China: A World of Contrasts and Opportunities

By The 2003 SOM China study trip members. Prepared by Jonathan Cohen.

"Why did you come to China?" This was the often-repeated question that Chinese students, managers in both domestic and multinational companies, and even the U.S. Consul General in Shanghai, asked us during our 15-day trip. Perhaps it was the diversity of our group that triggered the repetitive question. Of the 15 students that participated, there were 10 nationalities across 3 continents, 5 Mandarin speaking students, 3 second-year students and 12 first-years. Our whirlwind tour of China included visits to 6 cities (Hong Kong, Shenzhen, Shanghai, Hangzhou, Tianjin and Beijing), 20 Chinese and multinational firms in 10 sectors including financial services, law, consulting, pharmaceuticals, automobiles, energy telecommunications, media, consumer goods and real estate.

While each of us had his or her own interest in China, we did share some common ground. As a group, we wanted to learn about the Chinese business world, visit the only economy with 8% growth in a world downturn, strengthen a network of contacts, improve language skills, and get to know each other better as classmates in a challenging yet extremely rewarding environment. The result was a trip true to SOM standards: broad learning in a fun and open atmosphere with a diversity of people, culture and interests at the crossroads of business, politics, social and environmental studies. In summation, it was a real adventure!!! Not only because we escaped the SARS virus, and weathered the tension of the beginning of the Iraq war, in a group composed of Americans, Chinese, French, Spanish, Germans and Latin Americans -- but because we learned about China and business, and opened our minds to a new culture and different way of thinking.

We wanted to share with you, members of the SOM community, what we have learned about China from our rich meetings with CEOs, consultants, politicians, SOM alumni, Chinese MBA students and a small (very small) part of the Chinese population.

Cliché nº1: China is a huge market of 1.3 Billion consumers.
China is a huge country. Everything is gigantic: the Communist Party is composed of 55 million people (almost the entire population of France or England). Many state-owned-enterprises (SOE) have more than 1.5 million employees. Shanghai, with its 16-million people, represents only 1% of the entire Chinese population. China's economic growth rate of 8% is unprecedented in the current global economy. Some Chinese industries have become dominant in the world economy: for instance, 2/3rd of the world construction market and concrete production is in China. It is impressive to see how much cities are building. Shanghai's Pudong Area ("a mix of Disneyland and Wall Street", to quote one of our speakers), was farmland less than two decades ago and now looks like a city from Mars in science fiction comic books of the 60's -- with its futuristic and reaching skyscrapers.

Nevertheless, China is not necessarily a market of 1.3 billion people, as many foreign investors wrongly think when deciding to invest. Only 200 to 300 million people are benefiting from growth and have the disposable income to afford goods and services from foreign firms. The car market for instance is very tiny (there is a ratio of 1 car for every 100 persons in China, which is very low compared to 1 in 4 for Western economies) and still very exclusive. Shanghai General Motors produced 100,000 high-end Buicks with DVDs and a comfort that US cars do not reach. The real estate market is also booming but with apartments designed for a growing upper class.

Moreover, certain industries have limited access the Chinese market. A striking example is the TV market. Star TV, a subsidiary of News Corp., has entered the market but is only allowed to broadcast in hotels and foreign compounds in the Guangdong province -- and just recently to the rest of China. For these niche market and high end segments, a huge attraction towards the West prevails in the consumer needs. Hence we can find the same trends of health, wellness, and comfort as in the US or Europe.

Cliché nº2 - China is a place of cheap labor and low cost manufacturing focusing on the production part of the value chain
Thus, if in the last 20 years, about 420,000 foreign companies have invested around $450 billion in China, it seems that companies must see China more as a factory than as a market.

The main advantage of China is its low cost of labor. The average hourly salary is $0.27 in China (compared to about $1 in Mexico). Visiting Alibaba.com, an internet portal for Small to Medium sized suppliers and manufacturers in China, allowed us to see a successful Chinese start-up. It also showed us how China is still positioned to produce cheaply. China produces today 50% of photo equipment in the world, 30% of TV sets and Air Conditioners, 25% of washing machine and 20% of refrigerators.

Nevertheless, China is changing and developing modern infrastructures. For instance, BP is investing in one of the world's top-notch chemical plants in Shanghai. Shenzhen, the first specially designated economic zone, is specializing in high technologies, which already represent 46% of its production.

Moreover, it is interesting to see how a new social capitalist system is taking shape. For instance, some multinational companies like Lafarge China do not take a pure cost approach to investing in China but rather a "mutual benefit" approach. When Lafarge bought one of their concrete plants, it kept 800 out of the 5000 workers, when in reality they required only 300 people. However, by investing in training, Lafarge has managed to turn this plant into one of its most efficient plants. These practices are a way to promote links with local governments and to reconcile western capitalism and Chinese communism.

Cliché nº3 - Multinationals companies are losing money in China.
Historically, multinationals have settled in China with a contingent of expatriates and have invested in joint ventures with local Chinese firms. In fact, in many restricted sectors, the Chinese government does not allow multinational companies to operate non-Chinese majority owned companies. In many strategic industries, such as telecommunications and media, foreigners must operate with a local partner in a joint-venture and cannot take a controlling stake.

