McKinsey Greater China http://www.mckinseychina.com The leading management consulting firm in Greater China Fri, 27 Mar 2015 03:02:22 +0000 en-US hourly 1 http://wordpress.org/?v=4.1.1 Copyright © McKinsey Greater China 2014 china@mckinsey.com (McKinsey China) china@mckinsey.com (McKinsey China) 1440 http://www.mckinseychina.com/wp-content/uploads/2014/10/mckonchina144x144.jpg McKinsey Greater China http://www.mckinseychina.com 144 144 Conversations with McKinsey Partners on the hottest topics affecting the Chinese economy and business. Welcome to the McKinsey on China podcast. In this podcast, consultants from McKinsey’s Greater China Practice delve into the issues and trends shaping business and the economy in this dynamic region. Since we launched the podcast in December 2011, we’ve published over 45 episodes on topics covering the full gamut of critical issues in China, including urbanization, globalization of Chinese companies, energy, consumers, electric vehicles, macroeconomic policy and reform, and more. Your hosts are Nick Leung and Glenn Leibowitz. Nick is the Managing Partner of McKinsey’s Greater China Practice. Glenn heads up McKinsey’s external relations and publishing group in Greater China. Subscribe to the podcast for free on iTunes and listen to it while you’re on the road (or airborne). We’d appreciate if you could write a short review and rate it too. You can also listen to it right here on this website. Suggestions for future topics? Feedback? We’d like to hear from you. mckinsey, china, mckinsey, china, chinese, business, business, economics, chinese, economy, consulting, business McKinsey China McKinsey China china@mckinsey.com no no Meeting China’s Affordable Housing Challenge http://www.mckinseychina.com/meeting-chinas-affordable-housing-challenge/ http://www.mckinseychina.com/meeting-chinas-affordable-housing-challenge/#comments Mon, 16 Mar 2015 08:37:13 +0000 http://www.mckinseychina.com/?p=8366 Like everything else in China, the affordable housing problem is bigger than in most other places. In our recent research, A blueprint for addressing the global affordable housing challenge, we looked at the affordable housing gap (the number of households that live in substandard dwellings and/or pay a disproportionate share of income for housing) in cities around the world. We estimate that 200 million urban households in Asia, Africa, and Latin America live in substandard housing; 62 million of those are in China.

China has unique challenges

China has unique challenges and opportunities in housing. Because of rapid urbanization, demand for housing has outstripped supply, despite a building boom that created a massive construction sector that now accounts for about 15 percent of GDP. China’s cities may not have the sprawling squatter communities that are seen in the large cities of other developing economies, but it has tens of millions of housing units that either do not meet basic standards for essential amenities (plumbing, electricity), cost or space (even using a localized standard of 50 square meters for a four-member household compared with 90 square meters in the United States).

Across China, 60 percent of households in cities of more than 7 million cannot afford basic housing at market rates. In total, China’s affordable housing gap (the difference between market-rate housing costs and 30 percent of income for households in lower-income groups) equates to about $180 billion per year, or about 2 percent of GDP. That’s about 28 percent of the global gap of $650 billion, based on data for 2400 cities.

Not surprisingly, the housing affordability gap is concentrated in China’s largest cities, where residential property prices rose by as much as 86 percent from 2008 to 2014 (Exhibit). Today, about 14 million low-income households in China are financially overstretched by rent or mortgage payments exceeding 30 percent of income. And, based on current trends in urbanization and income growth, the number of low-income households in Chinese cities could rise by 56 million by 2025. Shanghai could add 2.3 million low-income households and Beijing could add 2.5 million. Four of the five cities in the world with the fastest-growing population of low-income residents are likely to be in China.

Four opportunities to close the gap

How can China halt the expansion of the affordable housing gap and begin to move millions of urban households into decent housing that they can afford? In our research, we find that there are four opportunities globally to improve the supply of affordable housing: securing land for development at the right price and in the right place for low-income households to integrate into the economy; improving productivity of construction firms; raising the efficiency of building operations; and expanding access to housing finance.

China is making progress in most of these areas, but there are still gaps in both policy and implementation. For example, to reduce land hoarding and speculation in cities, China imposes penalties on owners who leave tracts undeveloped. The government also releases public land for development every year, granting 70-year land leases. And local governments are starting to pursue innovative approaches to incentivize private developers to include affordable housing in their projects. In Nanjing a pilot land auction was held last December in which developers competed to maximize affordable housing once a target price was reached.

However, there are still shortcomings in China’s land policies. For example, industry continues to squeeze out other uses for land. Limits on building heights reduce the opportunity for densification. And while government’s own programs for building affordable housing are significant—from 2012 through 2014, government built an estimated 13.4 million units—local implementation of the new policy varies. In some places, for example, the migrant workers who are most in need are still excluded from publicly-financed housing.

Around the world, we find that advanced design and construction methods, including use of industrial approaches (such as greater use of pre-fabricated components), can cut construction costs by as much as 30 percent, helping make new construction more affordable. Chinese companies, such as the Broad Group, are pioneering new low-cost construction processes, but overall China’s construction industry faces the same productivity challenges that are seen around the world, including rising wage rates: average monthly wages in Chinese construction rose by 76 percent from 2008 to 2012.

While China spends about half as much as EU-27 nations on operation and maintenance as a share of housing costs, it has taken steps to improve efficiency. From 2006 to 2011, China funded energy-efficient retrofits (new heating systems, insulated windows, etc.) for 182 million square meters of housing in northern provinces. And in 2004, China regulated the property management industry and introduced a certification scheme for provider firms to encourage professionalism and cost-effective service.

Affordable housing can be an economic opportunity for China. We estimate that $94 billion to $104 billion per year would need to be spent on construction to close China’s affordable housing gap by 2025. Even a small share of that could help to engineer a soft landing for the construction industry as the building boom slows. The real estate market has softened considerably, with the value of transactions dropping by 14 percent from April 2013 to August 2014—and by 31 percent in Shenzhen. Inventories of unsold housing have risen to as much as 77 weeks’ worth in Tier 3 cities. Financing affordable housing would also be an opportunity for China’s banking industry. We estimate that it would take $300 billion to $400 billion a year in mortgage underwriting to close the affordable housing gap and perhaps a fourth of that would be needed in China.

Equally important as adopting new methods and pursuing the affordable-housing opportunity is ensuring the money that is spent is used effectively and efficiently. This requires comprehensive planning and targeted policies to encourage construction and rehabilitation of affordable housing. It also requires a clear understanding of how housing fits into an overall plan to integrate low-income Chinese into the modern economy and begin to raise their incomes. Hong Kong provides a model for successful transit-oriented development that includes affordable housing. Likewise Singapore excels in construction management with its CONQUAS construction quality assessment system. By adopting market mechanisms and best global practices, China can make affordable housing a reality for all.

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Photo credit: Chris/Flickr 

I’m a Director in McKinsey’s Shanghai office and Director of the McKinsey Global Institute (MGI) in Asia. I also co-lead the Urban China Initiative (UCI), a thinktank devoted to transforming China’s urban future. Visit the UCI website here.

Read my latest book, The One Hour China Book: Two Peking University Professors Explain All of China Business in Six Short Stories

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It’s Time To Reset China’s Economic Relations With Africa http://www.mckinseychina.com/its-time-to-reset-chinas-economic-relations-with-africa/ http://www.mckinseychina.com/its-time-to-reset-chinas-economic-relations-with-africa/#comments Mon, 09 Mar 2015 09:19:21 +0000 http://www.mckinseychina.com/?p=8361 A week in South Africa and I am even more convinced that now is the time for China’s best private sector companies to take the lead, resetting the China-Africa relationship and growing new profitable businesses as they do. Whether under the umbrella of China’s “One Belt, One Road” go international initiative, or simply off their own desire for growth, now is the time.

There will still be opportunities for China’s state-owned infrastructure builders as Africa extends it road, rail, power and telecom systems in the years ahead, but that is only part of the story.

The China traders who have made a living selling marginal quality “Made in China” goods will find life much tougher. Their golden period is over. As China’s ecommerce giants come to Africa, with local language websites and partnerships with local banks for payment, they will gradually displace the traders with higher quality, more reliable products. Local delivery logistics can be a challenge, but will be addressed.

The many private Chinese companies that equip factories, offices, hospitals, schools and homes should be targeting the growing demand that comes as Africa’s middle class expands, from Kenya to Nigeria to South Africa itself. China’s quality but value-priced medical testing equipment, consumer electronics, solar solutions, air conditioners, and more will see extremely rapid growth.

Now is the time to establish brands in the minds of first time buyers. Not only should these companies be looking to sell into Africa, they should also be establishing on the ground service operations and factories. Bringing quality manufacturing and service jobs into key African markets will be a catalyst for a changed relationship.

Agricultural exports to China are still a neglected opportunity. If Australia exports more than US$4 billion of agricultural products to China and has set agriculture as the cornerstone of the new free trade agreement between the countries, why should exports from South Africa be under $200 million? Chinese capital is investing in cold chain and related logistics around the world in addition to production. There must be partnership opportunities to be developed in this.

Chinese private capital can move productively into other sectors also. Chinese property developers are looking for international opportunities as their domestic market cools. Companies such as Soho, Vanke and Fortune Land have developed strong reputations for the quality of their business, residential and industrial park developments. There must be partnership opportunities to bring these capabilities (and their capital) to African cities and industrial zones.

Finally, Africa needs to embrace the Chinese tourist much more. It remains very hard for Chinese travellers to get a visa to vacation in many African countries, the marketing of the attractiveness of African vacations in China is lacking, and the number of direct flights is insufficient. Unsurprisingly, the numbers of visitors are in the low hundreds of thousands, with modest growth when they have the potential to rapidly scale into the millions.

A door is open. Let’s hope that the opportunity is taken.

Read more of my views on my blog, Gordon’s View. And please follow me on Twitter.

Image: GovernmentZA / Flickr

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Japan Is Back On The Map For Chinese Spenders http://www.mckinseychina.com/japan-is-back-on-the-map-for-chinese-spenders/ http://www.mckinseychina.com/japan-is-back-on-the-map-for-chinese-spenders/#comments Thu, 05 Mar 2015 08:12:15 +0000 http://www.mckinseychina.com/?p=8356 Throughout all the geopolitical ups and downs, Chinese investors and tourists have been opening their checkbooks wider and wider in Japan.

Japanese property is seen as a very secure investment and with CIC, China’s sovereign wealth fund, putting more than $1 billion into Meguro Gajoen, a landmark development, many more will follow. Fosun has also made sizeable investments in Japanese property.

And it’s not just big companies investing in Japanese real estate: many individual Chinese are also doing so. Prices are comparable to Beijing and Shanghai – maybe even less after the yen’s depreciation – and rental yields are much higher than in Hong Kong. Relatively cheap, easy to get to, low pollution, appealing food, and great shopping – what is not to like for wealthy Chinese looking for secure overseas investments?

Chinese tourists are seeking much the same. Last year, 2.5 million Chinese tourists visited Japan, an increase of more than 80%. Hotels and service industries have adapted well to the influx, and 2015 will likely see another very large increase in numbers.

Chinese students have maintained a low profile in Japan, but are there in very large numbers. Something like 80,000 have studied there in recent years, building language and business skills that put them at the front of the line in being hired in Japan or China.

Even Chinese language schools are becoming part of this trend. Beijing Language and Culture University is setting up a campus in Tokyo, with courses due to start in April. Japanese students are reluctant to go to Beijing because of the pollution, and by having a campus in Tokyo, the University expands its potential market massively.

