China’s State-Owned Enterprise Reforms
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China’s State-Owned Enterprise Reforms
Much has been written on China’s State-Owned Enterprises (SOEs) reform following the restructuring impact on China’s economic reform process in the last decade. However, as a major root of social and economic change, little has been discussed beyond a description of SOEs’ shortcomings and their overall impact on the economy. This book provides a more in-depth analysis of SOEs by assessing the transformation process of 11 specific industries, with reference to the state of competition, the influence of WTO membership, and the challenges these industries face in the future. Importantly, the authors also provide a personal perspective alongside the industry analysis with 11 case studies of firms actually undergoing this restructuring process, including interviews with crucial agents of reform such as CEOs and GMs. The provision of both a macro and a business perspective of SOEs reforms provides the reader with a complete and accurate insight into the economic, social, and business reality of China today. China’s State-Owned Enterprise Reforms will therefore be essential reading for those interested in the Chinese economy and Chinese business, as well as economists, foreign investors, MBA, and EMBA students, and scholars specializing in emerging or transitional economies. Juan Antonio Fernández is Professor of Management at the China Europe International Business School, Shanghai, China. Leila Fernández-Stembridge is Associate Professor of Chinese Economy and History at the Universidad Autónoma de Madrid, Spain.
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China’s State-Owned Enterprise Reforms An industrial and CEO approach
Juan Antonio Fernández and Leila Fernández-Stembridge
First published 2007 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN Simultaneously published in the USA and Canada by Routledge 270 Madison Ave, New York, NY 10016 Routledge is an imprint of the Taylor & Francis Group, an informa business This edition published in the Taylor & Francis e-Library, 2007. “To purchase your own copy of this or any of Taylor & Francis or Routledge’s collection of thousands of eBooks please go to www.eBookstore.tandf.co.uk.” © 2007 Juan Antonio Fernández and Leila Fernández-Stembridge All rights reserved. No part of this book may be reprinted or reproduced or utilised in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data A catalog reference for this book has been requested ISBN 0-203-96697-X Master e-book ISBN
ISBN10: 0-415-40268-9 (hbk) ISBN10: 0-203-96697-X (ebk) ISBN13: 978-0-415-40268-2 (hbk) ISBN13: 978-0-203-96697-6 (ebk)
To my wife, Wu Hanning, her love gives meaning to my life, and to Simon, our son, for bringing so many happy days to our marriage. To my mother, for her unconditional, wise and loving patience.
Contents
List of figures List of tables Foreword Preface Acknowledgments List of abbreviations Introduction 1
Home appliances
xiv xvii xviii xxi xxiv xxv 1 12
Industry restructuring: Overview 12 Industry outlook 13 Competition 18 WTO impact and challenges 20 Case study: Little Swan Group 23 Conclusions and future perspectives 32 2
Automobiles
33
Industry restructuring: Overview 33 Industry outlook 35 Competition 39 WTO impact and challenges 43 Case study: SABS 45 Conclusions and future perspectives 52 3
Civil aviation Industry restructuring: Overview 54 Industry outlook 56 Competition 58 WTO impact and challenges 61 Case study: Air China 64 Conclusions and future perspectives 70
54
xii
Contents
4
Construction
72
Industry restructuring: Overview 72 Industry outlook 75 Competition 76 WTO impact and challenges 78 Case study: CCSEB 81 Conclusions and future perspectives 90 5
Cosmetics
93
Industry restructuring: Overview 93 Industry outlook 95 Competition 99 WTO impact and challenges 101 Case study: Shanghai Jahwa United Co. Ltd 102 Conclusions and future perspectives 109 6
Energy
111
Industry restructuring: Overview 111 Industry outlook 116 Competition 119 WTO impact and challenges 122 Case study: XJ Group (XUJI Corporation) 125 Conclusions and future perspectives 131 7
Food
135
Industry restructuring: Overview 135 Industry outlook 145 Competition 147 WTO impact and challenges 151 Case study: COFCO 155 Conclusions and future perspectives 165 8
Insurance Industry restructuring: Overview 167 Industry outlook 169 Competition 172 WTO impact and challenges 176 Case study: Ping’an Life Insurance Company of China, Ltd 178 Conclusions and future perspectives 185
167
Contents 9 Pharmaceuticals
xiii 187
Industry restructuring: Overview 187 Industry outlook 189 Competition 191 WTO impact and challenges 193 Case study: Shanghai Synica Co., Ltd 194 Conclusions and future perspectives 206 10 Steel
208
Industry restructuring: Overview 208 Industry outlook 210 Competition 213 WTO impact and challenges 215 Case study: Baosteel Group Enterprise Development Corporation (BGE) 218 Conclusions and future perspectives 227 11 Telecommunications
230
Industry restructuring: Overview 230 Industry outlook 235 Competition 238 WTO impact and challenges 242 Case study: Alcatel Shanghai Bell Co., Ltd 245 Conclusions and future perspectives 256 12 Conclusions: Final summary Notes Bibliography Index
260 280 291 300
Figures
I.1 1.1 1.2 1.3 1.4 1.5 1.6 2.1 2.2 2.3 2.4 2.5 2.6 2.7 2.8 2.9 2.10 3.1 3.2 3.3 3.4 4.1 4.2 4.3 4.4 5.1 5.2 5.3 5.4 5.5 6.1
Interdependent nature of China’s SOEs reforms. Employment in the home appliance sector. Home appliances as GDP share (%). Home appliances: total revenue (RMB mn). Home appliances: total number of enterprises. Number of major durable consumer goods owned per 100 urban households at the year-end (unit). Firms ownership structure (%). FDI in China’s automobile sector. Total output. Output (% GDP). Ownership structure in China’s automobile sector. Employment in the automobile sector. Market share of carmakers in China, 2002. Total sales. Profit contribution by 16 major automakers, 2002 (%). Organization chart before December 2003. New organization chart. Civil aviation as GDP share (%). Civil aviation revenue. Civil aviation: number of employees (persons). Chinese airlines’ share in total traffic ton-km (1999–2002). Employment in the construction sector. China’s construction sector as GDP share (%). FDI in China’s construction sector. Firm distribution. Ownership structure in China’s cosmetics. Cosmetics as share of GDP. Cosmetics revenue. Production distribution in China’s cosmetics market, 2000. Total number of cosmetics companies (domestic and foreign). Energy supply production.
2 16 16 17 17 18 20 34 34 35 35 36 37 38 42 49 50 56 57 60 60 74 75 77 78 94 95 95 98 100 112
Figures xv 6.2 6.3 6.4 6.5 6.6 7.1a 7.1b 7.2 7.3 7.4 7.5 7.6 7.7 7.8 7.9 7.10 7.11 7.12 7.13 7.14 8.1 8.2 8.3 8.4 8.5 8.6 8.7 8.8 9.1 9.2 9.3 9.4 9.5 10.1 10.2 10.3 10.4 10.5 10.6 10.7 11.1 11.2
Energy consumption. Ownership distribution of energy firms, 2003 (N = 9,924). FDI in the energy sector. Employment in the energy sector. XJ group organization chart. Main export food commodities in value (US$ mn). Main import food commodities in value (US$ mn). Total number of TVEs (mn). Ownership structure of TVEs. Ownership distribution in the sugar subsector (N = 337). Ownership distribution in liquid milk and dairy products (N = 584). Ownership distribution in meat products (N = 960). Ownership distribution in canned food (N = 592). Ownership distribution in beer (N = 504). Ownership distribution in soft drinks (N = 840). Food as GDP share (%). Total food revenue (RMB mn). China’s grain production. COFCO before restructuring. COFCO after restructuring. Growth in total premium revenue (1985–2003). Insurance as share of GDP (%). China’s pyramid of age. China’s growing urbanization rates (%). Ownership distribution of insurance enterprises. Market share for life insurance in 2001. Market share for property insurance in 2001. FDI in the insurance (and banking) industry. Total number of enterprises in pharmaceuticals. Ownership distribution of pharmaceuticals firms (N = 3,488). Sales revenue of the pharmaceutical industry. Output growth of the pharmaceutical industry. Western vs. Chinese medicine in 2002. Ownership distribution in the steel sector in 2003 (N = 2,429). Employment in the steel sector. Steel as share of GDP (%). Ex-factory price indices of industrial products in the metallurgical industry. Varieties and quality of products. Domestic share and import share of steel in China’s domestic market (2004). Baosteel group. Telecommunications as share of GDP (%). China’s telecom carrier’s market share in 2004.
