For those who live or travel regularly to Shanghai, you have been the victim of the city’s wild abandon to prepare for the World Expo – new roads, bridges, tunnels, metro lines, bus lines, bike lanes, stoplights, security cameras … the list of infrastructure and hardware upgrades goes on and on.  Well, now that the Expo is finally here, many of us have been able to take advantage of that infrastructure … I, for one, am quite pleased with the new subway lines, making it much more convenient to get around the city.  However, the 9 squillion visitors a day to the Expo mean that there are just more people riding the subways and driving on the roads so a bit of the allure has rubbed off.

But all of these so-called improvements remind me of an old joke: a city slicker is lost in the countryside; eventually, he happens upon a local walking along the dirt road. The guy asks for directions back to the city and the local makes several unsuccessful attempts to explain the route. Finally, the local gives up and says to the city slicker: “Well, I guess you can’t get there from here.”

Needless to add, the point of this little jest is that there is always a way to get from point A to point B.

But not necessarily so in China. We may be all-too-familiar with the Confucian saying: “A journey of a thousand li begins with a single step.” Which is good advice (provided you know what the heck a li is), but it omits a crucial precondition. There first must be a road to walk on. Put another way, you may know your destination, but finding the path to get there is a whole ‘nuther matter.

Case in point: The Shanghai Pudong airport opened to much fanfare in 1999. Its size, capacity and architectural splendor was (and still is) truly world class. Anyone that calls Shanghai home can be proud of it … and even more so since they completed Terminal 2. What’s more, it was built in record time. However, the highway to the airport took a lot longer to complete. For the first year or two one had to pass through an obstacle course called Pudong, dodging pre-modern horse carts on the way to the post-modern airport. So while the destination was ready and waiting, there wasn’t a decent road to reach it.

Excepting the Maglev train, of course. Another marvelous example of modernity, which, unfortunately, had its own destination issues. True, on arrival at the airport the train seemed a welcome alternative to the long taxi line; one could whizz along at speeds of more than 400 km per hour all the way to Jinqiao, where … you waited in another long line for a taxi to get you home! Now don’t start writing me nasty letters. I am aware that the Maglev has since been connected to the #2 subway line and that getting to downtown from Pudong airport is now a breeze. But note the year: this happened in 2006, roughly six years after the airport opened.

The drive to modernize has had similar results in other areas. In keeping with the WTO provisions, China is opening up new forms of investment for foreign companies, though the process is frustratingly familiar.

Step One: The new rules are announced with much fanfare and praise from global punditry.

Step Two: One year later, the application procedures are announced, again with much fanfare and more punditing from the pundits;

Step Three: One year after that, applications are actually accepted by the government, with very little fanfare (by now the pundits have moved on to touting new developments, see Step One).

As I was saying, this process causes foreigners much rending of hair. Which in my case, I cannot afford because I cannot find my hair. For those of us that value convenience, efficiency and modernity, new forms of investment are useless unless we have means to access them.  Most foreigners (particularly Americans) have acquired the detritus of efficiency: daily planners, PDAs, alarm clocks, etc., all of which calculate time to the nanosecond. As such, a beautiful airport, or a beautiful new business opportunity, are anathema — without a means to reach them.

But before we get too huffy, keep in mind that we were warned of the dangers. Way back in the early 90s, Deng Xiaoping said that development in China would be “like crossing the river by feeling for stones.”

Today, we are standing on the banks of the rushing river we call Chinese Development looking across to the land of riches and eternal happiness on the other side. There are a couple of stones peeking out from the rushing rapids, but they look a bit slippery. So we need to tread carefully. Better still, we should watch while someone else crosses the river before us, to see where he steps. One day, there will be a solid bridge to cross, but in the meantime, many will fall in the water and be swept away.

Be that as it may, it’s silly to think that China should build roads (or bridges) for the convenience of foreigners. Like I said, no one made us any promises and if the existing road takes it toll on you, well, it tolls for all of us. In the meantime, buy a compass and a pair of hip-waders.

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 …

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.

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.

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

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…

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.

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.

So when our research manager, Frank Tsai, came to me and said that he could see some value in a review of the week’s news on China, I admit that I was a bit skeptical. It seemed to me like we were just anthologizing stuff already out there.  But as he kept talking and showing me some material, I came around … there is a TON of good writing on China and, while it is impossible to take it all in, it is important to try.  So we are going to try an experiment … every week, we’ll highlight some of the things that interest us about the news on China, adding comments where we feel we can add something or just setting it out there for you to take in.  We won’t stop the original stuff … that’s our bread and butter (and besides, its cheaper than therapy for us) … but let’s see how this goes.  Drop us a line and let us know what you think and/or clue us in to things that you think we should be paying attention to.

OK, here goes…

Living in a Bubble?

When your Chinese friends are making six figure (USD) salaries, and they say they don’t FEEL rich, even though the cost of living is almost invariably much lower in China, you know something is odd.  They feel that way because housing costs in Shanghai are 20 to 50 times annual income for the typical ($10,000/year) worker, and the better homes that rich Chinese executives want to buy are still 10 to 20 times annual income.   According to the China Daily, real estate prices rose at their fastest rate in two years in February, going up 10.7% year-on-year in 70 major cities, and undoubtedly even faster in major cities like Shanghai and Beijing.  Housing and housing-related purchases, according to the Global Times, now account for 40% of consumer spending, and have accounted for 20% of GDP since 1998.  While the government has recognized the risk that rising asset prices pose for inflation and social stability, and has signaled measures to curb the property market, some investment banks like UBS are, apparently, still bullish on Chinese property.  Needless to say, the continuing boom in housing-related purchases is great news for many foreign companies – from an IKEA, to home appliances, to decoration services, to home water purifiers.  However, we all get the feeling that “something” is out there and, at least among average people who have become “overnight millionaires” just by owning homes in Shanghai, there does seem to be the ominous feeling that values can’t keep rising.

Working for a Living

Years ago, the rallying cry for multinational participation in China was “cheap labor!!”.  Well, while labor costs in China are still much lower than North America or Western Europe, we are seeing some changes here as well.   In recent months, factory wages have risen by about 20 percent, as many migrant workers have gone home for the Chinese New Year and decided to stay home, having found better (and often less arduous) jobs in their hometowns.  According to the China Economic Review, many factories have had to lure back workers with substantial raises and that the average wage for a migrant worker in Shenzhen is now about $200/month.  Despite fears of a labor shortage at the low end, however, college graduates at the higher end are facing dimmer prospects, as detailed in pieces in both the LA Times and the New York Times.  So it seems that demand in the labor market is becoming curiously U-shaped, with factory workers getting raises and the experienced managers seeing their wages double and triple in just a few years, while recent graduates suffer on subsistence pay, even at good companies.

Gloom and Doom

Year-end predictions are lots of fun … you get to talk eloquently about what just happened (and drop a few “I-told-you-so’s” in if you can) and then go all Nostradamus and predict a gloomy future.  If you are right, kudos to you.  If you are wrong, that’s OK because it means the gloom-and-doom didn’t happen and everyone is basically happy.  This could be the case in an article in the New York Times that came out last December that highlighted the three greatest dangers that could derail the Chinese economy are inflation, protectionism, and inequality.  Let’s see how they’ve been doing so far …

• Chinese economists have been sanguine about Febuary’s 2.7 increase in the CPI, and policy shifts are unlikely in the near-term.  However, we’ve seen instances where China moves pretty quickly against inflation should the need arise so that might be the source of their comfort.
• Pressure for protectionism against China could rise, however, in light of China’s 46% export increase in February and slim chances that the government will let the RMB will appreciate.
• Growing inequality is reflected in the growing ranks of Chinese billionaires, and in a sign that the government is concerned about inequality, it recently capped the compensation of bank executives in line with similar measures in the West.

Hmmm … seems they’re doing pretty well so far, but the year is still young.  Stay tuned for more.

Well … its been awhile since we’ve posted a Podcast.  Sorry ‘bout that!  I took the week of Chinese New Year off and tried to ignore my computer and email.  That was nice … but then I really paid for it coming back to work afterwards.  Now I have been able to dig out from everything and get back to our series of Podcasts on China M&A.

If you recall, I have been having a series of conversations about China mergers and acquisitions with Kim Woodard – a vice president here at Technomic Asia and one of the leaders of our M&A practice.  The theme we have been orbiting around is “reducing risk” … this is because the failure rate for China M&A deals is quite high.  We estimate that fully three quarters – that ‘s 75% for the CPAs in the crowd – of deals that reach the letter of intent stage fail to close.  So that means, for successful M&A, we need to focus on reducing risk at each stage of the process.

Today, we go back to the beginning and talk about, what we feel, is the most important stage in China M&A … target selection.  Here is a conversation that Kim and I had just this afternoon in our Shanghai office…

We just received a comment from a faithful Podcast listener which spawned some interesting ideas here at China Business Podcast World Domination Headquarters (located in beautiful downtown Shanghai).  Full disclosure here … the “faithful listener” that made the comment, Dave, is actually a good friend of mine.  So I guess this is kind of like responding to a review of an elementary school play made by your mother … but I will take it where I can get it!

In any case, the question was a good one.  Dave asked, “Tell me this, as you think about the last 20 years, do you see a noticeable shift in the energy and excitement the Chinese Governments (local and central) have for recruiting western companies to expand their businesses to China? In the collection of articles I see, and recent business development work, I get the sense that there is a growing indifference. Is the China domestic growth ‘engine’ becoming so strong that western investments have become ‘ho hum’?”