Increased connectivity and investment from China into Japan has to be a good thing. Let’s hope for more in 2015.

Read more of my views on my blog, Gordon’s View. And please follow me on Twitter.

Image: halfrain / Flickr

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Putting China’s Debt Into Perspective http://www.mckinseychina.com/putting-chinas-debt-into-perspective/ http://www.mckinseychina.com/putting-chinas-debt-into-perspective/#comments Tue, 03 Mar 2015 03:38:37 +0000 http://www.mckinseychina.com/?p=8346 China’s total debt quadrupled between 2007 and 2014, which was about one-third of the $57 trillion in debt added globally during that period. Can this possibly be safe?

To answer this question, the McKinsey Global Institute devotes an entire chapter to China’s debt in the new report Debt and (not much) deleveraging. The key issue is whether China can slow the growth of debt without unduly crimping GDP growth, which already has fallen to the lowest rate in nearly a quarter century (see my Jan. 27 post here).

Our conclusion is that China’s debt situation warrants careful monitoring. In broad terms, China’s debt has moved from a developing economy level (158 percent of GDP in 2007) to advanced-economy status (282 percent in 2014, a bit higher than the United States and Germany). Not only does the speed of this debt buildup raise alarms, so does its composition. Almost half of new debt is flowing into the property sector and related industries, and around 30 percent of debt is provided by a shadow banking industry, whose lending standards and exposures are not easily discerned.

That’s not ideal but it may be manageable. Household and government debt are both low, even by the standards of developing economies, while debt of non-financial corporations is high. China has the financial wherewithal to weather a debt-induced crisis. And China’s government is taking steps to reduce the risk of crisis.

The report focuses on three areas of potential risk: a concentration of debt in the property sector; reliance on shadow banking; and the large debts of local governments.

  • Real estate. Nearly half the new debt in China since 2007 has gone to real estate development or related industries such as steel and cement. Now, the property sector is cooling off. The value of residential real estate transactions in 40 Chinese cities, after rising 26 percent per year for 10 years, fell by 14 percent from April 2013 to August 2014—and by more than 30 percent in Beijing and Shenzhen. While Chinese households are not, in general, over-extended with mortgage debt, a deep and prolonged housing slump could have huge impact on the construction sector, which accounts for 15 percent of GDP and includes tens of thousands of small players who would not be able to meet their debt obligations. The steel and cement industries, which already have excess capacity, would also suffer.
  • Shadow banking. The so-called shadow banking system—consisting of unregulated non-bank lenders—accounts for 30 percent of all new credit since 2007. Shadow banks, such as trust companies, raise money from wealthy investors seeking high returns and lend to players in real estate as well as to companies that cannot qualify for bank loans. Not only is shadow banking concentrated in real estate, the quality of its underwriting is not known—nor is the total exposure of shadow banks. One trust company missed its payment to investors because a single borrower—a steel company—missed a payment.
  • Local governments. As a result of China’s rapid urbanization and limitations on how local governments can raise revenue, the debt of local government in China has grown to more than $2.8 trillion. About $1.7 trillion of this is owed by local government financing vehicles, off-balance sheet entities that are used to fund investments in infrastructure, social housing, and other types of construction. The ability of some local governments to pay back their debts is in question: a 2014 audit found that more than 20 percent of recent loans were used to pay older debts and that almost 40 percent of debt servicing and repayments were funded by land sales.

Chinese policy makers are certainly aware of the risks associated with unsustainable debt and are taking steps to reduce them. The government has imposed punitive interest rates for mortgages on second homes, and banned purchases of third homes to cool off the real estate market . (However, facing slower growth, the central bank cut interest rates last fall—illustrating the tension between growth and safety). In shadow banking, the government has imposed stricter product marketing rules on trust companies. To reduce reliance on land sales and LGFVs, the government has allowed cities to issue municipal bonds (on a limited basis). The state also has changed the incentives for local governments, emphasizing sustainable economic development, social harmony, and environmental protection, which takes pressure off cities to build more costly infrastructure. If these measures are sufficient—and are implemented consistently—China’s debt might remain merely a potential concern for the global economy.

Image: Jan / Flickr 

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I’m a Director in McKinsey’s Shanghai office and Director of the McKinsey Global Institute (MGI) in Asia. I also co-lead the Urban China Initiative (UCI), a thinktank devoted to transforming China’s urban future. Visit the UCI website here.

Read my latest book, The One Hour China Book: Two Peking University Professors Explain All of China Business in Six Short Stories

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Merging State Owned Enterprises Achieves What? http://www.mckinseychina.com/merging-state-owned-enterprises-achieves-what/ http://www.mckinseychina.com/merging-state-owned-enterprises-achieves-what/#comments Tue, 03 Mar 2015 01:21:30 +0000 http://www.mckinseychina.com/?p=8336 Last year plans were announced to merge China’s two leading providers of high speed rail equipment – CNR and CSR. Both are state-owned enterprises (SOEs). Both are already world-scale given the volumes they have been producing for China’s domestic needs.

Demand looked to be plateauing in China. So was this announcement a far-sighted move to enable capacity to be rationalized? Very unlikely – allowing SOEs to lay people off is still a step too far in many cases.

Official statements talked about the opportunity to create a global champion of the scale to compete against Siemens and GE. Yet both had already achieved this scale.

It’s not much more likely that the announcement was the result of the embarrassing (to the Chinese government) of the two companies bidding aggressively against each other for international contracts from Turkey to Argentina to Malaysia, even when other bidders had dropped out. And domestically, having only one major supplier reduces the potential for bribe giving, always important in the context of the anticorruption campaign.

Despite the relatively weak logic for mergers between giant SOEs, it seems more will be coming. In the nuclear power plant construction industry, CNNC and China General Nuclear (CGN) are on the same path as CNR and CSR. Rumors of CNPC and Sinpoec being merged to create an oil giant twice the size of Exxon are becoming loud, recreating the “industry” structure of 20 years ago.

What could be next? Telecom? Could the government argue that capital expenditure would be more efficient with only one operator? That there would be fewer local price wars to sign up customers? Maybe even that there would be fewer disruptions as streets are dug up to lay cables?

And then maybe even banks? Even though China’s “Big 4″ banks are already some of the largest in the world by assets, surely they could be larger still? And is it not possible to argue that China has too many banks.

What we end up with is arguments for inertia, for the status quo, for less competition and less efficiency, which in the end the consumer will pay for. Too many SOEs are already in “do as little as possible” mode as a result of the anti-corruption program. Having them embark on a multi-year merger program will focus them internally, with extensive organizational infighting on who gets what role and the like.

Performance improvement will slip way down the agenda. Yet for a government official tasked with “doing something”, setting a merger in motion might seem like a low risk way of doing a lot. And by the time it is all settled down, any official will likely be long gone to their next role.

Finally, almost all of these companies are listed and have minority shareholders. Will directors be standing up for their interests in this process? Surely the intent of bringing in more independent directors as announced in the 2012 plans for SOE governance is exactly for this situation. Let’s see.

Read more of my views on my blog, Gordon’s View. And please follow me on Twitter.

Image: Spreng Ben / Flickr

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Northern China’s Water Deficit http://www.mckinseychina.com/northern-chinas-water-deficit/ http://www.mckinseychina.com/northern-chinas-water-deficit/#comments Tue, 03 Mar 2015 01:17:35 +0000 http://www.mckinseychina.com/?p=8332 There has been much doom and gloom recently in the media about water supplies in Brazil. Sao Paolo, Brazil’s economic hub, is running out of water according to recent government announcements. Reservoirs have run dry, ground water is receding, pipes leak scarce water away, and residents and businesses face de facto rationing. Social order could be stressed.

This made me wonder – how close are we to this happening in northern China, especially in and around Beijing? And how well prepared is government to mitigate the situation if it did?

It’s more than a decade since water intensive industries were banned from setting up operations around Beijing. And Beijing uses 20% less water today than in 1980 despite significant population growth. Yet even with that reduction, we saw unauthorized drilling of private wells not just in the countryside but in central Beijing last year by individuals desperate for supply.

We can’t blame industry as they use less than 20% of water consumed, with the heaviest consumers shut down over the last decade. Industrial water consumption is down 40%. Farmers have switched from rice to corn to use less water. Today, 30% less farmland is irrigated.

Certainly central government has invested heavily to avoid such scarcity, with the South-North water diversion project, costing more than $60 billion, coming online now to supply a billion cubic meters to Beijing annually. Almost 100% of waste water is recycled in Beijing through new processing facilities.

Water prices have been pushed up significantly. And still the water table around Beijing continues to fall – more than 10 meters since 2000. We are not at an equilibrium point yet. Some estimates put consumption still more than 50% above sustainable supply.

We have always kept a “back up” supply of 50-60 liters of bottled water in our apartment. I don’t think we’ll be eliminating that.

Read more of my views on my blog, Gordon’s View. And please follow me on Twitter.

Image credit: Black Dragon Pool, Lijiang China, strudelt / Flickr

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Chinese Investment In Russia Picks Up Steam http://www.mckinseychina.com/chinese-investment-in-russia-picks-up-steam/ http://www.mckinseychina.com/chinese-investment-in-russia-picks-up-steam/#comments Fri, 13 Feb 2015 03:53:40 +0000 http://www.mckinseychina.com/?p=8307 According to the Chinese Ministry of Commerce, non-financial direct investments into Russia in 2014 increased by over 250% to more than USD 8 billion.

However, a lot of the contracts were signed back in May 2014, and currently, many still remain as just intentions.

Some examples beyond oil and gas:

  • Several Russian banks acquired financing from Chinese banks: VTB received a credit line of USD 2 billion; VEB, a leasing of USD 300 million; and VnesheconomBankhas, a framework agreement for USD 2 billion.
  • RusHydro and Sanxia signed a contract for the construction of two hydroelectric power plants in Russia.
  • Eurocement signed procurement contracts worth nearly USD 1 billion with China CAMC Engineering and other Chinese suppliers.
  • Great Wall Auto started building a plant in the Tula Region.
  • Volga Group created a JV with China Harbour Engineering (CHEC).The JV’s primary activities will be coal mining and logistics services, including the construction of a container terminal in the Far East region of Russia.
  • Huawei won a tender for the construction of optical fiber communications in the Far East region.
  • Chengdong investment acquired 6% of the Moscow Stock Exchange for USD 100 million.
  • The Russian Direct Investment Fund and China Investment Corporation jointly acquired a company that is responsible for the construction of a railway bridge over the Amur River.

2015 will see another wave of Chinese investments in Russian energy. Initiatives discussed in the media include:

  • Chinese banks funding the Yamal LNG project, which will include the construction of a liquefied natural gas plant.
  • Chinese investors entering into the Vankor oil production venture, one of the largest oil production projects in the country
  • Chinese investors entering the Udokan copper field.

Additionally, there will likely be a broadening of investments to other sectors, such as:

  • A new high speed rail line out of Moscow.
  • Entertainment projects such as theme parks in southern Russia.
  • Service infrastructure projects from airports to hotels to bring more Chinese visitors to Russia.
  • Agriculture projects in wheat, fish, pork, premium fruits and dairy, among other products
  • Technology substitution projects.

Read more of my views on my blog, Gordon’s View. And please follow me on Twitter.