113 120 121 125 126 137 137 139 139 140 140 141 141 142 145 145 146 147 159 160 169 170 171 171 173 173 174 176 188 189 189 191 191 209 209 210 211 212 214 219 231 234
xvi 11.3 11.4 11.5 11.6
Figures Mobile phone producers’ market share, by sales (1999–2002). FDI in the telecommunications industry. GSM handsets – market shares of major vendors (early 2003). CDMA handsets – market shares of major vendors (early 2003).
239 242 246 246
Tables
I.1 1.1 1.2 2.1 2.2 2.3 3.1 3.2 4.1 5.1 6.1 7.1 7.2 7.3 7.4 8.1 8.2 9.1 10.1 11.1 11.2 11.3 12.1
Different waves of SOEs reforms Top ten white goods enterprises Top ten black goods enterprises China automobile price cuts (June 18, 2003) Teaming up with foreign partners Top ten automotive manufacturers CAAC airlines regrouping plan Top nineteen civil aviation enterprises Top twenty construction enterprises Top ten cosmetics enterprises Top ten energy enterprises Food variations and subsectors (a-e) Top ten drinks manufacturers by subsector Top ten fast food Chinese restaurants Top ten food enterprises Top ten foreign insurance enterprises in China (HMT funded included) Top ten insurance enterprises in China Top ten pharmaceutical manufacturers Top ten steel enterprises China’s schedule for telecom liberalization Top ten telecom enterprises Top ten foreign-funded telecom enterprises (major mobile phone manufacturers) Case studies: Learning points and challenges
5 14 15 40 42 53 55 62 92 97 134 138 143 150 166 175 186 207 229 244 258 259 277
Foreword
Having lived in China for three years, while I was the Dean of the China Europe International Business School in Shanghai, I am somewhat familiar with the Chinese economy and would be in a position to say which sort of material could be useful to those wanting to know more about China’s state-owned enterprise (SOEs) reforms, either for their own purposes or to prepare a course on the subject. The literature I know about China’s SOEs reforms falls into three categories: broad summaries with a few illustrations; works centred on a particular aspect of the reforms – incentives or governance – and case studies. This book has the advantage of combining the three elements in a balanced way, so that it can serve as a main reference for a course; in parallel, the interviews with executives alternate with the inevitably dry industry surveys. Such a combination makes the book much more accessible to the reader with a general interest in China’s economy. With some exceptions, works on China by Western authors tend to have nonChinese materials as the main or only sources. From reading this book, one can see this is not the case here: Prof. Fernández-Stembridge not only is thoroughly familiar with the Chinese economy, but she also reads and speaks Chinese, and many of the sources quoted are not available in languages other than Chinese; Prof. Fernández has interviewed personally the CEOs of the main companies, to many of whom he had access because they had been his students. The sectoral approach is necessary and convenient in China, where the economy was organized, until very recently, along sectoral lines. Sectors had very different developments, for which the industrial perspective gives a very useful background to the individual case studies. However, within each sector, individual firms tended to face the same challenges and shared the same concerns, for which the interviews give insights that can be extrapolated to other firms within the same sector. The use of interviews enhances the interest of the book, since it is the only way in which one can gain real insights into the history of SOEs reforms, its difficulties and achievements; and candid interviews with senior SOE executives are not easy to come by. Some points that I have found particularly interesting are as follows: A detailed explanation of the waves of industrial reform in the Introduction: most of the time, one assumes that 1978 is the dividing line between a dark past and
Foreword
xix
a brilliant present, while the fact is that reform proceeded, as it should, irregularly; the Introduction explains the reasons behind these hesitations. While the approach is descriptive, the data provided are fully adequate to substantiate the story. A detailed description of each one of the industries surveyed, listing the main players with their market shares. This is very useful, as it provides a first approach to each one of the industries. A description of each firm’s origins and culture: SOEs executives are often associated with bureaucrats – in the usual abusive sense of the term – whereas some of the interviews (e.g. CSCEC) show real entrepreneurs in action; in some cases, the executive states that he has consciously traded lower pay against higher responsibility (Air China). In general, SOEs culture tends to be more cohesive than is commonly realized, which ought to be of interest to anyone contemplating a joint venture with an SOE as a partner. An indication of the challenges faced by the managers: they differ among sectors. In some cases, the main disadvantages are technology and finance; in others, but not in all, the problem of parallel management is raised; in others, Government or Party interference is seen as a major drawback. These issues are common to public enterprises everywhere, but not to the same degree. In addition, something seems specific to Chinese SOEs: the old style of management is still very personal, with the boss demanding above all absolute loyalty. This is in deep contrast with Western enterprises. Suggestions of SOEs’ weaknesses: once again, they differ. Technology is sometimes a problem (automotive, construction) but often lack of finance or after-sales instruments are seen as equally important, or even more so. Very often, it is in the service part of their business where they seem less secure; again, this ought to be an interesting insight for someone thinking about a permanent commitment to China. Impressions on how joint ventures are perceived: in at least one case (SABS), the CEO suggests that the management structure of a joint venture tends to be unstable, with Westerners changing all the time. This is again a useful piece of advice. Privatization plans: although the SOEs’ culture is very cohesive, privatization is often seen as a device to escape Government interference. Once again, this is interesting, as it coincides with the experience of other countries. The question now is, who could be interested in this book? First, every business school I know wants to have “China” somewhere on its brochure. The book could be an excellent basis for preparing a course on the subject of SOEs reforms and China’s industry – possibly complemented with material on the private sector. It is broad enough in scope and detailed enough in the information it provides to be assigned as reading material. Second, people exploring opportunities in the sectors surveyed in this book should read at least the introduction and the relevant chapters. There are many firms sending teams of executives to look around China, and they would do wrong not to read this book.
xx
Foreword
Third and last, anyone with an interest in economic or industrial development can benefit from this book: it offers particularly valuable insights into the way important SOEs in crucial industries are evolving in a major economy such as China’s. I wholeheartedly recommend China’s State-Owned Enterprise Reforms: An Industrial and CEO Approach as a serious piece of research that will definitely benefit those interested. Alfredo Pastor Professor of Economics, IESE – Spain Former Dean, CEIBS – Shanghai, China
Preface
This is a great experiment, something that is not described in books. (Deng Xiaoping on China’s economic reforms, June 29, 1985)
Although former President Deng Xiaoping’s words are now more than twenty years old, they are still valid today. After all, the Chinese reform experience is an experiment in itself: it remains somewhat unique and it is not based on any blueprint. This uniqueness, which is part of a complex and dynamic transitional economic framework, has led us to offer a modest contribution reflecting the experimental process of China’s state-owned enterprise (SOEs) reforms and therefore a better understanding of China’s still undefined economic model. Despite the abundant literature on China’s economic reforms in general and the SOEs in particular, the singularity of this book stems from the combined profile of the two authors and fundamentally from the combined contents of the book, in which macro-economic and micro-economic analyses are joined into one. Indeed, this book is the product of the cooperation between a Professor of the Chinese economy working with Chinese public institutions, and a Professor of Management working with Chinese private firms. As observers of China’s reality, we professors would like to provide a print of real experiences combined as part of a common general economic context. This situation may be familiar to some readers, but we still think it could be a very useful tool of reference for people with an interest in the Chinese economy and the reform process of its SOEs, economists, foreign investors, Chinese investors, MBA and EMBA students, or specialists in emerging economies. The basic concerns in China’s SOEs reform process could be summarized as how to create a modern management system; how to manage joint ventures; how to prepare the company to compete in the domestic and international markets; how to change the firm structure, with special focus on corporate governance; or how to deal with surplus labor force. Within such a context, the objectives of our book are concentrated into two priorities: (1) Revise the evolution of key economic sectors in China and the SOEs in such sectors. (2) Reflect the lessons of the experience played by key actors in the SOEs reform process.
