A New Game Begins

A decade after joining the World Trade Organization, China’s foreign direct investment enjoys 40% annual growth. In 2010, China’s FDI was USD 68.8 billion, fifth in the world. According to government figures, over the past ten years, 900 different types of “made-in-China” products have the largest international market share. There were 54 Chinese companies ranked in the top 500 in the world by Fortune Magazine, up from only 12 in 2001.

During China’s ten-year membership in the WTO, some 347,000 foreign companies have done business in China and their annual profits have grown 30%. However, MNCs need to do alter their approach to prosper in an increasingly competitive market, argues associate dean and professor of strategy Liao Jianwen from Cheung Kong Graduate School of Business (CKGSB). Liao offered the example of Huawei’s success: It went from the countryside to major cities, and then to Southeast Asia, Africa and the Middle East; and it is now penetrating the mainstream telecommunication market in North America and Europe.

Liao argues that the central problem for MNCs lies in their top-down approach, which has not allowed them to make their products cheap and attractive enough. Eventually, they will hit a wall in the mid-tier market, beyond which they have no competitive advantage. What is worse, in industries where MNCs used to have a competitive advantage, such as medical equipment, there is the emergence of Chinese rivals who have improved manufacturing, design and marketing. Resulting in those firms becoming more competitive in higher-value areas that used to be dominated by MNCs.

Local Companies Show Agility

Liao offers an example from the consumer healthcare industry. Johnson & Johnson sought to differentiate Band-Aid and to beat out a domestic bandage company, Yunnan Baiyao. Johnson & Johnson’s strategy included putting forward an impressive image with well-dressed salespeople staying in fancy hotels. Yunnan Baiyao took a more grassroots approach. In third-tier and fourth-tier cities, their salespeople pitch store-to-store. Johnson & Johnson has lost 15 percent market share to Yunnan Baiyao over the last three years, and its market share is continuously declining.

The Chinese market today differs from the 1980s when Procter & Gamble shampoo was an anticipated commodity. In 2001, when local Chinese producers owned 50 percent of the shampoo market, P&G introduced a new product line costing RMB 9.9 to compete with the Chinese companies.

MNCs often fail to recognize that the traditional advantages of their business model disappear when they try to expand into third- and fourth-tier markets. Even if they realize the limitations of their business model and develop a cheaper version of the product, their overall strategy remains the same. Many look to the example set by GE , which segmented its business into autonomous units to cope with the unique challenges faced in China.

Companies Search for a Winning Strategy

In an article published in Harvard Business Review, GE’s Jeff Immelt admitted that the model his and other manufacturers had followed for decades — developing high-end products at home and adapting them for other markets around the world – would not suffice as growth slows in rich nations. He and his colleagues realized they had to do change directions: develop products in countries like China and India and then distribute them globally.

This strategy has indeed served them well. GE established a research center in Wuxi, a small town in southern China with the goal of developing a low-end portable scanner for use with a laptop. This was in response to the fact that a USD $150,000 ultrasound scanner developed in the United States could not sell in China outside of a few top-notch hospitals in first-tier cities of Beijing, Shanghai and Guangzhou. The research and development team in Wuxi was local and was given a high degree of autonomy — they reported directly to GE’s headquarter in the US, rather than the GE Greater China office. Eventually, their low-end portable scanner reached hospitals in every corner of China and has also been a hit in the US.

In 2011 nearly 60% of GE’s revenue comes from sales outside the US and it will grow even larger over time, according to GE’s annual report. But the USD $30 billion of industrial revenue in key global growth markets does not put Immelt at ease, as he wrote, there are deep conflicts between MNCs traditional trajectories and new approaches.
Local Diversity Further Challenges Old Assumptions

Boston Consulting Group also warns that not all secondary markets are alike: regional differences in spending habits, product preferences, distribution channels, and trade structures are significant. “Because regional differences are so significant in China, companies must define the source of their opportunity carefully and prioritize growth plans before allocating resource,” says BCG research.

There is also debate about corruption in MNCs originating in China, due to the country’s undeveloped regulations and unpredictable enforcement practices, which can lead to ruthless profit grabs. In addition, local governments flirt with big companies, burnishing their own credentials, but leave MNCs in a conundrum. Sometimes political outcry affects foreign operations, like the protests in many Chinese cities outside Carrefour supermarkets, after French president Nicolas Sarkozy met with the Dalai Lama before the 2008 Beijing Olympic Games.

Liao suggests MNCs unlearn business models and best practices developed in the west to better respond and adapt to the rapidly changing Chinese environment.