China has traditionally bewitched multinational companies. They come and they invest. They invest despite nagging concerns about the continuation of China’s economic boom, despite uncertainties about China’s political future and its commitment to a market economy. Enchanted by the promise that it will be one of the world’s most important economies by early next century, many multinationals are approaching China as a long-term strategic market, and they are investing large sums of money to help build sustainable long-term positions. This can be a rational strategy. Multinationals that do not consider exploring China’s vast market with its emerging consumer base could be missing a tremendous growth opportunity. But some multinationals take the long-term argument too far.
Although making profits is a matter of necessity, even of urgency, at home, some multinationals are not making—and do not expect to make—money in China in the short term. Moreover, these companies tend to point to early entrants, such as Coca-Cola, to support their belief that you have to be around a long time to get results, that it is critical to stay on in order to reap the early-mover advantage. This is nonsense.
Underperformance in the short term is probably the best indicator we have that a company’s current strategy or practices—or both—may be outdated and may not measure up over the long run. This is particularly true where no attractive opportunities exist in the market. (See the insert “When You Should Consider Exiting the Market.”) True, Shanghai Volkswagen, Matsushita’s TV tube factory, Charoen Pokphand’s animal feed ventures, and Otis’s elevator plant are all early entrants that are growing at double-digit rates. But Peugeot entered the Chinese market at the same time as Volkswagen, and it has lost tens of millions of dollars each year since 1995. Kraft entered China more than ten years ago, and all of its plants are now reported to be losing money.
Pepsi-Cola, in contrast, did not seek equity majority and management control until 1993. As a result, four of its bottling plants remain cooperative joint ventures rather than equity joint ventures. There are considerable disadvantages to cooperative joint ventures. Because they are based on cooperative contracts, they restrict the foreign party’s level of management control and complicate the process of making investment decisions. In short, when it comes to the Chinese market, Pepsi-Cola’s lackluster performance shows how even an experienced marketer can miscalculate the critical factors for success.
Pepsi-Cola had not even begun to wrestle with the question of partnerships in the early 1990s, when Coca-Cola was already taking important strides toward investing in a direct distribution system. Coca-Cola’s plan was simple: make Coke more readily available through a direct sales force. The consequences of this strategy were significant. The new distribution system allowed Coca-Cola to invest in opening new accounts, which increased coverage. The company was able to provide better service to retailers, perform merchandising and point of sale activities, motivate retailers, manage inventory levels, and increase profitability by capturing the wholesaler margin. Almost all of these activities would be considered elementary by Western standards, but they were entirely new to bottling partners and traditional wholesalers in China. So they gave Coca-Cola an edge. The result: with direct distribution in place, today 65% to 70% of Coke’s sales are managed through its own sales force, compared with only 20% of Pepsi’s. Coca-Cola is also able to cover more than 90% of urban areas, compared with Pepsi-Cola’s 60%.
Those moves in themselves would have been enough to demonstrate Coca-Cola’s mettle and determination to be the market leader, but the company nonetheless launched another offensive in the form of a bold investment policy. Although Coca-Cola has already invested $500 million in China, it recently announced that it will double its investments to $1 billion over the next five years. The implications for market share are significant. Today both Coca-Cola and Pepsi-Cola have bottling plants in major cities such as Beijing, Shanghai, Guangzhou, and Wuhan. Problems will emerge, however, as soon as the two competitors try to expand into smaller cities, where the volume potential will justify only one plant with sufficient scale to break even. The government has already announced that it will grant just one license in these cities. As a result, huge entry barriers will be established once a plant is built in a small city. Given Coca-Cola’s profitability and leadership, the picture looks bleak for Pepsi-Cola. If its announced plans are realized, Coca-Cola will most likely continue to lead Pepsi-Cola in market share by a margin of three to one.
Coca-Cola’s long-term success underscores why short-term results in volume growth and market-share leadership are absolutely essential. Its strategy allowed it to build sustainable advantages in the market by attracting better management talent and producing sufficient volume and profits to invest in a direct distribution system. This early success reinforced its commitment to the Chinese market. And it also deepened Coca-Cola’s understanding of the market and Chinese employees, thereby facilitating the relationship-building process with the government. A virtuous cycle was set firmly in motion.