xxii
Preface
With both priorities in mind, we combine an industrial overview with a case-study Chinese perspective. Cases gather the personal experience of senior managers who have played a key role in the reform process of their firms and are focused on the SOEs’ reorganization history. The interviews with senior managers took place between 2003 and 2004. The reader will notice that amongst all interviewees there are executive presidents, CEOs, general directors, as well as managers. This variety of positions is intentional, so as to minimize the bias: the President of the Board may offer a governmental perspective of the organization, while other more modest employees tend to provide a more internal and pragmatic viewpoint. Choosing the different industries and their SOEs was no easy task initially: we needed to determine selection criteria such as percentage of GDP; industries with the highest SOE density; or at least crucial industries in China’s transitional economic process. As a result of this selection, our book finally includes eleven distinct cases on the SOEs reform process. Data collection has been particularly problematic, as the greatest bulk of our research has been based on primary Chinese sources, which were full of contradictory information. The final results of such data have been rather time consuming, but we believe the effort has been worth it. Last but not least, the data provided are the most updated before publication, but we are obviously conscious of the rapid pace of China’s reforms and the short-term value of such data. The reader should therefore consider them more as a reference than as an ultimate piece of news. Our book is not an exhaustive study of all China’s industrial sectors: there are crucial sectors that have not been included in our study, such as banking (instead, insurance), tourism or textiles (as part of the light industry, home appliances and cosmetics instead). The aim for now is to show how SOEs have been reformed in some sectors, including eleven particular ones. Our purpose is to increase their number in future studies. Through all eleven cases, we would like to bring the reader the experience of these companies and how they are facing the challenges presented by China’s economic transformation. The companies selected provide examples of the reform process at the grass-roots level. We do not claim to be exhaustive but consider such examples to give a fair idea of the strategies and results achieved throughout reform efforts. Our objective is to learn from their successes and their mistakes. Furthermore, it is a record of how general policies are implemented at the company level and the challenges faced by the managers in charge of the SOEs, who are after all the silent heroes of reforms.
Preface
xxiii
The companies and interviewees included in our book are: Companies
Sector
Interviewee
Position
1. CSCEC 2. Shanghai Jahwa 3. Air China
Construction Cosmetics Civil aviation
Mr Zhang Pei Mr Liu Yuliang Mr Sun Yu
4. Group Little Swan 5. Baosteel Group Enterprise Development Co. 6. Synica Corporation Ltd. 7. Alcatel Shanghai Bell 8. COFCO
Home appliances
Mr Chai Xinjian
Steel
Mr Xu Nan
President Director and CEO Project Manager Corporate Development Vice Chairman and GM Vice Chairman and GM
Pharmaceuticals Telecommunications
Dr Zheng Chongzhi Mr Yuan Xin
Food
Mr Liu Kejian
Insurance
Mr Ni Rongqing
Energy
Mr Wang Jinian Mr Xue Jinda
9. Ping’ an Life Insurance Company of China, Ltd. 10. XJ Group Corporation 11. SABS
Automobiles
President and CEO Chairman GM Strategic Planning Division Vice GM
President and GM Deputy GM
As a compact study, we have tried to follow a common pattern in each one of the 11 chapters: (1) Overview of the industry’s restructuring process: description of the governmental policy under the umbrella of the 10th 5-Year Plan objectives. (2) Industry outlook: evolution of the industry in terms of output. (3) Competition: between domestic firms and with regard to foreign firms too, inside and outside of China’s borders. (4) WTO impact and challenges: how WTO entry affects the industry considered. (5) Case study: how the firm adapts its own challenges to the industrial context, according to the interviewee. (6) Conclusions and future perspectives: summary and forecasting. Note 1: apart from academic references, our sources include also numerous web pages, due to non-availability of relevant information for newly created sectors. Note 2: conversion rate used: US$ 1 = 8.27 RMB.
Acknowledgments
Quite a few people have made this work possible. First of all, Alfredo Pastor, Former Dean of China Europe International Business School (CEIBS), who gave us economic and moral support for this research. We must also thank all the CEOs and Presidents of Chinese SOEs who generously shared their experiences and knowledge with us. Last but certainly not least, our itinerant research assistants Lisa Chen, Dongmei Song, Jia Guohua, and Ronnie Zhang, whose support was fundamental in the logistics and search for information. Thanks indeed to you all.
List of abbreviations
AMCs: Asset Management Companies ASEAN: Association of South East Asian Nations CAAC: Civil Aviation Administration of China CCP: Chinese Communist Party CDMA: Code Division Multiple Access CDMA 1X: CDMA with one carrier wave CDMA WLL: CDMA Wireless in Local Loop network CEIBS: China Europe International Business School CEO: Chief Executive Officer CFO: Chief Financial Officer CIAH: China International Aviation Holding CIF: Cost Insurance and Freight CIRC: China Insurance Regulatory Commission CITIC: China International Trust & Investment Corporation CNAC: China National Aviation Company CNC: China Netcom Co. Ltd CNHC: China National Aviation Holding Company CNOOC: China National Offshore Oil Corporation CNPC: China National Petroleum Corporation
CRS: Contract Responsibility System DAL: Drug Administration Law FDI: Foreign Direct Investment FOB: Free On Board GDP: Gross Domestic Product GM: General Manager GMP: Good Manufacturing Practices GSM: Global System for Mobile Communications HDR: High Data Rate HR: Human Resources IP: Internet Phone IPO: Initial Public Offering IPRs: Intellectual Property Rights IT: Information Technology ITA: Information Technology Agreement ITU: International Telecommunications Union JVs: Joint Ventures LAN: Local Access Network LAS: Labor Allocation System M&As: Mergers and Acquisitions MII: Ministry of Information Industry MNCs: Multinational Companies MOFCOM: Ministry of Commerce (ex-MOFTEC) MOR: Ministry of Railways MRO: Maintenance, Repair, and Overhaul NDRC: National Development and Reform Commission (ex-SEPC) ODM: Original Design Manufacturer
xxvi
List of abbreviations
OEM: Original Equipment Manufacturer PICC: People’s Insurance Company of China R&D: Research & Development REP: Re-Employment Program RMB: Renminbi – China’s national currency SARS: Severe Acute Respiratory Syndrome SDA: State Drug Administration SEPA: State Environmental Protection Administration SERC: State Electricity Regulatory Commission SFDA: State Food & Drug Administration
Sinopec: China Petrochemical Corporation SMEs: Small and Medium Enterprises SOEs: State-Owned Enterprises SPC: State Power Corporation TCM: Traditional Chinese Medicine TD-CDMA: Time Division-CDMA TVEs: Township and Village Enterprises VAS: Value-Added Services WCDMA: Wideband Code Division Multiple Access WFOEs: Wholly Foreign Owned Enterprises WTO: World Trade Organization
Introduction
When pragmatic readers grab a new book in the bookstore, inevitable questions arise: Why was this book written? What is its aim? Why should the author(s) want to dedicate so much time to such a specialized issue? As we are (somewhat pragmatic) readers ourselves, we would like to provide a more or less coherent answer. China’s current reform context is focused mainly on the progressive dismantling of an unproductive industrial sector, where SOEs have been occupying until recently the greatest bulk of output and job creation, but generating low profits and inadequately responding to the necessities of an emerging market economy. SOEs have been, and still are, critical to the success of the reform process, considering their tight link to governmental reforms in general, as well as to crucial indicators such as the financial system, the labor distribution, or the social welfare system (Figure 0.1.). Each one of these areas entails important challenges, which themselves become obstacles to the SOEs reforms: the political interests in keeping the SOEs momentum and controlling their resources, the political interference in the concession of credits and loans, the unemployment pressures, or the ongoing reform of the social security system and the subsequent costs for the State. Thus, SOEs reforms need to be viewed as part of an interdependent reform system, where too many interests have been created and Party Cadres are unwilling to let go the power SOEs can offer them. Indeed, if SOEs are not reformed, all such areas remain stagnated and the roots of economic reforms become too weak; thus the need to further understand how SOEs are being transformed within China’s new context as an increasingly open and dynamic economy. With this necessity in mind, we consider it fundamental to offer an overview of the reform process with special focus on the SOEs and their implications on the rest of the economy. Indeed, the challenges are enormous, but benefits are also coming to light. As known by all, China is a vastly populated country that is currently undergoing one of the most particular and crucial transformations in the world’s economic history of these last 25 years. On a general level, China has been transforming itself from a command to a (bound-to-be) market economy, from an economy based on agriculture to one based on manufacturing and services, from one with high fertility and low longevity to one with low fertility and high longevity, and
2
Introduction
Figure I.1 Interdependent nature of China’s SOEs reforms.
