China and the Rightshoring Movement

In the Hutong
Monday Morning with Chinese Characteristics
1112 hrs.

Back in February I posted an article here (“The Beginning of the End of Outsourcing“) declaring that the thirty-year trend that had shifted jobs and manufacturing to developing countries had hit its apogee. I focused on the Apple-Foxconn relationship, but the point was not about either company. Rather, it was that this powerful partnership, one that has defined the limits of what is possible with contract manufacturing in a developing economy, was also quietly drawing the high-water mark of the offshoring/outsourcing trend. The pendulum was starting to swing back toward corporate control of manufacturing as a core competency and a return to manufacturing close to markets, rather than at the end of a trans-Pacific supply chain.

Entrepreneurs, Stay Home

Proving once again the value of a subscription to The Atlantic, James Fallows and Charles Fishman deliver a pair of superb features in the December issue that offer some more anecdotal examples to suggest that we may be witnessing the beginning of a tectonic movement in manufacturing. Fallows surveys Foxconn and finds its working conditions much improved but sees in those improvements the subtle signs that China’s traditional comparative advantages are in decline.

He then talks to a group of manufacturing entrepreneurs in San Francisco (of all places) who explain that global supply chains are simply not nimble enough to support many businesses. Offering the example of DODOcase, the guys making some of the most stylish smartphone and tablet cases anywhere, Fallows quotes co-founder Patrick Buckley as saying “To figure out all the things we needed to do, and design the product, and launch, and fulfill orders within one month—that meant that outsourcing to China was not ever a feasible option.”

One month. That’s the speed of business. The founders were quoted nine months from design to fulfillment to work with China. Would it have been cheaper? Maybe. Would it have lost them huge opportunities? Absolutely. Would it have exposed them to early knockoffs, possibly by their own contract manufacturer? Hell yes. And Fallows apparently spoke to several companies in the same predicament as DODOcase.

Made in Louisville

Interesting indeed, but a couple of guys in a loft making semi-custom luggage is a very different animal than a Fortune 500 company.

This is where Fishman steps in, telling the story of the revival of GE’s Appliance Park in Louisville, Kentucky. Five years ago the place was the definition of rust belt, a facility built for six production lines and 16,000 workers that had lost nearly everything to China. Things were so bad that GE tried to sell the division, but nobody would buy. As it turns out, that was a good thing. Today there are four production lines making high-end appliances and components for GE products that used to be made in either China or Mexico. One in particular, the high-tech, low-energy GeoSpring home water heater, became a corporate revelation.

So a funny thing happened to the GeoSpring on the way from the cheap Chinese factory to the expensive Kentucky factory: The material cost went down. The labor required to make it went down. The quality went up. Even the energy efficiency went up.

GE wasn’t just able to hold the retail sticker to the “China price.” It beat that price by nearly 20 percent. The China-made GeoSpring retailed for $1,599. The Louisville-made GeoSpring retails for $1,299.

Time-to-market has also improved, greatly. It used to take five weeks to get the GeoSpring water heaters from the factory to U.S. retailers—four weeks on the boat from China and one week dockside to clear customs. Today, the water heaters—and the dishwashers and refrigerators—move straight from the manufacturing buildings to Appliance Park’s warehouse out back, from which they can be delivered to Lowe’s and Home Depot. Total time from factory to warehouse: 30 minutes.

As it turns out, the factory floor is a core competency. What is more, some things can actually be made better and cheaper in America by U.S. labor, especially if those products are destined for markets nearby. Harry Moser, an MIT-trained engineer quoted in Fishman’s article estimates that as much as a quarter of what is made offshore for the US market could be made more cheaply in the US than overseas. After reading Paul Midler’s excellent Poorly Made in China and going back over my notebooks from my own four years as a factory inspector for a U.S. furniture importer, I am betting that not only is Moser onto something, he may actually be underestimating. The GE case proves something that I and Midler have long suspected – that too many companies have outsourced their production to China because they lack the imagination or intelligence to do anything else.

Whose Factory?

We can’t get carried away here, though. The idea that China is reaching the end of its stint as the world’s factory floor is getting tired, and it is too tempting to see in a few examples a trend of factories re-opening across America. Not only would believing either meme be unrealistic, it would miss what is actually going on. We are witnessing the beginning of two trends, rightsourcing and rightshoring.

Rightsourcing, as its name implies, is the science of deciding whether to make something or buy it. That decision used to be such a simple one that the “build or buy” formula was taught in first year managerial accounting. What we have discovered in the past two decades is that there is more to the decision than just the math, that there are attendant risks and variables that make the formula far more complex. Is somebody going to steal my designs and formulas and sell them to my competition? Can I really trust somebody else to help me avoid quality or labor issues that could hurt my business? Am I pouring away a hidden competitive advantage by getting out of manufacturing?

Rightshoring, by contrast, is the science of deciding where to make something. We used to think that making things in a country where people worked for less money would be cheaper. But that difference is dissipating, and more questions arise. How much is it costing me to keep a transpacific pipeline full? What are the opportunity costs involved in a six- to nine-month product development process? What are the hidden risks in making something six thousand miles away from the customer? And what happens if there is an uprising or the price of oil goes up 5o%?

