China Business Blog and Podcast

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In our last Podcast, I had a conversation with Steve Crandall, Vice President in charge of Implementation Services here at Technomic Asia.  We talked about how important people are to a winning China strategy … how to look for them, recruit them, train them and keep them.  After we were done recording it, I asked Steve if he thought that maybe we were being too “basic” … that this was stuff that people already know.  He said, “People might know this stuff, but its always good to be reminded of it … knowing and doing are two different things.”

Well, it turns out that Steve was right … because since we posted that Podcast, we have had LOTS of comments on how useful the information was and how important it was to revisit the basics.  So to that end, we are going to go “back to the basics” again in terms of thinking about China and building your China strategy.  This is particularly critical during these times in the corporate business planning cycle … the silly season where bold strategies are considered and aggressive plans developed.  And China – given its centrality to most global business plans – is susceptible to such ridiculous hopes, dreams and schemes.  So let’s go “back to the future”, if you will, and think about our China strategies from the beginning.

Click on the links to listen to today’s Podcast …

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Following is part two of my interview with Steve Crandall, VP for Technomic Asia in charge of our small- and mid-sized enterprise (SME) practice.  Today we focus on the importance of hiring and retaining the right people in your China operations.

Steve Ganster, managing partner of Technomic Asia is a frequent speaker around the world contributing to the discussion about business strategies for China. Yesterday, he presented to a Chamber of Commerce event in Memphis, a city accustomed to international business being the headquarters for FedEX and witnessing rapid growth in exports to China.

Ganster’s comments about how businesses can “China-fy”, a termed coined by Ganster, centered on the importance of long term engagement with the country, its economy and culture. The Memphis Commercial Appeal article reported others on the panel and the audience agreed with the tenets of Ganster’s concept. Ganster has seen many strategies come and go in his nearly three decades analyzing China’s economic and political journey.

Ganster shares his perspectives about developing sound business strategies for the China market in the book The China Ready Company. The book’s co-author Kent Kedl provides ongoing commentary on the China Business Podcast.

Kent Kedl, general manager of Technomic Asia was quoted in USA Today an article entitled “U.S. companies turn to China, other Asian nations, for growth”. The story focused on the only region of the global for growth being Asia, many companies are looking to how they can get in on that trend line.

Kent is a frequent contributor to articles and reporters’ background research. Kent can be heard on the China Business Podcast.

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Here on the China Business Blog and Podcast, we focus on being very logical and very practical … at least as logical and practical as China allows one to be.  Over the 25 years we have been working in China, we’ve seen a lot of experimentation, trying this and that to see what works.  We’ve even done a fair amount of it ourselves … and that’s fine for many multinational companies with deep pockets who can afford to try this and, if it doesn’t work, try that.

However, there is a group of companies for which this experimentation approach doesn’t always work so well … the Small- and Mid-sized Enterprise or as they are commonly referred to, the SMEs.  And that is the theme for a new series here on the China Business Podcast – The SME.

To discuss this topic with me, we are going to bring in the newest member of the Technomic Asia team, Steve Crandall, who recently joined us as Vice President in our Implementation practice.  We have been seeing a need lately to increase our capabilities in helping our clients execute their organic strategies in China – setting up manufacturing, hiring, establishing sales teams and pipelines, executing a sourcing strategy etc.  Steve comes to us with a long history in China, starting in the 1980s when he was a student here.  Steve went on to set up the first foreign owned car dealership in China when he set up Crandall Ford up in Tianjin (Steve comes from several generations of Ford dealers back in Ohio).  He then went on to start up several manufacturing and sales operations for SMEs in China, incubating them until the client was ready to take over.  After a stint at Ernst and Young where he had to wear a tie to work everyday, he came to join us.  Steve has been a good friend for a number of years and we are thrilled to have him in the Technomic Asia family.

There is no standard definition of the SME, just as there is no standard definition of the Multinational Corporation, or MNC.  However, generally, the SMEs are defined by their size – less than 500 employees – and their ownership – privately held or invested by a private equity company or other financial backer.  Now I’m sure I’m going to get some letters about this … because some subsidiaries of MNCs essentially have to stand on their own and really act like SMEs.  As my teenagers say: “Whatever!”  The key commonality here is that an SME is facing the same challenges in China as any other company here but they often have less global experience to work from and they typically do not have such deep pockets to do a lot of experimentation.  They have to get it right the first time.

Over the coming weeks, we are going to explore some issues that impact SMEs in unique ways such as HR, manufacturing, sales, operations, etc.  You will be hearing many of the same themes that we’ve been hitting for years here on the China Business Podcast … but we will be discussing them as they impact the SME and will explore several unique ways that we’ve seen SMEs handle these issues.