Image credit: Mark Turner / Flickr

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China’s iConsumer 2015: A Growing Appetite for Change http://www.mckinseychina.com/chinas-iconsumer-2015-a-growing-appetite-for-change/ http://www.mckinseychina.com/chinas-iconsumer-2015-a-growing-appetite-for-change/#comments Tue, 10 Feb 2015 02:27:50 +0000 http://www.mckinseychina.com/?p=8293 Chinese e-commerce is developing even faster than previously believed, with Chinese iConsumers embracing online commerce and major retailers rushing to offer ever more sophisticated online services.

McKinsey’s iConsumer China 2015 survey tapped into the behaviors and desires of China’s 630 million Internet users, across different city tiers and throughout rural areas (Exhibit 1). The research shows robust growth in social commerce, a trend toward transforming physical retailers into mere ‘showrooms’, and mounting consumer enthusiasm for more online-to-offline (O2O) services. Combined with a dramatic increase in online food purchasing and unexpected levels of online engagement among the rural population, these findings show Chinese digital consumers, already among the most advanced in the world, are embracing and demanding more innovative online shopping experiences at a rapidly accelerating pace.

iconsumer-image-excerpt

Download the full report here

Image credit: Jason Howie/Flickr

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The Temperature Is Rising In China’s Medical Device Market http://www.mckinseychina.com/the-temperature-is-rising-in-chinas-medical-device-market/ http://www.mckinseychina.com/the-temperature-is-rising-in-chinas-medical-device-market/#comments Mon, 09 Feb 2015 01:22:56 +0000 http://www.mckinseychina.com/?p=8288 The potential of China’s medical device market has led many multinational and local players to place large bets. But with lower growth, more intense competition, and government actions on pricing and compliance, it’s becoming a lot tougher.

China’s medical device market has been growing at annual rates of close to 20% for much of the past decade. Stagnant or declining growth in mature markets hasfueled enthusiasm for China and has led medical device players to place big bets there. Billions of dollars have been invested in manufacturing and R&D capabilities. Many multinationals have acquired local companies to tap into the China opportunity.

But the market is entering a new phase of development. Following the crackdown on non-compliant practices in the pharmaceutical industry, many medical device executives are investing heavily in minimizing compliance risks in their own commercial models, which often rely heavily on extensive, multi-layered distributor networks into which they historically had limited visibility.

Government guidance, suggesting hospitals should give greater consideration to local products in their purchasing decisions, has created uncertainty. And now, market growth is hovering below 15% – still fast by global standards, but a challenge for China.

How do industry leaders feel about their businesses in 2015? We talked to the general managers of 16 leading MNC medical device companies, representing about half of the MNC-generated revenues in China’s medical device sector. These executives remain positive toward the opportunity in China (they certainly don’t want to be transferred elsewhere), but at the same time, point towards areas where significant improvement will be required.

There is broad consensus that growth in the 10-15% range will continue. Market fundamentals certainly support this – demographics, the growing burden of non-communicable diseases, and improving affordability are leading to rising patient volumes and a concomitant need for medical supplies. Inpatient admissions continue to grow by more than 10%.

It’s therefore not surprising that three-quarters of the executives we surveyed expect to sustain their high levels of investment in China and continue efforts to localize their business activities. The surge in new privately-run hospitals is expected to be a new source of growth, though most growth is still expected to come from the larger class III hospitals in major cities.

Sales forces will need to change a lot – companies that make this switch best will come out ahead. In the past, a fast ramp-up of salesforce was a fairly sure way to drive growth; only one out of four executives now sees salesforce expansion as a priority.

By contrast, more than two-thirds believe that salesforces will have to become more broadly skilled to sell to a wider range of customer segments. Many see the distributor model if not dying, then at least consolidating dramatically as it has in so many other industries.

The “value segment” – the largest and most price sensitive segment-has been seen as the source of a key threat, the place local companies learned to compete and move up market. This is changing. More than half of the executives we asked now see this segment as a key source of growth.

Finally, executives express a shared concern around finding and retaining suitable talent, even in a market where millions of university graduates fail to find good jobs.

2015 will be a year of major change in the sales and marketing model used by medical equipment manufacturers in China. The industry will see new talent, new skills and new ways of working with (fewer) distributors.

Standing still means falling behind.

I’d like to acknowledge the contributions to this post by my colleague Florian Then, a Partner in McKinsey’s Healthcare Practice in China.

For a related article on this topic, please check out “How medical-device manufacturers can transform marketing and sales capabilities”

Read more of my views on my blog, Gordon’s View. And please follow me on Twitter.

Image credit: NEC Corporation of America / Flickr

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Deciphering Chinese Economic Statistics http://www.mckinseychina.com/deciphering-chinese-economic-statistics/ http://www.mckinseychina.com/deciphering-chinese-economic-statistics/#comments Mon, 02 Feb 2015 10:26:48 +0000 http://www.mckinseychina.com/?p=8283 I was looking this week at the Chinese government’s (National Bureau of Statistics) data on income and consumption for 2014 and comparing the current data to historic figures.

At the aggregate level, in China overall, there appears to be a headline fall in savings rate (income less consumption) from 31% to 27% between 2013 and 2014. This is relevant as savings rates have risen each year since 2005, and this would break the trend.

My next step was to look at urban savings separately from rural savings. Urban incomes appear to have risen 7% in 2014, expenditures to have risen a little faster, so the savings rate fell from 33% to 31%. Nothing in that to contradict what I hear and see in the economy.

That meant rural citizens were the main source of the lower national savings rate. And indeed, the statistics report that the rural savings rate fell from 26% in 2013 to 15% in 2014 on the back of a 27% increase in consumption (versus a 12% increase in 2013). I didn’t see what would have caused this, nor do I see signs that consumer goods companies are suddenly selling a lot more in rural areas.

Was the number right before? Is the number right now? Or is there really a discontinuity in rural consumption?

We asked NBS for an explanation, which they were very willing to provide (and I give them credit for their openness). The answer we received was that the NBS expanded the coverage of their rural survey in 2014, and that the (higher) 2014 data is not comparable to prior years. Which leads to the question of which survey is more accurate – the former survey with lower incomes and higher savings? Or the 2014 survey with higher incomes and much lower savings. Or neither of them?

And why, if the survey’s coverage was expanding, was it finding wealthier rural areas that it missed before to investigate. It would perhaps be easier to understand if they were adding more remote and poorer areas.

One thing is for sure: Don’t draw any trend charts including 2014 rural income or consumption.

Read more of my views on my blog, Gordon’s View. And please follow me on Twitter.

Image: Ken Teegardin / Flickr

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China’s Malls Reboot http://www.mckinseychina.com/chinas-malls-reboot/ http://www.mckinseychina.com/chinas-malls-reboot/#comments Fri, 30 Jan 2015 02:42:44 +0000 http://www.mckinseychina.com/?p=8280 Even government officials have worked out that something has to be done to reinvent malls (many run by government owned property developers) in their city centers and suburbs if they are to remain viable.

Not only are Chinese buying more and more online, but also when they do shop in physical stores, they want to shop in their local community, within walking distance from home. They are increasingly stepping away from the anchor hypermarkets in the malls that they have to drive to.

In Shanghai, for example, officials are celebrating the conversion of electronics-focused malls into “cultural and entertainment” centers. Doubtless we will soon see an overly supply of these. Metro City, for example, is converting part of its space into a 700-seat theater. Pacific Digital City is going further. It’s demolishing part of the current mall to build a recreation center. Other malls are not renewing leases for electronics vendors and are replacing them with restaurants. Where electronics-focused malls lead, others will follow.

Will the consumers flock to these repurposed malls in sufficient numbers? I doubt it. Will demand for eating out really grow that rapidly? Will restaurants be able to afford rents that mall owners need to charge to cover their interest payments? We will see.

Read more of my views on my blog, Gordon’s View. And please follow me on Twitter.

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What Should China Do About Slowing Economic Growth? http://www.mckinseychina.com/what-should-china-do-about-slowing-economic-growth/ http://www.mckinseychina.com/what-should-china-do-about-slowing-economic-growth/#comments Wed, 28 Jan 2015 01:24:55 +0000 http://www.mckinseychina.com/?p=8274 China’s economy is slowing from its blistering pace of recent years. Recent data shows that GDP grew by 7.4 percent in 2014, the slowest rate for 24 years.

Premier Li Keqiang told global leaders attending the World Economic Forum in Davos that this slowdown is no cause for concern, that there would be no hard landing, and that China is now focused on ensuring an “appropriate” pace of economic expansion.

His remarks point to an important truth about China’s growth in the years ahead. It is not the precise rate of growth that is the key issue, but what drives that growth. What’s important for China is changing its growth model from one that is investment-driven to one that is productivity-led.

An aging China

China, in common with many other countries, is aging. Over the past 50 years, rapid population growth meant expanding labor pools, boosting growth. But population growth is now slowing—with major implications for growth.

China’s labor force could shrink by one-fifth over the next 50 years. On current trends, China could have one dependent aged 65 or more for every two working-age citizens. Peak employment could occur as early as 2024, concludes a new McKinsey Global Institute (MGI) report Global growth: Can productivity save the day in an aging world?

Productivity imperative

This puts the onus even more heavily on raising productivity to drive GDP growth. China has already made huge strides to improve productivity, which has increased 14-fold over the past 50 years, and been responsible for three-quarters of China’s growth over that period.

But because of dramatic demographic change, even at those rapid rates of productivity growth, over the next 50 years China could grow at a 30 percent slower rate—an average of 5.3 percent a year compared with 7.6 percent over the past half century.

That would still be a significantly faster rate than in other major economies but there is plenty of scope for China to accelerate its productivity-growth rate and do even better.

The opportunity

About 80 percent of the productivity opportunity MGI has identified in emerging economies such as China comes from catching up with best practice in operations and business approaches; the rest can come from innovation, not just in the use of technologies but through imaginative ways of managing businesses and processes.

Let’s look at four key sectors:

  1. Today, China’s huge automotive industry has 67 percent of the productivity of the average in developed economies. But if China were to move from its large number of small plants to a smaller number of large operations, productivity could rise by up to 50 percent
  2. In agriculture, there is huge scope to boost productivity through mechanization, which is still relatively low in China with nine tractors per 1,000 hectares compared with 27 in the United States and 16 in India. Taking Zhejiang Province as an example, the evidence suggests that mechanization could reduce the labor needed to cultivate rice by more than 40 percent. This of course has an implication for migration which is one reason why government policy in this area has been cautious
  3. China is transforming retail through e-commerce players like Alibaba. By 2020, online sales could be as high as $650 billion, equaling the size of today’s US, Japanese, UK, German, and French markets combined. Online retail has far higher productivity than the bricks-and-mortar variety. Currently, labor productivity in China’s online retail sector is two-thirds of the US level, a much narrower gap than the 75 to 80 percent gap in retailing overall. If China’s online retailers were to match the productivity of their counterparts in other countries, this could boost overall retail productivity by 14 percent. In physical retailing, moving to modern formats is the most powerful way to boost productivity. Here, too, China is making progress. The share of traditional grocery stores fell from 31 percent of grocery sales in 2000 to 15 percent in 2009, largely through regulation encouraging more consolidation in the sector.
  4. The productivity imperative is particularly acute in health care because spending is growing so fast. China’s spending has almost tripled in five years and is projected to reach $1 trillion by 2020. Making health care more efficient is a potent source of productivity. Today, patients spend an average of 10 days in hospital, which is expensive. But there are ways to reduce hospital stays. Japan has cut the (still lengthy) time people spend in hospital by nearly a week since 2000. It did so by moving toward less invasive surgical procedures, and using digital technology to monitor patients at home.

Slower growth can be smarter growth and China can continue its march toward prosperity. Productivity and innovation need to be front and center of this journey.

