Covering the progress Chinese companies are making as they move into international markets

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.

Should Li-Ning Be Taking On America Now?

In the Hutong
In Pinewood Derby Mode
1432 hrs.

Li-Ning is popping up on the radar. On Wednesday I got a call from Bo Jin of Campaign magazine in Hong Kong asking me what I thought about the company’s announcement that it would be launching a multi-million dollar ad campaign in the US in May, Then today, catching up on my reading, I read Christopher Shay’s excellent piece in Time magazine about Li-Ning’s foray into the US athletic shoe market.

Let me say at the outset that I have a soft spot for the company: Li Ning gave me a job when I really needed one in the early 1990s, and I was fortunate to spend some time working with him and some of the people who helped form the company. Despite that history–or perhaps because of it–I have to wonder whether now is the right time for Li-Ning to be venturing overseas, and more specifically into the worlds most competitive and challenging sportswear market: United States.

A Long Time Coming

In the company’s defense, this move did not happen on a whim. Li Ning has been thinking about the U.S. market at least since the early 1990s, but the company held back, knowing that a secure market position at home and a positive view of Chinese products abroad would be essential before venturing into the home turf of its strongest rivals. They learned that lesson up close: Li-Ning’s parent company at the time, sports drink maker Jianlibao, made a premature and costly foray into more than a dozen countries overseas, including the US. Not only did Jianlibao fail to take off overseas, the drink maker soon found itself under siege at home from Coca-Cola and Pepsico. Today, though I may look, I cannot find a can or bottle of Jianlibao in any Beijing store.

The company–and it founder–believed then that they would go overseas eventually. But with Nike and Adidas starting to make huge forays into China at the time, the immediate focus was to retrench out of first-tier cities in China and learn to beat the global majors at their own game.

Today, sixteen years later, it is clear Li-Ning has made immense progress toward that goal. The brand is  number 2 in China, behind Nike and ahead of Adidas. The company is public, profitable, and took in over $1 billion in 2009. It has set up a flagship store/design center/listening post in Portland, Oregon, America’s unofficial sportswear capital, enabling it to start tapping into that city’s deep concentration of industry talent. And it has signed an NBA star, Baron Davis, as a spokesman.

So why not blitz America?

Leave aside the fact that Nike alone is twenty times the size of Li-Ning, or that the U.S. is an insanely expensive and competitive market in which to do business. Is this the right time for Li-Ning to be leaping into what is probably the richest and toughest sportswear market in the world? Or is there a better path to global leadership for the Chinese upstart?

I would say no, and here is why.

China is Still not Won

Yes, Li-Ning is now the second largest sportswear company in China. But that position is not unassailable. Nike is still tops, and leads in the more prosperous cities where styles, tastes, and habits more closely match those in developed markets like the U.S. I would argue that until the company can beat Nike in the high-end market in China (which more closely matches the mid-range in the U.S.,) the move abroad is premature.

What is more, foreign brands are delving deeper into Li-Ning’s traditional strongholds in 3rd, 4th, and 5th tier cities. The global majors are finding the going challenging, but they have learned that the formula for success in those cities is different than what it is in Shanghai, and persistent and well-funded, they are adapting. And the big international brands are not the only ones to watch: don’t forget Anta and others are fighting for a chance to steal Li-Ning’s crown at home.

Just when Li-Ning should be using its local advantage to secure the home field against the interlopers, it is turning its attention away.

In America, China Isn’t Cuddly Yet

This is not a particularly opportune time for a Chinese manufacturer to go venturing into the U.S. There is a lot of angst and a certain amount of distaste toward China in the U.S. at the moment. I suppose you could argue that as China rises, there will always be some underlying friction and, after all, the Cold War didn’t kill anyone’s taste for Russian vodka or caviar.

Practically, though, the first four or five high-profile Chinese brands to venture into the West are going to be carrying the burden of America’s China Anxiety with it. The Chinese government hasn’t done much of a job burnishing Brand China lately, and the government does not appear ready to soften its stance merely to ease the marketing challenges of its fledgling global champions. (Nor, for that matter, should it.) What that means, though, is that Li-Ning will need to succeed in spite of China carrying a poor reputation for product quality AND serving as the nation’s bogeyman for its economic challenges.

That’s a lot for a company to carry, and doing so will be expensive. You have to wonder if it might not be wise to wait for a day where the headwinds are not blowing quite as stiffly.

Home Is Where The Growth Is

If Li-Ning goes to battle against the majors in the U.S., they are going to be competing against a host of more familiar brands whose products also extend from the top of the line to the outlet store/bargain basement. The profit share in the US is going to the top-end players. Diving into a market with high sales costs and thin margins is no way to build a war chest to defeat Nike in a global battle.

