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2008-05-09 | All chapters

Innovation Nation
Venessa Wong, European Business, CNBC, May 2008

The days of profiting from cheap exports in China are ending, but there are still plenty of opportunities to be had if you approach the market with a fresh vision. Venessa Wong reports.

No matter how many product recalls, corruption scandals and trade disputes emerge from China, corporate managers can't seem to walk away from this alluring market. Even at this stage – 30 years after China opened its doors to foreign trade – new opportunities are brewing.

For Mika Heikinheimo, founder of Finnish IT services company Flander, opportunity came in the form of mobile software services. Just eight years after opening, Flander came to the People's Republic of China in September 2005. Heikinheimo quickly made China a core element in his company's growth plan, with the number of software professionals in its Beijing office jumping from five to 110 in one year. "I do not see cooling in the short run," says Heikinheimo, who now serves as managing director for Flander China. The firm expects Chinese revenue to grow by 100%, compared to 30% globally, and will open another site this year.

Heikinheimo is certainly not alone in having big hopes for China. Over the past two decades, thousands of companies have made their fortunes here, where GDP last year expanded by 11.4%. Heavyweights across industries are doing tremendous business: for 2007, Heidrick & Struggles reported Chinese revenues of €14m, Novartis China earned €220m, and Siemens ended the year with a jaw-dropping €5.2bn.

A good portion of foreign business in China is new. According to the 2007 Business Confidence Survey, conducted by the European Union Chamber of Commerce in China (EUCCC), 50% of EU investment into China has occurred over the past five years, with foreign direct investment stock reaching €35bn in 2006. Respondents in the Chamber's survey almost unanimously believe their business sectors will enjoy further growth. EUCCC Secretary General Michael O'Sullivan says their optimism "is mostly based on the continuing fast pace of China’s economic development and the resulting growth in domestic consumption."

While fairy-tale success is tempting, Charles-Edouard Bouée, managing director in China for Roland Berger Strategy Consultants, says managers looking at China must stay focused. "Look to see if China really wants you," he advises.

So the question, naturally, is: What does China want? Today, as the country begins to move away from cheap exports, prospects are improving for companies in the innovation industries. Among the pillars set by central government in the 11th Five Year Guideline (2006-2010) is the development of high-tech capability, building an environmentally sustainable economy and enhancing quality of life for China's 1.3 billion citizens. President Hu Jintao hopes to transform the country into an "innovationoriented" economy by 2020 to improve its long-term competitiveness. Incentives such as preferential tax rates are being provided to companies involved in the environmental protection, high-tech and venture capital fields to support these initiatives.

"To compete on cost and expect to win in China is a very unlikely scenario," says Steven Ganster, managing director of Technomic Asia and author of The China Ready Company. This is especially true as a stronger renminbi and rising production costs squeeze margins.

China is no longer just looking for investment; it now wants to ensure that any foreign investment will help the domestic economy and not merely translate into low-cost exports. Companies must have a solid "value proposition," Ganster says. "This means they have to bring something of value and differentiation to the game. For small- to mid-size firms this often means technology, a strong brand and attractive customer base."

Among the strongest value propositions is technology transfer, and European companies are playing a vital role. China imported €6.56bn-worth of technology from the EU in 2006, nearly 40% of global technology transfer that year, says EUCCC. Within the Chinese market, European enterprises have already positioned themselves as leaders in China's petrochemicals, telecoms, finance, insurance, pharmaceuticals, retail and environmental industries.

"The Chinese government encourages cooperation, joint efforts and knowledge-sharing between foreign companies and local companies and communities," comments Jiang Weiming, president of Dutch biotechnology and life sciences company DSM China. The company, which recorded €613m in revenue last year, has been actively seeking cooperation with local businesses and education and research institutions. It has already set up a research and development centre and a joint lab with Fudan University, one of China's most prestigious universities. "Establishing this R&D footprint in China gives us the opportunity to better integrate with China's science and technology community and become embedded with the Chinese business value chain," says Jiang Weiming.

R&D is not the only thing China is after. French industrial services company SUEZ Environment aims to add value by "bringing innovative technology and management experience that improves the welfare of people, protects the environment and contributes to sustainable development." A subsidiary, Sino-French Water Development, provides drinking water and sewage treatment services to more than 13.5 million residents across China; its second subsidiary, Swire SITA operates a hazardous waste incineration plant at Shanghai Chemical Industry Park that is "a pioneer for China in terms of size and technology, meeting EU emission standards." If China demonstrates a continued need for its services – which it surely will – SUEZ's outlook for China should be quite positive. Frédéric Grivel, executive director of SUEZ Environment China and general manager of SCIP Swire SITA Waste Services Co, says that the changes taking place in China "are going in the right direction for us."