* * *

I’m a Director in McKinsey’s Shanghai office and Director of the McKinsey Global Institute (MGI) in Asia. I also co-lead the Urban China Initiative (UCI), a thinktank devoted to transforming China’s urban future. Visit the UCI website here.

Read my latest book, The One Hour China Book: Two Peking University Professors Explain All of China Business in Six Short Stories

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China’s Auto Sector Puts On The Brakes http://www.mckinseychina.com/chinas-auto-sector-puts-on-the-brakes/ http://www.mckinseychina.com/chinas-auto-sector-puts-on-the-brakes/#comments Tue, 27 Jan 2015 08:10:38 +0000 http://www.mckinseychina.com/?p=8269 More and more industries in China will engage in a fight for a smaller pool of profits, not just among themselves, but also upstream and downstream with their suppliers and customers. Stresses that had lain hidden in an era of rapid growth will become very visible. Industries that have had above average profitability in the past may be most challenged.

Take the automotive sector for example.

While the market for all vehicles is still expected to grow at 7% this year, this is less than half the rate of recent years. Demand for passenger cars is expected to grow at only 3%. You can be sure that the supply of vehicles will grow faster than that. The era when dealers would beg for allocation of vehicles to sell is over.

The fine print in contracts that dealers may never have considered the implications of in the past is now driving relationships. To remain profitable, dealers have to hit volume targets (as is common around the world), leading to a wave of discounting to clear inventories that have reached close to two months across the industry.

Unfortunately for dealers, social media and auto-focused sites on the Internet make it fairly easy for potential buyers to find the best deals, increasing discounting pressures.

Dealers are taking action, however. Many are talking to the media to try to drum up sympathy. More pragmatically, others are consolidating. Almost all are organizing under the umbrella of the Chinese Automotive Dealer Association, a kind of union for owners of car dealerships. And not without impact, as BMW’s recent RMB5.1 billion payment to its dealers shows. Other vehicle manufacturers are “in the headlights” now.

Industry analysts have claimed that some global automotive OEMs have made up to half their global profits in China in recent years. This appearance of having deep pockets creates an expectation that OEMs will help out less profitable parts of the industry. Domestic OEMs may be harder hit as despite being large, their profitability typically remains much lower than their international competition.

And in the medium term are a number of unavoidable challenges for the industry, especially for dealers in first and second-tier cities. Seven major Chinese cities, most recently Shenzhen, have imposed limits on annual sales of vehicles. More are likely to follow. These could reduce sales in these cities by over 30%.

Moreover, with penetration of cars per household in these major cities already hovering at 0.6–0.7, how high is it really going to go from there? Demand is shifting to fourth, fifth and even sixth-tier cities – maybe some dealers will be able to fund expansion into these newer markets, but most will not.

And on the horizon is the challenge posed by the Internet: I can’t believe that Tencent’s and JD.com’s half billion-dollar investment in BitAuto (one of China’s top two internet sites focused on the automotive industry) did not have as part of its logic that they might at some point enable vehicle manufacturers to bypass dealers entirely in selling cars to customers. After all, China’s consumers love buying online.

This year (and next) it is probably better to be a car buyer than a seller.

Read more of my views on my blog, Gordon’s View. And please follow me on Twitter.

Image credit: Marianna / Flickr

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What Is China Buying? http://www.mckinseychina.com/what-is-china-buying/ http://www.mckinseychina.com/what-is-china-buying/#comments Thu, 22 Jan 2015 08:41:58 +0000 http://www.mckinseychina.com/?p=8263 What can we tell about the state of demand, and of the overall state of the Chinese economy, from the latest import numbers?

Looking at Q4 2014 versus Q4 2013:

  • The value of iron ore imports, used to make steel used largely in housing, cars and white goods, fell 34% to only US$18 billion! Due to a decline in prices though, this still means that volume rose 6% – so growth, albeit slow growth. A slightly more positive message than earlier in the year.
  • A similar story for oil. The value of oil imports fell 9% to US$50 billion, volumes rose 13%. I’m not able to separate how much of this went to stock piles, unfortunately.
  • And in agriculture, a mixed picture: import of nuts rose nearly 40% in value and volume as Chinese consumers went crazy for various nuts. Soybean imports fell 9% to only US$9 billion in the quarter.
  • Machine tool imports rose 15%, a good sign for future industrial output.
  • Automotive is concerning. The value of imports rose by almost a third in the first three quarters of the year, but only by 5% in the fourth quarter. This still represents US$15 billion of imports (at a value of roughly US$42,000 per vehicle). Maybe imports overshot in the first three quarters. Otherwise we see here signs of China’s larger spenders really pulling back.

Pay close attention to what China is buying in 2015. Look to what it can say about consumer confidence

Read more of my views on my blog, Gordon’s View. And please follow me on Twitter.

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China Clamps Down On Stock Investors http://www.mckinseychina.com/china-clamps-down-on-stock-investors/ http://www.mckinseychina.com/china-clamps-down-on-stock-investors/#comments Wed, 21 Jan 2015 05:16:49 +0000 http://www.mckinseychina.com/?p=8249 On Friday the China Securities Regulatory Commission (CSRC) took action to limit margin trading on the Shanghai Stock Exchange. A major reason why is visible in the chart below:

As a result of the recent rapid increase in share prices, many new (and unsophisticated) investors are being attracted in – new investor accounts rose to nearly 2 million in December from only a couple of hundred thousand a month earlier in the year. There are almost 100 million individual investor accounts on the Shanghai Exchange now.

In the past, when the market index has risen fast and then adjusted, investors have demonstrated noisily to show their displeasure and to blame the government for allowing it to happen.

What we see now are preemptive actions to try to prevent a reoccurrence in 2015.

Read more of my views on my blog, Gordon’s View. And please follow me on Twitter.

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This Is What Government Efficiency Looks Like http://www.mckinseychina.com/this-is-what-government-efficiency-looks-like/ http://www.mckinseychina.com/this-is-what-government-efficiency-looks-like/#comments Wed, 21 Jan 2015 00:56:42 +0000 http://www.mckinseychina.com/?p=8257 Having been frustrated by so many occasions when governments should have been able to perform a task more efficiently, more quickly or correctly the first time, I feel I have to highlight a recent experience that way exceeded my expectations.

I was in London for a day of meetings earlier this month. I needed to perform my annual task of renewing my passport as pages in the current passport were close to full.

I made a 15 minute appointment online for 2:15 in the afternoon. I filled in the form, which seems to get simpler each year, in about 10 minutes. I arrived early for the appointment and was seen early. I was able to collect the new passport at 6 pm the same day.

And the cost of doing this – at about US$210 – is less than the cost of renewing the passport in the past in Hong Kong or Shanghai.

Read more of my views on my blog, Gordon’s View. And please follow me on Twitter.

Image credit: Chris Fleming / Flickr

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The Growing Squeeze on Autos in China http://www.mckinseychina.com/the-growing-squeeze-on-autos-in-china/ http://www.mckinseychina.com/the-growing-squeeze-on-autos-in-china/#comments Tue, 20 Jan 2015 08:14:44 +0000 http://www.mckinseychina.com/?p=8225 Shenzhen has become the 7th major city in China (after Beijing, Shanghai, Guangzhou, Tianjin, Hangzhou and Guiyang) to impose limits on new car purchases. The trend is clear and is likely to come to more cities in the months ahead.

Shenzhen imposed a hard cap of 100,000 new license plates annually, a 180 degree turn around from a year ago when the Mayor committed to rely on market forces to improve traffic conditions. Additionally, the city banned all vehicles without local license plates from central Shenzhen during rush hour. (I wonder if this will impact the many dual license plate cars that drive from Hong Kong into Shenzhen every morning.)

100,000 new license plates compares to sales of over 500,000 vehicles in Shenzhen in 2014, about half of which were new sales and half were replacement. Shenzhen’s total vehicle stock is now just over three million (but with only one million official parking spaces).

Replacement sales should be relatively unaffected, as existing owners will be able to take their current license plate to a new vehicle. However, their current car will be worth less as potential buyers would have to buy a license plate first. Prospective buyers probably won’t bother.

The secondhand car market is likely to be severely impacted as it will be close to impossible to obtain a license plate, as plates will be issued half by auction (favoring wealthier buyers) and half by lottery (discouraging anyone from exploring a purchase until they have won a license). And 20% of licenses will be reserved for electric vehicles, further reducing the number of potential licenses open for second hand buyers. The market for moving secondhand cars out of Shenzhen into neighboring cities that have not imposed license restrictions will grow.

In the new car market in Shenzhen, first time entry level buyers will be disadvantaged. Scarcity of licenses will shift the market towards premium vehicles, whose owners can afford to pay for a license in the auction or the grey market. But eventually the premium market may also find itself squeezed by the additional costs imposed on car purchase.

Purchases of new cars in cities still without license restrictions may see a one-time boost in 2015 as buyers rush to buy in fear of imminent restrictions. Indeed, some entrepreneurs may seek to stockpile license plates in these cities in anticipation of something that costs very little today becoming overnight worth many thousands of dollars. Inland provinces are already the faster growing markets for new cars in China.

Perhaps you could argue that these restrictions might be more PR than substance. In many of the cities with restrictions the ratio of car ownership to households already exceeds 0.7. It’s not likely to go much higher given the cost of parking and the length of the drive to work.

If local governments invested more in their public transport it would be one of the most productive and sustainable actions they could take. Beijing, for example, has added over 230 miles of new subways in the last 7 years, as illustrated in this graphic.

Imagine what the traffic congestion in Beijing would be without this.

Read more of my views on my blog, Gordon’s View. And please follow me on Twitter.

Image credit: Chris / Flickr

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Will 2015 Be A Year Of Safer Food In China? http://www.mckinseychina.com/will-2015-be-a-year-of-safer-food-in-china/ http://www.mckinseychina.com/will-2015-be-a-year-of-safer-food-in-china/#comments Fri, 16 Jan 2015 03:45:27 +0000 http://www.mckinseychina.com/?p=8235 2014 ended with yet another unfortunate case of a food safety lapse in China as a fast-food chain announced that it is investigating Chinese media claims of staff manipulating the expiry date on various foodstuffs.

In many ways not a surprise, given the frequency with which such events have occurred over the year. Food service in China remains an industry with high turnover, with many relatively new and unskilled employees, and with a high degree of delegation to local restaurant managers.

Creating a culture that rejects taking short cuts and that puts safety first is a tough and in many ways never-ending task. Stores are benchmarked and ranked against each other on profit and revenue, and often profits are low.

It is unsurprising that the wrong choices can be made at the local level. Even as increasingly large-scale and professional suppliers are providing fully safe food to restaurants, effective control in the store remains the ultimate challenge.

I am more confident of progress in packaged foods sold through supermarkets or even direct to consumers, certainly in first and second tier cities. As larger companies, both Chinese and non-Chinese, establish a safety element in their brands, they need to push upstream themselves, either directly owning suppliers or at least managing all the way back to the farm.

The farms themselves are consolidating at an incredible pace. In many sectors, the era of the family plot of land as farm is ending. Large customers won’t buy from them, and as it has become increasingly simple to sell land use rights, many farmers choose that option as the next generation has already moved to the city for good.

I am hopeful, but not certain, that in 2015, as these trends continue, that we will get more comfortable with the quality of what is sold by national food brands in national retail chains. I wish I could be more confident about restaurants, individual or chain – but the challenges to control behavior in individual outlets remains enormously high. And remember it only takes one failure in one store to taint an entire chain’s reputation.