In China, conversely, more people every day have the ability to buy branded sportswear and footwear, and the market remains the largest in the world. What is more, the tastes of millions of loyal Li-Ning buyers are evolving. They are no longer looking for the basics, but more stylish and higher quality apparel. This is where the company has an opportunity not only to grow in unit sales, but to start using its overseas-built design expertise to grow its unit profits as well. Those profits, long term, will be Li-Ning’s competitive advantage as it takes on Nike and Adidas worldwide.

Other, Easier Fruit is Rotting

There are other markets in the world where the global majors remain weak, others where their products are inappropriate to local tastes and incomes, and even some where Nike and Adidas are only present on the gray market. Li-Ning could use its greater experience selling into developing markets to build deeper footholds into India, South America, Eastern Europe, Turkey, and Russia (and possibly Africa). This would help Li-Ning scale up to a size to be able to match the global giants, and it would fight the big boys on turf that suits its own strengths.

If Li-Ning can establish and retain leadership in China and build market-leading positions in the world’s most populated, high-growth markets, they could then take on Nike, Adidas et al at its leisure in their home markets, supported by immense economies of scale and a global footprint.

Better to Follow Mao

The above approach hearkens back to Mao’s strategy to win the revolution in China. Win the countryside and surround the cities. By dominating the developing markets first, and using those as a power/revenue/scale base from which to take on the more cosmopolitan markets of the world is the strategy that makes the most sense for Li-Ning, along with many of China’s bevy of global brand hopefuls.

So the question is what is compelling Li-Ning to jump into the US before taking the logical intermediary steps that might save it from Jianlibao’s fate? I could figure on several possible reasons. Perhaps analysts feel the “time is right.” Maybe it is all of the buzz about Li-Ning being a presumptive “global Chinese brand.” Perhaps the company wants to capitalize on the still-somewhat-fresh image of Li Ning doing his wire-assisted Peter Pan torch run during the Olympic opening ceremonies 30 months ago.

Or perhaps the company is getting impatient. Maybe they have bought into the idea that the global financial crisis somehow opens the door for them in the US and that they’ll never get a chance like this again. Or maybe it is a much simpler explanation: they signed Baron Davis, so that makes it time to go big time in the US.

Yes, there is something exciting about the prospect of a Chinese brand leaping into the global fray, and the company should be applauded for its guts. But when the applause and the excitement die, I hope they can give us all greater clarity as to why they chose this particular path to globalization.

China’s M&A Communications Problem: The Bankers Get It…

In the Hutong
Wikileaking
1531 hrs.

In an excellent article in today’s Wall Street Journal, Alison Tudor notes that Chinese firms are increasingly targeting consumer and media companies in their acquisition efforts abroad. Whether or not you agree if this is a new trend, Tudor’s review of China’s challenges in this effort is very good.

I say that because in particular her identification of communications issues as an M&A barrier comes up just below the fold:

Expansion-hungry Chinese companies are likely to encounter some of the same resistance that has snarled foreign deals in nonconsumer industries. To ease fears of the “800-pound gorilla that’s called China,” acquirers should communicate extensively with regulators and the public before pouncing, said Fred Hu, chairman of Primavera Capital Corp.

The good news in this story is that the warning comes not from another communications professional, but from the chairman of a respected investment house. Now that the bankers have caught on to the problem, the question is whether the prospective Chinese acquirers plan to do anything about it.

Rebuilding Hollywood with BRICs

Hollywood is a well-known area of Los Angeles ...
Image via Wikipedia

In the Hutong
Running a sand-table exercise
1930 hrs.

Keith Richburg and Zhang Jie wrote an enjoyable piece in The Washington Post about the different ways in which the U.S. film industry is seeking to tap China. The article is encouraging in that it suggests that Hollywood is getting over its blinkered view of China as a really big version of France (big market, different language, resists our product, resistance is futile, will eventually be assimilated.)

The article notes that product placement, scripts (read “story ideas”) and locales have made China more interesting to Hollywood. There is even a bit about the importance of “co-productions.”

It’s Spelled O-P-M

The biggest attraction, however, is cash.

For Hollywood, the reason for the sudden interest in China might be described as more mercenary. Hollywood traditionally runs on other people’s money – and China has a lot of cash to spread around these days.

Our favorite films notwithstanding, Tinseltown’s most remarkable achievement is its consistent ability to get outsiders to fund a business that is as unapologetically opaque as it is inherently risky.

In succession, Hollywood has tapped (and tapped out) Main Street USA (Gulf & Western, Kinney, Coca-Cola, General Electric), Main Street Japan (Matsushita, Sony) Main Street Europe (Vivendi), and Wall Street (take your pick of hedge fund and private equity-funded film partnerships and virtual studios). In the wake of the financial crisis and the drying of the Wall Street wells, the emerging markets were a logical next target.

It took someone with the foresight (or desperation) of Stephen Spielberg to lead the way. Spielberg, a producer/director not normally associated with low-budget, high-return films, began the trend when he longtime collaborator Stacey Snider closed a $1.2 billion deal with India’s Reliance ADA Group to produce six films a year.

