Competitive Dynamics in China:
Competition between localized Multinationals and emerging local champions
By
Sea-Jin Chang, Korea University, and Sam Park, CEIBS
To be submitted to the 1st International Conference
Organized by the Institute of Northeast Asian Studies
the Korea University, September 19
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Competitive Dynamics in China:
Competition between localized Multinationals and emerging local champions
Abstract:
This paper is based upon an on-going research project on competitive dynamics in
China. During the last decade, China has been the most popular place for direct
investment by multinational corporations. During this process, multinational
corporations have become important players in most industries. Yet, we have
witnessed that several strong local companies emerged out of industry
consolidation. For instance, Haier has become a strong player in both local and
global marketplaces in white goods. Several consumer electronics firms such as
Changhong and TCL now command dominant market shares. In consumer goods,
competitive challenges by local firms such as White Cat have plummeted any
profit. We are mainly interested in understanding competitive dynamics between
these emerging local champions and MNCs. We are conducting fieldwork by
interviewing top managers of three or four key players (including both MNCs and
emerging locals) in seven industries to understand relative success/failure of
emerging locals and multinationals in addressing this competitive challenge. We
have found that quality of expatriate and local managers of MNCs and
entrepreneurial talents of emerging local champions and their absorptive to learn
from foreign rivals were key success factors in their respective success.
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1. Introduction
The emperor Napoleon once said, “Don’t wake up a sleeping dragon. Once woken up,
China will become one of the great powers.” After almost two centuries, Napoleon has
vindicated himself. The greater China, which comprises of vast territories of mainland China,
Hong Kong, Taiwan, Singapore, and overseas Chinese immigrants, is now a steam engine for
the world economy. China’s GNP in 2001, adjusted for purchasing power parity, was
estimated to be 7.8 trillion dollars, which placed it as the 3rd largest economy only after US
and Europe. China recorded an average growth rate of 7% in the early 21st century while the
rest of the world was in deep recessions.
Foreign direct investments have been flowing into China, lured by an illusion of a
huge potential market consisting of 1.2 billion people. The cumulative foreign direct
investments in China by 2000 amounted to $ 676 billion. Respectable multinational
corporations hurried to set up operations in China to capture this most promising emerging
market. On the other hand, traditional local firms, with support from the government, reorganized themselves to protect their own turfs against the invasion of foreign firms. Several
strong local companies have emerged out of the restructuring processes, which now pose great
competitive challenges to foreign multinationals.
Those emerging local champions, as we refer to them, are either formerly state-owned
enterprises completely transformed by entrepreneurial managers or private firms run by
entrepreneurs.
They have managed to accumulate technological skills via forming joint
ventures with multinationals and hiring managers and engineers away from multinationals.
Several multinational companies successfully defended their market positions from these
challenges by pushing hard for localization of production and management. This paper
examines the competitive dynamics between these emerging local firms and localized
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multinational enterprises.
2. Characteristics of the Chinese Market
There are many reasons why foreign firms are having a tough time competing in
China. One of the common mistakes by foreign firms is to enter China with overly ambitious
plans and determinations to succeed in China, which has resulted in industry overcapacity and
prolonged price wars. Foreign firms investing in China often recite some magical words such
as “1.2 billion potential customers.” So, they come to China with deep pockets and a strong
determination to succeed. They often incur ambitious capital investments to set up their
operations. For instance, Jeff Immelt, the CEO of the General Electric, announced an
ambitious plan, dubbed as the 555 strategy, to achieve $ 5 billion sales in and $ 5 billion
sourcing from China by the year 2005. GE even moved its Asian headquarters to China to
demonstrate its commitment to this plan. Several pundits have argued that it is critical for
investors to have a long-term orientation to be successful in China. Many multinationals
similarly moved their Asian headquarters from Singapore or Hong Kong to mainland China.
As a consequence, foreign firms enter China with strong wills to stay put in China while they
are almost sure to lose moneys for many years from these “strategic investments.”