We are going to hear a lot more about these trends in the coming months, but it is important to emphasize that this does not mean the end of manufacturing in China, or anything close to it. These trends do point to a future where manufacturing begins to seep back into the world’s great companies, and where products are made closer to where they will be consumed. China will still make a lot of stuff, but it will make less stuff for Europe and America and more stuff for China and the rest of Asia.

At the same time, Chinese companies will set up factories closer to their customers. Think Haier in North Carolina, Lenovo in Europe and Brazil, and Great Wall Motors just about anywhere it sells cars. China will remain a hub of manufacturing as long as consumers in China and the rest of Asia are buying products. But the percentage of goods in the American or European shopping baskets that will be marked “Made in China” looks set to decline over time.

I’ll examine what this means for several specific industries in later posts. In the meantime, it would do many of us a lot of good to start reading up on manufacturing and operations management.

Business and The Xi Team: Focus on the Drivers

Xi Jinping 习近平
Xi Jinping 习近平 (Photo credit: Wikipedia)

In the Hutong
Information coma
1958 hrs.

Over the last couple of weeks, several people have asked me what the changeover in the Communist Party leadership will mean for international business in China. The short answer is that if I knew, I’d be wealthy. The longer answer is a bit more helpful.

Many years ago I had a mentor and boss who taught me that the parade of personalities and the flow of policies were fun to watch, but that sticking your finger up to feel the political winds would never offer the insight a business requires to make decisions beyond a six month threshold. What you need to understand, she told me, were the fundamental drivers of policy, not the policies themselves.

By fundamental drivers she meant the five or six issues that the nation’s leaders worried about the most, overlaid with the three core goals of the party at any given time. Add to that a general understanding of the climate in the country, and any relatively educated person could at least have a general hunch about a company’s horizons.

For example, I believe the thee core goals of the Party are:

  1. The continuance of Party rule
  2. The social stability of the nation
  3. China’s rise to global economic and political leadership

No rocket science there. Beyond this, though, things get tricker. What are the five things the members of the Politburo Standing Committee worry about when they wakes up at four o’clock in the morning?

Here is my list of the top five.

  • Controlling corruption without blackening the entire Party in the process
  • Getting the economy stabilized and on track for continuing growth
  • Keeping the PLA in line while retaining its political support
  • Cleaning up the environment without disrupting the economy
  • Keeping expressions of popular discontent from coalescing into a coherent anti-party front.

These are certainly open for debate, but what all of this suggests is that global companies will be welcome in China to the extent that they address (i.e., demonstrably take into account) these five priorities. What is more, given that domestic attitudes about foreign investment in China have, in the past five years, gone from “generally positive” to “generally ambivalent,” companies are going to find themselves compelled to make a case to their local stakeholders that they have something unique to offer just by being here.

Mind you, I’m not necessarily talking about approvals to do business, although that is an issue. Instead what I mean is that with every audience, from regulators to consumers, every business would do well to remember that being foreign no longer buys you much, and that in the current environment there is no particular priority placed on letting foreign firms into China.

In short, the outlook is not exceptionally good in the near term, but there is as yet little cause to be pessimistic. All of us need to stay tuned.

A Cloud with Chinese Characteristics

Software as a Service
Software as a Service (Photo credit: Jeff Kubina)

In the Hutong
Doctor, Doctor, Gimme some news
0917 hrs.

In addition to the matter of whether China remains a suitable regional headquarters for international firms, the recent government-imposed internet clotting also points to major changes that are taking place in the global topography of the Internet. Despite the long-treasured hope of Internet Libertarians that the ‘net would remain unified and self-governing, Bill Bishop’s prognostications of an internet fragmenting along national lines is looking increasingly likely.

Earlier this year I moderated a panel on the Cloud in China at the 2012 Roundtable on Intellectual Property Rights Protection convened by the U.S. Embassy in Beijing. There were representative of both foreign and Chinese entities on the panel, and while the focus was on the Cloud and its role in either helping or exacerbating the problem of copyright piracy, a few interesting bits came out that are relevant to the recent blockage.

First, the panel understood that there are two Clouds: one for China, and one for everyone else. The reason is not technical, but regulatory: the government has built a policy framework  that hampers access to Cloud-based services based offshore to the point where they are not viable alternatives to local storage. You don’t see very many ChromeBooks in China (I haven’t seen even one,) I can’t get workable access to Amazon Prime Videos, and downloading a movie from iTunes takes 16-20 hours – on a good day.

Second, that international firms seeking to offer software as a service (SAAS) in China must either base their offerings onshore or not bother. As the Google affair made clear to all, however, data based onshore remains particularly vulnerable to local compromise. Why do the cops need to bother with hackers when they can just show up at the door of the server farm and demand access?

Third, all of the panel participants noted a growing willingness on the part of Chinese businesses and consumers to pay for SAAS and Cloud services. There is an irony in that for the foreign SAAS providers, but there is an insight as well. Government policies that restrict access to foreign SAAS providers are functionally protecting local Chinese companies who want to get into the game.

What we face, then, is the development of a parallel Cloud sector in China that will mirror the SAAS business outside of the PRC. That sector will likely consist of two elements: local companies (i.e., Baidu, Tencent, Sina, and service-specific start-ups) that will provide Cloud/SAAS offerings; and international firms who find ways to address the challenges of latency and government access restriction, usually by setting up a subsidiary in China with localized offerings (i.e., Evernote.)