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

Image credit: Eddie F / Flickr

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China Has Four Times As Many Trademarks In Force As Any Other Country http://www.mckinseychina.com/china-has-four-times-as-many-trademarks-in-force-as-any-other-country/ http://www.mckinseychina.com/china-has-four-times-as-many-trademarks-in-force-as-any-other-country/#comments Wed, 14 Jan 2015 15:31:45 +0000 http://www.mckinseychina.com/?p=8230 According to a recent report by the World Intellectual Property Organization (WIPO), China has almost four times as many trademarks in force as any other country, including the US and Japan: 7.2 million trademarks in force in China, compared with less than 2 million trademarks in any other country.

Moreover in 2013, China saw 1.8 million applications for trademark registration (mostly made by resident firms)—a 16% increase over 2012—versus 600,000 applications in the US. I don’t believe that companies would increasingly be investing their money and time in registering their trademarks if they did not believe there was value in protecting their intellectual property in this way. Good news for all businesses that this is becoming the mindset, and a reminder to all those doing business in China to register their own trademarks there as early as possible.

In agriculture, China has become one of the leading countries for registrations of new plant varieties, now second behind only the US. Even in Chinese agriculture, recognition of the value of IP is rising. In some ways, this is not surprising: as farms consolidate and industrialize, much more science is coming into their operation through better use of fertilizer, irrigation and seed.

Much more detail on all this in the annual WIPO report.

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

Image: Tom Maglieri / Flickr

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This Is How Chinese Real Estate Is Going Digital http://www.mckinseychina.com/this-is-how-chinese-real-estate-is-going-digital/ http://www.mckinseychina.com/this-is-how-chinese-real-estate-is-going-digital/#comments Wed, 14 Jan 2015 06:54:21 +0000 http://www.mckinseychina.com/?p=8212 The construction cranes hovering over the Beijing and Shanghai skylines have come to symbolize China’s high-flying real estate sector. But for all the staggering sums that have flooded into new urban properties, it’s easy to forget that China privatized its housing market less than two decades ago. This young market is still evolving—and like most adolescents, it is still experiencing growing pains.

Like many sectors of the Chinese economy, real estate is also in the early stages of going digital. This transformation will shape how deals get done in the future, and it will speed up development of the infrastructure, standards, and practices that are the hallmarks of a mature market.

The vast majority of US home buyers and tenants now use the Internet as their primary tool for finding properties, and a similar shift is underway in China. Websites such as SouFun.com use search engines to filter property listings by location, property size, and price range. Online platforms are helping developers and agents target consumers and close deals quickly, reducing their marketing and carrying costs.

Some companies have partnered with major search engines and portals to gain consumer insights. Vanke, one of China’s largest developers, began experimenting with location-based advertising last year, using the Tencent social ad platform Guangdiantong to push property ads to a targeted group of QQ (instant messaging) users in Shenzhen. Online real estate marketing is taking off, and the potential is enormous, considering that US developers now spend more than 60 percent of their advertising budgets online.

Local governments, too, are realizing the Internet’s power to match buyers and sellers quickly. They now have the ability to move land auctions online and conduct them in a more transparent way. Wuhan now gets 90 percent of its total local land auction revenue through digital transactions.

Taobao, China’s largest C2C e-tailing site, launched an auction platform for foreclosed properties in 2012. Courts register as “stores” and list seized and forfeited properties for sale, allowing buyers to bid on them within a set time frame. This approach reaches a much larger buyer base across the nation than local auctions. Among the early adopters are courts in Zhejiang province on the east coast. The conversion rate and the premium obtained through online auctions are 20 percent higher on average than those achieved through traditional methods.

Mortgage application and approval processes are moving online, which could save consumers time and money, as well as help banks become more efficient. Online real estate platforms have recognized the value of connecting users with these services and have begun to offer a selection of mortgage offers from different banks.

Developers looking for new revenue sources are introducing online property management and community service platforms that connect residents through social networks, forums, and chat groups, and manage regular administrative and maintenance work such as garbage removal and repairs. These platforms also offer value-added services such as housework, gardening, dry cleaning, and elder care.. But because this type of market links online information to a customer’s physical location, privacy protections will be crucial to whether or not this market can grow.

All these innovations are going to contribute to making the real estate sector that much more productive but the Internet may have an even greater impact by shifting actual demand, especially for commercial properties. The explosive growth of China’s e-tailing market has ratcheted up demand for state-of-the-art warehouses while squeezing retail development. Malls now attract fewer tenants, and there is downward pressure on rents. Shanghai’s K11 Art Mall and Beijing’s Parkview Green are adapting by dedicating more space for restaurants, entertainment, and even art shows at the expense of retail. Another big shift in demand is related to office buildings. As the Internet enables employees to work remotely without compromising efficiency, companies can take advantage of the trend to optimize office space and reduce associated costs.

The Chinese government has its own stake in integrating the Internet more fully into the real estate sector. It now has the ability to create a registration system that could set the stage for imposing property taxes for the first time. This would require a herculean effort to standardize paper-based transaction and title data—and it would no doubt rankle the growing urban middle class. But a national property tax could provide a reliable source of revenue to local governments. It could also prove to be a valuable tool for cooling off an overheated market.

I’m a Director in McKinsey’s Shanghai office and Director of the McKinsey Global Institute (MGI) in Asia. I also co-lead the Urban China Initiative (UCI), a thinktank devoted to transforming China’s urban future. Visit the UCI website here.

Read my latest book, The One Hour China Book: Two Peking University Professors Explain All of China Business in Six Short Stories.

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China’s Rising Internet Wave: Wired Companies http://www.mckinseychina.com/chinas-rising-internet-wave-wired-companies/ http://www.mckinseychina.com/chinas-rising-internet-wave-wired-companies/#comments Wed, 14 Jan 2015 05:39:17 +0000 http://www.mckinseychina.com/?p=8205 Until recently, China’s Internet economy was consumer driven. The country leads the world in the number of Internet users, and Chinese enterprises deploy sophisticated e-commerce strategies. The same companies, though, have lagged behind the United States and other developed nations in using the Internet to run key aspects of their businesses (Exhibit 1).

Exhibit 1

China’s Internet has been more consumer than enterprise driven.

That’s changing. China’s companies are quickly climbing the adoption curve. Their increased digital engagement will not only give the economy a new burst of momentum but also change the nature of growth. China sorely needs a new leg of expansion because the industrial growth of recent years—driven by heavy capital expenditures in manufacturing—will be difficult to sustain. The Internet, by contrast, should foster new economic activity rooted in productivity, innovation, and higher consumption.

For global companies counting on China for continued growth, the new Internet wave will change the nature of competition: it will enable the most efficient Chinese companies to grow more quickly, shine more transparency on business and consumer markets, and create conditions for a better allocation of capital.

A new McKinsey Global Institute report looks broadly at the coming transformation.1 Our research shows that Chinese companies are investing heavily in the building blocks of the Internet economy: cloud computing, wireless communications, new digital platforms, big data analytics, and more. Across six sectors (Exhibit 2), which accounted for 25 percent of Chinese economic activity in 2013, we find that increased Internet adoption could add 60 billion to 1.2 trillion renminbi (about $10 billion to $190 billion) in GDP to individual sectors by 2025. About one-third of these gains will come from the creation of entirely new markets, the remainder from productivity gains across the value chain. When we scale up this level of growth across all sectors of the economy, we find that Internet adoption could add 4 trillion to 14 trillion renminbi to GDP by 2025. The Internet is also expected to contribute 7 to 22 percent of total GDP growth from 2013 to 2025.2

Exhibit 2

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

As the new technologies cascade through markets, less productive business models will cede ground to more innovative ones. Companies will realize broad productivity gains in operations by automating processes, streamlining product development, and digitally reinforcing their supply chains. Similar improvements will take shape in marketing and distribution as sales organizations deploy the Internet to expand their reach and enrich customer interactions. Consumers and businesses alike will benefit from lower prices and transaction costs, as well as better goods and services. And in a significant shift, a more wired world will allow China’s entrepreneurs and small and midsize businesses—often handicapped by lower productivity—to scale up rapidly at lower cost.

Five implications

More specifically, our exploration of how Chinese enterprises are integrating the Internet into their processes suggests five implications for competition and market dynamics:

1. A burst of digitally driven productivity

China’s industrial expansion will probably slow down from its levels during the past decade, and companies are struggling with excess capacity. Many are looking to the Internet for a new set of tools to engineer productivity improvements. In the automotive sector, one example is Anji Logistics, a subsidiary of SAIC Motor. Using sensors and communications capabilities—the Internet of Things—the company manages logistics for automakers and other OEMs, helping them optimize inventory levels and transport routes.

Our findings, in fact, indicate that supply-chain and operations improvements will be the most potent contributor to Internet-led value gains in autos.

China’s chemical industry, while still in the relatively early stages of Internet use, is exploring ways to employ big data on inventory levels and shipments to improve forecasting and product planning. In China’s dynamic real-estate sector, online markets operated by players such as Anjuke and SouFun are streamlining information-search and transaction processes, thus shaving commissions and bringing down prices for customers. Healthcare providers are implementing remote patient monitoring to stretch their footprints to underserved patient populations while substantially saving costs for patients with chronic disease.

2. Greater access to financing and lower risk

An underdeveloped financial infrastructure has constrained some areas of China’s economy. The growing use of Internet platforms, combined with increased data and analytics capabilities, means that China’s financial institutions can allocate their scarce resources more effectively and expand the economy’s base of borrowers and investors.

One of China’s most significant gaps is in lending to small and midsize enterprises. Data about a growing number of companies and new analytics tools are giving banks better ways to target risk, thereby lowering the incidence of nonperforming loans and increasing the confidence of lenders. Digitally mediated transactions, meanwhile, are reducing lending costs—another benefit for smaller business borrowers.

A parallel trend is unfolding in consumer lending. Digitization allows banks and other credit suppliers to monitor huge numbers of transactions and to evaluate the risks posed by borrowers more effectively while expanding loans. Regulators are authorizing pilot programs in online lending by newly formed private players. Technology companies such as Alibaba and Tencent are using access to massive amounts of data to lower lending risks and expand the horizons of consumer credit. Our research suggests that better risk management could create the greatest amount of additional value in China’s financial services.

Securities firms, insurers, and banks are building mobile and online channels to distribute new and more specialized products to a long tail of investors. Online discount brokers, for example, are using Internet platforms to lower commissions on investment products. This development has given rise to popular products such as Yu’ebao (created by Alipay), a money-market fund that lets consumers easily move excess savings to accounts bearing higher interest. Online mortgage lending is taking hold as well, expanding the base of home buyers.

3. A growing base of consumers and richer interactions

Social technologies and new digital platforms ease the way for richer interactions with customers and allow companies to meet demand from a more diverse range of buyers, often in new or hard-to-reach markets. Jiangsu Sanfangxiang and Shandong Chambroad, early movers among China’s domestic chemical manufacturers, are using e- commerce platforms to cut administrative and transaction costs and to provide a base for closer collaboration with their customers. Following the pattern in the B2C realm, China’s B2B players are using Internet technologies to expand their markets from large cities to smaller ones. Chemical manufacturers in the agricultural sector are sizing up the potential for big data to help farmers monitor crop conditions in real time, allowing these companies to customize their offerings of products to increase farm yields.

