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Managing in a Maturing China

Subscribe to Chief Executive Officer & Board of Directors 5/29/2014 Seth Peterson

Managing in a Maturing China 

The business environment in China today is increasingly more complex compared to just a few years ago. Economic growth overall is slowing down while domestic consumption is growing, costs are going up and competition is more intense. All these changes are part of a maturing market that is more important for its own sake rather than as a source for inexpensive labor and exports. 

In an effort to better understand how this maturing of the market impacts business, Heidrick & Struggles surveyed multinational executives both in and out of China and with responsibility over China operations. The results suggest most companies already in China still see a lot of potential in this market and are counting on it for much of their future growth. However, managing in today’s maturing China requires businesses to commit to the domestic market and develop the knowhow to overcome the challenges of a complex and increasingly sophisticated market.

Heidrick & Struggles surveyed executives at more than 100 companies to get their views on the opportunities and challenges they face in as they search for success in this market. Somewhat surprisingly, there were very few newcomers. About half of respondents said their China operations have been established for more than 20 years and another third between 10 and 20 years.

How Long has your company been doing business in china?Managing in a Maturing China

The results of the survey suggest that the most successful companies in China are those with the right strategies to compete in the domestic market. Looking at the country as a producer of inexpensive goods or a provider of cheap labor is no longer a viable approach. This shift is evident in the business focus among the 54 percent of respondents that provide goods or services to the China market as opposed to the 6 percent who say they are in China to manufacture primarily for export.

A number of companies have been vociferous in their denunciations of the China market as one in which profitability is difficult to attain and regulations difficult to track. Companies like cosmetics makers Revlon and Garnier (owned by L’Oreal) or generics drug manufacturer Actavis are among the biggest companies to have made the decision to leave. But these companies are not only in the minority but also operate in hypercompetitive sectors in which domestic companies or other MNC competitors are particularly efficient or have product offerings more suited to the market. More than three quarters of all companies Heidrick & Struggles surveyed reported stable or growing revenues in 2013 and 89 percent expected the same in 2014. At the same time, 89 percent of respondents plan to maintain or expand their China operations this year.

Most MNCs with established operations in China have found success. Economic and market expansion in China’s new of “smart growth” is slower than it once was but even at this slower pace it is twice as fast as in the US or Europe.

The end of easy money

The impact of megatrends is enormous in a wide range of sectors across China. Urbanization, for example, has had massive impact on industries as varied as retail to power generation; The latter is driving a large build-out of power grids and the development of the oil and gas sector. Benefitting from megatrends such as urbanization is not always easy, however. Companies must understand that the low hanging fruit is long gone and that from here on in, growth is going to be harder to achieve.

The simple reality is that the era of easy growth in China has come and gone. Foreign competitors are plentiful and domestic competitors are stronger. China is no longer a source of cheap labor. Rather, the companies with the best prospects and healthiest balance sheets have their sights set on the local market. Managing a business in this environment requires commitment to the domestic market and the ability to overcome a series of new challenges. The challenges, says one respondent, are: “Bureaucracy, corruption, unpredictable regulatory changes, inconsistent and arbitrary taxation, generally feeling of lukewarm to hostile towards international business, slower growth and damaged consumer and c-suite confidence, political uncertainty.”

Market Condition and Competition 

Managing in a Maturing China 

More than 90% of the respondents feel that the market competition and condition are getting more intense and challenging in China compared to previous years. 

Executives say the macro environment is getting generally tougher. One significant concern for most companies is hiring and retaining talent. Talent-related issues affect 80 percent of respondents. Other issues that companies have to tackle are low productivity, foreign competition, lifestyle considerations such as pollution and food safety, a shortage of innovation and a scarcity of qualified managers. Overall, 92 percent of respondents say market conditions are more challenging now. Among the many concerns for business, three emerged at the top of the list: higher costs, more challenging competition and regulatory issues.

The first of these challenges, the higher cost of labor, is one that has fundamentally changed the realities of doing business in China. More expensive labor means companies have to be more strategic in the way they approach staffing levels and costs.

The cost of labor has risen considerably in recent years. Regular minimum wage increases of 12 percent to 15 percent are only the tip of the iceberg. Migrant workers who move into urban centers find straight wages are not enough to live in the cities, so they have come to expect overtime pay that can double their take-home and creates much higher costs for companies, many of which are putting in place lean initiatives to streamline operations.