Barring an abrupt change in the mood on Wall Street, China looks to be next to fall into the celluloid web.

Or is it?

I’m Ready for my Closeup Now, Mr. Lou

Hollywood’s major studios and their affiliated production companies need literally billions of dollars a year to finance slates of films costing upwards of $100 million each to produce and market. There are a very limited number of entities in China capable of investing at that scale: the major state-owned banks, China Investment Corporation, and a handful of large state-owned industrial companies.

And while the leaders of those firms might well be attracted to Hollywood’s glamour, the Industry’s need comes at an inopportune time. CIC’s large paper losses in Blackstone Group caused an uproar, and the financial crisis has placed the stewards of the people’s funds under uncomfortable scrutiny at home. Senior cadres can well imagine the popular backlash that would occur if it were to become known that national wealth was lost investing in Hollywood flicks, and would be anxious to avoid such a scenario.

It is also instructive to remember the popular consternation whipped up in the US when Japanese keiretsu began to invest heavily in Hollywood. That storm would be a squall compared to the typhoon of opposition and angst blowing out of all corners of the US if a Chinese government-owned entity attempted to buy into Hollywood. Hollywood’s leaders need to think carefully about whether they want to fritter their political capital in Washington on such a quest.

None of which is to suggest that China will stay out of Hollywood: the kind of picture-by-picture deals that the WaPo article alludes to will continue and grow, and I think we can expect slow but growing connections between the US and Chinese film industries.

But we would be wrong to forget that the dynamics driving The Biz in the two countries are vastly different, as are the cultures they are spawning, and that it is a sizeable leap from an increase in co-productions to China replacing Wall Street as Hollywood’s Sugar Daddy.

Responsa: Dealing With the Disposable Backhoe

Caterpillar 12G grader.
Image via Wikipedia

In the Hutong
Managing the Phoenix
1330 hrs.

Jack Perkowski continues our serve-and-volley on the future of China’s construction equipment makers here on his Managing The Dragon blog, and he brings out the Caterpillar fanboy in me when he notes:

“How should Cat, Komatsu, and the other global leaders prepare for Chinese competition overseas? By far, the best way is to compete successfully with them in China.  That is why the battle for the construction equipment market in China is so critically important.”

That seems obvious, but the next logical question is how?

They Drive ‘Em Different Here

The global majors are geared up to compete in very different kinds of markets. In any ordinary market, you are selling a piece of equipment to a construction company that is concerned about things like the total cost of ownership of a road grader over a 10-20 year life. To serve markets like that, companies like Caterpillar design their equipment to maybe be a bit more expensive up front, but cheaper to own over the long term. They support that with a dealer network, and they have a growing division that rebuilds the big machines, extending the lives of the equipment even further.

China is not an ordinary market. There are exceptions, but I am willing to bet that the average construction equipment customer is thinking rather less long term. He probably wants to buy a backhoe that will be less expensive up front, will save enough money so he can buy two rather than one, that can be repaired cheaply, and that may even be dumped or sold to someone in one of the inland provinces after a couple of major jobs.

As an aside, I know a little something of what I speak. The Hutong Party Secretary spent a good bit of time in her career trying to sell Linde forklifts to both Chinese and Western companies here in China. (For those who are not in the materials handling business, it is worth noting that Linde are the Porsche of forklifts, and offer many of the advantages over their local competition that Cat and Komatsu do.) No surprise: the western companies, concerned about total cost of ownership and the lot, bought lots of Linde forklifts. But our Hutong Party Secretary was extremely challenged trying to sell any to local firms.

The pushback? They didn’t care about the quality. Breakdowns a problem? No worries – if we can buy three local machines for the price of one Linde (the differential wasn’t that large, but this is for illustration), we’ll buy two local machines and one will be operating while the other is being fixed, and we’ll still save money.

How does a company that extols its innovation, quality, durability, technology, and dealer support go head to head against companies that are ready to sell two disposable backhoes for the price of one good one?

Playing A New Game

At some point, in order to fight back without undermining their own corporate image, Caterpillar, Komatsu, Volvo, Bobcat, Kubota, and any other global equipment maker who wants to compete in China is going to have to find a way to win on the customer’s terms. And they are starting to get that.

Late in August, Caterpillar’s new CEO, Doug Oberhelman, came through China in the wake of a promise he made to Cat shareholders that he would make the company the leader in construction equipment in China by 2015. In an interview with Andrew Browne at The Wall Street Journal, Oberhelman hints at the foundation of a new China strategy.

[Oberhelman] said Tuesday that some Chinese equipment companies have become “pretty darned good” and that Caterpillar is studying their operations, including their product designs, as it goes toe-to-toe with them in China and, increasingly, in the U.S. and Europe, where good-quality Chinese exports are taking hold.

The exercise is driving down costs at Caterpillar and encouraging innovation, he said. Already, Chinese engineers are developing parts for Caterpillar wheel-loaders, a type of tractor that is made in China for a domestic market. Of the company’s 6,200 employees in China, only about 100 are expatriates, Mr. Oberhelman said, including managers brought in from other Asian countries. “We’re pretty Chinese,” he said.