from a closed economy to a fairly open economy, ever more since World Trade Organization (WTO) accession in December 2001. The literature on the significance and meaning of China’s economic reforms is quite abundant, for which we will not repeat what has already been extensively explained. We prefer rather to focus on the SOEs reforms. It is important to stress within this context, however, a glimpse of the burden of the scale China implies. Here are just a few of the most important indicators:1 (1) By the late 1990s, among China’s SOEs, there were 500 that employed more than 100,000 people – forty times the number of companies of similar size in the United States; (2) Every year, China’s economy must create 10 million to 15 million new jobs so as to avoid an excessive unemployment rate; (3) China has more cities of 1 million-plus population than the rest of the world combined; (4) The floating population of peasants moving to the cities to find a job oscillates at approximately 100 million, which is 10 million short of Russia’s entire population; (5) There is an emerging urban middle-class in China that accounts for an annual growth of more than 8% and represents a source of rampant consumption; (6) The urban population will reach about 50% of total population by 2020, while in 2000 it was a little less than 40%. (7) China has more than 40 million retirees: by 2025 there will be as many people aged 60 or more than the rest of the world combined; etc.
Introduction 3 The reforms launched in the late 1970s combined a general economic transformation between finance, taxation, pricing, foreign trade, foreign direct investment and, of course, SOEs reforms. After all, as an intrinsic part of the gradual draining of the economy, China’s SOEs have undergone crucial restructuring, particularly since 1993 in Shanghai and since 1997 at the national level, with a crucial turning point since the creation in March 2003 of the State-owned Assets Supervision and Administration Commission (SASAC) of the State Council. Indeed, after the Party’s 15th Congress in September 1997, a modern enterprise system broadened and accelerated – endorsed already during the 8th National People’s Congress in March 1993 – and pushed further for the incremental and experimental process of SOEs reforms through a new corporate governance system functioning through the motto of “grasping the big (SOEs), letting go the small (SOEs)” (zhuada, fangxiao), whereby over 10,000 large and medium SOEs would be kept under the Central Government’s control while converted into shareholding companies; and more than 100,000 small SOEs would be privatized or merged with non-state enterprises, forming joint ventures with foreign firms, or otherwise leasing assets to their workers. Despite the progress made at the administrative level (e.g. increasing managerial autonomy), the separation between government and enterprise remained incomplete: SOEs continued to be under the pressure of guaranteeing social services (housing, education, medical coverage) to some of their workers – including laid-off workers (xiagang zhigong) and redundant workers (fuyu renyuan) – and their productive functions were persistently weakened in detriment of higher output and productivity levels. Meanwhile, unemployment rates were threatening to increase beyond expectations – although always below 5%, according to official statistics but at approximately 15%, according to independent statistics. Then, SASAC got on stage in March 2003 after the First Session of the 10th National People’s Congress. SASAC can be briefly defined as a shareholder on behalf of the State made responsible for the supervision and management of state-owned assets, the appointment and removal of top CEOs in SOEs and the evaluation of their performances. It has the ownership of almost 200 SOEs, with assets worth 6.9 trillion RMB (US$834 billion). In theory, SASAC’s aim is to separate government administration and ownership from day-to-day enterprise management, while the guiding principle is that the state sector should withdraw from all competitive economic sectors and leave room for the development of the private sector.2 All in all, while the pace and direction of economic reforms has proven adequate, there are still some sectors where reforms remain incomplete, due mainly to the lack of economies of scale. According to Mr. Huang, President of Bearing Point Greater China,3 “there are too many companies that lack economies of scale: in the automotive sector; the steel industry, where there are about 160 companies; the electronics area, where companies are too small to sustain the next phase of R&D; pharmaceutical companies which are too small, very fragmented and have a huge problem in distribution; etc.” The solution suggested is to focus on the concentration process of such industries, “(because) these industries are too fragmented and because the market itself will force companies to merge.”
4
Introduction
Although our book is focused more on the implications of SOEs reforms at the industrial and entrepreneurial levels, we consider it fundamental to introduce a macroeconomic perspective and clarify how SOEs reforms have evolved. Once this framework is understood, the initiatives launched at the firm level will be more clarifying.4 From a historical perspective, it is important to notice that during the 1950s, a traditional employment system was set up as a result of the creation of the household registration system (hukou)5 with three distinct purposes: (1) to guarantee full employment to urban workers; (2) to keep down the wage rate of urban workers; (3) to divide rural from urban labor markets.6 All three aspects were integrated within the so-called heavy-industry-oriented strategy, which was implemented as the country’s economic priority. The contradiction was obvious: on the one hand, being the heavy industry sector capitalintensive, it had a very low capacity of labor absorption; on the other hand, there was no open unemployment, but rather an implicit underemployment, as the majority of urban dwellers of working age had a job, regardless of their human capital and productivity levels. Inevitably, the prices of the factors of production were distorted, as the problem of overstaffing pushed to the establishment of an institutional wage, rarely equivalent to the growth of labor productivity. As a result, not only was the macroeconomic policy fully distorted, but also the planned labor system was rather neutral to the variations of the economic environment. With the launching of economic reforms at the end of the 1970s, this situation could no longer be sustained. That is why, ever since, the Chinese government has been making special efforts to reinvigorate the deteriorated state-owned sector. These efforts have been translated by five waves of SOEs reforms (Table I.1.). During the initial stage of SOEs reforms (1978–1983), SOEs managers were given more autonomy and were allowed for the first time to retain a share of their profits. In addition, the baby-boom children of the 1950s and 1960s were entering the labor market and urban dwellers that had been sent to the countryside were returning from there, which altogether increased the pressures on job creation. In order to avoid higher levels of unemployment, or further overstaffing, local governments promoted employment out of the state-owned sector, encouraging the development of small businesses (getihu). Unfortunately, price distortions persisted, for which levels of efficiency and resource allocation remained insufficient.7 While the economy was being pushed to further marketization, a second wave of SOEs reforms was launched between 1984 and 1988, allowing SOEs to respond to market forces with an increasing autonomy in establishing wages according to their levels of productivity. In addition, SOEs were given more freedom to hire and fire workers, following their production needs. The so-called contract responsibility system (CRS), which had emerged by 1983 and appeared as an incentive for enterprises to maximize their financial surplus, was replaced
Economic context
• Launching of economic reforms. • Rural decollectivization (Household Responsibility System – baochan daohu).
• Maoist economic
heavy-industry-oriented strategy: priority of capital over labor. •People’s Commune System (renmin gongshe) in the rural areas. • Economic disasters caused by political instability (economic and political campaigns; Great Leap Forward; Cultural Revolution). .
1978–1983
1949–1978 System (Plan + Market) (zhuangguizhi). • Urban reforms and creation of SEZs. • Two crucial threats emerge: inflation and corruption.
• Dual-Track
1984–1988 military intervention (June 4, 1989). • Deng’s trip to the South (1992). • Introduction of new governmental policy: ‘Socialism with Chinese Characteristics’.
• Tian’anmen
1989–1992
(1994): recentralization of tax collection. • Unification of Rmb (1995). • Towards the so-called ‘Socialist Market Economy’ (XIV CCP Congress, October 93). • Asian Financial Crisis (1997–1998). • China joins WTO in December 2001.
• Fiscal reform
1993–2003
(Continued)
Premier Wen Jiabao take the lead (XVI CCP Congress, November 03). • Risks of overheating are controlled in specific sectors (steel, real estate). • Accelerated process of internationalization of Chinese firms (Haier, Lenovo, Huawei, CNOOC). • Timid revaluation of the RMB by 2.1%.
