by Edward Tse tse_edward@ Ronald Haddock haddock_ronald@ Discontinuities in China
12Managing Discontinuities in Chinapating, and managing them is critical to succeeding in China is very different today than it was in the Chinese market. Many executives in China readily the years when it was completely closed off admit to past mistakes in operating in this environ-from the rest of the world. Today, in large ment: They had done either insufficient or excessive cities like Shanghai, and dozens of others planning (a static five-year plan is of little use when across the country, shimmering skyscrapers, you might need to double output next month), allocat-many completed and many under construc-ed resources inappropriately, or did not have market tion, are ubiquitous. People shop in Western-strategies with relevant contingency malls, surf the Internet, and dream of Companies’ lack of experience in working in China making their first in managing the type of discontinuities found in Per capita gross domestic product (GDP) in China China doesn’t need to be a permanent handicap. has grown steadily at about 9 percent for the past The fundamental laws of economics are still in place. 15 years and the country is now a top five market in Companies must choose the right metrics to measure many consumer product categories; in mobile phones, the demand and supply sides of the marketplace and it’s No. 1, going from virtually zero subscribers in to interpret that data through the unique local con-1995 to 400 million ten years later. However, many text. They need to institutionalize skills to regularly executives from leading companies around the world capture and update market information and leverage are still having a difficult time grasping the opportuni-this knowledge to anticipate discontinuities and to ties and dangers in strategies. The most successful companies will have a flexible approach that allows them to lever-Its rapid growth and local rules of business do not age successes and opportunities and mitigate mis-mean that China will repeal the fundamental laws of steps or unforeseen events. Collectively, this means economics, but the fact that the country is growing that companies operating in China must develop a much faster than what most global executives are mindset and an organizational DNA that is entre-used to—with the possible exception of the dotcom preneurial, resilient, and adaptive. Companies must boom—requires a different frame of reference to oper-be flexible and nimble, capable of reacting to rapid ate effectively. In such a tumultuous environment, changes in the market, both known and “unknown,” the demand and supply patterns are often character-and they must cope with sustained marketplace ized by changes that are sudden and severe. We call “discontinuities” or “inflection points.”Demand-Side and Supply-Side Discontinuities Not surprisingly, many companies operating in China A variety of factors influence demand-side disconti-struggle to cope with the supply and demand discon-nuities and understanding these will help companies tinuities in this cauldron of new opportunities, new catch the S-curves, capturing the upside when the entrants, and new regulations; yet these discontinui-inflection point trends up while avoiding downturns ties are inevitable, and properly understanding, antici-when the inflection point moves the other way. As
12Exhibit 1Examples of Demand Discontinuities in ChinaMobile Phone Subscribers (1993-2005E)Mortgage Loans (1993-2004)Sedan Sales (1995-2004) N N N Two independent mobile players formed from SCDR: Personal housing reform – commercialization, SCDR: Tax reduction (sales, ownership, etc) N incumbent discounts, : Tariff reduction of imported auto parts and vehicles N N N Liberal issuance for handset manufacturing licensesPBOC: Tax benefits for mortgage loan holdersPBOC: Emergence of auto financingMillionsUS$ ...19931995199719992001200320051993199820002002200419951997199920012003Note: PBOC stands for The People’s Bank of China; SCDR stands for State Committee of Development and ReformSource: China Statistical Yearbook; Booz Allen Hamilton analysisin all markets, consumer awareness is essential. petition. Since companies in the same industry are But consumer demand in China is often not obvious mostly observing the same macro demand growth, before a product or service is available. We call this they tend to invest in the market at about the same “latent demand.” In China, there often needs to be time, frequently driving up supply in an even more significant market education around a product before pronounced manner. Indeed, one of the key drivers demand can really take off. There is also a time ele-of supply-side discontinuities is companies’ frequent ment to this pattern. Initial curiosity and hesitation erroneous assumptions that they are the only ones, about new ideas must run their course before these or one of only few, investing and building capacity in ideas are adopted. And predictably, bad ideas usually China when in fact many competitors are investing at don’t take off, but it is difficult sometimes to know the same time, unaware of each other. Exhibit 2 (on the good from the bad in advance of a real market page 3) shows the rapid building up of over-capacity pilot. Affordability is another factor since there are in China’s tire industry, especially during the period huge income disparities in China. Once prices fall from 2002–2004. to levels that are affordable for the massive middle But poor intelligence about how competitors are class, adoption can explode. Demand can also be investing is just one contributor to overcapacity; artificially constrained until a product is widely acces-another is arrogance. Some companies are too confi-sible, so there must be proper distribution and deliv-dent that they will win out even in the face of intense ery channels in place so customers can get the prod-competition. One Western white goods company’s uct. And, finally, government policies serve as wild head of China operations said in the early 1990s that cards since changes in policy can cause step-change he did not consider Chinese white goods manufactur-market reactions. Exhibit 1 shows some examples of ers to be relevant competitors because they were demand discontinuities in China.