The Best Story Wins

A thought provoker from Joseph Nye’s December article in Foreign Affairs:

Conventional wisdom holds that the state with the largest army prevails, but in the information age, the state (or the nonstate actor) with the best story may sometimes win.

Allow me to revise that for business:

Conventional wisdom holds that the competitor with the best products prevails, but in the information age, the competitor with the best story may sometimes win.

Just as strategic communications is increasingly important as a means of national power, corporate strategic communications should be a competitive weapon, a game-changer, not just news releases, press conferences, and spin.

Blessed few western companies understand that, and I’ve yet to find a Chinese company that does.


Huawei’s American Trust Issue

Huawei Logo
Image via Wikipedia

In the Hutong
Manic Monday
1425 hrs.

According to the Financial Times, Huawei has decided to unravel its deal to buy the intellectual property of Silicon Vally firm 3Leaf rather than risk a finding by President Obama that the Chinese telecommunications equipment manufacturer was in violation of the law.

That was a wise move, and perhaps the smartest thing Huawei has done with its government relations in a long time. Sadly, they do not go far enough, because while the solution addresses the most pressing issue – the 3Leaf deal – it does not help Huawei with the far more fundamental problem it faces.

Huawei has a trust issue in America of such magnitude that it all but closes the door to the company in the US market.

Starting with a Trust Deficit

Huawei starts in America with three strikes against it. First, it is foreign, and there is enough latent xenophobia in the United States to any form of direct investment from offshore a political challenge, even in the best of times. This is not the best of times, and no matter how bad the economy gets, nobody likes the idea of selling America’s innovative crown jewels (i.e., Silicon Valley companies laden with valuable intellectual property) just to keep the lights on.

Second, Huawei is Chinese. The level of suspicion and distrust of Chinese companies in America is high, rooted in causes too diverse to mention, from lead-painted toys to alleged currency manipulation, from movie piracy to industrial espionage, and from political causes from China’s handling of dissent to its opaque defense agenda. Giving the greatest possible benefit of doubt, Huawei is guilty of none of this, but the fallout of such a record – as an early international emergent from China’s corporate cauldron – falls upon the company nonetheless.

Third, Huawei’s links to the People’s Liberation Army are still not sufficiently transparent to sever the two in the minds of American regulators. Whether this is fair or not is hard to say. The company protests that there are no ties at all. But the opacity of China’s military-industrial complex, coupled with the nation’s ambitions, its focus on network-centric warfare, and the status of the company’s founder as a PLA veteran eat away at the credibility of such statements. The court of public opinion, as it were, rules against Huawei on this count.

So despite the company’s statements to the contrary, it clearly has not done anywhere near enough to overcome those issues in the U.S. As such, even before the 3Leaf deal came up, Huawei had a serious trust problem in North America. The company’s leaders either did not know this was a problem (thus proving that they are ill-informed and out of touch with the U.S.,) or they disregarded it as a serious issue (thus proving they were either foolish or arrogant, and, again, out of touch.)

For had the company known this was an issue and appreciated its severity, they would have done much more to solve it before they went shopping in Silicon Valley.

Sneaky and Opaque Are No Way to Go Through Life, Son

All of which made the entire 3Leaf deal look sneaky and underhanded, rather than smart and well-handled. Had Huawei bought 3Leaf as an outright acquistion, the company would have been expected to ask the Committee on Foreign Investment in the United States (CFIUS) for approval. Instead, Huawei waited for 3Leaf to declare insolvency, buying up assets and hiring staff. This may have been technically legal, but as Huawei discovered, it is perceptually suspect.

An untrusted company and tactics that arguably skirt the intent if not the letter of the law is a bad combination, bad enough that retrospect should not have been necessary to know that a more careful approach was necessary. As it is, had Huawei gone to the CFIUS for approval in the first place, and had the answer been “no,” Huawei would still be ahead of the game: they could have earned perceptual points for going through the process and for being upfront. Now, they have four strikes against them: foreign, Chinese, the alleged PLA connection, and sneaky.