Great question and good timing, Dave.  Because not only is this a topic of conversation among foreign companies here, but the Chinese leadership is talking about it as well, although in somewhat less-than-direct terms.  Chinese President Hu Jin-tao just this last week made a speech that, I think, is going to be referred back to in years to come as marking a turning point in Chinese economic development.  As far as speeches by politicians go, it was … well … a speech by a politician, and a lame-duck politician at that.  Remember that President Hu is expected to step down in 2012 and hand over the reigns to new leadership.  The leading candidate is Xi Jin-ping, one of China’s “princelings” with a significant political pedigree here, but a lot can happen in the next two years so stand by for further updates.  So President Hu is looking down the road at early retirement and he is trying to find ways to cement his legacy.  He’s already tried a couple of things.  Mr. Hu was behind the tepidly-received 和谐社会 or “Harmonious Society” campaign leading up to the Olympics which attempted to get people to stop spitting on the streets and be nicer to each other in public.  No one here has paid much attention to this – as evidenced by my messy shoes and bruised body from riding the subway to work every morning.

So this past week, President Hu had a chance to speak at the Party School of the Chinese Communist Party … now when I say “Party School”, I am not talking about the University of Wisconsin or Bowling Green.  This “Party School” is the institution that trains all up and coming cadres in the Communist Party of China, or CPC.  They used to teach these cadres how to wear musty wool Mao suits and engineer their comb-overs to cover bald spots … but now, they have more serious things on their minds.  The topic of President Hu’s speech – oddly, not covered much by the mainstream Western media – was on economic development in China.  Here is the English synopsis from the CPC website:

“General Secretary of the CPC Central Committee, Chinese President and Chairman of the Military Commission of the CPC Central Committee Hu Jintao delivered an important speech, stressing that we shall seize the opportunity to undertake the historic mission to take speeding up the transformation of economic growth mode as the important target and strategic measure to deeply carry out and implement the scientific outlook on development to unswervingly accelerate the transformation of economic growth mode and constantly improve the quality and efficiency of economic growth and increasingly raise the international competitiveness and the risk resistance capacity of Chinese economy in a bid to get higher quality, larger space and broader road of development.”

Got that?  Yea … no wonder this was not picked up by mainstream media.  I am actually interested in this stuff and I started to doze off by the line about “unswervingly accelerate the transformation of economic growth mode” (as a side note, this might be good advice to give drivers here in China because they tend to accelerate in a “swervingly” manner … President Hu’s people can contact me if they want further advice on this one).  Anyway, the speech in Chinese was not much more thrilling (like political speeches in ANY language, the Chinese for such situations tends to be very flowery and over-laden with adjectives).

In the past couple of months, China has been crowing about its 8% growth while the rest of the world is in the dumps and President Hu was responding to accusations that China’s economy was build on a foundation of sand … that government investment in infrastructure was going for short-term growth while ignoring long-term economic drivers such as technology innovation, consumer spending, etc.  Such accusations are not only coming from foreign sources but locals as well … the running joke in China is that the current leadership is pursuing the 保八计划 or “Protect the 8% Plan”, at any cost insuring that China reached that magic 8% growth that everyone thinks they need to avoid economic collapse.

This speech, I think, was intended to tell everyone that, “No, we really do have a plan here … we are not just going for short term development but we are trying to set China up for success in years to come.”  And how is that to be done?  Well, President Hu listed a lot of things: encourage the new energy sector; reform agriculture; support the growth of science and technology … heck, I think he even called for the development of a bubblegum to arrest male pattern baldness (a key concern for much of the world’s political leadership these days … they may want to pay attention).  But jumbled among the disparate ideas is a key phrase that President Hu used that responds – finally! – to your question, Dave.  President Hu said that China’s economic development is going to be driven, in large part, by “independent innovation”.

This phrase, “independent innovation”, is an echo of rumblings we’ve been hearing in China for some time.  Just last November, several Chinese ministries came out with the “Indigenous Innovation Product Catalogue”, a listing of approved vendors that government entities can purchase from.  The restrictions on this Catalogue are quite tight and makes it difficult for a foreign firm to get on the list, spurring many foreigners to accuse China of being “protectionist”.

Are they being “protectionist”?  I don’t know … that’s kind of a loaded word and it can be applied to other governments as well (similar accusations have been leveled at the U.S. for keeping China out of their oil, technology and agricultural sectors in the past).  But what they ARE being is “independent” … and that means, that, yes Dave, I think they are going to value foreign participation in China’s markets differently.  Not necessarily “less”, but certainly differently … whether or not it is “less” determines what we do about it.

This is a topic we are going to keep our eyes on this year and is closely related to one of the “Themes for 2010” that we identified in December of last year – China’s growing confidence in their own power and importance in the global economy.  But suffice it to say that foreign companies are going to have to pay even closer attention to the value that they are bringing to the China market.  We’ve been saying for some time that things have changed here … no longer can foreign companies just show up with money and cool technology and have China fall all over them.  Foreigners need to clearly articulate their value and to get local Chinese partners to agree to this value and to partner with the foreign company to bring it to China.  In the process, foreigners are going to have to give up this value to their Chinese partners … the risk being that you are starting to train your future competitors.

I am often asked if business is becoming “easier” in China – as in, “are the structural barriers to foreigners doing business in China becoming less?”  In general, I think this is true … China’s entry into the WTO has brought them in line with many global practices.  Sure, there are still questions of currency exchanges and the like, but I really don’t see these as being the greatest barrier to working with China.  I actually think that business is, in some ways, becoming MORE difficult to do in China because it is more difficult to determine exactly what foreigners bring to the deal; what we can do that China cannot yet do for itself?  You are right, Dave … we foreigners are becoming less interesting to China.  We need to work harder to find out what our value is to China and sell it to people here.  This is our game to lose.

As we’ve been saying on this Podcast for a month or so now, China had a really good 2009.  While most of the world is thrilled to send 2009 off to the Group Home for Annoying Old Years and welcome 2010 in diapers, China is still doing victory laps for their 2009 performance, even though it was down severely from previous years.  There is a lesson to be learned here … in a room of ugly people, the average schmuck is a supermodel.  And trust me … I know how to do schmuck.

But as we all know, there is the story of what is happening in China, and then there is the truth.  Not to go all post-modern on everyone here, but the truth – if there is one Truth with a capital T – is probably somewhere in between and pundits aplenty are rushing to fill the blogosphere with their version.   For some reason, every time a talking head heaves an opinion on China into the public sphere, I have this overwhelming need to comment on it, to give the general public the beneficent view of my own brilliance and expert insight.  I know, you don’t have to tell me, I need professional help, I am fully aware of that.  I’ve tried therapy, several mood-altering substances and, as a last gasp effort, producing this Podcast, but I it hasn’t helped much.  The end-of-the-decade articles on China were killers … everywhere I looked there seemed to be an opinion popping up that absolutely REQIRED my commentary!  I consider it a mark of my immense self control and budding maturity that I was actually able to lead a somewhat normal life in the midst of all of that and did not spend all my time blogging back.  Thank you in advance for your kind words of congratulations.  I just live one day at a time.

But there is one article published way last October that I keep coming back to and, finally, cannot help but comment on.  It is by Rana Foroohar in Newsweek International is tantalizingly titled, “Everything You Know About China Is Wrong”.  The title alone compelled me to read and comment on it since, as China market strategy consultants, we go to market with what we call a “correct” view of China based on 25 years of experience so I was anxious to read it.

Ms. Foroohar elucidates several reasons why China is not the economic miracle that everyone seems to think it is.  Her opinions are not rocket science nor are they all that original … over the years there have been China-doubters aplenty who look askance at the phenomenal growth in China and wondered two things: a) is it really possible; and b) is it really sustainable??  But just because something is not original does not mean that it is not worth listening to (I give you anything recently recorded by Lady Gaga and the Jonas Brothers as proof positive of this) and I would encourage you to read her article (those of you listening to this Podcast can go to our blog for the link).  Overall, I agree with most of the statements that Ms. Foroohar makes and, in fact, I think she makes them very well; however, I would like add a couple of perspectives from the cheap-seats…

One of the myths that Ms. Foroohar attempts to deflate is “The Communists are brilliant economic managers”.  The evidence in favor of this belief is that, in 2009, China was able to maintain an 8% growth in the face of what is arguably the world’s worst economic meltdown ever.  The criticism is that this growth is driven by government investment in infrastructure and that, some day, China will have all the roads, bridges, tunnels, telecommunications networks and subways that it needs and won’t be able to make the transition to a privately-driven economy.  And it is argued that this last round of economic stimulus spending in 2009 just further deepened this problem.

This is not a new criticism and, in fact, economists, China watchers and the rabble of doomsday pundits have been making this statement since China first started their massive investment campaign in the early 90s.  For the most part, I would agree … focused investment on infrastructure is, by definition, not sustainable and, someday, China is going to have to broaden their economy to bring in other, more sustainable engines of growth.  However, I would add two caveats that would argue against being too concerned about this right now.

First of all, despite nearly 20 years of infrastructure investment, China has just scratched the surface of their total need.  China is a MASSIVE place and, while the infrastructure in the big cities of Shanghai, Beijing and Guangzhou is quite good, there is SO much more to be done in China’s Tier 2, 3, 4 and smaller cities (remember that China has over 100 cities with over a million population plus a seemingly endless countryside).

What I am saying is that the need for this spending – and the associated support it gives to the broader economy in terms of employment and supply infrastructure – is not going to end any time soon.  In fact, its probably going to continue strong for the next 20 years or more.  Yes, there are many associated problems with such infrastructure investment – the housing and real estate bubble is probably the most concerning – and China is going to have its ups and downs.  But this is not a small country we are talking about where you work hard for 10 years and everything is built.

My friends and colleagues in India only WISH that their government would have a similar commitment and authority to build infrastructure in their country … if they could, then I think India’s growth would quickly catch up to China’s.  But as it stands, there are so many internal politics in India that infrastructure projects often get stalled and never completed (there is a highway construction project in Chennai that I see when visiting clients there … and for over 5 years it has remained in the same state of incompletion.  There are people at the site and they look like they are doing something … but nothing seems to get done!).