“not that capable” and likely never would be. As a Despite the wide array of factors that can impact result, the company did not even consider, let along demand for products and services in China, the plan for, contingencies that would have included local demand side of the equation is usually more stable Chinese companies as real competitors in its busi-than the supply side—which is where things can get ness plan. This executive long ago retired, his com-really complicated. This is a result of the substan-pany incurred a substantial loss in China, and today tial investments flowing into China as multinational we see some of the most competitive white goods and local companies crowd into the marketplace. manufacturers are Chinese companies. Names such Substantial capacity is being added, intensifying com-as Haier, Galanz, and Broad have become household
34names in China and in many Western markets, while for bottom-up sizing, look for a combination of macro many Western white goods players from abroad have statistical data and data from interviews, as well as struggled in China and at and channel market sizing. Meaningful Metrics Of course, not all of this data will be available, but To recognize both demand- and supply-side discon-scouring these various sources is the most pragmatic tinuities, it’s important to choose the right set of way to estimate the size of an uncertain market. metrics and triangulate these metrics in a way that However, companies must be very careful about what properly assesses the market and spots possible dis-they compare. For instance, a cruise line company continuities in the making. This is no easy task and in recently assessed the potential market in China. The a market like China it takes time and patience: both company’s approach, which had proven successful in the actual metrics used and in interpreting the cho-in other markets, was to use GDP per capita as a sen metrics in the context of China. Take one of the measure of market potential. Applying this, the result most often asked questions: “What is the real income suggested China was nowhere near the minimum of the Chinese consumers?” Published data on “offi-threshold. And yet, Chinese customers do go on cruis-cial income” is readily available and well documented. es in other parts of the world, numbering in the tens Yet there is an active and probably vast underground of thousands per annum. To get a real handle on the Chinese economy, and its magnitude probably varies market, the company then applied a set of indirect by segments. This makes determining actual income though revealing metrics, which included the number tricky, but ascertaining the real income of specific, of people in China who belong to golf clubs, the num-relevant consumer segments is imperative to under-ber who own Mercedes S class sedans, and the num-standing China’s true consumption power. ber of dollar-denominated millionaires. This analysis arrived at a very different conclusion from what simple Using a triangulation approach from multiple sources GDP-based measures especially useful and often necessary. From dis-tributors, contractors, and installers a company can Indeed, one of the great lessons to be learned about get current selling volumes and value by customer assessing the Chinese market is the virtual irrel-segments, estimated market shares, and projected evance of one of the business world’s most popular growth. From end-use customers you should look for metrics: the average per-capita GDP. In China, there end-product purchase volume and value by segment, is a huge disparity in income among its billion as well as growth by segment. When possible, gather people. It is not a single, homogenous market, so trade data and projections for key customer segments metrics chosen to evaluate market potential must be from industry associations and research firms. And, relevant to both the customer target and the product Exhibit 2Demand and Supply in China’s Tire IndustryThe Demand by SegmentTire Supply by Segment(Assumed 5% Replacement Capacity and 90% Capacity Utilization)Units (000’s)Units (000’s)100,000100,000Capacity without Replacement 80,00080,000and Utilization AdjustmentsPremiumOvercapacityPremium60,00060,000in 2004Middle40,00040,000MiddleEconomy20,00020,000EconomyExport00200220032004200520062007200220032004200520062007Source: Booz Allen Hamilton
34or service offering. Deriving the right segmentation was merely one event, albeit a major one, within and applying the right segment-based metric is essen-this ongoing program of deregulation. Western com-tial for reliable business analysis. panies competing in a newly opened industry must quickly grasp how different the new operating envi-Correct Context ronment is and, just as important, how differently Once the right metrics are in place to understand competitors—be they local or foreign—are going the demand and supply side of the equation, the to behave. Companies need to develop a quick but next step to recognizing and managing discontinui-deep understanding of the new competitive dynam-ties is interpreting the data in the Chinese context. ics. Drawing conclusions about a company or its China may be the most complex market in the world, industry today based on past behavior—even those defined by the number of uncertainties, the multidi-in or from China—can quickly lead to wrong deci-mensional and nonlinear nature of the growth drivers, sions. Traditional benchmarking practices prevalent and the pace of change. in