Overcapacities in many industries have been also caused by local Chinese firms. Many smallsized local firms have received subsidies from local governments, which have strong
incentives to support them to avoid unemployment problems.
Due to such prolonged
subsidies, local firms continued to operate in Chinese markets despite their inefficiencies.
Due to such overcapacities in most industries, many foreign firms were saddled with
huge losses and several opted to exit China. For instance, in the beer industry, many foreign
firms forayed into China in the mid-1990s with advanced technologies and huge marketing
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budgets. Among them, several foreign brewers such as Bass, Forster’s, and Carlsberg, had to
pull out of the market by early 2002. The beer industry might be the most notable case of
industry shakeout since it had relatively low exit barriers. In other industries of high exit
barriers, often characterized by huge capital investment, foreign firms may find it difficult to
exit. As a consequence, foreign multinationals suffer from great losses.
The overcapacity problems do not contain within China. As a way to resolve
overcapacity problems, both multinationals and local firms pursue export strategies using
Chinese operations as manufacturing bases. Thus, overcapacity problems in most Chinese
industries resulted in price wars not only in Chinese markets but also in global markets. For
instance, TCL, a local TV manufacturer exported a large proportion of their products to
overseas, particularly to Thailand and Vietnam.
Second, foreign multinationals might have made a mistake in approaching China as a
single homogenous market. The phrase of “1.2 billion customers” is simply incorrect since
those 1.2 customers are not homogenous customers. A manager in a Western consumer goods
company pointed out extreme heterogeneity of Chinese customers’ demand as follows:
We have to “de-average” any statistics in China. If we try to sell one product
to all customers in different regions, we are bound to fail. For instance, a
toothpaste product will be frozen in the Northern provinces where the
temperature can easily go down to minus 30 degree centigrade. The same
toothpaste can melt down in Southern provinces. The average income of
Chinese people is about 800 dollars but the Chinese coastal areas are much
wealthier than the barren and underdeveloped Western provinces. So,
customers in coastal areas demand more expensive and sophisticated products
while those in inner areas demand more basic products. We, therefore, have to
approach each regional market differently from each other.
Third, foreign firms are overwhelmed by the unprecedented pace of changes in
Chinese markets. New buildings are sprawling up every day in Shanghai so that even locals
may be lost after absence for several years. In particular, local companies are catching up to
foreign firms in terms of product design and technology with enormous speed. Several
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expatriate managers working for multinationals confessed that they were amazed by Chinese
workers’ abilities to learn technologies and other management know-how from them. Many
expressed concerns that their transferring of technology and know-how to Chinese workers
might eventually backfire. Despite their concerns, those foreign expatriate managers had to
transfer their best technologies and products in order to survive in these competitive markets.
Thus, foreign multinationals are now bringing their newest products and the most advanced
technologies to China. In the automobile industry, Volkswagen used to enjoy large market
shares with an outdated Santana model for a long time. After GM and other foreign firms
entered the Chinese market with their newest models, Volkswagen had to hurry up to
introduce their newest models such as Passat and Polo.
Fourth, China is experiencing a transition from a relation-based society to a systemoriented society. Chinese patronage of quanxi is already well-known to Western businessmen.
In the past, Westerners thought that quanxi would resolve any problems including getting
governmental approvals and getting around regulations. If there are still managers who think
that quanxi will solve any problems, they are mistaken. Quanxi has now become only a
strategic necessity but not a sufficient condition for business success.
Since all firms
operating in China have developed some types of quanxi, one has to possess other competitive
advantages to be viable in a Chinese market.
Fifth, some Western businessmen may be still fooled by the idea of “cheap labor.” It
is true that China has abundant supply of cheap unskilled workers. Many areas of China,
especially inland, have armies of unemployed workers. There is, however, a shortage of
qualified managers and engineers. An HR manager in a large multinational firm in the
telecommunications and electric system business mentioned that a qualified software engineer
or an electronics engineer could cost the firm about the same as it would do in Sweden or in
Finland. Qualified local managers are also in short supply and multinationals are having tough
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times in retaining them. The average turnover ratio of workers at multinational firms can be
as high as 15%. Considering that multinationals make huge investment in training and
education of their employees, retaining people is critical in their business success in China.