Spending on infrastructure is not going to end any time soon … but the government can do something about the types of infrastructure they invest in.  The 2009 economic stimulus package of over $600 billion from the China government earmarked over $100 billion for what is called “social infrastructure” … hospitals, schools, etc. In the long run, the return on this type of infrastructural investment can be huge … and as I’ve addressed many times before in these Podcasts, China healthcare is in desperate need of life support itself and sustained investment here will do wonders.

Secondly, we need to understand – and even appreciate – the investment perspective that the China government takes in these projects.  Ms. Foroohar quotes a business professor who observed that, although there was a nice new highway built between two rural areas in China, there was no traffic on the road.

[let me just stop for a moment and ponder what it would be like to have a road somewhere in China without an immense amount of traffic on it … living in Shanghai where traffic is so bad we actually USE our fenders, that is a nice thought . OK … I am better now.  Thank you].

A couple of quick responses to this: is there infrastructure in China that is built without any thought to its eventual use – what in the U.S. has been called the “bridge to nowhere”?  Yes, definitely.  The number of pork-barrel projects here are directly proportional to the number of people schlepping the barrels … and we have nearly 5 times that number in China than they have in the U.S.  So yes, nosy business professors are going to be able to observe such examples of poor use of capital resources.

However, I think that the professor should relish in the fact that he can stand on that highway in complete safety.  Fast forward 10 years and I would venture to guess that this same professor would not be willing to stand in the middle of that road – there will be SO much traffic on it so as to turn him into a human speed bump.  In any environment, the population expands to fit the capacity provided and in China, this is doubly true.  Where I live in Shanghai, on the Pudong side, this was just rice fields a few years ago and now it is bucking to be a leading financial capital of the world.  There are putting up an 80-story building where just 20 years ago water buffalo grazed (giving a whole new meaning to the phrase “a bullish market”, I suppose).  The primary reason behind the real estate bubble here is that people are SO confident in their speculation that they are willing to bet large sums of money on property that will quote-unquote “some day” actually be worth more than the exorbitant price they just paid for it.  Oh, that and the fact that much of the real estate investment is being driven by people not using their own money but the government’s … but that is an issue for another Podcast.

So we should not be asking the question: “Is China’s spending on infrastructure sustainable in the long term” because it is, by definition, NOT sustainable.  Of course it isn’t.  We should, on the other hand, be asking the more difficult-to-answer question “what do you mean by ‘long term’”?  We are only 20 years into a modern business environment in China, and look how far we’ve come.  Of course, you don’t drive well by admiring the view in your rearview mirror (although that might explain some of the traffic problem here) so we need to look ahead.  My point is that, barring disasters of all types, China’s near to mid term looks pretty good and very sustainable.

Of course, there is a LOT that I do not understand about macro-economics and I am sure that I will get nasty letters from the Association of Super Smart Economists of just how wrong I am.  But to be honest, how accurate are those Super Smart Economists?  They are working off of models developed in other economies in other cultures at other times and have been woefully inaccurate in predicting even the things they supposedly understand well (ala the mortgage crisis).  The fact remains that we don’t have ANY case studies to guide us as to what might happen here in China … there has never been a country in history that is this large and has made this big of an investment in their infrastructure and government spending.  The U.S. and Japan are in the same direction, but they did theirs at very different times in history when the world was a VERY different place.  Yes, China will eventually have to pull out of this model … it cannot continue forever.  But we don’t have any good examples of a situation of this scale where this has happened.  As I have said before, in China, we are working without a script AND we are working without a net!

Twenty five years ago, when I first came to China, if someone were to show me a picture of what Shanghai would look like in 2010, I’d think they were smoking something.  NO ONE could have – or would have – predicted this.  Indeed, there were multiple doomsday preachers talking about the immanent collapse of “Red China” (I love that term, Red China … like it’s a theme color for the day!).  But here we are, still technically “Red” but, so far, no collapse.  Could it happen?  You bet.  But I assume that the only completely untrue statement is “I am 100% right” so it could also not happen.  And I am betting on the latter.

Thanks again for listening.  Remember our motto: “In China, everything is possible but nothing is easy.”  We’ll see you next time on the China Business Podcast

We are continuing our series on mergers and acquisitions in China through a conversation I have been having with Kim Woodard, a Vice President here at Technomic Asia and a specialist in China M&A.  In over 30 years of doing business in China, Kim has done deals both from within the corporate environment – with companies like John Deere and AMP – and as an outside advisor.  In the last part of this conversation we talked about the five key risk factors in doing a deal in China:

1. The acquiring company chooses the wrong target for the wrong reasons.

2. Failure to connect well and build trust with the shareholders, management, and other stakeholders of the target company.

3. Inability to bridge the valuation gap

4. The target company fails to meet due diligence expectations on financial documentation or on financial and commercial performance.

5. The C-suite in the acquiring company gets worried about post-acquisition performance.

Let’s get back into the conversation as we now turn to the best way to manage these risks …

I was quoted recently in an article in the New York Times on the growing demand of direct sales in China.  The article is very well done and I highly recommend anything that David Barboza writes on China … the man knows his stuff about China and he really does his homework.  One of our Five themes for China in 2010 and Beyond is “Distribution” and the direct-sales model is a very interesting one for China so I wanted to add a couple more comments here.

For those not familiar with it, “direct sales” is when individuals are recruited by a company to sell their products directly to consumers who are, typically, their friends and family.  There are many well-known companies that have used this model such as Mary Kay, Amway and Avon (those of a certain age will remember the old commercials in the U.S. whose tagline was “Ding-dong, Avon Lady calling!”).  As David’s article notes, direct sales have not always had smooth sailing in China as the government has been wary of allowing individuals to start up their own businesses (because, as we know, once people have money-power they want all sorts of other power).  I think that the combination of entrepreneurial sellers and adventuresome consumers are fertile ground in China for direct selling business models for two main reasons: first, direct-selling can leverage relationship-based sales which have a long history and solid cultural foundation in China; and secondly, direct-selling goes around the modern sales channels in China which, although growing in strength, are still very immature and often very difficult to work with.

One of the main reasons that China’s distribution networks have been so fragmented is that they have been based on guanxi or relationships which are simultaneously personal and professional.  In a traditional distribution model, this guanxi holds you back because you are limited in they amount of personal relationships that you can maintain at any one time.  In other words, if my hometown is in Wuhan, all of my guanxi will likely be from that place because I grew up with many of these people, our families know each other, we went to school together, etc.  However, if I try to expand that guanxi network out to, say, a city like Chengdu (probably over 1,000 km away from Wuhan) it will not be possible to develop the same depth of relationships in that region.

Historically, sales in China have been based on this guanxi … I get the sale, not necessarily because I have the best price or the best quality product, but because I have good guanxi with you.  However, this is rapidly changing in China: while good guanxi is a necessary condition to successful sales, it is by no means a sufficient one — I now have to bring good products to the market at good prices.  And for most industrial and consumer products companies, this is a good thing because it means that they can develop more “professional” distribution channels and get a broader sales footprint in China.

So let’s go back to the direct-sales model … this is a model that leverages (and even celebrates) guanxi-based sales.  Sales most often are made to friends and family (or the friends and family of other friends) and, while these product suppliers are certainly concerned to bring good quality products to market, I would argue that they are relying even more on the strength of their sales teams’ guanxi in their local area.  The strength of the direct-selling model is that it goes with the flow of traditional Chinese culture, not against it, by making each sale personal.  And all you have to do is multiply the large number of people in China by their growing disposable income and you understand why executives at companies such as Mary Kay, Amway and Avon are having a hard time controlling their excessive drooling.

The second reason why I think that the direct sales model will have some legs in China is that it goes around the typical sales channels for consumer products: retail stores.  This is a topic too large for one blog post but suffice it to say that China is in the midst of a sea-change in its retail channels, moving from a “traditional” model — dominated by mom-and-pop stores and small specialty stores — to a “modern” model dominated by the larger hypermarkets, “Big Box” and grocery chains.  If you look at China as a whole, a slight majority of consumer products are sold through traditional channels; however, the growth is in the modern channels and particularly in the so-called “hypermarkets”, chains such as Wal-Mart, Carrefour, Rt-Mart, etc.

Initially, consumer products companies were excited about this change … selling to many thousands of traditional outlets is much more difficult than selling to fewer (and larger) modern chains.  However, what everyone is realizing is that these modern chains, while good looking on the outside, are often very difficult to work with simply because they are so big and wield so much power.  The cost of doing business with them — what consumer products companies call “trading terms” — are often quite high in China compared to the rest of the world so while consumer products companies are often happy with the volume that moves through modern channels, they are not as happy with the margins (and multinational consumer products companies are ALL about the margins!).  These companies are often finding that the hypermarkets are not all that good at merchandising and marketing themselves so consumer products companies often feel that they end up paying a lot in terms of marketing fees and not getting all that much for it.

However, the direct-sales model does an end-run around these channels and goes directly to the consumer.  The only marketing fees are the commissions to the sellers so, theoretically, both the margins and the volumes can be quite high.  Consumer products companies don’t have to deal with the retail stores nor do they have to work with distributors to those stores (a topic for another blogpost). In our work with consumer products companies, some of them — and some big names too — have secretly asked about direct-selling and whether or not they could do it.  To date, none of them have but that doesn’t mean that they are not thinking about it.

Now this direct-selling model is not all beer and skittles and in his New York Times article, David Barboza identifies some of the challenges that companies such as Mary Kay are facing (for one, direct sales companies are required to open their own “brick and mortar” retail stores through which to do they actual distribution of product).  Suffice it to say, there is no magic bullet in China retail … we are in the midst of a mini-revolution in China retail and all players — retailers, product companies, distributors and consumers — are changing faster than we can keep up with them.  However, given the sheer size and potential on the China consumer market, everyone is dumping massive amounts of investment and are exhibiting as much patience as they can.  Keep your eye on the direct-sales model in China … we could see it expand beyond the companies we typically associate it with and move into areas we never thought possible.