mature markets and ingrained in many companies An essential part of understanding the context is often backfire in China. recognizing the heterogeneous consumer base, with Capturing Market Knowledge people from a wide range of geographic and cultural Metrics and context are what form the core of market backgrounds. There are significant gaps in the level of knowledge, and it is a company’s ongoing ability to wages between wealthy urban dwellers and the rural capture market knowledge, and act on it, that results population—and thus, major differences in their famil-in success. Developing this capability and institu-iarity with products and services. The labor market tionalizing it takes a systemic yet entrepreneurial is also a mix of foreign workers, Chinese expatriates approach. We have found that the foreign companies returning, and homegrown labor—younger workers that do the best job capturing market knowledge have emerging from graduate schools and older workers at built market research organizations on the ground state-owned companies. Competition is intense and and have institutionalized their market research diverse, with a large variety of international brands capabilities in Europe, America, Japan, South Korea, and from the rest of Asia. These go head to head with However, even companies with established best established and aspiring local brands. There is practices still need to adjust their research method-also the well-known issue of brand and intellectual ologies to the realities of China, for several reasons: property is often latent; the supply side remains highly unpredictable; and proper metrics and market Layered upon this diversity of customers, skilled and segmentation must be defined. Companies need to unskilled workers, and companies, are diverse laws make a trade-off between achieving an amount of and guidelines for specific industries; there are dif-data deemed statistically significant; relying on sound ferent local interpretations of central guidelines in business judgment; and making prompt business smaller versus larger cities; there is a broad variety approaches to organization and investments; there are industry- and sector-specific sourcing and distribu-In addition to having homegrown research adapted to tion channels; and there are vast disparities in devel-China’s complexities, the most effective companies opment across industries. Some Chinese industries have executives who spend much of their time on are at a level comparable to the mid-1900s, while the ground—going to the trade, talking to custom-others are 21st century—creating economies within ers, visiting different markets, and finding out what an competitors are doing. Having one’s nose on the ground often generates valuable and surprising Understanding the regulatory context is also vital to insights that published data cannot provide, or at doing business. The government has been gradually least cannot deliver in a timely manner. A good case deregulating the economy—step-by-step, industry-by-in point: The China leader of one of the world’s larg-industry, for the last 15 years. And deregulation is est consumer goods companies described to us the continuing as China marches purposefully forward to disparity he found by driving a mere 30 minutes out-build a modern, productive economy. China’s entry side of a city in an eastern Chinese province where into the World Trade Organization in December 2001 his company had just opened a major production cen-
56ter. The retail structure and format was drastically dif-to react quickly enough. Earlier this decade, most ferent—much more primitive—than those in the large industry experts believed automobile purchases would city. Interestingly, despite the company having been in grow at a healthy 17 percent. Much to everyone’s China for several decades and spending tens of mil-surprise, growth has been at least twice this on aver-lions of dollars on advertising, he found that retailers age, and as high as 75 percent in one year. The on the outskirts of this important city had very little problem was that 17 percent was just an educated awareness of his company’s brands. The company guess. The fact was the Koreans, Japanese, French, was present but not —everyone making investments—did not know for certain how fast it would grow, and suddenly Because it is so important to capture evolving market many foreign tire manufacturers were caught by sur-information, the best companies in China make a prise and missed a huge opportunity for growth and point of encouraging formal and informal exchanges share gains. Now many of these same companies of market and regulatory information within their are overcompensating, rushing in and likely to creat-organizations, often through people in the field and ing significant short-term overcapacity and perhaps across different organizational units, so the most long-term structural overcapacity should demand can be made of what information they do gather. growth slow. Unfortunately, many foreign executives simply don’t get out into the field enough. Instead of spending The kind of flexibility that can respond to 17 percent time out in the market, they spend time in their plush growth or 75 percent growth is tough to achieve, to offices. They ask for reams of data to be delivered be sure, but there are a growing number of foreign to their desks so that they can make decisions, yet success stories in China. KFC, for example, has been much of this so-called data is incomplete or outdated in China since the late 1980s, when it started with a by the time it is gathered and presented in a formal small number of stores. KFC was careful in getting its manner. By eschewing the all-important in-person business formula right before rolling out across China field work, these executives generally don’t have the with major investments. Today, China is the second-judgment to make