Patience and Longevity Are Not Enough
Early movers do not necessarily succeed. More important success factors include managerial capability, critical mass scale, and product portfolio. This is true in any market but perhaps more so in China, where local market knowledge is not always intuitive or obvious. Kraft, for example, was an early mover that could not sustain its initial success—in part because of an inappropriate product portfolio in a quick-paced market.
In China, local market knowledge is not always intuitive or obvious.
Kraft entered China more than ten years ago with its product Tang. Subsequently, the company built three additional plants for producing coffee, dairy products, and gum. Despite this expansion, Kraft’s market position in all product categories today is weak. Sales of Tang, for instance, declined 25% in the last five years, eroded by many emerging substitutes, such as Jianlibao, a carbonated orange-flavored drink, and by numerous fruit juices. In coffee products, Kraft’s Maxwell House has always fought an upward battle against Nestlé’s Nescafé. As for the sale of dairy products, cheese and yogurt are not part of the traditional Chinese diet. Kraft’s competitors have gained market share by offering Chinese consumers products that are more suited to their tastes. Nestlé behaves much more like a Chinese food company. In addition to offering global brands such as Nescafé, Nespray, Milo, Kit Kat, and Polo, Nestlé has tailored several products to what the Chinese consumer wants and needs—instant noodles, seasonings for Chinese cuisine, mineral water, and a popular live-lactobacillus health drink. Unless consumer-goods companies can adapt in this way to build a more attractive portfolio of product categories, they are unlikely to be successful in China.
Product portfolio is not all that a multinational company must get right. The operating paradigm it follows in its home country should be reevaluated for its effectiveness in the local environment. For instance, given the low labor costs and the weak wholesaler capabilities in China, it often makes sense to have a direct sales force service key accounts instead of relying solely on wholesalers for distribution. Moreover, for many consumer products, often as many as half the consumers have not decided which brand they will buy when they enter a retail store. As a result, in-store promotions tend to be more effective than advertising.
In addition to reconsidering the best approach to distribution and marketing, a company might also have to adjust its product’s packaging. Consider, for example, the performances of Budweiser and Miller in the premium beer market.
Budweiser was launched in China in 1995. By 1997, it had leapfrogged to the number one position in the extremely competitive premium segment. Demand for Budweiser far exceeded capacity. Anheuser-Busch—the U.S. company that owns Budweiser—decided to double its capacity in China. It rationed beer to wholesalers until new capacity came on stream in the summer of 1998.
Anheuser-Busch achieved this success because it made a point of knowing its market. Before entering China, it had taken the time to study customers and had learned that in China, the characteristics of premium beer are very different from those in the United States. In China, some 70% of premium beer is consumed in restaurants and bars, only 30% at home. Chinese consumers choose cheap popular beer when drinking with their families, but when they eat out with friends, they order premium-priced beer in order to save face. In restaurants, moreover, beer drinkers like to share large bottles as a sign of courtesy and friendship. Because of low labor costs and subsidized energy rates, glass bottles in China are only half the price they are in the United States. Cans cost twice as much there because China can’t produce aluminum sheets, and can makers have to source them overseas, paying a high import duty.
Predictably, the most popular packaging for premium beer is the 22-ounce bottle. In packaging its product, Anheuser-Busch was quick to accommodate the needs and wishes of Chinese consumers; the reaction in the Chinese market was immediate and positive. By contrast, Miller—the number two beer in the United States after Budweiser—was launched in China in 1992, almost three years before Budweiser. At the time, Miller was available only in cans. Not surprisingly, it did not sell well and was discontinued in 1994. Miller Brewing reintroduced its beer in cans and large bottles in 1996. Due to fierce competition and the lack of investment support, the company struggled and pulled out of the market after only a few months. Currently, Miller has no local production in China and has only a tiny share of the niche import-beer segment. Clearly, early presence in the market provided no defensible advantage.
In fact, early movers are sometimes at a disadvantage. Diving in and treading water can be just as expensive as getting in too late. Consider the courier industry. In China, the courier market is highly regulated. When FedEx, UPS, TNT, and DHL first entered the market, they were all required to work with the same Chinese company, Sinotrans, as their exclusive agent. Although these players were accustomed to competing fiercely on a global scale, their restriction to the same agent in China stifled the level of differentiation between companies.