OK… I am just going to put it out there: these last 10 years have kind of sucked.  Years from now, we are going to look back on the first decade of the new millennium and only the very strong among us are going to be able to avoid using a variety of four-letter words to describe it.  From the rise of terrorism to the meltdown in the global economy, these have been tough times.

Things didn’t start well, of course, with the futuristic “Y2K” problem. It was, for the most part, just IT consultants crying wolf.  But to so completely lack faith in our own technology so as to doubt its ability to handle a digit change in the thousands column does not speak well of our confidence or our technology.

But, for me, what started things off on the wrong foot was our inability to agree with simply what to call this decade.  The “Aughts”? The “O’s”?  The “Naughts”?  Given the current state of the average American’s bank account, “the Nils” sounds like it’s the most appropriate.  But c’mon, folks … if we can’t even name the stinking decade, how are we supposed to handle the real issues.  Frankly, I am a bit ashamed that we Americans couldn’t come up with the marketing slogan that we could all hold hands around.  We are a country that brought you such ditties as Hooters, Cabbage Patch Kids and the Pet Rock.  And we can’t name a decade?  How embarrassing!

However, contrary to the desperation much of the rest of the world is facing, China had a pretty good decade.  From a GDP of about $2,000 per person when 2000 started, China is projected to be over $6,500 per person heading into 2010.   And unlike other changing economies such as the former Soviet Union, China’s political infrastructure didn’t go through a meltdown in the face of such growth.  Certainly, there were many doomsayers predicting the imminent collapse of China, but so far, these people with their Nostradamus For Dummies guidebooks have been, thankfully, quite wrong.

The Chinese authorities are, certainly, giving themselves a big Attaboy for their performance in this past decade.  Not only has their growth been the best in the world, but they’ve landed some pretty big gigs to show it off including the Olympics and the Shanghai Expo.  Fair enough, let’s give China their due … but let’s also look forward to the next decade and make some guesses ourselves as to what we might expect.

Here at Technomic Asia, we are celebrating our 25^th year in China … that is, if I might say so, pretty impressive for a boutique consulting firm where many of our peer firms have burned out long ago.  However, if you would have asked any one of us when we first started in China in 1985 to predict what China would look like in 2010, there is NO WAY that any of us would have come close to envisioning what I can see out my window right now.  Back then, I had to bring in coffee from Hong Kong and now I have three Starbuck’s stores and seven knock-offs of the same within a 10 minute walk of my office.  So predicting the future in China is not a science; heck, its not even an art.  I would liken it to a pin-the-tail-on-the-donkey game played by at a birthday party of some cargo cult voodoo priestesses.   Yea, its that much of a crapshoot.

But what the heck … its only my job to assess the China market and plan growth strategies for my clients, so I am going to go out on a limb here and introduce 5 themes for 2010 that I think will become even more important as the decade continues.   They are, in no particular order because they ALL are important and impact each other:

1. Growth

2. Distribution

3. Consolidation

4. Mergers & acquisitions

5. The emergence of China as a global power

As a year-end wrap up, I want to introduce each of these themes today and then we will re-visit them throughout 2010 and explore their progress (or lack thereof).  So let’s get to them …

The last decade has seen China grow in importance in companies’ global strategies … from just a blip on their radar screen at the turn of the century, China is now a major – if not THE major – strategic initiative for many companies.  And the reason?  Growth!  And its not just because, in 2009, China was the only market in the world to grow more than 8%.  The rumor perpetuated by politicians and angry journalists that China is ONLY a source of low-cost labor and a way for evil capitalists to export jobs from the U.S. is dead-wrong: China is a source of good-old top-line growth. In the midst of all the management theory bouncing around boardroom walls, it turns out that customers are important.  As a former sales manager of mine once told me, tongue firmly planted in-cheek, “Kent, I’ve done some research and have determined that 100% of our revenue comes from customers.  We better focus on them.”  And you know what?  China can be a great source of new customers for many companies.

We just completed the annual business survey for the American Chamber of Commerce in Shanghai and determined that over 60% of American companies were in China primarily to serve the China market … they were looking for growth!  As U.S. and European companies are emerging from the dark depths of economic depression in the past couple of months, I have increasingly had serious discussions with CEOs about ways to grow in China.  They have all said that they feel they have just scratched the surface of what they could – and should – do in China and they need to do more.

A sub-topic under our “Growth” theme for this year will be companies’ expansion into China’s Tier 2, 3 and 4 cities – its not only important to be in China but you have to expand across markets here as well.  Remember that a Tier 2 city in China can still have nearly 8 million people in it so we are not yet talking about selling into rural areas … this is still urban marketing.  But gone are the days when  company could just set up a sales office in Shanghai, Beijing or Guangzhou and hope to do enough throughout the country.  We see many companies today making significant efforts to expand their China footprints and throughout this year we’ll talk with some of these company leaders to find out what they are doing and how they are doing it.

Closely associated with the “Growth” theme is our second theme, “Distribution” … I guess this is overstating it but if you want to grow, you’ve got to actually get your products to market.  Companies who are already in China need to find a better way to get more products to more markets.   Companies are discovering that China is a VERY large and fragmented market and your route-to-customer in one region will not be the same as in another region.  We’ve said it before in these Podcasts but you will never – repeat, NEVER – find one distributor to represent you all over China.  I don’t care what industry you are in, it ain’t gonna happen.  Sure, your distributor will TELL you that they can do it, but they cannot, at least not as well as you need it done to realize the growth that you need.  You will need to take over that responsibility yourself, to find the right combination of distributors to reach the right markets.

In 2009, we did a lot of work for clients to assess the strength of their own distribution, typically benchmarking their operation against their competitions’ (both local and foreign).  And more often than not, we found huge gaps … geographies not covered, certain sectors totally missed and important customers under-served.  These clients are using 2010 to rebuild their distribution.  Sometimes they need to tear things down and then rebuild them … but more often than not, they just need to identify the gaps and start to fill them.

Not only do we need to address the people part of the distribution equation but we also need to consider the supply chain infrastructure.  From sourcing to manufacturing to transportation to warehousing and, finally, to distribution, foreign companies in China are reassessing how they handle their entire operation.  Growth without a firm distribution and supply chain foundation is impossible so 2010 will be the year when companies will start to get very serious about improving both.

The third theme that I think will be important in 2010 and beyond is “Consolidation”.  As I just said, China is a large and fragmented market and a key contributor to that fragmentation is purely the number of players involved in any particular sector.  For example, China has over 100 automotive OEMs … not just 100 brands but 100 distinct auto manufacturers (a long way from what we used to call the “Big Three” in the U.S. which is now, depending on how you count it, probably more accurately described as the “Big One-and-a-Half”).  In pharmaceuticals, there are over 3,000 manufacturers in China and over 10,000 pharma distributors.  Most of these are what China calls “sub-scale” which is a polite way of saying, in effect, that they are too small to survive very long on their own and really have no opportunity to grow very much.

The Chinese government is strongly supporting consolidation and are, in many cases, selecting key companies (often State-owned) to move to the top of the food chain in this Darwinian, survival-of-the-fittest process.  I did a Podcast recently on the Big Four automotive companies (including First Auto Works, Shanghai Automotive, Dongfeng and Changan) and how they are looking to acquire companies inside and outside of China to bring under their rapidly expanding umbrellas.  Look for some major automotive moves in 2010.  In pharma, the government is forcing the smaller distribution companies to merge with the larger ones, so much so that the rumor on the street is that there will be only one distributor per province in the end.  Personally, I don’t see how this can happen, at least in my lifetime, so while the end state is unknown, it is absolutely certain that consolidation will be the trend.

Foreign companies playing in China will want to play close attention to consolidation trends in their own industrial sectors.  The competitive landscape will change greatly as consolidation takes place … your competitors will be stronger, wealthier and have a larger geographical footprint.  In many cases, consolidation will result in a broader product portfolio, making it more difficult for you to compete with them toe-to-toe.

Our “Consolidation” theme leads us nicely to the fourth trend, “Mergers and Acquisitions”.  Not only will local companies grow through M&A but foreign companies are increasingly looking at growth by acquisition, particularly those who have been in China for awhile.  There are multinational companies who came into China through a joint venture many years ago but who are now, for all intents and purposes, operating as a wholly foreign-owned enterprise (or WOFE).  Once they did the deal, they started growing organically, adding products and distribution territories so that, over time, they have built quite a good presence.

However, they have gone about as far as they can go organically and, to speed up time-to-market and increase depth of market penetration, they are looking at acquisitions.  In the past couple of months, we have done some Podcasts on China M&A and will continue that again in the New Year.

Our fifth and final theme is a bit trickier and I put it under the heading of “China as a growing global power” … however, this requires some unpacking.  Here on the China Business Blog and Podcast, we tend to avoid so-called “macro views” and, instead, dig deep into the specific strategies and tactics that companies are using to succeed in China.  We don’t talk much about the goings-on in Beijing, the ins and outs of political leadership.  Its that not this is NOT important – it is – but such palace intrigue can often be quite far away from the day-to-day issues that company management faces in China and, for most of us anyways, we have very little direct influence on the seats of power.  Besides, our daily experience is in the trench warfare of markets, not hanging out in the rare air of the Zhongnanhai leadership.  And my momma always told me to talk about what you know…

However, I think we are seeing an emerging power and even “attitude” from Beijing that warrants mentioning and awareness.  Basically put, the Beijing leadership has been making more unilateral decisions lately and is doing so quite confidently that the rest of the world will not punish or even censure them all that much.  Just a few days ago it was announced that China executed a British citizen for drug trafficking, despite the VERY loud protests from the West that China should take some time and think about it.  The view from Beijing since the execution is that this is an issue of their “judicial sovereignty” and that the rest of the world should butt-out.  In the many articles I have read on this, the journalist inevitably mentions that Britain is China’s third largest trading partner and hints that British authorities are trying to “keep lines of communication open”.  Which means that, although they will whine a bit, nothing is going to happen to China because of their actions.