We begin the series today with the age-old issue of market opportunity …

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I am going to start this post out with a warning: in the world of global economic intrigue and gamesmanship, the following ranks rather low on the excitement scale … but on June 22nd, China announced that it would scrap the export tax rebate it gives to China producers of 406 categories of export products.  These products include steel, non-ferrous metals, fertilizers, chemicals, plastics, rubber, and glass.  This was the first adjustment in the export tax rebate since July 2009, when it was increased as part of China’s stimulus program.

Now I know that, for most of you, the phrase “export tax rebate” doesn’t send a thrilling chill down your spine … and if it DOES, then maybe you need to get out more.  But we think that there is something deeper here that is worth exploring just a bit further.

This policy announcement is coming at an interesting time.  The communication between the U.S. and China on the global economy and the RMB valuation has had more passive-aggressive subtext than a Midwestern family Thanksgiving – “PLEASE pass the SALT, DEAR!!” – so one rather hoped that any move by China would be attempt to alleviate some of the stress … as in “Please ADJUST your RMB rate, DEAR!!”.  However, at first blush, there is not a huge material impact to the trade imbalance as the policy change is not expected to make a major dent in exports, since it affects only $11 billion in exports, or about 1% of the total.

However, we think that the importance of this policy change goes beyond any material impact.  We think that China is trying to telegraph some very specific messages to two constituencies: the international community and its own people.

First of all, the Chinese government is signaling to its own domestic manufacturers that it wants them to curb overcapacity, move up the value chain, and turn away from the export-driven model of growth.  In this new policy, the government has focused on the environmental benefits of discouraging the production and export of these 406 products, which are highly energy-intensive and polluting, thereby scoring a point with the Greens, both domestic and international.  Lower production will save energy and reduce greenhouse emissions, in line with China’s stated promise of reducing energy consumption per unit of GDP by 20% from 2005 to 2010.  Again, this move is not going to get China all the way to environmentally friendly heaven, but it’s a step in the right direction.

At the same time, this move is a response to recent global pressures on the RMB and non-tariff trade barriers, trying to get China to be an engine of global recovery, rather than continuing its export-driven model.  Europe and the US are trying to export their way to recovery, so someone’s exports have got to go down.  By partially eliminating the export rebate, in line with RMB revaluation, China can better claim that it’s pulling its weight globally.  Given that this is a partial rollback of the stimulus package, China can also claim that it’s dealing with stimulus-induced preferences for domestic industry, further reducing what some say is over-investment by the Chinese government in their own infrastructure which has led to an over-inflation of China’s GDP growth.  So that’s quieting 4 squawking birds of international conscience with one stone of administrative action … not bad at all.  The tortured metaphor of that last sentence does not give enough Kudos to China for this move … China is definitely starting to understand that, for its policy changes to have impact, symbolism – properly spun – can have more power than substance in the world of international diplomacy.

However, of the two possible audiences for this move – internal and external – we fall on the side of this being a stronger message to its own domestic producers, an encouragement to move up the value-chain and pursue domestic innovation, not just be the manufacturer for the world.  Steel is a good example.  48 of the 406 affected products are made, at least in part, from steel that, until this action, had enjoyed a 9 percent rebate.  Steel exports from China have grown 127% year-on-year, and 266% alone just this past May.  However, along with this growth have been the installation of new steel-making facilities in China … despite a general ban on adding more capacity, Chinese companies found a way to build 40 new steel plants in this past year.  This has resulted in the overproduction of low value-added steel which means that China’s steel industry profits have come almost entirely from the 9% rebate.

But this new ruling makes a fine distinction between the two types of steel products. The rebate on the commodity steel goes away but the higher value-added steel products such as cold-rolled and galvanized steel – which many US buyers are more interested in anyway – still enjoy a 13% export rebate.  So, by getting rid of only the rebates on low-valued added products, the government is sending a signal to the domestic industry: “Start moving up the value chain, and stop building so bloody much capacity.  Move away from the low-cost export model and start innovating.”

After over 20 years of concerted effort on building their economy through exports, China is going to take awhile to turn this ship around.  In other words, China is not going to becoming a domestically-driven (and particularly a consumer-driven) economy any time soon … I don’t even think the next 20 years is going to get them there.  But bit by bit, they are moving that direction … and this recent policy change is one of those bits.  And keep your eyes and ears open for future policy announcements … more and more you are going to see the double purposes behind policy changes as China navigates the dangerous waters between both the internal and external constituencies most impacted by such changes.

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I’ve been hearing from listeners that our last post cut out in the middle of the Podcast.  Sorry ’bout that!

Here is the re-post.  If you still find trouble, please email me at kkedl@technomicasia.com

Thanks!

Kent

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I would like to begin this post with an apology … its been awhile since we checked in here on the China Business Blog and Podcast!  Thankfully, it seems we have not been forgotten as we’ve received many notes from loyal listeners asking how we are doing … if everything is ok.  I can assure you that, yes, things are just fine here in Shanghai, China … in fact, its because things are going so well that I just have not had the time to get these Podcasts recorded and posted.

