Silicon Hutong

China and the World of Business • China Business and the World

Silicon Hutong - China and the World of Business • China Business and the World

Brands in China: Cheap or Premium (and Aught Twixt ‘Em)

China’s brandscape is bimodal, polarized between omnipresent discounting versus high prices born of aspiration.  Cheap Xiaomi mobile phones, Yili ice cream and Nestle “three-in-one” instant coffee exist in the same universe as premium Apple, Haagen Dazs and Starbucks.

via Digital Commerce in China: Cheap Tricks or Deep Love? | Tom Doctoroff | LinkedIn.

Once again, the brilliant Tom Doctoroff nails it.

China: State Multinational or Global Superpower?

America fights, in other words, while China does business, and not only in Afghanistan. In Iraq, where U.S. troops brought down a dictator and are still fighting an insurgency, Chinese oil companies have acquired bigger stakes in the oil business than their American counterparts. In Pakistan, where billions in U.S. military aid helps the government keep the Taliban at bay, China has set up a free-trade area and is investing heavily in energy and ports.

via China succeeds by behaving more like a multinational company than a global superpower.
A
nne Applebaum
Slate
September 27, 2010

This was a clever observation when Anne Applebaum first made it five years ago, and there is still some validity to it. Nonetheless, one cannot help but wonder if things will stay this way much longer. China’s military posture overseas continues to rise, and its companies are beginning to discover that the easy fruit has fallen. We may well have witnessed either the high point of China’s overseas expansion, or, more likely, the end of China’s purely commercial overseas expansion strategy.

 

Making Crepes is Not Cultural Theft

US Jianbing Maker Accused of “Stealing Chinese Culture” | The Nanfang.

A young American goes to China. She finds out how to make jianbing, a popular local street food. She goes home to Portland, and she opens up a shop to make it.

And is promptly excoriated by Chinese netizens for “stealing Chinese culture.”

Leave aside unfathomable presumption (or cultural chauvinism) that would prompt someone to suggest that only Chinese should be allowed to make Chinese food (or that only French should make French food, or that only Italians should make Italian food.)  Those who have issues with Alisa Grandy making her living on making Chinese crepes miss the bigger point:

This is exactly the kind of cultural diffusion that the Chinese should be applauding as a natural result of China’s rise. The world is discovering Chinese culture, and in the process more and more aspects of China will wind up woven into the world’s cultural fabric.

If Chinese chefs can make hamburgers, pizzas, and fajitas (and I know more than a few who do, and some very well), American chefs should be allowed to adopt – and extend – Chinese cuisine.

The Confucius Institute Question

To: Dr. Gene Block, Chancellor, University of California, Los Angeles
From: David Wolf, California taxpayer, UCSD alumnus, UC Davis alumnus UCLA extension alumnus, and son of a UCLA alumnus

Dear Dr. Block:

I know that you are busy, so please pardon my intrusion into your holiday week. I have a concern I need to raise with you.

You have enough money in the campus budget to teach Afrikaans, Ancient Near-Eastern Languages, Arabic, Armenian, Czech, Dutch, French, German, Greek (Ancient and Modern), Hausa, Hebrew, Hungarian, Quechua, Iranian, Italian, Japanese, Korean, Latin, Polish, Portuguese, Romanian, Russian, Swedish, Norwegian, Danish, Serbian/Croatian/Bosnian, Hindi, Vietnamese, Thai, Tagalog, Indonesian, Spanish, Portuguese, Swahili, Turkish, Uzbek, Azeri, Ukrainian, Yiddish, Yoruba, and Zulu.

But when it comes to teaching Chinese, the language spoken by more people on the planet earth with the exception of English, you find it necessary to go begging to the Chinese Communist Party – via the Confucius Institutes – to adequately fund and staff instruction in that language.

This is, at best, a misallocation of priorities. If there are three languages that should be taught at your institution, they are English, Spanish and Mandarin Chinese. All of those should be funded as a matter of necessity. Choosing to fund staff in French, German, and Norwegian over Chinese suggests that the university might be losing touch with its core mission.

At worst, this compromises the independence of a public institution of higher learning. The Chinese government official charged with the oversight of the Confucius Institutes is not shy about her goals.

May I respectfully suggest that the university seek a way to fund instruction in the Chinese language and literature that does not entail a dependence on the funding of a foreign government with complex motives? And may I further suggest that such alternate funding not come paired with implicit leverage that might be used to undermine the political, philosophical, and behavioral freedom of the UCLA community?

Many thanks,

David Wolf

China’s Hidden Health Crises

Hutong Forward
Contemplating Anacostia
1940 hrs

I have done a lot of work over the past several years with companies in different parts of the healthcare industry, each seeking a way into the China market. Almost every first meeting entails the client bringing up China’s current Five-Year Plan, and trying to figure out how to capture opportunities around the nation’s healthcare priorities as laid out in the plan.

Unfortunately, everyone does that, so the result is that the entire industry is chasing the same set of opportunities. In healthcare, that’s shortsighted. The best opportunities lie outside the stated government priorities, in part because the field is less crowded, and in part because those are usually the problems that the government finds most embarrassing and is anxious to address quietly.

