China market, multinationals' paradise? (China Business Weekly) Updated: 2006-02-20 08:24
It is true that Chinese consumers are spoilt for choice as competition for
their attention continues to intensify.
The figures certainly support this assertion. Shampoo sales were more than 20
billion yuan (US$2.5 billion) last year, up from less than 10 million yuan
(US$1.25 million) at the end of the 1980s. For the numerically-minded, that's
2,000 times in a matter of about two decades.
Companies selling the stuff should be jumping for joy, but the sobering truth
bringing them down to earth is that there were only five or six brands in the
1980s, whereas now there are nearly 3,000.
Some more numbers: Over the same period, the number of toothpaste brands rose
from 100 to almost 800. Fruit juice makers were unknown two decades ago, now
there are more than 160. More than 100 car models were launched in 2004, double
from only two years before.
"China's market is not just big, it is also increasingly crowded. For foreign
companies, making money here demands more effort," says Alan Horton, an analyst
at US-based Summit Consulting Co.
He won't say it but it is clear that sheer brand power will not carry the
day, or the cash register, any more. It is not just a gentleman's contest among
themselves, but also against aggressive domestic competitors.
"This is a new strategic challenge for multinationals. The emergence of
strong local companies is creating a formidable challenge," he says.
Competition, which in many markets was almost non-existent in the 1980s and
1990s, is becoming intense, agrees Wang Zhile of the Chinese Academy of
International Trade and Economic Co-operation. Wang is an expert on
multinationals in China.
It's tough out there. Big multinationals, smaller firms from Europe and the
United States, ambitious companies from the rest of the Asia and domestic
players all want a slice of the market.
The challenge from domestic companies is particularly intense, Wang observes.
Domestic companies have grown in confidence and have improved the quality of
their products, helping them move into the middle and even upper segments, he
says. "This has been a painful development for multinationals."
Foreign firms have been forced to move in the other direction, cutting prices
in an attempt to hang onto market share, but losing profitability in the
process.
For instance, domestic companies' forays into flat panel TV production has
meant profit margins have plunged for the likes of Sony and Matsushita, which
have been forced into price cutting.
Procter & Gamble (P&G) and Unilever are well entrenched in China, but
their early dominance of some markets has been whittled down by domestic
competition. According to Euromonitor, a global market research company, the
domestic Diao brand now dominates China's detergent market, with a share of
almost 25 per cent. Unilever's Omo is in third place, with a share of just 10
per cent.
"Margins were very high till 2003 but there have been several price
reductions since then, and there will continue to be additional reductions as
consumers have more choices and as more competitors come to the market," says
Troy Clarke, head of GM's Asia-Pacific division.
"With competition coming in with even cheaper, better products, those that
can't come up with new strategies could be in trouble," Wang says.
Going local
So how do multinationals cope? Going Chinese seems to be the direction chosen
by most, either by cutting costs or by developing more locally popular products.
"You can't survive in China without becoming a Chinese company. That includes
local technology development, product design, procurement, manufacturing and
sales," says Yun Jong-Yong, chief executive of Samsung Electronics, the most
profitable technology company in the world.
If Samsung tries to sell products developed in South Korea, it could fail
because the same products can be developed in China much more cheaply, Yun says.
Until 2004, the company did almost all product development and design at home
and used China only for manufacturing.
"Gradually we are transferring development and design functions to China up
to a certain level. We now also use Chinese parts," he says.
Gary Coleman, global managing director of Manufacturing Industry Practice
with Deloitte, says multinationals should not use traditional ways to grow
profitably in emerging markets like China, despite their strong international
management experience.
"Emerging markets around the world offer significant growth potential, but
the most successful and profitable companies will be those that really
understand their customers and take a different approach," he says.
"Companies will need to acquire a new set of competencies and organizational
structures to generate a continuing stream of innovative products tailored to
the needs of consumers and industrial buyers in emerging markets."
He says multinationals now need to look at developing tailored product
offerings for the local market, building local research and development
(R&D) capabilities, integrating local supply chains onto the global level,
and maintaining margins.
It is also important to acquire deeper customer knowledge and find the best
talent, he adds.
Some multinationals have rised to the challenge of slimmer profits in China,
but that is only the beginning, because they will need more strategic planning
and deeper reforms, says Xu Deyin, a professor with Guanghua School of
Management, Peking University.
There is no one-size-fits-all solution, and different companies need a
different mix of strategies, he says.
Companies such as Siemens, P&G and UPS have stopped working with their
Chinese partners and have become wholly foreign funded companies, as wholly
owned ventures are, on average, more profitable than alliances, Xu says.
Many international giants are restructuring their operations and promoting
internal reforms.
They aim to apply a common strategy by setting a single goal, a single plan
and a single brand. The most apparent benefit is in financial flow, Xu says,
adding a unified financial system could help shave a third off overall costs for
multinationals in China.
But cutting costs is only part of the equation. Since many foreign
corporations may never be able to reach cost parity with their Chinese rivals,
they will have to think of other ways to create value, Xu says, adding that the
most common approach is to rethink their distribution systems and have more
R&D facilities locally.
Profit margins
But generally speaking, the profit margins of foreign companies are better
than domestic companies, says the Chinese Academy of International Trade and
Economic Co-operation's Wang.
According to the Beijing Statistics Bureau, profits of foreign companies were
eight times that of local companies in 2004.
Exactly how much profit multinationals make in China is not an easy question
to answer, however. Hard data on profitability is usually difficult to come by,
partly, observers say, because enterprises tend to understate the amount of
money they make in order to avoid taxation.
Some multinationals also lower their stated profits to have an impact on
Chinese companies and erode the time cushion that domestic firms would need on a
more gradual, organic path to expansion.
It is true that foreign companies face a future of slimmer profit margins as
their numbers multiply and competition becomes tougher, says American Chamber of
Commerce President Charles Martin.
A survey of AmCham member companies last year suggested that about 30 per
cent were seeing better profits in China than in the world as a whole, down from
40 per cent in previous years.
"China is acting more like a normal competitive market and we would expect
that to continue to happen over the coming years," he says.
However, the biggest profit source for foreign companies in China is often
overlooked because it is difficult to record, says Wang. The financial gains
generated by cheap sourcing in China are impossible to document because they
show up in the profits of multinationals in their traditional markets in the
United States and Europe.
The export businesses of foreign firms similarly often show little or no
profit. This is less a reflection of reality than of transfer pricing as foreign
firms attempt to avoid capital controls and taxes in China. For instance,
Wal-Mart buys more than US$12 billion worth of goods in China every year - and
more than 50 per cent of China's total exports are produced in foreign-invested
factories.
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