The experience of multinational companies shows that succeeding in doing business with China depends on a good understanding of local needs and wants.

Time and time again, the group buying company Groupon has found itself in hot water in China. Before Groupon’s Chinese site Gaopeng even launched, China’s group buying sites formed a loose alliance against the firm and threatened to blackball Groupon employees from any future employment in the industry. Then the news came out that Tissot watches offered through Gaopeng turned out to be fake and that McDonald’s had rejected 700 coupons for reduced price meals sold to customers in Beijing.

Multinational corporations (MNCs) like Groupon are discovering that success in China hinges on localization. Chinese consumers need to be wooed. If a firm fails to appeal to Chinese tastes, then it can’t seize or maintain market share in China, regardless of previous successes elsewhere. This
is particularly true, given the increasingly fierce competition from homegrown Chinese firms.

When starting an operation abroad, MNCs typically transplant talent from their home country headquarters, said Cheung Kong Graduate School of Business (CKGSB) Professor of Managerial Practice Shalom Saada Saar. But in the past few years, there has been “more and more demand from Chinese consumers for Chinese managers” who better understand local needs and wants, said Saar.

As a result, more and more MNCs are starting to localize staff and transition native employees into managerial positions in China. As they do so, they face a complex set of questions: Is localization the right decision? Which positions should be localized, and who should fill them? How can MNCs strike a balance between local knowledge and brand control?

Groupon’s Shaky Start

Groupon’s struggles following the Tissot mishap and the McDonald’s controversy illustrate the incredible challenges foreign firms face when moving into the Chinese market–particularly when they fail to be adequately local, says Ben Cavender of China Market Research.

Cavender, who studied Groupon since its intensified push into the Chinese market in 2011, says the company’s strategy of bringing in a large number of foreign MBAs “was just a total disaster”.

The foreign hires “didn’t understand what was happening in the market, meaning that they were expensive but did not have many valuable skills to add because they had not really worked in China or in the group buying industry for that long,” he says. Moreover, the company “limited the local team’s ability to actually drive change here or drive the organization in the right direction.”

But Groupon CEO Andrew Mason remains optimistic about the firm’s future in China. In a leaked internal communiqué to employees in August 2011, Mason said Groupon’s “China growth strategy was to hire quickly and manage out the bottom performers. So far, that strategy has improved our competitive position in China from #3,000 to #8.” Indeed, Groupon’s Chinese site Gaopeng captured 3.7 percent of China’s group buying market in September 2011, according to figures compiled by the group buying analytics platform Dataotuan. This put the company on the top 10 list of China’s group buying sites by revenue, for the first time. In October, however, its market share slipped to 3.2 percent, putting it just out of the top 10.

From Cavender’s perspective, the most critical lesson to be gained from Groupon’s experience thus far is: localize. “It’s really important for organizations to really allow the Chinese staff members themselves to make decisions about what is supposed to happen,” he said.

Stability, then Localization

From his interviews in 2009 with over 200 MNCs operating in industries from manufacturing to services, Chinese University of Hong Kong Business School Professor of Management Kenneth Law found that confidence and predictability were two key impetuses for MNCs making the final push to localize. A few years ago, Law says, firms “did not know what was going to happen in the future in China.” Without confidence in the sustainability of a long-term presence in China, firms were left with short-term plans of 3 to 5 years. But this changed in recent years, as firms observed that China’s economic and political environment was changing and stabilizing. This, in turn, encouraged confidence and longer-term planning. “Whenever a firm has a longer-term plan, they will start to localize,” Law says.

Why Local, Why Now

With China’s business landcape stabilizing and competition for Chinese consumers intensifying, localization is increasingly becoming a priority for MNCs in China. But as they make the leap to localize, more and more firms are dicovering that operating in China entails a steep learning curve, according to CKGSB Professor of Strategic Management Teng Bingsheng.

Maneuvering in China requires a thorough understanding of local conditions–what customers like today, what they’ll like tomorrow, what will offend them, how they spend money. “It’s important to have people in charge who understand the China market,” says Teng.

“When you have a fresh expat in China, the odds are that they cannot survive these days,” he says, because the significant competitive advantage enjoyed by MNCs and expats in China “is no longer so dominating or absolute.” MNCs can no longer coast on an international reputation,as the quality offered by local firms is gradually catching up with global standards. Foreign managers also no longer have clear advantages over local talent. General Electric recently recruited their corporate vice president in China from a purely Chinese firm, something which was “not common five or ten years ago,” says Teng.

According to Teng, MNCs are recognizing that some professional managers in China can be very competent and sometimes have training in Western management practices, even if they lack overseas experience. When Yang Yuanqing took over for an American as CEO of Lenovo. “performance improved drastically” for the firm, Teng says, citing this as just one instance where a Chinese manager outperformed an American predecessor on a global scale.

Expensive expatriate salary packages are also driving localization efforts. Expat salaries in China are traditionally much costlier than those for local workers, but fewer firms can afford them in the aftermath of the economic downturns in both Europe and the United States, Teng says.

On the flip side, the cost of local talent is also rising. “There is such a demand for local talent that a lot of the local managers are actually more expensive than the foreigners that companies were previously hiring,” Cavender says.

