Getting Past The Hype Of China's 1.3 Billion Customers
Very informative post on China's market over at Paul Denlinger's new China Vortex blog.
Before starting this blog last month, Paul (whom I have known for years) wrote a very informative and popular newsletter on China called China Business Strategy. I for one am glad Paul has switched over to a blog as it will only serve to strengthen the Chinese blogosphere, particularly on China business matters. Paul has been "doing" China business for more than 20 years and he definitely knows whereof he speaks.
The post is entitled, "Getting Past The China Market Hype" and it nicely sets out some of the common mistaken assumptions businesses have when they first think about or go into China.
The post starts out with Paul expressing amazement at the "sheer number of overseas investors seeking entry to China, who have a hard time seeing past the most basic facts and figures about the size of the Chinese market." Paul postulates that most of these firms are American because Americans are "generally speaking, more addicted to numeric data than their European and Japanese counterparts." It then goes on to cite numbers American businesspeople frequently cite to justify their China business:
The number of mobile phone subscribers in China is now greater than the US; China is now the world’s second largest auto market, trailing only the US; China’s demand for oil imports has far-reaching influence far outside its borders;
The post sees danger in relying on these numbers because they make no allowance for the fact that the "Chinese market is complicated" and "filled with traps to capture uninformed executives who fail to grasp the difficult realities of China’s markets."
The post goes on say that though China's consumer market is huge, there really is no single national market deals need to be negotiated city by city. The main problem with this city by city distribution is not so much the high costs, but the time it takes to roll out.
The post then makes some very good points on the pros and cons of partnering with a Chinese company to achieve national distribution. Those Chinese companies that are willing to take on partners are oftentimes in trouble. Many of these are state-owned enterprises which lack business marketing skills, and are trying to translate their monopoly charters into revenue with the foreign partner’s help."
The successful consumer companies in China typically have the following characteristics:
They are new, and while they did have some government backing and connections in their very early stages, they have now transformed themselves into privately-owned businesses with their own management team and CEO. For the most part, these companies are very centrally managed by their founder/entrepreneur. Unless a foreign company is able to present a very strong case for partnering with them, they will prefer to build and distribute on their own. Why should they share their profits and revenues with another company, and help to build another brand which may become a future competitor? After all, that’s how they became dominant in their own sectors; they’re not about to make the same mistake themselves.
I particularly like how the post discusses the need to be wary of China's state owned companies:
As China’s economy becomes more market-oriented, China’s state-owned enterprises are struggling to define their roles in this new economy. It is not enough to have a government-granted monopoly charter; they need to become profitable. This pressure for profit usually comes from the Chinese government’s State Council, which is China’s cabinet.Their preferred solution is to set up a joint venture with a foreign company, which injects startup capital since the Chinese government, as a matter of policy, does not inject capital into joint ventures, instead offering other fuzzy stuff like “markets” and “connections” into the joint venture.
Most of these joint ventures fail because the two sides fail to do the hard work to insure that there is a complete alignment of interests and accountability for their investment in the JV. Most of the time, I blame the foreign partner’s inability to see past the market hype and think and discuss the whole project through with the Chinese government partner and clearly defining which partner has responsibility to perform what needs to be done.
The endless procession of foreign companies who come to China and throw good business sense to the winds without performing proper due diligence in order to secure a footing in the “China market” never ceases to amaze me. Why is it they seemingly only do this in China? Do they think that the Chinese will throw them out of the country for asking good legitimate business questions?
Chinese SOEs [State Owned Enterprises] are in particular need of modern management skills, especially in the areas of marketing, sales and cost accounting. Foreign JV partners would in fact be helping the Chinese companies reform by holding them accountable to reach specific business goals. The SOEs have strong connections and resources in a potentially large market.
Exactly.
Comments
There is a famous "rags to riches" story about a minority peasant who worked his way up to the board of directors of one of China's major consumer goods manufacturers/distributors. He was asked by other board members, executives and investors how to get Chinese peasants to consume more (and mind you all of these other people are chinese, just from much better backgrounds).
His response was to take time to watch the migrant laborers (called "min gong") in all of China's major cities. People laugh at the min gong because they wear clothes until they literally fall off of their backs and wiped their mouths with the sleeves of their clothes. These behaviors are considered "primitive".
But the migrant now millionaire told them that these people are so thrifty they won't spend one Chinese cent on paper tissues for anything but post-defecation use. Aside from basic necessities, they won't spend money at all, instead they send it home for their parents, spouse and the one child (remember, in China you must pay for K-12 tuition, books and uniforms yourself). Each family is one injury, illness or layoff from utter financial ruin (ie street begging and/or prostitution).