An example is the scourge that diabetes has become in China. Before Johns Hopkins and the China Center for Disease Control and Prevention released their report last week, few had an idea of how large diabetes had become in a relatively short period of time. China now has 114 million diabetics, a third of the world’s total and representing 11.4% of the adult population – a higher rate than the US (11.3%). What is more, Chinese are developing diabetes at a lower body mass index than the US, so the rate of growth of the disease is not likely to abate soon.

China’s problem with diabetes: medications and treatment are more expensive than the average patient can afford. The obvious opportunity, then, a less expensive treatment regimen aimed at China’s massive population.

The upshot is this: global healthcare firms are going to find their best success not in chasing the obvious opportunities with remedies created for developed markets, but in addressing the health challenges that remain largely hidden from public view, and doing so with drugs and regimens that fit China’s local conditions.

Beijing’s New Internet Buzzphrase

Hutong Forward
Planespotting at Reagan National
1655 hrs 

In a ten minute speech last month in London at the 50th Meeting of ICANN, Lu Wei, the Minister of China’s Cyberspace Affairs Administration, introduced a set of seven principles under which, according to him, the Internet should be governed. While not much attention was paid Mr. Lu or his speech outside of the confines of the attendees, we can assume that it was an official statement of government policy, and therefore worth understanding, analyzing, and discussing.

His principles, as I heard them, are:

  1. The Internet should benefit all mankind and all of the world’s peoples, rather than cause harm;

  2. The Internet should bring peace and security to all countries, instead of becoming a channel for one country to attack another;

  3. The Internet should be more concerned with the interests of developing countries, because they are more in need of the opportunities it brings;

  4. The internet should place emphasis on the protection of citizens’ legitimate rights instead of becoming a hotbed for lawbreaking and criminal activities, let alone becoming a channel for carrying out violent terrorist attacks;

  5. The internet should be civilized and credible, instead of being full of rumors and fraud;

  6. The Internet should spread positive energy, and inherit and carry forward the outstanding culture of human beings;

  7. The Internet should be conducive to the healthy growth of young people, because that concerns the future of mankind.

There is a lot to grist in these, but what jumped out at me was this catchphrase “credible Internet.”

There is a ring to it that suggests that we are going to be hearing this much more in the coming months, but the aim seems clear. While in the past the boundaries of online expression have been defined by prurient content on the one hand and seditious content on the other, there is now a third piece to that troika: rumors.

This is worrisome: “non-credible” content implies a much wider scope for restriction than the modus vivendi we have enjoyed in the past, and opens to official censure a vast swath of online content. You can avoid posting prurient content rather easily by avoiding adult themes and illustrations. You can dodge seditious content by steering clear of domestic political issues. But “non-credible” content is in the eye of the beholder, and can easily extend to commercial content and company web sites as well as posts on Weibo or WeChat.

Watch this space, as I suspect we are going to learn more about where the authorities are going to be drawing the line. In the meantime, any company or individual producing a content-laden Chinese site or posts on Weibo or WeChat should err on the side of caution. Chinese law is unkind to those whom the authorities accuse of spreading rumors, and demonstrable veracity may not be enough to keep you out of the wrong kind of spotlight.

Bet the Farm, Or Settle for Table Scraps?

In China, Go for Broke or Accept that Less Is More
Franc Kaiser

Harvard Business Review
April 4, 2014

Nanjing Road pedestrian mall, perhaps the busi...

Nanjing Road pedestrian mall. (Photo credit: Wikipedia)

In this intriguing essay, Shanghai-based consultant Kaiser suggests that for foreign companies, the glory days are over, and the only two strategies left are to either fight for one of the top two positions in your industry (against what might be brutal competition) or accept that your market in China will be modest, picking up what others cannot.

I really enjoyed the essay, because I like contrarian thinking on business in China. But I have a couple of problems right out of the gate.

First, I find it hard to accept that all companies in all industries face such a stark, binary choice. Airlines and banks do not face the same challenges or opportunities as McDonald’s or Intel.

Second, Kaiser’s choices seem better suited to Fortune 500 multinationals with a single line of business. Many large companies will do very well being modest players in multiple markets or product lines without ever being a market leader or settling for modest returns, and many small- and medium-sized businesses will gorge themselves on a modest market position.

Third, the market is immense, and opens the door for a wide range of niche and multi-niche strategies that would be incredibly lucrative, especially for small- and medium-sized businesses from outside of China.

Finally, and perhaps most important, Kaiser implies that there is but a single motive that brings companies to China: profits from China operations. For many companies this is true, but for others, being in China offers other rewards. Companies in the mobile industry benefit from participating in the largest, most lucrative market in the world; other firms are in China so they can better defend against Chinese rivals elsewhere; still others could care less about profits, as China drives volume that supports lower unit costs in more lucrative markets.

One reason there are few good “China strategy” books out there is that there is no good, blanket approach for China that spans across a wide range of companies and industries over a modest span of time. Corporate strategy is bespoke, like the course for a ship. When we write books, we can talk about avoiding storms, rocks, and shoals, and we can talk about the processes that lead to great strategy or effective implementation. Everything else is situational.