For the international providers, this means figuring out how to operate two separate services while still offering the advantages of a global service to customers in China. This adds yet another degree of operational complexity to an already challenging market.

Yet for the local Chinese SAAS/Cloud service companies, it means a doubling of their home court advantage. Not only are they arguably better suited to offer more culturally relevant Cloud services than their foreign counterparts, they will also be playing inside of an electronic fence built for them (inadvertently or or otherwise) by government policy. Long term, though, this will make the effort to compete overseas more difficult.

Whether the meiosis of the Internet continues beyond the split twixt China and the rest of the world is unclear, but for the SAAS industry, the world now has at least two separate internets, and it needs separate clouds to go with it. Long term, the SAAS and cloud companies that succeed will be those who can thrive in an internet with increasingly high walls.

The Business of China is NOT Business

In the Hutong
Bandwidth-starved
0842 hrs.

Last week I had a chance to talk with Carlos Tejada at The Wall Street Journal about how Google services have become all-but-inaccessible for users in many parts of China, and how this all seems to have gotten worse over the last several weeks. What is worse, access to virtual private networks (VPNs,) most of which require offshore payment to access and upon which many business are dependent, has been all but severed.

The Hobbled Headquarters

I made the point to Carlos that there are a growing number of businesses who depend on cloud access – not just foreign firms, but organizations based in China who actively collaborate with groups overseas to conduct research and development as well as commerce. To these companies, access constriction is a man-made disaster that is in some aspects worse than a natural one: at least with natural disasters, even one like Superstorm Sandy, there are ways to fix or work around problems of data disruption. With access constriction like this imposed by an unaccountable, unseen human entity, there is no telling when it will end, and the work-arounds are cut off as well.

The longer this goes, the more it will force businesses to re-examine the wisdom of locating headquarters or back-office operations in China:

“If China insists in the medium and long term of creating another Great Firewall between the China cloud and the rest of the world, China will be an increasingly untenable place to do business.”

Anyone who wants to do business in China is well-advised to have a presence here. But China has long made it a goal to get foreign companies to locate their Asia-Pacific headquarters in places like Shanghai and Beijing rather than, say, Hong Kong and Singapore. How many companies are likely to consider that option with a sword of Damocles hovering over their links to data and the outside world?

A Lesson in Chinese Political Economy

There is a wider issue here than just the risk and inconvenience of having to do international business through an increasingly impermeable data force-field. The past two weeks have been a rude reminder that the government and the Party place social stability and continued Party control far above commerce; that they see commerce as serving the interests of the government and the Party rather than the other way around; and that the implicit conflict between the interests of the Party and the interests of business (especially SMBs and foreign-invested businesses) are more fundamental and closer to the surface than we might wish to think.

Let us not kid ourselves, then, and suggest that when you scratch a Chinese official you will find a capitalist not far under his Communist skin. There will ever be opportunists in positions of power, but in the end all business in China remains subject to the whim of the central government’s leadership. Thirty-five years after Deng Xiaoping declared China’s reforming and opening to the outside world, political risk for every company operating in the PRC remains as real and immediate as ever.

And it shouldn’t take an internet outage to remind us of that fact.

 

Shipyards Will Get Their Naval Salvation

In the Hutong
Cowering from the chill
0845 hrs.

I wrote in June that the current downturn in the worldwide market for large ships would hit Chinese shipyards especially hard, constituting as they do some 20% of global shipbuilding capacity. The shipyards had little to fear, I noted: if for no other reason than the sheer number of people employed at China’s shipyards (and memory of the Gdansk shipyards as the birthplace of Lech Walesa‘s Solidarity movement, an event that presaged the disintegration of communism in Eastern Europe), the central government would do anything they could to keep the yards operating, orders or not. Yet rather than simply pay for the production of more surplus tonnage that nobody would want, or for make-work or no work, the government would instead get the yards to re-tool to produce naval vessels – if not warships and landing vessels, then naval auxiliaries like replenishment ships, transports, and maritime patrol ships.

Sure enough, Hu Wenming, chairman of China’s second largest shipyard operator, China State Shipbuilding Corporation, was in Beijing during the just-wrapped 18th Party Congress lobbying to get orders for naval and “fishing” vessels. He is the first: expect the line of shipyard managers and owners to form behind him.

With China’s now-open goal of becoming a maritime power, the timing of the global shipbuilding downturn and stiff domestic competition means China can conduct its naval buildup at an accelerated pace AND at a lower cost that it might have otherwise. And the yards, instead of going bankrupt, will get contracts that will likely be more lucrative than orders for container ships, cruise liners, bulk carriers, and tankers. Who knows? Many may never go back.

Congress, Huawei, and ZTE

In the Hutong
Catching up post holiday
1108 hrs.

If you have been following the news, you will have heard that a U.S. Congressional committee has issued a report urging U.S. firms not to do business with either Huawei or ZTE. Those two companies, respectively the second- and fifth-largest manufacturers of telecommunications equipment in the world, are accused of a range of offenses. In my opinion, the real offenses for which those companies have been placed in the Congressional mush-pot have little to do with the reasons outlined in the Congressional report. The companies real offenses are:

  1. They are from China, and this is an election year;
  2. They are the first companies in 70 years to challenge American companies for dominance in a core US industry that have not been from an ally or a client state;
  3. They have failed to be sufficiently transparent when doing business in a country that demands transparency from all companies, and even more from those that hail from competitor economies.

