Outsmarting China's Start-Arounds

Outsmarting China's Start-Arounds

Opinions regarding China's economic rise have generally been shaped by two hard-to-ignore numbers.

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Outsmarting China's Start-Arounds

Opinions regarding China's economic rise have generally been shaped by two hard-to-ignore numbers: one is the country's current labor cost advantage, which is as much as 95% over multinationals in the U.S., Europe, Japan and South Korea; the other entails the prediction that in 30 years, China will become the world's largest economy.

Chinese policy makers certainly know the direction they want to go in. Today, China is home to 16 of the world's top 500 companies; the country is aiming for as many as 50 by 2010. But what path will they take?

Looking back on how Japanese and South Korean companies became global leaders, a common trajectory emerges with three distinct phases: They built local manufacturing, often in order to provide low-cost sourcing to multinationals; they borrowed capabilities through technology licensing and joint ventures to improve quality and processes and begin exporting; and finally, they bought assets and brands abroad to secure their global positions.

China will likely incorporate a similar buy, build and borrow strategy. But the economic engine that is accelerating the country along this familiar pathway is not well understood. Indeed, a distinctly Asian paradox underlies this growth, where stunning economic achievements are fueled by both entrepreneurial successes and, at the same time, great turnaround efforts.

As commonly understood, entrepreneurial—or start-up—implies beginning from zero, creating a climate that fosters innovation, unencumbered by corporate culture or history. Turnaround, by contrast, implies a concerted top-down effort, through central planning, to overcome burdensome elements of the past, adapting to a changing environment with the will to endure the painful effects of massive change.

These concepts would seem mutually exclusive. And yet, Asia's recent economic history bears out how these forces can be combined and multiplied into what we call a "start-around" approach. Indeed, one Asian country after another has devised its own unique method of combining start-up and turnaround activities to create some of the most impressive economic growth stories of the last century. Far from being contradictory, such centrally managed turnaround policies, yoked to the free pursuit of entrepreneurial wealth, reinforce each other.

Understanding this duality, one can see how the start-around pattern has repeated itself over and over, first in Japan, which combined MITI policies with free market trade, and then in Asia's "Four Tigers." But the standout example of the start-around is China, where an ancient culture has become the foundation of a colossal turnaround, and where a stagnant communist economy has been transformed by a booming capitalistic start-up culture. Indeed, China is probably the best example of an Asian nation that has allowed free market forces to create entrepreneurial energy while maintaining the influence of a centrally managed economy. China is truly the start-up of all start-ups and the turnaround of all turnarounds.

China has opened its once-rigidly controlled economy in a way that has allowed both domestic Chinese and foreign nationals to flourish, deftly handling the conflict between communism and capitalism by brushing economic ideology aside. Reverting to the pragmatism of their ancient culture, they are pushing their nation towards modernization, not Westernization. To quote Deng Xiaoping, "It doesn't matter if the cat is black or white, as long as it catches mice." While many difficult issues remain as China's economic revolution continues to gain speed, its leaders clearly understand the power of the start-around concept.

The corollary is that multinational corporations must also comprehend how economic energy is unleashed by China's start-around efforts. Today's global champions are already up to speed in the most important areas of business competition such as understanding customer needs, managing global supply chains, creating and motivating world-class talent and ensuring a steady supply of on-target innovations. But they need to accelerate their own growth to stay out in front.

Two high-growth Chinese companies exemplify how start-around policies reinforce each other. State-run Shanghai Automotive Industry Corp. began as a manufacturer of farm tractors and since 1984 has grown into a global player through government-negotiated joint venture agreements with Volkswagen and General Motors. It plans to expand production four-fold over the next 15 years. Its leaders, in fact, are aiming to make Shanghai Automotive one of the world's six largest automakers by 2020, joining GM, Toyota, Ford, DaimlerChrysler and Volkswagen.

The company has developed its own top-down/bottom-up market strategies to get there. In China, it will continue to grow in conjunction with Volkswagen and GM. To blunt challenges from regional rivals, it has taken a stake in South Korea's Ssangyong Motor. And in a bold bid for growth, in 2004 it attempted to buy the United Kingdom's Rover Group, eventually settling on the purchase of two Rover models it now sells under their own brand.

To gain scale and knowledge, Shanghai Automotive plans to exploit its burgeoning home market. According to Shanghai Automotive Chairman Hu Maoyuan, the company hopes to manufacture two million vehicles by 2010, including 1.5 million cars for Chinese buyers. Their own modest passenger car is set to hit the Chinese market by 2007. "With the increase in private buyers, the market potential is very huge," Mr. Hu says.

Just how huge? Recent data show that in the U.S. there are 940 vehicles for every 1,000 people of legal driving age; Japan has 502. In China, however, with a population five times larger than America's, that number drops down to eight. Inc., by contrast, began as a start up, but is already well into its next phase of growth. Although it has faced government censorship over the contents of its portal, China's most popular search engine has nevertheless developed in an almost purely capitalistic form. Often called "China's Google" (having surged ahead of the popular global search engine in China), made its debut on NASDAQ in August 2005. Its shares skyrocketed to a closing price of $122.54, more than 2,000 times the portal's 2004 per share earnings. Indeed, no other tech company—in any nation—has received such a response from investors since the glory days of the Internet.

