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Jonathan Woetzel, Director of the McKinsey Global Institute (MGI), on how Chinese companies are poised to influence the basis of global innovation

China’s business landscape has changed dramatically over the past decade. From being followers, today Chinese companies are competing head on with their multinational counterparts in nearly all sectors. In this interview, McKinsey Global Institute Director Jonathan Woetzel explores the impact that Chinese technologies are having and how China is increasingly in a position to influence the basis of global innovation. He also discusses the future balance between state and private business and the need for foreign companies to adjust their approach to the China market to remain competitive.

You co-authored No Ordinary Disruption: The Four Global Forces Breaking All the Trends. What are the key disruptive trends that you see now in global business and how has that changed since the book was published in 2016?

We highlighted four trends in the book, the factors of globalization, urbanization, technology and demographics. Those are fundamental trends that are intrinsic to the human condition and as such they certainly haven’t changed. The character of these trends might be changing, such as how globalization has become much more regional and digital than when it started, and how urbanization has changed from being a mega-cities focused event to being more focused on medium-sized cities and their growth. But overall, these trends are evergreen.

What’s new is the intensity with which they interact and the impact that they’ve had. We’ve seen a much greater impact in the last decade on everything from the environment to the consumer, the digitalization of everything and the impact on countries and their budgets, and the social contract and how that is provided for. There’s a difference between the trend and its impact—the trends are ongoing while the impact continues to evolve.

The rise of China could be viewed as disruptive or as a healthy realignment of global forces away from a paradigm dominated by the West. What would be your view on this process and of an emerging Asia?

The emergence of Asia as the world’s largest consuming market, destination for investment, source of investment and increasingly the world’s largest technology platform is a reality. There isn’t much to be questioned there. I sense that Asia’s emergence on the world stage is a product of these long-term trends in the sense that as those trends unfold, they have an impact on the ways in which regions interact, [and on] multilateral arrangements and trade flows.

We already have—and we’ve always had—competition amongst regions, countries and companies, and that’s not going to change. I believe most of us would like to see that this competition is to the benefit of all, that it helps consumers by encouraging innovation and enhancing productivity, as well as creating opportunities for investors to put their money to work in things that can create value. I wouldn’t frame it as an A versus B team event, as there’s plenty of competition within Asia, as there is within many other regions and across regions as well.

China seems to be playing a pioneering and leading role in a number of tech areas, including Big Data, artificial intelligence (AI) and digital finance. To what extent is China the future in terms of the systemic use of technology?

China has developed many uses for AI. Kai-Fu Lee has a categorization of different waves of AI: Internet AI, Business AI, Perception AI and Autonomous AI[1], with China leading in some of them because of its ecosystem, which is driven by manufacturing supply chains, for example. But in others it’s at parity at best, such as in Business AI and the digitalization of supply chains.

China is supportive of implementing AI at scale, so there is a large and ongoing program for most companies that I work with to invest in their IoT (Internet of Things) capabilities. This continues to generate very large amounts of data, which can then in turn be harnessed to create analytical engines to optimize and make better decisions. China is not unique in that and there are other countries and systems capabilities. This similarly recognizes that this technology is valuable and can deliver real benefits in terms of productivity, growth, customer benefits and government effectiveness.

In terms of the economy, how do you see the balance between the private sector and state sector changing over the coming years? Are there scenarios where the center will be willing to divest some of its control in return for a more dynamic economy?

Yes, of course. China’s history of economic reform and development is based over the last 40 years on the development of the non-state sector. That’s been the driving force of productivity, growth and innovation, pretty much everything associated with the Chinese economic ‘miracle’ as the world knows it. That is the past of how China has developed, and I don’t see that fundamentally changing. Going forward, over time the non-state sector will continue to grow in importance and the state sector, while it may not disappear, it’s relatively confined to a piece of the economy and it’s probably going to stay there.

What do you see as the main challenges for foreign companies operating in China?

The biggest is that the competition is much harder. When foreign companies entered decades ago, there was no local competition. Today, there are as many Chinese companies on the Fortune 500 list as there are US companies. But even though the competition has increased, it’s still early days for those Chinese companies. They’re not truly global, they’re not as productive and their brands aren’t as strong. Foreign companies as a class still have significant advantages and generally speaking higher market share in China than they do in other markets that they participate in. The automotive sector is a good example of that.