If Huawei and ZTE are guilty of anything, it is that they have built their U.S. businesses and ambitions before they have laid a foundation of trust with the American public and its elected officials. Ideally, no company should have to do that as a prerequisite do doing business in America, but trust is the price for any company stepping into a new country. The two companies are learning a lesson that must be absorbed by every Chinese company expanding overseas. China as a nation may or may not be successful in its efforts to reform the global system to suit its ambitions. Even if it is, though, Chinese companies must still conduct themselves in a manner that is acceptable to the governments and consumers in the markets they seek to enter.

At the same time, there is also an effort underway to tar Huawei and ZTE as a malevolent presence in the telecommunications industry, an effort that steps beyond fact and into the realm of speculation and rumor. As I noted in Making the Connection: The Peaceful Rise of China’s Telecommunications Giantsit behooves both the U.S. government and the U.S. telecommunications industry to stop relying on politics and the F.U.D. pump to preserve their markets. Instead, it is essential that American companies focus on Huawei as a competitive threat where it counts: in the market. A failure to do so only postpones their inevitable implosions.

I’ve spent much of the morning talking to reporters about the report, so I won’t belabor this. If you are interested in some balance about the issue, I talked about this this with Kaiser Kuo, Jeremy Goldkorn, and Will Moss on the Sinica podcast recently. Take a listen – I think the podcast covers the issue far better than 60 Minutes did. For a more U.S. policy-oriented viewpoint, I also covered this in The Pacific Bull Moose, my U.S. politics blog.

Silicon Hutong 3.0: The Merchant and the Dragon

In the Hutong
Where have I been lately?
0740 hrs.

If this forum has been silent for the past month, we* have had good reason. It is now evident to anyone watching that China is on the cusp of change so large that its own leaders likely still do not grasp it. We’ve spent the last month trying to do so, and we’ve realized it is time to make some changes.

The End of Harmony

The particulars have been summed up at great length and eloquence elsewhere. In short, China has enjoyed 35 years of relative harmony enabled by acquiescence at home, accommodation abroad, and consensus within the Party. The past five weeks have made clear that this period of harmony is now at an end.

In fact, China is entering a period of great disharmony. The implicit promise of growing, shared prosperity looks increasingly difficult for the Party to keep, just as revelations emerge that suggest widespread malfeasance among the Party’s highest ranks. The willingness of Chongqing’s citizenry to accept Bo Xilai’s microwaved Maoism hints at a national mood that continues to sour. Suggesting that China is on the verge of a new revolution would be hyperbole, but the days of acquiescence are over, and the days of a more vocal, demanding populace are here.

The consensus-building approach that has characterized Party decision-making for the past 25 years appears to have reached its limits as well, and for good reason. When the way ahead was sustaining the status quo, consensus was easy to establish. The way forward is now unclear, and different political end economic visions are battling for precedence. Building general agreement among all leaders, even within the Politburo Standing Committee, will become difficult if not impossible.  The choice will be between paralysis and the end of the consensus-based system. Either direction will have vast repercussions.

As China takes its place among the leading nations of the world, especially in the wake of the Global Financial Crisis, the nation’s leaders have begun to address the world based on two implicit assumptions. First, that as an emerging world power China is entitled to change the rules of the global system to suit its needs, or ignore those rules if they obstruct China’s goals. Second, that the rest of the world will – or should – continue to accommodate China’s growing international assertiveness, even to the point of appeasement. That such assumptions place China at loggerheads with the rest of the world is of little concern. Japan, Europe, and the U.S. are too saddled with domestic troubles to effectively oppose China’s ambitions.

The Tale of the Merchant and the Dragon

If you watch China, none of the above should come as a surprise. And unless we’re living under a rock, we have to take notice. And we have. As we have done occasionally over Silicon Hutong’s decade in publication, we have taken a strategic pause in order to assess how we need to evolve this forum in light of China’s development. You will begin to see the results immediately.

First, you will see an evolution in our focus. Following the direction of my clients, this space has been moving beyond the original confines of technology, media, and public relations for some time now. We will now take the next step. Whether you do business in China or not, China will alter your playing field, and understanding why that is the case and what to do about it will be essential to everyone’s success. Our focus will become that why and the what. To that end, our five major topic areas will be:

  1. China’s Breakout: The emergence of China, Inc., and its role in global industry;
  2. China Rules: The effort by Beijing, Chinese companies, and Chinese executives to alter business norms, practices, and regulator behavior to favor Chinese firms;
  3. China Goggles: The globalization of China’s media industry and how that will enhance China’s economic and political influence;
  4. China Rewires: China’s consumers are going to alter the world’s business landscape, both for companies and consumers;
  5. Strategy, Action, Behavior, and Communications: Ideas and approaches to help executives and entrepreneurs deal with challenges of China’s rise.

Some of this, especially the last, is a recognition of the direction we have been taking for some time. The other four themes match the major directions I’ve taken in my own research and advising since 2008. It is now time to start delivering those insights.

Discussions about China’s national security, politics, arts, culture, history, and international relations will shift to The Peking Review, and will be delivered in the context of reviews of books, articles, and scholarly works about those topics.