3. Changing Nature of the Competition
The competitive landscapes of Chinese markets are dramatically changing due to
intensified competition between locals and multinationals. Up until the mid-1990s, most
industries were controlled by two types of firms. Multinational enterprises were positioned in
the upper end of the market segments. They entered China via importing final products or
assembling locally with imported parts. Major competitors in this high-end segment were
other multinationals. They competed mainly on the basis of technology and brand. The
second type of firm was local companies positioned in the low end of the markets. Their
products were of low quality and they competed based on regional monopoly and price. Most
of these local companies were state-owned enterprises (SOEs). Since multinationals and local
firms were positioned at opposite ends of the market, they rarely competed with each other.
By the early 21st century, this somewhat peaceful landscape was turned upside down.
As illustrated in Figure 1, the high-end segments that were occupied by multinationals with
imports have been squeezed by other multinationals that have progressed far along in
localization. These localized multinationals has pursued localization aggressively not only by
producing locally but also by sourcing parts locally. They have put significant efforts to
localize management as well. They also develop products that are tailored to local customer
demands.
In the consumer electronics industry, Sony, Philips, and LG are competing fiercely
with each other by bringing in the most advance products. They competed in high-end
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products such as projection TVs, LCD TVs, and HDTVs for wealthy Chinese customers.
They spent huge advertising budgets to establish brand loyalty among customers. While some
multinationals continued to serve this high-end market with imports from their home
countries, others decided to capture larger market shares by localizing parts and productions.
Similarly, in the automobile industry, since China’s entry into the WTO, many foreign
automobile manufacturers flocked to the market. Yet, several early entrants such as
Volkswagen localized their parts by more than 98% and enjoyed substantial cost advantages
against late entrants. Late entrants such as GM, Hyundai, Toyota and Honda had to push hard
to increase the level of localization. Industry experts expect that, while official tariffs for
imported cars will be lowered to 25% and imported parts to 10% by 2006, imported cars
cannot compete effectively with locally produced cars in terms of cost and price.
Several multinationals formed joint ventures with local players to penetrate inland
markets. For instance, Philips entered into several strategic alliances with local firms such as
TCL. Philips relied on TCL’s distribution channel to sell Philips products to customers in
small cities and rural areas. Philips in return supplied some key components for high-end
products to TCL so that it can manufacture some high-end products with Philips components.
Similarly, LG Electronics pursued localization to gain cost advantages in local markets as well
as exports. According to a manager in charge of DVD production, his Chinese operation
maintained 30% cost advantages over the same operation in Korea. In terms of materials and
components, local sourcing had 5% cost advantages. LG Electronics used this cost advantages
to penetrate local markets as well as serve overseas markets. In the consumer products
industry, Henkel also used both global and local brands to capture both market segments.
While Henkel itself focused on the high-end products with its own global brands, it used
several joint ventures to serve mid-range segments with their local brands. By doing so,
Henkel expanded its market shares while covering broad product market segments.
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In the mobile telecommunication industry, Motorola is covering entire segments from
the high-end to the low-end. Motorola enjoys great market shares in China. The large portion
of the cost of a mobile phone is the semiconductor chip, which is subject to strong scale
economies. Since Motorola commands a large market share, it can serve both the high-end
and low-end market with cost advantages in chip manufacturing. Motorola also provided its
semiconductor chip to its local partners such as TCL that it used for its own handset. Although
Motorola had to compete with TCL in the handset market, Motorola could exploit scale
economies in chip manufacturing through this strategic alliance. Motorola’s strategy to cover
both high and low-end segments with strategic alliances is similar to the approach taken by
Philips. Similarly, Simens’ Chinese operation also developed a cheap version of the CT
system for the Chinese market as well as for export. More and more R&D activities were
handed over to the Chinese operation as it gained more reputation and capabilities.
