dec 2013 12:20:36 +0000 Several senior professors from Oxford University, my alma mater, were in Shanghai last week. Their mission was to deliver the first Oxford China lecture (here’s a link to the video of the lecture on Youtube if you are reading this from a location where you can access it). Professor Steve Rayner focused his talk on the Future City, an excellent topic for Shanghai today, with the visible pollution challenge leading many to ask if a significant evolution of the current development model is needed and is possible.

One of the key risks he highlighted was of lock-in (specifically of social-technical lock-in) and path dependency, that decisions made early in a city’s development can create constraints that last hundreds of years into the future and for future generations of city planners to deal with. For example, the street plan of the city of London is still largely that laid out by the Romans. Other examples he used were the enduring nature of the QWERTY keyboard, which was only ever required for hammer key typewriters, and how the diameter of the boosters on the space shuttle were determined by the axle length of Roman chariots (look it up).

In some areas, Shanghai has been terrifically foresighted. Building such an extensive subway and light rail transport system at such an early stage in the city’s development will surely make Shanghai more liveable for future generations. But will the 8 and 10 lane highways through the center of Pudong be as valued? If the individually-owned and operated car becomes less and less common, how much less road space will be needed? How much space will be needed for shopping malls – can they be designed to be easily repurposed into new forms of social meeting space? Are buildings being constructed in ways that allow them to be readily upgraded to incorporate foreseeable technologies that improve energy and water technology but which are not economic today?

An interesting framing of a core challenge for city planners.


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Action on SOE reform in Shanghai Tue, 17 Dec 2013 11:55:04 +0000 Shanghai has moved quickly to take the lead in issuing new guidelines on state-owned enterprise (SOE) reforms.

To frame the changes, three categories of SOE were introduced by Mayor Yang Xiong:

■ Competitive SOEs which focus on maximizing economic returns, while still respecting their social responsibilities.

■ Functional SOEs which focus on completing strategic tasks or major projects, with attention to economics.

■ Public service firms which ensure daily operation of the city.

One goal is to accelerate the introduction of more private capital, both from IPOs and private equity firms. The government aims to step back from day-to-day operation of SOEs, and instead put its efforts into regulating and supervising the market.

The overall industry focus for new investment and growth will be in advanced manufacturing, infrastructure and modern services, with a strong intent to consolidate to scale – with 5-8 competitive MNCs and 8-10 local champions resulting. SOEs are encouraged to explore overseas acquisitions and merger opportunities to achieve these goals, with simplified procedures for doing so.


The announcement also contained some important changes for senior executives

■ Competitive SOEs should separate the position of general manager from that of chairman of the board, who can also be the company’s Party secretary. For functional and public utility SOEs, the same person can be the chairman and general manager, but cannot be the firm’s Party secretary.

■ Compensation systems should adopt more best practices used in other countries and regions.

■ SOE senior executives will be hired based on contracts for limited time periods.

■ Supervision methods should be standardized.

■ Government employees’ performance will be evaluated based on their effectiveness in introducing the reforms.

Financial success is important as 30% of profits are targeted for return to the government by 2020. This is a major public commitment for the mayor and the Party secretary.

Directionally, many of these changes sound positive. Separating commercial entities from public utilities in how they are considered and governed makes lots of sense. Bringing in more capital and a stronger focus on performance are also wise moves. However, if the proposed consolidation of Shanghai SOEs to create local and national champions results in local oligopolies rather than greater competitiveness, the medium-term performance and returns to the government may be disappointing.

As these initiatives get implemented, I hope to see more on governance, specifically the power of boards, and on the authority of management to hire and fire their executive team. And the ambiguity of where to draw the line between economic returns and social responsibility will certainly cause tensions on a regular basis.

But, we should congratulate Shanghai on putting out a signpost that certainly points in a very positive direction.


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Time for China Inc. to invest in Korea? Mon, 16 Dec 2013 12:34:17 +0000 I just returned to Shanghai from a visit to Korea where I was struck by the openness of the discussion on the need for restructuring in many chaebol. This by itself could potentially provide over US$10 billion of investment opportunities in 2014. Add on to this proposed government sales of their stake in various corporations (perhaps another $10-15 billion) and planned private equity exits (possibly $7-8 billion) and close to $30 billion of assets will be up for sale.

It is unlikely there will be sufficient interest from domestic capital to take up all these opportunities. Banks are aggressively reviewing if and where they should pull back their lending, with distressed conglomerates at the top of the list. Interest in corporate bonds is at a several year low. Potentially, foreign private equity funds could pick up a lot of the opportunities, but they have had a mixed welcome in Korea in the past.

So perhaps now is the time for Chinese corporations to make a move? Many of the assets and businesses coming available could well be of interest to Chinese companies. In Korea it has been discussed that China Investment Corporation and ICBC might be interested in financial assets such as Woori Investment and Securities and Woori Bank itself. In the restructurings, potential assets available range from agricultural (where we have seen large-scale Chinese investment around the world this year) to steel to port terminals to technology and engineering and housing construction, all areas where we have seen Chinese companies push forward on their globalization this year. And PE exits might range from beer to heavy industry.

The opportunity is there, Chinese companies have a depth of capital and the level of aspiration to be interested and willing bidders. Will it happen? I suspect the answer lies more in how the Korean government reacts if there is a sudden surge in bids from Chinese private and state-owned enterprises to acquire Korean assets, which remains an open question.

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The coming transformation of China’s trust industry Tue, 10 Dec 2013 15:13:17 +0000 The Chinese trust industry is unique by international comparison. Globally, trust is a legal form used in financial solutions for risk isolation and tax optimization purposes. For example, it is widely used for cross-generational wealth transfer and by philanthropic foundations. In China, however, it refers to a particular type of financial services license enabling it to engage in a number of quite distinct areas of financial services.

Trust companies in China today are primarily engaged in two businesses.

  • ƒPrivate placement investment banking – providing financing to relatively higher risk borrowers, funded by high-net-worth individuals (HNWIs) and corporations/institutions (investors)
  • ƒƒConduit business – providing a conduit to banks and other financial institutions that are restricted from investing into certain asset classes or launching certain wealth management products. Trust is the only financial license that can invest in asset classes spanning across money market, capital markets and unlisted assets (such as loans, unlisted shares, etc.)

The trust industry has seen strong growth in AuM over the last 5 years. It had collected RMB7.5 trillion AuM by the end of 2012 (Exhibit 1), and this number rose to RMB10 trillion by Q3 2013 – more than the insurance and the mutual fund sectors. This rapid increase was due to the inability of the Chinese banking and capital market systems to provide sufficient financing for the fast growing and cash-hungry sectors like real estate and SMEs. Trusts were able to fill this gap in the financial system by bridging this financing need with the investment need in particular of the rapidly growing segment of wealthy investors looking for higher returns. The rise of HNWIs, (defined as individuals with personal investable assets worth over USD1 million or RMB6 million) looking for alternative investment opportunities to low interest rate deposits and long under-performing equities, have been key to generating funding for the industry.

Download the full report here:

The coming transformation of China’s trust industry

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4G in China Tue, 10 Dec 2013 14:19:25 +0000 China’s three mobile operators have received formal permission to roll out their 4G networks. This is likely very good news for consumers and internet companies, maybe for equipment vendors, and probably not for the operators. Higher bandwidth speeds (assuming network congestion does not negate the potential benefits) should finally make mobile video services widely available, possibly creating a revenue source for content providers, but certainly better services for consumers.

Operators are communicating that prices will be lower, perhaps in order to encourage switching and to undercut the attractiveness of all the MVNO (mobile virtual network operators) they are now being forced to license 3G capacity to. Pricing will be very tricky – low enough to attract people onto the networks, not so low as to immediately saturate them, balancing data versus voice tariffs to avoid accelerating the loss of voice traffic to free “Skype”-like solutions from the large internet players.

At the same time as the operators are needing to invest billions in network roll out, they also face losing 30% of their profits in dividends back to shareholders to comply with decisions from the Third Plenum. And to the extent that they utilize debt finance, they are likely to have to pay higher interest rates. The impact on 20 or so MVNO operators on the 3G network should not be neglected either. If even a handful of these entrants create attractive bundled packages of 3G voice and data with their other services, or choose to cross subsidize to increase traffic in their core business, it could further drive down prices and send the operators running off to the regulator to seek relief. It may not be an exciting picture for them.


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Will some cities simply fade away? Tue, 10 Dec 2013 13:43:09 +0000 I recently saw a quantification of the percentage change in population in different parts of China as a result of urbanization, prepared by Jason Sun of Goldman Sachs. The percentage change in population was striking, perhaps less in the urban centers that are growing, but in the provinces and cities that are shrinking.

For example, between 2006 and 2011, the analysis suggests Beijing grew 26%, Tianjin 25% and Shanghai 18%, while Guizhou shrank 10%, and Guangxi and Anhui shrank 6%. Shrinkage is even faster in some cities: Xinxiang shrank 25%, Zhoukou 20%, and Fuyang 19%. A scale of decline that any local government leadership is going to find hard to cope with. A vicious cycle of decline may be precipitated in these cities.

This flow leaves the proportion of the population that is working age (15-64) in the areas of outflow at 70%, ten points lower than areas of inflow. And those that choose to stay have significantly lower educational achievement. Among other things, this makes it harder for companies to justify investing in production under the “Go West” imperative. Yes, Chengdu in particular is a stand out beacon of growth and development, but local markets in many smaller towns and cities are potentially shrinking; certainly not growing at the national average. Qualified talent – even if it is cheaper – is less and less readily available.

These trends have taken place prior to any adjustment in Hukou policy. Cities already facing the fastest declines in population are unlikely to see any benefit from the proposed relaxation; indeed, they could see departures accelerate if people feel it is financially safe for them to move to a slightly wealthier city, if not a tier-one location.

How will such cities support the pensions and social services for their remaining citizens? How will they attract businesses if the demographics of their population tend towards the older and less educated? The employment base erodes, the corporate base erodes and the tax base erodes. It is a problem that cities in many parts of the developed world are familiar with and struggle to find good solutions. China will be looking to develop its own specific solutions in the years ahead.


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Shanghai air pollution Mon, 02 Dec 2013 03:38:32 +0000 I am just leaving Shanghai for Tokyo after another weekend of “taste the air” weather in Shanghai. I am starting to wonder if Shanghai is taking on the imperative to clean up the air with the same vigor as Beijing. Perhaps some complacency crept in when the peaks in Beijing’s pollution attracted such levels of criticism earlier, sparing Shanghai from criticism that objectively it might have deserved? Or is that it is easier for Beijing to get action taken against the largest polluters in adjacent provinces than it is for Shanghai?

Shanghai’s weekend traffic jams are becoming notorious, creating large amounts of pollution themselves. Even the auctioning of car license plates at more than USD10,000 has not stopped the roads filling up. The lightest traffic incident creates traffic jams miles long.

Shanghai has been a leader and role model for the rest of China in so many things economic and commercial. It would be a shame if it failed to be a leader in China in creating a world class environment.

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Why not list in London Sun, 01 Dec 2013 03:35:38 +0000 When the Alibaba listing saga entered a new phase a few weeks back with heightened competition between the New York Stock Exchange (NYSE) and the Hong Kong Stock Exchange (HKEx), I found myself wondering: Why not London? Why do so few Chinese companies list in London? When Alibaba actually initiated discussions with the London Stock Exchange (LSE) just a few days later, I decided to look into it.

China in London?

For close to two decades now Chinese companies have been listing abroad. Few have chosen London, which lags behind Hong Kong, Singapore and New York.

■ Hong Kong: 339 companies

■ Singapore: 98

■ New York (NYSE + NASDAQ): 154

■ London main market: 4 (Air China, Sinopec, Datang International Power Generation Company and Zhejiang Expressway, all state-owned enterprises)

■ London Alternative Investment Market (AIM): 41 (small caps)

Yet, London has one of the highest shares of international listings among exchanges worldwide – above 15%. The US, Canada, Japan, Korea, Egypt, Russia, India all have between 10 and 30 companies listed on the LSE. Clearly London has missed the previous China wave, but why? For the north Asian companies, they generally have an ADR in New York; adding a GDR in London enables trading in their stock to continue seamlessly 18 hours a day. Perhaps that is something Chinese companies should emulate as their non-Chinese shareholder base expands.

With London being a global center for listing energy and natural resources companies, why are there only two Chinese energy companies listed? How about China’s emerging global financial services companies?

Is it the cost of creating and maintaining a listing? Is there a prestige issue? Is there a shortage of relevant analysts covering the market?

Is there a shortage of fund managers in London with a mandate to invest in Chinese stocks? Certainly, the majority of asset managers in London are focused on EMEA, already a pretty broad geographic remit. It is their peers in Hong Kong and Singapore who have the mandate to invest in Asia stocks. Often the fund’s global headquarters is in New York from where they feel able to invest globally and, if they wish, into Chinese stocks listed in New York. The EMEA focus of London based asset managers also means there are relatively few analysts in London with a lens towards China.

Or is it a governance issue? Yes, the U.S. has Sarbanes-Oxley and all that entails, but it also allows foreign private issuers to defer to their place of incorporation for their governance rules (so Cayman Islands or similar for many Chinese tech companies). In contrast, London imposes its own governance requirements on all premium main market listings – certainly an impediment for fast-growing, entrepreneur-driven companies.

Emerging niche?

London does have a niche niche position for Chinese listings of small caps. LSE’s Alternative Investment Market (AIM) has listed 41 Chinese companies in recent years, including 10 in 2012. However, momentum for new listings has declined with no new listing in the first half of 2103, perhaps due to the wave of scepticism around Chinese overseas listings following the issues several have had with reporting accuracy in the U.S. Or perhaps this is due to the stock price decline that hit 7 out of the 10 companies that listed last year.


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From plenum to action Thu, 28 Nov 2013 03:34:22 +0000 I’ve had the chance to listen to a cross-section of Chinese government officials over the last week or so as they recast their priorities to be consistent with the direction of the Third Plenum. They seem to take conclusions from the document at three levels.

The simplest and most direct is where there is a sentence that says X will happen in Y industry. There the focus is pretty much on the when, not the what. The second level is to take the overarching themes, such as the role of the market, and infer how that applies in their area of responsibility. The third is to draw second order consequences from direction in the document that primarily applies to another sector or topic but which could be taken to apply partly to the speaker’s area.

In general, I have been very impressed by the speed with which directions have been internalized and the intellectual agility demonstrated in articulating directions that sound coherent and consistent.

Take today for example – a vice minister talking about urbanization policy.

■ There is the specific statement in the report from the plenum on how government systems will be reformed and relevant bodies diversified. The city planning system in particular needs to move beyond its current “chaos”.

■ Then there is the discussion of how making the role of the market fundamentally changes urbanization policy and processes. Specifically, what are the areas that the government gets out of (e.g. pricing of land) and which (example given of environmental management) does it step up on?

■ Treating the private sector as a full equal of the public sector allows private investment in provision of urban services, a prerogative previously given exclusively to the public sector. The government becomes the procurer rather than provider of services. With the enhanced focus on jobs, the private sector is seen to be the natural engine for providing them.

■ Making local government debt transparent in both its scale and purpose. Consequently establishing a policy finance institution to support social housing.

■ The shift away from GDP growth as the core key performance indicator (KPI). For 50% of towns and cities in 2014, GDP will not be a KPI at all. Less land will be allocated to industrial purposes at any cost, some will be taken back. Industrial businesses will be priced out of urban locations.

A very large and diverse agenda, well laid out. However, implementation will really come down to who controls the money and who evaluates the people who spend it. We will see.

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Where will the jobs come from in China? Mon, 25 Nov 2013 03:33:05 +0000 As I see more and more production lines in China equipped with robots and not workers, as I read about the modularization of housing construction and presumably the reduction in needed workers, and as I write about the impact of e-retail in eliminating many physical retail locations and related jobs, I do increasingly wonder where the next wave of jobs is going to come from, and what skills people will require to fill them.

One force, digitization, is not just going to increase labor productivity in retail, but also in banking. Will there be bank branches in China 10 years from now? For many of us that would not be a loss, but what will happen to these millions of workers? Will there be any B2C direct sales forces, as in insurance, or will China shift rapidly to online sales and comparison shopping? Will our boarding pass need to be checked 4 times in passing through the airport?

A second force comes from multinationals operating in China that are responding to wage inflation but bringing more and more of their global best practices on productivity to China. Local companies observe and learn, applying these solutions to themselves. As advisors, we have a small role to play in this also. We see state-owned enterprises that would not have engaged in a discussion on efficiency 18 months ago, being only too keen to do so today.

Many of the forecasts of job numbers and mix in China, don’t really take into account the potential discontinuities that can result from these two forces

In short, will China get productive, before it gets rich? Will returns pass to capital rather than labor?

What could offset this? Yes, China’s demographic dividend has passed and growth of the absolute work force is slowing. Maybe more workers could remain in agriculture, but even there, mechanization is increasing its penetration. Maybe more workers could upgrade their skills, but do we really believe that former construction workers are going to take readily to service industry skills?

Likely (more than maybe) China’s retirement age will remain remarkably low by international standards, taking tens of millions out of the workforce and paying them little in the way of pensions.

Can I see this being enough? Not really. This remains a problem that I don’t see a good solution to yet.

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A chat with the BBC World Service Wed, 20 Nov 2013 03:30:19 +0000 I recently spoke to Peter Day of the BBC World Service about the rise of the consumer economy, Chinese firms going global, and innovation. You can listen to the full conversation here. Here’s a transcript of my comments:


The rise of the Chinese consumer economy (4:40)

“The underlying trend is clearly moving toward the emergence of a consuming middle class. Say just go back to 2000 and to the average household in a city. Nearly 50% of their spending was just going on basic food stuffs. Now it’s below 30%. That’s why people are starting to pay attention to brands now, because historically, half your expenditure was going on rice, pork, completely unbranded wet market stuff.

It’s been a very strong mindset toward ‘secure my future.’ If I got sick, I need to have the money to pay for the doctor, I need to save some money for my retirement. But equally it’s been saving up to get into the housing market. You pay cash for your house and car, largely. Once you buy your house, that’s such a trigger point for increased consumption. Typically, when you buy your apartment here, you’re buying a concrete shell. And so then you’re paying to furnish it, and everything that goes with that.”


Chinese companies going global (12:25)

“There’s an awful lot, over time, of very large American companies with very strong brands in America that took an awful long time to go international and I do think there are parallels there.

When your domestic market in China is growing at the pace that it is growing here, and it has had the profitability that it has here, the added complexity of going international just seems to be more of a challenge than it’s worth for many of these companies. I think the opportunity to be satisfied here is pretty high. It doesn’t mean that many companies won’t start to go more international.

Take the consumer electronics guys, the fridges and air-conditioners, and the like. Many of them have been exporting massively for years, but to someone else’s brand name. The Gree in air-conditoining and Midea – we don’t know these names internationally, but we have their products in our homes with someone else’s brand name on them.”


Chinese innovation (19:15)

“The shift to becoming more fundamentally innovating is happening very rapidly, it’s happening yes, partly in R&D, but it’s partly in inventing entirely new business models for China. To take a couple of R&D examples, if you look at the biotech space, there are all sorts of Chinese ecompanies that are essentially r&D factories, that are led often by Chinese folks that have been educated at MIT and the like, who are back here, taking advantage of the talent, the capital that is available, the encouragement of the government, and a regulatory environment that actually lets them get product to market very quickly.”

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Reimagining India Wed, 20 Nov 2013 03:28:26 +0000 I spent a recent Friday evening in Chennai at the launch of a new book, Reimagining India. Great panel and conversations afterwards. But it is hard not to reflect after such an event on the contrasts between India and China in government decision-making and execution. In China, after the recent plenum, we now have a pretty clear direction, and indeed some decisions already implemented, that are creating momentum on the agreed action program. Yes, there was a lot of preparatory work and pre-syndication, but we have gone from the decision-making discussion to execution in little more than a week. One may not agree with the policy direction, but it is hard to object to the speed to execution. In India, by contrast, it is a little harder to fathom exactly when the focus on taking action will return. After the state elections this month? The national elections next year? Every country has its own timetable and rhythms, but there needs at some point to be a transition to action.

And yet, below the surface, there are some excellent multinational success stories even in retail in India, stories that need to become more well-known for India to attract additional foreign investment. From North Asia, companies such as Honda in motorcycles, Hyundai in passenger cars, Samsung and LG in consumer electronics, and Lenovo in PCs are all seeing very positive trajectories in their Indian operations. And in retail, as Howard Schultz describes in Reimagining India, Starbucks is developing rapidly in partnership with Tata. Retailers such as Benetton and Marks & Spencer have developed deep local sourcing operations in India and are finding the market more attractive today than China. India Inc does itself a disservice by not highlighting more of the existing success cases.

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Shenzhen 2.0 Thu, 14 Nov 2013 03:26:42 +0000 As we finally opened a McKinsey office in Shenzhen, almost 20 years after we first discussed doing so, I was reflecting on why now? Are we just very late, or has something changed in Shenzhen to make the time right?

From within, what has clearly changed is that we have colleagues who want to live in and make their professional base Shenzhen, and not just colleagues from other offices in the China practice, but Chinese colleagues from around the world who want to move back there. This gives us the critical mass of professionals that we need to open an office.

There are a number of external factors that make Shenzhen stand out, starting with the number of companies, private and state-owned, that make Shenzhen their base ,and in sectors that go well beyond consumer electronics and into financial services, the internet and more. Unlike in a number of other Chinese cities, the leaders of Shenzhen-based companies tend to spend a lot of time in Shenzhen.

Accompanying the growth of Shenzhen-based companies has been a tremendous increase in the quality of the infrastructure, ranging from the quality of office buildings to the new terminal opening at Shenzhen airport next month which is 1.5x the size of Heathrow terminal 5.

Shenzhen is increasingly a magnet for talent who find it easier to become part of the business community than they do if they are new arrivals in Shanghai or Beijing. The quality of life is rising – Shenzhen’s climate is a plus if you are not a fan of winters in northern China, and pollution is much lower than most cities. The size of the international executive community is also growing fast – Shenzhen-based companies seem to be more open to hiring such executives and the city has a growing global reputation as good place to take a position.

Proximity to Hong Kong is a plus, with one of the world’s most efficient border crossings. Not only does it bring executives from Hong Kong into Shenzhen but it gives easy access to Hong Kong services such as the airport with its global connectivity – it can take less than an hour from the office in Shenzhen to the gate at Hong Kong Airport.

Excellent foundations for vibrant future development.

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Progress for soccer in China Sun, 10 Nov 2013 03:20:47 +0000 Congratulations to Guangzhou Evergrande on winning the AFC Champions League, the first Chinese soccer team to win an Asian competition in more than 20 years. Indeed, they also won the Chinese Super League to complete a very special double this season. Interest in the final game against FC Seoul was massive. For the first time in a long time, there was a significant secondary market for tickets to a soccer game in China. Yes, Guangzhou leveraged international experience with a World Cup-winning Italian coach and the maximum permitted number of international players, but no more than teams in the English Premier League.

I just hope their success inspires other Chinese soccer teams to follow, upping the overall standard of soccer played in the Chinese Super League. The potential for soccer to become as large and financially successful as in Europe is absolutely there, and I hope this year is a tipping point in its development.

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Investing in Chinese agribusiness Fri, 08 Nov 2013 04:04:29 +0000 Our experts in agriculture assembled in Beijing recently to meet and debate with the China-based leaders of more than a dozen private equity funds. Their focus was on where in the $1.7 trillion agriculture industry chain in China will there be interesting investment opportunities. Four or five themes came up, described below. I have also added a couple of my own personal viewpoints.