More often than not, an entire village will pool money for one big TV if they decide to buy one at all.
And it is THESE people who constitute the 1 billion out of 1.3 billion. Now try to sell them a tv or dvd player so they can pay higher electric bills as well or some fashionable clothes that can't tolerate the wear and tear of rural life.
Posted by: nanheyangrouchuan | August 15, 2007 5:03 PM
What hype? It's real. Anyone who has been living here for at least a few years can see the amazing growth and the rapid rise in "spending powers". If it's not there now, then it will be in a few years - not long. Would you rather step in now and conquer your piece of land, or wait a few years and fight for what's left?
Posted by: Jonathan | August 16, 2007 2:16 AM
NH: You are so right in your observations, but so wrong in failing (or refusing?) to observe how humans somehow push forward to obtain the objects of their desire. That hundreds of millions can buy cell phones is already a great accomplishment. Increased domestic consumption of other products will inexorably follow. Yes, life is tenuous for hundreds of millions in the countryside, but that won't preclude them from setting their sights on improving their stations in life and purchasing what they can as they progress. Even you, as prophet of gloom and doom, can acknowledge as much.
Posted by: Law Office of Todd L. Platek | August 16, 2007 1:48 PM
Jonathan is not mistaken. Taken within the context of the article in question, this means working with patience to build the accountability which we hope for. But given the recent well-publicized product flops of numerous American corporate buyers, one must seriously question whether American companies are in a position to instruct Chinese factories and workers in "accountability." Before we continue this onslaught against Chinese manufacturers, perhaps we should shift focus to examine the design and purchasing departments of our American corporations. I would assert that in cutting costs to the bone, our own American corporations bear responsibility in failing to protect the American consuming public. Further, if American investors are going to succeed in JVs with SOEs, total dedication to accountability has to be job #1, and not permit dumbstruck salivating at charts indicating 1.3 billion-and-counting to be the end-all and be-all of American corporate activity. If we want to do it right, then just do it right. Commissars at all levels will not substitute for American hard-headed corporate sense.
I take the same view when dealing with legal cases in China. The "this is China" routine sounds exotic and is meant to put us off. Well, "this is the client," and it wants accountability and solid results. Bottom line, and the Chinese can understand it. We better start to understand it too.
Posted by: Law Office of Todd L. Platek | August 16, 2007 2:07 PM
Wow. For the first time ever I find myself agreeing with nanheyangrouchuan. Really.
Mr Platek: I've just come back from a week in my in-laws' village. Their village, indeed the county, is really quite well off compared to most of rural China. Looking around my parents-in-law's house, most of the spending power is mine. I mean that literally.
Johnathon: It is mostly hype.And it will take much, much longer than you seem to understand for it to no longer be hype.
Everybody: I ain't no businessman, but my experience makes it pretty clear that most foreign companies in China are aiming at a middle class that just isn't as big as the hype says.
Posted by: chriswaugh_bj | August 17, 2007 12:18 AM
Todd and Johnathan:
In order for 300 million to be lifted up, 1 billion had to be pushed down. Those 1 billion are being sacrificed (literally) to build those buildings, extract the energy, harvest the crops, provide basic services and make the basic components for those items consumed by the new Chinese and old western consumers.
In order for their condition to be improved, Beijing and provincial governments would have to enforce alot of pay and labor laws that are on the books. But that kind of institutional reform is one of the root causes for alot of China's problems.
Posted by: nanheyangrouchuan | August 17, 2007 9:11 AM
NH: Don't think me callous, but the 1 billion really didn't have all that much to do in the first place. When I first lived in China in 1981, lunchtime was a 3-hour eat-and-sleep daily repetition for countless millions, and nobody had enough of anything. Food I couldn't finish in restaurants was actively solicited by hungry citizens. I could go on. If you think poverty and no work is preferable to having opportunities to work and eat and clothe oneself, and that the Chinese nation agrees, you're living in LaLa-land. Remind me to stop by your soapbox to catch your latest lecture next time I'm in Tian An Men or wherever you set up.
Posted by: Law Office of Todd L. Platek | August 17, 2007 4:10 PM
It is part of the grand "50-year plan" in China to urbanize more than half of the rural billion - and to improve the income of those who remain on the land. It's an optimistic target, the process of achieving it fraught with difficulties. There can be endless debate about how quick or successful progress might be, but for now.... you can leave the billion out of the equation as far as foreign businesses in China are concerned. They don't have any surplus income. NONE.