Based on these and other directions that the market is taking, I would expect a global construction equipment maker to pursue some mix of the following three approaches in the effort to go head-to-head with the locals.

Three Strategic Directions

First would be to sell second-hand, factory refurbished machines. As I noted, Caterpillar has made a huge businesses rebuilding and refurbishing construction equipment. China might be a good place to sell some of that gear, especially since I suspect there is plenty of it floating around in the depressed construction markets of the world.

Second would be to buy a local construction equipment manufacturer. That might be tough, though: China has proven itself rather touchy about selling off healthy companies, especially in this sector. As other companies have discovered, betting your future on a complex local acquisition often takes management attention away from other means of building business. But if the right opportunity comes along (an underperforming factory, for example) and the government gives a quiet nod, expect a bidding war.

Third – and I like this best – would be to launch an OEM line of construction equipment carrying a different brand, using local designs but with inspectors and other “soft inputs” from the international company. It would not be necessary to own the factory, just to contract the production capacity. The separate brand creates the division between the quality standard of the core brand, while offering many of the advantages of working with the global brand. The company would offer that brand alongside its own in China and in export markets in the developing world, where Perkowski notes the Chinese manufacturers will be looking when it is time for them to export.

The Stakes

I am reflexively skeptical of any company who makes the case for doing business in China by saying that success elsewhere depends on success in China. That sort of thinking tends to lead to bad business decisions, like foregoing profits for market-share victory. If you are not planning on making money in a given market, you are effectively declaring it a money sewer, and down that path lies heartache.

But for the world’s leading construction equipment manufacturers, what is at stake is that in order to thrive on the development of the world’s emerging economies, those companies need to build large and profitable businesses in China serving the full range of customers. China is a must win, but the Big Iron merchants must win on China’s terms, not their own.

Schell Gets China Investment Problem Half Right

In the Hutong
Working on contracts
1052 hrs.

As is the case with many China watchers who came of age in the 1980s, I am a longtime admirer of Orville Schell’s writings on China. His books have been an essential companion to those of us seeking to understand the PRC and the social impact of the nation’s economic and political evolution.

But in a recent article in Project Syndicate, “The China Investment Challenge,” Schell, the former Dean of the Graduate School of Journalism at the University of California, Berkeley, takes a surprisingly one-sided view on the matter of China’s investments overseas. He concludes:

If American officials do not begin to recognize the realities of today’s globalized world, the US may unwittingly (and self-destructively) find itself cut off from the kinds of new foreign investment flows that are sorely needed to revitalize its manufacturing and infrastructure sectors.

The congressional xenophobia that has blocked major foreign direct investment or acquisitions of ailing U.S. firms is lamentable, if not disgusting. But it is also predictable: America has experienced recurring bouts of fear and loathing toward foreign investment throughout its history. In recent years, Our Distinguished Solons have balked at investments from Japan, the Gulf States, and Europe. China is by no means alone. A well-advised, thoughtful Chinese effort to purchase any major US firm or asset would have considered history, causing the potential buyer to approach the purchase with greater care.

And this is the rub: half of the problem with Chinese companies buying American firms is U.S. opposition to Chinese investment. The other, more important half of the problem – which Schell alludes to but then ignores – is the core cause of that opposition, which is that the average U.S. voter and his elected representative do not trust China or Chinese companies. That is not the fault of the U.S. Congress. That is the failing of a China that has not yet learned the importance of currying the trust of the outside world.

I suspect it will take some time before the leaders of the People’s Republic take that need to heart. In the meantime, it falls upon the shoulders of Chinese enterprises seeking to invest or acquire in the United States to build that trust among Americans in spite of whatever they may think of China as a whole. It is certainly doable. Even in the height of “Rising Sun” Nipponophobia in the United States in the late 1980s, a handful of companies managed to rise above the fracas, including, notably, Sony, Toyota, Nissan, Toshiba, and Nintendo.

Chinese companies serious about investing in the United States – or Australia, New Zealand, Canada, or any other country where trust of China has become an issue – need to recognize that Brand China looks to many Americans like the Death Star from the Star Wars movies, and that the companies on their own need to build contacts, trust, and goodwill among the wider citizenry long before leaping into the fray. Until Chinese firms acknowledge that fact and act on it, the doors will remain closed, and the safe move on Capitol Hill will always be the blocking maneuver.

China’s African Honeymoon is Over

China Tightens Purse Strings in Guinea and Other African Nations
http://www.nytimes.com/2009/03/26/world/africa/26chinaafrica.html?pagewanted=print

China’s approach to securing minerals in Africa has been to sign agreements to build huge projects in exchange for minerals.

But that formulation has proved problematic in an economic downturn. African governments are now realizing that these deals are in essence loans against future revenue, and falling prices could leave them saddled with giant piles of debt.