Today, commands the loyalty of about one-third of China's more than 100 million Web surfers. Founder Robin Li thinks this is only the beginning: "Although 100 million is a huge number, it is less than 10% of the population of this country, so the network effect is not fully developed yet," Mr. Li told the U.K.'s Guardian newspaper. "There is a lot of room to grow. That is why I am more focused on long-term investment than short-term profits." To succeed at this next phase of growth, is already looking to "start-around" its search-engine capabilities, enhancing its core offering at a time when its competitors are concentrating on portal content such as news and entertainment. and Shanghai Automotive are examples of how companies in China have not only learned how to harness the power of start-around policies, but have done so with incredible speed. For the main difference between China's recent economic history and that of its Asian predecessors is simply the overwhelming rate at which this is now happening. To prepare their defenses, today's global leaders will need to understand how China is leapfrogging ahead.

Perhaps the apotheosis of China's rapid emergence is Lenovo, now the world's third-largest PC manufacturer. Confronted with its ubiquitous marketing blitz—it seemed as if Lenovo single-handedly sponsored the 2006 Winter Olympics, and it recently hired Brazilian football superstar Ronaldinho as part of its intensive World Cup campaign—it is easy to forget that Lenovo only began laying the groundwork for overseas expansion in 2003.

Like Japan's MITI in the 1980s, China's leaders are steering a course for expansion, only at almost breakneck speeds. What's turbocharging the effort is China's deft synchronization and fusion of Asia's traditional growth steps. In the past, companies largely completed one phase before making a clear transition to the next. Not China: It's compressing the three distinct phases of building, borrowing and buying into one simultaneous push.

Japan's Sony, for example, despite first entering the U.S. market in 1960, did not burst onto the world scene until the Walkman hit stores 19 years later. After that, Sony gradually added unique businesses through acquisitions only where it wanted to test synergies with new products and customer segments adjacent to its core business: In 1988 Sony purchased CBS Records, and in 1989 Columbia Pictures was acquired to provide content to support Sony's devices.

Similarly, South Korea's Samsung Electronics, founded in 1969, was developed through export-driven growth. In 1972, it began exporting electronics, and by 2004 it was the world's largest producer of semiconductors and one of the leading producers of monitors and televisions. Yet while Samsung built an overseas plant in Portugal in 1982, it wasn't until 1988 that the Korean firm established its first joint venture, in France, to sell products overseas.

Lenovo, on the other hand, has cut decades from the process of building organically, borrowing capabilities strategically and buying globally. Founded in 1984, the company then known as Legend began as a distributor of foreign-brand PCs, including IBM and HP. It started creating its own PCs for the Chinese market in 1990, and throughout the decade borrowed innovations through more than a dozen joint ventures with the likes of AOL and Microsoft. But its export drive didn't begin in earnest until 2003 with the launch of Lenovo. Since then, it's been in hyperdrive, leaping ahead of the global competition last year by acquiring IBM's PC unit, becoming the world's third-largest PC manufacturer and moving its world-wide headquarters to the U.S.

As Chinese firms like Lenovo continue to push into markets around the world, this growth tempo will only accelerate, and the government is doing its part to quicken the pace. Chinese companies seeking to invest offshore, for instance, formerly had to apply for special approval from the government; but Beijing recently signaled that this cap will be abolished sometime in 2006, which is likely to trigger a buying spree among Chinese firms.

In response to China's start-around economic growth, multinationals must adjust their strategies accordingly and play to their own strengths. Yes, it's important to learn how to manage costs to meet the competitive threat from China. But in areas such as low-cost manufacturing and speed to market, companies already know they have to be at par or outsource to compete. The best way for global firms to defend core markets, then, is to focus on areas where Chinese firms still have a lot to learn.

Most important, of course, is building customer loyalty. This entails addressing the needs of both the end consumer and intermediate distributors. Although Chinese companies have historically dealt with fewer distribution partners—relying instead on megaretail channels—even in this regard Chinese companies are closing the gap, in part through the acquisition of non-Chinese firms. But customer insight takes time to develop.

Second is innovation. Many industries appear to be on the path to becoming commoditized, with limited freedom to innovate. But in reality, leading players are finding their own ways to differentiate themselves. Innovations do not have to come as breakthroughs in engineering, but can also arise from new methods of production or sales. In the past, industry leaders tended to become lazy with customers and innovation, giving rise to opportunities for emerging players in Japan and Korea. Leading corporations today should not repeat this same mistake with the Chinese.

Multinationals must be willing to empower their frontline and factory floors to calculate risks, and their business units to set high standards for new and innovative products, developing faster product cycles in major markets. They should encourage customer, supplier and even competitor collaboration on research and development, looking outside—even beyond their own industry for innovation. Don't just build innovation—borrow and buy it, all at once. That's what Chinese firms are doing.

Third, multinationals need strategies for developing talent that optimize diversity in skills and experience. The battlefield for talent will be critical and will require people with global experience. The most successful global companies will be those that motivate their front line through distributed leadership, rather than command-and-control.

Such strategies are likely to lift the global competitive playing field. But, in the end, the race will not be won by the swiftest. Rather, it will go to those that endure the longest. The centuries have taught China's people to be patient, which is yet another ingredient fueling its growth. As Deng once put it, all of China will get rich, but "Let some people get rich first." With their emphasis on quarterly earnings, today's multinational leaders have yet another lesson to learn from their fast-approaching Chinese rivals: the idea of thinking forward in decades.

Mr. Ellis is the worldwide managing director and Ms. Gadiesh is chairman of Bain & Company.

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