Creativity in the Face of Scarcity

The dearth of adequately trained local Chinese talent has already created a bidding war between firms in China.

The British multi-national financial services firm Standard Chartered Bank (SCB) found it “nearly impossible to recruit commercial banking talent” because of poaching from other firms, according to Kenan-Flagler Business School at the University of North Carolina Chapel Hill Professor of Leadership Doug Ready. Ready, who has authored case studies on SCB’s struggles to retain talent, said the firm would recruit and train local employees, only to have a competing firm “steal them away for a 3 percent pay increase.”

Beyond salary, SCB also had to compete with a sense of nationalistic pride–the idea that “now is our time”–that motivates Chinese talent to work for local firms like Tencent, Baidu, Alibaba and Lenovo, Ready says.

Frustrated, SCB in 2007 went on the hunt for untapped human resources, engaging in what the firm called a “raw talent initiative.” Instead of competing directly with other financial firms for talent, Ready says, SCB recruited from outside of the finance industry, looking for employees “who understood client service, customer relationships, and building an effective working climate.” They turned to the hospitality industry and drew out new hires from hotels like the Ritz Carlton and the Four Seasons, giving them training in finance for six months.

The raw talent initiative has proved “enormously successful” for SCB in the years since its inception, according to Ready. SCB’s salary packages were competitive compared to those in the hospitality industry, and the personal development opportunities they offered made SCB attractive as well.

SCB has also actively worked to establish a meritocratic, development-based culture where employees see opportunity for future advancement, explains Ready. This is in contrast to the phenomenon of Chinese employees at some MNCs feeling they are “second-class citizens” whose career prospects are limited by their nationality, says Law.

The company stopped “throwing BMWs at people” to get them onboard, instead making it clear to employees that there were no glass ceilings for local employees, Ready says. In the first year of the new policies, attrition declined by 3 percent, which was significant compared to the dramatically increasing attrition rates other foreign financial firms are seeing.

At the end of the day, there is simply not enough trained, capable talent to satisfy demand. Attracting and retaining that talent requires ingenuity and a corporate culture that will keep employees excited, energized, and upwardly mobile, Ready says.

Balancing Autonomy and Control

Successfully leveraging localized staff requires decentralized decision-making, but this can become problematic if local managers are given too free a hand and stray from a headquarters’ oversight and control. The experience of Yum! Brands, the parent company of KFC and Pizza Hut, is illustrative of the delicate balance between independence and control.

Walking into a Pizza Hut in China, guests are escorted to a cushioned booth in a large, warmly lit dining area. They receive a tome of a menu, with pages upon pages of choices ranging from pizza and spaghetti to snails, octopus and quail eggs. In Chinese KFCs, guests are welcomed by the ubiquitous smiling face of Colonel Sanders and can choose from traditional local cuisine such as fried dough and soy bean milk, classic KFC fried chicken meals, and East-West crossovers such as chicken sandwiches accented with a spicy Szechuan sauce.

Contrast this to customer experiences in the United States. There, Pizza Hut is generally a take-home food, and the storefronts themselves tend to offer little in the way of selection beyond different toppings. KFC is also mainly a takeout affair, and the only choice that many customers make is how many pieces of fried chicken they want in their bucket.

It is specifically these kinds of innovations away from their home base models that have brought Yum! Brands success in the China market, said CMR’s Cavender. These innovations only exist because Yum! authorized “their local teams to actually make decisions, allowing them to grow and respond to change very quickly,” he said.

But localizing is only half the battle for an MNC like Yum! Brands. Yum! has also managed to protect its international reputation for quality, even when confronted with challenges.

In 2005, consumers were scared off when a food coloring product linked to cancer was found in one of KFC’s sauce products, leading KFC to suffer a 30 percent drop in its profits during the second quarter of 2005, following the scandal.

Since the incident, KFC has been vigilant, ensuring that no similar accidents will occur. If KFC hadn’t improved its safety protocols following the incident, the chain might not enjoy its current level of success in the mainland, Cavender said. Yum!’s China operations generated $4.1 billion in revenue in 2010, 36 percent of the MNC’s total global revenue, and KFC and Pizza Hut both dominate their respective restaurant sectors in the country. KFC alone has captured 40 percent of China’s fast food market.

Yum! managed to dodge the quality concern bullet, but it is unclear whether Groupon will manage to survive quality- control mishaps like the Tissot and McDonald’s scandals.

“If you get caught selling something that is fake, whether or not you intended to, it is pretty much guaranteed that people are not going to trust you anymore,” Cavender says. Since the Tissot scandal broke, Groupon has raised the compensation it is offering to customers who purchased the watches, to double the original $109 purchasing price. In December, the Shanghai Public Security Bureau’s Economic Investigation Department said it was still investigating Gaopeng for criminal liability in the Tissot sandal.

For his part, Groupon CEO Andrew Mason said that the company would be giving more autonomy to its China operation Gaopeng. In an investors’ conference in late November, Mason indicated that working in China’s market would require a unique approach.

“We’re patiently supporting the team,” he said.