China, Inc. is starting to realize that the road to globalization for Chinese enterprises does not begin with Europe or North America, but with emerging and developing  markets like the nations of Africa.

They are also starting to understand that winning friends, influencing people, and building markets demands more than dumping a few fat wads of cash on the natives. The problem is that few of these companies – if any – know what to do to arrest the tattering of their image in their most promising markets.  

Posted via email from Silicon Hutong on Posterous

China, the WTO, and Censorship

In the Hutong
Fighting the Hump Day Blues
1616 hrs.

There is a movement afoot to build a case for filing a complaint against China at the World Trade Organization, alleging that China’s efforts to censor the Internet are in violation of the terms of its WTO membership, which Reuters’ Chris Buckley begins to examine here.

As I am not an attorney, I won’t comment on the law involved – I’ll leave it to Dan Harris and Stan Abrams to do that. But the law is not the only issue here. Perhaps more important is whether, even if China were to lose the case, the rest of the world would be willing or able to enforce it.

It is hard to overstate the importance that the Chinese government places on its ability to manage the content to which the broader Chinese public is exposed. The nation’s leaders would undoubtedly see a ruling that strips them of this ability as not only a commercial challenge to the local media industry, but also as a direct attack on their ability to govern the country.

In the face of such a ruling, China would have four potential courses of action:

  • comply, and watch the country flooded with all manner of content, including the salacious and seditious;
  • partially comply, opening up access to more sites but come up with ways to circumvent the ruling;
  • ignore the ruling, continuing to censor but risking sanctions that may provoke a trade war during a difficult economic period; or
  • withdraw from the WTO, replacing it with a series of bi-lateral agreements.

All of these, even the last, are on the table. There are those among China’s leaders who would view the removal of their right of censorship as a major assault on China’s sovereignty. Rather than lose one of their most important means of governance, many would sooner abandon the WTO and return to the old system of bilateral agreements, or, alternately, take the lead in establishing an alternative trading regime.

It is unlikely that the Chinese government would simply stand aside and allow the country to be flooded with everything from separatist advocates to kiddie porn, and the other scenarios would make it difficult or impossible for the ruling to make a significant difference to the commercial prospects of foreign Internet or media companies in China. Surely those planning the complaint must know this.

So the real question must be whether the motives behind this action are, in fact, commercial, or whether the issue of business access is a cover for another agenda. Given the that a commercially satisfactory result in the case is unlikely, and given that the advocates for the complaint that Reuters quotes are free speech organizations, not business groups, this action is in danger of being perceived more as a political assault against the underpinnings of Party rule in China than as a straight commercial dispute, both in Beijing and in Geneva.

If this action is to go forward, and if it is to achieve its stated aims, it must do so with commercial complainants and a very specific commercial objective. To try and accomplish more far-reaching goals with such an action, however well-meaning, risks undermining the legitimacy of the WTO and disrupting the global trading system.

Taiwan Discovers Mainland’s Taste for Luxury

In the Hutong, 1247 hrs.

The English language China Post ran an article today entitled “China’s super-rich have craze (sic) for luxuries.”

Ignoring the Chinglish headline (where do they find their editors), the story looked like it was pulled from a college newspaper. Nothing is untrue, but it is shockingly shallow analysis of a meaningful trend by a newspaper that should be able to bring more insight to the matter.

Anyone ever wonder why Taiwan’s newspapers have failed to become “papers of record” in Asia?

China’s Route to Best Practices: It is not M & A

Housha Village, Beijing
Counting the fireworks stands
1414 hrs.

In a well-done post on his blog at the Council on Foreign Relations website, Brad Setser takes a contrarian view on why local Chinese banks have been happy to take foreign investment, and why the government has been happy to let them. And it wasn’t about what everyone thought it was.

“One more subtle sign the world has changed. Anderlini and Tucker report in today’s FT that China wasn’t all that interested in getting access to Western financial technology after all. China’s government let foreign banks take stakes in China’s state banks more to increase their IPO valuations than out of a desire to have the state banks emulate the US and European bank practices.”

This is compelling for several reasons, one of which is my belief that China’s first global brands will not be consumer goods companies or tech firms, but companies from the service sector. Banks may well be one of these.
But mergers and acquisitions do not teach or confer best practices upon either the acquirer or the acquired. Nor, despite all-too-regular protestations to the contrary, do they provide either party with exclusive access to some operational mojo unavailable elsewhere.

Resistance to change in any large financial institution is perhaps exceeded only by that in large marketing agency groups, and China’s banks are no exception. For this reason, partial foreign ownership will not inspire Chinese banks to alter their practices. Chinese banks will be motivated to improve their practices only when the growing demands of their customers make doing so a matter of survival, and/or when the government makes clear that a failure to do so will result in China’s central bank, the People’s Bank of China, taking some executive scalps.