There are more changes as well, but this post is long enough. Expect periodic updates in the coming weeks.

In the meantime, thanks for reading, and keep the feedback and comments coming.

Best,

David

* When I use “we” here, I do so not in the sense of the “royal ‘we,'” which would be a nauseating affectation, but “we” in the sense of myself and my wife and partner. While she does no writing for this forum, she is and has always been my sounding board and editorial adviser. Also, my time is our asset, so any expenditure of that asset needs sign-off. Finally, she has become a deep supporter of this forum (and The Peking Review). For those reasons, any major decision is ours, not mine alone.

Caixin and China’s Great Equity Repatriation

LG Twin Towers, Beijing
Can’t see the ground through the haze
1018 hrs.

Just under a year ago I suggested that a large number of Chinese companies that are listed on stock exchanges in the United States and Europe were going to be de-listing, buying out their offshore investors and bringing the equity home. This has now become a large enough trend to capture the attention of mainstream media, and China’s excellent Caixin picked up the story this week (“Overseas Listed Firms Seek a Path Home.“)

Under the increased pressure of competition and regulatory oversight in the U.S. market, many Chinese companies that are primarily listed on overseas markets are returning home. One by one these companies have fled overseas markets seeking the high prices and loose regulatory environment in China’s A-share market.

The constant public oversight, pressure of short-sellers, and the persistent difficulty of dealing with investors who have only a vague idea of what you do is trying for even the best-run companies. If you’re not so well-run, regulations are a burden as well, especially the dreaded audit requirement.

Which brings us to the less-discussed political issues. The Party is concerned about foreign auditors digging into domestic companies, not because the CCP wants China’s companies to be poorly run lash-ups that systematically deceive investors, but because the Party is concerned about the political fallout from “unmanaged” revelations that result from public audits. In the past year the CCP has had their fill of such revelations in the Bo Xilai/Gu Kailai case, and the leadership is rightfully concerned about the effect of such disruptions.

Further, though, the Party would like the soft-power win of having its stock exchanges match, then exceed, the power and importance of the world’s leading exchanges. You can’t do that when your best companies head offshore for their indirect capital. For this reason, expect the CCP to grease the ways for the Great Equity Repatriation.

Where is Tencent Going?

QQ Icon
QQ Icon (Photo credit: Wikipedia)

China’s Tencent Raises $600 Million from Note Offering
Josh Ong
The Next Web
August 29, 2012

Chinese Internet giant Tencent Holdings Ltd. (TCTZF.PK) is raising some $600 million from a senior note offering this week. Given that in the second quarter they posted $492 million in profit on $1.7 billion in revenue on top of having some $3 billion in cash, the question has to be “why?”

There could be several reasons, one of which could be a desire to buy back the shares of one or more major shareholders. Keep in mind that South Africa’s NASPERS Group is a major shareholder, and in a volatile regulatory environment policy could shift against foreign holdings in Chinese internet companies at any time. A full or partial buyout of foreign shareholders could insulate Tencent from that problem quickly.

What I think is more likely, and what I told Josh at TNW, is that the company will use the money to support expansion in two non-core but highly strategic areas of its business.

Fighting the China E-commerce War

First, the money will go to e-commerce. The company has already made a huge push into the area, and told analysts at the end of Q2 that it was planning on expanding its effort.

As Amazon discovered when it reached a certain point in its growth, to be truly competitive in e-commerce you need to make major investments in logistics infrastructure. That is especially the case here in China. Being an online e-commerce platform with lots of online bells and whistles is not enough: you have to support merchants and customers with a logistics infrastructure.

At the risk of getting too granular, Bill Schereck, who was the driving force behind the founding of Australia’s TV Shopping Network and its expansion across Asia in the 1990s, defined e-commerce logistics as the effort to surmount five challenges:

1. Get the signal to the customer (i.e., get your portal online, and get people to find it.

2. Get the customer to place an order.

3. Get the order to the customer.

4. Take the payment from the customer

5. Be able to take a return in a way that is both convenient for the customer and economical for the firm.

For Tencent, the first challenge is a matter of having a good website, and the second a matter of marketing and the quality of merchandise being sold.

In many parts of the world, the last three are easy. In certain parts of China, like the downtown areas of major coastal cities, this is all relatively simple, especially if scale is modest. But Tencent wants to sell to users in all of China, and it wants to scale to a point that is likely to exceed the capacity of locally-available package couriers. That is going to mean investments  well into the hundreds of millions of dollars, especially if they want to match Alibaba‘s Taobao.

Tencent’s leadership also understands that Taobao will not be standing still, and that to pass the market leader they will need to outpace Alibaba’s rate of investment, innovation, and improvements in customer service.

For these reasons, I suspect that if this new war-chest is allocated to capex and not buyouts, this is the largest direction that the allocation will take.

Tencent on the Street

The second direction is mobile. Tencent has made some excellent progress in this area with its Weixin/WeChat messaging service, which in its most recent iteration also incorporates much of the functionality of Instagram.

The challenge with mobile is that nobody has quite figured out how to turn a great mobile experience into revenue. People are using the services, but somehow the industry has yet to figure a way to get someone to pay for it all.

