Western firms need new strategy to crack China

By:
Published on:

Foreign firms with ambitions in China need a smarter strategy to crack the country as the old certainties of double-digit growth, untrammelled markets and low-cost production are replaced by a more complex growth picture, says Ben Simpfendorfer, founder of Silk Road Associates.

They may have not have noticed but unprecedented numbers of their Chinese rivals are heading the other way – looking for friendlier markets where competition is gentler and costs cheaper. China’s long-term growth is undoubtedly on a lower trajectory compared with the booming first decade of this century. Yet China remains the world’s most exciting consumer frontier. Opportunities have become more difficult to grab here but investors with a smart approach can still enjoy huge rewards. First, China’s middle class is already large and rapidly expanding. Eight Chinese cities are home to more than 1 million households who earn over USD15,000 a year. Dozens more cities are approaching that mark. Second, China’s interior provinces – home to 720 million people – are catching up after 20 years of relative economic obscurity in the shadow of their compatriots in the fast-growing coastal regions. Those inland markets are low-yielding, costly to run and highly-fragmented, while in richer cities the fight for fatter middle class wallets has become intense. To penetrate both markets a clear commercial plan is more vital than ever. Store location is a good example where foreign multinationals need to smarten up. In 2000, a retailer might have set up shops in Beijing, Shanghai and Guangdzou. Today, the same company would have to target at least 12 cities to avoid surrendering its intellectual property to copy cats who could swiftly roll out a rival offering. Foreign firms can easily be dazzled by the lure of such a huge market but they should understand that unless they are prepared to commit to building a meaningful presence, they might do better targeting smaller growth markets such as Indonesia or the Philippines. Those companies which do take the plunge in this new, more complex phase of China’s growth story will also have to be far savvier about specific local conditions than earlier arrivals. They will need strong partners to help them navigate the cultural tastes and customs of new, inland markets. They will also have to recognise the need to educate consumers about the value of their brands in more far-flung corners of the country and be prepared to invest accordingly. Such extra complexities and costs might discourage some from considering a move into China. That would be a mistake. More farsighted Western firms are beginning to understand they can no longer opt out of the world’s second biggest economy. Chinese multinationals and others from this fastdeveloping region are quickly innovating and quietly gaining an edge over Western competitors in important areas such as e-commerce. It won’t be long before more are looking to exploit that advantage overseas. China’s state-owned corporations went global some time ago in an effort to secure resources for continued growth. But today, as China’s economy slows, local competition hots up and costs rise, a new wave of more nimble private corporations are looking overseas. They are likely to act a lot more like Western multinationals – partnering local companies in emerging markets and increasingly in Europe and the US, and with far more interest in the services sector. As a result, there are good defensive reasons why Western firms should get into China. Familiarisation with Chinese business practice and gaining new thinking on technology, cost structures and economies of scale may help when those Chinese competitors start to target their home markets. Some are hesitating however. Heightened tensions between China and Japan over the disputed Senkaku Islands – or Diaoyu as China calls them - has impacted the way multinationals think about the region. Japanese firms in particular are looking at their exposure to China and a growing number of are looking to diversify their manufacturing across the region. China’s rising cost base and ageing population feed into the same story: China will never again be the outsourcing destination it was. That does not mean we will see China’s manufacturing base shrinking significantly. China is already importing vast quantities of low-value goods from its South East Asian neighbours. Countries like Vietnam and Cambodia are showing competitors can take on China in sectors like clothing and electronics, and win. That does not mean South East Asia will mount a serious challenge to China’s status as Asia’s factory – its neighbours simply aren’t big enough to replace it. Chinese clothing exports for example, are six times greater than those from the rest of the region combined. The size of Cambodia’s whole economy is equivalent to that of Guangzhou’s. But a marginal shift for China’s economy represents a massive boon for the rest of South East Asia. No other region has the capacity to supply its vast markets. And anyway, why would manufacturers base themselves elsewhere when Asian factories are increasingly producing for newly-wealthy Asian customers? Manufacturing used to constantly reallocate around the globe, in the search for efficient, low-cost labour close to markets. That is why the world’s factory is now stuck in Asia for good. Ben Simpfendorfer is founder and Managing Director of Silk Road Associates, the Hong Kong based consultancy. Mr Simpfendorfer was previously Chief China Economist at RBS.