This raises another question: why? Maybe they were arrogant. Maybe they were ignorant, even willfully so. If you believe either of those answers, you must accept that Huawei is many years from being ready to operate in developed, transparent, regulated markets. If you reject that line of thought, the only other compelling answer is that Huawei believed that what it would get from 3Leaf was so valuable that it was worth more to them than the trust of the industry, the US government, and by extension the American people. What could have motivated a company to burn such bridges?

Given that the Pentagon flagged the Huawei/3Leaf situation to the CFIUS, it is entirely possible that Huawei was engaged in the acquisition of technology that would have been beneficial to the defense of China at the expense of the U.S. For Huawei’s sake, I hope this was not the case, for if it was, not only is Huawei’s name in America under a cloud, so is its credibility in Europe, in India, in Russia, and elsewhere, for it will have proven by its actions that it serves the Chinese defense establishment before its own interests, thus undermining its earnest protests to the contrary.

Somebody Snitched

While we ponder this, let us not forget that there are unanswered questions on the U.S. side as well. We know that the Pentagon dropped the dime on Huawei to the CFIUS. What we do not know, and what we may never know, is who dropped the dime on Huawei to the Department of Defense? Who told somebody in the Pentagon “hey, guys, you need to look at what is happening and go for the block on this deal.” If it was a competitor, this is politics, plain and simple: some smart company may well have capitalized on Huawei’s lack of trust in the US to block this.

We could go Ian Fleming on this situation ad nauseam. But there are three essential takeaways.

Three Problems, Three Fixes

First, Huawei has a slow-burning but serious trust crisis that it must move immediately and resolutely to resolve if the company is not going to find itself the object of suspicion in the U.S. and elsewhere, and thus locked out of countless deals for non-commercial reasons.

Second, Huawei has proven itself a tyro at navigating the U.S. political and regulatory process. It needs to take drastic action to rectify this problem and repair the damage done this far, or it can write off the U.S. market for the foreseeable future. (Which I think they should anyway, because pickings are better elsewhere, but that’s another issue.)

Third, the morass around cross-border mergers and acquisitions continues to deepen. Eighty percent of the problem in this case was poor communications on Huawei’s part, but the other twenty percent is a problem in the global foreign investment regime. Standards of approval for foreign investments are made on a country-by-country basis, are thus inconsistent, and are becoming a growing source of friction between countries that could easily (in the case of the U.S. and China particularly) devolve into a costly and profitless tit-for-tat rejection of each other’s investment forays.

Just as was done with trade, first through GATT and later the WTO, China and the U.S. need to lead the way toward the forging of a more transparent and consistent global regime governing direct investment.

These lessons would be well-learned by other Chinese companies seeking access to overseas markets or intellectual property via acquisition: the deck is stacked against you before you start, so play accordingly.

Joseph Nye on the Future of American Power

In the Hutong
Winter Reading Blitz
1842 hrs.

The essay by Joseph S. Nye in the December issue of Foreign Affairs was by itself worth the cost of my subscription. Decrying those who have already dragged their morose carcasses onto the Declining America/Rising China bandwagon, Nye, who coined the term “soft power,” makes a critical distinction in the essay between relative and absolute declines in American power:

Some Americans react emotionally to the idea of decline, but it would be counterintuitive and ahistorical to believe that the United States will have a preponderant share of power resources forever. The word “decline” mixes up two different dimensions: absolute decline, in the sense of decay, and relative decline, in which the power resources of other states grow or are used more effectively.

Nye suggests that relative decline is not only natural, but to some extent should be welcomed as the logical outcome of an increasingly prosperous planet. Decay at home, he suggests, is what undermines American power abroad.

On the question of absolute, rather than relative, American decline, the United States faces serious problems in areas such as debt, secondary education, and political gridlock. But they are only part of the picture. Of the multiple possible futures, stronger cases can be made for the positive ones than the negative ones. But among the negative futures, the most plausible is one in which the United States overreacts to terrorist attacks by turning inward and thus cuts itself off from the strength it obtains from openness.

Nye doesn’t quite come out and utter the famous Rooseveltian “we have nothing to fear but fear itself,” but he underscores that the way Americans perceive ourselves is perhaps our greatest vulnerability in the formative years of this century. Declinism, he suggests, can too readily become a self-fulfiling prophecy. Stop whining, stop talking about just giving up, Nye seems to tell us, and deal with the issues that plague America at home rather than what to do about a Chinese aircraft carrier.