When that happens, they will glean those best practices deemed appropriate to their enterprises and specific needs from any of a host of sources, from consultants and software vendors to the aggressive imitation of exemplary competitors at home or abroad. They may also manage to develop some of their own homemade, culturally appropriate best practices in the meantime.

Regardless of how they do it, the banks (and all Chinese enterprises) can acquire best practices without resorting to the expense and trouble of a corporate shopping spree. Any protests to the contrary are rationalizations of an acquisition pursued for other reasons.

Zen and the State of BYD Innovation

Starbucks Guomao 2
Tinny jazz, burnt coffee
1149 hrs.

Amid all the debate about China’s supposed “lead” in green technologies, it is worthwhile reading this article from Matt Forney and Arthur Kroeber from the Wall Street Journal last fall, wherein those two China hands offer telling insights and point a course for BYD.

“But the true competitive advantage of BYD, as with most Chinese firms, is its ability to commoditize technology products, thereby making them cheaply available to a wider range of customers. This is a useful function, and it will be critical in ensuring that new-energy products can rapidly increase market share against traditional carbon-based technologies. But there is little evidence that Chinese companies are ahead in this new-energy innovation race.”

For the moment, I tend to agree. As Christina Larson recently pointed out in Yale360, while China is extending its role as the world’s factory floor into green technology products, the country and its business leaders all too often still confuse imitation with innovation.

“The first essential fact to be aware of is that most news stories about China’s greentech gains are about manufacturing. China is becoming the wind-turbine factory to the world for much the same reasons it has long been the TV and t-shirt factory to the world: lower wages, lower land prices, fewer regulatory and other requirements, etc. This isn’t particularly surprising, and it shouldn’t be seen as a reversal of the status quo. What’s changed most dramatically in the last five years has been growing global demand. With significant government investment, Chinese factories have planned for and stepped up production accordingly.”

To summarize the sentiment, China’s growing role in greentech is about efficient manufacturing, not innovation. BYD is no exception.

Not the Imitator Forever

What we must guard against, however, is the belief that this will ever be the case. Leaving aside whatever process innovations BYD has developed to crank out its batteries, BYD may well not be doing much innovation today, but the Buffet touch and properly applied capital could help it build on its core competency and make a jump into developing genuine innovations.

There are plenty of “ifs” implicit in the preceding sentence, and BYD is unlikely introduce disruptive innovations in the next few months. But just as we should not be surprised that BYD is not an innovator today, we should not be surprised if and when that changes.

A smart businessman does not wait for his competitor to emerge before taking measures to protect his advantage. He assumes the competitor is there, and acts accordingly to build and extend his lead and to lay the groundwork for the constant renewal of that leadership. Forney and Kroeber remind us not to buy the hype coming out of BYD. I suggest it is wiser for BYD’s presumed competitors to foster a little paranoia and start figuring out how to beat them before it becomes a problem.

And Forget the Motorheads

Forney and Kroeber also note that Car and Driver magazine was scathing in their review of early BYD electric vehicle portotypes, with the magazine’s columnist saying “We drive faster in our driveways.”

Yes, that’s a great line. And it brings a smile to my face as I gaze lovingly out my window at my V6-powered suburban assault vehicle.

Levity aside, though, it would also be unwise to accept the verdicts of the automotive press on BYD’s cars. Auto reviewers are notorious testosterone junkies, and any vehicle that does not incite an involuntary glandular response is dismissed out of hand. For three quarters of a century, that worked, because North Americans (and plenty of Europeans and Japanese) were making their personal transportation decisions with the back half of their brains.

But we are entering an era where a growing number of buyers are overruling their glands in favor of an emotional response linked to a fear for the future of the planet. A niche market this may be, but BYD does not need much more than a niche, a low price, and some volume fleet sales to establish the first generation of its cars in the United States.

Those with a sense of automotive history will remember that both Toyota and Nissan were ridiculed (or worse) by the American automotive press throughout the 1960s. Yet ignoring their detractors, they created the American predilection for Japanese imports, beginning with fringe consumers, then slowly and painfully learning how to appeal to U.S. drivers based on changing consumer tastes and priorities.

Matt and Arthur (and probably Car & Driver) look at BYD and think “Yugo.”

Me, I look at BYD and think “Datsun.”

How the East Will Rise

China Construction Bank
China World Tower 2, Beijing
Watching the pre-holiday ATM rush
1129 hrs.

In the face of a growing herd of commentators foretelling the rise of China, Niall Ferguson has identified what he believes to be the six factors that gave the west an opportunity to overtake and surpass China’s early cultural and technological lead. He shares them with us in the Financial Times:

“What gave the west the edge over the east over the past 500 years? My answer is six “killer apps”: the capitalist enterprise, the scientific method, a legal and political system based on private property rights and individual freedom, traditional imperialism, the consumer society and what Weber probably misnamed the “Protestant” ethic of work and capital accumulation as ends in themselves.