At the same time, the low-end market segment, which used to be occupied by
traditional local firms, is now squeezed by some local companies that have emerged to be
strong contenders by improving product quality and by exploiting scale economies via
mergers and acquisitions. The emergence of strong local firms out of myriad of small-sized,
fragmented and weak local firms has been an important trend in China. Before China opened
its markets to foreign firms, most Chinese industries were composed of many fragmented
small operations scattered around the country. In the old days, there were hundreds of local
firms producing cars and thousands of TV manufacturers. This level of fragmentation was
partly due to the legacy of the communist regime where there was no concept of efficiency.
The production quota was allocated by the central planning committee, and the factories were
there to produce the given number of products without considering costs or quality. Since the
opening of the economy, those traditional local firms had to face tough competition from
foreign imports.
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There are two main routes by which strong local firms emerged. First, local joint
venture partners to multinationals emerged as a strong player. Mainly due to government
policies to protect local industries, many multinational enterprises were forced into joint
ventures with local firms. SAIC (Shanghai Automobile Investment Corporation) and SVA
(Shanghai Video Audio) are prime examples of such joint venture partners designated by the
government. SAIC operated joint ventures with Volkswagen and GM. SVA had a total of 40
joint ventures with foreign multinationals such as Sony, Sharp, Simens, LG, etc. Those local
joint venture partners had opportunities to absorb technology and management know-how
from their foreign partners. These local firms leveraged their learning to acquire weaker local
firms in order to build a large market share.
Second, some state-owned enterprises and private firms run by a cadre of
entrepreneurs were turned into strong local players. Several well known Chinese firms such as
Legend or Haier were created by entrepreneurial managers. For instance, Legend was
established by Ryu Chuanci and ten other researchers from the Chinese Academy of Science.
Ryu and his colleagues at Legend developed cheap but high quality personal computers for
Chinese consumers and rapidly increased market share from 6.9% in 1996 to 28.9% in 2000.
Ryu stepped down in 2001 and handed over the presidency to Yang Wuianching who was at
that time only 37 years old. Yang was chosen to be a successor to Ryu, mainly on his own
merits. Legend developed a well developed HR policy where individual managers were
evaluated not only by their superiors but also by subordinates.
Some entrepreneurial managers successfully turned around staggering state-owned
enterprises into strong and nimble local champions. Chang Ruimin transformed a small sized
freezer company in Qingdao into a multinational corporation known as Haier. It is a well
known anecdote that the first thing Chang did at Haier as a top executive was to smash 76
newly produced but mal-functioning freezers in front of the workers. He instituted quality
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control system in Haier and forced workers to focus on quality. He fined individual workers
for any defects and anyone who did not accept his principles was fired. Haier then acquired
many other failing consumer electronic firms and transformed them into quality producers.
Haier has now become a dominant player in the freezer business and at the same time
diversified into other areas of white goods and consumer electronics. Haier was not satisfied
with the number 1 position in China but also wanted to become a global player. As a step
toward being a strong global player, Haier opened a production plant in South Carolina and
captured 20% market share in the US freezer market. Several local firms set up R&D facilities
overseas to tap technology. For instance, a Guangdong-based telecommunication equipment
company, Huawei, set up a R&D center in Gothenberg. Apparently, Huawei was not the only
company that made foreign direct investment in Sweden. The Ministry of Industry of Sweden
recently set up a representative office in Shanghai to attract more Chinese investment to
Sweden.
Kejian is a local firm in the mobile communication sector that accumulated
technologies from strategic alliances with Samsung Electronics. It relied on the supply of key
components from Samsung on the OEM basis while it established a R&D facility in Korea to
develop its own skills. TCL, a strong player in consumer electronics, a prime example of a
successful private firm run by entrepreneurs. The founder of TCL is Li Dungsung. He raised
5,000 RMB to establish a company. TCL then acquired a small Hong Kong-based TV
manufacturer, Rutsu, and began to mass-produce TV sets. TCL had become the largest TV
producers in China by 2001. TCL diversified into the personal computer and cellular phone
business. TCL raised capital for expansion by listing stocks on the Hong Kong Stock
Exchange.