In the late 1980s, the government allowed Sinotrans to enter into equity joint ventures. Most players quickly moved to form fifty-fifty joint ventures; only FedEx held back. It adopted a two-pronged strategy that forced it to stick to the old agent arrangement but also enabled it to leverage its lobbying power to push China to relax the regulatory environment. The strategy paid off. FedEx has managed to sever its relationship with Sinotrans and pick a new agent. It has also secured landing rights in Beijing and Shanghai through its acquisition of Evergreen, an established cargo airline. FedEx has negotiated the “fifth freedom” landing right in Japan, so it can load cargo there during stopovers for its flights to China. Finally, after FedEx chairman Fred Smith met with Chinese President Jiang Zemin, FedEx obtained the right to fly to Shenzhen.
If FedEx had followed the competition, it could not have adopted and implemented the same frontal strategy that it used, to great effect, in the United States in the 1970s and in Europe in the 1980s. Specifically, a fifty-fifty joint venture with Sino-trans would have prevented FedEx from playing the lobbying card so hard. It would have been significantly more complicated for FedEx to secure the rights to fly planes to Beijing, Shanghai, and Shenzhen, and it could not have made aggressive investments in its service network and marketing. (Under the fifty-fifty arrangement, the Chinese partner has to agree on—and cofund—those investments.) If the regulatory environment opens up still further and China joins the World Trade Organization, FedEx will be better positioned than its competitors to set up its own operations with full control and an extensive ground delivery network.
Paradoxically, although FedEx’s competitors entered into a seemingly attractive deal, they ended up creating difficulties for themselves when market conditions changed. FedEx was the only company bold enough to wait, gambling that a joint venture could be a costly undertaking from which it would be difficult to extricate itself. Early-mover disadvantage can be expensive.
Short-Term Success Is Not a Pipe Dream
Traditional wisdom says that it takes a long time to make money in China, but a hopeful note can be sounded. A survey of the top 200 joint ventures in China reveals that they are growing at an average compound annual growth rate of 38% at an 8% after-tax margin. Moreover, individual examples of short-term success are impressive. For instance, Ericsson—the Swedish telecom company—acquired 40% of the cellular handset market, worth $4 billion, in only three years. Kodak gained a 15% share of the $500 million film market in less than two years. Tingyi built a $500 million instant-noodle business from nothing in just four years; its average operating margin over that period was more than 20%.
Many of these successes can be attributed to recent moves these companies have made, not to how long they have been in China. The examples of Ericsson, Kodak, and Tingyi show how companies can plan for success by making smart short-term moves, thereby helping to establish new rules for the game. Their successes are also founded on their continuous learning in the market and their ability to react correctly to changing dynamics. Performance is driven by an adaptive strategy that can be implemented rapidly. In this respect, recent developments in the cellular handset market are particularly instructive.
Ericsson was an upstart in the market, and it beat its competition through an imaginative and enterprising consumer-marketing approach. Using a flashy advertising campaign, the company turned cellular handsets into fashion accessories. As a result of its revision of the rules of the game, Ericsson poached market share from Motorola, the early entrant in the paging and cellular handset markets. Although Motorola once commanded a monopoly position, its early successes did not help it sustain its lead. Ericsson was able to take advantage of fundamental shifts in the demographics of cellular handset buyers and the transition from analog to digital systems. And in the process, it vividly demonstrated the limited advantage of the early-mover position.
Ericsson’s first hit in the Chinese market was the model 377 handset, which was somewhat smaller than competitors’ offerings and appealed to female consumers. Given the extensive distribution and service network already set up by established competitors, Ericsson decided to focus on advertising. After a series of brand image and product benefit ads, the company signed up a famous Chinese actress, Gong Li, for a series of lifestyle ads, which proved to be extremely appealing to women. Sales continued to explode despite competitors’ launches of similarly sized products. Learning from its initial success with the celebrity ad, Ericsson launched an even larger advertising campaign with another actress, Maggie Cheung. This campaign was so popular among those surveyed that it was hailed as the best ad in China in 1997. Ericsson then introduced a series of color phones to reinforce its position with trendy women. Impressively, by 1997—less than three years after it first deployed its new marketing strategy—Ericsson had captured around 40% of the handset market in China.
Kodak is another player that managed to steal the spotlight. Before the widespread establishment of minilabs for film developing, Chinese consumers sent their rolls of film to large photo labs for processing. Most of the photo labs used domestic equipment, paper, and chemicals; the high-quality advantage of foreign films could not truly be realized. It was Fuji—working with its distributor for Hong Kong and China—that started the minilab concept in China.