Some of those things (numbers one and two) China has clearly replicated. Others it may be in the process of adopting with some “Confucian” modifications (imperialism, consumption and the work ethic). Only number three – the Western way of law and politics – shows little sign of emerging in the one-party state that is the People’s Republic.”

One could argue with Professor Ferguson’s conclusions, and as an (amateur) historian I have a problem with such deterministic models. Any number of ex post theories can be drawn to fit the facts, and Dr. Ferguson is neither the first nor the last to propose a reason for China’s failure to keep up with the rest of the world during the Ming and Qing dynasties.

For the sake of argument, though, let us grant him his six “winning” factors. In return, he must grant that had he made a case for these six factors to European leaders 500 years ago he would not have been feted for his foresight. Rather, depending on the country in which he made the case, he would been ridiculed, cashiered, excommunicated, exiled, and possibly executed.

Plainly, there was no deliberate choice or point of determination where the west consciously chose such a path. It was a series of unrelated, non-sequential choices and events that brought about these changes, each important but few if any seen at the time as critical. Indeed, as my fellow readers of alternate histories will readily point out, at any number of junctures things could have gone a very different way.

It seems equally unlikely that we could foretell with any accuracy what factors will drive the rise of an Asian or African civilization in the future, or whether they would be as palliative as the happy factors that got the west to where it is today. Indeed, to assume that the influences that brought the west to its zenith are required for the east to attain its own apogee reeks of cultural hubris, wishful thinking, or both.

The political, cultural, economic, and ideological drivers behind the rise of each successive civilization in the history of the west – Babylon, Egypt, Greece, Rome, The Caliphate, Spain, England, and America, to name a few – have varied radically from one to the next. Certainly a professor of history at Harvard would consider that. Why might he believe this time would be different?

It is (to me at least) axiomatic that the forces and factors that will determine what nation, political system, or culture leads the world in the coming centuries are probably not what we think, and are likely not what Dr. Ferguson thinks, either. Those factors will emerge over time, and we will have to leave it to historians hence to sift such insights from our future.

No one would be happier than I if Dr. Ferguson is correct. Yet while I am warmed by Dr. Ferguson’s implicit faith in the underpinnings of western civilization, we must all acknowledge that the road to the future of China and the world will likely be paved with somewhat different ideas and institutions.

Cheerleading the Bankers

Starbucks, China World Tower 2, Beijing
In the course of human events
1001 hrs.

Contemplating the irrational messiness of China’s corporate landscape, investment bankers around the world must salivate in anticipation of the fees and bonuses that will be theirs when they finally convince China’s ambitious business leaders that mergers and acquisitions are a viable growth strategy.

Success for Whom?

The pressure to sell M&A to China’s corporate leadership must be particularly acute in the wake of the financial crisis, since the flow of such deals in the U.S. and Europe have dried to a trickle. What other reason for this recent pronouncement coming out of Wall Street’s alma mater, Wharton:

“Lenovo is probably the prime example — having bought IBM’s PC business — where [a company] did successfully use the acquisition strategy. And the main reason is that, beyond quick access to markets like the United States and Europe and so forth, they need high-end technologies and also established brands. Those are the elements that the Chinese firms have been missing. And so it fits very well to combine the strong and cost-efficient back end of Chinese firms with the branding, market access and technology that Western developed firms can offer them.”

I find it puzzling that a professor at one of the world’s most prestigious business schools is still able to characterize Lenovo’s acquisition of the IBM PC division as a “success.” The only unqualified success to date is the one for which the investment bankers received a fee. A more holistic analysis of the acquisition – such as the performance of the combined company in the wake of the merger, falling market share, and a failure to capitalize on the assets acquired – might yield a much different assessment.

Let us grant the possibility that at some point in the future, the move will have been a good one, and possibly even justifiable from a financial or brand value standpoint. The evidence to date does not support the idea that the money Lenovo spent buying IBM’s PC division would not have been better spent pursuing a more targeted, more organic, and more manageable international growth strategy.

What the evidence does appear to support – to date – is that Lenovo pursued the acquisition at the urging of an young and ambitious senior executive who managed to dazzle Lenovo’s leadership with the sheer audacity of the buyout, in the wake of an utter failure to build consensus on a realistic strategy for international expansion.

Lenovo’s own preliminary verdict on that acquisition came when Liu Chuanzhi returned last year and refocused the company’s international growth strategy on emerging markets like Russia and India, rather than the developed countries where IBM had been stronger.

Leaning Tower of Ivory

Wharton, for its part, would have served itself better with a less sanguine assessment of Lenovo’s purchase of IBM. As an institution whose primary product – and major source of alumni largess – is investment bankers, Wharton faculty must appreciate the implicit conflict of interest in publicly praising the work of its benefactors.

Knowledge at Wharton may not be a peer-reviewed publication, but the public holds members of the academy to the same high standard regardless of medium. We expect academics to be, by virtue of their sinecured isolation from the rough-and-tumble of commerce, an intellectual priesthood focused on finding and telling The Truth. We do not expect them to be tenured fanboys for Wall Street’s Big Swinging Dicks and Chicks. If the last two years have proven anything, it is that Wall Street could use more informed criticism from trusted and respected observers.