• President Hu Jintao and
2003–today
(1) 1978–1983: increase of the SOEs’ managerial autonomy through the launching of experimental initiatives such as profit retention and performancerelated bonuses that permitted SOEs to produce outside the mandatory plan; (2) 1984–1988: replacement of profit remittances by profit taxes, while SOEs were allowed to sell surplus output quota. Introduction of the so-called contract responsibility system, implying more freedom for SOEs to hire and fire workers and therefore clarifying the authority and responsibility of managers; (3) 1989–1992: slowdown of labor reforms (SOEs are pressured to increase their quotas of labor demand); (4) 1993–today: creation of a modern enterprise system and increase of SOEs autonomy, with the launching of a corporate governance system, through the ‘zhuada fangxiao’ policy.
Table I.1 Different waves of SOEs reforms
• Persistence of
price distortions. • Insufficient resource allocation.
inter-enterprise and inter-regional mobility. • Establishment of an institutional wage in urban areas. • Unemployment is minimized through the reallocation of urban labor in rural areas.
managerial autonomy: wages and employment decisions are decentralized. • Contract Responsibility System (chengbaozhi): freedom to hire and fire workers. • Tax-for-profit system (li gai shui). • Growth of TVEs inter-enterprise competition. • Distortion of marketdetermined prices (because of the dual-track system).
• Limited
• Increase of
of SOEs increases: they are able to retain a share of their benefits. • Employment promotion in the non-state sector. • Development of small businesses (getihu).
1984–1988
• The autonomy
1978–1983
1993–2003
re-emerges. • Profits decrease. • Demand of bank credits credits increase.
• Under-employment
is externalized. • Pressure for other reforms to be launched: finance, banking, housing, social security, pension, etc.
• Unemployment
• Homogeneous to increase labor accounting system demand. for all SOEs. • Labor reforms are • Hard budget slowed down: return constraint. to the old “iron rice • REP launching. bowl” system • Launching of a (tiefanwan – new corporate lifetime governance employment). system based on the ‘zhuada, fangxiao’ system (XV CCP Congress, September 1997).
• SOEs are pressured
1989–1992
under SASAC’s control; small/medium SOEs still subject to local decision-making. • Despite tight control of the economy, the private sector has larger scope of development and compensates increasing unemployment rates.
• Largest SOEs remain
as a watchdog and supervisory institution responding to the interests of central authorities. • Need to focus on a more effective capital management system. • SOEs have to catch up with the rapidly emerging private sector.
• SASAC is established
2003–today
Notes SOEs: State-Owned Enterprises; TVEs: Township and Village Enterprises; CCP: Chinese Communist Party; REP: Re-Employment Program.
Sources: Hu and Li (1993: 148–153); Naughton (1995: 207–212); Lardy (1998: 22–24); Fernández-Stembridge and Huchet (2006: 32–36).
Results
SOEs • From a national (and labor) Unified Labor reforms Allocation System (LAS) to a centralized and arbitrary LAS.
1949–1978
Table I.1 Different Waves of SOEs Reforms—cont’d
Introduction 7 by the tax-for-profit system (li gai shui reform) until 1986, where profits were reclassified as taxes, and enterprises emerged as residual claimants on after-tax profits. As this system proved to be inefficient, a more developed CRS re-emerged, lasting only until January 1994, when fiscal reforms took place (enterprise tax payments were re-centralized), and the CRS was replaced by an income tax. With the dramatic surge of Township and Village Enterprises (TVEs) since 1984, inter-enterprise competition emerged. Between 1984 and 1988, the number of TVEs increased from almost 6.1 million to almost 18.9 million, and the number of employees rapidly rose from almost 52.1 million to 95.5 million, whereas during the same period SOEs slowly employed from 86.4 million to 99.9 million. Although job creation does not represent a direct measurement of output value (after all, gross output value of industry of SOEs was almost three times higher than the TVEs gross output value within that same period), labor costs were lower in TVEs than in SOEs, as TVEs only performed productive functions, whereas SOEs were in addition burdened with providing social services (fuli) to their workers. The competition caused by the growth of TVEs progressively changed the conditions of the SOEs reforms, narrowing the monopoly profits of SOEs. By 1989, SOEs had progressively lost their leading position in the national economy: in the late 1970s, they contributed nearly 80 per cent to industrial production, whereas, by the end of the 1980s, their contribution had declined to little more than 55 per cent. In addition, the dual-track price system created a misleading trend of market-determined prices and incentives for corruption.8 The launching of an austerity program after the 1988 high inflation rate, as measured by the consumer price index (18.8 per cent), provoked a systematic risk of social unrest, for which SOEs were pressured by the Chinese government to increase their labor demand during this third wave of reforms (1989–1992) – despite their lower capacity of production – and to continue to provide, as in the past, an “iron rice bowl” to their employees. As a result, underemployment re-emerged, profits decreased, and the demand for loans and credits increased. SOEs were again unprofitable. By mid-1993, the situation changed, and a fourth wave of reforms was launched: job reallocation of laid-off workers had to be done through the so-called Re-Employment Project (zaijiuye gongcheng, REP), where the government not only ordered all enterprises to use the same accounting system, but in opposition to the past, it imposed a relatively hard budget constraint aimed to stop the SOEs’ indiscriminate access to bank loans, and therefore avoid a collapse of the banking system. The breakdown of the “iron rice bowl” system was equally suggested: as an increase of unemployment was foreseen, an institutional watchdog had to be prepared. That is why the Ministry of Labor launched the REP, instigating local governments to promote the development of training programs through the creation of re-employment service centers (zaijiuye fuwu zhongxin) through which unemployed redundant workers could be matched with other enterprises, or otherwise encouraging them to be self-employed. By 1996 the REP proved to be effective and operational in 200 cities. As a result, the Ministry decided to re-launch
8
Introduction
new re-employment training programs for at least 4 million laid-off workers and 6 million unemployed from 2001 to 2003,9 as part of the Tenth Five-Year Plan (referred to as the 10th 5YP here). The current wave of SOEs reforms (since 2003) is much determined by SASAC’s role in centralizing state-owned assets and pushing at least in theory for a more effective capital management system. While the private sector is rapidly growing, the remaining strong SOEs (mostly large ones, within an approximate total of 200) have to further transform their corporate governance system, their productivity levels and eventually their over-dependence on the banks’ generous non-performing loans. Summing up, with the launching of SOEs reforms and the more or less systematic breakdown of the traditional employment system, SOEs production and employment systems should depend more on an effective managerial decisionmaking environment. After all, the gradual achievements of the state-owned sector have pushed for the progressive growth of the non-state sector, while the Chinese labor market should develop accordingly. Indeed, from a labor perspective, long-term initiatives should be considered, such as an effective reform of the social security system; an increase in the information about employment opportunities; an adjustment of the human capital (through more effective training programs for laid-off workers); an adjustment of the industrial structure (small and medium enterprises should also benefit from credit and loan policies and stop being under-capitalized in comparison to big SOEs, which still have distorted corporate systems and ineffective enterprise management); a better balance between the state-owned and the non-state-owned sectors (further enhance their competition levels). In addition, the WTO factor has an impact on competition and specialization, where non-productive SOEs are dismantled but where in the longer-term positive labor perspectives can be much linked to the establishment of new technologies and know-how through the massive entry of foreign direct investment. As new economic sectors (services, tourism, etc.) settle down, employment absorption should be more effectively redistributed. From a more entrepreneurial perspective, it is essential to continue providing greater space for the private sector to flourish, and therefore create a better investment climate, improving transparency and accountability in business, reducing corruption, and upgrading the legal system.10 But a key component for the success of these initiatives is the restructuring of the banking and financial sector. Capital markets still remain small, being the banks’ main source of financing in China. With the main role of state banks to feed the SOEs sector, their portfolio of non-performing loans is far too huge (about US$ 500 million). Since 1998, reformers have been able to push ahead with the reform of the financial sector through two fundamental steps: (1) the reorganization of the People’s Bank of China’s branches along regional lines and therefore reduce political interference by powerful provincial party chiefs in lending decisions; (2) to move the non-performing loans off the books from the four major commercial banks and to recapitalize them. Asset Management Companies (AMCs) have been created and the capital is provided by the Ministry of Finance;