Consolidation Regional champions are starting to emerge across a number of value chain segments, from seed production to retail, and represent attractive platforms for roll-up plays.
Productivity Most value chain segments are in dire need of productivity enhancements, and investors with operational expertise could reap rich rewards in deploying better management practices.
Branding based on safety The rising middle class is increasingly willing to pay a premium for safe and quality food; the branding opportunity also extends to B2B, with leading brands willing to pay more for providers of quality inputs
Convenience Pull for ready to eat foods and adult nutrition is becoming increasingly strong. Frozen dumplings are an early success case of what is likely to happen in many other categories.
Cross-border investment Chinese corporates and investors are increasingly going abroad to secure land, production and technology. From the Ukraine to New Zealand they are investing in land, cereal production, dairy and multiple value added categories.
Water Water scarcity is a well-known issue for farmers. Solutions to manage available water more efficiently will be in high demand. Over and above this, demand for sufficiently clean water – at least 20% is too polluted for use today – to grow food safely will expand even faster.
Farm Mechanization A decade from now there may be 100 million fewer farmers in China and consolidation of farmland may have tripled average farm size. This in turn leads to increased mechanization.
Cold Storage Cold chain penetration is rising fast, but remains below 20% for meat and vegetable. Lack of refrigerated vehicles and non standard regulations are contributing factors. Probably the prohibitive cost of land to build facilities is one of the most significant factors. Those able to access land in good urban locations at a reasonable cost are likely to be very successful.

What are your bets for interesting opportunities?

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In search of new growth models for big pharma in China Fri, 01 Nov 2013 02:58:50 +0000 The Chinese pharmaceutical market has emerged as a major driver of revenue growth for global pharmaceutical companies, according to a new report.

The Chinese pharmaceutical market has emerged as a major driver of revenue growth for global pharmaceutical companies, according to a new report published today, “In Search of New Growth Models for Big Pharma in China.” The report was written by McKinsey & Company as Knowledge Partner of the PharmAsia Summit-Shanghai 2013, and published in collaboration with Elsevier Business Intelligence and BayHelix Group, co-organizers of the Summit. Their analysis shows that China’s pharmaceutical market has grown at a rapid 21% compound annual rate over the past five years, reaching 0.6 trillion renminbi (US$98 billion) in retail sales value in 2012. In a recent forecast developed jointly by McKinsey and the China Pharmaceutical Association, China’s pharmaceutical market is projected to continue to grow at around 17% annually through 2020. By then, the market is expected to reach 1.9 trillion renminbi in retail sales value (US$310 billion). Most experts agree that China is likely to become the second-largest pharmaceutical market by 2020, and ultimately, the largest one in the world.

On average, China sales of the top 10 multinational pharmaceutical firms accounted for 3.8% of their global business in 2012, up from 3% just a year earlier. For some companies, the figure is already much higher, reaching 8% to 10%. For many pharmaceutical firms, China is now a key contributor to absolute value growth in global revenues, a trend exacerbated by ongoing pricing and access pressure in Europe and the US, as well as a global wave of patent expirations.

The report shows a substantial increase in revenues among the top multinational pharmaceutical companies in China. From 2005 to 2012, the top 10 companies saw their cumulative sales leap from $2.5 billion to $12.3 billion. Sales of individual brands of drugs are also rising: eighty-five brands of drugs topped $50 million in sales in 2012, compared with just eight brands in 2005. In 2012, the single largest-selling prescription-drug brand reached nearly half a billion dollars in sales, up from just $110 million for the largest drug brand in 2005.

The report is based on research that included a survey of 50 pharmaceutical industry leaders in China. According to the survey, 90% of executives said China is already a top five global strategic priority for their company, while 65% said it would be among their top three global strategic priorities within five years.

Such optimism is fueled in part by the substantial long-term growth potential of China’s pharmaceutical market. The Chinese government is doing its part to promote more spending on this sector, and has established a target for healthcare spending at 7% to 7.5% of GDP by 2020. While higher than the current level of 5.6%, this still falls short of the 18% of GDP in the US, and 12% of GDP in France.

Per capita spending on healthcare in China is also expected to remain low by 2020, suggesting substantial opportunity for further growth in demand. China’s expected per capita spending on healthcare is set to reach just $710 by that year, compared with a projected $5,100 per person in Western Europe and $12,200 in the US.

The incidence of chronic disease will continue to be a major driver of spending on healthcare in China, with treatment accounting for 68% of total healthcare spending today. Recent epidemiology data suggest that the prevalence of diabetes in the Chinese population has historically been underestimated, and is already comparable to that of the US population. Further, Chinese patients still have very limited access to important drug therapies for cancer or immune disorders, representing both a challenge and an enormous opportunity for multinational drug makers.

Multinational drug makers face a number of hurdles in their quest for greater access and faster growth in China. In the survey conducted by McKinsey, 84% of respondents cited the lack of reimbursement for innovative drugs as either a very significant or the most significant barrier to market growth in the near term. Furthermore, 74% cited intensifying pricing pressure, while 70% pointed to the slow registration process for new drugs currently in place, as additional barriers to growth.

Multinational firms have also been ramping up investment in R&D: the number of R&D centers in China has more than quadrupled over the last decade, increasing from seven to 30. Given the enormous market potential, multinational pharmaceutical companies are planning to keep up the pace of investment in R&D in China, with annual spending expected to grow at a compound annual rate of 15%, according to RDPAC, an association of leading R&D-based foreign pharmaceutical makers in China. In the survey of pharmaceutical executives conducted by McKinsey, 88% agreed that forming partnerships with local R&D firms is a major lever for improving their R&D capabilities and outcomes in China.

“China represents a unique opportunity for the pharmaceutical industry. The demographics are undeniable: huge unmet needs, an aging society, and the adoption of Western lifestyles. But real challenges remain, from rising pressure on pricing and costs, as well as emerging reimbursement and access trends, to the government’s drive to reform the operating model of public hospitals. Players need to formulate new strategies if they hope to continue to capture the tremendous opportunity for growth offered by China”, said Franck Le Deu, Partner and leader of McKinsey’s Healthcare Practice in Greater China.

“Our report points to a recognition that innovative drugs are required to differentiate portfolios in China and maintain premium pricing. Industry executives will accelerate the introduction of global innovative products, working with their China-based R&D units and, increasingly, with local partners that can help speed the development of drugs for the Chinese market”, said Joshua Berlin, Head of Emerging Markets at Elsevier Business Intelligence.

“Companies will need to increase engagement with central and local governments to help shape the market, collaborating on new schemes that increase affordability and outreach. And bolder and bigger partnerships will be needed to capture the vast opportunity and minimize risk. Without doubt, the next 12 months will prove as eventful as the past 12 months,” said Jimmy Zhang, Chairman of BayHelix Group.


About Elsevier Business Intelligence
Elsevier Business Intelligence (, a global leader in the field of healthcare industry information, provides business intelligence on regulatory, business and reimbursement issues that are vital to the healthcare industry. Through a range of products including publications, conferences, e-learning, databases and reports, Elsevier Business Intelligence places biopharma and medical device professionals, and those who focus on these industries, at the forefront of knowledge, by providing the perfect combination of news and information together with penetrating insight and analysis. Our leading publications include PharmAsia News, IN VIVO and “The Pink Sheet.”

About BayHelix
BayHelix ( is an organization of leaders of Chinese heritage in the global life sciences and healthcare community. We aspire to shape the growth of the life sciences and healthcare industry around the Pacific Rim and beyond, foster and create business opportunities, supply and nurture the leaders for the community, and network and share information and experience. BayHelix is a non-profit organization and its membership is by-invitation-only.

About McKinsey & Company in Greater China
With over 8000 consultants deployed from over 100 offices in 60 countries, McKinsey & Company is a global management consulting firm that advises companies and public institutions on issues concerning strategy, organization, operations, and technology. McKinsey’s Greater China Practice comprises offices located in Beijing, Hong Kong, Shanghai and Taipei. McKinsey has completed nearly 2000 projects in Greater China within the past two decades, helping leading local enterprises improve their management skills and boost their global competitiveness, as well as advising multinational companies seeking to expand their business in the region. Visit for more information.

For further information, please contact

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Are Asian CEOs built to last? Fri, 25 Oct 2013 04:00:21 +0000 CEOs of large Asian companies face many of the same challenges of their counterparts from other parts of the world – but on steroids. They have to capture the growth wave in emerging economies, which also happen to be their home market. They have to constantly cultivate and add new talent able to lead fast-growing and increasingly complex corporations. They need to leverage technology in much more fundamental ways with a very limited capability set in the organization. Given these often more extreme challenges, I took a look at where Asia’s CEOs come from, and how long they stay in the role.

Where do they come from?

We analyzed the 3,000 largest listed companies in the world. A sixth (465 companies) are from Asia. The most material factor differentiating Asia is the significantly larger proportion of externally hired CEOs. In Greater China and South Korea, they are even in the majority.



Digging further, we found that Asian CEOs that are hired into the role are younger – by almost 0.5 and 3 years compared to their European and North American counterparts, respectively. But Asian CEOs that are promoted to the role are 1.5 and 4 years older than their North American and European counterparts, respectively. They have also spent 11 years in the company, more than promoted CEOs in any other region.




How long do they last?

Much is written about the short time the average CEO of Western companies remain in their role. For hired CEOs in our sample, those in Asia average about half a year longer in their role than those from other parts of the world. For promoted CEOs though, those in Asia average almost a year and a half less1. In other words, Asia sees more CEOs hired from outside than other regions, and they seem to survive in the role longer.




Why might that be? I believe that in some cases it is because the rapid growth of the company has outstripped the ability of the internal candidate to grow at the same pace. In others, it is because the basis of success (perhaps previously a “land grab” of unaddressed market potential) has shifted to a radically different skill set (perhaps operational excellence) that no one in the leadership team possesses.

1: Tenure of current CEOs in the role as of August 14, 2013

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Urban world: The shifting global business landscape Tue, 22 Oct 2013 10:57:09 +0000 Emerging markets are changing where and how the world does business. For the last three decades, they have been a source of low-cost but increasingly skilled labor. Their fast-growing cities are filled with millions of new and increasingly prosperous consumers, who provide a new growth market for global corporations at a time when much of the developed world faces slower growth as a result of aging. But the number of large companies from the emerging world will rise, as well, according to a new report from the McKinsey Global Institute (MGI). This powerful wave of new companies could profoundly alter long-established competitive dynamics around the world.

Our research shows that the emerging economies’ share of Fortune Global 500 companies will probably jump to more than 45 percent by 2025, up from just 5 percent in 2000 (Exhibit 1). That’s because while three-quarters of the world’s 8,000 companies with annual revenue of $1 billion or more are today based in developed economies, we forecast that an additional 7,000 could reach that size in little more than a decade—and 70 percent of them will most likely come from emerging markets.1 To put this dramatic shift in the balance of global corporate power in perspective, remember that many of the world’s largest companies have maintained their current status for generations: more than 40 percent of the 150 Western European companies in last year’s Fortune Global 500 had been founded before 1900.

Exhibit 1

In 2025, almost 230 Fortune Global 500 companies will be based in the emerging world’s cities, up from 24 in 2000.


A wake-up call for CEOs

Corporate leaders can’t afford to be complacent about a change of such magnitude. In fact, we have seen all this before. In the 1970s and 1980s, Japanese carmakers began gaining global market share and, in some cases, outcompeted their US counterparts. More recently, South Korea’s Samsung has weakened Apple’s grip on the global smartphone market. In the decade ahead, this type of story will play out on a much bigger scale, and the rate at which newcomers topple industry leaders will probably accelerate.

Such up-and-coming companies could disrupt entire industries by designing superior products at lower cost, by bringing them to market faster, and by streamlining business processes. Many of these businesses, having been nurtured in difficult operating environments, are not only more agile than their counterparts from advanced economies but also prepared to invest for the long term, even if this cuts earnings in the next few quarters. Many new players will be setting their sights on expanding into international markets. Business leaders will have to monitor trends constantly to spot new markets and competitors. They need to meet three imperatives.

  1. Optimize sales networks. The growth of new businesses is not only a competitive threat to older ones but also gives suppliers and service providers a significant opportunity. B2B companies will need to assess how to organize themselves so they can sell to a much more diverse and dispersed customer base. To do so, they must rethink (and perhaps redeploy) their sales networks.
  2. Understand how customers and competitors are evolving. New industry hotspots will be sources of both competition and demand, so companies must track up-and-coming hubs in emerging regions. Hsinchu (in northern Taiwan) and Brazil’s Santa Catarina metropolitan district, for example, may not be household names, but they are already hubs for multiple billion-dollar companies in industries such as advanced electronics.
  3. Reconsider the headquarters configuration and the location of other core activities. Already, many businesses find that the traditional single-headquarters model no longer meets their needs. Companies such as Caterpillar and General Electric have thus split their corporate centers into two or more locations that share decision making, production, R&D, and service leadership. Unilever created a second headquarters, for global development, in Singapore, which now has key members of the company’s senior-leadership team.

A big opportunity for cities

Today, just 20 major cities host one-third of all large companies. Tokyo is by far the leading hub, with more than 600 large companies. Only nine other cities around the world are home to 100 or more of such companies’ head offices (Exhibit 2).

Exhibit 2

Of the 20 cities with the largest number of big companies, only 5 are in emerging regions.


In emerging regions, the leading cities for business today are likely to capture a disproportionate share of company growth in the future. The number of large companies based in São Paolo, for instance, could more than triple by 2025. Beijing and Istanbul could have more than twice as many head offices as they do today. Yet company headquarters will become more dispersed across the emerging world: about 280 of its up-and-coming cities could host a large company for the first time, thus becoming new hubs in global industry networks.

Although many city officials focus on luring corporate head offices, relatively few companies actually move them. But as thousands of global businesses expand into new markets, giving themselves a real choice of locations, the more promising opportunity for cities lies in attracting foreign subsidiaries. China is without a doubt the most powerful growth engine for new global companies, and now is the time for forward-thinking cities to build their reputations among its business leaders. The largest foreign subsidiaries cluster heavily in just a few key cities in each region of the world. Thanks to the highly effective efforts of Singapore’s economic-development board, that country is far and away the location of choice for Western multinationals setting up operations in Asia’s emerging economies. Other cities should learn from Singapore’s approach.

The quality of the business environment isn’t the only consideration. Cities with reputations for a high quality of life—such as Prague, Sydney, and Toronto—have been more successful than others in attracting the foreign operations of multinationals. But in selecting locations for future expansion, the emerging world’s more diverse companies may consider a broader set of criteria, including the personal ties of executives educated abroad, the need to diversify family holdings, reputation building at home, or an exceptional willingness to enter frontier markets.

The rebalancing of the global business landscape will probably be even faster and more dramatic than the shift of economic growth to emerging regions. Large companies matter, and not just for their ability to create jobs and generate higher incomes; they are also forces for increased productivity, innovation, standard setting, and the dissemination of skills and technology. Their geographic shift will have profound implications for the nature of competition, including not only the race for resources and talent but also, more broadly, the emerging markets’ efforts to reach the next level of economic development and prosperity.

About the authors

Richard Dobbs, James Manyika, and Jonathan Woetzel are directors of the McKinsey Global Institute, where Jaana Remes is a principal; Sven Smit is a director in McKinsey’s Amsterdam office.


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Changing rules of the road for China’s auto industry Tue, 22 Oct 2013 10:56:04 +0000 In many areas of the Chinese economy, from refrigerators to computers and banking to consumer goods, domestic players have captured the lion’s share of the enormous market. There is only one glaring exception: autos. Even after the government plowed billions into building up domestic champions, Chinese auto makers account for fewer than 30% of the new cars sold in China each year. This week’s Shanghai Auto Show is a good time to consider why that is and how local firms can change it.

Chinese auto makers have achieved impressive success, building their 30% market share from virtually zero 15 years ago mainly by delivering relatively inexpensive cars to a large number of first-time car buyers. They also are closing the quality gap with their international peers in surveys such as the J.D. Power and Associates Initial Quality Survey, although a gap still remains.

But their share has remained relatively flat in the past five years. This suggests they already have plucked the low-hanging fruit in the marketplace. Further success will hinge on their ability to adapt to a more sophisticated auto market.

China is the world’s largest car market, and it’s growing rapidly. As the market expands, new opportunities also will arise for car makers. They’re currently focused almost exclusively on selling new cars. But as the number of cars in circulation increases, consumers will have new needs. For instance, if auto makers can help develop a used-car market, they would boost resale values, encouraging car owners to trade in their older models for newer ones more often.

However, to capitalize on all this potential, car makers need to navigate around several speed bumps. One is the possibility that Beijing may impose stricter emissions, fuel efficiency and quality standards in response to broader environmental worries. Such a move would require Chinese car makers to develop costlier engines, but without the kind of brand reputation that would allow them to offset the costs with higher car prices.


Associated Press
Visitors look at a Dongfeng EQ2050 at the Shanghai International Automobile Industry Exhibition.

Consumers also will place new demands on auto makers as they become more sophisticated shoppers. While earlier generations of car buyers tended to focus mainly on exterior styling, today’s buyers are paying more attention to safety features and the overall driving experience. Today’s buyers also seek better customer service both in the showroom and in the dealer’s garage after a purchase. Chinese car makers still lag their foreign competitors in providing such after-sales service.

Another competitive threat is that foreign car makers increasingly are muscling into the budget-car segment traditionally dominated by domestic manufacturers. This will accelerate as the foreign companies boost their presence in lower-tier cities where budget buying is more prevalent.

Compounding all of these challenges is the declining profitability of domestic car makers. Although the demand is huge, local firms don’t always meet that demand in the most efficient way, and produce too many models that aren’t quite right for Chinese auto consumers while being costly to manufacture. Narrower profit margins and less support from local governments will make it ever harder for companies to invest in developing new products.

None of these challenges is insurmountable, but car makers will need to act quickly to address them. They should focus on three areas when doing so.

Especially with lower profitability eating into R&D budgets, car makers need to focus on delivering cars consumers want, and only cars consumers want. One problem has been the strategy of underpricing and overdelivering on starter cars. Almost all China-branded budget cars include expensive features such as anti-lock braking systems and luxury touches such as leather seats that consumers don’t really want at that level anyway. Car makers should invest more heavily in market research to understand their consumers.

Also on the theme of efficient investment, Chinese car makers need to be more willing to collaborate with other companies, including their competitors. It’s not unheard of for competing car companies in the West to strike deals whereby, say, one offers to the other a license on one technology in exchange for a license to use one of the second company’s technologies. China’s GAC and Chery recently signed such a three-year agreement to collaborate on certain R&D projects, but in general domestic firms still are too unwilling to work together with their peers.

Finally, car makers need a change in product strategy. They still offer too many models in a futile attempt to be all things to all consumers. Chery, for instance, offers 10 models but only three sold more than 40,000 units in 2012, and those three accounted for 76% of total sales volume. Focusing on such winners will reduce costs by cutting down on manufacture of cars no one wants to buy, and also enable much higher R&D spending to improve models consumers do want.

China’s auto makers have made great strides in a short period of time. But if they hope to compete with international players, even on their own turf, they’ll need to rethink how they design, build and market cars. Opportunities abound. New customers and new businesses are waiting to be created. The market is theirs to lose.

Messrs. Wang, Gao and Krieger are partners with McKinsey & Company’s automotive practice in China.

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A new direction in Chinese banking Tue, 22 Oct 2013 10:55:15 +0000 Shifting from primarily servicing larger enterprises to individuals and small business presents Chinese banks with a major challenge.
July 2013 | by Hongying Liao, Emmanuel Pitsilis, and Jun Xu

After several years of seemingly clear sailing for China, bank analysts are now fretting about the nonperforming loans that the 2009 economic stimulus left behind and the proliferation of wealth-management products manufactured by underregulated trust companies. These problems are real, but bank executives face a much bigger longer-term challenge.

Using international benchmarks, China’s historic growth patterns, and our understanding of upcoming reforms, we have developed projections suggesting that the structure of China’s banking market will continue to change at an unprecedented rate as business opportunities shift from large state-owned enterprises to small and midsize businesses and the newly enlarged ranks of middle-class consumers (exhibit). The implications for the business and organizational models of banks, and for the capabilities they’ll need to succeed in this new environment, are profound. Regardless of the impact of the cyclical issues worrying analysts at the moment, the profits of those banks unable to respond to the structural shift in the sector will come under growing pressure.


A new direction in Chinese banking

About the authors
Hongying Liao is a consultant in McKinsey’s Shanghai office, where Jun Xu is a principal; Emmanuel Pitsilis is a director in the Hong Kong office.

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Mapping China’s middle class Tue, 22 Oct 2013 10:54:59 +0000 June 2013 | by Dominic Barton, Yougang Chen, and Amy Jin

The explosive growth of China’s emerging middle class has brought sweeping economic change and social transformation—and it’s not over yet. By 2022, our research suggests, more than 75 percent of China’s urban consumers will earn 60,000 to 229,000 renminbi ($9,000 to $34,000) a year.

In purchasing-power-parity terms, that range is between the average income of Brazil and Italy. Just 4 percent of urban Chinese households were within it in 2000—but 68 percent were in 2012. In the decade ahead, the middle class’s continued expansion will be powered by labor-market and policy initiatives that push wages up, financial reforms that stimulate employment and income growth, and the rising role of private enterprise, which should encourage productivity and help more income accrue to households. Should all this play out as expected, urban-household income will at least double by 2022.

Beneath the topline figures are significant shifts in consumption dynamics, which we have been tracking since 2005 using a combination of questionnaires and in-depth interviews to create a detailed portrait by income level, age profile, geographic location, and shopping behavior. Our latest research suggests that within the burgeoning middle class, the upper middle class is poised to become the principal engine of consumer spending over the next decade.

As that happens, a new, more globally minded generation of Chinese will exercise disproportionate influence in the market. Middle-class growth will be stronger in smaller, inland cities than in the urban strongholds of the eastern seaboard. And the Internet’s consumer impact will continue to expand. Already, 68 percent of the middle class has access to it, compared with 57 percent of the total urban population (see “China’s e-tail revolution”).

Importance of the ‘upper’ cut

The evolution of the middle class means that sophisticated and seasoned shoppers—those able and willing to pay a premium for quality and to consider discretionary goods and not just basic necessities—will soon emerge as the dominant force. To underscore this group’s growing importance, we have described it in past research as the “new mainstream”. For the sake of simplicity, we now call consumers with household incomes in the 106,000 to 229,000 renminbi range upper middle class. In 2012, this segment, accounting for just 14 percent of urban households, was dwarfed by the mass middle class, with household incomes from 60,000 to 106,000 renminbi. By 2022, we estimate, the upper middle class will account for 54 percent of urban households and 56 percent of urban private consumption. The mass middle will dwindle to 22 percent of urban households (Exhibit 1).


The behavior of today’s upper middle class provides some clues to China’s future. Our research indicates that these consumers are more likely to buy laptops, digital cameras, and specialized household items, such as laundry softeners (purchased by 56 percent of the upper-middle-class consumers we surveyed last year, compared with just 36 percent of the mass middle). Along with affluent and ultrawealthy consumers, upper-middle-class ones are stimulating rapid growth in luxury-goods consumption, which has surged at rates of 16 to 20 percent per annum for the past four years. By 2015, barring unforeseen events, more than one-third of the money spent around the world on high-end bags, shoes, watches, jewelry, and ready-to-wear clothing will come from Chinese consumers in the domestic market or outside the mainland.

Generation 2 comes of age

China’s new middle class also divides into different generations, the most striking of which we call Generation 2 (G2). It comprised nearly 200 million consumers in 2012 and accounted for 15 percent of urban consumption. In ten years’ time, their share of urban consumer demand should more than double, to 35 percent. By then, G2 consumers will be almost three times as numerous as the baby-boomer population that has been shaping US consumption for years.

These G2 consumers today are typically teenagers and people in their early 20s, born after the mid-1980s and raised in a period of relative abundance. Their parents, who lived through years of shortage, focused primarily on building economic security. But many G2 consumers were born after Deng Xiaoping’s visit to the southern region—the beginning of a new era of economic reform and of China’s opening up to the world. They are confident, independent minded, and determined to display that independence through their consumption. Most of them are the only children in their families because when they were born, the government was starting to enforce its one-child policy quite strictly.