Tencent has the sheer mass of users, and it has them engaged not only in social media and chat, but most of the top online games as well. They need to create a mobile platform that replicates their PC experience, and I would wager that is where they are going to focus their efforts.

A case can be made that the future of mobile involves finding a way to mix three technical capabilities: fourth generation wireless broadband networks (4G); the ability to make web pages to essentially become powerful applications that is implicit in version 5 of HTML; and a new, slick version of rule set that governs how the web operates, IPv6. I know that might sound like a lot of technical hogwash, but together these three technical changes mean that the smart phones of the future may be web-based rather than based on apps running on a computer-like operating system.

If and when that change happens, it will give companies like Tencent a phenomenal degree of control over the experience they can offer on a mobile device, and, by extension, the things that they can do to turn that experience into cash. Tencent understands this, as does search giant Baidu, portal/socials Sina and Sohu, and e-commerce leader Alibaba. Each is investigating how to offer web-based mobile operating systems.

The stakes are immense for Tencent. If it can create an immersive, sticky mobile experience, it can tie that into its e-commerce infrastructure and bring both merchants and advertisers to its half-billion plus users via the mobile phone. This looks tiny now, but it could be what makes the difference between decline (as users shift from desktop to mobile) and dominance of mobile social media, mobile commerce, and mobile advertising in the country with the most mobile users of any in the world.

If that’s not worth taking out a little $600 million loan for, I’m not sure what is.

Update: Peter Schloss, who in over two decades in China has been in the middle of some of the most interesting and complex deals in the media and internet industries, makes an excellent point about why Tencent is doing this deal now. “Tencent was able to tap the markets at a good time for the company, and getting money was cheap,” Schloss noted. “They also wanted to break new ground for Chinese issuers.”

I think Peter offers a reasonable explanation for Tencent’s timing. I do not think the company intends for the money to sit idle, however, hence this post.

On Goldman’s Future in China

 

English: Logo of The Goldman Sachs Group, Inc....
Logo of The Goldman Sachs Group, Inc. (Photo credit: Wikipedia)

“Breakingviews: Goldman still on wrong side of China’s great wall”
John Foley

Reuters
August 21, 2012

John Foley quesitons whether Goldman Sachs‘ new leadership in China, coupled with a greater focus on offshore listings and cross-border mergers, will be enough to keep the firm’s business growing in China.

Maybe not, if that’s the full scope of the company’s prospects. I’m no particular fan of Goldman, but I suspect they are also looking to expand in two other business areas: listings of foreign companies in Chinese markets, and financing the stock buybacks that will help Chinese companies listed in the US to repatriate their equity.

Those are certainly growth areas, and Goldman is well positioned to capture a lot of that business. What is unclear is the degree to which such deals would face regulatory challenges. Both of these new business areas would have regulatory ramifications in China, if for no other reason than Chinese officials are uncomfortable with foreign companies in novel business lines.

Foley’s core point – that the company needs a regulatory point person, is thus at least half correct. Where practiced best, government relations is no longer a discrete function within companies in China. Rather, it is something that has to be a core competency of management at every level of the firm.

The challenge for Goldman’s new China leads, Mark Schwartz and Matthew Westerman, then, will be to address regulatory challenges proactively while trying to build deal flow. In this market, and at this point in China’s development, that’s a big ask. We’ll soon find out if Goldman sent the right team.

Fredrik Öqvist does some interesting reading of the VIE tea-leaves. The Ministry of Commerce, he suggests, doesn’t like VIEs very much, but they are less likely to outlaw them outright than slowly squeeze them so the structure becomes more headache than benefit.

Further Reading:

VIEs: The Long Resolution (siliconhutong.com)

Joining the Niall Ferguson Pile-On

Galvin Plaza, Wangjing, Beijing
Watching the wires
0931 hrs.

If you haven’t read James Fallows‘ thoughtful deconstruction of Harvard professor Niall Ferguson‘s partisan Newsweek cover story “Obama’s Gotta Go,” read it now, regardless of your political preferences. In the piece, Fallows details two areas where Ferguson has been wrong – or just polemical – about China.

For further reading on this vein, check out the view from the other side of Harvard Yard, Ross Terrill‘s “The Case for Selective Failure” in The Wilson Quarterly (registration required,) and my critique of his take on China’s historical and future competitiveness in Silicon Hutong,How the East Will Rise.”

There are great lessons to be learned from some of those who observe China from afar, not least from Fallows. But those who have genuine insights to offer have paid in time, blood, and treasure for their wisdom. Instant China experts like Ferguson (take scholar, add two weeks in Beijing and Shanghai luxury hotels meeting with assorted locals, stir, and pour into nearest editorial page) on the other hand, need to be consumed with the kind of caution one brings to boxed wine.

Chinese Want 3-D Movies, and They’ll Make Their Own

James Cameron speaking at 2010 TED Conference.
James Cameron speaking at 2010 TED Conference. (Photo credit: Wikipedia)

“U.S. Filmmakers Eager to Feed China’s Appetite for 3-D”
Jonathan Landreth

The New York Times
August 12, 2012

China has made few concessions to the U.S. in the effort to gain more access to Chinese audiences for Hollywood films of late, and no significant concessions since China’s accession to the WTO. Then, on a U.S. visit in February, Chinese Vice-President Xi Jinping told U.S. Vice-President Joe Biden that 14 additional films would be allowed into China each year. The catch: they had to be either 3-D or IMAX pictures.