Automakers, meanwhile, are finding that popular vehicle-shopping sites, such as Autohome and BitAuto (Yiche.com), help them to identify and inform likely car buyers. That is proving to be an important tool for increasing conversion rates among undecided shoppers. Chinese car buyers, like those in the West, are demanding systems offering GPS, maintenance alerts, and diagnostics that not only improve the customer experience but also offer robust data to manufacturers for improving products and marketing efforts. In addition, Internet sites are sparking China’s online used-car markets, where companies like Cheyipai and Youxinpai are bridging the information gap and helping dealerships source quality used cars.

Across consumer markets, companies are using China’s established social and search sites, such as Baidu, to mine data on ever-changing tastes and customer preferences. Their ability to expand delivery through mobile channels is growing as well. In real estate, China’s big residential-property developer Vanke has experimented with location-based advertising, using Tencent’s advertising platform, Guangdiantong, to build awareness among potential buyers. Vanke has also partnered with online marketplace Taobao to offer promotional coupons to purchasers. In healthcare, advanced communication technologies permit China’s first-tier hospitals, via regional health-information networks, to extend high-quality treatment to underused lower-tier hospitals by linking patients to medical specialists.

4. Lower barriers to innovation

The Internet blazes new pathways to innovative products, services, and business models. Digitally enabled innovation will add a new dimension to the efforts of Chinese companies, large and small, to compete as they climb the learning curve.

In consumer electronics, companies are gaining familiarity with open-source processes that can transform R&D. These processes widen access to innovative designs that can differentiate products and get them to market faster. Mobile-device maker Xiaomi has built a community of fans, known as mi fen (a play on words that means rice flour and is short for Xiaomi fan), who provide feedback and recommendations for smartphone designs, consumer-friendly features, and other improvements. Computer maker Lenovo held a chuang ke3 competition where 50,000 participants contributed close to 100,000 product ideas.4 Some participants even developed their products with funds raised on crowdsourcing platforms. Volkswagen’s China operations, meanwhile, launched the People’s Car Project to develop new concepts. To shape product innovations, chemical manufacturers are starting to share information with suppliers and customers, hoping to enlist their expertise.

As Internet capabilities are integrated with a growing number of products, new business models are arising. China’s fast-moving Internet-TV market is a case in point. Because Chinese consumers are highly price sensitive, vendors often make little money from hardware. Instead, they are looking for ways to use digital platforms to create “multisided” markets where revenue streams flow from services such as media content and advertisements. LeTV, for instance, provides its Internet-TV set-top-box hardware for free but charges 490 renminbi for a 12-month subscription. This model has sparked new collaborations between China’s TV manufacturers and content providers seeking to bundle services with hardware offerings. Some companies are swiftly turning to successful new models pioneered beyond China’s borders. Following the trend in Western cities where popular smartphone apps have revolutionized taxi services, residents of China’s major urban areas now use Didi and Kuaidi to summon the nearest available cab.

5. New competition as the Internet empowers entrepreneurs and small businesses

Internet technologies lower entry barriers across sectors, giving unexpected competitive power to new players, from online insurers without field agents to mobile-service providers with capital-light models. This new competition may render the business models of some established players obsolete, weeding out companies that can’t adapt. In China, businesses with fewer than 1,000 employees contribute 70 percent of GDP.5 Yet for the most part, they lag behind bigger players in productivity. Going digital will neutralize some of the disadvantages these enterprises face, by helping them manage supply chains more effectively, cement customer loyalty, lower transaction costs, and achieve wider distribution.

One example of the trend is appliance maker Xiaogou. Originally lacking the scale or capabilities to build up a network of brick-and-mortar distributors, Xiaogou shifted to the exclusive use of online platforms for marketing and distribution. We expect that a growing number of smaller Chinese enterprises will eventually become “micromultinationals” by operating from new platforms, particularly as the number of digitally savvy Chinese entrepreneurs continues to grow.

Managing in the new environment

Since the Chinese market lies at the heart of growth strategies for many global companies, senior executives must ready them to compete on the new terrain. Four principles will help define their response.

Zero in on the customer. Given the size and rapid growth of China’s consumer market, companies have often prospered by focusing on large-scale production and mass-market channels. Looking forward, customer needs will become increasingly fragmented. To meet this challenge, companies have to widen their choice of suppliers, glean the more detailed customer insights available from better information, and ultimately produce a broader and more complex portfolio of products targeted to what consumers really want.

Consider the competitors you don’t know yet. The Internet has unleashed a new era of intense competition, and companies will need to be fast and flexible to stay ahead. Competition can emerge rapidly from unexpected corners, and as barriers between sectors become blurred, start-ups based on digital models will gain momentum. Leaders will need to commit resources to the digital transformation to maintain their position. Although the cost of these efforts will strain companies in the short term, they will open the way for long-term benefits.

Retool operations for a digital age. Agility is the key word. Across the new Chinese landscape, Internet capabilities will require much more than a focus on customer-facing operations. A new operating strategy will integrate Internet technologies into back-office functions, production processes, and supply chains, to achieve new efficiencies. CIOs and other technology specialists will need to change their mind-set about big data, adopt multichannel models, and champion operational improvements.

Drill down on your organizational capabilities. Across China, companies are facing talent shortages for highly specialized roles in big data analytics, particularly in sectors such as finance, where changes are coming fast. Meantime, labor-intensive industries will need to attract more knowledge workers as digital technologies become “wrappers” for many goods and services. Outside hiring to attract new talent will be needed, but companies must also be creative about developing their talent pipelines, exploring industry collaboration to create skills in short supply in China, and seeking out partnerships with universities.

The open-ended characteristics of Internet technologies will challenge traditional business models that keep value-chain activities in-house. The next phase of change will tax the capabilities of companies in China, and executives should be open to collaborative ecosystems involving partnerships with upstream suppliers, downstream vendors, and consumers. China’s increasingly wired landscape, in short, is changing the face of business there and challenging the strategies even of companies that have prospered through earlier waves of tumultuous growth.

About the authors

Yougang Chen is a principal in McKinsey’s Hong Kong office; Jeongmin Seong is a senior fellow of the McKinsey Global Institute, where Jonathan Woetzel is a director.

Image Credit: Amanda Mills/FSP

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Four Trends Shaping China’s Retail Banking Landscape http://www.mckinseychina.com/four-trends-shaping-chinas-retail-banking-landscape/ http://www.mckinseychina.com/four-trends-shaping-chinas-retail-banking-landscape/#comments Thu, 08 Jan 2015 07:13:48 +0000 http://www.mckinseychina.com/?p=8178 China’s retail banking revenues have grown 30 percent a year since 2009 and could exceed RMB 2.6 trillion (over US$430 billion) by 2020, making the country the largest retail banking market in Asia. Intense competition for the Chinese retail banking consumer’s wallet has accompanied this fast growth. Meanwhile, the retail banking landscape has faced several challenges, including interest rate liberalization, major regulatory changes, and the rise of digital finance.

To better understand Chinese banking customers, McKinsey conducted in 2014 a personal financial services survey of more than 3,500 consumers across Tier 1, 2, 3, and 4 cities. (McKinsey has done similar personal financial services surveys since 1998, and most recently in 2007 and 2011.)

Highlights of our current research include:

  • Chinese consumers are still among the least loyal in Asia. For example, less than half of Chinese consumers will remain loyal to their primary bank when offered more attractive pricing terms from competitors, compared with nearly 70 percent in emerging Asia.
  • Consumer needs and behaviors are becoming increasingly similar across China. For example, penetration of several banking products now varies by less than 5 percent across tier cities.
  • The country’s “Big Four” banks are less dominant. For example, their market share is eroding across tier cities and income segments.
  • Digital banking is going mainstream. Today, more than 70 percent of Chinese consumers say they would open an account with a pure digital bank.

Implications for traditional retail banks and Internet players are far-reaching. For retail banks, a key to success in the future is moving toward more of a total relationship model. Internet players, for their part, must better understand how to integrate financial services with the Chinese consumer’s digital lifestyle.

Download the full report here

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How Do The Chinese Bank Today? http://www.mckinseychina.com/how-do-the-chinese-bank-today/ http://www.mckinseychina.com/how-do-the-chinese-bank-today/#comments Tue, 23 Dec 2014 05:07:05 +0000 http://www.mckinseychina.com/?p=8171 China’s retail banking revenues have grown 30 percent a year since 2009 and could exceed RMB 2.6 trillion by 2020, making the country the largest retail banking market in Asia. Intense competition for the Chinese retail banking consumer has accompanied this fast growth. Traditional retail banks face several challenges including interest rate liberalization, major regulatory changes and the rise of digital finance.

What do we see?

Chinese consumers are not loyal to their banks. For example, less than half of Chinese consumers will remain loyal to their primary bank, compared with nearly 70 percent in emerging Asia. A typical Chinese consumer has accounts with 3 banks, up from 2.5 in 2011. However, the Big 4 banks are gaining almost none of these new accounts. Consumers are adding accounts at the smaller joint stock banks.

Consumer banking needs and behaviors are becoming increasingly similar across China. For example, penetration of savings products and mortgages now varies by less than 5 percent across tier 1, 2 and 3 cities. Even in third tier cities, credit card penetration is over one third, up from only 5% 3 years ago.

The “Big Four ” banks lose more share. While 73% of consumers still say a Big 4 bank is their primary bank that is down from 78% three years ago and leaves the Big 4 only holding 48% of retail deposits (down from 55% 3 years ago). This decline is consistent across tier of city and income segments. If consumers decide that their salary no longer needs to be deposited in a Big 4 bank, the share slide could accelerate.

Digital banking is mainstream. Today, more than 70 percent of Chinese consumers say they would open an account with a pure digital bank and only 40% are not using internet based banking services. 5% are exclusively using Internet companies for their financial service needs. Almost the entire population is aware of epayment options and nearly three quarters are aware of online investment options

Implications for traditional retail banks: Lower share means fewer branches, fewer employees. Digital means new skills. The government means new regulation. Follow the customer means expand internationally.

A total transformation ahead.

 

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What could happen in China in 2015? http://www.mckinseychina.com/what-could-happen-in-china-in-2015/ http://www.mckinseychina.com/what-could-happen-in-china-in-2015/#comments Mon, 22 Dec 2014 08:13:18 +0000 http://www.mckinseychina.com/?p=8147 It seemed harder to prepare my “look ahead” this year. On reflection, I believe this is because political and economic leaders in China have clear plans and supporting policies that they are sticking to. You can debate the pace at which actions are being taken, but not really the direction in which the country is traveling. This means a number of the themes I highlighted for this year will remain relevant in 2015:

  • Improving productivity and efficiency will remain the key to maintaining profitability for many companies, given lower economic growth (overall and at a sector level) and the impact of producer price deflation on multiple sectors.
  • The impact of technology as it eliminates jobs in services and manufacturing will become even greater (but still not in government).
  • As a result, the government will keep a sharper focus on net job creation and the quality of those new positions. Companies will hire even more information technologists to keep up in the race to exploit technology better than their competitors.
  • The push to lower pollution, and now carbon emissions, will lead to even greater investment in domestic solar and wind farms, boosting the global position of Chinese producers.
  • High-speed-rail construction will continue domestically and increasingly abroad, as Chinese companies become the builder of choice for high-speed rail globally. Beyond these, there are several additional themes that will be important in 2015. I describe them below.

What else may happen in 2015?

China will be the focus of many, many boardroom discussions around the world next year. Unlike most previous years, the topic won’t be whether to double down on China—it will be whether to hold or even reduce exposure to a particular sector or the country overall. With China experiencing lower growth, greater competition, and more volatility, it won’t only be multinational companies having these conversations. Similar questions will be asked by senior executives of many of China’s private-sector leaders, who are looking to sustain their historic growth rates by pivoting to new sectors within China and especially to international markets. Most companies will ultimately decide to stick with their current China strategy, but there will be real choices and trade-offs on the table.