Meanwhile, hordes of other players such as Veolia, Airbus, BP, Sanofi-Aventis, Ericsson and Philips are aligning their efforts to develop solutions in the energy, environment, transportation, pharmaceutical and high-tech industries for the China market.

These industry giants clearly benefit from having resources and funding, but fortunately for managers of small- to medium-sized enterprises (SMEs), which account for 99% of all firms in the EU, opportunity is not merely reserved for big players. There are a rising number of European SMEs in China. Leaders on both sides recognise their role in supporting economic growth and are working to improve market access. The European Directorate-General for Enterprise and Industry and China's National Development and Reform Commission signed a memorandum of understanding in 2006 to open policy dialogue to promote cooperation between EU and Chinese SMEs. In a symbolic move, China designated a preferential tax rate for small foreign companies in the new tax law, which eliminated many incentives used to attract overseas investment when it took effect this year.

As the overall environment for foreign business improves and emerging inland markets liberalise, more doors will open for investors throughout the country. Transparency and regulatory enforcement are already decent in developed cities such as Shanghai and Beijing and the momentum is spreading to new business hubs such as Qingdao, Chongqing and Chengdu.

Succeeding in such a rapidly expanding market may seem foolproof, but the Business Confidence Survey shows that over 40% of companies "have lower than average profitability in China" and the share of respondents in the red actually increased from 23% the previous year to 28%. Clearly, not every company is living the Chinese fairy tale.

Problems begin when the business objective is not clearly defined. Ganster says doing business in China remains "complex and risky, so management needs rigorous validation of its reasons to invest." Enterprises must first answer two questions, according to Bouée: What is my strategic advantage and what is my brand perception in China? "Don't go to China if you don't know how to make a profit," he says. No matter how hot the opportunities may seem, "you need to have the right business model."

Unfortunately, many fail to do adequate homework before plunging into the market, especially when it comes to partner assessment and due diligence, says Ganster. This leads to significant problems later on – an example being the failed joint venture of Peugeot and Guangzhou Automobile Group, which collapsed in 1997 due to conflicts between the partners.

To avoid such disasters, management must look at its resources in terms of operations, management team and financials. This means sending "the best and the brightest" to China, says Per Jenster, professor of management at China Europe International Business School. In such a high-potential yet high-risk environment, managers need good leadership skills, a keen understanding of how business is done and the flexibility to localise their approach. Moreover, they should have significant international experience under their belts to survive in this unpredictable market. In other words: "You can't date China. You have to marry it," says Robert Watson, father of the LEED green building standard and founder, chairman and CEO of green building services firm EcoTech International. His advice for those looking to sell to the Chinese market: be patient. Entrepreneurs coming with riches in mind will be disappointed initially – the first few years will likely be lean – although Watson reassures managers that "China rewards loyalty."

In addition to strategy issues, managers also cite unclear regulations, bureaucracy and poor protection of intellectual property rights (IPR) as major problems. "Companies whose business is IPR-dependent should also take extensive pre-emptive action to protect their IPR before starting business," suggests O'Sullivan, such as local registration of their trademarks. Yet, for Steve Clark, executive director of SUEZ Environment China and Sino-French Holdings, the big challenges today are human resources and rising competition. Clark is certainly not alone in having these concerns.

In the Business Confidence Survey, more than 70% of respondents said they had had difficulties retaining qualified managers. SUEZ’s Grivel says: "Technology is one thing … but without proper experience and know-how there is nothing." While companies are currently sending managers from overseas to fill senior positions, this is both expensive and unsustainable as business localises. There is also the added problem of retaining staff. Chinese employees are moving from one company to the next for pay rises and promotions. A first quarter report for 2008 by HR services firm Hudson finds that China's average turnover is over 10%, the highest in Asia, and wages are rising sharply.

To cope with the HR crisis, SUEZ is recruiting from local universities and offering in-house training for locally hired managers and staff. As for retention, firms are developing comprehensive compensation and benefits packages and providing employees with attractive opportunities for career progression.

The difficulties do not stop there. Managers also have to deal with the intensifying competition from domestic companies. During their struggle to gain market access over the past few years, many Chinese companies have pursued an "intense improvement agenda" and are now equipped with better technology and high quality products, says Jenster.

Chinese brands are also quickly expanding their market share overseas. After all, opportunity is a twoway street. China's exports to the EU jumped by 21% in 2006 and brands such as Lenovo and Huawei are gaining credibility around the world. To ensure that strategic markets both in China and back home are not neglected, managers must develop a clear global vision.

As China matures, opportunities and challenges are becoming more complicated. Building a global brand means realising which opportunities are real, which are diminishing and which are fairy tales. One thing is certain: China wants innovative solutions to sustain economic development for years to come. For those with the right strategy and enough determination, New China is still an open playing field.

Source: http://www.cnbceb.com/Articles/2008/May/42/make-money-in-china.aspx