McKinsey research has shown that this generation of Chinese consumers is the most Westernized to date. Prone to regard expensive products as intrinsically better than less expensive ones, they are happy to try new things, such as personal digital gadgetry. They are also more likely than previous generations to check the Internet for other people’s usage experiences or comments. These consumers seek emotional satisfaction through better taste or higher status, are loyal to the brands they trust, and prefer niche over mass brands (Exhibit 2). Teenage members of this cohort already have a big influence on decisions about family purchases, according to our research.

Exhibit 2

Generation 2—Chinese consumers in their teens and early 20s—takes a more Western approach to shopping.


Even as the G2 cohort reshapes Chinese consumption patterns, it appears to be maintaining continuity with some of the previous generations’ values. Many G2 consumers share with their parents and grandparents a bias for saving, an aversion to borrowing, a determination to work hard, and a definition of success in terms of money, power, and social status. For the G2 cohort, however, continuity in values doesn’t translate into similar consumer behavior. Likewise, 25- to 44-year-old G1 consumers, despite their loyalty to established brands, are more open than their parents to a variety of schools of thought, and as retirees in the years ahead they will certainly demonstrate a “younger” consumption mind-set than today’s elderly do.

The rise of the west (and the north)

In 2002, 40 percent of China’s relatively small urban middle class lived in the four Tier-one cities: Beijing, Shanghai, Guangzhou, and Shenzhen. By 2022, the share of those megacities will probably fall to about 16 percent (Exhibit 3). They won’t be shrinking, of course; rather, middle-class growth rates will be far greater in the smaller cities of the north and west. Many are classified as Tier-three cities, whose share of China’s upper-middle-class households should reach more than 30 percent by 2022, up from 15 percent in 2002.

Exhibit 3

The geographic center of middle-class growth is shifting.
lightbox title


Tier-four cities, smaller still, will also be part of that geographic transition. Consider Jiaohe, in Jilin Province. This northern inland Tier-four city is growing quickly because of its position as a transportation center at the heart of the northeast Asian economic zone, an abundance of natural resources (such as Chinese forest herbs and edible fungi), and the fact that it is one of China’s most important production bases for grape and rice wine. In 2000, less than 1,000 households out of 70,000 were middle class, but by 2022, those figures are set to rise to 90,000 and 160,000, respectively.

Another Tier-four city, Wuwei, in Gansu Province, is growing rapidly because it’s within the Jinchang–Wuwei regional-development zone and at the junction of two railways and several highways. Wuwei too had less than 1,000 middle-class households (out of 87,000 total) in 2000. By 2022, though, 390,000 of the city’s 650,000 households should be middle class.

Continued strong growth in the size and diversity of China’s middle class will create new market opportunities for both domestic and international companies. Yet strategies that succeeded in the past, given the wide distribution of standardized products for mass consumers, must be adjusted in a new environment with millions of Chinese trading up and becoming more picky in their tastes. A detailed understanding of what consumers are doing, how their preferences are evolving, and the underlying reasons for their behavior will be needed.

Armed with better information, companies can begin tailoring their product portfolios to the needs of increasingly sophisticated consumers and revising brand architectures to differentiate offerings and attract younger consumers eager for fresh buying experiences. There will be not only challenges but also plenty of opportunities for companies whose strategies reflect China’s new constellation of rising incomes, shifting urban landscapes, and generational change.

About the authors
Dominic Barton is McKinsey’s global managing director, based in McKinsey’s London office; Yougang Chen is a principal in the Hong Kong office; Amy Jin is a consultant in the Shanghai office.


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Thriving in a ‘PC-plus’ world: An interview with Lenovo CEO Yang Yuanqing Tue, 22 Oct 2013 10:50:44 +0000 The Chinese computer maker—now among the world’s largest—expects mobile devices to supplement PCs, not replace them.

June 2013
For its first two decades, Lenovo Group was largely unknown outside its native China. That all changed in 2005, when the company’s $1.75 billion purchase of IBM’s personal-computer business,1 including the iconic ThinkPad line, catapulted Lenovo into the ranks of the world’s biggest personal-computer makers. Today, the Chinese company is among the world’s largest PC manufacturers and is aggressively pursuing fast-growing markets for tablet devices and smartphones.

Yang Yuanqing, who was in the fledgling company’s first wave of employees, joined Lenovo as a salesman in 1989, just five years after it was founded. He rose rapidly through its ranks to head the personal-computer business in 1994, becoming chief executive officer when founder Liu Chuanzhi stepped down in 2001. He himself stepped down as CEO in 2005 and then served as chairman for four years. In 2009, Yang Yuanqing returned as CEO and Liu Chuanzhi as chairman. Together, they steered Lenovo through the aftermath of the world financial crisis. Following the company’s successful recovery, Liu Chuanzhi retired in 2011 and Yang Yuanqing became chairman and CEO, spearheading Lenovo’s ascent to its current position. In this interview with McKinsey’s Rik Kirkland and Gordon Orr, Lenovo’s chairman and chief executive explains the importance of investing in innovation and why personal computers must evolve.


Yang Yuanqing biography

The Quarterly: There are a lot of people, particularly in the United States, talking about a very rapid decline in the PC industry over the next couple of years. How are you preparing Lenovo for the possibility that might happen?

Yang Yuanqing: Strategy. The industry is absolutely shifting toward mobile devices, such as smartphones and tablets, which are growing fast. But Lenovo has prepared for this shift for many years. Our belief is that we can address those markets as well as our core PC market. In the smartphone sector, for example, we’re number two in China; we’re in the top five now worldwide.

The Quarterly: Mostly driven by China.

Yang Yuanqing: Mostly, yes, but we are entering other emerging markets. Having said that, we just don’t believe the PC is dying. You can use a phone or tablet to do some simple work, but you cannot do everything—it’s simply not as functional as a PC. For example, I prefer to reply to e-mail using a keyboard. We know that we still need to innovate when it comes to the traditional PC, however, and Lenovo has done a lot of work on that.

Yoga, our ultrabook that functions both as a laptop and tablet, is a good example. Before we launched it, we had never addressed the high-priced-laptop market in the US. Now, since launching Yoga, we have a more than 40 percent market share in the $900-and-above price band in the US retail market. That’s from this one product with just two models, a 13-inch and an 11-inch. It’s been a huge, huge success. And it’s not only helped us to grow our volume and market share but also to build our brand. It has repositioned us as a brand known for innovation.

So that’s one example. Another good example is our just-launched table PC, called Horizon, which evolved from the traditional all-in-one PC or desktop PC. We’ve changed it from a one-person machine to a multiple-person machine—a family entertainment center—focusing not just on hardware but also software and applications. It’s this kind of innovation that ensures that the PC won’t die, but actually grow. We don’t think there’s a post-PC era—we see a PC-plus era. We know that the PC is no longer the only Internet-access device, but it’s still critical.

The Quarterly: You became the world’s largest PC maker by some metrics during one quarter last year. How important is that for you and your competitors?

Yang Yuanqing: In the past, we were a Chinese local brand. Now they view us as a very serious competitor—we are more competitive in the market. This is a volume industry, a scale industry. If you have the scale, you have the advantage. So, first, becoming one of the leaders is very important from an efficiency point of view. And, second, being a top PC company promotes our brand. This is even more important for Lenovo, given where we were just a few years ago. Someone in the Chinese media asked me how important it was to become number one, and I asked him, “Can you name the world’s highest mountain?” And he replied, “Everest.” Then I asked, “And what’s the world’s second highest?” That’s why being number one is important.

The Quarterly: Did your competitors do anything wrong?

Yang Yuanqing: I think some were too slow to address the mobile-Internet trend. And one reason is that they believe you can outsource everything, not only manufacturing but even R&D. When you do that—when you rely on external parties to think for you—you lose the spark of innovation.

Our momentum has been stronger than our competitors’ not because we quickly follow whatever Apple does; we don’t. It’s been stronger because we saw the market trends a decade ago and have invested in innovation. We knew that, sooner or later, the PC market would become smaller. I still insisted that we undertake R&D on a smartphone, and, after I took over as CEO, we bought back the phone business that was previously sold and launched the device because we already had it designed. And, fundamentally, we executed. We executed well. So that’s one example of how we have maintained strong momentum.

The Quarterly: This is interesting because many people around the world view Chinese companies as exactly the opposite: they believe Chinese companies have no R&D and just copy other countries’ products. But you view in-house R&D as critical and are investing in R&D centers not just here in China but also in Japan and the United States.

Yang Yuanqing: Well, on the one hand you can say we are focusing on devices—Internet-access devices. That’s pretty basic. But we know that the future is not just hardware. R&D is critical because we must consider the whole package: hardware, software, services, and content. That’s how you give customers the best user experience and rich applications. Our belief is that if you want to be the most innovative, you must leverage the best talent. And that talent and new technology come from everywhere, and different countries and different markets have different demands and requirements. So having global R&D centers is very important.

The Quarterly: Were there challenges when you sought to evolve Lenovo from a China-centered company to a global one?

Yang Yuanqing: There are a lot of challenges with becoming a global operation. Even small things: when we had our first global-operation call, I couldn’t understand everything that was said. Everybody spoke English, but the accents were completely different! Seriously, culture was definitely a challenge—we didn’t know the Western culture at all. And from a business-model point of view, we didn’t know whether our success in China could be replicated in the rest of the world. It was very tough. But I often use this story: if someone always swims in the river and has never swum in the ocean, it doesn’t matter how strong a swimmer he is; he’s never swum in the ocean! He’s scared. But you have to remember that the skills transfer. You can swim very well in the ocean; you just need to become more confident.

The Quarterly: You jumped into the deep end when you bought IBM, and you’re now acquiring a lot of other companies in Brazil and Germany and other places. Are you swimming confidently now?

Yang Yuanqing: We are, and we have realized over time that it’s critical for globalization to be real. Many so-called multinational companies—global companies—are not actually global. Most companies in the Fortune 500 are not global; most of their top executives are American. In European companies, most top executives still come from Europe. So they’re not real global companies. Given Lenovo’s heritage, we have no choice; we have to be genuinely global.

When we bought IBM’s PC business, we were a $3 billion company buying a $10 billion company. To be honest, we didn’t even know we were going to swim in the ocean until we actually were, so we had to hire a coach to teach us. We had two generations of American CEOs who helped the company finish the first stage of globalization: to integrate the company, to make it more efficient. Because of this heritage, our top executives come from everywhere. As an example, our Lenovo executive committee has nine members from six nations.

We also know that if we want to be an even more successful global company, we must leverage local talent. And that’s not just for sales and marketing but also for more roles and functions, such as manufacturing and R&D. Our belief is that we can best serve local customers and understand local markets that way rather than trying to do so remotely. Our ambition is to build Lenovo as a global local company. So in key markets, we want to build a local footprint, either organically or through acquisition. And we already have a strong foundation in China, the US, Japan, and Germany, and now we’re moving into Brazil, India, and Russia.

The Quarterly: In India, you’ve become the biggest PC maker organically. How?

Yang Yuanqing: There are four aspects that apply to how we approach all markets. The first is having the right strategy and good execution. For us, that means moving up the value chain over time in all of our product areas. The second is good products and innovation. The success we had at this year’s Consumer Electronics Show was proof of that—people really saw us as innovative and at the cutting edge. The third is our business model, which is effective and efficient. And the fourth is having a diversified, global team and culture.

In all markets, our business model is important. A direct model, such as Dell’s, is good for enterprise customers. They care about reliability, durability, security, those kinds of things. But it’s not a perfect model for consumers. Consumers care about whether they’re using the latest technology, what’s in fashion. The supply model is different. A relationship model is good for enterprise customers and more profitable for direct sales. But for consumers, we believe a transactional model works best—it must be a push model in which products are pushed from the manufacturer, not requested by customers.

So we built our end-to-end integrated-transaction model in China and we have replicated that in India across all of our functions. In terms of growing organically there, we have approached low-tier cities first in an effort to be the pioneer to develop these emerging markets. Basically, we have been careful not to view India as just one big emerging market—we look at it as a number of smaller markets, and we separate it into different tiers.

The Quarterly: How will people describe Lenovo ten years from now?

Yang Yuanqing: We want to become an even more respected company in the world, with a strong global business across all segments and technologies—PC and mobile, consumer and commercial, mature markets and emerging. We know that China still contributes most of our profit—after all, in the US we had never had a consumer business until a few years ago. And since we’ve just started that business, and in other countries too, we can’t squeeze every penny into the bottom line; we must use some money to invest in the future or invest for the future. We believe the investments in those businesses will start to pay off in the next few years.

We want to transform ourselves from a PC market-share leader into a PC-plus innovation leader. This will ensure we have sustained growth, profitability, and the strong foundation to build a great global company that can last for generations.

About the authors
This interview was conducted by Rik Kirkland, senior management editor of McKinsey Publishing, based in McKinsey’s New York office; and Gordon Orr, a director in the Shanghai office.
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A strategic role for China’s CIOs Tue, 22 Oct 2013 10:43:43 +0000 CIOs have a key part to play as Chinese enterprises start looking to IT for business growth and global competitiveness.
June 2013 | by Driek Desmet, Kevin Wei Wang, and Chenan Xia

As Chinese organizations move from early-stage businesses to large global players, IT will need to play an increasingly important and strategic role. However, a 2012 McKinsey survey on business technology in China, undertaken in collaboration with Peking University, finds that Chinese enterprises continue to spend less than their global counterparts when it comes to IT investment. What’s more, many Chinese CEOs and business leaders view their IT function as good at helping to run the business but not strong at helping to grow it.

Indeed, the results of the survey show the majority of corporate IT investment in China remains skewed toward improving operational efficiency. Comparatively little investment is directed to delivering customer-facing, top-line pursuits. Such pursuits could include digital-sales channels tapping big-data analytics to improve the customer experience (Exhibit 1) or leveraging social media for marketing of products and services.

Exhibit 1

The IT function excels at internal business-process improvement but not at supporting external customer- and market-facing initiatives.



TKey survey findings

Exhibit 2

Approximately 40 percent of surveyed CIOs take on business roles beyond IT, and that number is expected to grow.


Exhibit 3

Adoption of emerging technologies varies widely.

About the authors
Driek Desmet is a director in McKinsey’s Singapore office, and Kevin Wei Wang is a principal in the Shanghai office, where Chenan Xia is a consultant.
The authors wish to thank Peking University and its Guanghua School of Management and the Center for Informatization and Information Management for their support. The authors also thank McKinsey’s Harrison Lung, Janet Tang, Eileen Tu, Jason Wang, and Ryan Yang for their contributions to this article.
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A new era for manufacturing in China Tue, 22 Oct 2013 10:43:14 +0000 Companies that continue to base their manufacturing strategies solely on China’s rock-bottom wages and stratospheric domestic growth rates are in for a rude awakening. New challenges will require new competitive priorities.
June 2013 | by Karel Eloot, Alan Huang, and Martin Lehnich

China’s emergence as a manufacturing powerhouse has been astonishing. In seventh place, trailing Italy, as recently as 1980, China not only overtook the United States in 2011 to become the world’s largest producer of manufactured goods but also used its huge manufacturing engine to boost living standards by doubling the country’s GDP per capita over the last decade. That achievement took the industrializing United Kingdom 150 years.

Today, however, China faces new challenges as economic growth slows, wages and other factor costs rise, value chains become more complex, and consumers grow more sophisticated and demanding. Moreover, these pressures are rising against the backdrop of a more fundamental macroeconomic reality: the almost inevitable decline in the relative role of manufacturing in China as it gets richer. Manufacturing growth is slowing more quickly than aggregate economic growth, for example, and evidence suggests that the country is already losing some new factory investments to lower-cost locations, such as Vietnam, sparking concern about China’s manufacturing competitiveness.
Competitiveness, of course, is a broad term that can confuse more than clarify. During the 1980s, for example, there was much hand-wringing in the United States about declining manufacturing competitiveness versus Japan. In the following decade, however, those concerns faded, replaced by a focus on the failings of “Japan Inc.,” the SUV-fueled resurgence of the US automotive sector, and the boom in US high-tech manufacturing. In the United States then, as in China today, there isn’t just one manufacturing sector; there are many, each with different competitive strengths and weaknesses.

In this article, we move beyond the hyped hopes and frantic fears for Chinese manufacturing as a whole, to gain a more balanced picture of this diverse sector. We start with a summary of four key challenges that affect different types of manufacturers in different ways and then move on to a discussion of competitive priorities whose importance again varies for players of different stripes. Despite the variation across manufacturing subsectors, companies—Chinese owned and multinational alike—can’t escape the need to raise their game and move up the value chain by boosting productivity, refining product-development approaches, and taming supply-chain complexity. Those that do should prosper in the years ahead, while those that rely on yesterday’s model of rock-bottom wages and stratospheric domestic growth rates are likely to fade.

Four challenges

For years, China’s low salaries; strong supply base; high investment in port, road, and rail infrastructure; and solid engineering and technical skills provided a strong platform for manufacturing exports. Meanwhile, a vast domestic market helped fuel China’s continuing transition to a consumption-based economy. Today’s outlook is more mixed. Here, we review four core challenges and the types of players particularly affected by each of them. In doing so, we draw on a set of global manufacturing archetypes established recently by the McKinsey Global Institute (see sidebar, “The makeup of Chinese manufacturing”).

Sidebar: The makeup of Chinese manufacturing


Rising factor costs

Rising wages and the appreciation of the renminbi have dampened China’s exports in recent years and focused global attention on its future viability as a low-cost manufacturing center. Most multinationals that produce labor-intensive goods, like textiles and apparel, are actively seeking to diversify beyond China to reduce costs and mitigate political and supply-chain risks. China-based processors of goods such as beverages, fabricated metals, food, and tobacco are also concerned about rising costs, including those for packaging. Yet their regional focus makes this less a global competitive issue and more a question of which players in the value chain will create the most value.


Rising consumer sophistication

McKinsey research suggests that by 2020, the income of more than half of China’s urban households, calculated on a purchasing- power-parity basis, will catapult them into the upper middle class— a category that barely existed in China in 2000 (for more, see “Mapping China’s middle class”). The members of this group already demand innovative products that require engineering and manufacturing capabilities many local producers do not yet adequately possess. An executive of a Chinese television-panel maker, for example, recently confessed that his company cannot fully meet the requirements of high-end customers and that the quality of his company’s flat-screen panels is exceeded by that of products from fast-moving South Korean competitors. China’s automakers face a similar challenge: consumers perceive their brands as lower in quality, even compared with foreign brands assembled in nearby Chinese factories.

These issues confront players in a range of other sectors—from appliances and chemicals to electrical and office machinery, pharmaceuticals, telecommunications gear, and transportation equipment. What they have in common is that they compete on the strength of their R&D, technology, and ability to bring customers a steady stream of new products and services. Rising consumer expectations will require even food and beverage players to raise their game on freshness and regulatory compliance, areas where China’s standards still lag behind Western ones.


Rising value-chain complexity

Another big challenge is coping with the rising value-chain complexity that accompanies consumer growth. Greater affluence and rapid urbanization require product makers to manage, make, and deliver an array of increasingly diverse and customized products to increasingly remote locations. Between now and 2015, for example, almost two-thirds of the growth in demand for fast-moving consumer goods will come from smaller (Tier-three and Tier-four) cities, which outnumber their Tier-one counterparts, such as Beijing or Shanghai, by a factor of 20.

Product proliferation and booming e-commerce also contribute to value-chain complexity. Business-to-consumer online sales in China are expected to grow by 45 percent a year from 2010 to 2015. For product makers, this means smaller and smaller lot sizes and deliveries to households farther and farther “out there.” During Chinese festival periods, the supply chains of many companies already creak under the strain of online orders. Demanding consumers contribute to supply-chain headaches, as well. Since many retailers in China accept cash-on-delivery payments, it’s not uncommon for shoppers to pit online retailers against one another by ordering, say, three identical products from three retailers—and refusing delivery to all but the first to arrive.

Such issues are relevant for technology companies and others responding to the Chinese consumer’s increasingly sophisticated tastes. But rising value-chain complexity is also a worry for manufacturers of more labor-intensive goods, given the sheer variety of products they make, and for regional processors, whose logistics networks are affected by urbanization and booming infrastructure development.


Heightened volatility

The uncertain global economic environment since 2008 has complicated life for manufacturers everywhere. Those in China have arguably been the most severely affected, given the country’s status as the workshop of the world.

In China’s steel industry, for example, annual demand growth slowed to 3 percent in 2012, after a decade of double-digit increases. The result has been lower capacity utilization, cutthroat competition, and a 56 percent decline in average profit margins for the industry from 2010 to 2012. Similarly, in China’s massive auto industry, annual growth rates over the past five years have varied from 7 percent to 52 percent. Appliance and electrical-machinery producers have also experienced strong demand fluctuations, exacerbated by gyrating overseas demand.

Volatility at such levels makes planning difficult for China’s manufacturers. This is problematic for companies that routinely make large, long-lived capital expenditures whose returns are crucial determinants of performance.

Three imperatives for China’s manufacturers

As labor costs rise and slowing growth dampens the ability of China’s steadily rising industrial output to deliver regular productivity gains, manufacturers there will need to strive for global levels of operational excellence. Energy efficiency is a particular opportunity for many companies (see “Seizing China’s energy-efficiency opportunity: A case study”), but far from the only one. Companies hoping to differentiate themselves beyond low-cost labor also can focus their efforts upstream (to harness innovation and product-development efforts) or downstream (to tame supply-chain complexity) or both, depending on the characteristics of competition in their sectors.


1. Achieve manufacturing excellence

Lean and Six Sigma are not new to China. Plant managers in domestic and multinational companies alike have worked hard to bring manufacturing-excellence tools and approaches to the country’s shop floors. But for all these efforts, significant potential remains, mainly because plant managers in China often focus on “hard” technical tools at the expense of “softer” ones involving mind-sets and behavior. A recent lean-manufacturing transformation at one state-owned enterprise, for example, fell far short of its efficiency targets when managers and supervisors failed to complement the otherwise excellent technical changes with the necessary softer skills—including leadership—that would have made the changes stick.

One factor that complicates these problems has been the breakneck development of China’s manufacturing sector, which means that many workers are relatively new to the job. We have seen too many frontline managers, lacking the experience to identify the problems inevitably associated with new plants and new ventures, merely react to problems rather than look for their root causes. Companies facing this problem will never get the full benefit of the productivity improvements they expect from lean. In one auto-assembly and body-shop operation, for example, team leaders spent as little as 5 percent of their time on coaching and problem solving (best practice is about 30 percent). Improvement efforts stalled until the company introduced standardized daily work agendas for team leaders and supervisors, to emphasize that shift meetings were occasions for problem solving and coaching—not firefighting.

Cultural differences also continue to thwart operational improvements in Chinese companies. In one auto plant, the multinational joint venture partner installed visual-performance boards to make the status of work projects transparent, assuming that the tools would be accepted as they are elsewhere in the global auto industry. In fact, the frontline workers resisted them, interpreting the initiative as a criticism of individual colleagues and forcing the joint venture’s leaders to devise ways to achieve the same effect without alienating the staff. Moreover, the Chinese company’s senior plant managers, while supporting the changes, were initially uncomfortable about role-modeling the more transparent and inclusive way of working. A new continuous-improvement department eventually helped workers and managers alike to view greater transparency and continuous improvement as a new way of working rather than a “flavor of the month” exercise. The automaker’s experience is not uncommon; indeed, the fact that the domestic leaders became involved was encouraging—all too often, the front line must sort out such changes itself.

Finally, companies in China must aspire to extend efficiency improvements throughout the value chain. An automotive joint venture recently began this journey by working with 60 of its suppliers to address the 30 most pressing quality problems. The company fixed them in only six months and has since prevented their recurrence, in large part by equipping its people with assessment tools and skills and by engaging suppliers to address problems at the source. A new performance-management system helps ensure that both the automaker and its suppliers keep up their ends of the bargain. (For more on the relationship between purchasers and suppliers, see sidebar “Seeking purchasing excellence in China.”)