What will be at the center of these conversations? I believe that it will be a debate about Chinese consumers and how they will behave in a slowing economy and, ultimately, the extent to which they will be the driver of economic growth over the next few years. Let me elaborate.

Wages

Next year will likely see the lowest annual income growth in China for at least a decade, with knock-on implications across the economy. Early signs are already there. Government data show urban disposable income rose in single digits year on year in the first nine months of 2014, a hint at the big shift that is under way. The vast majority of the economy has seen double-digit wage growth for the past decade, with the minimum wage in many cities doubling in less than five years. This has created an expectation that this is simply the new normal for income growth. It is not. As a result, workers are pricing themselves out of the market: for example, International Monetary Fund research in China suggests that a 10 percent increase in the minimum wage leads to a 1 percent fall in employment.

The manufacturing sector provides a telling example. Manufacturing wages are up fourfold in dollar terms over the past decade. In recent years, private-sector enterprises have had to agree to annual wage increases three to four percentage points higher than state-owned enterprises in order to narrow the significant pay differential that had developed by 2010. The challenges for low-skill assemblers in Guangdong and Zhejiang are well documented. They are downsizing, as countries from Bangladesh to Kenya gain share. The cost of technology that substitutes for labor in factories has plummeted, displacing more and more workers. Chinese assembly lines today bear no resemblance to those of a decade ago. The best Chinese private companies are as capital intensive as an equivalent factory in the United States. Employers today are under enormous short-term pressure to reduce wage costs amid ongoing weakness in the Purchasing Managers Indexes and persistent deflation in producer prices.

Service industries will also be affected. For example, Chinese airlines use e-ticketing to substitute for desk agents at least as aggressively as any mature-market airline. Telecommunications, financial services, and retail are all being challenged by “people lite” Internet-based business models from new competitors, which have already led them to substantially reduce hiring. In 2015, they will need to quietly cut back further, whether they are in the private sector or a state-owned enterprise—it doesn’t matter. In some sectors, such as professional-services industries, entry salaries are actually falling. I believe 2015 will be seen as a tipping point for wages in China.

Jobs

Job seekers next year will realize that the historical attractions of working in state-owned enterprises and government are not coming back—the job for life, opportunities for status, high pay, and other perks are gone for good. Smaller state-owned enterprises are, in many cases, anyway destined for the more commercially demanding world of private ownership. Many larger state-owned enterprises are recruiting less and encouraging departures to improve efficiency. Lower growth means fewer promotion opportunities, and the upcoming regulatory limitations on the multiple of highest and lowest compensation in state-owned enterprises will increase wage compression.

The private sector has become the driver of job creation in China, with official statistics (likely understated) showing an increase of 50 percent or more in private-sector jobs over the past five years. However, many of these jobs are relatively low skill and low paying. In 2015, the service sector’s criticality to job creation will be called out even more by the government, with expanded policies to encourage service-sector hiring and additional focus on the quality of jobs created.

In the government sector, the official salaries of teachers, doctors, and civil servants remain low, and opportunities for side arrangements are shrinking. Eventually, the government is going to have to pay its employees more—but I don’t see that happening at scale in 2015, despite the growing number of cases of teachers striking for better pay. The number of students taking the central-government entry exam fell this year despite an increase in open positions. There has to be a connection.

The substitution by technology of certain categories of service jobs that have been at the heart of the growing middle class—call centers, shop assistants, bank tellers, insurance agents—will accelerate in 2015. Even those who retain their jobs will wonder if technology will displace them next. Critically, their confidence in their personal economic future will decline.

At the city level, we will start to see signs of the “Detroit-ization” (post-auto) or “Glasgow-ization” (post-shipbuilding) of some Chinese cities. Many cities are heavily dependent on a single industry, not just mining or steel but often a specific single manufactured good—lamps, socks, or automotive wheels. While great in times of fast growth, the reverse is also true. It’s not just that real-estate construction is no longer a driver of growth in those cities. Construction, even when it overshot true demand, was always driven off the back of the success of an industry creating jobs and incomes that enabled citizens to buy housing. That success will no longer be there. And with loans to business often guaranteed by other companies in the same industry in the same city, a single default can quickly cascade into other otherwise viable companies. In 2015, we will see the first of many “city transformation” programs as cities go through a Chinese version of restructuring and workout. Hopefully, cities at risk will see what may be coming and will act early to create new economic engines.

It’s all about consumer confidence

As a result, Chinese consumers will feel less financially secure in 2015. Fewer will feel they have a job for life, most will see wages rise more slowly, many of their real-estate investments will decline in value, and lower interest rates will make other investment products look less attractive. Overall, the momentum of their wealth generation will slow dramatically after a decade of remarkable acceleration. And if they have children graduating from college in 2015, they will likely see them struggle to get a good job.

Lower consumer confidence may then translate into lower growth in discretionary spending. Fortunately for many in the middle class, they have already bought their home, car, and other core trappings of middle-class life. Many Chinese consumers could easily postpone further big-ticket-consumption items and, at the same time, cut back on daily consumption spending. Price deflation reduces the perceived opportunity cost of waiting to spend. Already there are signs of this. Recent Nielsen numbers showed only a 3 percent increase in annual purchases of fast-moving consumer goods. More specifically, food and beverage company Tingyi reported a 13 percent decline in turnover in the third quarter of 2014, while beer volume sold by brewing and beverage group SABMiller fell in its most recent reporting period. And remember: very few in the current Chinese middle class were in the middle class the last time there was an economic slowdown. They could well overreact to a small slowdown and turn it into a larger one as a result.

With fewer attractive investment options in China, the opportunity to invest in Hong Kong–listed companies through the Shanghai–Hong Kong stock-exchange connection will look more attractive in 2015. Currently, a lack of awareness about the available stocks and a high minimum investment are holding people back, and the fund flows are way below daily limits. In 2015, that will change.

Where will growth come from?

The result of all of this is that drivers of economic growth will be harder to find in 2015. Increasing consumption has accounted for more than 50 percent of GDP growth for the past couple years. Its share, for reasons laid out above, will likely be smaller next year. Infrastructure investment is directly under government control and will likely remain at current levels and contribute to growth as it did this year. However, property investment—historically, the driver of around 15 percent of GDP—will probably have another weak year. Residential supply has exceeded demand in many cities, and investor interest has diminished as prices have stagnated. While the picture is city specific, significant unsold inventory exists in many cities, and new building is only adding to it. Policy support will have some impact in growing demand, but it would take much lower real interest rates to make a meaningful difference. Could growth be driven by exports? Not since 2007 have net exports contributed more than a percentage point to China’s growth. Recovery in the United States has not led to a growth in net exports, and a big boost from demand in Europe in 2015 seems unlikely, even with lower oil prices.

Students reinvent themselves for the jobs of 2015

It will be another year of frustration for students, both those graduating and those still in school considering their prospects. A substantial proportion of new graduates will not find jobs that require a degree. Indeed, many will find what they learned and how they learned at university has done little to prepare them for the 2015 job market in China. Other than for an elite minority, starting salaries will be flat yet again, at levels less than the income level of a full-time taxi driver (student starting salaries have only increased 1 to 2 percent annually over the past five years, one of the few categories in the economy where wages have not risen). The consequences will become increasingly obvious—graduates will be unable to pay off their education debts, let alone save to buy a home or a car or to become meaningful middle-class consumers.

The way forward for most is finding employment in the private sector, services, or small and midsize enterprises, or becoming an individual entrepreneur—none of which average students have been prepared for by their education or their family. Growth in vocational schools is being boosted by many newly graduated students who realize they need to gain more work-relevant skills. Those students still in school will become more vocal in demanding change in what and how they are taught.

Individuals going global

Governments around the world will compete harder to capture a greater share of China’s international tourism and outbound-investment boom. The new US ten-year multientry visa sets a bar for other countries to follow. The United Kingdom’s guaranteed 24-hour turnaround on visas for premium business travelers sets a bar for speed, although the $1,000-plus price is eye watering. Beyond visas, many countries also offer popular investment paths to a passport or permanent residency. The majority of those using these schemes in most countries are Chinese. In the most popular countries, limited supply is allowing governments to push up the required investment dramatically. We might hear about a $10 million passport this year.

Airlines are also big beneficiaries of this growth in international travel, with a new wave of growth in direct flight connections to key global cities from second- and third-tier Chinese cities (two recent examples are Wuhan to San Francisco and Changsha to Frankfurt). While these routes have been subsidized initially by local Chinese governments, the subsidies won’t be needed for long. The big Middle Eastern airlines are also expanding beyond Beijing, Guangzhou, and Shanghai, for example, with Qatar Airways now flying into Hangzhou. Next year will see the launch of dozens more direct flights to non-Asian destinations from second- and third-tier Chinese cities.

Chinese innovation—seriously

Does China innovate? Next year, we will finally stop asking that question and focus on the global impact of the innovation that is clearly taking place. The number of Silicon Valley–based investors visiting China to learn from Internet-enabled business is now remarkable. These folks don’t waste their time on sight-seeing trips.

Beyond the Internet, hundreds of midsize companies in the Chinese industrial sector are creating their own version of the German Mittelstand, providing ever-more-serious competition to Fortune 1000 competitors. No longer focused simply on cheap, they deliver great value, listen to what customers want, and develop products in response. Only this month, on a visit to India, I noticed a tipping point. No longer were there complaints about the low quality of Chinese industrial goods; instead, there were compliments about their remarkably high quality. Biotech, pharmaceutical, consumer electronics, medical tech, drones, graphene, and telecommunications equipment are just some of the sectors where aggressive Chinese midsize companies lead the way in their field, often privately owned by a founding chairman or CEO who has a true passion to become a global leader.

Rule of law increases its impact in 2015

A comment you’ll hear less in 2015: I can do this—it’s China. Businesses will more fully recognize that anticorruption initiatives and rule of law with Chinese characteristics are long-term foundational elements of this leadership’s platform—they’re not optional, and they’re not going away. Companies will need to become clear about how recent statements—such as President Xi declaring that the objective of advancing the rule of law is conducive not only to updating state governance but also to deepening reform—apply to them.(1)

We will see the government standardize more of its approaches to decision making on business and regulatory issues, using the precedent of cases heard. For example, reviews of acquisitions should be faster, with clearer conclusions. We will also see the government leveraging technology more to monitor, audit, and impose sanctions on bad behavior, from tax avoidance to overly aggressive entertainment of government officials. Where could anticorruption investigations bite in 2015?

  • in an Internet company where a senior executive gets investigated for begging forgiveness, rather than asking permission, once too often
  • in local government, where rapid asset sales made it possible for some sales to be made to favored individuals at below-market prices
  • in companies that have yet to fully get their sales forces under control

Return of the DVD store

Shops offering pirated DVDs will make a comeback in 2015 as the rule of law extends to what can and cannot be shown online, pushing very popular international series off the Internet. US series including The Big Bang Theory and The Good Wife have already been blocked, and rules announced in September by the State Administration of Press, Publication, Radio, Film and Television require unapproved shows to be removed from websites by the new year. Perhaps only in China will the selection of available online content be more tightly controlled than the availability of physical content. Or maybe the international providers of virtual private networks will learn to accept payment from UnionPay cards, and demand for their services will skyrocket. Cinemas will likely also benefit, as good-quality online sources for newly released movies have almost entirely disappeared.