The real issue is how big is the middle class, and how quickly is it growing? Even here, I think there is huge naivety, great exaggeration.
The enormous figures we regularly see for "cellphone users" are in fact for the number of handsets or SIM cards sold within a given period, not for the number of SIM cards actually in use on a given day. There is an exceptionally high rate of turnover in cellphones in China (loss, theft), with the average life expectancy of a handset usually given as under 6 months. Therefore, any "user" figure based on sales over a greater period than 6 months is likely to be misleadingly high. Moreover, very large numbers of people here operate more than one cellphone each. (I myself have three: work, personal, spare.)
Similarly, the large figures for Chinese "netizens" don't take into account the amount of usage or the means of access. Most Chinese are getting online at work, or via Internet cafes; rates of domestic PC/laptop ownership are still very low. Many of these so-called "netizens" are only getting online fairly infrequently; and amongst the most regular users, online gaming and ("illegal") downloading of music and movies are probably the most common activities. If you want to gauge the growth of the Chinese Internet in comparison to Europe or North America, it would be better to measure the site traffic on Baidu or Sina - but bear in mind that it is generated by a relatively small number of people with a lot of time on their hands.
Posted by: froog | August 18, 2007 6:59 PM
Todd,
Back then, life wasn't great. But the water was drinkable. Those 1 billion still don't have enough to eat and the food they do get is a chemical disaster. So is the air they breathe and they never know when a local boss will show up to throw them out of their house for a new commercial park.
Posted by: nanheyangrouchuan | August 18, 2007 7:00 PM
Todd,
Back then, life wasn't great. But the water was drinkable. Those 1 billion still don't have enough to eat and the food they do get is a chemical disaster. So is the air they breathe and they never know when a local boss will show up to throw them out of their house for a new commercial park.
Posted by: nanheyangrouchuan | August 18, 2007 7:00 PM
NH: Yes, currently plenty of problems, some the same, some different. Nonetheless, individuals have more opportunity to direct their own lives. That's worth a lot. The glass is now half full, at least in Chinese terms.
Posted by: Law Office of Todd L. Platek | August 20, 2007 6:08 AM
nh --
I have no doubt there are hundreds of millions (maybe around 900 million) of the people you describe here. But that still leaves a lot of others and many from these 900 million are rising too.
Posted by: China Law Blog | August 22, 2007 8:36 AM
nh --
I have no doubt there are hundreds of millions (maybe around 900 million) of the people you describe here. But that still leaves a lot of others and many from these 900 million are rising too. And even these 900 million buy necessisties. How many hundreds of millions in China now have a cell phone?
Posted by: China Law Blog | August 22, 2007 8:36 AM
Jonathan --
I'm with you.
Posted by: China Law Blog | August 22, 2007 8:38 AM
Todd Platek --
Great minds apparently think alike. I wrote my response to NH before seeing yours.
Posted by: China Law Blog | August 22, 2007 8:40 AM
Todd Platek (ii) --
My sentiments exactly.
Posted by: China Law Blog | August 22, 2007 8:41 AM
chriswaugh-bj --
It is and it isn't hype. 1.3 billion is hype, but Shanghai, Beijing, Dalian, Qingdao, Suzhou, Tianjin, Wuhan .... and the growth in all those places is not hype. Get in now for the future, but get in with eyes open. All I can say is that those of our clients who play China smart make good money there, almost without exception. AmCham stats bear this out as well.
Posted by: China Law Blog | August 22, 2007 8:43 AM
nh (ii)
True enough. But what you propose would keep all 1.3 billion down and that certainly is no answer.
Posted by: China Law Blog | August 22, 2007 8:44 AM
Todd Platek (iii)
I'm always just one step behind you.
Posted by: China Law Blog | August 22, 2007 8:45 AM
Froog --
Thanks for the dose of realism, supported by fact. There is enough of a middle class already in China to make money and it is increasing. Beyond that, I leave the rest to the marketers and businesspeople.
Posted by: China Law Blog | August 22, 2007 8:47 AM
nh (iv) --
Ah, the noble savage theory of business.
Posted by: China Law Blog | August 22, 2007 8:49 AM
Todd Platek (iv) --
Half full with more to come....
Posted by: China Law Blog | August 22, 2007 8:49 AM
You are too kind :-)
Posted by: Law Office of Todd L. Platek | August 22, 2007 10:31 AM