Sidebar: Seeking purchasing excellence in China


2. Look upstream

For industries reliant on innovation, the triple whammy of rising costs, complexity, and competitive pressure means that the old ways of developing products in China now risk becoming liabilities. Staying competitive will require domestic companies and multinationals alike to change, starting with the mind-sets and attitudes that have pervaded product-development activities in China.

Product-development roadblocks. Domestic Chinese companies must get beyond the “faster, cheaper” fixation that has characterized their approach to R&D in recent decades. For every world-beating Chinese innovator, we still see dozens of smaller players struggling to develop the R&D pipelines that would help them grow from scrappy upstarts into incumbents that can realize their global ambitions. The growth of one China-based medical-device player, for example, has halved in recent years as smaller domestic competitors copy its designs and undercut its prices, much as the company itself copied from multinationals in earlier years. Yet even as it works now to boost its R&D capabilities and to generate market insights—extremely difficult tasks given the absence of necessary skills and institutional processes—the copying mind-set remains strong.

To some extent, multinationals face a mind-set challenge as well. Many invest significantly in their China R&D units while continuing to regard them as cost-saving satellites of the home-office “mother ship.” Even when multinationals establish supposedly autonomous R&D units in China, many lack the support and skills to become intellectual-property creators, not just consumers. The experience of another medical-product company we studied—this one a multinational—highlights the challenge.

The leaders of the multinational’s China R&D group thought they’d identified a lucrative niche for a new, low-cost medical-diagnostic product—but were denied funding by the head office back home. The general manager of the China business fought what he thought was a shortsighted decision, winning permission to proceed if his business unit could finance the new product itself. His unit ultimately did just that, in part by promoting the product to customers and collecting advance orders. Once launched, it was highly successful—at first in China but soon in other countries too as the company’s sales reps got wind of its popularity and began offering it in their own regions.

Fast-forward about 18 months, when the company decided to revise the product. Rather than entrust its development to the China R&D team, the company assigned it to the main R&D group at headquarters and used the China team for support. The product flopped when new and technically elegant features and other changes insisted on by the Western group proved too expensive for customers or irrelevant to them.

A success story. The experience of a global lighting manufacturer suggests how some companies are overcoming the challenges. With global consumer preferences shifting toward new applications of a decades-old technology, the company identified a huge market opportunity in LED lighting. The market was also hugely competitive—Chinese and Taiwanese players were piling into the lower-end consumer segments—so a well-designed product clearly wouldn’t be enough. Hitting a low price point and rapidly establishing scale would also be necessary.

The multinational briefly considered using its world-class global R&D unit to develop the product. But senior executives worried that the group’s insular, engineering-centric culture would lead it to “overspec” the offering with costly features. Leaving it to the company’s China unit, on the other hand, was too risky: that group couldn’t generate unique customer insights and didn’t have enough experience working with supplier networks upstream or with the company’s global supply chain downstream to compete on cost and speed. The obvious compromise—combining the groups in a more traditional way by playing to the strengths of each—might mean suffering the usual time-zone delays while reinforcing the “silo” cultures the company’s leaders wanted to break. It ultimately chose to view the project as an experiment for improving both units, so that the one in China would become more independent and the effort’s benefits could be leveraged globally.

To get there, company executives quickly assembled a mixed R&D team in China comprising representatives from the marketing, procurement, supply-chain, and quality groups. For ten weeks, the team worked closely to develop an idea-generation and decision-making process that could not only create a winning, scalable design but also build skills and develop processes the company could use globally. The team collaborated to create and test customer insights, complementing the work with teardowns of competitors’ products. It also conducted shop-floor walkthroughs with suppliers and met with a variety of manufacturing experts to learn how the product could incorporate cheaper, more modular designs.

A set of simple rules proved critical to breaking old habits and unlocking good ideas: to ensure that the team never fixated on one part of the value chain at the expense of another, it consistently asked a handful of total-cost-of-ownership questions when it made its most important decisions. This approach helped spark improvement ideas in unusual areas, such as product packaging: the team found a way to give one of its products a more prominent shelf appearance—a locally important factor because of high levels of competition—while lowering logistics and other costs through the efficient use of materials.

As the effort picked up steam, it became popular with other managers in the China business. The company trained some of these “evangelists” as change agents to maintain momentum at the end of the pilot. This effort ultimately helped the company to lower the costs associated with the product line by an additional 20 percent beyond initial expectations. Further, the effort positions the company well for future cost-reduction opportunities that should arise as the industry matures.


3. Tame supply-chain complexity

While the effects of value-chain complexity vary by manufacturing subsector, most Chinese consumers are changing faster than supply chains are adapting. Indeed, supply chains in the country—both multinational and domestic—are generally set up for a low- labor-cost environment that is quickly disappearing.

Now that long cycles characterized by so-so levels of transparency and cross-functional collaboration are proving insufficient, companies will have to start by revisiting their demand planning. Consider the experience of a large consumer-electronics company whose processes were proving unsuited to the new demand patterns associated with some of its high-end products. Poor or delayed forecasts were disrupting operations and leading to excess inventories, while also upsetting customers downstream.

The turning point was the company’s recognition that its planners were applying the same broad-brush approach to all products, regardless of their market characteristics. In response, the company’s leaders created a tiered approach to detach planning activities for some basic appliances whose demand patterns were well understood (rice cookers, for example) from plans for faster-moving products with less certain demand. For the basic products, the company developed a streamlined, “good enough” planning approach. For the high-end goods, it crafted specific plans by product line.

Its results, including an overall improvement in forecast accuracy to more than 65 percent, from 35 percent, have been impressive. Inventory fell from more than 55 days to 30 days, and the company increased its proportion of on-time deliveries to more than 95 percent, from 60 percent. What’s more, the changes in the company’s planning approach made the work more interesting for its employees, as many of them subsequently received training in advanced forecasting techniques. Consequently, employee turnover among the planning teams went down dramatically—from 50 percent before the effort to just 20 percent afterward. In a second phase, currently under way, the company extended this approach for high-end products to others with similar demand characteristics.

Significantly, the company is separating what had been a monolithic China supply chain into nimbler “splinters” that can better manage complexity. Products with steadier demand go to market in the traditional manner: via coastal distribution centers and large drop-ship orders to retail partners. Higher-end ones travel via smaller regional distribution centers located closer to demand inland. For some products, this approach allows the company to experiment with postponement strategies—finalizing product assembly closer to demand—that help reduce costs and inventory levels (in the case of some customers, by as much as 45 percent).
As companies look to move their footprints closer to customers in Tier-three and Tier-four cities in China’s interior, another likely change will be the long-term development of logistics hubs and assets. In this way, those companies will be better positioned to serve booming demand for online purchases (see “China’s e-tail revolution”). These investments are risky, and many senior executives we know are worried about overextending their companies. Some describe what they say is a need to “go West—but not too far West.” As for domestic Chinese companies with global plans, they know that getting closer to customers means Western customers as well. A few of the largest white-goods makers are thinking about expanding their assembly and test activities in the developed world, because they recognize that they can no longer adequately serve it from Shenzhen and other hubs.

China’s rise to manufacturing preeminence in recent years has been amazing. Yet rising costs, more sophisticated consumers, and fundamental macroeconomic realities mean that yesterday’s approaches to manufacturing are losing their relevance. For Chinese-owned and multinational manufacturers alike, the imperatives now are to boost productivity, refine product-development approaches, and tame supply-chain complexity. Those that do so can create an enduring competitive edge.


About the authors
Karel Eloot is a director in McKinsey’s Shanghai office, where Alan Huang and Martin Lehnich are principals.
The authors would like to thank She Guo, Mads Lauritzen, Gregory Otte, Gernot Strube, Min Su, and Forrest Zhang for their contributions to this article.
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Developing China’s business leaders: A conversation with Yingyi Qian Tue, 22 Oct 2013 10:43:13 +0000 In an interview with McKinsey’s Dominic Barton, the dean of Tsinghua University’s School of Economics and Management reflects on the characteristics of successful Chinese leaders and the skills they’ll need to thrive in the future.
July 2013 | by Dominic Barton and Mei Ye

China has spent decades, and hundreds of billions of dollars, building the physical infrastructure necessary to support the world’s second-largest economy. In the years ahead—as the country’s growing middle class places new demands on the companies that serve it, manufacturers compete on more than low-cost labor, and the ability to innovate becomes more important—building China’s human infrastructure will move to the fore. Local players and multinationals alike are already struggling with rising salaries and lengthy recruitment processes. Furthermore, the manifold changes taking place in China mean it’s unlikely that the effective Chinese manager of tomorrow will look like the Chinese manager of yesterday or today—prompting a need to reexamine leadership development.

While Western business schools, many of which now operate outposts in China, are part of this transition, so is a thriving crop of Chinese institutions focused on management education. A prominent example: Tsinghua University’s School of Economics and Management, in Beijing. The school’s dean, Yingyi Qian, is from China—he graduated from Tsinghua with an undergraduate degree in mathematics in 1981—but subsequently spent more than 20 years in the United States before accepting his current role, in 2006. (Qian earned master’s degrees from both Yale University and Columbia University, as well as a doctorate in economics from Harvard University, in 1990.)

Dean Qian has written extensively about comparative and institutional economics and has taught at Stanford University, the University of Maryland, and the University of California, Berkeley. Now he’s helping Tsinghua rethink what it means to educate business leaders for China. In this interview with McKinsey’s global managing director, Dominic Barton, and Shanghai-based consultant Mei Ye, Dean Qian shares what he’s learning on that journey, as well as some nuances of Chinese management that Western companies need to understand.

The Quarterly: What is the state of leadership development in China?

Yingyi Qian: It’s a challenging question because there is no such thing as “the enterprise” in China, and there is no one kind of successful leader. Our EMBA1 students are a good representation of this. We have students from SOEs,2 for example, and everyone can tell they’re from SOEs. They have the attributes of bureaucrats, but at the same time have good managerial qualities, and some of them are quite entrepreneurial as well. These students are comfortable in both the government and business worlds, and this is an important skill in today’s China.

Then we have students from multinationals, mostly midlevel managers. They speak good English, follow the rules very well, and are very worldly. They know a lot. They probably have most of the standard skills that Western business-school students have.

Finally, about 40 percent of our students are locally grown entrepreneurs. Some have strong technical backgrounds in IT or other fields, while others have very little formal education. Some are almost entirely self-taught. Many of them have good people skills—in some cases, incredible people skills—and they are adept at dealing with the uncertainty of emerging markets and changing environments, as well as with government bureaucracy. All of them are very entrepreneurial.

All three types of leaders can be highly successful in today’s China, but in different ways.

The Quarterly: How do you see these various leadership models evolving over the next five to ten years?

Yingyi Qian: They will definitely change, but how is hard to say. If you had asked me ten years ago, I would have told you that the move would have been toward more market-oriented and international business skills. But over the past few years, we’ve seen some leaders moving from the private sector back to the SOEs, and in some cases even from leading multinationals to SOEs, so it’s a much more complicated business environment in China now.

The Quarterly: Are there common skill requirements that cut across all three groups?

Yingyi Qian: The “softer” skills are a leadership necessity for all leaders in China: things like teamwork, communications, presentations, culture—all the skills that help you deal with people. Leadership is built on these skills, but in the past, Tsinghua University was only strong in the “hard,” analytical skills: things like accounting, mathematics, science, and engineering.

We changed our MBA curriculum five years ago to emphasize the “softer” things. For example, we have an experiential course called “leadership development.” We have required courses in things like communications, presentations, corporate ethics, and crisis management. These are basic but very important skills, but they are only the starting point.

The Quarterly: Beyond those basics, what leadership attributes do you feel are most important to developing strong business leaders in China?

Yingyi Qian: When I address our new EMBA students at the beginning of their programs, I always remember that most of them are in their 40s. Many of them are already successful; arguably, they are already leaders, and even quite successful ones in their organizations. I remind them of this.

Then I tell them that we hope they can do better—that they can aspire to lead not only their enterprises but also their industries, or beyond them. I tell them that if they really want to become leaders who make a big difference in a fast-changing China and the world, they must have vision and must see the future ahead of other people. It’s ambition that separates a “CEO of the year” from the “CEO of the decade.” I cite Steve Jobs, a visionary business leader, as an example of the latter.

The second thing I tell these students is that we will challenge them to think critically and creatively. They have to think differently, and that is very hard in the Chinese context. In their previous education in China, the goal was most likely rote memorization and seeking standard solutions. Thinking differently is very hard when everything up to now has been about conforming, herding, and group thinking. Even the word “critical” has some negative connotations in contemporary Chinese language that it doesn’t have in English. We are working hard to change this mind-set at Tsinghua, because this is essential to achieve the mission of our school: to create knowledge and cultivate leaders for China and the world.

The Quarterly: Western managers often speak of mind-set differences, or cultural differences, as unique challenges in China. What are the biggest differences you see, and how do they affect business leaders there?

Yingyi Qian: The first difference is the institutional environment in China—half market and half government. It’s in transition. This can be very challenging for Western managers. It requires managers to learn the “hidden rules” in addition to formal rules. Not only do you have to manage your enterprise but you have to know the government, the politics, the laws—you have to know everything, and everything is changing fast. In the United States, for example, a CEO might simply hire a lawyer or other experts to understand and navigate many of these things. In China, it’s the leader’s job. A CEO here must know a lot more.

This explains why there are so many more forums between academics, government, and entrepreneurs in China than there are in the United States. I asked some entrepreneurs once why they attend all these forums—they have to pay to go to them—and they said, “We’ve got to go to understand the government and how government policies will be interpreted and implemented.”

The second difference is about culture, and it is all about people. This includes the importance of personal connections, of your network, and of the value, for example, of not losing face. Face is hugely important. In a US company, for example, you can do a 360-degree feedback evaluation effectively as part of a performance review. But here in China, that’s very difficult because people just don’t like to give such honest evaluations—they are afraid that others will take things too personally. If I say something strong to an employee in the US, people say, “OK, that’s not personal.” That never works in China. How to get things done in China is different—even if you want to achieve the same things.

The Quarterly: Were you personally challenged by any cultural differences when you returned to China to become the dean of Tsinghua’s School of Economics and Management in 2006?

Yingyi Qian: Absolutely. I previously knew many of these things in theory—as a social scientist, I’d studied them in the literature—but I really only learned them after I became the dean. I spent 25 years in the United States as a student first and then as an educator, and in some ways probably behave more like a Westerner than a Chinese. Some of these lessons took a lot of pain for me to learn. I call it “reverse culture shock.”

For example, if you want to get something done in the West, you have a meeting and you discuss the issues and perhaps you vote. Not so in China—the meeting is usually the last step, only a formality. You have to communicate and persuade people before the meeting, not during the meeting. And unlike in the West, a 51 percent majority is not enough if you’re making a decision. Achieving a kind of consensus is important, and everyone has a veto power to some extent. No one necessarily tells you these things beforehand, though, so you have to learn them from your experiences.

Like many economists, perhaps, I had a tendency to deemphasize the behavioral and cultural sides of things. But now I pay a lot of attention to these things. It reminds me of a study in cross-cultural psychology carried out by a professor I know at UC Berkeley.3 He and his coauthor showed participants a picture of a group of fish, with one fish out in front of the others. American participants were more likely to think that fish was leading, while Chinese participants were more likely to think it was an outlier. There really is a cultural difference with roots in cognitive psychology that we need to understand.

About the authors
This interview was conducted by Dominic Barton, McKinsey’s global managing director, based in McKinsey’s London office; and Mei Ye, a senior expert in the Shanghai office.
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A CEO’s guide to innovation in China Tue, 22 Oct 2013 10:43:03 +0000 Dynamic domestic players and focused multinationals are helping China churn out a growing number of innovative products and services. Intensifying competition lies ahead; here’s a road map for navigating it.

China is innovating. Some of its achievements are visible: a doubling of the global percentage of patents granted to Chinese inventors since 2005, for example, and the growing role of Chinese companies in the wind and solar-power industries. Other developments—such as advances by local companies in domestically oriented consumer electronics, instant messaging, and online gaming—may well be escaping the notice of executives who aren’t on the ground in China.

As innovation gains steam there, the stakes are rising for domestic and multinational companies alike. Prowess in innovation will not only become an increasingly important differentiator inside China but should also yield ideas and products that become serious competitors on the international stage.

Chinese companies and multinationals bring different strengths and weaknesses to this competition. The Chinese have traditionally had a bias toward innovation through commercialization—they are more comfortable than many Western companies are with putting a new product or service into the market quickly and improving its performance through subsequent generations. It is common for products to launch in a fraction of the time that it would take in more developed markets. While the quality of these early versions may be variable, subsequent ones improve rapidly.

Chinese companies also benefit from their government’s emphasis on indigenous innovation, underlined in the latest five-year plan. Chinese authorities view innovation as critical both to the domestic economy’s long-term health and to the global competiveness of Chinese companies. China has already created the seeds of 22 Silicon Valley–like innovation hubs within the life sciences and biotech industries. In semiconductors, the government has been consolidating innovation clusters to create centers of manufacturing excellence.

But progress isn’t uniform across industries, and innovation capabilities vary significantly: several basic skills are at best nascent within a typical Chinese enterprise. Pain points include an absence of advanced techniques for understanding—analytically, not just intuitively—what customers really want, corporate cultures that don’t support risk taking, and a scarcity of the sort of internal collaboration that’s essential for developing new ideas.

Multinationals are far stronger in these areas but face other challenges, such as high attrition among talented Chinese nationals that can slow efforts to create local innovation centers. Indeed, the contrasting capabilities of domestic and multinational players, along with the still-unsettled state of intellectual-property protection (see sidebar, “Improving the patent process”), create the potential for topsy-turvy competition, creative partnerships, and rapid change. This article seeks to lay out the current landscape for would-be innovators and to describe some of the priorities for domestic and multinational companies that hope to thrive in it.

China’s innovation landscape

Considerable innovation is occurring in China in both the business-to-consumer and business-to-business sectors. Although breakthroughs in either space generally go unrecognized by the broader global public, many multinational B2B competitors are acutely aware of the innovative strides the Chinese are making in sectors such as communications equipment and alternative energy. Interestingly, even as multinationals struggle to cope with Chinese innovation in some areas, they seem to be holding their own in others.

The business-to-consumer visibility gap

When European and US consumers think about what China makes, they reflexively turn to basic items such as textiles and toys, not necessarily the most innovative products and rarely associated with brand names.

In fact, though, much product innovation in China stays there. A visit to a shop of the Suning Appliance chain, the large Chinese consumer electronics retailer, is telling. There, you might find an Android-enabled television complete with an integrated Internet-browsing capability and preloaded apps that take users straight to some of the most popular Chinese Web sites and digital movie-streaming services. Even the picture quality and industrial design are comparable to those of high-end televisions from South Korean competitors.

We observe the same home-grown innovation in business models. Look, for example, at the online sector, especially Tencent’s QQ instant-messaging service and the Sino Corporation’s microblog, Weibo. These models, unique to China, are generating revenue and growing in ways that have not been duplicated anywhere in the world. QQ’s low, flat-rate pricing and active marketplace for online games generate tremendous value from hundreds of millions of Chinese users.

What’s keeping innovative products and business models confined to China? In general, its market is so large that domestic companies have little incentive to adapt successful products for sale abroad. In many cases, the skills and capabilities of these companies are oriented toward the domestic market, so even if they want to expand globally, they face high hurdles. Many senior executives, for example, are uncomfortable doing business outside their own geography and language. Furthermore, the success of many Chinese models depends on local resources—for example, lower-cost labor, inexpensive land, and access to capital or intellectual property—that are difficult to replicate elsewhere. Take the case of mobile handsets: most Chinese manufacturers would be subject to significant intellectual property–driven licensing fees if they sold their products outside China.

Successes in business to business

Several Chinese B2B sectors are establishing a track record of innovation domestically and globally. The Chinese communications equipment industry, for instance, is a peer of developed-world companies in quality. Market acceptance has expanded well beyond the historical presence in emerging markets to include Europe’s most demanding customers, such as France Télécom and Vodafone.

Pharmaceuticals are another area where China has made big strides. In the 1980s and 1990s, the country was a bit player in the discovery of new chemical entities. By the next decade, however, China’s sophistication had grown dramatically. More than 20 chemical compounds discovered and developed in China are currently under-going clinical trials.

China’s solar and windpower industries are also taking center stage. The country will become the world’s largest market for renewable energy technology, and it already has some of the sector’s biggest companies, providing critical components for the industry globally.

Chinese companies not only enjoy scale advantages but also, in the case of solar, use new manufacturing techniques to improve the efficiency of solar panels.

Success in B2B innovation has benefited greatly from friendly government policies, such as establishing market access barriers; influencing the nature of cross-border collaborations by setting intellectual property requirements in electric vehicles, high-speed trains, and other segments; and creating domestic purchasing policies that favor Chinese-made goods and services. Many view these policies as loading the dice in favor of Chinese companies, but multinationals should be prepared for their continued enforcement.

Despite recent setbacks, an interesting example of how the Chinese government has moved to build an industry comes from high-speed rail. Before 2004, China’s efforts to develop it had limited success. Since then, a mix of two policies—encouraging technology transfer from multinationals (in return for market access) and a coordinated R&D-investment effort—has helped China Railways’ high-speed trains to dominate the local industry. The multinationals’ revenue in this sector has remained largely unchanged since the early 2000s.

But it is too simplistic to claim that government support is the only reason China has had some B2B success. The strength of the country’s scientific and technical talent is growing, and local companies increasingly bring real capabilities to the table. What’s more, a number of government-supported innovation efforts have not been successful. Some notable examples include attempts to develop an indige nous 3G telecommunications protocol called TDS-CDMA and to replace the global Wi-Fi standard with a China-only Internet security protocol, WAPI.

Advantage, multinationals?

Simultaneously, multinationals have been shaping China’s innovation landscape by leveraging global assets. Consider, for example, the joint venture between General Motors and the Shanghai Automotive Industry Corporation, which adapted a US minivan (Buick’s GL8) for use in the Chinese market and more recently introduced a version developed in China, for China. The model has proved hugely popular among executives.

In fact, the market for vehicles powered by internal combustion engines remains dominated by multinationals, despite significant incentives and encouragement from the Chinese government, which had hoped that some domestic automakers would emerge as leaders by now. The continued strength of multinationals indicates how hard it is to break through in industries with 40 or 50 years of intellectual capital. Transferring the skills needed to design and manufacture complex engineering systems has proved a significant challenge requiring mentorship, the right culture, and time.

We are seeing the emergence of similar challenges in electric vehicles, where early indications suggest that the balance is swinging toward the multinationals because of superior product quality. By relying less on purely indigenous innovation, China is trying to make sure the electric vehicle story has an ending different from that of its telecommunications protocol efforts. The government’s stated aspiration of having more than five million plug-in hybrid and battery electric vehicles on the road by 2020 is heavily supported by a mix of extensive subsidies and tax incentives for local companies, combined with strict market access rules for foreign companies and the creation of new revenue pools through government and public fleet-purchase programs. But the subsidies and incentives may not be enough to overcome the technical challenges of learning to build these vehicles, particularly if multinationals decline to invest with local companies.

Four priorities for innovators in China

There’s no magic formula for innovation and that goes doubly for China, where the challenges and opportunities facing domestic and multinational players are so different. Some of the priorities we describe here, such as instilling a culture of risk taking and learning, are more pressing for Chinese companies. Others, such as retaining local talent, may be harder for multinationals. Collectively, these priorities include some of the critical variables that will influence which companies lead China’s innovation revolution and how far it goes.

Deeply understanding Chinese customers

Alibaba’s Web-based trading platform, Taobao, is a great example of a product that emerged from deep insights into how customers were underserved and their inability to connect with suppliers, as well as a sophisticated understanding of the Chinese banking system. This dominant marketplace enables thousands of Chinese manufacturers to find and transact with potential customers directly. What looks like a straightforward eBay-like trading platform actually embeds numerous significant innovations to support these transactions, such as an ability to facilitate electronic fund transfers and to account for idiosyncrasies in the national banking system. Taobao wouldn’t have happened without Alibaba’s deep, analytically driven understanding of customers.