Enhanced by Zemanta

Setting the Stage for Chinese Innovation

Near People’s Square, Shanghai
Skyline in Silhouette 
0700 hrs. 

Walking the floor at both CES in Las Vegas and Electronica China in Shanghai within a ten-week space provides one with a clear view of how far Chinese enterprise has come, and, equally important, the degree to which international technology businesses have lost their former dominance in China.

One could conclude from these impressions that multinational tech companies are in a state of permanent decline in China: Beijing’s unstated but ongoing policy of import substitution has succeeded, and foreign companies are fighting a losing battle. You don’t need to go to trade shows for anecdotal evidence. Just look in purses and backpacks: ZTE, Huawei, TCL, Lenovo, and Yulong are five of the top ten mobile device brands, and they’re gaining on the global giants.

But if you dig a bit deeper, as you can at a show like Electronica, you find that the opportunities for foreign tech companies have not disappeared: they have evolved. To understand why and how, it is useful to start by looking back on how the tech business developed in China.

From Buy to Make

Since the beginning of reforming and opening in China in 1978, the nation has essentially gone through three phases of foreign involvement in technology-based industries.

The first phase was imports, when the government focused on bringing urgently-needed products like personal computers, telephone switches, automobiles, machine tools, and other technology-based products into China. The need for these products, most of which were essential to ease key bottlenecks in the development process, was so urgent that key ministries were permitted the use of precious foreign exchange to purchase those goods.

China’s leaders always expected, however, that the nation would begin producing these goods on its own, preferably in local companies, but realistically in joint ventures with global technology companies who would bring three essential ingredients: the products, with their component technologies; production know-how, with process technologies; and the capital to build the production facilities. This was the second phase: the shift to local production.

Fast Followers

By the mid-1990s, though, another shift began to take place. As the global tech giants ramped up production in China to a mass-scale, local firms began manufacturing their own technology goods. Local firms began to dominate production, using a “fast-follower” approach: “maybe we won’t be innovators, or even the first to market with a given innovation, but we will come to market so soon after the innovation leader that we will still reap our share of the market.”

By last year, the payoff of this shift had become apparent. Chinese high-tech companies were long past needing foreign manufacturers to teach them how to build high-tech products, to help them implement cutting-edge production processes, or even to finance the construction of factories. Those local firms unable to bootstrap their own capabilities and finance now had a vast stable of local and foreign companies ready to provide the necessary technology, and finance, thanks to cash flow and capital markets, was no longer a problem.

Innovation, however, remained a challenge. While a handful of local tech companies –  notably (but not limited to) Huawei, ZTE, Xiaomi, and Leovo – had begun to innovate, widespread innovation that would offer a more sustainable competitive advantage (and a larger share of profits) still seemed a ways off.

Enter the Innovation Platforms

And there it remains today.

This gap between efficient production and value-driven manufacturing is the heart of the next opportunity for foreign firms. While the days of foreign brands utterly dominating technology markets in China may be past, more than ever China’s manufacturers need a steady stream of innovations upon which they can base their own innovating.

Technologies that serve as the foundation that allows others to innovate are what we can call innovation platforms. Five factors make innovation platforms stand out from other technical advances:

Significant – The core innovation is a genuine advance that is both useful and relevant;

Substantial – There is a obvious, large, and diverse market for products based on the innovation that offer substantial profit potential, and the technology is easily commercialized;

Shared – The company promulgating the core advance is more interested in creating an ecosystem than a monopoly, i.e., it is content with focusing on supporting and enhancing the core technology and not getting into the business of its customers/licensees;

Stable – Any subsequent changes in the underlying technology are likely to be iterative, not major, for several generations of products. This makes it economically viable for companies to invest in R&D based on the innovation platform.

Supported - Rather than serving as a glorified patent troll, the companies that develop innovation platforms invest heavily in resources designed to assist product developers create viable commercial products, such as on-site engineering support, system validation labs, extensive documentation, or developer groups. In addition, the company continues to invest in improving the core technology.

Early Innovation Platforms

Many innovation platforms take the form of acknowledged industry standards. Examples like Wi-Fi, Bluetooth, and USB could be considered a form of innovation platforms, in that their technologies enabled the creation of products and even companies.

But when we talk of innovation platforms, we are really looking at products and technologies that spawn not only products, but companies and entire industries. Some illustrative examples:

The Xerographic Process: Invented by Chester Carlson and later commercialized by Haloid/Xerox, which begat the photocopier, the laser printer, desktop publishing, and many specialized sectors;

The Intel 8000 microprocessor family, that together enabled the creation of the personal computers, stand-alone video games, and a half-dozen major industries;

Qualcomm’s CDMA: CDMA enabled the commercialization of the internet, created the telematics industry, and is on its way to recreating the automotive, trucking, and healthcare industries, among others.

Each of these companies took an indirect lesson from the failure of Thomas Edison’s Motion Picture Patents Company, an industrial trust that tried to control the film business as well as the manufacture of cameras and film stock. It was, arguably, Edison’s greatest failure. By exercising a modicum of control over the core technology, supporting it, advancing it, and making it available on reasonable terms, Xerox, Intel, and Qualcomm each fostered the creation of immense economic value.

