SOEs in China today – Not your Grandfather’s State Owned Enterprises any more!
November 26th, 2009 by Kent KedlDownload this podcast
Length – 6:43
Those who have been doing business in China for awhile are quite familiar with the differences between the State-Owned Enterprises (SOEs) and the Privately-Owned Enterprises (POEs). For those of you not familiar with this distinction, let me break it down for you. The POEs are just that, companies owned privately with little or no government involvement – they are often run by business-savvy executives with global business experience. The SOEs, to put it succinctly, are seen as hulking, unprofitable behemoths chocked full of aging assets and run by 55 year old Party hacks in moth-eaten Mao suits and greasy comb-overs. OK … maybe I am being a bit too hard on them, but the term “SOE” has been used as a pejorative descriptor more often that not.
After Liberation in 1949, the Chinese Communist Party brought all businesses under their control and POEs were, for all intents and purposes, completely eliminated in China (as was nearly all foreign investment when they were unceremoniously kicked out of China). Through a series of disastrous events in the 50s through the 70s (the Great Leap Forward, the Cultural Revolution, etc.), the government proved that, not unlike their Soviet cousins, they were terrible CEOs – factories were inefficient, poorly run and churned out bad-quality junk that had no relationship to any market demands whatsoever. That wasn’t as bad as it seemed because China retail and commercial trade was not yet standardized so bad products were also hard to purchase. Go figure.
One of the many reforms that the Deng Xiao-ping administration started in the early 80s was captured under the Party phrase 民进国退 (min2 jin4 guo3 tui4): “POEs will advance; SOEs will retreat.” What this meant, in effect, was that the Party wanted to get out of the business of being in business and started the long, mind-numbing, ulcer-inducing process of unwinding the complicated SOE culture … which included, for many people, guaranteed housing, education and healthcare.
Fast forward to the mid-2000s and you begin to see private Chinese companies really moving the market. Thanks to China’s joining the WTO in the early part of this century, various sectors in the China market were opened to foreign investment, particularly retail and distribution/logistics. This led to further (and more rapid) modernization of China’s business environment and it looked as if the SOEs were going to go the way of the dinosaur, only to be studied by business anthropologists who dug up their jerry-rigged balance sheets and padded expense accounts.
But don’t count the SOEs down for good … we see that there might be life in these old war horses yet, in part because the Chinese government and the Party (one in the same thing here) sees some advantages to keeping their fingers in the business world, particularly in areas that have remained the jurisdiction of the government such as automotive, oil & gas, media, etc. Not to over-simplify things but these SOEs have two unique competitive advantages over their foreign competitors: first, the SOEs are not held to strict growth and profitability metrics and are encouraged by the State to get as big as possible, regardless of margin targets; and second, the government makes available an almost unlimited stock of growth capital through forced lending from the State-controlled banks. Imagine if you, as a business executive, were told by your shareholders, “OK … here is the deal – we want you to grow this company. Don’t worry about profits, just bring in the revenue … we have ways of dealing with the P&L. And when you need money, just ask. We’ve got plenty.” Sounds like a dream scenario, right?
Well, it seems to be working and we are seeing a surge in some of these SOEs – in automotive, the so-called “Big Four” (First Auto Works, Shanghai Automotive, Dongfeng and Changan) are on a consolidation tear, encouraged by the government to acquire smaller, regional automotive companies, much like GM, Chrysler and Ford did in the early days of the U.S. auto industry. The Chinese oil, gas and mining giants are actively looking outside of China for investment and, though they have been rebuffed by some foreign governments, are slowing expanding their global footprint. Several of the larger SOE construction equipment companies are aggressively expanding, both inside and outside of China (as a side note, some say that this is why Carlyle’s acquisition attempt of construction giant XCMG did not go through last year … that the government wanted to maintain control in what they saw as a very strategic industry). All of these SOEs – and many more besides – benefit from very easy capital lending requirements from State-run banks.
A recent article in the New York Times highlighted the pressures that Chinese banks are under to insure that they keep their lending capital accounts well-stocked and rumors are flying around China that the government is requiring China banks to raise their capital adequacy ratios. Some might see this as a slowing down of lending. However, I interpret it as just the opposite: the government wants the Chinese banks to keep good reserves of dry powder to be able to lend to those, predominantly, SOE companies that need growth capital. It’s a “go slow to go fast” strategy if there ever was one.