We’ve been working on a series of discussions on mergers and acquisitions in China with Dr. Kim Woodard, one of the leaders of Technomic Asia’s M&A practice here in China, and we are continuing that today.  It is appropriate that one of the reasons we’ve been so busy lately is that we’ve seen a big upswing in M&A activity for clients here in China … lots of strategy development and target identification, the early stages of an M&A program.

Well, today, we are going to talk about a stage of the M&A process that, we believe, is unique in China – we call it “deal cultivation”.   Remember that we’ve been talking about the relatively “young” market for M&A in China … we are still in our first generation of doing deals here and there is not a lot of experience floating around.  Therefore, it is critical that we help bring the Chinese companies along in the process, helping them feel OK about it while, at the same time, doing what we call “discovery” – finding out as much about the target as we can ahead of the more formal legal and financial due diligence process.

I started today’s conversation with Kim by asking him about deal cultivation and why it is so critical in China…

Item from today’s Bloomberg – “China’s property market is a bubble that may burst by as early as this year, according to hedge fund manager James Chanos.” According to Chanos, this will put China’s economy, “on a treadmill to hell…” when the real estate bubble bursts later this year or sometime in 2011.

This Bloomberg report on Chanos’ comments is the latest prognostication on China’s property bubble from a respected Wall Street financial guru. The article cites supporting forecasts from Mark Faber and Kenneth Rogoff, also highly respected financial economists who were on the right side regarding the U.S. economic meltdown. We have actually heard this forecast for China before and you will see more items like this in the U.S. business media over the next few months. Even Charles Evans, the unflappable president of the Chicago Fed, raised a question about China’s property bubble when he recently visited Shanghai and Beijing.

It is absolutely true that (1) residential property prices in major urban centers have more than doubled in the last couple of years and (2) the recovery in China was driven by massive bank lending (some US$1.5 trillion in 2009) that was largely soaked up into the property sector. High-end residential real estate prices in Shanghai jumped 60% in 2009 alone. Average residential real estate prices were up 10% year-on-year in February 2010. Furthermore, Chanos is also correct that China’s still hot economic growth is primarily driven by investment, not consumption. Investment is well over 50% of GDP, certainly the highest investment/GDP ratio in the world for major economies. To kick the economy back up to speed, Beijing just slammed the investment pedal to the metal once again, injecting massive liquidity through the State-owned banking system last year, in addition to the $585 billion Chinese stimulus program.

However, I do not buy the forecast that there will be a sudden real estate price deflation, particularly in residential property prices. The government routinely manipulates property price levels, using transaction taxes and access to bank lending to either stimulate or cool the property market. Right now, we are in a cooling phase, with the government raising real estate sales and business taxes, doubling mortgage down payment requirements, and dampening speculative buying dampened with local rules limiting the number of apartments that can be purchased by a single owner. But the government can just as easily reverse these levers, as it did in 2008 when property prices briefly showed negative growth.

Chanos and the other pundits who expect a property market crash in China have missed the invisible elephant in China’s “socialist market economy.” The simple fact of the matter is that there are about 10 million active Communist Party members who control the government, the banks, the State-owned sector, land allocation and development, and many other elements of the economy. Guess what – they are all residential property owners, in many cases of multiple residential properties and in some cases of commercial property! The levers of political and economic power are in the hands of the same relatively small group that benefits from rising, or at least stable, real estate prices. They will continue to pull those levers in a way that maintains the value of their assets. They would lose substantial personal wealth from a sharp decline in the residential property market. Given low bank interest rates and highly volatile domestic stock exchanges, real estate is the primary reservoir of personal wealth.

This is why urban real estate prices in China appear to defy the laws of economic gravity and will probably continue to do so for the foreseeable future. There is more potential volatility in commercial property prices than in residential prices, but this volatility will be largely local in nature and will depend on the supply/demand situation in different urban areas. China has a real estate market that is driven by the lack of other personal investment opportunities and that is controlled within parameters that are set by the same people that own the assets. That is a market reality that will not change later this year or sometime in 2011.

I tell you … things are pretty touchy around China these days with respect to U.S. and China business relations. I don’t think I have seen such a sensitive environment since my boy scout troupe accidentally marched through a huge patch of poison ivy (thereby simultaneously losing our merit badges AND giving ourselves a week of pain!). What with Google, Rio Tinto and the threat of the “indigenous innovation policy” on the horizon, it seems that western companies here are getting up in arms about “fair treatment” from China.

So I thought I’d add my two cents … and where else to put in such a paltry amount than on National Public Radio?? Here is a link to a commentary I did that aired on Monday in the U.S.

This ain’t over … there is LOTS more to come.  Stand by for further updates from the front.