Platforms for the Future

In a world where industrial and engineering capability is a scarce quantity, the easiest way to make a return on a major innovation is to create a vertical industry around it, building the components, creating the product or system, and distributing it under your own brand. The Bell System did this for nearly a century with telephones, and IBM and a handful of other companies did this for the first three decades of the computer industry.

But when the ability to design, engineer, and industrialize complex products is widely distributed, as it is today, robust companies are built on either using innovation to enable industries, or in building on innovation to create industries.

For the time being, Chinese companies are (generally) comparatively better at building industries based on key innovations, and European and particularly US companies are (generally) comparatively better at consistently creating core innovations that can serve as the platforms for those industries. This does not mean that no core innovations will come out of China, or that the US is no longer capable of product development and commercialization.

But it does suggest that the richest opportunities in China for foreign companies, particularly those in science, engineering, and technology-based industries, lies in licensing and enabling Chinese manufacturers, rather than competing with them.

The question facing tech companies, then, is whether and how to make use of the company’s innovations – or an ongoing stream of them – in order to serve as a profitable and indispensable platform for Chinese innovation. And for those of us who watch this market, the pressing question is “in which industries will the next round of innovation platforms emerge?

I leave the first question to the companies themselves. For the second question, my early research points to transportation, healthcare and biosciences, construction, energy, and the environment. I know: I have my chips on a lot of spots on the roulette table. In the coming months, I look forward to sharing with you why I think things are going that way.

Five Predictions: China’s Business Environment in 2014

Hutong West
Sunday Afternoon Countdown to Morning in Beijing
1526 hrs. 

Much ink and focus has been given of late to understanding China’s political evolution. Too little, on the other hand, has been given to what it will all mean to those of us who must decide what role China will play in our business plans in the next two to three years.

Futurism is alchemy in the best of circumstances, and nowhere more so than in the case of China. Nonetheless, if we extrapolate from current events, it appears that China has embarked on a course of commercial nationalism, if not outright mercantilism.

In the spirit of the season, then, we offer our five predictions for 2014:

1. China will build a more protected environment at home for its state-owned, state-coopted, and “accidental champion” enterprises through an increase in the use of soft protectionism.

2. Those enterprises will thrive at home, but increasingly will be pushed abroad, seeking prestige, less competition, and faster growth.

3. Trade and industrial policy will test the absolute limits of what China can get away with under the WTO, and Beijing will conduct a propaganda campaign to try and undermine the Trans-Pacific Partnership.

4. Foreign brands will find it more difficult to gain share in China. In addition to soft protectionism, they will face the continued relative decline in the prestige of foreign goods/brands in a growing number of sectors.

5. In 2014 we will see the beginnings of a new crop of Chinese entrepreneurs, more of whom will be starting their companies from second, third, and fourth tier cities, or even overseas. The cost and complexity of doing business in China’s first tier cities – along with the declining quality of life – will shift focus away from Beijing and Shanghai.

I’ll be addressing these more in the coming year.

Is Apple Going (China) Mobile?

Hutong West
Two hours sleep, three cups coffee
1039 hrs. 

 

China Mobile

China Mobile (Photo credit: Wikipedia)

The Wall Street Journal has lit up the net with an article proclaiming that the ink is drying on a deal between Apple and China Mobile for the carrier to (finally) (officially) offer iPhones on its network. Nothing has been confirmed by either Apple or China Mobile, but that has not stopped the speculation.

My take on the deal has not changed from when I wrote this piece in September: the value of this deal is far from clear. As such, it might be time to add a few more points to the debate to provide some perspective:

1. There have been 89 million iPhone 5 handsets sold thus far.

2. There are already 42 million iPhones using the China Mobile network. These are people with iPhones and a China Mobile account.

3. Optimistic analysts expect another 20 million iPhones will be sold next year in the event of an China Mobile deal, around 1.5 million phones a month.

4. Said analysis suggests that just under 3% of China Mobile’s subscribers will buy iPhones in the first year, and presumably a percentage of those will be replacements, given that your average Chinese smartphone user replaces his/her device every 15-18 months.

5. If Apple did sell an additional 20 million iPhones in the first year of its business with China Mobile, at, say, $400 revenue per unit, that would be $8 billion. A very nice chunk of change, and it would deliver a respectable jump in iPhone sales worldwide.

6. Putting that in perspective, Apple’s revenues for the 52 weeks prior the end of last quarter were over $170 billion. Therefore, even a very successful debut with China Mobile would give Apple a 5% revenue bump.

None of this is to say that this will be a bad deal for Apple. Even if Apple sold only an additional 10 million units, selling 10 million units of anything in the mobile business counts as a win, even for Apple. At the same time, it is important to keep in perspective exactly what a China Mobile deal would mean – and, more important, what it would not mean – for the company.

Six Principles of Entrepreneurial IPR Protection in China

Hutong Forward
Somewhere in San Francisco
0930 hrs. 

The issue of intellectual property rights and their protection continues to bedevil the agenda between China and the rest of the world. Do Chinese companies cheat? Certainly many do. Does China have on the books a comprehensive set of intellectual property protection laws? Without doubt. Does the government act to protect the IPR of foreign companies? Not as much as they could. All indications are that this situation will continue for at least the foreseeable future.