All of this has led to private chats over dinners and drinks all over China that the government is trying to reverse their dictum of the 80s and say, rather, 国进民退 (guo3 jin4 min2 tui4): “SOEs will advance and POEs will retreat.” While I seriously doubt we will ever see this in an official government document, the government’s practices are certainly encouraging this. The SOEs are no longer run by Party hacks … their CEOs are often Western-business educated and understand very well both international commerce and the unique requirements of doing business in China. They are dressed in Armani suits, have their hair styled and show up at the right parties, all the while maintaining their status in the Party-with-a-capital-P!
Just this past year, we’ve been involved in more competitive intelligence programs with our clients, helping them understand the ever-changing landscape around them. It used to be that they were just interested in understanding their foreign competitors; however, more and more we see Chinese companies – and particularly SOEs – coming to the forefront of our clients’ concerns. And given the competitive advantages these SOEs bring with them, everyone is very smart to be concerned about them.
So the question you need to answer is this – do you know your SOE competition? Do you know who is backing them? Who is running them? Do you know what their growth strategies are and what their plans are to grow in the market? Do you know what they think of you?!? I can almost guarantee that they are no longer the lazy competitors you once knew. You better understand them because they are a big threat, whether you know it or not.
November 26th, 2009 at 9:55 am
One of the fascinating things about dealing with a company, any company, is their decision-making. In the “old” days, one could pretty well safely assume that in the end, at SOEs anyway, it was the 55 year old Party hack with the bad combover who made EVERY decision that mattered and that the decision would not usually be based so much on profits, but on maintaining power and on maintaining jobs and on dishing out favors. But that is changing as well, making strategy all that more difficult. I would love to see you write a piece on that as well, but man that will be difficult.
November 26th, 2009 at 1:39 pm
China Law, what I find interesting about your comment is it reminded me of the US Congress, a little bit of power, a little bit of profit and good old capitalist spirit any way, and a dash of cronyism er I mean constituent services.
November 26th, 2009 at 2:48 pm
Dan:
Great question … and one loaded with both business and cultural baggage. I will think about it some. Anyone else out there have some thoughts on this?
November 27th, 2009 at 9:16 am
Good to see this sightful update.
One day maybe i will end up being in one of these SOEs, which trend news have been showing these days( SOEs more attractive now)…
November 28th, 2009 at 2:28 pm
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SOEs in China today – Not your Grandfather’s State Owned Enterprises any more! [link to post]
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December 2nd, 2009 at 6:57 am
Certainly true of the really big companies in industries deemed strategic. True to form, the Chinese government and private sector adapt and change with the times, faster than anyone ever has before.
But the situation with the 300 pound gorillas in automotive, energy, media etc. are not necessarily indicative of what’s happening at the majority of SOE’s.
Some of lower-tier SOE’s, for example, which are out of the spotlight have been acquiring private enterprise for the sole purpose of revenue growth, without regards to the target company’s operational efficiencies. This means that the already inefficient SOE is likely to be that much more inefficient after the mergers or takeovers.
Maybe I’m just hanging out with the wrong SOE’s, but down at the lower level I’ve been seeing the same operational, financial and HR mismanagement I’ve come to expect from SOE’s.
That being said, I have no doubt that, like the rest of Chinese society, the lower-tiered SOE’s can transform themselves when they feel the need to do so.
December 2nd, 2009 at 12:59 pm
For larger companies, the “Public – Private” movement in China appears really to be “Public” – fully SOE & “Private” – partially state owned. How does one determine what the “Private” company’s state ownership and influence is?
It’s easy in smaller companies where they are either Taiwanese or native mainland owned.
December 2nd, 2009 at 4:44 pm
David:
Good comments … and I would agree with you. In fact, I would probably agree that even the bigger SOEs are not being “properly” managed in the sense that most of them are not following anything we’d recognizes as GAAP. We did a competitive benchmarking program for a client and several of the targets were large SOEs. We were surprised to find them quite well-run … particularly in their sales and marketing, they showed that they really understood the market and responded to it quickly (much better than our client, in fact!). However, at some point, the SOEs broke down into a traditional behemoth, and typically that happened at the cash management stage — as I discussed in the Podcast, these SOEs had access to tons of cash through bank loans so they didn’t need to manage their cash flow in the same way our client did. The SOEs could respond quicker to competitive threats because they could throw money at the problem in ways our client could not.