the right decisions when the mar-largest source of revenue and profits for the company ket information is incomplete or ambiguous. This is worldwide. Yet contrast KFC’s approach to some of the crux of the challenge for many foreign executives its major international competitors who, until recently, in still in the process of assessing whether there was a market for them in China. Starbucks built simi-Strategic Anticipation and Business Flexibility lar flexibility into its entry and growth model in China At the best-run companies in China, systematically by choosing to do joint ventures in a couple of key capturing market knowledge helps to develop a capa-entry cities—the only market in the world where it bility for “strategic anticipation,” which a company took this route—as a way to hedge against potential can use to gauge when and where discontinuities may losses while buying an option on the upside through occur and to position themselves to take advantage an agreement that allowed it to buy out its partners. as they up market knowledge over time eventually Critical to this positioning is building as much flex-puts a company in a position to make a big bet. ibility as possible into every business venture. The General Motors, for example, entered the market in challenge is not to fixate on a single scenario, but 1997 with the Buick and today, without China, would rather to envision several scenarios and bet on a be in far greater financial peril than it already is. In few of them. Sometimes buying into a market will China, GM has carefully built a series of successful make sense, sometimes building is the right alterna-partnerships that are now paying off. GM’s sales in tive, and often teaming up is the best way to hedge China grew percent in 2005, boosting its market against a downturn while still being able to capture share to an estimated percent, second only to the upside. No matter what the choice, it is vital to Volkswagen at that time. Shanghai GM, the compa-implement flexible business plans that can react to ny’s flagship joint venture with Shanghai Automotive different Corporation Group (SAIC), sold per-The tire industry is a good example of how companies cent more cars than in 2004. SAIC-GM-Wuling, GM missed a huge opportunity because of their inability
56China’s small car joint venture with SAIC and Wuling tively with headquarters in order to align expectations Automotive Co., also had a record year, with sales and percent from 2004. Pending Chinese Finally, spotting and managing the discontinuities government approval, GM plans to invest more than within market segments through smart triangulation $3 billion over the course of the next three years and of available data is paramount if companies are to expects sales in 2006 to set another record. capture the S-curve while avoiding, or at least mitigat-Conclusion ing, downturns. To this end, strategies and business Many foreign companies are looking to China to pro-models in China should be flexible and adaptive. vide a future boost to sales and profits—and many There’s no doubt the challenges to success in China companies that aren’t, should be. However, suc-are significant, but the payoff potential is greater still ceeding in China requires that companies navigate and the repercussions of failure can be severe. With markets that are highly diverse, complex, and fast-China’s continued economic growth, numerous busi-changing. They need the right organizational DNA—the ness opportunities will present themselves. Company right mindset—coupled with strong leaders who have executives who miss the opportunity today may be their noses on the ground, and thus can use market creating a permanent competitive disadvantage for discontinuities to exploit opportunities. To succeed, their executives also need to communicate effec-What Booz Allen BringsBooz Allen Hamilton has been at the forefront of management 2005 and in 2006, Fortune magazine named Booz Allen one consulting for businesses and governments for more than of “The 100 Best Companies to Work For,” and for the past 90 years. Integrating the full range of consulting capabilities, seven years, Working Mother has ranked the firm among its Booz Allen is the one firm that helps clients solve their “100 Best Companies for Working Mothers.” toughest problems, working by their side to help them To learn more about the firm, visit the Booz Allen Web site at achieve their missions. Booz Allen is committed to delivering . To learn more about the best ideas in results that , visit , the Web site for With 17,000 employees on six continents, the firm generates strategy+business, a quarterly journal sponsored by annual sales that exceed $ billion. Booz Allen has been Booz as a consultant and an employer of choice. In Edward Tse is the managing partner for Booz Allen Hamilton Ronald Haddock is a vice president and director of Booz in Greater China. In 1993, he was the partner in charge of Allen Hamilton. He has been a consultant to companies China’s first authorized office among all the leading global in the United States and Asia for more than 10 years. strategy consulting firms, shortly after China opened itself His tenure in Asia, which began eight years ago, spans to the management consulting profession. Since then, he China, Korea, and India. Based in Shanghai, Mr. Haddock has advised hundreds of Chinese and foreign companies can be reached at 8621-6340-6633 or by e-mail at across the full range of strategic issues facing companies haddock_ronald@ China. He is a published author on numerous topics related to succeeding in China and is a regular guest speaker at executive and academic conferences throughout China and the world. Dr. Tse can be reached by e-mail at tse_edward@ digital versions of this article and other Booz Allen Hamilton publications are available from .
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