Today there was an excellent op-ed in the Wall Street Journal on multinational, high-tech firms operating in China. I think this is an excellent spin-off piece from a recent op-ed in The Financial Times by IBM's Chairman and Chief Executive Officer, Samuel Palmisano, and discussed extensively at the Enterprise Resilience Management blog by Steve DeAngelis.
The op-ed is titled, "Middle Market Kingdom," and written by Ingo Beyer Von Morgenstern and Xiaoyu Xia, both of McKinsey & Co., and much of what they write indicates the need for a higher-level of resiliency--a transition to Palmisano's "globally integrated enterprise."
"If you can't beat them, acquire them." This has become the mantra favored of late by multinational high-tech firms in China as they face fierce competition from Chinese firms. Our research into 1,000 Chinese high-tech firms shows them to be growing on average three times as fast as multinationals. So what are multinationals doing wrong?"
The above opening lead to the editorial reminds me of a comment that Viveca Chan, CEO, Grey Global Group, China/HKSAR, made at the 2004 Asia Business Conference at the University of Michigan Business School, paraphrased by me as: "In the past, the ruling phenomenon in business was that "the big fish eat the little fish;" however, in China, it is "the fast fish eat the slow fish." By this, she explained that "size and scale prevails" is not the rule of strength in the Chinese market. The authors go on to explain the failure of large multinationals:
"By sticking too rigidly to product specifications for developed markets, and high prices, multinationals in many sectors have squeezed themselves into the thin, high-end market in China. To succeed in China, these firms would do better to focus on the faster-growing mid-range segment of the Chinese high-tech market, where products cost an average of 20% to 30% less than their high-end counterparts."
Rigidity is a killer of resiliency. Basically, there is a specific phenomenon of smaller, agile Chinese firms quickly working their way up the value chain from the lower tiers of technology while large multinationals linger at the high-end, making themselves susceptible to losses in overall market share:
"Take electrical equipment, a $60 billion industry comprising sectors such as automation and power generation. While multinationals focused almost exclusively on the high end of the market, mid-range Chinese players -- led by emerging contenders such as Chint, a maker of low voltage electronics, and Shanghai Electric, maker of power generation products -- have expanded their share of the overall market to 65% from 55% over the past five years. This segment is growing almost twice as fast as the market for electrical equipment as a whole. As a result, multinationals as a group saw their share of the market drop to 35% from 45% since 2001."
Exclusivity is also a killer of resiliency. On their current pace, smaller agile Chinese firms--the fast fish--will be overwhelming the larger multinationals--the slow fish--in a very short time frame:
"Local firms such as auto-electronics-maker Hangsheng Electronics or medical-equipment-maker Shinva may not yet be household names, but such enterprises are sweeping to dominance in their industries. By 2010, we estimate Chinese companies will hold as much as 80% (worth about $260 billion) of China's high-tech market, up from 67% in 2004."
Without the management systems in place to instill the resiliency necessary for China, the large multinationals resort to "eating the little fish" to recapture lost market share:
"Some multinationals have responded to the erosion of their market share by buying into the new breed of mid-range Chinese winners in order to quickly build up a competitive mid-range product line for the Chinese market."
However, this acquisition strategy does not work towards adapting the multinational's foundations for resiliency. In fact, conditions on the ground in China illustrate the limits of this strategy:
- The multinational out shopping faces a number of obstacles in its path. First, there's the question of what they should be looking for. Simply spotting a suitable company is a challenge in a market characterized by a lack of transparency.
- When a multinational tries to buy a local company, it may find Chinese competitors, which have been fiercely battling each other for survival, close ranks against a perceived foreign threat. The local companies may enlist the support of government officials to require foreign players to find a local partner before bidding for a project, or to require a certain amount of locally made components.
- Chinese companies can also squeeze foreign competitors out by pushing down prices. Chinese companies are used to operating on very thin margins: last year, the top 1,000 electronics firms in China earned an average net margin of only 2.5%.
Companies that can acquire the smaller, more agile Chinese firms and integrate them successfully into a more resilient enterprise will succeed, although current examples have not had a long enough track record to judge long-term success:
"...some foreign companies are overcoming these hurdles. For example, one multinational maker of industrial electronics last year bought a Chinese company with a 30% share of the mid-range segment and 25% annual growth. To ensure that customers and employees didn't flee post-merger, the acquirer enticed key management to stay put by allowing the Chinese firm to maintain day-to-day management control. While it's too early to judge the outcome of the deal, initial signs look positive: in the first quarter of this year, sales increased by over 60%."
The authors conclude with the following:
"That is a trend which other multinationals can be expected to follow. China is becoming an increasingly competitive market, and the route to success for foreign companies will lie in eschewing their past preference for the high-end in favor of carving out stronger positions in mid-range products."
I would go further in saying that the route to success for foreign companies will lie in eschewing such old paradigms as "succeeding by acquisition" and adopting the new paradigm of succeeding through enterprise resilience management systems. In this way, acquisitions become simply one option and foreign companies will have in place the ability to adapt earlier and more appropriately to competitive threats within and across markets and products.
NOTE: For always excellent, running commentary on foreign firms operating in China, visit China Law Blog.