I mention this, not to criticize either side for their behavior – and I am sure there is lots of criticism to go around – but rather to highlight that we are moving into some new territory here.  2009 was a heady year for China … the Olympics, the fastest growing economy in the world, huge cash reserves, significant investments in U.S. t-bills all added up to an administration that, frankly, thinks they are pretty bullet-proof.  You can be sure that, increasingly, the Chinese government will be making more unilateral decisions and will be less and less sensitive to the opinions of other international players.  How it plays out is anyone’s guess … but suffice it to say that this will be a factor, starting in 2010.

One word of caution here – just because things are happening in Beijing does not necessarily mean that there will be a direct impact on what you are doing in your local area.   All governments move along their own timelines … and some would say their own dimensions of reality … and these timelines are often best measured using carbon-dating methods, things move so slowly.  So please don’t assume that I am prophesying doom and gloom … this is just another data point you will need to include in the algorithms you use to understand what is happening in China.

So there you have it … my predictions for the future.  Radical and cutting edge?  Probably not, but I am very certain that we will see these themes come into play and interact with each other this coming year.  As for each of you and your companies – include these themes in your strategic planning.  Assume that your competition is moving in these directions and challenge yourself and your China management to be able to articulate, in detail, how you are going to handle all of these, both defensively and offensively.

One of my favorite quotes about the future is from Alan Kay, the American computer scientist, researcher and visionary, who said “The best way to predict the future is to invent it.”  It has been true for the past quarter century I have been in China and will be so for the next 25 years – China is a unique environment where you can, literally, create your own future.  And this is what we at Technomic Asia hope for you in 2010 and beyond which is why we end every Podcast with our motto: “In China, everything is possible but nothing is easy.”  We wish you all a very Happy New Year and we’ll see you next time on the China Business Blog and Podcast.

We are at the end of a two-part interview with David Thomas, Founder and Managing Director of Think Global Consulting, based in Sydney, Australia.  In the first part of our interview, we explored the long – and often complicated – relationship between Australia and China.  As members of the Asia-Pacific Rim group of nations, there is a lot of activity going on between the two countries … and, as we’ve seen in the media this past year, not all of it has been smooth sailing.  I started off this last part of the interview by asking David to talk a bit about some of the Australian firms that are finding success in China and what their attitudes are today…

In  past interviews here on the China Business Podcast, we’ve talked with business leaders about their approaches to China … why their company came to China, how they are approaching the market, how  things are going, etc.  I am trying to think back, but I don’t think we’ve ever talking to someone about how a country approaches China.  Well, in today’s Podcast, we are going to change all of that by talking with David Thomas, Founder and Managing Director of Think Global Consulting, a firm based in Sydney, Australia.  David and his firm work with Australian businesses and government to make connections to China.  I’ve known David for a couple of years and, in fact, I think we might have even met through his listening to our Podcasts in the early days.  But as we’ve talked and done business together, I learned more about the deep connections between Australia and China and how those ties are becoming even stronger as both countries find a deeper affinity with each other.  Certainly, those deeper ties are not without their conflicts as we’ve been seeing recently with the dust-up around Rio Tinto and mining contracts.  But as we’ll hear from David today, though the road might be a bit rough, there are some good things ahead for both countries.  Attached is part 1 of my interview with David Thomas of Think Global Consulting…

In our recent Podcast series, we have been talking with Bill Powell, senior writer for Time and Fortune magazines, based in Shanghai.  In the last Podcast, we got into, what I thought, was a VERY interesting discussion about the uniqueness of what is going on in China these days.  Literally, what we are seeing in China is unprecedented … never before has an economy (and a society) grown and changed so much in such a short period of time.  Understanding it, let alone predicting it, is very difficult and we are all, in a sense, working without a script.  We talked earlier about what the U.S. and other Western economies could learn from China … to wrap up our conversation, I started by asking Bill what he thought China could (and should) learn from the West …

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.

We are in the middle of a discussion with Bill Powell, senior writer for Time and Fortune magazines.  In the first part, we talked about China and the rest of the world, how we try to make comparisons to what is happening in China with what we have seen in the past.  In this Podcast, I wanted to start off by getting Bill’s take on the challenges of covering China.  I prefaced my question by saying that, in our consulting practice at Technomic Asia, we are very careful not to talk about “THE” China market … there are, in fact, MANY China “markets” taking into account big cities, small cities, northern cultures, southern cultures, urban and rural, etc.  I asked him to talk about the practicalities over covering such a vast subject and the challenges he finds in trying to do so …

Over the past 4 years of the China Business Podcast we’ve done many interviews with business people in China, typically leaders of companies or operations.  We’ve talked about the intricacies of doing business here, the opportunities and challenges, and specific strategies and tactics that have worked for them.

Well, I would like to take a chance to back up a bit and view the China environment from a different perspective through an interview with someone who has been reporting on the action, not only in China but around the world.  Bill Powell is the senior writer for Time and Fortune magazines and is based in Shanghai.  We’ve known each other for a couple of years and he calls every now and then to bounce around some ideas and perspectives.  I have always appreciated his perspective and I thought he would make a great interview … and I was right.

Here is part one of that interview …

But that was yesterday; this is today and all seems clear now.  President Obama will arrive in Shanghai on Monday.  Or maybe it is Sunday.  And he will have a town hall meeting here.  Or maybe he won’t.  He might also visit the new Disney site.  But maybe not.

I’m surprised that he could get a flight at this late date.  Usually I have to make a reservation a year in advance for my trips back to the U.S. to keep from getting stuck in the seat where the guy in front of you leans so far back you could do dental work on him.  But maybe the President has a better travel agent than I do.

Now that the trip is on, I want answers to the really important questions.  Ones like “Will Mr. Obama shoot some hoops while he is here?”  The Chinese LOVE basketball and not just because Yao Ming is their John Lennon minus the guitar and annoying wife.  His O-ness has got some game, or so they say.  Maybe he and President Hu can play a game of H-O-R-S-E to see who gets the comfy chair at the U.S. Security Council.  Or a gimmee on higher emission standards at the Copenhagen conference.  I’ve heard Mr. Hu has a mean skyhook so Mr. Obama should definitely take it downtown on a crucial point.  It looks like Hu has no vertical.

Another question: “Can the President use chopsticks?”  I am not trying to be smarmy here (its natural, I don’t have to try) but if he bellies up to the banquet table and is presented with a slimy plate of sea cucumber or duck tongue, he’s got to bring game there too.  And even more so … a sea cucumber splotch on a nice white shirt will be treated like a Rorshach test by the international media.  Glen Beck will see Elvis telling us to roll back health care reform.  Like The King could even benefit from it now (Elvis would have a hard time too).

But maybe the biggest question is: “What does President Obama’s China trip really mean?”  I’ve been polling my local staff and friends here in Shanghai and the general (yet non statistically-significant) opinion seems to be “so what?”  20 years ago, the President of a Super Power showing up in China gave Chinese leaders the vapors.  Heck, even Gorbachev stopped traffic back in the day, and not just because he was a natty dresser.  Now these trips are more like a weekend event between the Olympics and the Expo.  Most people here just complain that is going to further snarl traffic in a system that already looks like the Indy 500…if bicycles and pedestrians could cross the track at will.

When I ask locals how they think it will impact business, some have quoted the old Chinese saying, 天高皇帝远 (tian1 gao1 huang2 di4 yuan3), “Heaven is high and the Emperor is far away.”  Or “what happens at the seat of power has nothing to do with me down here.”  I would paraphrase (badly) Tip O’Neill, “All business is local” – if you are doing business here, you need to figure out how the game is played in your ‘hood, wherever that happens to be.  What happens in Beijing, stays in Beijing.

So while the China watchers will be analyzing to the nanosecond differences in handshake durations and depth of eye contact to interpret just what is “really going on”, I will continue to advocate that Western businesses spend their time finding out more about the activities of their competitors in China than their political leaders in same.  I am going to choose not read too much into this trip.  As Freud said, “sometimes a cigar is just a cigar.”  Now if Obama and Hu sit down over a Montecristo No. 4 and talk shop, we might have something to analyze!

I was in Los Angeles a couple of weeks ago for a conference.  I flew from Shanghai to LAX, landing there at about 11:00 in the morning.  By noon I was on the road in my rental car.  But it wasn’t until about 12:45, driving 70 mph on the 405, when I remembered that, in the U.S., the lines on the road are more than just mere suggestions … you are expected to stay between them and other drivers get upset when you drift aimlessly.  And some of those other drivers are armed and in a very bad mood too!

My inability to cross traffic cultures aside, this raised in my mind an important point about safety in China … and frankly, things are still a bit loose here.  While it is better here in Shanghai than it used to be, cars don’t always stay between the lines, on their side of the street or even off the sidewalk.  If a driver doesn’t know where they are, they stop, wherever they happen to be, to consider their options.  They will stop in the middle of a street, an intersection or even the elevated highway.  They are not thinking about safety … they just don’t want to be lost.  While I admire their commitment to truth and knowledge, if they are not careful, they will soon know very well where they will end up … on a stainless steel table in the morgue!

Pedestrians here will only stop at a crosswalk when there is a traffic cop to shame them into waiting the 12 seconds required for the light to turn.  And if you are on a bicycle, scooter or motorcycle, you can – and will – just go right through any intersection and any light.  Apparently, no traffic rules apply to you and cops, in general, won’t even try to stop you.  Its as if the presence of two wheels under you gives you superpowers of invisibility, Kevlar underwear and a get-out-of-jail-free card.

So when I saw a New York Times article a couple of days ago titled “Salute All Cars, Kids. It’s a Rule in China”, I was intrigued.  In a nutshell, the article tells how Chinese education officials are encouraging children in the countryside to, literally, salute all cars on their walks to and from school … the purpose of which is to get these kids to pay attention to traffic and notice when cars are coming and to stay out of the way.  However, what I thought was going to be an article about improving traffic safety in China turned into a diatribe about the ridiculous edicts that come from the government here and the citizen outrage that often accompanies it.  The journalist cited numerous examples of silly government pronouncements – such as forcing people to purchase local cigarettes and liquor to inflate the state-owned enterprise sales figures – and the fact that ordinary Chinese are fighting back.  Fair enough … its good to see that voices are being raised against government silliness, something we’ve known how to do for a long time in the U.S. (however, we haven’t quite figured out how to actually END the government silliness).