These emerging local firms have accumulated technological skills by emulating
foreign multinationals. Not all local firms are imitators, however. Several local firms are
leading the technology dimension. For instance, the Chinese developed a new standard for 3G
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mobile communication standard, TD-SCDMA, which was developed by Datang, a local
company, and Siemens. UTA has acknowledged TD-SCDMA as the 3rd standard in addition
to Europe’s W-CDMA and America’s CDMA2000. TD-SCDMA is known to be more efficient
in densely populated regions such as large cities in China. China hopes to establish TDSCDMA as the de facto standard in China and uses it as leverage to lower loyalties to other
standards. Another area of great advantage for local firms is their access to distribution
channel. While most foreign multinationals covered mostly large cities in coastal areas, local
firms had developed a dense network of distribution. For instance, Kejian, TCL, Jahwa, and
White Cat had developed strong distribution networks, which maintained their competitive
advantages over multinationals that focused on large cities.
These two new types of firms – localized Multinationals and emerging locals – are
now dividing the middle-range market while competing fiercely with each other.
Multinationals try to push harder for localization. Multinationals relocated more production
plants to China and moved more responsibilities to Chinese operations. Many multinationals
such as General Electric moved their Asia-Pacific regional headquarters to China, to
emphasize its role over there. In competition between localized Multinationals and emerging
locals, a key success factor is learning. The localized Multinationals try to adapt themselves
to local customers’ needs. They also try hard to execute management with local people. The
emerging locals try to learn technology and know-how from multinationals by hiring people
away from them and by having them as joint venture partners.
4. Industry Variations
The degree of competitive challenges by local champions and multinationals’ abilities
to hold their positions differs by industries. Two main dimensions for industry variations are
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market heterogeneity and technological complexity. From our field-based research, we found
that the more complex the technologies are and the more heterogeneous the consumer
demands are, the harder local companies would challenge multinationals. For instance, in
complex products, where many parts are integrated into a system, it is harder for local firms to
copy or imitate multinationals’ products.
A senior manager in an MNC specialized in industrial systems pointed out that local
firms can easily copy single products but not a system that consists of multiple products
intertwined in complex ways. According to him, “Chinese workers are not particularly strong
in complex problem solving skills, which are essential to be successful in this industry. It
takes a high level of abstract thinking and coordination skills to solve complex problems.”
Therefore, in industries where there exist technological complexities, local firms do not show
strong competitive edges. For instance, in industrial systems business that includes automation
and power systems, Multinationals such as GE, ABB, and Siemens are maintaining
competitive edges over local rivals. In industrial systems, customers are not interested in a
product.
Customers are interested in whether the entire power plants with various
components will run without failures. In those industries, multinationals are more successful
in defending their positions against local rivals. The automobile industry is another example.
A car consists of more than 20,000 parts.
Chinese firms might have acquired some
technologies to manufacture some parts locally.
In fact, Volkswagen transferred those
component technologies to local parts suppliers. However, local firms have yet learned
enough skills to design a car while optimizing performances of individual parts.
In industries characterized by extreme market heterogeneity, it is also hard for local
firms to emulate multinationals. One of the most critical core competencies of consumer
goods producers such as P&G and Unilever is to develop brands tailored to specific consumer
segments. They also have large advertising budgets and efficient distribution systems that
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deliver products to the doors of customers. Local firms may be able to develop a product
tailored to regional markets but do not have skills to develop a brand at the national level.
Thus, in segments such as personal care and hair products, P&G and Unilever are still tightly
holding their shares even though some local companies such as Jahwa are trying very hard to
penetrate the market. In laundry detergents, however, foreign multinationals are having
difficulties in maintaining their market leadership. Unlike personal care and haircare products,
consumer demand is rather homogenous and puts less weight on quality. Thus, P&G and
Unilever that used to maintain large market shares are losing ground to local firms.