***

A footnote: be careful with national-level statistics from China in 2015. In times of slower growth, they are historically less reliable.

 

Download a PDF of this article here.

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(1) “Xi says China adheres to socialist path in rule of law,” Xinhua News Agency, Global Post, October 10, 2014, globalpost.com.

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China’s Drug Industry Must Innovate http://www.mckinseychina.com/chinas-drug-industry-must-innovate/ http://www.mckinseychina.com/chinas-drug-industry-must-innovate/#comments Sun, 21 Dec 2014 05:02:07 +0000 http://www.mckinseychina.com/?p=8167 80% of the sales of multinational pharmaceutical companies in China in 2014 were derived from mature products that are off-patent, of which over 70% were launched more than 10 years ago. These numbers do not indicate a sector with a surfeit of innovation.

Yet many are innovating in the healthcare industry in China, and more could be doing so soon.

Innovators are bringing IT into Chinese healthcare at pace and scale. These range from personal healthcare innovations such as Baidu’s Jiankangyun, to Tencent’s physician network, to Alibaba’s e-pharmacy, to EMR services from many players, including cross-cutting players like Neusoft.

The pace of change driven by innovative use of data across the healthcare chain will be faster in China than most other countries as consumers embrace the Internet from shopping to finance and now healthcare, and the government encourages experimentation that delivers patient benefits and lower costs.

In parallel, we are seeing massive private sector investments in hospitals and clinics, from local, Asian and global institutions. This is leading to new, highly visible best practices in treatment, and closer linkages between the best hospitals and the emerging health insurance industry. The impact on the much larger public hospital infrastructure will be gradual but significant.

Chinese domestic pharmacos are becoming both higher quality and more innovative. Huahai, for example, is investing tens of billions of RMB in production and research facilities, and the pipeline of new class 1 drugs at all stages, from pre-clinical and on, from Chinese pharmacos now exceeds 200, from less than 100 just four years ago.

While the quality of the innovation generated at this point is certainly subject to debate, the increase in flow cannot. And even the multinationals, despite their reliance on older drugs to grow revenues, are investing heavily in R&D facilities in China. In just the last 12 months, Sanofi committed 1,400 staff to an R&D hub in Shanghai, Amgen inaugurated its R&D Center at ShanghaiTech University, and J&J opened its Innovation Center in Shanghai.

In biopharma, the story is even more exciting, with a fourfold increase in investment in R&D over the last six years, and a doubling of international drug patent filings. These Chinese companies need a short path to market for their drugs to earn a return on their investments.

Both local companies and multinationals are finding the pathway to markets for their innovative drugs slower and more difficult to navigate than they would like. Multinationals have continued to innovate globally, but only 50% of the global top-selling drugs launched since 2008 are currently available to Chinese patients. The vast majority of new drugs launched in China since 2008 are still not on the national drug reimbursement list, including ten class 1 drugs launched by domestic companies.

This is a problem common to all players in the industry, regardless of national origin, and requires a common solution, a solution based on trust. The industry needs to present a common face to the regulators, and there needs to be increased collaboration, as you see today between Sanofi and Zai Labs, Merck Serono and BeiGene, BMS and Simcere, Pfizer and Hisun.

Some of these partnerships leverage local capabilities, some focus on co-development of multinational assets, some on the co-development of China assets. Players will partner in some spaces and compete in others. Regulators embrace these partnerships, and recognize that shortfalls in innovation are an industry level problem, that the real issue holding it back is impact on cost and the need for new capacity and capabilities. They will reward innovation, but maybe not so much the sort of innovation that we focus on here; perhaps more innovations that lead to higher manufacturing quality and the like.

All those involved in the industry recognize that a turn to innovation has to happen, otherwise the industry will increasingly look out rather than in, using Chinese talent to innovate, but bringing these innovations to patients outside China rather than close to home.

 

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The Hangzhou Paradox http://www.mckinseychina.com/the-hangzhou-paradox/ http://www.mckinseychina.com/the-hangzhou-paradox/#comments Fri, 12 Dec 2014 01:13:43 +0000 http://www.mckinseychina.com/?p=8135 Hangzhou, home of Alibaba and many other successful Internet ventures, has created a massive wave of millionaires in 2014.

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

Why? Is it because citizens of Hangzhou are:

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

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

What do you think?

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

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

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

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

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

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

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

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

A few of the positives include:

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

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

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

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

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

 

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

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

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

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

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

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

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

1. Boarding School or Not

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

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

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

2. Engineering or Business

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

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

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

3. BCG or McKinsey

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

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

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

4. London or China

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

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

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

Three common themes:

1. Make a big change only rarely.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

1. Start in the air

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

2. In the airport

Firstly, departures:

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

Transit:

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

Arrivals:

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

3. On the plane

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

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

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

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

What did they have to say?

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

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

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

AIR TRAVEL IN CHINA: SUBSTANTIAL LATENT DEMAND…

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

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

…WITH (SURMOUNTABLE) BARRIERS TO CAPTURING IT

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

 

AVERTING A VALUE-DESTROYING SCENARIO

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

 

FOUR MOVES TO WIN IN A MORE COMPETITIVE ENVIRONMENT

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

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

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

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

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

 

LOW-COST SUBSIDIARIES ARE A DISTRACTION

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

***

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

 

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

 

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

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

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

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

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

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

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

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

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

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

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

 

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

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

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

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

Trends shaping growth and creating new opportunities in China

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

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

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

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

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

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

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

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

The risks

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

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

Industries with potential for faster growth in the next decade

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

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

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

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

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

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

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

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

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

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

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

Doing business effectively in China

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

Establish the right strategic positioning.

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

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

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

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

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

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

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

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

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

 

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

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

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

What would I suggest as a few bold initiatives?

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

 

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

Image credit: Antonio Tajuelo / Flickr

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

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

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

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

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

 

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

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

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

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

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

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

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

 

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

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

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

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

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

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

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

 

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

Image credit: University of Oxford

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

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

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

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

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

 

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

Image credit: IOE London / Flickr

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

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

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

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

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

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

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

If you get through these positively:

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

What kind of priorities to set for yourself:

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

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

 

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

Image credit: Penn State / Flickr

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

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

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

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

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

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

 

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

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

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

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

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

2. There was never a shortage of capital.

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

Image credit: Luis / Flickr

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

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

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

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

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

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

A market-based policy effort

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

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

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

Implications for semiconductor players

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

1. Pressure for localization will increase

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

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

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

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

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

How should multinational players respond?

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

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

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

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

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

 

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

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

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

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

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

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

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

Prerequisites for Citizens, Businesses and Government

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

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

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

Impact on Related Industries

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

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

* * *

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

 

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

Image credit: Frank Yu / Flickr

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

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

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

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

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

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

Watch out!

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

Image credit: World Economic Forum / Flickr

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

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

What’s changing?

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

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

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

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

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

A market-based policy effort

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

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

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

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

Implications for semiconductor players

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

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

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

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

How should multinational players respond?

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

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

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

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

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

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

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

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

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

About the authors

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

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

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

Exhibit

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

China's digital transformation - McKinsey China

 

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

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

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

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

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

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

Download the executive summary: China’s digital transformation

Download the full report: China’s digital transformation

 

About the authors

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

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

What’s going on?

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

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

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

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

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

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

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

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

Image credit: Paul Arps / Flickr

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

How did I respond?

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

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

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

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

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

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

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

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

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

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

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

What would you have said?

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

Image credit: Steve / Flickr

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

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

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

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

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

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

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

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

Image credit: Kalyan Chakravarthy / Flickr

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

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

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

Some things to consider:

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

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

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

Image copyright: sjenner13 / 123RF Stock Photo

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

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

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

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

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

McKinsey China

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

* People’s Daily, Wikipedia, ABC

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

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

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

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

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

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

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

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

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

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

McKinsey China

The chart also highlights:

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

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

*Main source: UBS

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

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

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

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

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

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

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

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

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

 

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

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

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

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

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

 

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

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

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

 

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

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

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

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

 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

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

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

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

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

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

 

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

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

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

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

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

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

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

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

 

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

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

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

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

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

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

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

Image credit: The Institute of International & European Affairs

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

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

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

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

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

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

2. Focus on growing needs in China

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

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

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

3. Don’t overlook services

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

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

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

Image credit: Danica / Flickr

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

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

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

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

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

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

Image credit: Propeller TV

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

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

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

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

But in the meantime, enjoy the blue sky.

 

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

Image credit: Junyu Wang / Flickr

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

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

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

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

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

 

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

Image credit: Conor / Flickr

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

Time To Act

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

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

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

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

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

RISING EXPECTATIONS FROM INDIA

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

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

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

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

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

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

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

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

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

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

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

india-exhibit1

OPPORTUNITIES FOR MNCS IN INDIA

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

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

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

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

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

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

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

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

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

MNC IMPERATIVES

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

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

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

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

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

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

india-exhibit2

***

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

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

 

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

Image credit: Tiberio Frascari / Flickr

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

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

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

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

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

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

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

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

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

Expect a lot more.

 

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

Image credit: Elliott Brown / Flickr

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

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

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

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

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

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

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

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

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

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

 

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

Copyright: rido / 123RF Stock Photo

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

Basic Materials and Energy

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

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

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

Agriculture

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

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

Infrastructure and Real Estate

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

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

Digital

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

People moving

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

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

Looking forward

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

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

Image credit: Miles Willis

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

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

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

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

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

Beyond Exports

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

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

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

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

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

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

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

Image credit: Miles Willis

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

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

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

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

What might be additional opportunities?

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

The potential for trade to flourish is there.

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

Image credit: Anne Rigby, AusAid / Flickr

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

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

The full list is below.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

30. Strategic Partnership Agreement between JSC RusHydro and POWERCHINA

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

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

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

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

35. Cooperation Agreement between JSC Sibur Holding and Sinopec

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

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

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

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

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

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

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

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

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

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

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

 

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

Image credit: Sebastien Wiertz / Flickr

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

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

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

Slide0

Click here for the full survey.

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

Image credit: J B / Flickr

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

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

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

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

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

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

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

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

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

Image credit: Marco Belluci / Flickr

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

 

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

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

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

Energy and Basic Materials

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

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

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

Manufacturing

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

Infrastructure

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

Agriculture

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

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

Image credit: Ryan Hyde / Flickr

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

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

Overall messages

The report highlights the following key messages:

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

Why is China low on the list?

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

The ranking combines two measures.

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

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

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

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

Closing thought

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

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

Image credit: Wolfgang Staudt / Flickr

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

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

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

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

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

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

Image credit: leniners / Flickr

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

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

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

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

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

Image credit: Ford Asia Pacific / Flickr

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

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

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

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

For example:

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

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

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

Image credit: Brian Yap / Flickr

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

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

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

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

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

Image credit: yuliang11 / 123RF Stock Photo

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

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

How did this work? Four elements:

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

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

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

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

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

Image credit: gyn9037 / 123RF Stock Photo

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

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

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

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

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

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

Image credit: manli /123RF Stock Photo

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

Why is this still the case?

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

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

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

What happens next? Will things change?

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

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

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

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

What the Government might do next

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

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

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

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

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

What are the key messages?

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

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

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

Image credit: chungking / Shutterstock

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

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

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

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

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

Image credit: arekmalang / 123RF Stock Photo

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

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

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

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

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

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

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

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

In closing, a couple of perspectives on Russia:

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

 

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

Image credit: cescassawin / 123RF Stock Photo

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