Unfortunately, what gets lost in article, buried at the very end, is that this edict, no matter how silly it may seem, actually seems to be reducing traffic accidents, at least in the mountainous village where the journalist did their interviews.  And that, I think, should be the point … in Shanghai where I live in MORTAL fear of hitting some kid that runs out into traffic, finding some way … ANY way … of teaching kids to respect traffic is OK in my book.

Teaching civil behavior in China has been an issue ever since … well, ever since there was society here.  And China has one of the world’s oldest civilizations so you do the math … but its been awhile. Chinese leaders over the years, from Meng-zi to Mao, have been seen not only as political leaders, but social leaders as well.

The big phrase in China over the past couple of years has been an encouragement from President Hu Jin-tao to work together to create a “he2 xie2 she4 hui4”, a “harmonious society.”  They started it leading up to the Olympics when they expected airplane loads of tourists to descend upon China and the leaders wanted to put on their best face … kind of like when you were a kid and were told to “go wash up, Aunt Marge will be here any minute” and you were dreading that dry, moth-bally kiss and the comments on how big you’d grown and isn’t it cute at how they grow up so fast, but really, can’t you do something about that acne and … well, no need to drag you into my adolescent nightmare.  Let’s just say that the Harmonious Society campaign has gone over about as well here.

So maybe teaching kids to salute cars isn’t so silly after all.  And c’mon, admit it … isn’t EVERY country’s teaching of civil society a bit ridiculous?  Imagine you are sitting in the pitch meeting for the Woodsy the Owl campaign … “OK, J.R., here is how I see it … we don’t want people to throw garbage on the ground, right?  Makes the place look like a dump, right?  OK … so picture this … a grown man, dressed in a cheesy owl costume … and he says ‘Hoo … Hoo … Give a Hoot, Don’t Pollute!’  Huh?  Huh? Is that great or what??”  Yea … I know I am guy of limited taste and erudition, but I don’t think I would have signed off on that one.

I think that China is reaching a tipping point in matters of public safety and I really think that the government should – and CAN – step in and start to move public opinion and behavior.  Private cars are proliferating like bunnies in the dark here, but car seats for children are not and Junior is playing Red Rover between the front and the back seat.  Start putting some pictures at the car dealerships of what happens if Junior goes through the front windshield … guaranteed there will be a lock down pretty fast.  And maybe adults will actually start using their own seatbelts as well instead of just draping them across their laps whenever they drive by a policeman.  Seriously, taxi drivers do this all the time!  And people are still dumping garbage out their windows here.  Sure, there are tons of municipal workers running around with brooms to sweep the streets, but polluting for the sake of fuller employment doesn’t make sense to me.

So I say, bring on the saluting if it helps teach kids to respect a ton of speeding death metal on the road.  Heck, get them to bow, curtsey and say “By your leave, m’lord”, I don’t care!  Just keep them from being human speed bumps!  And bring on the animals teaching moral lessons … in the U.S. we had our Woodsy, Smokey and G’ruff, China should have theirs.  Imagine the pitch meeting for that one, “OK … Wang … here’s how I see it.  We want to get people to stop throwing garbage on the ground … so let’s dress up some guy in a cheesy panda costume and have him say, ‘Polluters should be nearly extinct … like me!’  Huh?  Huh??  Is that great or what???”

Yea … maybe I will just stick to Podcasting.

Thanks again for listening … remember our motto: “In China, everything is possible but nothing is easy.”  We’ll see you next time on the China Business Podcast.

OK … we are on to Part 3 of our interview with the newest addition to the Technomic Asia team, Kim Woodard.  In this section, we get down into the nitty-gritty of doing deals in China.  Enjoy!

We are in the middle of a Podcast interview with Dr. Kim Woodard, the newest addition to the Technomic Asia team here in Shanghai.  Kim’s background includes setting up A.T. Kearney in the early days of China business and running his own boutique M&A consulting firm.  We brought Kim into Technomic to fill out our ability to provide end-to-end services for our clients doing deals in China.  While we saw a bit slow-down in 2009 for M&A in China (and, in fact, around the world), we see that things are really going to pick up in 2010 as companies are looking for aggressive growth opportunities.

In this Podcast, I talk with Kim about the practical do’s and don’ts of doing deals in China …

Unless you have been living in a hole or the dark side of the moon for the past year, your life has somehow been impacted by the global economic slowdown.  You, a friend or a family member have lost a job; your municipal budgets are being cut; heck, your OWN budget is being slashed.  It has not been a fun year, even here in China where things are still moving along at a pretty good clip.

Though there are signs that things are getting better, I am not convinced we are totally out of the woods yet.  But just because we have no guarantee of where things might be going, that doesn’t mean we can crawl back into our hole or retreat to the backside of the moon … no, we need to keep moving forward.

And at Technomic Asia, that is exactly what we are doing.  For many years, our consulting practice has been involved with foreign companies doing all kinds of alliances in China: from joint ventures to licensing to distribution to acquisitions, we have helped our clients put their alliance strategy together and then execute it.  Up until about a year ago, we had been seeing a real upturn in acquisitions in China: the government rules for acquiring companies were loosening up and foreign companies were looking to China for new growth opportunities.  Then the bottom fell out of the economy and companies put all that activity on hold.

However, as things settle around the globe, multinational companies are looking for ways to grow and China seems a very good place to look for that growth.  And one of the methods they are returning to is growth through acquisition.

To capture this wave, we have brought in a new team member to Technomic Asia: Dr. Kim Woodard.  Kim has had over 30 years of experience in China, first coming here in the 70s in the earliest stages of China’s opening to the West following Nixon’s “Ping Pong Diplomacy”.  Armed with a Ph.D. from Stanford, Kim was soon a respected leader of foreign companies’ earliest advances into China.  Kim helped establish A.T. Kearney’s China practice and then went on to help big names such as John Deere and AMP establish their China operations.

Most recently, Kim had his own firm, Javelin Investments, to assist Western multinationals with acquisitions in China.  We wanted to bring Kim in to Technomic Asia to give us the ability to provide a complete M&A advisory practice – from initial strategy development all the way through to negotiation, closing and integration.

Given the returning importance of M&A in China, I wanted to have a series of conversations with Kim about M&A and, in his experience, what makes for a successful acquisition in China.  Attached is the first in a series that we will roll out in the coming weeks.  I hope you enjoy it!

However, even if the task for “universal coverage” seems more daunting in China than the U.S., I wouldn’t bet against China to actually get there before the U.S. does.  Why?  Simply put, the Chinese government is starting to see that universal healthcare is a responsibility of the government to provide to all its citizens.  In other words, China seems to be looking at healthcare first as a right, and then as a business  This means that, while companies are invited to participate in healthcare and private companies can expect to make a profit, at the end of the day, healthcare is a right and it is a moral responsibility of the government to provide it, at the expense of business, if necessary.

Don’t get me wrong … the Chinese government is being pretty self-serving in considering healthcare as a right.  They know that, in order to maintain the support of the people, they need to provide for their basic needs.  The Party and the government (one in the same in China) knows that healthcare is an issue of national security, not just the health of its people.

But the U.S. is different.  Healthcare is not a right in the U.S., it is a “benefit” that only the employed (most of them) receive from their employer and many (but not all) elderly receive from the government.  If it were assumed to be a right – as it is in most of the rest of the developed world and much of the developing world (like China) – I think we would have a VERY different discussion on our hands.

China’s rapid development in the past 15 years can leave one feeling a bit dizzy.  My first time in Shanghai in the late 80s – in town for an escape from the small central China city where I was living and teaching – was heady enough.  There were only 10 taxis in the entire city and you had to get around on diesel fume-belching busses or by foot (and it was a battle between the aerobic benefits of walking and the heart-stopping inhalation of diesel exhaust).  Now its tough to step in the street here and avoid getting hit by a cab (unless, of course, it is raining or you are late to a meeting or you have two heavy boxes you are trying to schlep to a client … and then there are NO taxis to be found in the entire city.  Go figure).

So when China seems like its returning to the bad old days, it is a bit shocking, particularly when this return is signaled by increased regulation from the Party.  There have been a series of steps over the past year that, in hindsight, are heading in a direction that could be of concern to everyone who does business in China, local and foreigner alike.  Late last year we saw the government put extra restrictions on Carlyle, the financial investor, as they sought to buy out XCMG, one of China’s leading heavy equipment manufacturers.  Carlyle eventually let the deal die because the limitations were so onerous.  At the time, everyone clucked about “protectionist policies” but eventually chalked it up to China wanting to guard an industry that could figure into national defense (ala the U.S. blocking the Chinese oil giant CNOOC from investing in a U.S. offshore oil company a couple of years ago).

The next big restriction was for visas for foreign visitors wanting to enter China just before the Olympics last year.  Thousands of businesses were impacted by this and many Olympic events were sparsely attended because people just could not get here.  Again, apologists for China cited so-called “legitimate” reasons for this … in this case there were serious security concerns.  The reality was that China was playing a game of CYA – “Cover Your Anterior-region” – and was willing to go overboard on restrictions in order to insure that nothing happened while the spotlight was shining so brightly on them.  Sure, it bothered me too but I guess I understand erring on the side of caution – my own country’s Transportation Safety Administration recently busted my daughter on a routine check at an airport … she was relieved of a fingernail clipper, ostensibly because she might use it to hijack the airplane to Cuba (where she would need said clipper because you simply cannot buy them there).  In the immortal words of Fleetwood Mac: “Oh well.”