On the other hand, where there is less market complexity and technological
complexity, it is relatively easy for local firms to emulate multinationals. Personal computing,
consumer electronics, beer industries are some cases. In those industries, local firms quickly
caught up with multinationals. For instance, in the consumer electronics industry, local firms
are capable of making high-end products by purchasing key components from suppliers. Since
major products such as TVs and DVDs are now maturing, it is easy to purchase parts and
manufacturing them for Chinese customers. Even for some semiconductor chips to be used in
consumer electronics products, there are many independent design houses in the US which are
willing to design chips and manufacture them as long as the orders are large enough.
5. Implications for multinationals and local champions
In this paper, we have addressed some competitive dynamics between localized
multinationals and emerging local firms. We also described consolidations among local firms
and some foreign entrants due to intensified competition in Chinese markets. Industry
consolidation of local firms is similar to what happened in the US at the turn of the 20th
century, whose process was described in detail in Chandler’s (1962) book, Scale and Scope.
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Among foreign entrants, many weak players without deep pockets will continue to exit.
For both localized multinationals and emerging local firms, it is critical to have a
learning attitude. We emphasized the fact that a key success factor for multinationals is to hire
and retain local employees. Due to the Cultural Revolution, many older generations lacked
both technical and managerial skills. As a consequence, multinationals were forced to hire
relatively young and inexperienced workers and to train them. It will be therefore critical for
their success to hire and retain talented local workers in their Chinese operations.
For emerging local firms, it is also critical to have a learning aptitude. As a way to tap
technology and know-how of foreign multinationals, SVA hired away a chief scientist from
Philips in 2002 to spearhead its own efforts. SVA created a corporate level R&D center to
develop key technologies as well as development centers in each of the four business groups.
Kejian is another interesting example that emphasizes the “learning culture.”
Several
managers attributed its success to the learning culture. Kejian had several strategic alliance
partners including Samsung. Learning takes place in both the technology and management
dimensions. Kejian also emphasize hiring talented local engineers and properly training them.
In addition, Kejian is trying to achieve its advantages in tailoring its products to local
customer demands. Mobile phones are increasingly becoming an consumer electronics gadget.
Customers want more than simple voice transmissions such as SMS, various bell sounds, and
games in the handsets. Kejian therefore set up an R&D facility in Korea to tap local skills in
mobile telecommunication and to pick up the new trends in handsets.
There are several weaknesses to these emerging local firms. Some lacked strategic
focus and vision. Several others were noted to be short-term oriented and did not invest
enough on building management systems. They are opportunistic. It is possible that their
success can be short-lived. People point to ethics as one of the weaknesses in local firms.
Emphasizing integrity and instituting a strong corporate culture will also help them maintain
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their success.
References
Ambler, Tim and Morgan Witzel. 2000. Doing Business in China, Routledge.
D’Aveny, Richard. 1994. Hypercompetition, Free Press.
Chen, Ming-Jer. 2001. Inside Chinese Business. Harvard Business School Press.
Chow, Gregory. 2002. China’s Economic Transformation. Blackwell.
Yi, Jeannie and Shawn Ye. 2003. The Haier Way. Homa & Sekey Books.
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Table 1: Sample Composition (MNCs and local companies in each market segment
Consu-mer Consu-mer Pharmaceu Mobile
Electro-nics Goods
ticals
phone
Philips
Uni-lever
Henkel
Roche
Siemens
P&G
BMS
Moto-rola
Sony LG
Kao
SVA
BKK
White Cat
PersonalCo Elevators
m-puters
Dell
IBM
Sam-sung
Xinya
Kexian
Schindler
ABB
VW
Otis
GE
GM
LG-Otis
Legend
17
Heavy
Automobile
Electro-nic
Equip-ment
Hyundai
SAIC
Figure 1: Changing Nature of Competition
Changing nature of competition
Now
Before
Import
Battleground 1
High end
High end
Localized
MNC
Import
Battleground 2
Local
Emerging
Locals
Low end
Low end
Locals
18
Battleground 3