Few Chinese companies have the systematic ability to develop a deep understanding of customers’ problems. Domestic players have traditionally had a manufacturing led focus on reapplying existing business models to deliver products for fast-growing markets. These “push” models will find it increasingly hard to unlock pockets of profitable growth. Shifting from delivery to creation requires more local research and development, as well as the nurturing of more market-driven organizations that can combine insights into detailed Chinese customer preferences with a clear sense of how the local business environment is evolving. Requirements include both research techniques relevant to China and people with the experience to draw out actionable customer insights.

Many multinationals have these capabilities, but unless they have been operating in China for some years, they may well lack the domestic market knowledge or relationships needed to apply them effectively. The solution-building a true domestic Chinese presence rather than an outpost—sounds obvious, but it’s difficult to carry out without commitment from the top. Too many companies fail by using “fly over” management. But some multinationals appear to be investing the necessary resources; for example, we recently met (separately) with top executives of two big industrial companies who were being transferred from the West to run global R&D organizations from Shanghai. The idea is to be closer to Chinese customers and the network of institutions and universities from which multinationals source talent.

Retaining local talent

China’s universities graduate more than 10,000 science PhDs each year, and increasing numbers of Chinese scientists working overseas are returning home. Multinationals in particular are struggling to tap this inflow of researchers and managers. A recent survey by the executive-recruiting firm Heidrick & Struggles found that 77 percent of the senior executives from multinational companies responding say they have difficulty attracting managers in China, while 91 percent regard employee turnover as their top talent challenge.

Retention is more of an issue for multinationals than for domestic companies, but as big foreign players raise their game, so must local ones. Chinese companies, for example, excel at creating a community like environment to build loyalty to the institution. That helps keep some employees in place when competing offers arise, but it may not always be enough.

Talented Chinese employees increasingly recognize the benefits of being associated with a well-known foreign brand and like the mentor-ship and training that foreign companies can provide. So multinationals that commit themselves to developing meaningful career paths for Chinese employees should have a chance in the growing fight with their Chinese competitors for R&D talent. Initiatives might include in-house training courses or apprenticeship programs, perhaps with local universities. General Motors sponsors projects in which professors and engineering departments at leading universities research issues of interest to the automaker. That helps it to develop closer relations with the institutions from which it recruits and to train students before they graduate.

Some multinationals energize Chinese engineers by shifting their roles from serving as capacity in a support of existing global programs to contributing significantly to new innovation thrusts, often aimed at the local market. This approach, increasingly common in the pharmaceutical industry, may hold lessons for other kinds of multinationals that have established R&D or innovation centers in China in recent years. The keys to success include a clear objective—for instance, will activity support global programs or develop China-for-China innovations? and a clear plan for attracting and retaining the talent needed to staff such centers. Too often, we visit impressive R&D facilities, stocked with the latest equipment, that are almost empty because staffing them has proved difficult.

Instilling a culture of risk taking

Failure is a required element of innovation, but it isn’t the norm in China, where a culture of obedience and adherence to rules prevails in most companies. Breaking or even bending them is not expected and rarely tolerated. To combat these attitudes, companies must find ways to make initiative taking more acceptable and better rewarded.

One approach we found, in a leading solar company, was to transfer risk from individual innovators to teams. Shared accountability and community support made increased risk taking and experimentation safer. The company has used these “innovation work groups” to develop everything from more efficient battery technology to new manufacturing processes. Team-based approaches also have proved effective for some multinationals trying to stimulate initiative taking.

How fast a culture of innovation takes off varies by industry. We see a much more rapid evolution toward the approach of Western companies in the way Chinese high-tech enterprises learn from their customers and how they apply that learning to create new products made for China. That approach is much less common at state-owned enterprises, since they are held back by hierarchical, benchmark-driven cultures.

Promoting collaboration

One area where multinationals currently have an edge is promoting collaboration and the internal collision of ideas, which can yield surprising new insights and business opportunities. In many Chinese companies, traditional organizational and cultural barriers inhibit such exchanges.

Although a lot of these companies have become more professional and adept at delivering products in large volumes, their ability to scale up an organization that can work collaboratively has not kept pace. Their rigorous, linear processes for bringing new products to market ensure rapid commercialization but create too many hand-offs where insights are lost and trade-offs for efficiency are promoted.
One Chinese consumer electronics company has repeatedly tried to improve the way it innovates. Senior management has called for new ideas and sponsored efforts to create new best-in-class processes, while junior engineers have designed high-quality prototypes. Yet the end result continues to be largely undifferentiated, incremental improvements. The biggest reason appears to be a lack of cross-company collaboration and a reliance on processes designed to build and reinforce scale in manufacturing. In effect, the technical and commercial sides of the business don’t cooperate in a way that would allow some potentially winning ideas to reach the market. As Chinese organizations mature, stories like this one may become rarer.

China hasn’t yet experienced a true innovation revolution. It will need time to evolve from a country of incremental innovation based on technology transfers to one where breakthrough innovation is common. The government will play a powerful role in that process, but ultimately it will be the actions of domestic companies and multinationals that dictate the pace of change—and determine who leads it.

Sidebar: Improving the patent process

In innovative sectors such as biotechnology, electric vehicles, pharmaceuticals, and solar energy, the number of patent applications from Chinese companies is rising. In fact, Huawei and ZTE ranked among the world’s top five corporate patent registrants by volume in 2010. Intensifying patent activity reflects a growing recognition that intellectual property is essential to value. As this mentality takes hold, domestic innovators may pressure the government to create a more modern intellectual-property system.

Currently, China recognizes three categories of patents: invention (what most people elsewhere think of as worthy of a patent), utility (a new use for something that already exists), and design. Invention patents run for 20 years, the others only for 10. Patent reform—such as reducing the duration of design or utility patents and raising the bar for what can be registered in those categories—would be a powerful way for the Chinese government to signal its seriousness about promoting indigenous innovation. If China decides to move ahead with patent reform, a desire for global consistency could well make it a high-priority multilateral issue.

Without patent reform, companies must rely on one of two strategies for protecting intellectual property. The first is to continue to outrun thec ompetition by developing increasingly innovative solutions or building in protection through complex integration that is difficult to reverse-engineer. The second is to create easily identifiable technology “signatures” that would be hard to refute in legal proceedings

About the Authors
Gordon Orr is a director in McKinsey’s Shanghai office, where Erik Roth is a principal.

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Capability building in China Tue, 22 Oct 2013 10:42:26 +0000 Skill building must be rewards-based, rooted in real work, and tailored to local conditions.
July 2013 | by Karel Eloot, Gernot Strube, and Arthur Wang

Capability building—leadership, managerial, and team-based skills rather than technical ones—has become an urgent imperative for many companies in China. As the country loses its extreme low-cost-labor advantage, businesses must look for ways to increase productivity and internal collaboration, to better understand consumers, and to develop a more sophisticated appetite for risk.

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Companies in China face many of the same challenges—a lack of up-front planning and inadequate resources—that bedevil capability-building exercises everywhere. But certain “China factors” stand out. For starters, the demand for managers with strong leadership skills and international experience is growing significantly faster than the supply of qualified candidates. That imbalance makes it more difficult to pull off successful skill-building efforts, even for multinationals that typically invest more in training than Chinese companies do. (Indeed, one implication of China’s white-hot war for talent is that outside trainers brought in by multinational companies to set up and run new programs often move on before relevant tools and internal processes are in place.) Another perennial challenge for multinationals: the Chinese context and culture, which may require local tailoring of global approaches.

Then, of course, there are China’s state-owned enterprises. Many of them only recently converted from government departments into commercial entities and are still working to adapt to a competitive environment and adopt a true business mind-set. These companies generally lack a systematic approach to nurturing employees moving up the organizational ladder. They misconstrue capability building as a classroom activity, missing the impact of linking it to actual business. And they are too inflexible either to fire underperformers or to reward and promote employees, including managers, who change their behavior and adopt the necessary mind-sets.

While the challenges facing multinationals and state-owned enterprises differ, our experience with leaders at both kinds of organizations (as well as with private-sector Chinese companies) has highlighted the importance of some common, broadly applicable principles. In this article, we describe three that should help companies overcome many of the obstacles that have frustrated capability-building efforts in the past.

1. Relate capability building to real activities

In many Chinese companies today, capability building remains synonymous with classroom training, partially thanks to the tradition of rote learning in schools. The case for building new skills is easier to understand, however, if the exercise is rooted in visible operational outcomes, as well as improvements in the welfare of participating employees.

A large state-owned enterprise we know consciously built the capability-building program at one of its refineries around tangible targets. About 30 change agents were held accountable for 12 productivity improvements, such as higher energy efficiency and more reliable equipment. In the process, these employees had an immediate opportunity to apply the technical and managerial skills they had learned and to observe the benefits, including a 10 percent fall in energy consumption.

Or consider the experience of a Chinese automotive joint venture that recently began to develop new car models in China after years of manufacturing only cars transferred from mature markets. The venture has now set up a “corporate university” to encourage cross-functional collaboration among a range of functions—notably, engineering, finance, manufacturing, purchasing, quality, and sales—as well as better communication with global headquarters to ensure a successful launch. This is capability building with a purpose that everyone can understand and rally around.

As this example emphasizes, capability building rooted in real work and aimed at overcoming real challenges often benefits from a broader support system. Historically, many human-resource departments emphasized quantity over quality, placing priorities such as cross-functional collaboration and leadership skills on the back burner. Even today, many HR functions do no more than oversee salaries and benefits, relying largely on one-to-one training in local plants. As industry processes and value chains grow in complexity and innovation becomes more important, a comprehensive approach is required.

2. Instill incentives and create opportunities for promotion

In China, a hierarchical culture remains a formidable barrier to better performance. Individuals do not always gain promotion or receive sufficient reward for their efforts; the plaudits tend to go automatically to people with the longest tenures in the highest ranks. In many corporate environments, the most important thing is not to make mistakes and, hence, not to take risks.

All of those problems proliferated at one big Chinese state-owned heavy-industry company we know. Most of its leaders had transferred from technical positions into general-management ones, without sufficient training or coaching on how to manage that transition. Seniority and technical skills rather than broader leadership and managerial talent or potential determined promotions and rewards, and no centralized knowledge or learning resources were available to help fill in capability gaps. As a result, some talented young managers chose to leave the company.

By contrast, another state-owned enterprise recently discovered the power of incentives. To sustain its improvement program, it established an accreditation process that officially certifies change agents who outperform their peers, rather like General Electric’s Black Belt program. The rule now is that every senior manager has to pass this certification test before being considered for further promotion. Ten percent of the profit improvement the change program generates is used to motivate the people involved. As employees have come to see how the initiative is improving performance and winning them recognition from the company’s leadership, participation has climbed.

3. Don’t forget China’s unique culture

Chinese employees will be much more receptive to capability-building materials that reflect the local culture rather than, say, American or European examples and case studies. Local trainers invariably add know-how and credibility to the wider organizational rollout, notably in winning over skeptics.

One worldwide industrial-packaging leader, facing significant competition in a highly commoditized and fragmented market, sought to use its global commercial-excellence program to accelerate growth. But its salespeople could not apply what they learned to the China market, and the costs, in the form of employee fatigue, were considerable.

The solutions may sound obvious: developing Chinese teaching materials to help solve problems, building day-to-day business problems around products that participants would find in the Chinese market, and localizing global training materials through culturally appropriate metaphors and examples. But we know from experience how easy it is to overlook these issues. In our own work, we routinely use a case involving a coffee machine to teach managers about the seven types of waste and how a “lean” perspective can address them. When we recently used this case at a Chinese state-owned enterprise, however, the managers couldn’t make sense of the story, because they had never used a coffee machine. We have now adapted the context to tea making.

About the authors
Karel Eloot is a director in McKinsey’s Shanghai office; Gernot Strube is a director in the Hong Kong office, where Arthur Wang is a principal.
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Twin-track training Tue, 22 Oct 2013 10:41:25 +0000 A member of the board of Knorr-Bremse Asia Pacific explains how the German braking-systems company has developed a global–local approach to capability building in China.
July 2013 | by Henrik Thiele

Most multinationals seeking to establish a successful local business have to build a high-performing team with strong capabilities and relevant local knowledge. I know from experience that in such a competitive and rapidly growing market as China, it’s a daunting task to shape an organization that combines the best local talent with the practices and culture of the parent company.

Knorr-Bremse now has seven wholly foreign-owned or joint-venture factories in China making state-of-the-art braking systems and other subsystems for the railway industry, as well as two major factories manufacturing parts for commercial vehicles. We’ve succeeded by using a phased approach that reflects how our China organization has evolved from a small local presence, tightly run by group headquarters in the early years, to a more fully fledged, entrepreneurial, and self-standing business today. Our approach also acknowledges the changing nature of the Chinese marketplace and the growing demands of the customers we serve.

In the almost 15 years since we first started local production and assembly in China to supply air brakes to Shanghai Metro, the Knorr production system (KPS) has been central to our operations. Closely modeled on the classic Toyota Motor production system and applied to our industry environment, it reflects our focus on quality, efficiency, and safety. This means that if you go to any of our plants in China, Europe, or the United States, you’ll find the same culture and ways of working.

Our ramp-up in China was massive, especially from 2004 onward, when the Ministry of Railways allowed the introduction of localized non-Chinese technology for the country’s new high-speed railway network. Provided we could produce and deliver what our customers were asking for, we were well positioned to grow very quickly.

While our Chinese companies have always had—and still have—local managing directors, operations were primarily driven by KPS-trained expatriates, and most of the engineering skill and knowledge in our brake products remains in Europe. Initially, the management capabilities and strategic drive for China came from these expatriate managers, from the heads of our centers of competences in Germany (who had direct responsibility for making the Chinese operations work), and from our Asian headquarters in Hong Kong.

With KPS as the backbone, the key challenge was to instill the execution and quality culture into our local employees. We taught those in “line” jobs how to apply KPS methods and tools so as to achieve the right standard of reliability, rather than providing them with theoretical training they would have had to transfer to the workplace themselves. We strove to create a culture of continuous improvement on and from the shop floor—which doesn’t come naturally in a country that’s far more hierarchical than ours.

An important dimension for us from the beginning was to foster a workplace where people wanted to stay. Knorr-Bremse’s long history and reputation in the market certainly helped, as did our rapid expansion and our emphasis on employee learning. As a result, Knorr-Bremse’s attrition rate at, for example, Suzhou (near Shanghai) is today about a third that of the surrounding industrial players. That’s a huge competitive edge; if, as some companies do, you have to replace one-quarter of your workforce each year, the investment in training multiplies accordingly. We still lose too many people—every well-trained and experienced member of our staff who leaves the company is a big loss—but we are making a big effort to improve our retention rate.

The second phase of our China journey, starting about four years ago, has not only made our operations more self-reliant but also increased our local application-engineering know-how and expertise. Gradually, local leaders started to replace our expats. The need to work on problem solving with our Chinese customers and to meet their new requirements prompted us to add more China-based engineering support. In some cases, we even started to develop, entirely on our own, local products such as platform screen doors that separate passengers from the railway track when there is no train in a station. Since at least 80 percent of the world market for these products is in China, we knew that we could be successful only by developing them there instead of relying on imported technology. For this part of the business, we therefore established our center of competence for product development in Guangzhou—a move that I am absolutely convinced was and is the right step. However, we have taken a different approach with our brake products, which are more safety sensitive and complex.

Knorr-Bremse has now embarked on a third phase of capability building, which will help our operations in China become fully self-standing for our other products. We are concentrating on both the better application of local engineering skills to the needs of local customers, as well as the development of an organization and business system that can meet heightened customer expectations. Our competitors do not sleep on the job; if we don’t act, they will.

Chinese customers may take a bit of time to make up their minds about things, but when they have decided on, say, a supplier, they expect delivery yesterday. For us, that means instilling a Chinese organizational culture that builds on European processes for systematic quality control while adapting to the more flexible approach of our Chinese customers. Some will say that this challenge is as tough as squaring a circle. It’s certainly not easy, but we are making progress. Non-Chinese people sometimes find it hard to understand the expectations of our Chinese customers, but it is our responsibility to ensure that Knorr-Bremse’s organization is well adapted to meet their needs and allows us to remain their trusted partner. In other regions, companies may object that a particular quality problem is not their responsibility and do nothing about it. In China, by contrast, you need to help your customer solve the problem first; only later should you sort out whose fault it is and how you’re going to share the cost. If the customer is king in Europe and the United States, in China the customer is god.

Most people know the concept of guanxi: the personal relationship between individuals exchanging favors. That is very important in a Chinese business context. I believe that in addition to personal guanxi, which will always play an important role, we need to think about company relations in that light. For me, this “corporate guanxi” means that companies exchange services and help each other out even if there is no contractual obligation to do so. You know that a trusted partner—a customer or a supplier—will return the favor in due course, and both parties will ultimately benefit from a long-term trusting relationship.1
What I’m talking about is a way of doing business that formerly prevailed in Europe but has gotten lost in a world where companies there and in the United States too often write huge contracts and then haggle over the small print. We must embed corporate-guanxi thinking not only into our local-company culture but also into our broader business model for China.

Our step-by-step, phased approach has served us well, and I think others can learn from it. However, given the speed of change in China, it is necessary to reevaluate the master plan at any moment. What seemed like the right thing to do today might be overtaken by some new development tomorrow.

About the author
Henrik Thiele is a member of the board of Knorr-Bremse Rail Asia Pacific, based in Hong Kong. This commentary is adapted from an interview by Gernot Strube, a director in McKinsey’s Hong Kong office, and McKinsey Publishing’s Tim Dickson.
The author would like to thank Knorr-Bremse’s Martyn Perkins for his helpful comments and advice.
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Managing the Chinese way Tue, 22 Oct 2013 10:40:49 +0000 An executive with 20 years of experience in China says that to succeed there, leaders must learn to think differently and devote particular attention to people.
July 2013 | by Nandani Lynton

Despite decades of experience in China, many organizations still struggle to identify and select executives who will make a tangible impact there. My research and experience suggest that companies can do better by focusing on two crucial skills—an ability to read the external environment and an understanding of what makes employees tick—and on a tough truth: a generational challenge is making the talent equation more complex.

Everything is political. Being effective in China means realizing that everything is political. Executives must have a keen grasp of political and social trends so they can position their business strategies and communications within that landscape. One example is the reframing of proposals for corporate-social-responsibility initiatives, to promote the “harmonious society” when that was proclaimed as a government priority.

Executives must develop a nonmarket business strategy, as well as the usual market strategy, for China. The nonmarket strategy includes plans for building a network that intersects with the government, business partners, suppliers, customers, and other industry and public stakeholders.

Successful executives develop their intuition, are receptive to learning from Chinese patterns, and thus begin to think and behave differently. The sort of linear analysis generally favored in the West divides a problem into its component parts and seeks rational solutions. Intuitive thinkers seek patterns and relationships between a problem and its context, including contradictions. “The Chinese don’t polarize—it’s the last thing a Chinese would do; we get moving instead,” says the Chinese head of a global life-sciences company.

Everything is personal. Managers in China need to pay more personal attention to staff and colleagues than managers in many other cultures do. The head of China operations for a major global manufacturing concern says he does his e-mails and reports during the evening because during the day he needs to talk with employees or meet external stakeholders. In China, leadership is a contact sport.

Senior leaders too often succumb to time pressures and put the wrong candidate in charge. One European retailer, for example, chose a manager to head up its China operations who had an excellent track record in his home market but lacked any experience outside Europe and was a poor listener. Within months, relationships with the retailer’s Chinese joint-venture partner were shaky, several well-qualified Europeans had resigned, and staffing was behind schedule. Employees said the executive did not care about their observations and ideas, expected the staff only to follow his instructions, and did not listen to customer feedback. After two years, the executive was replaced, but the damage was done and the operations closed 18 months later.

To keep capable staff from becoming disengaged, demotivated, and disinclined to share important information gleaned from interactions with customers and suppliers, the best companies have a culture, set from the top, of working toward common goals in a spirit of mutual respect.

It’s getting harder. The talent challenge for multinational companies in China has intensified since the generation born in the 1980s began to take on managerial responsibility. As a result of the government’s one-child policy and the uneven pattern of higher education, many businesses are facing a shortage of capable young executives. Moreover, the new generation of leaders demands both purpose and work–life balance, and no longer automatically accepts hierarchy in the workplace. The best way to retain these leaders is to have role models who inspire commitment—which makes it even more important to select leaders who can read and respond sincerely to their stakeholders.

About the author
Nandani Lynton is director of leadership development at Maersk Group, in Copenhagen, and visiting professor of management at China Europe International Business School, in Shanghai. Based in China for 20 years, she is the author of the report Ain’t Misbehaving: Labours and Loves of China’s Gen Y (CLSA University Blue Books, May 2011).
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Forecasting China Tue, 22 Oct 2013 10:40:48 +0000 McKinsey’s Gordon Orr has been publishing predictions about China for nearly five years. Join him for a review of the good guesses, major misses, and lessons he’s learned from both.
July 2013 | by Gordon Orr

I started writing lists of what might happen in China seven or eight years ago. At first, they were just for me—a way of organizing my own thinking in early January for the 12 months ahead. Then I began to post some of the more interesting ideas on the blog I write for McKinsey colleagues.

Four years ago, when my publishing colleagues suggested I share my predictions externally—first in English, then in English and Chinese—the stakes rose significantly. This development not only brought the forecasts to the attention of thousands of users on a McKinsey site but also made it possible for social and traditional media to amplify the message to hundreds of thousands of people (and, in the case of one notorious forecast, to several million of them). Better data, more coherence, greater sensitivity to the possible implications of what I was saying, and thorough editing were needed. In the annual forecasts, I have tried to strike a balance among the following:

Developments that I’m convinced will really happen and have a material impact on the country but aren’t being highlighted as much as I think they should. They range from small changes that illustrate a broader point—sometimes even a real discontinuity—to large changes of national significance.
Things that might or might not happen, but whose impact would be very material if they did and are worth thinking about anyway for what they tell us about China today.
Things that are highly unlikely to happen but would be fun if they did. Exploring them has allowed me to share interesting and perhaps unexpected things I learned about China.
For 20 years, it has been my privilege to make China my home and to immerse myself in the transformation of its business, its economy, and its society. I live and work in China but I am not of China. I hope that gives me both optimism about what can be achieved there, often rapidly, and objectivity enough to see the flaws alongside the successes and to recognize when foundations are solid and when they are cracked.

The themes I write about come implicitly and explicitly from my interactions with many people. I have seen four, five, even six generations of country heads of multinational companies come and go. I have been able to work with the executives of many multibillion-dollar Chinese companies as they have moved from middle management to the top of their organizations. And I have seen many of the talented Chinese nationals we recruit for McKinsey grow into partners and, in some instances, move beyond the firm to lead some of the most exciting enterprises in China today.

How did the forecasts do?

Here are some of the highlights and lowlights of my forecasts over the past four years.


The forecasts for 2009 were perhaps the most provocative—and specific—and included one that subsequently went viral and was read by millions. In my comments on the substandard quality of Chinese construction, I had suggested that a major tower block would fall over. So when fire destroyed a tower in the new China Central Television (CCTV) complex in Beijing a few months later, and a newly completed housing tower block in Shanghai collapsed for lack of proper foundations, China’s social media claimed I had magical foresight.

Slightly less presciently, I forecast that Mexico would expand significantly as a production base for Chinese manufacturers. South Korean producers already had a large presence there, and the early signs suggested that cost and demand pressures were driving the growth of multiple manufacturing hubs. Foxconn and Haier did acquire factories in Mexico, and recently Lenovo announced that it will be assembling PCs in the United States. But Chinese manufacturers did not act as boldly to diversify their production geographically as I had expected. The advantages of staying close to their existing supplier base and avoiding complexity far from home proved more compelling.