The reasoning behind this concession is not hard to surmise: the number of Chinese cinema screens has leapt to 11,000 screens after languishing for over a decade at around 3,000 screens. Why the boom? Simple: China’s hyperactive real estate developers have begun including cinemas in their commercial, retail, and mixed-use complexes throughout China’s 600 cities. Cinemas, apparently, attract the kind of foot traffic that supports retail business. Those developers wield considerable political influence, and they want more foreign films because in order to fill the seats.

Across the proverbial table are the party ideologues and China’s own film production industry whom, after decades of effort, are just starting to see Chinese going to the cinema in droves, and increasingly to see Chinese films. They don’t want to give it all away just as they’re capturing the market.

Enter 3-D.

There are over 7,000 screens in China that are 3-D capable, yet only a tiny number of Chinese films produced each year can take advantage of that additional investment. For the government to allow access to 3-D films was almost cost-free: it made the developers happy without upsetting the film industry.

This is going to be a good thing for Hollywood as well, but we must hope that the MPAA was not expecting any further 3-D slots beyond what has already been granted. Any hope of that was dashed last week by none other than James Cameron.

Mr. Cameron, the mercurial director of “Terminator,” “Titanic,” and “Avatar,” announced on August 8th that it would set up a joint venture with the Tianjin government to produce 3-D films and television content. In short, Mr. Cameron proposes to teach Chinese filmmakers how to make 3-D content of their own.

As I’ve noted before, China’s goal is neither to partner with the U.S. in the movie business, nor focus exclusively on its large and growing home market. China – and by that I mean not only China’s film industry but also the central government and the Communist Party – has every intention of competing with the U.S. and European film industries globally and, if possible, beating them. It is only realistic to see any partnerships with and concessions to Hollywood in the light of that effort.

One hopes Mr. Cameron understands his role in The Big Picture: China will happily use the Cameron Pace Group as a means to learn how to make fantastic 3-D content. Once that is done, Chinese 3-D filmmakers will not only be able to fill the growing number of 3-D cinemas at home, they’ll come gunning for Hollywood in its own increasingly-essential overseas markets. Cameron Pace may make a lot of money, or it may not. It will certainly make a competitor for Hollywood in 3-D.

Mr. Cameron may not mind: he’s near enough to the end of his storied career not to care. At the same time, you have to wonder how the students at NYU, USC, and the Directors Guild might feel about it.

The New Public Affairs

Enroute HND – PEK
Dodging thunderstorms
0811 hrs.

A lot of the talk in the public relations industry relates to how much the media business is changing, and what that means to a craft that has traditionally placed a heavy emphasis on informing and (hopefully) influencing journalists. That focus remains viable in markets like China and India, where the media – especially traditional media – retain tremendous influence. In places like America and in Europe, that influence is in decline.

One aspect of public relations that is going through a huge change, however, is what we like to call public affairs. Despite a racy name that implies exhibitionistic behavior, public affairs is the term applied to the craft of understanding the government decision process and effectively influencing policy on behalf of a company or organization.

Whether through direct lobbying or indirect communications, the idea of a company or a special interest group influencing policy does not go down well among the citizens of free and open societies. Events of the past several years have cast this process as a bit underhanded, and perhaps nefarious, and much of the reason for that is that the practice of public affairs was formed at a time where some degree of behind-the-scenes sausage-making was expected in governance. A lot of people simply didn’t want to know about the ugly process, they were interested in the result.

But in the wake of two economic downdrafts in the past decade, alleged commercial-governmental collusion on a vast scale, the failure of regulatory institutions to act in the public benefit (particularly in the US and Europe), and growing public expectations of procedural transparency (thank you, Internet), the process of governance is now a public sport. Public affairs, as practiced, has to catch up. Discretion is no longer the better part of valor: it is suspect.

Updating this practice is going to demand some radical steps and a lot of discussion. In order to start the process, I suggest we alter our approach to government relations worldwide to conform to the following guidelines:

1. Transparency to the greatest possible extent. This means standing up in public and telling the world exactly what you are telling the government, and why. The agenda must be in the clear and open to both scrutiny and debate, as should be the tactical approach the company is taking. This also means that public affairs becomes more than a matter of speaking to government officials about company input on policy: it means involving the public as well.

2. Behavior and actions that withstand public scrutiny. The public is going to find out what you are doing to influence the process. Just ask Big Tobacco, Big Oil, Enron, and the Nuclear Power industry. In addition to making clear what you intend to do, conduct yourself in the process as if an overweight socialist documentary filmmaker from Detroit was following you around with a camera. Forget chummy dinners and back-room deals. When you are influencing public policy, you are going about the public business, and you need to behave accordingly.

3. Avoid behavior for which others have received opprobrium or censure. If someone else has done it before and gotten in trouble for it, why are you taking the risk?

4. Stop playing moneyball politics. Yes, the Citizens United decision in the United States has given corporations an unprecedented opportunity to influence the political process with money, and the opportunity for money or favors to influence the process exists in nearly every market in the world. Don’t do it. Let me say that again: don’t do it. Just because something is permissible doesn’t make it right in the eyes of your publics. The more you use money to influence the process, the more liability you are building in the bank of public opinion, and in each market a reckoning will come, rest assured. Find another way that does not hang a sword over your company’s head.