For that reason, it is perhaps past time to start drawing bigger lessons from this situation. It is time we started approaching IPR less as inventors and their attorneys, and more as businesspeople.

To that end, I propose six principles of what I call “entrepreneurial” IPR protection in China. Lawyers and the like are essential to the IPR protection process, but experience in China has proven that legal protection is insufficient. In addition to having legal eagles at your side, you need to take your own steps to protect yourself.

1. Start by protecting the rights of others. Remember that if it is all about you or a small subgroup, you are going to lose in the name of the greater good. The more protection benefits everyone, the more it benefits you.

2. Make it about citizenship. Actively support the creation of an IPR protection system that serves the interests of all parties, including the public at large.

3. Look inside before looking outside. Do all you can in your internal processes to protect your rights. For example, if you are walking around with a laptop that is not using disk-level encryption, but you pay for a high-power IPR attorney, you are doing this all backwards.

4. Don’t be an IPR troll. Protect only what you must. License what you can. Give away as much as possible.

5. Be a wellspring, not a storehouse. People will support your IPR if they depend on you as a source of innovation more than they depend on the innovations themselves. Remember that the well is more valuable than a bucket of water.

6. Talk about what you are doing. When you are being smart about protecting your IPR outside the court system, talk about it. Each of the steps above will brand you as smart, forward-thinking, and the kind of company people will respect. If nothing else, all of that reputation capital will serve you well when you are forced to take the nuclear option and drag some beloved Chinese company into court, as it strengthens your case politically (and make no mistake – court decisions in China are political.)

In the case of many companies, there are even more steps you can take that are specific to your industry or situation. This list, however, represents a set of general prescriptions and a place to start in rethinking your approach to protecting your IPR in China.

Qualcomm: Cometh the Reaper?

Hutong Forward
Learning not to eat fish 400 miles from the ocean
1840 hrs. local time

LinuxTag 2011 - Qualcomm

LinuxTag 2011 – Qualcomm (Photo credit: LinuxTag)

Two days ago, QUALCOMM (QCOM) announced that its chipset business was the subject of an investigation by China’s powerful National Development and Reform Commission. Details are sketchy, as the company has been instructed to keep the details to itself. It appears, however, that the issue is whether QCOM’s chipset business, QUALCOMM CDMA Technologies, is an effective monopoly in China.

Yesterday I got a note from Edmond Lococo at Bloomberg, who was curious about the degree to which QCOM’s critical China business will take a hit as a result. (Full disclosure: QCOM was a client from 2000 to 2004, but I have had no direct interaction with the company for nine years.)

As I told Edmond, reports of QCOM’s monopoly are exaggerated, to say the least. Apple makes their own chips, as does Huawei, and MicroTek and local upstart Spreadtrum been supplying China’s smartphone market for years. To suggest that Qualcomm has anything approaching a monopoly defies the facts: one need only check the specs on the 10 most popular phones in China to ascertain as much.

Impact on QUALOMM

At this point, though, it is hard to say what impact this will have on QCOM’s sales in China, which represents some 49% of the company’s revenues. There have been no specific accusations made, and few handset manufacturers who are committed to the QCOM architecture are likely to change on the basis of an unspecified investigation, particularly for those devices well along in the development cycle.

Where this may impact QCOM will be in the case of companies who are not committed to the architecture for devices in development, but who are looking to make a decision on chipsets in the coming months. This means that the longer this goes on, or if there are accusations of a specific nature levied at QCOM, there may be a meaningful impact. In the meantime, however, I expect many manufacturers to take a “wait-and-see” attitude.

Why Qualcomm, and Why Now?

There could be any number of reasons behind this: it could be concern about Snowden’s allegations; retaliation for Huawei’s treatment in the US; a growing nationalist discomfort with the success some foreign companies have enjoyed in China; or, indeed, a specific issue with QCOM. But suggesting any or all of these reasons at this time is little more than speculation.

As this all plays out, I expect we will learn more, and that we will soon know whether this is aimed at a single company, or whether all foreign enterprises in China should be concerned.

In the meantime, the wise course for any company would be to assume that “the bell is tolling for thee,” and address the specter of a changing business climate head-on.

Bill Bishop on Apple: We Need More Mojo

Temporary Hutong, Wangjing
K-Pop O.D.
1307 hrs. 

Sinocism editor Bill Bishop wrote a thoughtful piece about Apple (“Apple Needs China Mobile Deal to Regain Smartphone Mojo”)  that ran in USAToday late last week. Reading between the lines, Bill’s motive for writing the article is to give context to the excitement that rumors of a China Mobile deal are stoking among Apple shareholders. Since even before the iPhone was officially introduced in China in late 2008, speculation has been rife about whether, when, and how China Mobile (CMMC), the nation’s largest carrier in number of subscribers, would offer the phone to its users.

Five years later, the speculation continues. Yet while Apple fans talk up the company’s stock with visions of a Yangtze-sized cataract of money that flow into Cupertino’s coffers, questions persist about exactly how big of a win it would be for the company.