In the early 1990s, Fuji led the photo film market with a 60% market share. Due to the limited financing capability of its distributor, however, Fuji could not invest sufficiently in minilabs to dominate the market. Kodak jumped in and franchised its own network of more than 3,000 Kodak Express minilabs—roughly 50% more than Fuji had. Because Chinese consumers believe that Kodak films work better with Kodak equipment, paper, and supplies—and Fuji films with Fuji supplies—the wide network of Kodak minilabs drove up sales of Kodak film. Kodak’s market share shot up by more than 15% in less than two years; earnings grew by more than 40% per year. Recently, Kodak committed to investing $1 billion in three local Chinese film companies. This will almost certainly provide Kodak with a quantum leap in the world’s third largest film market, where Kodak already holds a 32% share of the market compared with Fuji’s 35%.
Tingyi, the small Taiwanese food company that markets noodles, also muscled its way into the Chinese market, showing remarkable enterprise and persistence along the way. Tingyi’s story is typical of the new winning strategy in China: strike while the iron is hot.
In the late 1980s, China’s travel industry exploded when midlevel managers, students, and elderly people began to travel both for business and for fun. Airports and train and bus stations were jammed with travelers. The transportation infrastructure was stretched to the limit, and there were no catering services in place to feed hungry travelers. Even now, restaurants can be found only in airports and in some large train stations; most of them are state run and are open less than six hours a day. Enter Tingyi.
Tingyi’s success does not derive from having invented anything new but from staying ahead of the market. Consider instant noodles, which are hardly a new invention in China. The company’s leading competitor—the mighty market leader in Taiwan, President Enterprises—already sold noodles wrapped in plastic. But it took Tingyi to recognize the real opportunity. It sold no-preparation-needed noodles in Styrofoam bowls. Plastic utensils and packaged seasonings were also included because hot water is the only resource widely available in public transport stations. The Styrofoam bowl concept was not new: a Japanese product called Cup Noodles had been around for much longer than Tingyi’s product. But Cup Noodles was too small for famished travelers and—because it is imported from Japan—too expensive. Tingyi found a niche and exploited it. The company then maintained market leadership through innovations such as new seasonings and continual distribution expansion.
The moral is unambiguous: companies can make money quickly in China.
The moral is unambiguous: companies can make money quickly in China. As noted earlier with Coca-Cola, such success is not only feasible, it is crucial. The Chinese economy is changing very fast. It is experiencing high single-digit economic growth, the transition from central planning to a market economy, integration with the world trade systems, indigenous and imposed deregulation, the emergence of collective and private enterprises at the expense of state-owned enterprises, and so on. All these factors are dramatically altering the competitive landscape in many industries. The Chinese market is in such tumult that it is constantly challenging the positions of incumbents and creating fresh opportunities for innovative competitors that know how to change the rules of the game. It is fundamentally unsound to tolerate poor short-term results in the mistaken belief that they are an investment in the future. On the contrary, short-term success is critical both to generate profits for investments and to discourage competitors.
Smart Companies Learn and Adapt
The kind of success that Ericsson, Kodak, and Tingyi have achieved in the short term demands continuous learning and adaptability in order to manage the vastness of the market and the rapid rate of change. This is difficult in an environment like China, where Western managers face exceptional language and cultural differences, and doubly difficult because consumer demographics and tastes are constantly changing. Kraft’s Tang was successful at the start, but carbonated drinks and fruit juices were quickly substituted for it. Motorola was very successful with male consumers, but Ericsson took advantage of the demographic shift in the cellular handset market toward women. As Ericsson’s success dramatically shows, in an emerging market, effective learning is essential.
Consider Peugeot. Although Peugeot and Volkswagen entered the Chinese automobile market at roughly the same time, their performances have differed dramatically. Volkswagen’s revenues have grown at a compound annual rate of 77% since 1985. Sales exceeded $2 billion by 1995. Today Volkswagen has expanded its capacity to 300,000 cars; the company produces close to 200,000 cars per year. It enjoys more than a 50% share of the passenger car market and earns a double-digit after-tax profit. By contrast, Peugeot has built a 90,000-car capacity and sold only 2,000 cars in 1996. The company has lost tens of millions of dollars annually since 1995.