If China and her companies are proceeding cautiously in considering the value of mergers and acquisitions as a growth strategy, the record suggests that they should be encouraged to be careful. The last thing China needs is to spend her national treasure in a global corporate shopping spree. And given the size of the bonus checks in New York this year, I would suggest it is the last thing Wall Street needs as well.

Learning to Love Shanzhai Marketing

Peter’s Tex-Mex
Ex-Post Hospital
1331 hrs.

In my column in Media magazine in December I forswore the practice of knocking the unsophisticated way in which many Chinese companies conduct marketing. Shanzhai Marketing, I noted, was for many companies better than no marketing, and that the better and more earnest of these companies was at least building their craft in a Chinese context.

As both a participant in and an observer of the marketing craft in China, part of me wants to see Chinese companies adopt world-class marketing practices before they leap overseas. At the same time, I nurture a growing appreciation that not only will marketing in China will be different than it has been elsewhere, but that practices developed in China will change the way marketing is conducted worldwide, especially as Chinese companies begin their inevitable quest for global leadership.

What we want to avoid, naturally, is the worst of those practices, most particularly the endemic kickbacks and petty corruption that undermine marketing effectiveness. Rather than dismissing local practices out of hand, though, we would be well-served to start questioning our own assumptions about what makes for good marketing practice.

Just to give one example from the public relations side, corporate communicators (including agency types) can foster closer relationships with journalists in China than would be possible elsewhere. This does not necessarily mean that anything improper takes place: on the contrary, it means that the PR professionals wind up with a better idea of what the journalist wants to write about, and is less likely to bother him or her with stories that would be of little interest. It is axiomatic that, in a world of user-generated content and citizen journalism, such practices would have benefits that extend far beyond journalist relations.

Editors who continue to insist on a rigid church/state divide between their journalists and corporate spokespeople have understandable concerns, but this would not be an unmanageable practice and it would do little to undermine western journalism’s vaunted (but, with respect, largely fictional) objectivity.

Another aspect of Shanzhai Marketing that I appreciate is the resistance to rigid metrics among marketers, particularly when it comes to new media. I am an advocate for measurement, but I also recognize that it is impossible to measure all of the effects (positive and negative) of a marketing campaign with the tools we have. Feelings, beliefs, and unspoken convictions cannot be reduced to mathematics, and the attempt to do so is fraught with increasing peril as our segmentation increases. Sadly, marketing in the west is rushing willy-nilly into the waiting arms of the quants, as if persuasion could be reduced to a mathematical formula, but much of what goes into crafting a superb communications program is intuitive.

Shanzhai Marketing, at its best, is an intuitive exercise, one that relies on a deep empathy with and an instinct for the audience over research and quantitative metrics. What we could use in marketing is a comfortable balance between the two, and Chinese marketing practices could help us do that.

I do not advocate seeking virtue where there is none, and it is not my goal to promote a “noble savage” view of Chinese marketing. But our failure to recognize the cultural basis (and bias) of international marketing tools, and to disregard the virtues of the wiser homemade practices will only undermine otherwise great marketing campaigns.

Does Geely Care About Volvo Owners

In the Hutong
Do Marketers Dream of Sheepvertising?
1553 hrs.

When I wrote in Media in October about Tengzhong acquiring Hummer, GM’s suburban assault vehicle marque, I noted that in addition to the challenge of developing new vehicles and upgrading its lackluster marketing program, Tengzhong would need to completely rehabilitate a brand that had become the poster child of environmental nihilism. As we enter the home-stretch of Zhejiang Geely Holding’s purchase of Volvo from the Ford Motor Company, Geely faces many of the same problems as Tengzhong, but with one more very important issue.

Current owners.

One of Volvo’s greatest assets is its consistent consumer satisfaction, a factor that helps significantly in building repeat business. Repeat business is really important – it drops your customer acquisition cost, and that means you don’t have to spend as much on advertising and other forms of marketing, savings that either go right to the bottom line or to the customer in the form of lower prices. In other words, high satisfaction means greater competitiveness. No rocket science there.

But Volvo’s dependence on its large customer base means that Geely will have a major communications challenge ahead: how to convince millions of Volvo owners around the world to stick with the brand when some Chinese compact-car manufacturer with neither reputation nor brand awareness outside of China starts running the show?

Initial messages have been alright, but have come off in that stilted sort of a way that sounds like they’re playing to the industry, the dealers, the unions, and the street, but forgetting the consumer.

This is a worrying first sign that Geely has a tin-ear for its current marketplace, and is thus ignoring one of Volvo’s great undervalued assets: Volvo owners. Unless Geely is betting on China being Volvo’s only market in the future, or on having to spend a fortune correcting for it’s weak communications, it needs to start tuning into current owners, and right quickly.