Tim’s Empty Quiver

First, as Bishop points out, Apple lacks leverage with China Mobile. At this point, Tim Cook’s company needs CMMC more than the carrier needs Apple. The iPhone has a shrinking share of an increasingly competitive market, and the company has made no secret of the extent to which its profits depend on China. China Mobile would almost certainly have used those facts as leverage in negotiations.

Arguably, China Mobile does suffer for not having the iPhone in its display cases, but the company has managed to do quite well without Apple, especially as the selection of devices that run on its unique TD-SCDMA 3G network and its new TD-LTE fourth-generation network. For this reason, it is possible, if not likely, that Apple made commercial concessions to get China Mobile to offer the phone. China Mobile is unlikely to be prepared to subsidize sales of the phone, especially given its keen watch on cost management over the past years. Apple may not be able to expect the high returns it once enjoyed on the device, especially if China Mobile agrees to put a bunch of advertising dollars behind the introduction.

More Users, or Same Old Users?

Second, and more important, we do not know the extent to which China Unicom and China Telecom have slurped up everyone in China who wanted an iPhone. Because a phone number change is mandatory when upgrading to a smartphone, many people took the leap with China Unicom, whose once anemic network has improved radically in recent years. As such, most of those who really wanted an iPhone may well have gone ahead and jumped to China Unicom or China Telecom.

Granted, China Mobile does have 130 million 3G users who don’t have an iPhone, and you can bet if China Mobile cuts a deal with Apple both companies will put big marketing dollars behind the device. But most of those users were added to CMMC’s 3G rolls after China Unicom introduced the iPhone, so you have to wonder whether those users are really going to care.

Finally, while a deal with China Mobile is a necessary step for the iPhone to regain its market share and “mojo” in China, it is not likely to be sufficient. As even Bishop admits, the iPhone is not “cool” anymore. Making it available to a whole lot more people is not going to help the cool factor much, and is likely to sandblast off whatever remains of the iPhone’s snob appeal. It will become, in the words of a good friend of mine, like “wallpaper:” ubiquitous and unremarkable. And that, for Apple investors, means that the premium will be eroded.

More than just Distribution

Facing a steroidal Samsung, plucky HTC, and local favorites Xiaomi, Huawei, ZTE, and Lenovo, all running some form of the increasingly impressive Android operating system, the iPhone needs more than a larger addressable market: it needs to get sexy again.

That’s a tall order. Chinese mobile users swarm to and discard phone manufacturers periodically, never to return in the same masses again. This happened to Ericsson and Nokia in China. Within three years of getting dumped by Chinese users, Ericsson was groping for a partner to save its bacon in the devices business. Nokia lost its luster three years ago, and today its mobile phone business on its way to becoming part of Microsoft.

I’m not ready to suggest that Apple is entering a similar tailspin. But what it does over the next six months will determine whether it regains its seat at the head of China’s mobile phone table, or whether it gets shoved further and further down the ranks in a very robust market.

Big Pharma, Bad Medicine, and What GSK Can Teach MNCs in China

Hutong West
Watching Louis Malle films
0813 hrs

I’m a little late to the bar with my take on this, but here it is, in three parts. Experienced China hands – go straight to the third section below.

When I first joined a global PR firm in China in 2000, I spent one day in my first week reviewing potential clients with my new boss. While my beat at the time was technology companies, I suggested we also look at pursuing some healthcare clients, maybe the big pharmaceutical companies. Surely, I thought, growing prosperity would send the demand for medicines skyrocketing, but local challengers would bring increasingly heated competition. A high-profit industry vulnerable to local competition sounded like the ideal client for us.

My boss gave a derisive snort and told me to forget big pharma. Seeing my confusion and taking pity upon the ignorant, she softened, and then gave me an eye-opening education in the ways of the pharmaceutical business in China. I won’t recount the details, but the gist was that pharmaceutical firms didn’t need public relations, because, allegedly, they marketed their wares in a rather more straightforward manner: they simply spiffed hospitals and physicians for prescribing the drugs.

Why spend money on PR, the thinking went, if what you needed was sacks of cash? I promptly forgot about Big Pharma in China until two weeks ago. Now it is clear that the plight of GSK and its cohorts is something none of us should forget.

The China operation of GSK stands accused of price fixing, of bribing doctors and hospitals by funneling those funds through travel agencies, hiding the bribes as travel costs and thus engaging in fraudulent financial accounting, and of conducting an internal investigation that failed to turn up any of these actions – actions the company now acknowledges were perpetrated by at least some employees.

This is an ugly litany, but it is not a new one. For over a decade it has been something of an open secret that some major pharmaceutical firms have been pursuing some variant of the pay-for-prescribe model. Doubtless, over the years many of those companies were counseled to cease such practices by employees and advisers. (There is some speculation as to why GSK was singled out as the monkey that would kill the chicken, but I’ll leave that to others.)

But one wonders whether, under the circumstances, GSK had a choice. It is a China business truism is that once a company has been through the market entry obstacle course and has begun generating (often spectacular) profits here, the pressure to sustain and grow that flow of cash is enormous. News about a company’s business in China moves the share price, and the prospects for business in the PRC is a key topic at a growing number of quarterly earnings calls. And the question is never “how” a company is doing business in China, but “how much.”