I had thought that following Huawei’s failed 2008 attempt to buy the US network-equipment manufacturer 3Com, another iconic US technology company might be the object of Chinese attention in 2009. Since the Lenovo acquisition of IBM’s PC business unit in 2005, however, no Chinese company has succeeded in buying a US technology business of any size, not even those that have fallen on hard times. Many observers have noted the changing political climate: if the Lenovo acquisition had been proposed a few years later, it would probably have been turned down. Fear of rejection remains a powerful deterrent to larger-scale Chinese acquisitions in the United States—so much so that the American Chamber of Commerce in China is currently planning an initiative to help Chinese companies invest in the United States.

Competition in the telecom sector, meanwhile, has declined to a whimper even without the continued consolidation I forecast at the start of 2009. Government-orchestrated share shifts enabled through policy and regulatory pronouncements have prevented the weaker operators, with their large legacy fixed-network assets, from getting into serious financial distress.

Although China has not made quite the leap I predicted in electric cars, its commitment to developing the world’s leading electric-vehicle (EV) industry has been substantial. That commitment includes billions of dollars in subsidies and huge incentives for potential buyers, as well as directives to government purchasers to buy electric. The original Program to Promote the Automotive Industry, in 2009, set a target of 500,000 new-energy (EV, hybrid, and other) vehicles by 2011. The actual volume turned out to be 15,000, of which 10,000 are EVs.

To date in China, as elsewhere in the world, consumers have largely rejected EVs, and EV technology has failed to live up to the commitments of Chinese companies. The share price of BYD, one of the businesses I highlighted, has fallen by more than 65 percent since the euphoria that followed Warren Buffet’s investment. The timing of my forecast was spectacularly wrong. But the need for electric vehicles is still pressing—if anything, more so given the intense pollution in Beijing earlier this year. Chinese companies recognize how challenging it will be to develop the technology, particularly batteries, and are reaching out globally. Wanxiang’s recent purchase of A123 Systems is a case in point. There will be a second wave for EVs in China, but probably not on a major scale until after 2017.

I was at least partly justified, at the start of 2009, in looking forward to warmer cross-strait relations between the mainland and Taiwan. Mainland banks have invested modestly there, although the first representative branch didn’t open until 2010. By the end of 2012, four mainland banks—Bank of China, Bank of Communications, China Construction Bank, and China Merchants Bank—had a branch or office in Taipei.


As a result of a couple of transactions I was supporting over the Christmas and New Year period, I wasn’t able to make that year’s forecast in time for publication.


The list of forecasts was shorter in 2011 than in other years. I thought inflation would be a problem, and, sure enough, it rose by more than 5 percent (against 3.3 percent in 2010 and –0.7 percent in 2009). The jump in food prices was of particular concern to government officials. To this day, the food chain remains highly strained, vulnerable to harvests disrupted by weather or outbreaks of disease. Imports of agricultural products also took off in 2011, encouraging financial investors to find opportunities in the sector.

I predicted a rise in minimum wages as well, albeit with the caveat that productivity gains would outstrip labor costs. With the push to boost economic growth through consumption, minimum wages did increase, by as much as 20 percent annually in many cities. Companies struggled to achieve matching productivity gains, though. For the first time, many multinationals experienced a China with middling, even high, labor costs and significant rigidities when it came to hiring and firing workers. The country now has a much clearer understanding of the trade-off between hiring factory workers and making capital investments—and especially of the risks of hiring expensive white-collar staff with, at best, average productivity levels.

As I expected, 2011 was a bumper year for outbound acquisitions by Chinese companies, which committed more than $50 billion to deals. A majority of the largest were in the energy sector, notably Sinopec’s purchase, for $4.8 billion, of a 30 percent stake in Petrogal Brasil (petroleum and natural gas); China Three Gorges Corporation’s $3.5 billion strategic partnership with Energias de Portugal, an electric utility; and China Investment Corporation’s decision to invest $4.3 billion for a 30 percent stake in the exploration and production division of GDF Suez (natural gas). Chinese companies also acquired rights to exploit oil and gas fields in Australia and in the United States, and there were several sizable mining acquisitions. In other sectors, Lenovo bought NEC’s personal-computer business and a 37 percent stake in Medion, a German consumer-electronics manufacturer. Chinese investment in international port operations also grew.

My poorest forecast was probably that China’s government would meaningfully reduce its stake in state-owned enterprises, particularly in the industrial companies overseen by the State-owned Assets Supervision and Administration Commission (SASAC). Instead, the status quo well and truly held. Indeed, since 2010 the market share of state-owned enterprises has grown in numerous sectors.


I had some easy wins in 2012. For example, compensation again predictably rose across the board, as did minimum wages (by 13 percent in Shanghai and even more in many other cities). White-collar salaries rose still further—so much that it might be cheaper to employ a researcher in Munich than in Shanghai. In one Chinese company’s R&D organization, the average compensation cost rose to $70,000.

Accounting scandals in Chinese companies grew in number and scale through 2012 and continued in 2013, at a pace faster than I had anticipated and across a broader range of industries. Even an illustrative list is long: Boshiwa, China MediaExpress, Daqing Dairy, Focus Media, Longtop, Sino-Forest, Zoomlion, and, more recently, Zhengzhou Siwei Mechanical & Electrical Manufacturing (a subsidiary of ERA Mining Machinery). This is an important issue, and not only for shareholders. A number of multinationals have walked away from acquisition negotiations because they were worried that problems might be lurking, and not because they found anything (see “Due diligence in China: Art, science, and self-defense”).

Chinese companies also became bolder with their acquisitions in 2012, particularly in agriculture and in basic materials. Larger deals were still most common in energy. They included Sinopec’s minority stakes in five of Devon Energy’s US shale-oil and -gas fields (for $2.44 billion); China Guangdong Nuclear Power Holding’s 57 percent stake in the uranium-focused Australian company Extract Resources (acquired for $1.3 billion); and Sany Heavy Industry’s $700 million purchase of the German concrete-pump manufacturer Putzmeister.

I was right that the Chinese automotive market would slow down—as it turned out, from 32 percent growth in 2010 to 9 percent in 2012. The impact was greater on domestically owned producers (which grew by just 5 percent) than on the major joint ventures between local companies and multinationals (sales were up by 11 percent in 2012). OEMs at the very high end of the market grew more than 20 percent, notwithstanding the economic slowdown and the clampdown on conspicuous consumption.

Hospital reforms also went ahead as anticipated. Hospitals may now be 100 percent foreign owned, though the reluctance of medical staff to leave the state sector constrains private-sector growth.

At the start of 2012, I was bullish about green investment. It proved to be a great year for solar installations in China and a terrible year to manufacture solar equipment there. China installed about 5 gigawatts (5,000 megawatts) of solar capacity in 2012, double the more than 2.5 GW achieved in 2011, itself four times the 2010 figure. The country is now the world’s number-two end market for solar, thanks in large part to increased support from the Chinese government.

Solar-module manufacturers, on the other hand, faced lower selling prices, weakening demand in Europe, industry overcapacity, and rising trade barriers. China’s manufacturing capacity in 2012 was about 40 to 45 GW, against global demand of about 30 GW. Chinese solar panels are selling for 60 cents per watt-peak1 (Wp)—at or below manufacturing cost—compared with $1/Wp a year ago, $1.60/Wp in 2011, and $4/Wp in 2008. Most manufacturers depend on borrowing from Chinese banks to survive, and consolidation is overdue. However, as too often happens in China, when demand growth slows, local government steps in with support.

China escaped any disease-driven discontinuity in 2012 but has done little to reduce the potential for the further food inflation I expected. Structurally, China’s trade deficit in agricultural products continues to grow, reaching $56 billion in 2012. Given tight global markets in many agricultural products, inflationary pressures have been building, but across-the-board inflation did not materialize in 2012; indeed the pig price cycle was at a disinflationary point in 2012. I could have seen that more clearly.

My suggestion that private-equity and venture-capital funds might go “walkabout” perhaps proved too alarmist. But although there was no high-profile instance of a private-equity manager diverting funds, I believe this development is only a matter of time. At a personal level, I saw the owner of my son’s school in Shanghai divert school fees to another project. No money remained for salaries, housing, or insurance—or to renew the visas of non-Chinese teachers. It was only thanks to the staff’s loyalty that the school kept going until the end of the year.


Much less than halfway through the year (as I write this article), it’s too early to tell how my list for 2013 will fare. I’ve predicted, among other things, a rough time for banks, a doubling of pork or chicken prices, the bankruptcy of a brick-and-mortar retailer, and investment by European soccer teams in the Chinese Super League. The banks are indeed increasingly concerned that their wealth-management products are becoming a liability, and German retailer MediaMarkt has highlighted the challenges in retailing with its announcement that it is leaving the China market (following the closure by Best Buy of its branded stores in 2011). We will need to wait until the end of the soccer season in Europe to see if its teams will invest in China.

What I have learned

New Year forecasting is a widely practiced business art in most areas of the world, but in China it carries particular risks and rewards. Here are a few reflections to help leaders trying to plan ahead in this fast-changing land:

  • As long as you are directionally correct, growth in China will make your predictions right at some point, and often very quickly. Having a sense for the pace of change is critical.
  • Don’t rely too heavily on government statistics. In the past, at least, the government struggled to gather quality data, and what data it had were often heavily massaged.
  • Trying to forecast exactly when discontinuities will happen is a fool’s game. But identifying what types of discontinuities will happen is a fool’s game. But identifying what types of discontinuities could occur—and having a plan to deal with them if they do—is a basic corporate responsibility.
  • Volatility is a central feature of the Chinese economy. Consumers and businesses still overreact to signals to spend, to invest, and to cut back, so there will be unexpected jumps in demand—and setbacks. Don’t forecast in straight lines.
  • Economics is still economics in China. If something looks odd, it probably is. Find out why before you forecast (or invest).
  • It is more important for forecasting to be interesting—thereby encouraging debate, scenario planning, and a flexible mind-set—than comprehensive.

As for my own modest efforts, I’ve learned to live with the fact that public forecasts never disappear; people still circulate the old ones online. So I’m developing a thick skin, while trying to balance my role as provocateur with my desire to avoid saying something today that will embarrass me in years to come.

About the author
Gordon Orr is a director in McKinsey’s Shanghai office.
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Seizing China’s energy-efficiency opportunity: A case study Tue, 22 Oct 2013 10:38:41 +0000 Improving energy efficiency in industrial environments starts with changing minds—not machinery. The progress made by one of China’s largest state-owned enterprises holds lessons for industrial players of all stripes.
June 2013 | by Steve Chen, Maxine Fu, and Arthur Wang

Energy efficiency and conservation have rocketed up China’s corporate agenda, particularly for heavy-industry players such as power plants, steelmakers, chemical companies, and automakers. Energy is the largest expense for some of these industries, and since variable costs represent a larger share of total costs in China than in more developed countries, where fixed labor outlays are higher, volatile commodity prices hit China’s core industrials much harder. These economic fundamentals apply to multinationals and local players alike, so efforts to secure the benefits of improved energy efficiency are important for a wide cross-section of companies.

Yet achieving those benefits is difficult. The tendency at most industrial companies, and not just in China, is to equate energy savings with capital expenditures, hardware, and other technical solutions. Actually, what is often most important to change is poor cooperation and unhelpful mind-sets prevalent on the front line. Similarly, many companies in China and elsewhere lack an integrated view of how energy yields, energy output, and energy consumption combine to affect their operations. Some measure these factors only in a superficial way.

Nonetheless, a few of China’s leading industrial players are making impressive headway. In this article, we’ll look at one such company—a large resource- and emission-intensive Chinese state-owned enterprise—that in the wake of the global financial crisis began rolling out a series of energy-efficiency improvements across its plant network. A closer look at the company’s flagship plant, where energy consumption fell by more than 10 percent, offers insights for other industrial groups, in China and beyond, as they seek ways to lower costs and use energy resources more wisely.

Welcome to the downturn

As consumer demand plummeted at the start of the global economic downturn, the company’s leaders watched as prices for its goods fell by more than 50 percent in a matter of weeks. Within four months, the group’s record figure for profits was followed by a comparable loss.

To stanch the bleeding, the company’s leaders launched an aggressive operational-improvement effort. To no one’s surprise, energy efficiency appeared the likeliest starting place—after all, energy was the biggest cost driver, representing half of a plant’s variable costs and about 40 percent of the total. Personnel costs, by contrast, were less than 8 percent of the total. Only by improving energy efficiency, the leaders believed, could the company hope to regain profitability and put its operations on a more solid footing.

‘Energy is free’

The team of company experts these executives assembled to assess the situation faced an immediate hurdle: no one at the plant level was responsible for tracking energy in the necessary detail. Even at the group level, the company had little visibility into the way energy consumption, yields, and output combined to affect the economics or operations of plants. At the company’s flagship facility, only one employee worked on energy-related issues—part time—and he focused on basic monitoring and on collecting data for government-reporting purposes, not on efficiency improvements.

This state-owned company’s inattention to energy efficiency is far from unusual in China, and far more common in industrial environments around the world than you might expect. The reason is that the costs associated with energy use often are felt, if they are felt at all, far from the factory floor, where energy is consumed. Most of the Chinese company’s line workers thought of energy as “free,” when they bothered to think of it—a sentiment we hear across shop floors around the world. At this company, that mindset encouraged well-meaning yet shortsighted activities. On the front line, for example, workers used compressed air to cool down motors and extend their operating lives, although on an annualized basis the compressed air cost several times more than a new motor.

As company experts began to work closely with leaders at the flagship plant to gather data and identify opportunities, they quickly encountered another mind-set challenge common to operational-improvement settings: complacency. The leaders of the plant knew full well that it was the pride of the group, and many believed that its efficiency approached or matched global standards on some measures. Only a few percentage points of improvement were possible, many thought, and new equipment would be needed to realize energy-efficiency gains. This attitude was shared throughout the plant. “We thought we were already the best in China,” said one worker. “We were running at our technical limits,” said another.

Wake-up calls

Two events began turning the tide. First, a benchmarking effort showed that the flagship plant was squarely in the middle of the pack when ranked against global competitors. The company’s best wasn’t good enough.

Second, the company’s CEO decided to pay a surprise visit to the facility. He recognized that seizing energy-efficiency opportunities would require determination and a new way of thinking about operations and wanted to see the starting point first hand. He also hoped to send a clear signal—to plant leaders and workers alike—that he was serious about change.

Leaving his company car and driver at his hotel to avoid tipping off the plant’s staff, the CEO set out with two others in a private car late one evening to observe the night shift. After spending nearly 20 minutes locating a supervisor in the guts of the vast plant, the CEO was dismayed to find no one working in an area of its coal-gasification1 unit where employees should have been making energy-saving temperature adjustments. Instead, these workers were visiting with colleagues in a control room. One detail illustrated the lack of seriousness some of them showed in approaching the energy challenge: a maintenance checklist bore a signature indicating that an inspection had been completed at 5 AM the following morning. It was not quite midnight.

A similar visit later that week to a nearby satellite facility, while not as dramatic as the first one, also drove home the need for change. A week later, the CEO announced a wholesale replacement of the plant’s leadership, in an effort to impose the management discipline needed for energy-efficiency efforts.

Getting down to business

Following these wake-up calls, managers and workers began buckling down. In the plant’s coal-gasification unit, for example, the company rationalized the way coal was transported and stored. Coal begins to oxidize and degrade as soon as it’s mined, but through better handling and a straightforward “first in, first out” system, the company improved the energy yield of its coal significantly.

Meanwhile, a better screening system ensured that coal particles were more uniform in size, which improved the efficiency of gasification. Finally, better management and tracking in the coal yard helped the company reduce inventory from 20 days to 10. All told, these changes—plus comparable moves to make the boilers, turbines, and other steam-related equipment more efficient—helped reduce costs in this area by 13 percent (and by 7 percent in the first month alone).

The company launched similar efforts to improve the efficiency of motors, pumps, and other equipment vital to plant operations. Like the changes to the steam-related processes, most of these improvements will require little in the way of capital investment. To date, company executives have identified a potential 15 percent improvement in this area and expect to fully achieve (or exceed) it within 12 months.

Measure, then manage

To help ensure that the changes would stick, the company implemented rigorous data-gathering and performance-management systems alongside the operational changes. Earlier, it hadn’t measured energy use in any of the plant’s large operational processes. Today it measures all of them. Improved tracking and straightforward shop-floor kanbans (signboards that help workers visualize work flow and trigger activities that enhance fast responses) help workers monitor temperatures, processes, and tolerances to maximize energy efficiency. The plant also conducts “theoretical limit” analyses to see what best performance looks like—an exercise that lets workers determine where and how to focus and quantify their efforts.

Efficiency targets are now tied to the performance appraisals of plant managers. Similarly, managers and workers who have direct control over underlying factors that drive energy efficiency—say, the operating temperature of a mechanical process—are assigned as “owners,” with direct responsibility for meeting targets. Daily performance dialogues help workers keep on track while giving them a forum to identify, discuss, and solve problems in a timely manner. Moreover, by carefully defining, sequencing, and weighting the targets at the plant and individual shop-floor levels, the company keeps frontline workers focused on the underlying factors that influence the efficiency of the process or activity at hand. This approach also ensures that these workers’ specific areas contribute to the plant’s big-picture energy-efficiency goals.

Meanwhile, at the corporate level, the company created a new organization, headed by a group vice president, that is responsible for energy efficiency. Assistant managers in each of the company’s plants work closely with specialists in the most energy-intensive divisions to monitor progress and suggest improvements. Some of these ideas have come from the shop floor, where workers now have a much clearer idea of how their actions influence energy use. Collaboration is also improved. As one vice department manager put it, “We have established much closer communication and cooperation between departments and plants along the energy value chain.”

The initial wave of results was encouraging, and changes continue to be rolled out at the flagship and other plants. After the first year, the flagship had exceeded its overall target, lowering its energy consumption by 12 percent and saving some 200 million renminbi (about $32 million). A second wave of energy-efficiency improvements, under way now, is expected to generate additional savings. Subsequent benchmarking found that the flagship plant is poised to become one of the world’s ten most energy-efficient facilities of its kind—a goal the company’s leaders expect to achieve in the near future. They now see energy efficiency as the biggest lever for boosting profits. Indeed, it is expected to contribute a majority of the operational-improvement gains the company has identified this year across its whole network of plants. These gains are projected to exceed those achieved at the flagship plant by more than a factor of ten.

About the authors
Steve Chen and Maxine Fu are consultants in McKinsey’s Shanghai office; Arthur Wang is a principal in the Hong Kong office.
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Seizing China’s new digital opportunity Tue, 22 Oct 2013 10:33:22 +0000 The rise of digital technology has become a global business issue. The global managing director of McKinsey & Company discusses some of the big and potentially bright implications for Chinese enterprises.

Dominic Barton

Over the past year, I’ve met one-on-one with more than 300 CEOs, including 60 in Asia. For most of them, digital technology is now a top-two agenda item for the year ahead. As one executive noted, “Technology is changing five times faster than management.” That’s exactly right, and it underscores the mix of excitement and anxiety I hear in these conversations. Business leaders have no doubt that the opportunities are enormous. Their big concerns are exactly how—and how quickly— they can prepare their organizations for what is becoming a shift of seismic proportions.

Every day we see how digital technologies are both creating value and driving industry disruption. For example, customers in South Korea can now shop while waiting for their subway trains by using a Tesco mobile app to scan the Quick Response (QR) codes from the grocery giant’s billboards and then get the goods delivered to their homes. Alongside creating new customer services, business processes can be optimized and automated.

One bank found that 50 percent of its workforce could be replaced by software over time. And supply chains can be taken to new levels of efficiency using remote sensor networks coupled with sophisticated analysis and prediction techniques.

Digital continues to lower barriers to entry. Online consumer-payment solutions such as Square—a mobile app and device that enables merchants to accept payments—are challenging traditional merchant acceptance solutions. Digital technology also changes the basis of competition by allowing companies from adjacent sectors to compete. For example, motor manufacturers are planning to enter the insurance market as data from in-car “black boxes” provide a competitive edge in pricing.

In China, of course, the consumer economy has already gone digital in a big way. As of December 2011, China had 513 million Internet users, compared with 245 million in the United States. In a recent first-of-its-kind survey of the Chinese “i-consumer,” McKinsey found that the country has by far the world’s most active social-media population, with 91 percent of respondents saying they visited a socialmedia site in the previous six months. More consumers in China than anywhere else say they are more likely to consider buying a product if a friend or acquaintance recommends it on a social-media site.

Where China lags is on the corporate side. Despite pure digital success stories such as Alibaba and Tencent, most big Chinese enterprises are still playing catch-up when it comes to technology. According to McKinsey’s latest survey of Chinese CIOs, the typical  Chinese company spends 2 percent of revenue on IT, in comparison with the 4 percent that international counterparts customarily spend. While respondents predict their IT spending will climb to 3 percent of revenue by 2015, up from 1.5 percent at the beginning of the decade, that still leaves a large gap.

I believe real change in China needs to come faster—and be accompanied not just by more investment but by real business-process and business-model transformation. Building more capable digital enterprises will help China’s companies close their productivity gap versus
the leading multinationals, a must if they are to remain competitive as their labor-cost dvantage erodes. It will also help them scale
rapidly at a time when finding qualified talent is a key bottleneck. If Chinese enterprises really embrace this imperative, going digital may even allow them to “leapfrog” their Western competitors’ efforts to reengineer  processes and improve productivity in much the same way that Chinese telecommunications  famously skipped the stage of fixed-line voice telephony and went straight from greenfield to mobile.

What will it take? A few leading international corporations are already going all in. General Electric, for example, is building apps ranging
from industry-specific monitoring and diag- nostic tools to business-intelligence resources. It is also embedding digital innovations in its
“ecomagination” products to make them more energy efficient. Internally, GE is pushing hard to complete its digital transformation by integrating enterprise-resource-planning, product-life-cycle-management, and customerrelationship-management systems in a fundamentally new way.

1. Decide your digital direction

Every enterprise needs to start with a clear stance on its core digital strategy. It can choose to defend, attack, or become an innovator.

Defense is as important as attack. Digital creates threats to revenue as it tends to transfer value to the end customer—due to better price
transparency, for example—and also to attackers. One global telco estimates that it faces opportunities to increase profits by around 20 percent but a downside in excess of 50 percent. Defenders limit digital downsides, for instance, by increasing customer service in physical channels. Attackers see digital as a competitive differentiator and invest to outperform. Innovators see opportunities in entirely new business models.
Bankinter in Spain has invested heavily in digital channels from the start and was the first bank to use video chat for advising customers; it is now creating a seamless experience across online and offline channels. UK online portal Funding Circle is bypassing banks entirely through peer-to-peer lending.

To gauge progress, enterprises are introducing digital scorecards that track performance on metrics such as percentage of sales through
digital channels or percentage of transactions requiring no human intervention.

 2. Revisit the portfolio

A vital part of a digital strategy is to understand the relative attractiveness of portfolio businesses in a digital future and to restructure accordingly. For example, retailers with large physical networks but poor online capabilities now look challenged in an increasingly digital
environment. By contrast, after years of being a less attractive part of the equation, logistics businesses that deliver parcels are growing rapidly due to online shopping. It may make sense to add new businesses to the portfolio to extract counterintuitive synergies. A US insurer, for instance, has acquired a securitysystem  provider because it can use the data  from the security systems to improve insurance pricing.

3. Build a technology firm inside

Digital success requires focused leadership and a ring-fenced operating model in order  to breed innovation and insulate rare technology
talent from dilution in the wider corporate culture. Roles like data scientist and user-experience manager didn’t exist a few years ago. Such skills are in high demand, and the individuals possessing them can take their pick of employers. Ringfenced operating models come in different
guises. A European telecommunications company has set up a stand-alone business, and one global bank has created a center of
excellence. Regardless of the precise model, strong leadership with both technology and business experience is a must.

Fifty years ago, the emergence of M&A led to the creation of the CFO. We believe the digital explosion may now require a chief digital officer
(CDO) in a role distinct from the CIO. The CDO could add value by being responsible for the financial results of digital businesses, realizing
new digital opportunities, understanding the impact of technology and influencing corporate strategy accordingly, and building digital skills
and culture across the enterprise.