I do not disagree with Nye, and I agree that his point needs to be made to quench some of the rhetorical and perceptual excesses that Americans have begun to harbor about themselves and China. At the same time I am wary that his palliatives underplay some key strategic complexities in the Sino-US relationship.

Nye addresses Chinese capabilities (rightly noting that while China has come a long way on the road to global power, it has a road of at least equal distance yet to travel,) but he ignores Chinese challenges, intentions, perceptions and aspirations and the role they may play in bending China’s strategic calculus.

Worse perhaps is the decidedly Western lens Nye uses to examine an Eastern power and culture.  China may not yet be able to match American power according to our measures, but neither Neoliberals like Nye nor Neorealists like John Mearsheimer bother analyzing China’s options and capabilities through a lens polished by Eastern theories of strategy, international relations or power. That is a critical error, because in so doing they place far too much emphasis on Chinese physical strength and far to little on its wiles. China, after all, has been practicing and honing its own version of “smart power” since long before Sun Tzu took up a pen.

As an aspirin for America’s alarmist declinism, Nye’s article is a masterstroke. At the same time, he subtly reminds us of the persistent blind spot in the worldview of the West’s leading international relations theorists.

China’s Global Luxury Consumer

In the Hutong
Polishing my apologetics
1711 hrs.

In an excellent article about luxury retailers going online in China, Laurie Burkitt at The Wall Street Journal drops an interesting little insight halfway through the piece:

China is the world’s second-largest market for luxury brands when counting purchases by Chinese consumers world-wide and is set to overtake Japan for No. 1 in a few years, according to consulting firm Bain & Co. Chinese sales of luxury products surged 20% to €9.2 billion ($12.1 billion) last year, Bain said. [italics mine]

Counting purchases worldwide vs. locally is no small distinction. China’s consumers know they pay a steep duty on the price of the baubles they buy in China, and those with the means (and the patience) often shop locally but put off their purchases for when they go abroad. That’s important for a couple of reasons.

First, it is impossible to judge the real return-on-investment of a store inside of China based solely on how much product that store sells, because that store is probably winning sales for stores elsewhere in Asia, in Europe, and in the Americas. By extension, it is impossible to judge the profitability of China luxury operations based on retail sales in China. To some degree, the China operations of luxury lines are subsidizing global sales.

That arithmetic is going to get increasingly critical as the cost of labor and prime retail space rises in China’s second, third, and fourth tier cities, and as more Chinese get comfortable buying their luxury goods direct from the labels online. Put another way, retail in China is not just a sales expense, it is a marketing expense as well. The companies that learn how much of those costs to allocate to sales and how much to marketing (and then plan and behave accordingly) will be the long-term winners in this market.

Second, as home-grown luxury brands emerge, they will have to do so knowing that high-end shoppers are used to making purchases at overseas destinations. Those brands will thus need to begin their development with global expansion in mind so as to catch shoppers while they are overseas and in a buying mood. That is not to say their first stores need to be overseas, but that depending on the product, luxury brands will want to address their competition globally so as to capture their local market globally as well.

Thus I am betting that some of China’s early home-grown luxury brands will find themselves compelled to ally with – or be bought by – one of the major global luxury houses, much as Shanghai Tang went to Richemont. Retail presence in China is important marketing, but having global retail presence will be an important part of placing Chinese luxury brands on an even par with the global majors in the eyes of locals, once those locals are even amenable to a local luxury marque.

An Old China Hand and China’s New Foreign Policy Factory

In the Hutong
New Year Day Five
1718 hrs.

Ross Terrill of the Fairbank Center is an old China Hand, and he writes incisively about a range of topics on China, most notably the nation’s foreign policy.

Recently, he contributed a brilliant article to the Wilson Quarterly entitled “The Case for Selective Failure“, in which he argues for and posits several scenarios where China would stumble just enough to provoke positive and meaningful reform but without experiencing complete systemic breakdown. Undoubtedly we could talk all day about the likelihood of such an event occurring and argue ourselves to a standstill: there is just no way of knowing until after it happened, but the uncertainties are enough that you’d never want to purposely try to provoke such an outcome.