So yes, while some of these SOEs are getting better, if you peel back enough layers, you’ll find vestiges of your grandfather’s SOE!
December 2nd, 2009 at 4:49 pm
Good question, Jonathan. Identifying ownership of a company is a long and difficult process. As everyone knows, you can’t trust what is on their books and you have to dig around to find out. In China, we think it is not only important to identify “ownership” but also “influence”. We have an M&A program now where we are doing some commercial and legal due diligence on a target and one of the big questions is ownership. On their books, the founder owns the majority of the company and then his parents, his wife and his in-laws have minimal shares. Through talking with people inside and outside the company, we found that the parents and in-laws have no influence … they have shares because it makes sense from a local tax perspective. The wife, on the other hand, has a LOT of influence, even though she has very few shares. We also discovered two other people who don’t have legal equity but who have a lot of influence in the deal and, if a deal happened, would get some cash from the owner (one is a former professor of the owner and the other a friend with a government position). So while this is, technically, a private company, there are ties back to government that cannot be ignored. All VERY complicated!
December 2nd, 2009 at 7:00 pm
Add to the mix shares held by banks– I don’t know how prevalent it is, but one SOE I worked closely with (the scars will be with me forever) was little more than a leaky bucket for government funds.
The bank was ordered to keep pouring money into that bucket. Instead of paying back the loan (which never seemed likely) , they simply transferred shares to the bank– “lets just call it even”. Since the bank had zero influence or interest in how the company was run, the company ran itself into the ground. Not out of existence, mind you, the bad managers still kept their cushy jobs, but they stopped doing their core business and the value of the company dropped to almost nothing. Same with their brand. A virtual write-off.
I guess my point is that there is a large gap between:
a) The improvement in innovation, technology and marketing which has moved quite fast and has improved SEO competitiveness, at least as far as the big boys are concerned, and,
b) Improvement in operational technology and leadership (accountability, for instance) … the stuff that makes companies successful in the sense that they are self-sustaining, and which may NOT be improving at the same pace.
Once again, I have only had contact with SOE’s at a lower tier— I don’t know what goes on up in the Parthenon of SOE leadership.
December 3rd, 2009 at 8:27 pm
The SOEs and quasi-SOEs that I deal with are a mixed bag. Some have some excellent operational staff and a reasonable level of responsiveness to the market, others a lingering remnant relying on their privileges and past reputation, one that should but will not die. Like a bad vampire movie really.
The access to cheap capital that being an SOE provides is an extraordinary advantage that allows SOEs to overcome certain levels of operational inefficiencies. The POE Wenzhou bosses pay a lot for capital and use it well. The SOEs do not use capital well and could do a lot more with a lot less. They gain certain efficiencies by fairly average staff pay & benefits (except in monopoly industries where the benefits are great), and staff trade that off for a more structured work environment and career path.
Service by SOEs has genuinely improved in banking, telecoms, power etc. Front line staff that deal with customers are generally fine and some excellent. The SOEs have adopted fairly standard global customer service platforms and pulled out efficiencies in those areas (nothing like a Chinese bank queue).
At the mid and top level though the brutal efficiencies forced through private organisations are absent. Too often too few people are willing to take bottom line responsibility for investment and generating real returns on the capital deployed in the business. Funds come too easily. Too low a return is expected and allowed (excepting the monopolies where they can price in higher returns).
Nice while it lasts. However all this comes at a terrible price to the average Chinese punter. The SOE can obtain funds at 5% interest, while the poor bank saver gets a measly 1.9% interest (12 month term deposit) on which they are slugged 20% income tax. Dreadful return. The bank makes a healthy 3.1% and the SOE borrower gets a long term low cost loan.
December 7th, 2009 at 8:44 pm
Great comments, Chris. Couldn’t agree more. The big question in my mind is the sustainability of the SOE-as-vampire (and not the cool kind of vampires that are so popular in movies these days … we are talking Bela Lugosi in his most laudanum-infused-haze days here!). I am all about helping your friends, but when there is this unholy unity of the government, banks and SOEs, that is a tough clique to compete with. We are still a LONG way from any discussion about unfair business practices and enforcement of such standards here. However, as we all know, there is still some great business to be done here … and with a healthy slug of caveat emptor juice, some creativity and a never-say-die attitude, some foreign firms are doing quite well here.