Today, it seems that 1/3rd of foreign companies are losing money and 1/3rd are at breakeven. For instance, AT&T has been in China since the beginning of the 90's. But, due to legislative constraints, the company has not been able to build infrastructure until recently - and then, only in a quarter of Shanghai and for large companies. BP also is investing in large infrastructure and plant and will need several years before earning profits.

However, 1/3rd of the foreign companies are profitable. Danone has been very profitable in the water, dairy and biscuit markets and has several joint ventures with major brands such as Wahaha, the largest bottled water producer in the world. Lafarge, Star TV, GM, and GSK are also examples of successful joint ventures or ventures.

Cliché nº4 - Multinationals companies are run by Expatriates
The multinationals are actively looking to hire local Chinese talent because of language, culture and also cost issues. It is more cost-effective to nurture local talent than to expatriate executives from outside China. For instance, the entry monthly salary for a Chinese MBA graduate is $600 at PricewaterhouseCoopers, which prides itself on being one of the most competitive in the market. Expatriates with similar responsibilities cost at least double. However firms continue to hire expatriates to create international interactions and, according to the VP of a major multinational in China, to act as "scapegoats" for Chinese workers when implementing changes. It is easier to make Chinese workers accept change in work habits if it comes from foreign managers.

Multinational companies manage to attract the majority of graduate students because of the better pay and the opportunities they offer to Chinese employees. The most popular companies for many Chinese graduates are multinational companies, especially in the IT sector such as Microsoft, IBM or Dell.

Cliché nº5 - State-Owned Enterprises (SOEs) are huge inefficient companies.
Their size is amazing. Some SOEs can have upwards of 1.5 million employees, like PetroChina. SOEs typically have had a large role beyond just providing a job. They have the responsibility to care for their employees on a social basis: providing salary, benefits, housing, insurance and lifetime employment.

These giant companies are changing, influenced by western management style and a desire to reach international markets. But the process is difficult. For instance, the former Chinese monopolist of the telecommunications industry has been split into 3 companies. But, instead of benefiting from its oligopoly position and cooperating, as Sharon Oster would recommend, they are instead competing on price and in each other's territories, driving down margins for all.

On the trip, we also had the chance to visit two very different pharmaceutical companies in Tianjin. First, we visited a subsidiary of the giant multinational GlaxoSmithKline, named Tianjin SmithKline & French Laboratories (TSK&F) and then a State-Owned-Enterprise named Tianjin Tianyao Pharmaceuticals Co. (TJPC), which is a world leader in the production of Corticosteroid. It was impressive to see the differences. The Multinational had brand new modern facilities and a modest conference room. Whereas the SOE, even though it has gone public and is a world leader in its market, had facilities that appeared to be less high tech. But, interestingly enough, TJPC also had the most luxurious conference room that we had seen during our trip. The Board of Directors of TJPC said that they were proud to host a meeting with students from "the university of the last 3 US Presidents," and they treated us in the real Chinese Communist style: not only were Chinese soldiers saluting each person that entered the company headquarters, but they also took us to the best restaurant in town to drink Baijio (local rice wine) and taste Tianjin seafood delicacies (including crocodile and scorpion!!!). Haven't we told you that discovering Chinese business culture is really enriching?

Cliché nº6 - The tremendous power of the Communist Party and the control of the country by the Central Government in Beijing.
Beijing is a strong power center of the Communist Party, but there are competing forces that arise within the party from members that represent interests of provinces outside the capital. The power of the Central government is visible in some instances -- like censorship or WTO decisions. Hence, the Media sector has been kept out of WTO negotiations and is still ruled by "The Government's 16 guidance points".

However, the central government is not the only power in China. Its power is more and more dependent on world pressure because of the Chinese economy's reliance on foreign investment. The best example of this is the concessions made by China to include the telecommunications market in the WTO agreement. Moreover, the Central government functions in a very consensus-driven culture that causes decision-making to be a long and difficult process. As a consequence, local regional governments are very powerful and sometimes distant from Beijing's central government. The Shanghainese government has been able to shape Shanghai into a major global metropolis. The investment decisions of foreign companies are also dependent on relations with local government. For instance, Lafarge worked closely with a local government to build a new plant in Central China, which was eager to benefit from the tax base of having a large multinational enterprise located there.

Another trend is the birth and growth of a private sector. Symbolic of this phenomenon is the accession of CEO's and entrepreneurs as members of the Chinese Communist Party. There is growing freedom to start businesses and keep profits. Alibaba.com, an internet company based in Hangzhou, is hailed as the success story of a home-grown entrepreneur who built a thriving business in China. Many MBA students we met in Beijing and Shanghai shared their aspirations to start their own companies in the future. It is in the interests of the Communist Party to promote entrepreneurship; as the reforms of SOE's make many workers redundant, the Party is looking to the small businesses to absorb surplus labor.

Cliché nº7 - Gray areas in China are everywhere: bribing customs, lack of respect for intellectual property rights...
China's accession to the WTO in 2001 is prompting the government to bring transparency to the market, but it remains a major challenge for the immediate future.