5. All of this means you will have to create a new set of tactics and techniques for conducting government relations. The way to start the process is to find a way to align your interests with those of the public at large, and keep them there. This will not be easy, but we have ample examples in the history of business to prove that it is not only possible, it is the best way to do business.

Let the discussion begin.

China and the Glocal Mix

Enroute LAX – HND
Looking forward to a day in Tokyo
1500 hrs.

There are two basic schools of thought on marketing best practices in China. One school, the Exceptionalists, holds that China is such a unique place that there is little or nothing of value to be learned from overseas experts, academics, or practitioners about the marketing crafts that is applicable here. Only practices that are home-grown and developed with long local experience and a deep understanding of the Chinese culture can ever hope to succeed.

The other school, the Integrationists, holds that China is basically like any other market, just not quite as far along in its development. You may not be able to pull the latest marketing books off of the shelves at Barnes & Noble in New York and apply the recommendations here, but China is pretty much like the U.S. was 10, 20, or 30 years ago. (One member of this school of thought actually said that Chinese advertising agencies bore spooky resemblance to the HBO Miniseries Mad Men.)

I have been to both schools, and I have wound up as what I would call an Experimentalist. I believe that effective marketing in China comes from a combination of global best practices and locally-specific, highly relevant tactics and techniques. Let’s call this the Glocal Mix.

Marketing Mixology

If that seems like a no-brainer, think again. The challenge is that there is no viable formula for how to strike this balance. Not only does the Glocal Mix vary from company to company and sometimes from product to product, but also the given Glocal Mix of a product changes over time as new tools are introduced, old ones lose effectiveness, and the media mix changes.

The most obvious issues with a global approach come in social media. Facebook pages are de riguer for companies around the world, but they don’t work in China for obvious reasons. Simply “localizing” the tactic by taking pages on social media site Renren.com will not garner comparable results, if for no other reason than differences in how people in China use social media, and how much those people have to spend. A year from now, however, this might not be the case.

Engaging bloggers is less effective in China than elsewhere as well, because with a few notable exceptions, blogs play a lesser role in shaping opinions than, say, online forums, QQ, or microblogs. Yet changes in China’s political landscape, and the growing willingness of China’s online “opinion platforms” to actively manage the conversations could well change that. When public discourse is controlled, private platforms get precedence, and it will be the voices who can master tools like WordPress.org who will retain their influence.

The Geek and the Chic

But for those industries where customers around the world share many of the same concerns, lifestyles, and habits (and indeed often directly influence each other), the Glocal Mix tends to be more global. Early adopters of technology and luxury products are prime examples.

Technology early adopters are a part of a global subculture, so much so that buying habits and priorities are often more similar between, say, an early adopter in China and his Korean counterpart than between the Chinese early adopter and his less technically-oriented next-door neighbor. This phenomenon is not restricted to hardware: games tend to make the leap among global early adopters faster than they leak into the general populations of any country.

Luxury early adopters also share a global sub-culture. It would be trite and simplistic to think of this as the global “jet-set,” because the crossover in relationships is limited to the pinnacle consumers in the group, but the similarities in culture are notable: Hong Kong society types may not mix with their counterparts in Paris, Beverly Hills, or the Hamptons, but the toolkits to reach the women waiting for the next LV purse or the men waiting for the next Breitling watch are remarkably similar.

The challenge in selling to the global early adopters is the same for each group: finding the global mix early, and executing simultaneously worldwide.

Once the early adopters are on board, however, companies find that the tactics and approaches need to change in order to reach into the wider market. This is where local focus comes into the mix. Culturally specific, locally-relevant approaches become essential.

Meet the Glocal Team

Operationally, this means that rather than fighting over who owns the campaign design and strategy function among local and global marketing teams, the answer is more nuanced. For those companies, products, and campaigns that depend on an initial bump from early adopters or from markets where there is a high degree of cultural commonality across geographies, global marketing teams create the master plan and strategy, and local teams localize (in coordination with global) and then oversee execution.

For those products or campaigns that seek to leap into wider, even mass markets, the strategy, messages, creative, and execution all need to be developed in market, sharing as much commonality with the global campaign as possible, but not shackled to it. This is the point where considerable autonomy must be granted to local marketing teams.

The challenge for the CMO and his direct reports is to come up with a shared view of the nature of the global market. Is there a global sub-culture that would allow for a more global approach? Or is it necessary to reach a culturally distinct audience in each market, and thus decentralize campaign planning. Regardless of company, this is the essential step, and it can be the most difficult of all.

Being Experimental

Once that agreement is reached, however, focus should be off of massive annual marketing plans and onto highly flexible teams (including agencies) working from clear, measurable, and consistent objectives. Strategies should be in flux as the nature of the market changes and as competitors respond to campaigns.

The idea of committing to yearlong media buys and marketing commitments is passe, especially with both the media landscape and the global economy in a state of flux. Experimentation (in the form of rapid measure-analyze-strategize-execute cycles) takes precedence over research and commitments, and diverse toolkits made up of global and local approaches, tactics, and techniques become more valuable than Big Bang marketing.

This will all be brutally difficult for companies used to more traditional marketing practices. Those who can master it, however, will turn marketing from a cost center into a genuine competitive advantage.