Disclaimer The statements and opinions expressed in this article are solely the views of Ben Simpfendorfer speaking at an RBS Insight event in London on June 4, 2013 and do not necessarily represent the views of the Royal Bank of Scotland. This communication has been prepared by The Royal Bank of Scotland N.V., The Royal Bank of Scotland plc or an affiliated entity (‘RBS’). This material should be regarded as a marketing communication and has not been prepared in accordance with the legal and regulatory requirements to promote the independence of research and may have been produced in conjunction with the RBS trading desks that trade as principal in the instruments mentioned herein. This commentary is therefore not independent from the proprietary interests of RBS, which may conflict with your interests. Opinions expressed may differ from the opinions expressed by other divisions of RBS including our investment research department. This material includes references to securities and related derivatives that the firm’s trading desk may make a market in, and in which it is likely as principal to have a long or short position at any time, including possibly a position that was accumulated on the basis of this analysis material prior to its dissem nation. Trading desks may also have or take positions inconsistent with this material. This material may have been made available to other clients of RBS before it has been made available to you and regulatory restrictions on RBS dealing in any financial instruments mentioned at any time before is distributed to you do not apply. This document has been prepared for information purposes only. This document has been prepared on the basis of publicly available information believed to be reliable but no representation, warranty or assurance of any kind, express or implied, is made as to the accuracy or completeness of the information contained herein and RBS and each of their respective affiliates disclaim all liability for any use you or any other party may make of the contents of this document. This document is current as of the indicated date and the contents of this document are subject to change without notice. RBS does not accept any obligation to any recipient to update or correct any such information. Views expressed herein are not intended to be and should not be viewed as advice or as a recommendation. RBS makes no representation and gives no advice in respect of any tax, legal or accounting matters in any applicable jurisdiction. You should make your own independent evaluation of the relevance and adequacy of the information contained in this document and make such other investigations as you deem necessary, including obtaining independent financial advice, before participating in any transaction in respect of the securities referred to in this document. This document is not intended for distribution to, or use by any person or entity in any jurisdiction or country where such distribution or use would be contrary to local law or regulation. The information contained herein is proprietary to RBS and is being provided to selected recipients and may not be given (in whole or in part) or otherwise distributed to any other third party without the prior written consent of RBS. RBS and its respective affiliates, connected companies, employees or clients may have an interest in financial instruments of the type described in this document and/or in related financial instruments. Such interest may include dealing in, trading, holding or acting as market-makers in such instruments and may include providing banking, credit and other financial services to any company or issuer of securities or financial instruments referred to herein. This marketing communication is intended for distribution only to major institutional investors as defined in Rule 15a-6(a)(2) of the U.S. Securities Act 1934 (excluding documents produced by our affiliates within the U.S.). Any U.S. recipient wanting further information or to effect any transaction related to this trade idea must contact RBS Securities Inc., 600 Washington Boulevard, Stamford, CT, USA. Telephone: +1 203 897 2700. In Singapore, this marketing communication is intended for distribution only to institutional investors (as defined in Section 4A(1) of the Securities and Futures ct (Cap. 289) of Singapore). In Hong Kong, this marketing communication is intended for distribution only to Professional Investors (as defined in Schedule 1 of the Securities and Futures Ordinance of Hong Kong). Issuers mentioned in any material may be investment banking clients of RBS Securities Inc. and RBS Securities Inc. may have provided in the past, and may provide in the future, financing, advice, and securitization and underwriting services to these clients in connection with which it has received or will receive compensation. Accordingly, information included in or excluded from this material is not independent from the proprietary interests of RBS Securities, Inc., which may conflict with your interests. For further information relating to materials provided by RBS, please view our RBSMarketplace Terms and Conditions: RBSM Terms and Conditions The Royal Bank of Scotland plc. Registered in Scotland No. 90312. Registered Office: 36 St Andrew Square, Edinburgh EH2 2YB. The Royal Bank of Scotland plc is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. The Royal Bank of Scotland N.V., established in Amsterdam, The Netherlands. Registered with the Chamber of Commerce in The Netherlands, No. 33002587. Authorised by De Nederlandsche Bank N.V. and regulated by the Authority for the Financial Markets in The Netherlands. The Royal Bank of Scotland plc is in certain jurisdictions an authorised agent of The Royal Bank of Scotland N.V. and The Royal Bank of Scotland N.V. is in certain jurisdictions an authorised agent of The Royal Bank of Scotland plc. Copyright © 2013 The Royal Bank of Scotland plc. All rights reserved. This communication is for the use of intended recipients only and the contents may not be reproduced, redistributed, or copied in whole or in part for any purpose without The Royal Bank of Scotland plc’s prior express consent. Copyright © 2013 RBS Securities Inc. All rights reserved. RBS Securities Inc. member FINRA (http://www. finra.org) / SIPC (http://www.sipc.org), is a subsidiary of The Royal Bank of Scotland plc. RBS is the marketing name for the securities business of RBS Securities Inc.