Introduction 9 although AMCs have little power to reorganize SOEs, they can at least acquire at face value loans from SOEs and swap them for equity. Separating SOEs and commercial banks from the government is arguably the most immediate and important of all ongoing reforms in China. The nation’s future lies with competitive and private firms in the industrial and services sectors: in the financial sector this means government at all levels should stop interfering in the lending decisions of state commercial banks. In other words, banks must begin to build trust, relationships and information channels with non-state firms by establishing systems for management information, risk evaluation and provision for bad debts, while a flourishing capital market is needed to allocate resources, diversify risk and raise returns to investors. However, more market does not mean less government; it means a different government. Government energies need to shift away from direct involvement in productive activities and further develop transparent and participatory institutions that promote the rule of law and a stable economic environment. But as reforms move to more advanced stages and China fully integrates into the world economy, there will be significant losers, including those workers and institutions that have formed the core of the CCP socialist system: SOEs reforms have become a significant bulk in overall reforms, for which their adjustment is of prime concern. To transform the state-owned sector without encountering major social unrest is indeed a challenge that the authorities must deal with. China has crucial advantages such as its very large and potential domestic market, its gigantic inexpensive and disciplined labor force, its relatively high savings rate, etc., for which the overall reform program needs a more effective draining of the stateowned sector. Indeed, not all SOEs should be privatized, especially those that are “tightly linked to the national economy: military and national security, natural resources, hi-tech and some major service industries.” However, the government’s interference in the management of any company appears to be one of the most important impediments to a clearer draining of SOEs.11 The idea to imitate Japan and Korea’s conglomerate systems was latent for some years. However, the Asian Financial Crisis in the late 1990s proved the system to be a failure: both Korea (chaebol) and Japan (keiretsu) conglomerates concentrated all kinds of companies together, including manufacturing, banks, securities, etc. But as these companies progressively became focused on themselves by serving their own bureaucracies, they neglected the market, i.e. the fact of having banks within their firms forced other companies in the Group to do business with such an exclusive bank. It goes without saying that with China’s opening to the world economy after WTO entry, the traditional challenges faced by SOEs becomes even more acute and the success of reforms may only become true if particular issues are fully addressed. These are some of the ideas provided at the managerial level:12 (1) Establish an independent decision-making system: if every decision in terms of investment or finance needs to go through various levels for approval, how can companies obtain real autonomy?
10
Introduction
(2) Have an effective HR system: in the past, leaders and managers of companies were all government officials and were appointed by the government. If those who run the company cannot appoint key personnel, how can companies develop? (3) Reform the financial and tax system: SOEs were before asked for both profits and taxes and bore very heavy burdens. They should keep their own profits and would then become more competitive. (4) Create professional management systems: SOEs need to realign their organizational structure towards the business process and focus more on the market, i.e. on the customer. In management areas such as marketing, production, or HR, the gap between global and Chinese companies is still very big. For instance, if CFOs do not have the financial management in place, they can never manage the company well and control the performance to meet their targets. Another example: if marketing continues to focus on channel management, SOEs will lag behind MNCs in branding, distribution and globalization strategy. In terms of production, SOEs should stop neglecting long-term planning and increase their inventory turnover in sectors such as home appliances (refer to our case study here). The establishment of a professional financial management will help SOEs to improve their production mechanisms. (5) Reinforce the in-house R&D: SOEs need to enhance their research and development capability. Now, in most of the companies, product quality is approaching to global standards but the technological level is not high enough. As JVs are no longer the preferred option, it will be necessary to upgrade internally. (6) Introduce an effective corporate governance mechanism: today’s SOEs corporate governance does not allow to make quick decisions or establish an effective organization. SOEs need some entity to represent the interests of the State, but they also need a CEO who is not assigned by the State, but recruited from the market. According to China’s current Company Law the main institutions within a firm are: board of directors, supervisory board, chairman and general manager. The supervisory board is meant to supervise the company, the board of directors and its chairman are meant to represent the interest of the shareholders, and the general manager is meant to execute. However, there is a problem of role definition: who is going to be responsible for what is not clear. The root cause is that the board is actually the so-called executive committee, such as we know it in the West. In China, the chairman is responsible for the performance of the company, but he/she also represents the shareholders’ interests and also supervises the management team. He/she plays all three roles. This system cannot work in any organization. Thus the immediate need to introduce more board members from the US, Europe or Japan, i.e. foreigners as independent directors into the board, at least on a transitional basis. (7) Open up SOEs to the globalization process: the bottleneck right now for the globalization of Chinese companies is that they do not have enough international management teams.
Introduction 11 As seen in Figure 0.1, SOEs reforms must be seen as a piece in the general system of reforms in China. For SOEs reforms to succeed, parallel reforms must take place at different levels: government, financial, labor market, and the establishment of a modern social welfare system. For all the above seven points to be implemented, it is critical that the government reforms itself first. But this is a long-term job. After all, SOEs reforms touch the interests of almost all ministries and bureaus: Personnel Ministry, Organization Ministry, Discipline Inspection Committee, Ministry of Finance, National Development and Reform Commission, Ministry of Labor and Social Security, etc. As interests become involved, it becomes increasingly difficult to establish an effective and modern corporate governance system: once property rights are clarified and the board of directors has the decision power, government authorities will be greatly weakened. Indeed, this overall reform “is a second revolution in China.”13 The fact is that China is changing so fast and is so full of complexities and contradictions that it is difficult to keep abreast of developments. Pragmatic readers will find in the following eleven chapters an industry-based analysis, followed by the specific case of a particular SOE belonging to each one of the eleven industries. This way they can appreciate with more detail how the general economic framework conditions the evolving process of SOEs reforms, while the future of China’s economy indeed relies heavily on the success (or failure) of SOEs reforms.
1
Home appliances
Industry restructuring: Overview Generally speaking, China’s light industry has been a priority in the country’s overall economic restructuring. It is therefore not surprising that throughout the Tenth Five-Year Plan (2001–2005, hereafter 10th 5YP) over 100 IPO light industry companies were launched. Meanwhile, SOEs-related rules and regulations were gradually renovated, while management standards improved. As the non-state-owned sector rapidly developed, the ownership structure of light industry underwent the following distribution: SOEs accounted for 28.7% of the total number of firms in the industry, while collective firms represented 21.9% and “others” (we assume private and foreign-funded firms mainly) accounted for 49.4%.1 Considered as the main focus of restructuring within the 10th 5YP, large-scale SOEs gradually improved their organizational structure and about 520 key SOEs accounted for 11.7% of the whole industry, owing mainly to the centralization of their production. In the particular case of home appliances, the output of the top six refrigerator manufacturers accounted for 75% of the total national output, the corresponding figures being 74.6% and 68.5% for the top six manufacturers of washing machines and air conditioners, respectively. Within this official framework, home appliances became a priority in terms of “efficiency, power-saving, environmental protection, noise free, quality, etc.”; the total output for China’s appliances industry was expected to reach 180 billion RMB by late 2005. In particular, the demand for home appliances was forecasted by the authorities to be the following by that same year: 13 million refrigerators, 18 million washing machines, 20 million air conditioners, 9 million microwave ovens, 4 million dishwashers, and 10 million water heaters. As a result, key home appliance enterprises were pressured to speed up their pace of internationalization: the scale of overseas production was programmed to reach US$ 0.5 billion, including 18 million refrigerators/freezers, 20 million washing machines, 26 million air conditioners, 20 million microwave ovens, 18 million fridge compressors, and 26 million air conditioner compressors. On a more precise level, as the SOEs restructuring process evolved, large corporation groups such as Haier, Changhong, and Meidi emerged, already having famous brands and worldwide logistics, distribution, and manufacturing facilities. This grouping strategy allowed the industry to reach large-scale economies and enter
Home appliances
13
a new competitive phase, previously unknown, at both national and international levels. Today, the top four firms in the whole industry (Haier, Changhong, Hisense, Chunlan) already share more than 50% of China’s total market – Hisense and Chunlan being fully state owned (see Tables 1.1 and 1.2 for a detailed ranking of firms within the industry).2 This means that while, during Mao’s period, priority was given to the heavyindustry-oriented strategy, with the launching of economic reforms, light industry has been given special attention: with a high added value and a short investment cycle, almost all local governments have encouraged the development of light industry in general, and home appliances in particular. After all, their domestic production follows China’s comparative advantage in labor-intensive goods. In fact, despite restructuring and the increase of laid-off workers in the late 1990s, job creation is increasing (Figure 1.1). As a result, the home appliance market has played an increasingly important role in GDP terms, contributing to 3.3% of GDP in 2002 (Figure 1.2). This rapid growth is related to the evidence that production factors have tended to be more effectively used; while total revenue increased from a little more than 81 billion RMB (US$ 9.8 billion) in 1993 to almost 345 billion RMB (US$ 41.7 billion) in 2002 (Figure 1.3), fierce competition allowed only the strongest firms to survive, therefore reducing the market from 2,644 firms in 1993 to 1,547 firms in 2002, despite the slight increase of firms in 1995 (2,852 firms) (Figure 1.4). In other words, concentration trends have been rather evident in the light industry. Summing up, restructuring in this industry followed the logical pattern of efficiency, with a fairly realistic official forecasting (see updated figures in the next section). Meanwhile, China’s growing consumer society has contributed to widening the access to basic appliances, mainly in urban areas.