It is extremely difficult to enforce a contract in China. According to one veteran corporate lawyer we met in Shanghai, the role of foreign law firms is to advise foreign multinationals and to serve as a "guide-dog for the blind in a minefield." Many multinationals who establish a presence in China often do so with ebullient profit projections but without thorough due diligence. To any foreign firm looking to invest in China, this particular lawyer recommended bringing to the country only the expertise and know-how that one could afford to lose. The lack of law enforcement is also obvious when talking about intellectual property rights protection. As an example to illustrate this point, we can use the case of Viagra. According to a representative that we met from the U.S. Foreign Commercial Service in Beijing, more than 95% of Viagra produced in China is not produced by Pfizer in spite of their patent. This excess has led Pfizer to create a lobby of world pharmaceuticals industries to work with the U.S. Foreign Commercial Service to put pressure on the Chinese government. The message it is clear, if the Chinese government does not enforce the property rights, pharmaceutical companies will stop their operations and eventually leave China.

A Canadian entrepreneur who has started a deli chain in Beijing also shared with us the challenges he faced when setting up a company, and the need for bribes. These practices are less obvious and direct than we may think, but they do exist. Even more striking is the fact that bypassing the law seems to be entrenched in the Chinese culture. In his words, "every Chinese is a lawyer who tries to bypass the law".

On the other hand, many firms we visited did not suffer any of the issues described above. BP, for example, managed to impose its ethical standards and corporate-wide values in its Chinese joint ventures. GSK told us that it is not worried of fake copies of its products because it has developed good relations with wholesalers and its brand is well known for its quality.

Cliché nº8 - China is open to the world since its ascension in the WTO and is becoming a world leader in the global economy.
After 130 years of instability and conflicts -- from the Opium Wars against Great Britain in 1847, the Taiping and Boxer Rebellions, the fall of the Qing dynasty in 1911 and the subsequent establishment of a nationalist government to the invasion by Japan in 1937, the rise of communist power in 1949 and the Cultural Revolution in the 60's -- China has experienced 25 years of stability since the end of the 70's. The accession to WTO in December 2001 was a great milestone in its quest for growth and development. And the 2008 Beijing Olympics and 2010 Shanghai Expo will have the same role.

China has definitely become a major player in the world economy. At Foreign Direct Investment levels of nearly $60 billion, China has attracted more than the US has in 2002. Its economy is growing; foreign investments and exports keep increasing, SOEs are investing and developing overseas and have been able to raised $20 billion from foreign funds in tough times.

Nevertheless, China is still confronted with tremendous challenges in years to come. Reforms will be key to China's future economic development. The toughest issues are to manage the growing gap between Western and Eastern provinces, to find a solution on the non-performing loans (up to 50% of all the loans in China according to analysts) which are threatening China's growth and stability, to reform the legal system by giving the means of enforcement, and to reform the pension system. Unemployment issues and the distribution of benefits could also be difficult with an absent middle class.

Our 27 meetings from March 9th to March 22nd :
In Hong Kong: Goldman Sachs, Merrill Lynch, The Boston Consulting Group. Chinadotcom,

While in Hong Kong we also organized an alumni dinner at The Peak Café where we had sweeping views of the city and were joined by Raymond Chia, another SOM alum, and an admitted student. After dinner we met up with two other SOM alums, Nancy Yao and Alan Cheng for drinks in Lang Kwai Fung.

In Shenzhen: Vanke Group

In Shanghai: Freshfields Bruckhaus Deringer, Star TV, Shanghai Danone Biscuits, BP, Shanghai General Motors, US Consul General (Shanghai), Fudan University MBA students joint event,

While in Shanghai we organized a special dinner with the Shanghai area SOM alums. Six SOM alums and one Yale College alum attended the event.

In Hangzhou: Alibaba.com,

While in Hangzhou, we met with Joel Packer (SOM Charter Class) for lunch at the West Lake. He also joined us for the Alibaba.com meeting.

In Tianjin: GlaxoSmithKline (TSK&F) and Tianjin Tianyao Pharmaceuticals Co. (TJPC)

In Beijing: Lafarge, AT&T, PricewaterhouseCoopers, JP Morgan, Cummins Engines, Sammy's Sandwiches, US Foreign Commercial Service, Beijing University MBA program / Qinghua University MBA / and Sloan MBA multi-school event.

While in Beijing, we organized dinner and drinks with local SOM alums. About 10 alums attended the event, including Yu Yang and Tong Zhang.

The 2003 SOM Study Trip Team: Mark Bussow, Amyon Chaffey, Jonathan Cohen, Luis Cuellar, Graham Goodkin, George Hager, Evelyn Huangfu, Rob Johnson, George Luo, Colm Rafferty, Malik Rashid, Carlos Reyes, Roberto Sobrino, Stephen Vaccaro and Kevin Ye.

Trip Coordinators: Colm Rafferty, Amyon Chaffey, Carlos Reyes


If you want more information about our trip or The Greater China SIG, feel free to contact us at chinabusiness@mail.som.yale.edu