Peugeot’s poor performance appears to be caused by its repeated inability to learn in and adapt to a rapidly changing environment. As Volkswagen’s success demonstrates, the Chinese automotive industry is attractive, and Peugeot began its operations in China with plenty of advantages. Its joint venture was set up in the wealthy south, which has a more entrepreneurial culture because of its proximity to Hong Kong and because of the early promotion of the reform policies of the late Deng Xiaoping. By contrast, Volkswagen’s joint venture was established in the more conservative Shanghai region. Until the mid-1990s, Shanghai’s economy was dominated by loss-making state-owned enterprises, and the city was not allowed to implement aggressive reform policies.
Yet Peugeot was not able to exploit its advantageous position in the south and did not learn how to succeed with commercial customers. In the 1980s, automobile industry experts predicted that growth would be driven by consumer wealth and consumer demand. But the market in China remained commercial. Even now, the vast majority of Chinese consumers cannot afford to own cars—more than 70% of the cars in China are purchased by commercial companies. Volkswagen was quick to adjust its assumptions and operating paradigms; Peugeot was not.
Car manufacturers in China must learn to cater to commercial customers, who buy more than 70% of the the cars there.
To serve the commercial market, Volkswagen built an aggressive distributor network and sales force. The company recognized that commercial buyers were less price sensitive than other consumers given that they needed—and were willing to pay for—high-quality after-sales servicing. Volkswagen was able to push volume through its distributors and achieve critical mass. This growing volume allowed Volkswagen to realize considerable scale economies, thereby allowing it to drive down prices. Because Peugeot never managed to develop an effective approach for commercial buyers, it never generated the prices and profits needed to motivate distributors. Without this high channel profit, it was unable to attract capable and aggressive distributors and could not develop a reasonable service network.
Peugeot also failed to learn other important lessons. An understanding of the development of downstream industries, for example, was crucial in identifying and promoting potential demand. Volkswagen’s partner lobbied the government to support the establishment of taxi companies in Shanghai. Although consumers could not afford to buy private cars, their demand for taxi services supported the growth of taxi companies, which did buy cars—from Volkswagen. Peugeot did not follow a similar strategy. The company was unable to secure a dominant position in its home province in China. Hence, it never achieved critical mass and competitive cost position to grow its operations to a national scale. Losses piled up, and after a 12-year stay in China, Peugeot exited the market.
By contrast, successful companies learned to capitalize on the conditions of the Chinese market. When Ericsson first introduced the lifestyle ads, it received mixed responses from various consumer segments. Older men thought the ad was frivolous, and some even switched their televisions to other channels. The ad elicited positive responses from female audiences, however, and sales of cellular handsets soared. Encouraged by this initial success, Ericsson invested more money to develop the Maggie Cheung ad series. Learning brought further changes and successes. For its part, Kodak learned from Fuji that minilabs were an effective tool for gaining market share. Knowing that Fuji’s investment capability was limited because of its distributor’s restricted finances, Kodak outspent its competition. The results were outstanding. Similarly, Tingyi learned from its initial successes in product development and distribution. The company continued to invest in new product developments that cracked the code for what Chinese consumers need and want. These companies all learned from their successes; they were able to reinvest and replicate the process. Such short-term results are not only critical to fostering a virtuous cycle but also constitute the very basis for effective learning.
Making Money in China
Just as in any other market, a superior understanding of the changing environment and the successful implementation of shrewd strategies drive profitability in China. Early movers like Coca-Cola that continually adapt to China’s shifting market will enjoy success. Early movers that are unable to learn from and change with the market, like Peugeot, will exit. Early movers that start strong but fail to stay abreast of shifts in the market, such as Motorola, will lose market share. Early movers that enter into unattractive arrangements too soon—recall the situation that most of the courier companies found themselves in—will experience early-mover disadvantages. And late entrants, such as Ericsson, Kodak, and Tingyi, will enjoy success, despite their late entries, if they know how to make the right moves in an emerging market.
Don’t buy into the myth that China is so unique that short-term profits aren’t necessary.
Short-term success is the best litmus test there is for companies as they continue to monitor the external environment, to influence the competitive landscape, and to adapt their responses to opportunities and threats. Any company operating in China today should carefully analyze its situation, understand what differentiates success from failure, and then formulate the best course of action. Multinationals should continue coming to China because the opportunities for growth and profit are immense. But buying into the myth that the Chinese market is so unique that companies need not be profitable in the short term will never do. That is like applying the medicine of witchcraft in a scientific age.