But then this year, things have been getting even more tight, it seems.  We started the silly season off with Coke being denied their acquisition of the large Chinese juice manufacturer, Huiyuan.  The government was oddly silent on the specific reasons for the denial.  There were some mumblings of avoiding “monopolistic” practices which, in a way, was legitimate as the merger would create a beverage company that would rule in two key categories: sodas and juices.  But many legitimately pointed out that China’s industries are ripe for consolidation and that, following pretty much any other economy as its developed, there are, as time goes on, going to be fewer but larger players in the market.  There is speculation – no none of it published, as far as I have seen – that the government is pushing Huiyuan to themselves become more acquisitive … to go out and start buying up smaller beverage companies to grow larger themselves, in effect creating a competitor to Coke.  Typical of China, the old adage is flipped on its head: “if you can’t join them, beat them.”

Just this last week, two things have happened to make me even more concerned.  The first was the release last Friday of the new Postal Law in China which everyone in the logistics and delivery sector has been anticipating like Christmas morning at the Bill and Melinda Gates household.  However, much to the chagrin of foreign delivery companies like FedEx, UPS and DHL, the law bans foreign companies from participating in domestic express delivery, citing the original 1986 Postal Law that limits domestic delivery of regular mail to the government-owned China Post.

1986?  In China in 1986 it took an entire day to mail a letter!  We had to, literally, make our own envelopes, painstakingly cutting out a template from paper and then using paste thoughtfully provided by the post office to glue them together.  Then you had to let them dry before stuffing them with your letter.  You ended up with glue all over, trying to cram a sticky mess in a drop box with fingers webbed like Aquaman.  And if you wanted to send a parcel in China, fuggitaboutit!  You had to purchase white cloth and make your own bag in which to put your items.  Seriously, I am not making this up.  Around the post office were stores selling fabric, needles and thread and you had to form your own sweatshop on the steps outside the post office to assemble your package for mailing.  I had flashbacks to 7th grade home-economics class, nearly failing for improper needle threading and insufficient stitch tightness.  Who knew that I was actually learning life skills that would come in handy some day??

Anyway, I digress …  This new and unimproved interpretation of the Postal Law is going to be a serious setback to the entire postal system in China.  Plainly speaking, the foreign delivery companies have, for the most part, cracked the code in express delivery in their home markets.  Pretty much anywhere in Europe or North America, if I want something delivered by 10 a.m. tomorrow morning, its going to get there.  I might have to take out a second mortgage on my house to do it, but dang-it, its going to get done!  Now, I don’t for a minute think that any express delivery company would be able to quickly transplant their system in China … China is too big and too complex to do that simply.  But the China postal system could certainly use some external influence and best practices … mailing a letter by regular post is a hit-or-miss thing these days.  The Chinese authorities cited security reasons for keeping the foreigners out … I guess news of the express-delivered anthrax a couple of years ago in the U.S. freaked some people out here.  But seriously, can the Chinese postal system do any better??  I guess in one way they can – with such a dismal delivery rate for their mail the insidious package can’t do any damage if it never reaches the intended receiver.  Let’s hear it for incompetence!

The last indicator that something’s up is the rumor – at this point unsubstantiated – that China is going to once again be very restrictive in issuing visas this summer and into the fall.  This year marks two very important anniversaries in China: the 20 years this June since the Tiananmen Square movement and 60 years this October since the founding of the People’s Republic.  Like with the Olympics last year, China wants to keep out anyone who might make a placard and march on the streets, shouting their support of any one of a number of banned issues.  Hong Kong’s South China Morning Post published a story last Thursday saying that Beijing has said that all “F” business visas issued after April 15th will expire on September 15th.  An F visa is for short-term stays of less than 6 months.  The paper quoted several China visa agents who said that applications for F visas beyond September 15th would be put on hold until there were more clarifications from the government (who, like any government, avoids clarity like the plague).  Again, there have been no confirmed announcements of this, just newspaper articles … so let’s not wig out until we have to.

But shy of wigging out, I think there is some indication for concern here. There is DEFINITELY a protectionist wind blowing in China and with it could come a storm that could hit us all.  There are two sides of this coin here:

First, remember that Chinese regulations are often published but never – or are selectively – enforced (on a side note, the converse is also true … China has been known to enforce rules for which they do not allow the publishing of the official law … I have heard stories of people being prosecuted for breaking a law and were refused the request to actually read the law on the basis that the law was a state secret).  What this means is that there are varying levels of sensitivity in China – if you are a big company and are doing big things in China, the light shines more brightly on you and you have to take more care to cover your bases.  All the big Fortune 500 companies working in China spend squillions of dollars each year in lobbying efforts in Beijing and in the various localities in which they do business.  This is just good business practice (hey, they even do it in Washington!).

But for many companies, they work hard at doing a series of smaller things in order to stay below that radar and to not attract attention.  In any M&A deal we do in China, one of the biggest commercial due diligence questions to probe is how the regulating authorities will treat the new entity once it has foreign ownership.  Chinese companies can get away with things that foreign companies cannot, simply because they are foreign companies (and, contrary to popular practice, having local staff often does not protect you … the spotlight is just brighter on you when you are a foreign company).  So the lesson here is to explore all the possible regulatory implications of what you are doing in China … not just the laws on the books but to talk to all the authorities who touch your business to get their read on what might actually be enforced.  Your business leaders here – your general managers and CEOs – should be spending a large amount of their time schmoozing with the authorities here.  If they are not, you are exposed.

The second thing to remember is, simply, that China is different – it is a one-Party system and that Party is primarily concerned with maintaining their singular hold on power. On a global scale, it is not the riskiest place to do business – that honor is held with dictatorial grip by some southeast and African nations.  But it is comparatively riskier than doing business in the West.  Walk the streets of Shanghai and you can often forget that – the signs for Western products and services make it seem like New York with a really big Chinatown.  But its not.  China is different from other markets.

And, truthfully speaking, I often forget this.  Therefore, I have made myself a May Day resolution (my New Years resolutions having drowned in the Ocean of Poor Self Discipline long ago) – I resolve to be more observant of some of the macro-regulatory moves here and to not be so flip and dismissive of them when they do happen.  I firmly believe that China is moving towards more openness … my last quarter century hanging around here is proof of that.  However, these changes progress at glacial speed with short-term freezes and retreats in the midst of forward movement.  Whether what we have been seeing recently is such a momentary freeze or the tip of a larger iceberg remains to be seen.

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Sheesh … can’t a guy get away for holiday without the world falling apart??  I go for 10 days of sun, sand and minimal Internet and come back to find the world upside down.  AIG needs more money (to fund bonuses? foreign banks? Liddy’s baseball card collection?) and President Obama is firing CEOs (not that many others have wanted to do the same in the past but lacked the political will and cajones).  China dope-slapping Coke in its attempted acquisition of Huiyuan is counter-slapped by Australia for Minmetals attempted investment in OZ Minerals.  An apt description from Dr. Venkman in Ghostbusters: “Cats and dogs living together!  Real wrath-of-God stuff!!”

Not that the situation would be any different if I would have been on the frontlines last week, bravely Podcasting and blogging about the world from my 5th floor Shanghai office … but I do have a bit of a Rip VanWinkle feeling about it all.  To have so much happen in the space of just over a week makes my head spin (causing the too-small brain inside my rather large cranial capacity sound like some Cinco de Mayo maraca jam session).

The suddenness of all this – and too much free time on a beach – has led me to think of three deep thoughts:

Deep Thought Number One: the age of dominance of the western multinational company (MNC) is over. Actually, I think this dominance has been over for some time but we’ve been so busy kicking the body and yelling “Look!  Its moving!” that we’ve not realized its dead.  Certainly this is true in manufacturing … that happened some time ago when we started worshiping at the alter of the god Wal-Mart to receive the deity’s blessings that came from cheap products manufactured in low-cost countries.  I am not saying we would/could/should have done anything differently, but we are where we are.

So maybe the proper way to say this is that we Westerners need to lose the illusion that we are in total control of the world.  We are not.  And the last stand where at least Americans could claim dominance – the financial sector – has completely lost its mojo (and most of its money).  The title “Bank Manager” has become the new oxymoron replacing “student-athlete” and “country-music”.

Practically speaking, this means that Western companies will now be the seller as often (or even MORE often) than they are the buyer.  For every Coke-Huiyuan situation we will find Chinese companies buying medical companies (ala Mindray), mining rights (ala Minmetals) or car companies (ala a billion rumors in the market about various GM divisions being schlepped to the Chinese ).  Certainly, there are massive financial and cultural hurdles to overcome for Chinese companies and institutions to become major buyers, but there is definitely the motivation here and there are certainly enough Western assets – distressed and otherwise – for them to pursue.

Deep Thought Number Two: China WILL become a stronger global player in several sectors. This is a natural result of the first … if there is a leadership vacuum created by the decline of Western firms, someone will step into their place.  And the Chinese seem to be the most likely to come off the bench and make the winning basket.  I see three sectors to keep our eyes on – two are no-brainers and one might be a long-shot.

The first sector where China will begin to gain global leadership is, obviously, automotive.  Already the second-largest auto market in the world, China is also the leading supplier of auto parts and components to the world.  China will begin to leverage this supply chain dominance into actually creating cars to sell into other markets.  It is already happening in southeast Asia where a number of Chinese suppliers are exporting cars.  And Chery attempted a distribution agreement for small cars with Chrysler in the U.S. before the U.S. auto world turned upside down.  Finally, China has declared that they WILL be the global leaders in electric cars and technology – in the next three years.  That is very aggressive but it seems the entire economic and political system is focused on doing this.  Look for the leading China auto companies – SAIC, FAW, Dongfang, Changan, Chery and the cheeky BYD – to flex their muscles internationally.