Capital, like justice, is willfully blind.

In a market where doctors make a pittance, where hospitals are overwhelmed yet constrained from charging reasonable rates for  care, the medical profession aches for streams of revenue that will keep the wheels on, if not line the otherwise threadbare pockets of underpaid physicians and administrators. Pharmaceutical companies foreign and domestic offer a ready source of cash, inciting a practice so pervasive that any drug firm unwilling to pony-up is simply not in the game. Add those pressures together, and a company could find itself fairly pushed down a slippery slope.

Having invested heavily for years in people and facilities and immersed in an industry where “everyone does it” and apparently gets away with it, it is easy to see why a company like GSK might be tempted – nay, compelled – to engage in behavior considered unethical or illegal elsewhere. At that point, the only alternative was to pack up and leave. This, it seems, was never an option.

And that is precisely the point.

GSK and several other multinational pharmaceutical firms look set to undergo a public revelation of the ugliest parts of their China businesses. That these revelations will damage the companies prospects in the world’s largest market is a given. All that remains to be seen is how far the Chinese government is prepared to go in sanctioning these companies for their past behavior.

Those events will take their own course. What must concern us now is a more urgent question: what other industries in China hide similar practices?

Already in the past week the Chinese government has taken to task the handful of international firms supplying infant formula to the Chinese market. The charge: price-fixing. Never mind that local companies in the same industry, by taking production shortcuts, have earned a reputation for sickening and killing children with their product, and that parents able to afford it in desperation have taken to buying imported formula often smuggled from abroad.

In so doing the government has sent a powerful message not once, but twice: no industry or company, however vital to the well-being of the Chinese people, will be allowed to engage in illegal and unethical business practices, and the foreign firms will be punished first and with greatest vigor.

In so doing, the government accomplishes three aims: it slows or stops practices likely to enrage the populace; it sends an unequivocal warning to its own local industry; and it cripples or eliminates foreign competition for its own local firms.

To every other multinational company in every other industry in China, ask not for whom the bell tolls. Xi Jinping’s administration has put the world on notice that no matter what local firms do, unethical and illegal business practices on the part of multinationals in China will no longer be tolerated, and in fact they’re coming for the foreigners first.

It is time for an immediate and thorough self-examination for the kinds of business practices that will not withstand government or public scrutiny. The time to clean up is right now, even if it cost contracts, relationships, and hard-won business. Failure to do so only puts off the reckoning and ensures that the cost will be much higher when that reckoning comes.

And there is one more lesson for the leaders and directors of any company that does or would do business in China, perhaps the most important of all.

A company entering the China market may well decide how much it is willing to spend in time, resources, and capital to attempt success there. No board worth its name would underwrite a leap into the PRC with a blank check: at some point, the cost is higher than it is worth. There would be no shame in such a decision, if for no other reason than the list of companies who have given up on China after finding no long-term payoff is long and distinguished.

But it is rare to find a company that has set an explicit limit on how far it is willing to go ethically to succeed in China, to say “here are the things we will absolutely not do in order to win in this market,” and gain board and shareholder support for that initiative. The readiness to define how much a company is willing to invest in the pursuit of success in China, but the failure to define how far it is willing to go to do so is what ensnares good companies like GSK in a web of worst practices.

And that is the lesson for all of us: if we do not draw a line in the ethical sand, stating in advance that our success in China will not be won at the cost of our ethical bottom line, we are effectively licensing the people building and operating our offices and operations in the PRC to do anything in the pursuit of financial gain.

Whatever your ethics, the Chinese government is now making clear the practical costs of pursuing such a path. If there is a future for foreign enterprise in the PRC, it belongs to companies who are prepared to live and die by a better standard of behavior, not to those who follow the lead of the meanest actors in the market.

China and Soft Protectionism

In the Hutong
What, cold again?
2142 hrs.

Protest in Hong-Kong against WTO on december 2005

(Photo credit: Wikipedia)

Though we may not be talking about it much, those of us who watch China for a living are looking forward with a mixture of dread and anticipation to the upcoming “two meetings,” the annual sessions of the National People’s Congress and the China People’s Political Consultative Committee. Even though the die of China’s future leadership was cast at the Party Congress in November, the coming NPC is the juncture where the reins of government are handed over to the new leadership, and the retiring members of the Hu Jintao/Wen Jiabao entourage graduate to the status of “elder statesmen.” For that reason, this is the point at which we will all be watching for some indication of how Xi Jinping and Li Keqiang will run the show a little differently.

While some will be looking for signs of political reform, my eyes will be cast elsewhere, namely to trade. What I want to find out is whether and how the new administration plans to play by the rules it signed up for when it acceeded to the WTO eleven years ago. Or, indeed, how it intends not to do so.