What interested me most, though, was Terrill’s view of China’s foreign policy-making process, revealed in this bit of the article.

There are wise heads in Beijing who understand the latent power of American nationalism and other dangers facing a Chinese rush to the top. They urge their leaders to stick with Deng’s maxim of “hide our strength and bide our time.” These cautious folk in well-connected think tanks and even government ministries do not believe the public mantra that the United States is “holding China back.” Rather, they see clearly that the United States is a force fueling China’s rebirth—by buying Chinese exports and supplying technology for Chinese industry, among many other ways.

There are indeed wise and cool heads in Beijing, but Terrill’s view of how foreign policy is formulated in China comes across as a tad outdated. As I wrote in “The Case for a New Public Diplomacy in China” both here and in AdAge China in 2008, the “cautious folk in well-connected think tanks and even government ministries” are no longer the sole nexus for the creation of policy. As we have seen evinced all too clearly in the past several months, there are a lot of chefs in China’s foreign policy kitchen, and two of the most important new entrants to the process are the PLA and popular opinion.

Over time, these two players will the formulation and execution of foreign policy a complex, slow, and highly politicized process that threatens to retard the conduct of diplomacy in China. To depend on the realists and ignore the idealists, irredentists, and nationalists in Chinese foreign policy would be like ignoring the progressives and the Tea Party in the United States.

Terrill “hopes” that events will see these players in Chinese foreign policy marginalized. But hope is not a method, and it is a poor approach to the conduct of international relations. Wise heads in Washington, DC, Tokyo, Brussels, London, and elsewhere need to adjust their efforts, strategies, and toolkits to incorporate the full set of foreign policy influencers in China, not just the ones who play by the old rules.

The above aside, the article is superb, especially the barbs he tosses at Nouveau Sinologists like Niall Ferguson and American Declinistas. Give it a read.

Consumer Price Spot Check

So the Hutong Secretary went to Jingkelong in Tianzhu to buy some eggs this morning. A five-dozen egg bulk pack set us back RMB 66, or around $10.02. The same eggs, USDA inspected, would have cost us RMB 65 at Vons in California, delivered to our home.

Not a big deal, but an interesting anecdotal indicator.

The Best of the Peking Review, January 2011

From our free-book-fixated sister blog The Peking Review, here is a list from among the January reviews that Silicon Hutong readers might find interesting:

Affairs of State: The Interagency and National Security

Communist China’s Policy Toward Laos: A Case Study 1954-1967

Contemporary Chinese Views of Europe

Current Studies in Japanese Law

Film Piracy, Organized Crime, and Terrorism

India as a New Global Leader

Managing a Changing Relationship (China and Japan)

Pacific Currents

Whither Strategic Communications?

Why Russian Policy is Failing in Asia

Not All Chinese Real Estate is Equal

In the Hutong
Waiting for guests
1203 hrs.

The question of whether China’s real estate market is overvalued or not is a recurring theme in the regions business media. The most recent example is an article in MarketWatch by Chris Oliver, which quotes Forensic Asia managing director Gillem Tulloch as saying “the bubble will likely burst sometime in the next year.”

You can debate Mr. Tulloch’s prognostications, as well as of his wisdom in using dark windows and Google Earth as evidentiary sources to support his thesis. My problem with the entire debate is that most analysts, foreigners in particular, lump all Chinese property into a single amorphous mass when analyzing value.

This is not a mistake an analyst would make in other real estate markets of the size, and for good reason. When not accompanied by major economic crises, real estate markets are naturally cyclical. In each of these cycles, some properties, by dint of either size, price, or location, tend to fall faster when drops occur, and rise more slowly when recoveries begin. Prices of condominiums and homes in less desirable neighborhoods, for example, fall faster and further – and recover more slowly – than single-family homes in more exclusive locations.

While 15 years ago the case could be made but there was not much differentiation among Chinese properties, that is no longer the case. Even a casual jaunt though China’s largest cities reveals vast differences among both residential and commercial properties. The variances of design, construction quality, and management among new apartment developments in Beijing or Shanghai that would surpass even the gap between a Harlem walk-up and a Park Avenue penthouse.

