Target the China Market to Ride out the Recession

In a slowing global economy, foreign-invested enterprises in China should refocus on China’s domestic market

by Sigmund Floyd

The United States and large parts of the developed world are struggling through financial crises, and the global downturn has severely affected China and developing countries as well. Yet China is positioned to emerge relatively unscathed and as a greater power than ever before.

Nevertheless, companies operating in China must find ways to deal with the recession. Attempts to treat China investments like US investments—using the standard US playbook to cut costs and staff—could prove counterproductive. On the other hand, companies must navigate through these difficult economic times. Given the need to manage costs through the downturn, companies should balance short-term priorities with long-term objectives and avoid actions that will damage their future stakes in China.

Companies that export from China to the United States should be realistic—the US market will remain relatively weak for the foreseeable future. To stabilize China-based ventures in trouble, companies should look to China’s domestic market or other markets that have been less affected by the economic crisis.

Companies taking a long-term approach have already introduced their best technology, good manufacturing practices, and management expertise to their China operations. These companies should resist any urge to cut back on their commitment to the China market. By recognizing that China is just as important as, or even more important than, their home market, US companies can use the current crisis as an opportunity for long-term change. They should pay attention to several areas when revamping their China operations.

Companies that currently do not focus on China’s domestic market will find it tough to adapt, but these are precisely the companies that need to make the transition and expand their customer base relatively quickly. They must reexamine their business models, develop relationships from scratch, and thoroughly review assumptions inherent in the North American business model they may be using. Success or failure in China’s domestic market often hinges on the ability to make deep changes in fundamental thinking. Such companies also need to recognize that change takes time and that the sooner they begin, the better positioned they will be in the future.

Learning the hard way, one US company applied its business model—based on outsourcing production that required highly skilled blue-collar labor—to China without considering labor-market differences. Unfortunately, the required skills were in short supply in China, and the company struggled with training and retention, losing money over a two-to-three-year period. In this case, the company’s situation improved after switching to a business model based on domestically sourced raw materials and readily available unskilled labor. The company would have saved a lot of time and money had it developed a better understanding of local conditions before constructing a multimillion-dollar production facility.

Foreign companies should also remember that business decisionmaking within Chinese companies can be different from US practices, especially in the state-owned sector, and may require a simpler or more flexible commercial approach. For example, the above-mentioned company’s commercial package offer was composed of product, application equipment, and service personnel. Many US customers are favorably disposed toward such package offers, which enable them to outsource entire operations. But for Chinese companies, in which separate functions handle purchasing decisions for different types of products, separate offers for each component are often easier to negotiate.

It is also important to target market niches—a “one-size-fits-all” approach is no more likely to work in China than anywhere else. Though “trawling for interest” is necessary in the early phases of selling to China’s domestic market, it is easy to lose focus while trying to meet the conflicting needs of many customers. Concentrating on a limited number of strategic accounts will usually bring better results.

In the initial phase of targeting the Chinese market, companies should make liberal use of conferences and host seminars. China is one of the few countries in the world where industry competitors will willingly attend a supplier-sponsored “discussion group” (yantaohui)—a tremendously valuable and cost-effective way to meet many customers, learn about real market needs, and build reputation. Chinese companies are interested primarily in products and technology that are unavailable from Chinese suppliers, so foreign companies should emphasize their high-tech products and technological know-how. Once the foreign company has narrowed down the customer base to a select group that is seriously interested in the company’s offering, it should work closely with those customers and develop products and services tailored to their needs.

Low-cost, flexible production and research and development (R&D)

Though Western best practices, such as Six Sigma and International Organization for Standardization (ISO) certification, are good manufacturing practices to follow, the two things that are essential for success in China’s domestic market are flexibility and low production costs. It is difficult for foreign companies to outmaneuver the local Chinese competition, which is highly responsive to customer demand. To do so, a company must keep working capital low, emphasizing short-run, made-to-order production with fast turnaround times. During a downturn, when a company may have surplus capacity, this is a realizable objective, provided production staff has not been cut too much.

Products and services for the Chinese market are needed at Chinese price points. With hundreds of small entrepreneurial enterprises and state-owned enterprises in almost every industry sector, China may be the most competitive market in the world. Just because a product offers the best performance in the field does not mean it can be sold in China at the same price as in markets with less competition. Thus, R&D teams must be tasked with developing products at a realistic price while maintaining a performance profile that comfortably exceeds that of local competition. This will typically require companies to use local raw materials or parts, some of which may not meet the standards of overseas markets. Developing such products can be greatly facilitated by having an R&D presence in China, something the PRC government actively encourages. With general uncertainty prevailing in the employment market, the timing for hiring technical personnel probably could not be better.