Industry outlook By 2000, China’s appliance industry became one of the world’s largest suppliers, with sales amounting to almost 262 billion RMB (US$ 31.68 billion), accounting then for 2.94% of GDP.3 Official data show that in 1980 the total output of China’s household refrigerators was less than 50,000 units per year; annual production of television sets, washing machines, and air conditioners was approximately 2.5 million, 250,000, and 13,000 units, respectively. However, by 2004, refrigerators and washing machines had separately reached an output of about 30.3 and 23.5 million units respectively, i.e. more than 20 and 25% of the world’s total output, respectively; air conditioners rose to more than 64.5 million; and color TV sets increased to almost 74.5 million units, i.e. about 51% of the world’s total output.4 Meanwhile, appliance ownership also increased rapidly, particularly in urban China. In the early 1980s, it was rare to find major electrical appliances in Chinese households. By 2004, the penetration of color TVs reached 133.44 units per 100 urban Chinese households (i.e. homes having on average more than one television set); 95.90 for washing machines; and 69.81 for air conditioners (see Figure 1.5).5
Haier Co., Ltd (1980)
Guangdong Galanz Group Corporation (1996) Gree Electric Appliances Inc. of Zhuhai Guangdong Kelon Electrical Holding Co., Ltd (1997) LG Electronics (Tianjin) Appliances Co., Ltd (1995) Qingdao Aucma Group General Company (1989) Jiangsu Little Swan Co., Ltd (1995) Panasonic. Wanbao (Guangzhou) Air-Conditioner Co., Ltd (1993) Guangdong Zhigao Airconditioner Co., Ltd (1997) Henan Xinfei Electric Appliance Co., Ltd (1994)
1
2
Refrigerator
Air conditioner
Air conditioner
Washera
Freezer
Air conditioner
Refrigerator
Air conditioner
Microwave oven
Air conditioner
Main product
Guangzhou (Guangdong) Foshan (Guangdong) Xinxiang (Henan)
Qingdao (Shandong) Wuxi (Jiangsu)
Qingdao (Shandong Province) Foshan (Guangdong) Zhuhai (Guangdong) Shunde (Guangdong) Tianjin
Location
Foreign funded
Private owned
Foreign funded
SOE
Collective owned
Foreign funded
Joint stock
Joint stock
Joint stock
Collective owned
Ownership
2.45
2.46
2.54
4.41
4.92
5.11
6.16
7.03
8.62
30.29
Revenue (RMB bn)
a The term “Washer” in this table refers to both washing machines and dishwashers. Source: Zhongguo shichang nianjian (2004) (China Markets Yearbook), Beijing: Waiwen chubanshe (hereafter: China Markets Yearbook).
10
9
8
7
6
5
4
3
Company name (year founded)
Ranking
Table 1.1 Top ten white goods enterprises
4,551
2,200
2,590
7,527
5,731
2,548
8,375
5,575
11,200
18,131
No. of employees
14 Home appliances
Hisense Co., Ltd (1969) Sichuan Changhong Electrics Group Corp., Ltd (1993) Konka Group Co., Ltd (1980) Dalian Daxian Group Co. Ltd Xiamen Overseas Chinese Electronic Co., Ltd (1985) Changzhou Xinke Digital Technology Co. Ltd (1998) Philips Consumers Electronics Suzhou Co., Ltd (1994) TCL Electric Appliances (Huizhou) Co., Ltd (1994) Shenzhen Sanyo Huaqiang Laser & Electron Co., Ltd (1993) China Hualu Group Co., Ltd
Source: China Markets Yearbook (2004).
10
9
8
7
6
3 4 5
1 2
Ranking Company name (year founded)
Table 1.2 Top ten black goods enterprises
DVD
Laser head
TV set
TV set
DVD/VCD
TV set TV set TV set
TV set TV set
Main product
Dalian (Liaoning)
Shenzhen (Guangdong)
Huizhou (Guangdong)
Suzhou (Jiangsue)
Changzhou (Jiangsu)
Shenzhen (Guangdong) Dalian (Liaoning) Xiamen (Fujian)
Qingdao (Shandong) Mianyang (Sichuan)
Location
SOE
Foreign funded
O/C funded
Foreign funded
Limited liability
Joint stock SOE O/C funded
SOE Joint stock
Ownership
3.81
4.09
4.23
5.26
5.47
8.25 7.31 6.49
14.84 13.41
Revenue in 2001 (RMB bn)
2,663
7,000
4,399
2,130
5,080
2,349 10,162 4,881
7,828 32,908
No. of employees
Home appliances 15
16
Home appliances
Figure 1.1 Employment in the home appliance sector. Source: China Markets Yearbook (2004).
Figure 1.2 Home appliances as GDP share (%). Source: China Markets Yearbook (2004).
The geographical distribution of domestic appliances manufacture has tended to concentrate in eight areas: Shunde (Pearl River delta); south of Jiangsu Province; Qingdao (Shandong Province); Mianyang (Sichuan Province); Shanghai; Ningbo (Zhejiang Province); Hefei (Anhui Province); and Xiamen (Fujian Province).6 Despite the overall growth of this industry, the rural–urban gap has been particularly evident in its distribution statistics. The consumption of appliances in
Home appliances
17
Figure 1.3 Home appliances: total revenue (RMB mn). Source: China Markets Yearbook (2004). Notes a In 2002, the added value of heavy industry was 1,235 billion RMB (US$ 149.4 billion); light industry’s figure was 1,065 billion RMB (US$ 128.8 billion). b Home appliances here include: washing machines, vacuum cleaners, refrigerators, electric fans, television sets, air conditioners, lampblack releasing equipment, and other household electrical appliances.
Figure 1.4 Home appliances: total number of enterprises. Source: China Markets Yearbook (2004).
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Figure 1.5 Number of major durable consumer goods owned per 100 urban households at the year-end (unit). Source: SSB (2005).
China focuses mainly on the urban economy, especially in large cities, which is almost 15 years ahead of that in the rural areas. Urban people, who account for about 40% of the total population, share over 60% of the market, except for TV sets and fans: the prevalence rate between urban and rural areas differs greatly. For instance, while refrigerators have a penetration level of about 82 for every 100 urban households, in rural areas the figure is less than 15. But as living standards increase, the consumption of appliances tends to diminish in large cities such as Beijing, Shanghai, Tianjin, and Guangzhou, and to increase in small cities and towns, which still lag a little behind in terms of economic growth. While the urban household appliances market is approaching saturation, the rural areas lack basic goods: not only do farmers earn less than one-third of the average urban workers, but there are also locations in the rural areas that lack basic conditions for the usage of appliances. Meanwhile, the aggressive entry of foreign direct investment (FDI) and the bourgeoning of joint ventures (JVs) clearly give a new approach to the market.