In addition, a clear dividing line must be drawn between commercial and residential real estate. Even in China, these markets move to different rhythms, often to the frustration of developers and managers of large, multiuse properties. And, as my friend Bill Bishop would happily point out, to compare the dynamics of the real estate markets in Beijing and a third-tier city in Gansu is a specious exercise: by definition properties in those cities appeal to buyers in vastly different circumstances.

It would be useful, as the debate around when and how far Chinese real estate prices will fall proceeds, for all of us to begin to divide Chinese real estate into types and classes better suited for analysis. While this may still not adequately explain the disconnect between rental rates and property prices, it will take us a long step closer to understanding how and why this market behaves as it does.

Update: A superb entry by Ranjit Lall in the FT’s “beyond brics” blog explains why the Chinese Property Bubble meme may well be a myth.

Deconstructing Pat McGovern of IDG

In the Hutong
Winter into Spring
1014 hrs.

Eric Jackson at TheStreet did an intriguing interview with IDG’s Pat McGovern on investing in China. IDG Capital Partners was one of the earliest – and is today among the largest – of China’s venture investors. I would go so far as to say that they are to venture capital in Chinese technology what Kleiner Perkins is to Silicon Valley.

McGovern had several interesting tidbits to offer, but the two that I felt were most invited exegesis had to do with the M&A strategies of Chinese tech firms and with Google.

Why China’s Big Fish are Vegetarians

On the subject of M&A in China, Jackson asked McGovern:

Q: When will we see the bigger Chinese tech companies like Baidu(BIDU) or Sina(SINA) start acquiring more of the smaller Chinese start-ups as we do in the States?

A: The Chinese entrepreneurs are very proud of their companies and have great determination to have the company they have started succeed in the long run. They are not attracted to being acquired by a larger company which would prevent them from achieving their personal business goals.

With respect to Mr. McGovern, I think that answer might have been a bit sugar-coated. There are certainly Chinese tech startups that would prefer to retain their independence, but there are many who would not object to being purchased by the larger players, provided the terms were right.

I italicize the last because I think this, rather than some militant independence streak, is the real reason we don’t see more intramural M&A action in China: the terms of purchase would not make business sense for the buyer. There are several extant issues in the market that have brought this about, but the most important one is the great pool of cash sitting in China.

There is (and has been since about 2004) far too much cash and far too many players chasing too few viable technology startups in China. The combination of product idea, technical skills, and management ability is a rare one, but the country is thick with private equity funds, hedge funds, venture capitalists like Mr. McGovern, and strategic investment funds like those set up by Intel, Qualcomm, and the like. This pool has deepened with the addition of a growing number of local Chinese companies looking to capture the same opportunities.

So much money raised and uninvested places significant pressure on investors to put their money somewhere. This results in a degree of value inflation among viable investments, and more among the really good ones. I am certain Mr. McGovern does not want to hint that IDG might pay more for its investments than it needs to, and I would never make such an accusation.

But funds and investment houses are judged on a different set of criteria than Sina or Baidu, and this is where the disconnect occurs. As long as IDG buys in at a price lower than the price at which it cashes out, IDG wins. Major local internet companies, on the other hand, need to decide whether it is cheaper to buy a startup with an interesting looking business, or just grab the idea and do it themselves. Given their substantial internal coding resources, the power of their brands, the time cost and uncertainty around negotiating an acquisition, the possibility of a bidding war, and the headache of integration, and the unlikelihood of expensive IPR litigation over a business idea, one could see how it would make more sense to do it themselves.

It makes more fiscal sense for both the big players and the startups to continue along this vein as long as there is plenty of capital to support startups in the market, and as long as the big players believe it will be cheaper to duplicate than to buy.

There are other reasons, prime among these the aforementioned shortage of viable targets. Ask Kai-fu Lee at InnovationWorks: he chose to create an incubator because he sees so many interesting ideas and businesses die aborning because they lacked so many of the key skill sets to simply survive as a business. Investment houses have the time and the resources to form these into true companies, and by the time they finish that job, the wind is whispering “IPO.”