The second sector is medical device.  Again, China is a leading player in the supply chain of components to the global medical industry but strict regulatory requirements have kept them largely from being very strong in Western medical markets.  The Mindray acquisition of Datascope last year was their attempt to change that – Mindray is the biggest Chinese medical device company, competing against the big boys of GE, Philips, Toshiba and Siemens.  Their acquisition of Datascope, a mid-sized U.S. player in the patient monitoring device sector, was Mindray’s first entry point into the U.S. market.  Look for them and others to follow. But look particularly at China becoming an even stronger growth market for medical companies of all kinds.  China will be investing a big chunk of their economic stimulus package in their medical sector in an attempt to rapidly upgrade the penetration and quality level of medical care for their 1.3 billion population.  As they do this, there is going to be a lot of money out there to purchase medical devices, pharmaceuticals, lab equipment and even healthcare management solutions.  Any medical company of any size should be looking at China as their key growth market in the mid-term.

The third sector to keep your eyes on – and I know I am out on a limb here – is the financial sector.  What?, you say.  A centrally-controlled, socialist system with a partially convertible currency is going to become a leader in global finance??  Yes, that is exactly what I am saying.  I am not saying “tomorrow” or even “in the next 20 years”, but all you have to do is follow the money and the motivation.  China certainly has the money – both in cash and U.S. T-bills – and their motivation is repeatedly being articulated – the latest has China’s leadership saying that they hope to build Shanghai into a major financial sector by 2020 and that “the Chinese Yuan will become a new world-favored currency by then”.  Gutsy?  Sure.  Possible?  Maybe.  But are they going to work on it?  You can bet on it!

This all leads us to my Third Deep Thought:  When it comes to the future, we don’t know JACK!! I know … as the proprietor of a leading market strategy consulting company in China whose very JOB it is to predict market futures for our clients, it is counter productive to admit this.  But c’mon … consider the situation.  If, 18 months ago, you would have told anyone with half a brain and a cable TV subscription that Lehman Brothers, Bear Sterns and AIG would be toast at the start of 2009, we would have assumed you had only a quarter of a brain.  Two years ago – even in the midst of big changes already happening in the automotive market – if you would have said that the U.S. Big Three would be on the edge of global collapse and that BYD (hitherto known as a battery maker) would make the biggest splash at the Detroit Auto Show, we would have taken away the last 25% and made you ride the little bus.

The truth of the matter is that we – meaning pundits, consultants, politicians, TV news anchors, banking regulators (if there are any left) – have NO idea what is going to happen next.  Sure, we know that “down” is still the trend and that “flat” is the new “growth”, but the details of which movers and shakers will actually be the ones shaking and moving is a complete mystery.  So let’s give up trying to predict where things are going and start act like they are going to go somewhere.

This means that we – and by “we” I mean “we Westerners” – get it through our neatly coiffed (but thick) skulls that we are not going to be returning to “normal”.  This economic crisis is not just a speed bump on the journey that we’ve been on since the dawn of the industrial age … it is a fork in the road with a car-swallowing pothole in it, at the bottom of which is a pack of very hungry lions who have been subsisting only on lettuce and Fruit Roll-ups.  OK … that metaphor needs a bit more work, but the bottom line is that EVERYTHING has changed!  The products, pricing, distribution, supply chain, competitors and even regulatory environments of your business are changing radically.  New players – many of them Chinese – are not just playing in the shallow end of the business pool; they are swimming in the deep end and, frankly, many of them look pretty good.

What has not changed is the advice for Western companies regarding China – we have been saying this for a LONG time and, in fact, we can maybe put a sharper point on that advice which is: your company’s future WILL be involved somehow with China so find out what it is now and start working on it.  In the midst of the global economic meltdown, China is still one of the best places for pure growth in most sectors.  You are probably not going to find growth in your home markets in the U.S. or Europe so why keep banging your head against that wall?  Net-net: if China is not at the top of your list of “Ways to save your corporate ass and position yourself for the future”, then you are missing the boat.  That is a fact that I feel 100% confident in predicting.

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There has been a lot of press, not to mention moaning and groaning, about stimulus packages in the last few months. Many countries have put forth their genius to turn their economies around…but we haven’t seen much fruit yet to be sure, and their remains a high dose of skepticism out there on virtually everybodies stimulus approach. This skeptical view even exists with China, the global champion in actually getting things done. As usual, there is a lot of noise in the media about anything to do with China and the ever present political filters that tend to bias realities. In this podcast, I will try to cut through this static and identify what we think is really happening with China’s stimulus plan and how western companies can benefit. I’ll cover the current status of the plan, what forms the various stimuli are taking, some key themes that underly the programs and the industry sectors that will benefit most. In this horrible economic environment there are few places one can go for revenue growth. China is one of those places… so companies with the intent to find growth despite the current pain they are experiencing in their home markets, will do well to take a hard look at what is happening in China.

So let’s set the context a bit before getting into specifics on the stimulus plan. It should be clear to us by now that when the Chinese government is determined to get something done, it usually happens… and it happens fast, and often in a big way as we saw with the Olympics last year. Go to a rural township one year and it’s a patchwork of dirt roads and asphalt. Go there the next year, and not only are all the roads paved, but they are lined by quaint looking trees of all the same breed, shape, and height. Ask around, and a peasant points into the distance and says that the government “uprooted all those trees from that mountain over there”.

The Chinese government has, to date, earmarked (can I use that word?) some US$ 584 billion to stimulate things in the economy. By our US standards of throwing trillions at a problem in the hopes of overwhelming it, this figure may seem a bit paltry. But keep in mind that at 10 to 20 times the wages of those peasant tree-movers, we’re getting a lot less investment bang for our stimulus buck here. Further, the actual usefulness of the monies spent almost embarrases our US program (most pork bellies in China are served with a nice Maotai). There is some opaqueness to the source of these funds (about 25% is slated to come from the central government and the balance from provincial and local government sources). Yet China’s track record when it comes to stimulus spending is pretty stellar so we have confidence this level of resource will indeed find its way in to the market…eventually.

Best estimates say that about $57 billion (or one-tenth of the total package) has already been spent as of the end of 2008. Of this, about $39 billion has been spent on rural infrastructure, roads, railroads, and housing construction. Construction has already started on a $13 billion gas pipeline from Xinjiang to Shanghai, and there are plans to start building at least four nuclear power plants this year. As a result of these and other mega-projects, Yangtze River cargo throughput of steel, coal, and cement ticked up in January after suffering declines since last August. A sign of the stimulus at work!

I was in a meeting with China’s largest grocery chain a couple weeks ago and they were describing their brand new 1.3 mm sq ft., state of the art distribution center being developed…with monies from the stimulus. Our stimulus activities in the US seem like taking a couple advil to ease the pain of a heel spur versus China’s shot of cortisone right into the ­­­affected area.

In these types of programs, we see the Chinese government taking more of a long-term, strategic view of the investment. The goal is not only to address the short-term pain, but to build the country’s overall health and competitiveness. In this regard, it is interesting to note some of the main themes of the stimulus package…

1. Upgrading technology through forced obsolescence and replacement of outdated, energy intensive and polluting processes & equipment
2. Upgrading/expanding capacities e.g. an astonishing $90 billion has been budgeted to more than double China’s rail network over the next decade, adding 25,000km of track.
3. Providing rural development/support, as in offering coupons to get discounts on purchasing durable goods
4. Providing investment and incentives for innovation and expansion of R&D
5. Implementing industry consolidation
6. Spurring export promotion and competitiveness via putting back some of the VAT tax refunds
7. Expanding energy sources including nuclear, coal and renewable energy

We also see the government using a creative mix of methods to stimulate the market using both direct and indirect tactics…it’s not all about spending cash.

1. Tax rebates/cuts
2. Direct investment
3. Policies e.g. consolidation, financing terms
4. Technology funds
5. Direct subsidies

Ten industries have been designated as direct stimulus beneficiaries: automobiles, steel, textiles, shipbuilding, petrochemicals, light industry, electronics, nonferrous metals, equipment manufacturing, and logistics. Not many areas will be unaffected. The government will employ a mix of the methods I just mentioned to bring help to these sectors. Some will benefit from consumption subsidies, e.g. 13% off for peasants to buy mobile phones, computers, and home appliances. Others, such as textiles and light industry, will get bigger export tax rebates. The auto industry will get some help through tax reduction, e.g. going from a 10% to 5% purchase tax to buy a car.

Almost all of the industries will benefit from government commitments to invest in innovation and new technology, with multi-billion dollar funds already announced for the auto and steel industries. The government is also taking industrial policy one step further, guiding consolidation in the fragmented auto and logistics sectors, and getting rid of excess capacity in steel, metals, and equipment manufacturing. Industrial policy is not always spending per se (and it is important to keep in mind that the Chinese term for “stimulus,” zhenxing jihua or “rejuvenation plan,” does not necessarily imply spending), but China is clearly thinking of the global crisis as an opportunity to enhance its industrial competitiveness.

While the ambition of government planners has never been in doubt, there is always some concern for the reality of things in China given that the government always retains a level of opaqueness in its announced programs. So we do need to take some of these specifics with a grain of salt. There certainly will be some, how shall we say “leakage” as the money flows into the system (or the pockets of some politicians). It’s easy to suspect that some big-ticket projects and industrial policies are simply “piggy-backing” on the stimulus to give their proponents bureaucratic momentum, thus exaggerating the headline figure of $586 billion. My litmus test for the reality of these types of things in China is simply to look out my apartment window to see if I can see tangible evidence of activity. I recall during China’s boom periods in the 1990s and early 2000s when many economists doubted the reality of China’s double digit GDP growth. Yet the fact that 50% of the world’s construction cranes were operating in China at the time presented a pretty compelling case for the reality of China’s growth.

So, bottom line? China’s stimulus package is real and its impact will not only spur more economic growth in China’s domestic market but will take China to the next level of global competitiveness as we have seen happen before. The plan is not without its faults and false advertising but don’t doubt its real impact on the economy. Foreign companies, with smart and targeted growth initiatives, can take advantage of this stimulus package to obtain some added growth. You need to be proactive and aggressive to exploit these opportunities. They won’t just fall in your lap!

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