4. Find the investment sweet spot

Leading digital companies achieve a higher return on digital investments than on other capital investments and successfully manage the risks associated with technology projects. They do this in three ways. First, they find the investment sweet spot. Small digital experiments are effective in testing new customer propositions but don’t move the needle on business performance. Large projects often deliver too late in fast-moving
markets. Successful companies experiment widely, and they rapidly scale up successes. Second, they use “agile” project techniques to drive tangible change that delivers measurable business performance every month—or even more frequently. Finally, they centralize decisions on technology spending to maximize reuse and avoid creating new legacy systems.

5. Increase the corporate clock speed

Digital increases the pace of innovation by allowing new customer products and services to be developed and deployed in days instead of months or years. To keep pace with all this innovation, corporate processes, such as budgeting and planning, need to move to “digital time.” Some corporations are moving from an annual to a monthly reallocation of investment spending.

Getting this right requires careful execution and a deep understanding of each company’s external context, industry dynamics, and corporate culture. There is no one-size-fits-all model. But there is also no longer an option to ignore this imperative. It’s time for business leaders in China to join the global movement to radically reshape and upgrade their core operations and strategies by building more truly digital enterprises.

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Meet Maxine Fu, transformer of state-owned enterprises Tue, 22 Oct 2013 01:48:48 +0000 Maxine Fu, an engagement manager (EM) in Shanghai and member of McKinsey’s Operations Practice, contributes to the firm in two areas key to our future growth: China and the Global Energy and Materials practice. Read on to find out how she helped transform a Chinese state-owned enterprise into a model for the many others in the country, as well as her advice to other EMs interested in helping change the firm.

1. Tell us about your role.
For the past 20 months, I’ve been leading teams on an operations transformation project for the Guangxi branch of a major basic materials producer. We’ve conducted ten similar projects at the client’s sites across China, and I’ve worked on four of them.

2. What’s the nature of the work you’re doing?
We created a transformation process focusing on improving their business systems and instilling operations excellence, which was tested at several plants and is now being put to work throughout all of the client’s operations. We are currently in the process of building capabilities for more than 7,300 employees at the shop floor level through various capability-building programs.
We also helped the client build a model factory to help train its staff on topics like visual management, energy efficiency and equipment reliability, so all of its plants can benefit from emerging best practices.

3. What excites you about the Global Energy and Materials practice in China?
For me, the most excitement comes from potential impact we could have. We usually deal with production costs in units of a billion RMB ($200 million USD), so even a 1 percent improvement would mean a lot. And it’s likely that for most organizations, there is a double-digit potential for cost savings from energy efficiency, material consumption, and other operation lift, without much capex.

4. What are the biggest challenges of working in this area?
In addition, you can observe positive changes directly from your daily work, and people enjoy getting your help and respect you as an expert teacher and coach. It’s very fulfilling.
The biggest challenge is getting each staff member to buy in and be a positive part of the change. In order to do that, each person must have a relevant goal which serves as the motivation to change the way they work. For example, the CEO was supportive from the beginning, but what made him become our biggest advocate and a daily participant was linking the transformation goals and activities directly to his challenging business targets.

It’s also difficult to change the status quo at a middle management level, especially when people don’t readily see room for further improvement. In the pilot, we implemented several aspects of the transformation, and highlighted the successes. Then we invited other plants to review and learn from the pilot.

Eventually, a group of 400 leaders at all levels began sharing best practices on a monthly basis, and the CEO and his staff began to do monthly Gemba walks with plant managers (drawing on a lean principle which involves management visiting the shop floor to understand how value is created and where waste can be eliminated). These regular events demonstrated the many possibilities for improvement, and became a catalyst for other plants to follow suit.

Another challenging aspect was getting every employee to actively participate in the change improvement activities. We used the full influence model on this: increasing motivation by aligning incentives; encouraging leaders to role model by advocating at all opportunities; encouraging autonomous kaizens (based on the Japanese operations philosophy of continuous improvement) by recognizing best practice; and launching KPI campaign programs and a poster competition about “finding lost energy at work” and seeking improvement at the level of individual shifts, as well as creating an annual “star award” for best-performing shop floor.

All of these activities are concrete ways of driving change at each working level, and as they were carried out, more and more employees participated. One of our top goals was to make autonomous improvement part of the culture.

5. How did you choose energy efficiency and resource productivity as your area of functional focus?
At the time, I was looking for sustainable ways to reduce costs for our client. We were designing a comprehensive operating system for them, and energy management is one part of this. In the diagnostic, we found that the client lacked integrated thinking or a professional approach to managing energy; they paid attention to production efficiency, but simply treated energy as a cost. But energy cost is generally 30 to 50 percent of total production cost for Chinese GEM companies, and setting up a system to professionally manage for energy efficiency usually leads to a reduction in energy spending of 5 to 15 percent, leading to a significant profit margin improvement.

Therefore, through this client work, we have shown that energy efficiency is a function that urgently needs to be improved, both because of the great savings potential and to fulfill the government’s strict regulations. At the client, we started from the heating process, and eventually touched all energy media, including steam, electricity in motor and smelting, energy-efficient material manufacture, and energy-efficient organization design.

Then I decided to make it more professional as an offering, and promote it to other GEM sectors beyond Basic Materials. In addition to the great potential for client impact, the topic also satisfies my personal passion for creating both financial and social value in the Green sector.

6. Broadly speaking, what kind of impact and opportunity are you seeing as a result of your work?
The data speaks for itself. In the past 20 months at the client, we launched four phases of operation transformation engagements, a strategy project, Centered Leadership forums and capability-building programs, with more than 30 teams on site to support this effort. We have turned a shop floor into a model visual factory, and totally changed the way they do daily management and problem solving. We’ve established a permanent organization with 15 full-time value stream managers and change leaders, and 65 internal trainers to deliver 30 courses to the full company. And, with the Guangxi client teams, we have developed a client-specific business system, which will be the main driver for change across all of the client’s operations for the next 2-3 years.
All of this has led to potential impact with a run rate of at least 290 million RMB ($46 million USD), with at least 150 million RMB ($23.8 million USD) realized and captured in 2012. Going forward, we will continue to support them in a variety of ways; for example, next year we will train 40 managers in how to become world-class change agents, with much of that work taking place at our CCOE (China Center for Operational Excellence / Chinese Model Factory).

In addition, we were very pleased that McKinsey’s support for the clientwas the primary ‘success story’ showcased at a recent semi-annual leadership meeting of the State-owned Assets Supervision and Administration Commission (SASAC), which is attended by all CEOs of China’s SOEs. The CEO, the Guangxi CEO, and a shift manager from Guangxi presented the story of how the transformation positively changed their business. This has led to our work becoming the role model for the SASAC’s three-year initiative on “operations excellence in basic management” among all of China’s SOEs.

7. What was it like to have the government recognize your work by making Guangxi a model for basic management operation excellence of all SOEs in China?
For me personally, I am thrilled to have such recognition. I do have a dream to help Chinese companies build better internal capabilities to become more competitive on the global stage, and now I can see this starting to come true in a more concrete way. The demonstration of the Chalco Guangxi site can help answer the “how” and “why” questions that can hold people and companies back from making changes; the financial impact and beautiful shop floor can set an example for others. I am looking forward to influencing more SOEs by showing them a result they can see and feel.

9. What do you like to do on your time off?


I love to spend time with my 5-year-old son, Julius, and my dog, a 12-year-old American Eskimo. They all inspired me to make more time for my private life.

Traveling alone with my sketch book is another way to refresh myself and get in touch with my spiritual side. Recently, I’ve sketched my way through Egypt, Kyoto and parts of Europe. I also enjoy taking long bike rides across provinces, and writing poetry and posting my poems to my blog. I kind of believe that I might have been a painter and poet in my previous lives.

10. What would you say to another EM thinking about spending time working in GEM?
It is very important that you find your work interesting and enjoy what you do in any role. If you work in GEM, you may not find yourself in a luxury hotel or a fancy office, but you will work directly and regularly with senior leadership and see impact firsthand. At our client, we had weekly sessions with the CEO and senior staff members to problem solve, quickly break barriers, overcome challenges and push solutions forward. Then, we went back to the shop floor to make it all happen. For me, helping to completely transform a site to enhance a company’s performance is very exciting and personally fulfilling.

There are so many things can be done in GEM – from daily operations and beyond. A “Nothing is impossible” attitude is important. Throw yourself in and set yourself as a role model and advocate of change. Try to always inspire your clients, and you will make your mark in this area.

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What’s keeping consumer marketers in China awake at night? Mon, 21 Oct 2013 03:55:47 +0000 At a recent forum, we hosted about 110 CxOs from over 65 fast-moving consumer goods companies as well as a handful of executives from the pharma, auto, and high tech sectors in China.  Both local and global companies were well represented.  To kick-off the event we asked the group 3 questions, responses in the charts below.  Contrasting the responses from local and global companies, I drew the following conclusions:

■ Everyone is facing increased competition, much of it coming from companies that had previously focused on a few categories broadening into adjacent areas

■ Multinationals are struggling with rising costs, in particular the rising cost of labor.  The approaches they take to raising productivity in more mature markets may not be working as well here

■ Multinationals have a tendency to blame the market slowdown much more than locals, for whom perhaps slightly slower growth is a chance to catch up organizationally and operationally

■ Local consumer companies are recognizing that they need to up their game on customer insights and channel management to stay competitive

■ A majority overall seem to believe they are distinctive in modern trade. Perhaps not.

■ Unsurprisingly, multi-channel strategy is seen as a major improvement area for locals and multinationals.  Advanced analytics has similar needs.  Both areas have emerged only recently and are developing so fast that few companies are on top of the implications

■ Local companies finally see the need to bring science to assortment optimization, rather than the traditional “put the product out there and let’s see who buys it”

■ Net net, there is an increasing convergence in understanding of what best practice in customer management is, and a convergence in the operational model to deliver it.  Competition is only going to get more intense




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How to make a city great Wed, 16 Oct 2013 02:30:21 +0000 By 2030, 60 percent of the world’s population will live in cities. That could mean great things for economic growth—if the cities handle their expansion wisely. Here’s how.

What makes a great city? It is a pressing question because by 2030, 5 billion people—60 percent of the world’s population—will live in cities, compared with 3.6 billion today, turbocharging the world’s economic growth. Leaders in developing nations must cope with urbanization on an unprecedented scale, while those in developed ones wrestle with aging infrastructures and stretched budgets. All are fighting to secure or maintain the competitiveness of their cities and the livelihoods of the people who live in them. And all are aware of the environmental legacy they will leave if they fail to find more sustainable, resource-efficient ways of managing these cities.

To understand the core processes and benchmarks that can transform cities into superior places to live and work, McKinsey developed and analyzed a comprehensive database of urban economic, social, and environmental performance indicators. The research included interviewing 30 mayors and other leaders in city governments on four continents and synthesizing the findings from more than 80 case studies that sought to understand what city leaders did to improve processes and services from urban planning to financial management and social housing.

The result is How to make a city great (PDF–2.1MB), a new report arguing that leaders who make important strides in improving their cities do three things really well:

  • They achieve smart growth. Smart growth identifies and nurtures the very best opportunities for growth, plans ways to cope with its demands, integrates environmental thinking, and ensures that all citizens enjoy a city’s prosperity. Good city leaders also think about regional growth because as a metropolis expands, they will need the cooperation of surrounding municipalities and regional service providers. Integrating the environment into economic decision making is vital to smart growth: cities must invest in infrastructure that reduces emissions, waste production, and water use, as well as in building high-density communities.
  • They do more with less. Great cities secure all revenues due, explore investment partnerships, embrace technology, make organizational changes that eliminate overlapping roles, and manage expenses. Successful city leaders have also learned that, if designed and executed well, private–public partnerships can be an essential element of smart growth, delivering lower-cost, higher-quality infrastructure and services.
  • They win support for change. Change is not easy, and its momentum can even attract opposition. Successful city leaders build a high-performing team of civil servants, create a working environment where all employees are accountable for their actions, and take every opportunity to forge a stakeholder consensus with the local population and business community. They take steps to recruit and retain top talent, emphasize collaboration, and train civil servants in the use of technology.

Mayors are only too aware that their tenure will be limited. But if longer-term plans are articulated—and gain popular support because of short-term successes—leaders can start a virtuous cycle that sustains and encourages a great urban environment.

Download the full report, How to make a city great (PDF–2.1MB).

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China’s crash course in post-M&A management Mon, 07 Oct 2013 02:47:29 +0000 Now that Shuanghui – China’s largest pork processor – has received approval to complete its acquisition of US-based Smithfield –the world’s largest pork processor – I am reminded of several experiences over the last decade in supporting Chinese companies as they made their first major international investment.

The under-performance trap

M&A is the preferred globalization route for Chinese companies – 70% of outbound Chinese investment is done this way. For some of the companies I have seen, it was a conscious “bet the company decision”; for others, it unintentionally became that, especially for major acquisitions and serial deals.

From 2008 to 2012, the 44 Chinese companies which made acquisitions worth more than 30% of their market capitalization underperformed their Chinese industry peers by 16% in terms of total returns to shareholders. In the same period, the 8 Chinese companies which made two acquisitions or more underperformed their peers by 12% using the same metric.

When problems arose, too often the core question revolved around the competence of the acquired management team – and especially the CEO. Were performance issues really unavoidable or did the company have a culture of accepting under performance? In many cases, I have seen the Chinese acquirer be much more performance-driven than the company they acquire. Unfortunately for them, it is the rare acquisition where the entire management team are top performers and will want to stay. In most cases, some changes are required in the first year, so for a company making its first major international acquisition, learning how to assess the acquired top team, when to replace someone, and how to identify and attract a stronger replacement are absolutely central challenges.

So how can executives avoid falling into the under-performance trap?

Here are a couple of lessons from successful Chinese overseas acquisitions I have been privileged to witness over the past few years.

Be ready for management changes

If you believe that you are going to want to make management changes, create options as quickly as you can. It is quite likely that executives could stick around in a passive-aggressive and unproductive role until you buy them out. On the other hand, they could leave overnight, creating a significant gap in the team. Starting a search from scratch as an executive leaves could easily leave a hole for 6 months in the executive ranks.

Spend time together

The top team should spend enough time to get to know each other and agree on ways of working together, on cultural norms, as well as management processes. Expecting the same level of implicit understanding from executives who work on the other side of the world as from those whom you have seen 7 days a week for 20 years is simply unreasonable.

Some acquirers try to manage through a board structure construct, flying in just to attend a quarterly meeting for a couple of days. This low level of interaction almost always leads to misunderstanding, followed by mistrust and second-guessing.

Over and above regular in-person contact, install the highest quality video conferencing infrastructure available – and use it. If room-based HD video conferencing ever pays for itself, it does so here.

Meet customers

While customers of the acquired company are often very anxious, they usually have no reason to be, as the intent of the deal is for nothing to change. In one of the most successful acquisitions that I have seen, the Chinese CEO and the CEO of the acquired company spent a total of nearly 8 weeks travelling together to see customers. This helped the Chinese top team understand much more clearly what international customers wanted, as well as creating a much deeper trust between the two CEOs.

Be realistic

Be more realistic in estimating what the synergy potential is in the first place – its size, how long it will take to achieve, and how much management resources it will absorb.

If a turnaround is required and you are planning to retain the existing management team, be very clear about what it is that you are expecting them to do differently that will create the turnaround. Link incentives to these actions.

- See more at:

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Disruptive technologies: Advances that will transform life, business, and the global economy Wed, 02 Oct 2013 02:25:20 +0000 The relentless parade of new technologies is unfolding on many fronts. Almost every advance is billed as a breakthrough, and the list of “next big things” grows ever longer. Not every emerging technology will alter the business or social landscape—but some truly do have the potential to disrupt the status quo, alter the way people live and work, and rearrange value pools. It is therefore critical that business and policy leaders understand which technologies will matter to them and prepare accordingly.

Disruptive technologies: Advances that will transform life, business, and the global economy, a report from the McKinsey Global Institute, cuts through the noise and identifies 12 technologies that could drive truly massive economic transformations and disruptions in the coming years. The report also looks at exactly how these technologies could change our world, as well as their benefits and challenges, and offers guidelines to help leaders from businesses and other institutions respond.

We estimate that, together, applications of the 12 technologies discussed in the report could have a potential economic impact between $14 trillion and $33 trillion a year in 2025. This estimate is neither predictive nor comprehensive. It is based on an in-depth analysis of key potential applications and the value they could create in a number of ways, including the consumer surplus that arises from better products, lower prices, a cleaner environment, and better health.

Some technologies detailed in the report have been gestating for years and thus will be familiar. Others are more surprising. Examples of the 12 disruptive technologies include:

Advanced robotics—that is, increasingly capable robots or robotic tools, with enhanced “senses,” dexterity, and intelligence—can take on tasks once thought too delicate or uneconomical to automate. These technologies can also generate significant societal benefits, including robotic surgical systems that make procedures less invasive, as well as robotic prosthetics and “exoskeletons” that restore functions of amputees and the elderly.

Next-generation genomics marries the science used for imaging nucleotide base pairs (the units that make up DNA) with rapidly advancing computational and analytic capabilities. As our understanding of the genomic makeup of humans increases, so does the ability to manipulate genes and improve health diagnostics and treatments. Next-generation genomics will offer similar advances in our understanding of plants and animals, potentially creating opportunities to improve the performance of agriculture and to create high-value substances—for instance, ethanol and biodiesel—from ordinary organisms, such as E. coli bacteria.

Energy-storage devices or physical systems store energy for later use. These technologies, such as lithium-ion batteries and fuel cells, already power electric and hybrid vehicles, along with billions of portable consumer electronics. Over the coming decade, advancing energy-storage technology could make electric vehicles cost competitive, bring electricity to remote areas of developing countries, and improve the efficiency of the utility grid.

The potential benefits of the technologies discussed in the report are tremendous—but so are the challenges of preparing for their impact. If business and government leaders wait until these technologies are exerting their full influence on the economy, it will be too late to capture the benefits or react to the consequences. While the appropriate responses will vary by stakeholder and technology, we find that certain guiding principles can help businesses and governments as they plan for the effects of disruptive technologies.

  • Business leaders should keep their organizational strategies updated in the face of continually evolving technologies, ensure that their organizations continue to look ahead, and use technologies to improve internal performance. Disruptive technologies can change the game for businesses, creating entirely new products and services, as well as shifting pools of value between producers or from producers to consumers. Organizations will often need to use business-model innovations to capture some of that value. Leaders need to plan for a range of scenarios, abandoning assumptions about where competition and risk could come from, and not be afraid to look beyond long-established models. Organizations will also need to keep their employees’ skills up-to-date and balance the potential benefits of emerging technologies with the risks they sometimes pose.
  • Policy makers can use advanced technology to address their own operational challenges (for example, by deploying the Internet of Things to improve infrastructure management). The nature of work will continue to change, and that will require strong education and retraining programs. To address challenges that the new technologies themselves will bring, policy makers can use some of those very technologies—for example, by creating new educational and training systems with the mobile Internet, which can also help address an ever-increasing productivity imperative to deliver public services more efficiently and effectively. To develop a more nuanced and useful view of technology’s impact, governments may also want to consider new metrics that capture more than GDP effects. This approach can help policy makers balance the need to encourage growth with their responsibility to look out for the public welfare as new technologies reshape economies and lives.


About the authors

James Manyika and Richard Dobbs are directors of the McKinsey Global Institute, where Michael Chui is a principal; Jacques Bughin is a director in McKinsey’s Brussels office; Peter Bisson is a director in the Stamford office.

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Two models behind rising M&A flows from China Mon, 30 Sep 2013 02:42:12 +0000 In preparing for a recent conference focused on increasing investment flows between China and Europe, I pulled a few data points from our Corporate Finance Practice and wanted to share some of the highlights.

Towards a new record year in outbound M&A

Oil and gas, again. With $48 billion of outbound M&A year to date1, Chinese companies are on track to beat last year’s record of $64 billion. This is largely driven by oil and gas, where Chinese state-owned companies have already spent $22 billion in international M&A this year1, exceeding 2012’s $16 billion and 2011’s $18 billion.

Most of these transactions are acquisitions of stakes in oil or gas fields, which are either in the exploration or production phase, rather than the acquisition of entire companies. This is perhaps a reflection of greater maturity in considering investment types, as well as the scarcity of targets to acquire outright. It is not likely that this trend will slow anytime soon given the growth of China’s energy consumption, and despite real efforts to become more energy-efficient, China will likely need to treble oil and gas imports by 2020. However, there is a robust trend of M&A in the technology, manufacturing and consumer sectors – the very recent acquisition of US pork processor Smithfield by Shuanghui for $4.7 billion is an example.

- See more at:



Looking to EMEA, the Americas, and Australia. EMEA’s and the Americas’ share of China’s outbound M&A has grown over time and seems to have stabilized at around 70-80%, leaving the rest to other Asian economies – a reflection of Chinese companies’ globalization appetite. Within Asia, Australia is by far the largest recipient. At a time when economic nationalism is poking through the surface more and more in Asia, Australia has, in contrast, shown a remarkable degree of openness, so far. Not to say that Australia accepts all investment proposals, but the government has made the rules of the game clear enough, enabling a number of deals to get through without ignoring the public debate. It will be interesting to see if this continues with the new government in Canberra. From coal mines to vineyards, Australia has attracted 30% of the M&A volumes flowing between Asian countries since 2012, a majority of which originated from China.

SOEs vs private enterprises: Two outbound M&A models

Beyond the aggregate M&A flows, I’ve tried to compare and contrast the way Chinese state owned enterprises (SOEs) have been doing overseas M&A versus their private sector counterparts, over the 2008-12 period.

SOEs conduct many more large deals. Almost 30% of SOEs’ overseas transactions in the period were $1 billion-plus deals, while close to 80% of private enterprise deals were for $300 million or less. This is no real surprise given the SOE domination of the oil, gas and basic materials sectors and their aggressive policy of going out and acquiring assets.

SOEs tend to buy highly profitable assets, private Chinese enterprises the reverse. At 18%, the average operating margin of businesses acquired by Chinese SOEs is a few percentage points higher than those acquired by US or European companies, and nearly twice the margin of companies acquired by private Chinese enterprises. Perhaps due to the inherent risk aversion in the leadership of many Chinese SOEs, the logic is that it is safer to buy a high performing asset. They reason it will need less work to extract value from it – certainly not a turnaround. Private enterprises, by contrast, often buy extremely distressed businesses, perhaps with an overly rosy view of their ability to turn the business around or to create synergies with their existing China business.

SOEs tend to pay a higher premium. Chinese SOEs pay a median one-week premium of 19% versus 10% in the rest of the world, and only 7% for private Chinese acquirors. This high premium reflects a bit of a “must have it” attitude as well as the fact that there are often multiple (Chinese) bidders for these higher performing assets. In contrast, for some of the poor performers that private Chinese entrepreneurs have acquired, there have been no other bidders.

1: Gross outflow, as of September 20, 2013

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Meet Jin Yu, Beijing office leader Tue, 24 Sep 2013 09:29:25 +0000 Beijing office leader Jin Yu discusses her work at McKinsey, having impact in the community, and spending time with her children.

Schools: Institute of International Relations (China); University of Arkansas Business School; Cal Tech

Beijing office head Jin Yu has been with the firm for 13 years, and all of it in the same office. She serves many leading Chinese companies across all sectors; from a leading airline, to one of the country’s largest insurance companies, to a major chemical company; helping them with organizational transformations.

Jin does a lot of outreach with the capital’s professional community, and works to help develop high-potential women through leadership coaching. She was recently a keynote speaker at an Executive Development Roundtable organized by the All-China Women’s Federation and the International Women’s Forum.

Outside of work, Jin’s life revolves around her young family but she also has time for charity work, being involved with teaching under-privileged children – as well as prisoners – how to develop practical business-building skills. She also acts a coach for local young entrepreneurs.