One could also suggest that China generally and the engineering-based industries in particular are more “make” cultures than “buy” cultures, and i seems that the M&A game has not yet become a national pastime in the PRC. One could also suggest that there is no shortage of founders’ hubris at the top of China’s largest internet enterprises. I think those are valid, and they contribute to the problem.

But simply suggesting that this is a mindset problem among Chinese entrepreneurs is an inadequate answer at best.

Google and Government

At the very end of the interview, Jackson drops to G-bomb:

Q: If you had been advising Google(GOOG) at the start of 2010, what would you have told them about doing business in China?

A: Doing business successfully in China is based on personal relationships. Google should do more to develop personal relationships with key levels of the Chinese government involved in the technology industry, the information industry, and regulating the information available on the Internet.

By establishing mutual trust among the Chinese government officials involved with regulating the Internet, each side would have more clearly understood the position of the other.

If Google is able to establish better personal relationships with Chinese government officials and work out business practices that accommodate the Chinese laws, Google will be better positioned to compete with other Internet search and service companies in China.

I like McGovern’s answer here, given the question, but Jackson asks the wrong question. By the start of 2010, there was nothing left to advise Google: the die was cast years before, as far back as 2003. Google’s actions had limited its tactical options by the end of 2009.

As to the issue of government relations, yes, Google probably could have done a better job at the most senior levels of the company to build relationships in China, but I question whether there was a consensus to do so among the top brass in the Googleplex. Doing business in China was going to be Just Like Doing Business Everywhere Else But With A Different Alphabet, so why bother?

In his answer McGovern was being polite and just a bit cagey. He was not offering any free lessons to foreign companies seeking to come into China. And why should he? IDG Capital does very well creating the impression that it does something very hard, if not magical: it makes money in China.

As a communicator, I have to applaud him for being “on message.”

America, Lead China by Example

In the Hutong
Partaking of Yale Lit Classes on iTunes U
1651 hrs.

In an excellent editorial in The New York Times, “Scolding China Won’t Help,” Beijing-based attorney James Zimmerman offers his prescription for anyone in the West interested in helping China transition to a more democratic form of government.

First, Western leaders should appreciate that open and frequent government-to-government dialogue and legal, cultural and commercial exchanges are the most effective tools. China came out of its shell three decades ago due to vigorous engagement with, not lectures from, Washington and Brussels.

Second, we should give Beijing credit where credit is due. Those that deserve credit are the moderate voices that have taken bold steps to lead China down a path of reform. Unfortunately, few elected officials in the United States would even consider giving the Communist leadership praise for its accomplishments. Acknowledging progress on problems like poverty helps build credibility on more contentious issues.

Third, it is important to keep in mind the internal struggle between moderate and conservative voices within China. The Chinese people continue to view with suspicion any attempt to impose Western values on China. Liberal institutions need to be nurtured, rather than thrust upon Beijing. Keeping this tension in mind serves as a framework for productive engagement.

Leaving aside the fraught matters of whether democracy is the right system for China, and if so what form it would take, Zimmerman makes some valid points that should be made to those behind every door of importance within the Beltway. There is no good reason to coddle or appease Beijing, but lecturing it on its national governance gives aid and comfort to the opponents of political progress in China, and paints every would-be reformer with a patina of American stoogedom.

Nonetheless, there is an important point that Mr. Zimmerman leaves out in this process: that is America’s role as an exemplar of the principles for which it stands in both its domestic and international conduct, and thus as an inspiration to those seeking a better model of government. We can debate what those principles are, but when we abandon them we cease to light the way forward for all of the nations and peoples seeking more representative and responsive forms of government.

We cannot lead when we preach clean government but tolerate the fig-leafed corruption of campaign financing, when we call for multilateralism but act unilaterally, when we argue for tolerance then show ourselves to be intolerant, or when we call for greater consumer spending even as we recover from the debilitating economic hangover of our last consumer spending spree.

The people of China see right through these contradictions and call us, not without justification, hypocrites. And along with their leaders, they laugh and shake their heads at our temerity, our chutzpah.

And our messages, our words, and our ideals go unheeded or, worse, are dismissed altogether.

No house is totally clean, no family ever bereft of dirty linen. But until we openly acknowledge and address the cracks in our own democratic edifice, the peoples of the world will look elsewhere for lights, even in places we wish they daren’t look.