Yet, even with the higher costs of unskilled or low-skilled labor, most companies surveyed still expect to maintain or even boost staff levels over the next year.

The second issue is increased competition. Companies must balance the higher costs of doing business in China against the strengths of a “phenomenal supply chain and strong infrastructure” that allows companies to continue growing even in the more complex new environment. Among respondents to the Heidrick & Struggles survey, 91 percent say competition is more intense. Increased competition is coming from both multinational and domestic companies.

“The leading market players have aggressive expansion objectives which exceed the rate of growth in the market,” said one executive. Growing faster than the market will, by necessity, require companies take market share away from weaker competitors.

The more competitive landscape has forced MNCs to learn to deal with the local market, albeit often reluctantly. One executive suggested there is a clear difference in the way HQ and local operations see China. Add to this the reality that domestic companies are producing better products in a more efficient manner than ever before. 

“Global players continue to invest and expect growth from China while domestic companies are growing quickly and using their increased scale to advantage,” said one respondent.

Multinationals are expanding to second and third tier markets in China to find opportunities for growth. And, many of these businesses in the region have reached such as scale and significance to the company that greater structure and processes are required to ensure targets are achieved, especially with slowing growth and higher costs. Some companies are also carving out Greater China to report separately from Asia Pacific so it gets the requisite level of focus. 

Do you expect an increase or decrease in headcount in 2014?

Managing in a Maturing China 

While Competition is much more intense, it does not always take place on an even playing field. Even as China becomes more market oriented there are State owned enterprises (SOEs) with unlimited capital and huge overcapacity that create imbalances and destroy margins in entire sectors of the economy.

The most successful international players have adapted to local realities while local competitors have emerged as international players.

For some MNCs, participating in the China market can be a defensive play by stepping up competition with Chinese companies on their home turf as part of an attempt to contain their international expansion. For others, the global expansion of some Chinese companies creates opportunities for these companies to “pull” MNC products to new markets outside China; MNCs with Chinese engineering, procurement and construction (EPC) customers, for example, may benefit as these companies win more projects around the world.

The third issue is regulatory complexity. Among respondents, 23 percent said regulatory issues are the top challenge facing their operations in China while a total of 71 percent pointed to fickle regulations and unpredictable government policy as a concern going forward.

“Regulatory approvals are extremely slow and timelines are getting much longer,” said one respondent.

Optimistic outlook

Despite this widely held view of intensified competition and generally more challenging market conditions, most companies continue to see clear advantages to China over the rest of Southeast Asia. The outlook is one of cautious optimism. Most respondents, 71 percent, expect the majority of business growth in the Asia Pacific region will come from China. These results are generally in line with the latest Business Climate Survey by the American Chamber of Commerce in China that found 75 percent of respondents are optimistic or slightly optimistic about business outlooks for the next two years.

The Situation of their China business

Managing in a Maturing China
 

The top three statements that the respondents feel represent the situation of their China business are:

  • The majority of business growth in APAC still comes from China
  • We will slowly shift our Chinese operations from the south/east coasts to the western/inland provinces
  • We will shift our focus from ‘manufacturing in China’ to ‘selling in China

The majority of respondents to the Heidrick & Struggles survey experienced growth of more than 5 percent in China last year and expect continued growth in 2014. These companies are expanding their capacity and expect to maintain or increase current levels of staffing. Most also expect to maintain the current levels of expatriate or non-local employees.

China’s government has set a target of 7.5 percent growth this year, level with last year but well below the double-digit growth of just a few years ago and in comments in early April, Premier Li Keqiang left the door open for even slower growth. In many ways, the lower economic growth that China is likely to experience through 2014 and 2015 is part of a premeditated push to speed up structural reforms that would see the economy rely more on domestic consumption than on exports and investment. In the long term, this should only strengthen the economy but, in the short term, this slowdown creates new pressures on costs and operations.

“All global players are strategic on China so not only is the competition tough with the rise of the Chinese brands, it is also a challenging market to compete with the global players in it,” said one company executive in the Heidrick & Struggles survey.

Companies have to design their strategies to fit the market and treat China as a second home market rather than attempting to fit products from their home markets into China. Trying to fit square pegs in the round hole of the China market is a losing strategy. Rather, managing a business in China’s maturing market requires deeper commitment, local insight and a willingness to navigate a market that is growing in size and complexity.

Are you expecting your sales to increase or decrease in China in 2014?

Managing in a Maturing China 


Seth Peterson Partner +852 21039300

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