Since at least the early days of the Hu Jintao administration it was clear that the so-called Fourth Generation of leaders was somewhat less enthusiastic about playing the globalization game, and much more interested in just keeping a lid on the place. Stability was the name of the game, and the spirit of we-can-take-whatever-free-trade-can-dish-out that exuded from Zhu Rongji like a heavy cologne was blown out the window when Zhu left the building in 2003. In its place came a series of policies that I term collectively “Soft Protectionism (软保护主义),” a series of measures and behaviors that allow China to circumvent the intent of the global free trade regime almost at will.

Soft Protectionism, as I see it, consists of several pieces.

National Standards. We see this most blatantly when it comes to technology. The government establishes a standard based on a technology that is locally developed, and by so doing secures all or at least part of the market for Chinese output. The TD-SCDMA standard for third-generation mobile phones is a great example, as is the WAPI wireless LAN standard that was supposed to supplant Wi-Fi. China has learned that this policy is best conducted when it is done within the parameters of global standards-making bodies like the International Telecommunications Union (ITU) and the Institute for Electrical and Electronic Engineers (IEEE.) Through organizational activism, horse-trading, and the occasional theatrical tantrum, China is able to gain acceptance for standards that are, in some cases, little more than laboratory experiments. Using this global legitimacy, the standards ploy becomes legitimate. And lest you accuse me of being biased, let me make clear that we Americans all but invented this game, and we perfected it with our bull-headed nationalist behavior when it came to standards for digital televisions and the first digital phones. China is simply turning the tables.

Creative Use of Non-Tariff Barriers. Despite the openness promulgated by the WTO, there are still back doors that will allow governments to selectively protect industries. The first and favorite of these is the so-called National Security Exemption from the World Trade Agreements. The key phrase is “Nothing in this Agreement shall be construed . . . (b) to prevent any contracting party from taking any action which it considers necessary for the protection of its essential security interests”

That exemption gives wide latitude to any government willing to interpret it liberally, and China can and does do so, especially when it comes to information products and software. Other countries use this exemption to ensure that they have access to weapons production in the event of international isolation. The U.S. uses it, for example, to ensure its ships, tanks, and warplanes are all made by factories on US soil, but it does not use it to stop the import of foreign merchant hulls, diesel trucks, or civil aircraft. China, according to Nathaniel Ahrens at the Center for Strategic and International Studies, is comfortable crossing that line.

China also manages to restrict the free trade in publications, television, film, and music by stretching the WTO’s Cultural exemption (introduced by France in 1993) beyond the breaking point. Under the guise of protecting its vulnerable culture, China requires specific approval for any publication, recording, video, or film coming into the country. Keep in mind that we are talking about the culture that for nearly two thousand years has managed to assimilate every culture and nation that tried to subjugate it. Nonetheless, the exemption is used at every juncture.

Passive resistance to WTO Rulings. Rather than submit to WTO rulings it does not like, China conducts a passive-aggressive policy of resistance, even at the risk of undermining the institution. Dan Harris of China Law Blog fame put it like this:

“China still intends to remain within the WTO so as to be able to obtain certain trade benefits. Rather than openly disregard the minerals decision, China will resort to “procedural games” (游戏规则) to render any response against China ineffective as a practical matter. China is proud of how it has  used “procedural games” to avoid its responsibilities to respond to adverse WTO decisions and it openly states that it will continue to use this approach in these “national interest” cases. In fact, the term “procedural game” has become a standard feature of the China’s trade policy vocabulary.”

Government Catch-up initiatives. These are the micro-level great leaps that the government attempts to engineer over time in order to substitute domestically-made products and technology for locally-made equivalents. The past thirty years has seen China-government sponsored initiatives succeed in “catching up” in several industries, including shipbuilding, digital telephone switches, heavy trucks, wind-power generators, and solar power, and it is attempting to do so in automobiles, commmercial aircraft, microprocessors, and encryption software. The end result is the same: serviceable and appropriate products from overseas are gradually pushed out by government programs designed to deny them access to the market.

Government encouraged SOE support. This comes in many forms, but the most prevalent is outright cash payments. By offering low-interest or permanently rolled-over loans for state owned enterprises through state-managed policy banks at either the national or local level, China creates effective trade subsidies that are not counted according to international standards. A senior Obama administration official confided in me on the sidelines of the Strategic Economic Dialogue in Beijing last year that China’s export loans dwarfed even the U.S.’s generous programs through the Export Import Bank.

There is not much that the US, the EU, or any grouping of governments can do about any of this, short of an all-out trade war, if China chooses to continue with these policies. What this means is that even as a full-fleged WTO member, China is still capable of providing a protected environment for its firms, and has proven willing to do so.

Such policies will help companies beat foreign interlopers at home, but at what cost? At some point China will confront the other edge of that sword, whether in the form of having its behavior mirrored by other countries with tit-for-tat trade measures within the scope of the WTO; or by discovering that the companies it protected at home were weak and unprepared when venturing abroad.

For Xi Jinping, the choice in the coming months is whether to continue to use Soft Protectionism as the nation’s de-facto trade policy, or whether he will instead switch off the pumps and force Chinese companies to build the resilience necessary to beat global competition away from home. For the companies themselves, as Sunzi said, “Enemies strengthen. Allies weaken.” The wise Chinese company will seek to step out from under Beijing’s umbrella as early as possible to learn to compete on a globalized playing field, rather than a nationalized one.