The challenge that foreign companies face is how to respond to a new wave of nimble, agile, largely digital and private sector competitors who are out to eat their lunch.

From a management perspective, to what extent are Chinese companies now operating in equivalence to their Western counterparts?

They’re on the same track, but there’s still a significant gap. If you look at the average share of global revenue, around 20% of Chinese companies’ revenue comes from countries outside of China, whereas for US companies it’s closer to 40%. So simply speaking, they’re just less globalized, which is an indicator of many things, including their management capacity to incorporate multiple markets, global product development capability and global supply capability. That’s then reflected in their operations. While they’re very good at some things, typically in the era of the entrepreneurial founder, they’re not good at others, such as more systematic company-wide process development.

Over the next decade, Chinese companies will likely be able to catch up and surpass their Western counterparts in some areas, given the size of the country’s economy and its growth trajectory. You can argue that in some industries Chinese companies are already setting a benchmark, notably in areas where China gets an ‘unfair share’ of the marketplace because of the competitive advantages it’s been able to build. Some processing and manufacturing industries and consumer-facing industries come to mind.

What innovations do you see coming out of China and its economy and business that have would global application?

There are strengths in consumer-facing innovations, like the use of the internet, as well as processing innovations, such as leveraging the manufacturing ecosystem of the country. Technologies that are benefiting from scale, either of the marketplace or in the factories, are what you can see coming from China. And perhaps solar panel manufacturing or battery technology or internet solutions and internet portals are examples of innovations that are having a global impact.

What China hasn’t been as successful at is engineering-based innovation, which requires a network of suppliers working together, for example, in the automotive sector and perhaps in telecoms equipment. Research innovation has also been relatively slow. You may see some innovations in biopharma, but by and large China still lags in things that require science-based innovation, like semiconductor design.

However, as China continues to invest in and become more innovative, it will actually change the nature of innovation so that innovation itself will become a different thing than we might have imagined before. Typically, innovation might have happened with a rarefied atmosphere around it, but innovation in a Chinese context is a contact sport where it’s all-hands-on-deck in trying a lot of things and hopefully some of them work. So, we characterize it as cheaper, faster and more global. It’s cheaper because it’s benefiting from the Chinese cost structure for innovation, which allows a lot more human resources to work at one time. It’s faster because of the manufacturing ecosystem that already exists, and finally it’s more global because it benefits from a global innovation ecosystem in China. That’s perhaps in the medium-term the biggest impact that China is going to have. It’s going to make innovation itself that much cheaper, faster and more global.

What do you see as China’s role in rethinking energy usage and sustainability in the new era?

China has made a commitment officially to become net zero in carbon emissions by 2060, and with that commitment we’re now starting to see a transition on multiple fronts, in energy, mobility and agriculture. All of these things are happening and it is going to make a difference to the energy economy of the world as China continues to ramp up its renewable energy investments over the next decades. That will ultimately have an impact on fossil fuel consumption, a likely reduction in imports of fossil fuels to China as well as a drop in the consumption of fossil fuels within China itself.

In a broader sense, as China invests in a renewable energy transition, it will create a trend in investing in technologies that will ultimately be global technologies. So, whether we’re talking about grid management and storage or batteries, these will be technologies that will no doubt become drivers of the learning curve worldwide. There are big implications for others as I see China making these investments.

As China grows and its billion plus people become part of the global dialogue, they’re certainly going to play a bigger role on climate. Climate is a good proxy for a global dialogue in the sense that climate change is an outcome of those long-term trends. It’s not that we woke up in the morning and said that we’d disrupt climate. What we intended to do was to urbanize, develop and use technologies. Climate impacts are an externality, so as countries urbanize, globalize and digitize, they create climate impact and it’s necessary for them to be part of the conversation because it’s fundamental to who they are. We’re not going to solve climate issues unless everybody is at the table, and that is something that China will definitely have a bigger role in. In the same way, they’ll have to have a bigger role in how we address any global issue of public goods, which would include public health, security, data and internet regulation among others.

[1]   In Internet AI, the world mostly learns from masses of user data to curate content. In Business AI, businesses use data to create leverage for modern corporations, such as by issuing loans via AI. Perception AI sees AI moving into sensors and smart devices and Autonomous AI will integrate all four and give machines the ability to sense and respond to the world around them.

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