Localize the supply chain

Companies need to shift their supply-chain management focus to support the localization of the company’s output for the domestic market. Though supply-chain management has received enormous attention, it has come primarily from the overseas-sourcing standpoint. To ensure quick turnaround and minimize costs, raw materials for Chinese products need to be sourced in China as much as possible. Though competent supply-chain professionals in China do not come cheaply, their expertise is critical.

The supply chain is probably the function that is most prone to internal corruption issues (followed by sales and marketing). Local managers who have cozy relationships with suppliers can easily increase a company’s entire cost structure by a few percent. Companies should therefore maintain strict oversight of the supply chain, with at least one non-local manager who interacts directly with key suppliers and conducts frequent audits of key transactions. A mistake some companies make is to assign supply-chain management to a remote office near the supplier rather than centralizing this function within their China headquarters. Though this might make sense in the US business environment, in China it increases the supply chain’s vulnerability to corruption.

Human resources: A development opportunity

During a restructuring, companies in China should take a different approach to human resources than they might in the United States. A company that conducts layoffs in a manner perceived as insensitive could give PRC government regulators, employees, and customers a negative image of the company and endanger its future in one of the most important markets in the world. Because Chinese employees tend to value organizational stability, reducing work hours across the board and cutting bonuses for management-level employees are preferable to paying costly severances.

Lower consumer demand in the short term can free up employee resources, and the current downturn is an excellent time to develop the capabilities of local staff. Many local managers in China have come of age without ever facing a recession and have little idea of what it means to downsize operations or stabilize losses. Having spent much of their working life in “boom conditions,” some local staff may have an entitlement mentality that must be challenged. To develop local staff capabilities, senior managers must coach their younger counterparts and take on a more active leadership role.

Whether in production, marketing, or other functions, it is extremely important to recognize the benefits of retention even in difficult times. Retention has never been easy in China, but in the current downturn, local employees are realizing the benefits of staying with their employer. It would be shortsighted of foreign employers to cut their ties with key employees when talent is needed to get through the downturn and to develop a strong local customer base for the future. Instead of cutting training, development, and meeting budgets, companies should reduce costs by reducing travel expenses and bonuses in a way that is proportional to the level of actual business activity and, therefore, understandable to local staff.

Maintain environmental, health, and safety (EHS) standards

The government and general public have become deeply concerned about the toll of indiscriminate development on the environment, and this is one area where US firms possess an undisputed competitive advantage. Companies should ensure that their EHS efforts in China are world-class and promote them vigorously among employees and customers.

Good EHS practices can also play an important role in product marketing. For example, one wholly foreign-owned enterprise in China’s refractory materials sector initiated programs for employee safety and housekeeping practices based on US standards, a practice that was extended to its employees working at customer sites. After about a year, the company became known for its program, and customers began to request that the company teach them its safety-management practices. The company held seminars at customer sites and for groups of customers at the company’s plant. The program was directed by a strong local EHS manager with full support from senior management in China and functional experts in the United States. Training seminars strengthened customer-supplier relationships, facilitating the introduction of the company’s cost-effective products for safe maintenance. Companies should select their “EHS champions” with care, because these employees can become some of the company’s best marketers.

Refocus on China’s domestic market

Companies that seek long-term success in China must maintain an investment mentality despite the tough times. This does not necessarily mean the time is right to make new investments, but companies should certainly continue to spend to protect the value of the assets that are in place. Companies need to take a hard look at their domestic and overseas customer bases and make necessary adjustments to succeed in China’s domestic market. It will not be easy, but companies that approach this task with a clear purpose and commitment to China’s future stand to benefit greatly.

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Why China Will Be Less Hard Hit by the Global Economic Downturn

• The “toxic assets” that have shaken US and European governments and brought their financial systems to the brink of collapse have had little effect on China.
• Rapid declines in global commodity prices have benefited China’s manufacturing base, helping to cushion the drop in demand. China is taking advantage of lower prices and aggressively acquiring companies that produce raw materials. Lower international prices have also relieved inflationary pressures in China’s domestic economy.
• As a proportion of gross domestic product, the PRC government’s ¥4 trillion ($585 billion) stimulus package is nearly three times larger than the United States’ initial $789 billion stimulus. On February 1, China launched a program that offers rural consumers a 13 percent subsidy to buy certain computers, television sets, refrigerators, and mobile phones. The PRC State Council, China’s highest-ranking administrative body, has also announced a similar program for several cities and various subsidies to promote industry revitalization.
• China has accrued nearly $2 trillion in foreign-exchange reserves and can easily afford further stimulus, if needed, without relying on external borrowing.
• High personal savings rates mean that China’s consumers are much better positioned to weather a temporary economic slowdown than their debt-strapped US counterparts.
• China has ample opportunity for industrial consolidation and can continue sidelining antiquated or inefficient capacity.

—Sigmund Floyd[/box]

[author]Sigmund Floyd is president of Valushar, a management consultancy that focuses on strategy, tactics, and human resources training for multinational companies in China.[/author]