Describe your McKinsey journey in 100 words or less:
I had traditionally served clients in the energy and basic materials sectors, but have branched out to several more sectors. I’ve been fascinated particularly by the people side of our profession, especially around training and development. Clients tell us that technical solutions won’t have much impact unless you also solve the people and organizational issues.

Working with the firm’s emerging market initiative team is also something I’ve found particularly inspiring. I feel like I’m getting a chance to help shape where the firm is going, but at the same time I’m impatient to make change happen and see the impact we can have.

Where do you spend your happiest moments away from work?
I really try to avoid working weekends and dedicate my time to being an “executive assistant to my kids.” The highest compliment I think I’ve ever received is when my son said “Mom, I think you have two roles – your work at McKinsey and your other work as my psychiatrist: when I am down you can always bring me up.” That’s something I’m truly proud of.

Clockwise: Jin with her children Sophie and Jerry and husband Joe.

What is your most unusual team event memory?
When I was a Senior Associate, we were helping a telecom operator roll out a business process redesign program. On the first day we kicked off at a local branch and in the evening the clients invited us to a team event at an outdoor hot spring. I had a terrible fall and was rescued by the senior client, who carried me to the ER, where I got seven stitches in my head!

I ended up being featured in their internal magazine as the “committed” consultant who was helping them transform: so committed that I was willing to shed not just tears and sweat, but actual blood. The client who rescued me that day is still one of my best friends.

What is your favorite “new” thing about McKinsey?
I’m constantly impressed by how we deploy new technology across the firm – things like desktop video conferencing and some of the things we’re doing with iPads are significantly improving efficiencies.

Do you have any new goals or projects outside of work?
Mostly they’re family and personal goals, related to trying to be an inspiring parent and helping my children live the best life they can. Elsewhere, I want to continue to make a contribution to helping more people, particularly women, unleash their leadership potential.

What McKinsey traditions are you most proud of?
Apart from the things that guide us as a values-based firm, I am particularly proud of how we collaborate. After working with different organizations where you recognize that collaboration can be so powerful, but can also be so blocked, one thing I’m very proud of about McKinsey people is that, wherever you go, you can put together a group of colleagues and know they will respect each other and function at a high level as a team. That is truly a tremendous asset that the firm has.

The Beijing office has a very strong home and family ethos – there are a lot of personal bonds among the people here. Obviously when people work on the same client team they will be close, but in our office you will see that among colleagues of different tenures. I’m very proud of that. It’s partly Beijing culture: we bring a lot of energy and passion to everything we do.

Up in the air

1. What’s your favorite vacation spot?
For me, it’s always the place I haven’t been to yet. For our kids, though, it’s probably spending time in Pasadena, California.

2. What’s on your iPad?
There are several books, but with two main themes: how to be a better parent (I’m now reading Nurture Shock) and what’s going to be disruptive in the world (I’ve just finished The Third Industrial Revolution by Jeremy Rifkin).
As you grow older, you need to become wiser, and one example of that is Mitch Albom’s Tuesdays With Morrie.

3. What’s always in your briefcase?
I always have my ID as well as various power cords and chargers.

4. What was the last movie or TV show you watched on a flight?
Probably The Big Bang Theory – I’m a CalTech alumni.

5. What will you do to take a moment for yourself, even if you have a few minutes?

I would love to be able to do meditation, but I never learned to do it properly.

6. How many countries have you visited in the last 12 months

Seven or eight countries this year – Switzerland was the only one for the first time.

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Wanted: More flights between China and India Thu, 19 Sep 2013 11:13:02 +0000 1.]]> Who would believe that Mumbai is not better connected to China than Addis Ababa, Ethiopia’s capital? Mumbai has only 8 flights a week to mainland China, while Addis Ababa has 16. If you add Hong Kong, the numbers become 22 and 21 respectively – not much of a win for India’s commercial capital1.

For anyone with a regional role in Asia, the high degree of shyness between China and India is an intriguing reality, and the low level of air connectivity is a depressing one. If any airline executives are reading this, I thought I might as well suggest a couple of routes which I believe have potential demand.

Mumbai to Beijing

How can there not be demand for a daily direct flight?  The two cities are home to many of the most successful international businesses India and China have – in technology with Tata Consultancy Services (TCS) and Lenovo, in biotech, in financial services, and more. TCS, for example, has high ambitions for China and is the only company that Chinese Premier Li Keqiang visited when he visited India in June 2013, while Lenovo is India’s top PC seller. Besides, Tianjin – China’s largest port –  is a few minutes by high speed train from Beijing, while Mumbai is India’s largest port.

Bangalore or Chennai to Shanghai

China’s leading commercial city needs to be connected to southern India, either to Chennai or Bangalore. Bangalore as the center of India’s IT services industry certainly looks to China for opportunities and Chinese companies look to Bangalore as a natural location for an R&D hub.  Why should we have to fly to Singapore or Hong Kong to reach these locations? Chennai as an emerging hub of automotive manufacturing will have an increasing number of opportunities for East China’s auto component manufacturers who will want an on the ground presence that is easy to reach.

More flights from Mumbai to Shanghai

Both cities are financial hubs. Indian banks like ICICI and Axis have branches in Shanghai today.  China’s banks should and will become more present in India. I will concede that there is limited current demand to fly from Mumbai to Shanghai – having taken it many times the flight is very rarely close to full. I wish this was only due to size of the plane being used on the route that day.

1: From Addis Ababa, Ethiopian Airlines flies to Beijing and Guangzhou 6 times a week, to Hong Kong 5 times a week, and to Hangzhou 4 times a week – with a stop (not a change of flight) in Delhi. From Mumbai, Air China flies to Chengdu 4 times a week, Air India flies to Shanghai 4 times a week – with a stop (not a change of flight) in Delhi. Jet Airways and Cathay Pacific fly every day from Mumbai to Hong Kong.

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A few reflections on the World Economic Forum’s ‘Summer Davos’ Thu, 12 Sep 2013 12:08:57 +0000 Just wrapping up my involvement at the World Economic Forum’s “Summer Davos” event in Dalian.  A very intense couple of days of being on and listening to panels, one-on-one meetings, breakfast sessions and a McKinsey hosted dinner.   It requires military precision to make the logistics work, though this was made slightly easier this year by the brand new conference facility, next door to the brand new hotels. The construction industry is alive and well in Dalian for sure.

Li Keqiang’s keynote has been widely covered.  It was a confidently delivered statement of intent on direction and the broad levers to get there which resonated with stakeholders in the room and, it seems, to those watching on TV also.  Underpinning many of the changes ahead is the theme of greater productivity – using energy resources more productively to support the environment, using labor more productively in state-owned enterprises and in government, using capital more efficiently through greater use of market signaling.

The much smaller McKinsey dinner continued on this theme, with speakers from the energy, chemicals, food and industrial sectors sharing views on how China can fuel itself in the years ahead.  The dinner rapidly evolved into a cross table debate with more than two dozen guests making contributions.

From my one-on-ones, I sensed more positive energy from consumer facing industry leaders than B2B or B2G executives.  This was reinforced in one panel that I sat on, where China’s world-leading progress in e-retail was highlighted as having reached a tipping point in the reshaping of industries from retail to logistics to property development and more.

I shared some of my views on how e-retail is transforming consumption in China in a conversation with Peter Vanham of the FT. Here are some of the comments I made in a piece which appeared on the FT’s beyondbrics blog:

“Ecommerce is central to the behavior of many Chinese people,” says Orr. “Consumers in the third-tier cities often can’t buy premium or western brands at home, as these companies don’t have bricks and mortar shops there.” As a consequence, these shoppers go online.

But this need-based online buying is quickly turning into a preference than a necessity. Price-conscious Chinese shoppers are discovering that online often is cheaper and more consumer-friendly, as there is much more competition between sellers. Increasingly, they are looking to buy goods online that are available locally offline as well.

“In China, 7 to 7.5 per cent of total retail sales already happen online,” says Orr. “That’s about the same level as in the US, and higher than in Europe.” But in China online sales grew by a whopping 50 per cent last year, whereas in the US the growth was less dramatic at 18 per cent. This means that soon China will be the biggest overall market for online sales.

With consumer spending power rising and an appetite for online purchasing already established and growing, China should surge ahead in terms of ecommerce innovation.

Read the rest of this article on the FT’s beyondbrics blog here

I also spoke to CCTV this week about the tremendous progress China is making on the innovation front.  When asked about the state of innovation in China today, here’s some of what I had to say:

“The situation for innovation in China is the best today than it’s been in 20 years. There’s more talent able to create innovation. There’s more capital committed to innovation. More and more businesses understand the value they can create out of innovation. And people see there’s an ecosystem that works: if you innovate, you can be rewarded for innovating, and you can capture the value from innovation.”

Watch the clip here.


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Multinational companies are slowly shifting their centers of gravity towards Asia (Part 2) Tue, 10 Sep 2013 12:05:20 +0000 In my previous post I talked about multinational companies shifting their centers of gravity towards Asia, and specifically by relocating business unit headquarters or shared service functions. In parallel, a high level of reconfiguration in the organization and aggregation of geographic units is taking place within multinational companies. We track this closely through McKinsey’s Asia Center.

Making emerging markets more visible

Last year, a leading industrial conglomerate created a single “Emerging markets” region reporting to the CEO (archetype 3), while others created several regions made up entirely of emerging markets (archetype 2). A leading global bank and a leading global chemical player went a different way to give more visibility to Asia, by having countries like China or India report directly to the CEO (archetype 4).


No dominant pattern

This is clearly an area of experimentation and at this stage we do not see any dominant pattern emerging – and don’t let anyone tell you that there is.

Specific company characteristics such as business opportunities and availability of talent remain key shapers of the answer, which in any case seems to change, on average, every 30 months depending on leadership considerations.

Question: What is your experience with regional configurations? You can leave a comment below.

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Multinational companies are slowly shifting their centers of gravity towards Asia (Part 1) Wed, 04 Sep 2013 11:52:33 +0000 With two 6 trillion dollar-plus economies and the majority of the world’s economic growth in Asia, it is not surprising that many global corporations are adapting their organization blueprints. In this post, I would like to highlight the first aspect of this trend – companies moving more global functional and business roles into Asia.

Shifting business leaders

A number of multinational companies are consciously shifting business unit headquarters to Asia. It is a very different story from, for instance, car makers building plants in China and India in order to gain the right to sell and be cost-effective in these markets. These are voluntary acts, whose objective is, most of the time, to consciously reflect the weight and potential of Asia in the global leadership team, culture and talent pool. We are not yet at the tipping point of companies making the move to shift their entire headquarters to the region, but for some we cannot be far away. Here are a few examples:


Disaggregating corporate centers

At the same time, some companies (sometimes the same) are relocating functional leadership and HQ shared service functions into Asian countries. As early as 2007, Dell set up its global logistics and supply chain center in Singapore, and in 2010, it made India its global servicing hub. IBM was also an early mover, when it chose Shenzhen as its global sourcing headquarters in 2006, and created a global research center in Beijing. Microsoft followed suit, with a fundamental research center in Beijing.

Setting up key facilities in Asia is sometimes not enough to ensure Asia’s visibility in the global organization, as grooming local talent is a challenge for most multinational companies. Some are taking explicit measures to encourage local talent – for instance making it compulsory for expatriate managers to train locals as their successors.

In another post I will share some thoughts about another aspect of multinationals shifting their centers of gravity towards Asia – the way they group countries and demarcate business regions.

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McKinsey tops Vault’s 2014 ranking Wed, 04 Sep 2013 01:10:43 +0000 McKinsey tops Vault’s 2014 rankings of consulting firms
According to the latest rankings from the career site Vault, McKinsey’s reputation as a great place to work just keeps growing. In Vault’s new survey, McKinsey & Company took the top spot in both Vault’s Consulting 50 (up from number two last year, surveying both internal and external respondents) and its Prestige list (external respondents only).

According to Vault’s website:
“The rankings are based on the results of Vault’s annual Management and Strategy Consulting Survey. More than 7,500 consulting professionals of all levels assessed their peer consulting firms on a scale of 1 to 10 based on prestige (respondents were unable to rate their own employers and rated only firms with which they were familiar). Consultants also rated their own firm’s quality of life in a series of “Best to Work For” categories such as firm culture, compensation and work-life balance, among others. For the Vault Consulting 50 Ranking, a weighted formula was used to combine findings from both prestige and selected best to work for categories to identify the top 50 consulting firms operating in the U.S. today.”

“McKinsey’s ranking marks a return to the top of the Consulting 50, the result of marked improvements in its Best to Work For scores including overall satisfaction and firm culture. ‘McKinsey is a place where you will get much more than you give. It is a 24/7 learning environment. You are constantly exposed to an atmosphere where you can improve as a person and a professional,” said one employee at McKinsey.’

“McKinsey took the No. 1 spot in an unprecedented 18 Best to Work For categories: Ability to Challenge, Benefits, Compensation, Firm Leadership, Informal Training, Innovation in the Industry, Interactions with Clients, Internal Mobility, International Opportunities, Overall Business Outlook, Promotion Policies, Relationships with Supervisors, Overall Satisfaction, and Selectivity, in addition to topping the rankings for Minority Diversity, Diversity for Individuals with Disabilities, Diversity for Military Veterans, and Overall Diversity.

According to respondents, the firm’s commitment to its staff is noticeable right from the onset of employment. ‘Career development is a top priority at McKinsey, with each new hire having a team of people including a designated professional development officer and a partner working to prioritize their development, through providing an optimal project mix as well as access to a variety of firm training programs,’ said one respondent.”

“McKinsey emerged as the Most Prestigious Firm for the 12th straight year while also finishing No. 1 in six categories on Vault’s Practice Area Rankings: Energy Consulting, Financial Services, Healthcare Consulting, Management Consulting, Retail Consulting and Strategy Consulting.

Peer consultants at rival firms noted McKinsey’s ‘longstanding reputation,’ calling the firm ‘incredibly impressive,’ ‘innovative,’ ‘thought leaders,’ and the ‘gold standard.’ Respondents also said McKinsey represents ‘strategy consulting at its best,’ and believe ‘they define prestige.’”

For the complete results, visit Vault’s website.

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Due diligence in China: Art, science, and self-defense Thu, 22 Aug 2013 02:50:55 +0000 Widespread delisting of Chinese companies has investors rethinking due diligence and looking harder for subtle clues that something is amiss.
July 2013 | by David Cogman

It’s not often that the credibility of an entire class of companies is called into question at once. The aggregate market capitalization of US-listed Chinese companies fell in 2011 and 2012 by 72 percent—and around one in five was delisted —even as the Nasdaq rose by 12 percent (exhibit). Nor is delisting of Chinese companies purely a US phenomenon: since 2008, around one in ten Chinese companies listed in Singapore has also been delisted or suspended.


In recent years, the aggregate market capitalization of US-listed Chinese companies has fallen dramatically.

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The extent of the damage to investor confidence is hard to gauge. The broad decline in market capitalization suggests investors may be tarring even the most transparent and upstanding Chinese companies with the same brush. Now-familiar cases like Longtop Financial Technologies, the China-based software company charged with fraud in 2011, or Sino-Forest, the erstwhile forest-plantation operator that announced plans to liquidate itself last year after allegations of fraud, have left investors with fundamental concerns. These companies had, after all, followed required listing procedures, yet they somehow slipped through the regulatory requirements of the IPO and statutory-reporting processes that might have identified deficiencies. In many cases, the problem was fraud, and often involved false or misleading documentation that would not have been discovered by a regular audit—since such audits primarily rely on documentation supplied by the company itself. Indeed, almost all the companies involved were audited by Big Four firms; most were brought to the market through IPO or reverse takeover by major US investment banks. Even investigative diligence, which can be extremely costly and time-consuming, has been far from foolproof; past examples have shown that private-equity and strategic investors can miss accounting fraud despite conducting a detailed, professional diligence.

The problem is surely not limited to just Chinese companies, though they are at the center of investor concerns today given the importance of that country’s growth and stability to the world economy. Overcoming investor concerns—in China, as anywhere transparency is lacking—may mean going back to some investing basics. Diligence is, after all, as much about developing a sense of trust in a company as it is an exercise in finding and checking facts. Financial, portfolio, and corporate investors alike need to revive the habit of looking beyond the usual statutory and regulatory disclosures for less direct indicators of trouble in areas such as the ones we discuss in this article: governance, management, financing, market context, and partnerships. Such indicators are not conclusive in themselves. Nor are they a replacement for the other aspects of diligence. But they can be valuable clues that something unpleasant is hiding under the surface, even when everything looks healthy on paper.


Corporate governance merits serious attention for a variety of reasons. To start, when it’s weak, the floodgates open for unscrupulous management teams. Blatant misappropriation of company resources may be less common than it once was, but it was a factor in some of the companies delisted in the United States recently: in one case, for example, the board chairman transferred ownership of company assets to himself just prior to raising funds from US investors and conspired with the CEO to avoid disclosure.

Governance arrangements also reveal how the top team thinks about its rights and responsibilities. Senior management demonstrates its understanding of them in myriad small and large ways that sometimes serve as early-warning signs. Consider, for example, the many private Chinese companies where a single minority shareholder plays a de facto controlling role. This is not necessarily a problem, but it pays to look closely at how such shareholders view their relationship with the company. Minor things, such as small transactions between the company and the controlling shareholder, can reveal much about shareholders’ attitudes toward the company. Do they see it as something to which they have a duty of trust or as an extension of their personal property? Do they understand and respect basic boundaries between company and personal business? Have they gone out of their way to treat minority shareholders fairly during corporate restructurings—something that is easy to avoid doing?

When Chinese companies list their shares on foreign exchanges, particularly in the United States, they need to make sure their corporate-governance infrastructure complies with exchange regulations. The choices made in this process say a lot about management’s motivation and about whether there is real intent to improve the company’s governance. Have managers made a serious attempt to upgrade their controls and decision-making process? Have there been concrete changes in how top management works and in how it is overseen by the board, or have managers simply made token changes to comply with regulations? Halfhearted governance-compliance efforts may be a leading indicator of deeper problems—even outlandish ones, such as questions that arose about the very existence of an oil and gas exploration company’s operations after it was listed.


A number of delistings of Chinese companies in the United States involved accusations of falsified transaction documents provided for audits. In some cases, the fraud was happening well below top management and even without its direct knowledge, as was alleged at one energy company. Investors therefore need to keep a lookout for warning signs about management that extend beyond the top team and its compliance with governance standards.

How can that be done? A first step for many investors should be examining the bench strength of a company’s professional management. It is relatively easy to assemble a senior team that will leave a good impression in a roadshow. As part of their IPO process, in fact, a number of Chinese midcap companies have fielded compelling leadership teams that included several figureheads brought in recently to add credibility. It’s much harder, especially in a market like China where talent is expensive, for executives to build a strong pipeline of competent operational managers with long tenure in the company: that can often take years to develop. Depth of management talent is an indicator of a company that’s being built to last—and its absence could signal that a company may have deeper problems.

A mismatch between a company’s management capabilities and its growth plans is another potential red flag. If the CFO plans to upgrade the company’s financial planning, investors should confirm that the finance team has the size and experience to follow through. If the company plans to expand manufacturing capacity, does it have enough plant managers to run existing facilities as it ramps up new ones? If the company plans to locate manufacturing overseas, does it have general managers who can work in a foreign-language environment? These questions may seem obvious, but too often they go unasked.

The quality of operational management is another area where on-the-ground scrutiny is worthwhile. Good plant discipline is hard to develop and harder to fake, and its absence is typically visible to the trained eye on a single site visit. Even a one-hour walk-through, if used carefully, can provide validation of staffing levels, inventory levels and age, and plant utilization. If a company resists a walk-through, that should sound alarm bells. How good are the company’s manufacturing or service operations? Are there good visual-management systems? Is there evidence of strong health, safety, environmental, and quality systems? Are testing labs in constant use, or does a layer of dust cover work desks? Affirmative answers to questions like these don’t necessarily mean a company is trustworthy, but negative ones should be cause for concern.


Financial management is, in China at least, one of the greatest risk factors. Although proper evaluation is only possible in the context of a full diligence, a company’s commercial-banking relationships can offer some indications of whether the conditions exist to facilitate fraud—and these indicators can be assessed quickly and easily through frank discussion with managers. Among the companies delisted in the United States were several that colluded with banks to falsify audit documents, others that took on excessive leverage through sweetheart loans that circumvented banking regulations, and still others that borrowed unnecessarily and then moved the cash out of the company. Investors should ask several questions. Does the company have relationships with multiple banks, or is it reliant on a single one? Are its critical financial relationships with major, well-regarded national banks or smaller, less well-known provincial or municipal ones? How important is the company’s business to the bank branch or branches that it works with? None of these factors would prove the existence of financial malfeasance, but they would make malfeasance a lot easier.

Similarly, much can be inferred from the way a company structures and times its loans. Investors should examine whether a company has structured loan facilities and projects to get around restrictions (for instance, breaking a project into sections that are within a loan officer’s approval limit). Has historic capital raising occurred when there were no clear needs—for example, has the company borrowed money when it had ample reported cash on its balance sheet and no major investments under way? Do current patterns of capital raising clearly match its investment plans?

Discovering fraud in these areas through regular audits can be a long process. Well-run Chinese companies are usually keen to provide transparency to investors; reticence is in itself a warning sign. In either case, closer observation of transactional banking relationships and capital raising can give an early indication that something is wrong, without definitively showing what.

Market context

Several of the companies delisted in the United States operated in opaque and protected markets, such as reselling advertising, importing specific fuel or agricultural products into concentrated and highly regulated markets, or operating logistics infrastructure in specific geographies. From an investor’s perspective, these episodes reinforce something more fundamental: companies that have competed effectively in open markets are intrinsically more credible than those that function in closed ecosystems.

Of course, many companies operating in protected sectors are reliable and trustworthy and deserving of capital. It can be challenging for investors to reassure themselves of that, though. Further complicating matters is the role that low-cost financing from Chinese banks is alleged to play in some sectors; companies that on the surface seem to be competing vigorously actually may be floating on artificially cheap capital.

For skeptical investors, the other indicators covered in this article can help. Moreover, many Chinese companies are already making the transition to more open competition: consider the country’s telecommunications-equipment providers, which have moved from dominating the domestic market to succeeding in international markets, where they must stand on their own without government support. Others, including both private and state-owned enterprises, still face limited natural competition in their domestic market. This is often due to regulation aimed at creating a stable industry structure that government can more easily manage. When policy support is a factor in a company’s performance (as was the case in solar-panel manufacturing, where it led to overcapacity), it is usually obvious—and rarely sustainable.


A final reliable sign of corporate trustworthiness is a company’s track record with partners. It’s reasonable for investors to conclude that a company involved in multiple joint ventures with the same leading multinational partner has survived several rounds of close-up diligence from an experienced operator. It may still have issues, but it was reliable enough to motivate the multinational company to form additional joint ventures rather than turn to other potential partners.

This is not foolproof logic, however. In China, investment restrictions force multinational companies in many industries to work with local joint venture partners—and some multinationals have clearly gotten partnership decisions wrong. In the infamous high-speed-rail cases, for example, partnerships that multinational companies hoped would help them address the local market turned into disputes over local partners’ development of their own technology platforms.

The spate of delistings in the past two years may, in retrospect, have had some beneficial effects. It has forced many corporate and private-equity investors to increase the depth and detail of their formal due diligences. It has spurred the growth of what could be termed forensic equity research—analysts that specialize in looking for potential fraud in listed companies. Although often disliked by their targets, this group provides a valuable balance to traditional equity research. It is also forcing the US Securities and Exchange Commission to look hard at the reliability and acceptability of certain audits, which will most likely result in better standards of practice. Finally, we hope that it will leave investors more cautious about the information on which they rely and more thoughtful and circumspect about how they interpret it.

About the author
David Cogman is a principal in McKinsey’s Shanghai office.
The author would like to acknowledge the valuable contributions of Ravi Gupta, Rishi Raj, and Rachna Sachdev.

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