Competition With the introduction of foreign advanced technology and competitive mechanisms, the domestic appliance industry has progressively established new production processes, such as manufacturing, marketing, R&D, and distribution. These elements have allowed domestic production to become a fundamental factor in China’s light industry. Indeed, the domestic appliance market has dramatically changed as a result of the increasing abundance of different players, both domestic and foreign. For instance, Japan, one of the largest export-oriented producers of home appliances throughout the 1980s and 1990s, tended then to select China as its
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main export market for Japanese-made home appliances such as washing machines, air conditioners, and refrigerators. However, since 2000, as Sino-Japanese JVs developed, the exports of the above products to China inevitably declined. Mitsubishi Electric and Panasonic, two of the largest air conditioner export companies, announced in 2001 that their air conditioners would stop being exported to the Chinese market. Instead, they began production there itself.7 Another example is LG Electric, a company from Korea: although it accessed the Chinese market in 1994 and was therefore one of the last multinational companies to enter the Chinese market (together with Samsung), by 2004 it had reached a total accumulated investment volume of around 55.4 billion RMB (US$ 6.7 billion). Its so-called “strategic loss” investment style was to enter the Chinese market using low labor costs and low prices through the establishment of its largest overseas manufacturing base in China, including basic appliances such as washing machines, air conditioners, and refrigerators. It is located in Hangzhou (Zhejiang Province). LG’s entry into China indeed put a lot of pressure on the domestic home appliance manufacturers, as LG’s revenue from air conditioners and microwave ovens is among the top three, while washing machines, refrigerators, and color TVs are all within the top ten in China. At the time of writing our book, and despite having tried to find more updated data for 2005, all that we know is that the forecast for LG in 2004 was to increase its investment in China by over 50% more than in 2003, while its sales target for its main product lines was to be 1.5 times that in 2003.8 Indeed, the best strategy for overseas companies to compete with domestic home appliance corporations has been through production cost reduction and the combination of their high technology with China’s cheap labor and natural resources. The advantage has then become double-edged, both in terms of brand and price. This situation applies also to JVs such as Amoisonic (electronics, created in 1981, a listed company in Shanghai since 1997, total assets of approx. 1.3 billion RMB/US$ 160 million) or Tianjin Samsung (electronics, 1993, total investment of 7.7 billion RMB/US$ 929 million), which have become major competitors for domestic firms and tend to gradually reduce their competitive advantage in labor, in addition to their lack of key technology (their R&D capacity is still quite small) and to their reduced distribution network overseas. The entry of international firms with new products and accessories, such as vortex compressors, top cylinder washing machines, air conditioner compressors, magnetrons, and so on, have inevitably hit the Chinese high- and middle-grade home electrical appliance producers. Of course, influence has been even more significant on those sectors where China’s appliance industry is not yet upgraded. Siemens has even become a “household name” in China’s home appliance market. It is probably the largest foreign-invested employer in China, with about 30,000 employees, and has established more than 27 sales offices and 45 operating companies throughout the country, with a total long-term investment exceeding 5.4 billion RMB (US$ 653 million), and sales in China of about 37.2 billion RMB (US$ 4.5 billion) in 2003 alone.9 Siemens entered the Chinese market in 1995 and established two factories in Wuxi (Jiangsu Province) and Chuzhou (Anhui Province). Siemens has invested US$ 0.2 billion only in China’s home appliance industry. Already in 2000, according to the data released by the official
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Figure 1.6 Firms ownership structure (%). Source: China Markets Yearbook (2004). Note Despite thorough research, no data were available for years 1997 and 1999.
China National Information Center (Zhongguo guojia xinxi zhongxin), in terms of sales revenue, Siemens’ market share for refrigerators and front loader washing machines was then 8.2 and 21.6%, respectively, which made it rank first among all multinational companies in China.10 There are also some private players in this industry. Many big ones are located in Guangdong Province, such as: (1) Guangdong Zhigao Air Conditioner Co., Ltd, funded in 1997, with a revenue of almost 2,457 million RMB (US$ 298 million) in 2002, ranking fourth in China’s air conditioners market; (2) Guangdong Xinde Science & Technology Group Co., Ltd, smoke absorber manufacturer for kitchens, with a revenue of 359 million RMB (US$ 43.5 million) in 2002; (3) Shunde Jinke Electrical Appliance Co., Ltd, and Zhongshan Ganglian Huakai Electrical Appliance Products Co. Ltd, electric fan manufacturers, with a revenue of 266 million RMB (US$ 32.2 million) and 231 million RMB (US$ 28 million), respectively in 2002.11 Having said this, it is true that while some SOEs generally tended in the past to occupy the largest share of China’s household appliances market, foreign firms timidly, but increasingly, already entered it during the late 1990s (Figure 1.6). This industry being particularly competitive, not only within China’s borders but also abroad, the latest large-scale industrial restructuring and its laborintensiveness have tended to be ultimately exposed to the various opportunities linked to WTO entry, especially when considering the derogation of the Agreement on Textiles and Clothing since January 2005.
WTO impact and challenges With WTO entry, technical improvement and renovations should intrinsically become a trend in this industry, as the protection of intellectual property rights speeds up the industry’s pace from imitation to innovation. In addition, all import
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quota and quantity restrictions have in theory been fully eliminated and import tariffs have been reduced from 22.1% in 2000 to 17% in 2005. On the other hand, already by 2000 the export growth rate of the home appliances industry was higher than that of China’s total volume of exports. Home appliances were exported to more than 175 nations and areas all over the world, with the USA as the main destination.12 But, as prices became competitive, many of the SOEs in light industry were inevitably under constant pressure. One option was to enhance exports to offset productivity surplus. Another option was to internationalize. As WTO membership has given Chinese firms a more stable access to foreign markets, they have been able to utilize their excess capacity in urban areas, provided that the quality of products has been good enough to meet the demand of foreign consumers. The most crucial example of internationalization can be found in Haier, which has reached the highest level of product manufacturing and distribution not only in China but also in very diverse markets such as the United States, the EU, the Middle East, and Latin America. Its growth strategy has been based more on branding than on saving labor costs, as they hire local labor (more expensive than China’s) in the destination markets.13 Another example, concentrated on R&D, can be illustrated by Sichuan Changhong Electric: the company massively exports manufacturing products such as TVs, air conditioners, batteries, components, small household appliances, video systems, LCD displays, etc. It has adopted a strategy based on “high–low combination, fighting with two sides”, i.e. it gains profits in the domestic market and participates actively in the international market’s competition. As with Haier, Changhong has been very successful in its push for an internationalization strategy, and has passed international certificates such as UL, CE, CB, GS, TUV, and CCIB successively. In recent years, its products have been delivered to more than 30 countries or regions including the United States, Russia, Australia, Indonesia, the European Union (EU), Singapore, Czechoslovakia, Pakistan, Thailand, and Peru. Meanwhile, export earnings keep increasing by 100% on a year-on-year basis.14 As explained in more detail in our case study, Little Swan Group has followed another path, pushing forward its global development strategy and forming a strategic alliance with Germany’s Siemens, Japan’s Matsushita and Toshiba, Italy’s Merloni, and the United States’ Whirlpool. As part of the global economic tide, branch companies have also opened in Japan, the United States, Germany, Indonesia, and Malaysia. In other words, Little Swan Group has exerted itself to change from a domestic household appliances manufacturer into an international one. Under WTO pressures, domestic firms in this industry need to exercise significant changes in their ownership structure, mostly in terms of efficiency, thus introducing innovation in technology, management, services, upgrading their industrial structure, and so on. Although there are many kinds of ownership initiatives and types of association, we solely concentrate on the most common ones in this industry: (1) with foreign partners (JVs, technology coordination, branding exchange); (2) with domestic partners (complementary production).
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With foreign partners Joint ventures are a common type of combination in this industry. For instance, in 2002, Haier established multinational cooperation relations with international rivals such as Sanyo and SAMPO for a win–win development. Partnership through technology coordination is also quite popular. Sichuan Changhong Electric is a crucial example: as part of its improvement in high-tech levels, it has built a close cooperative relationship at the technological level with both domestically famous scientific research units (e.g. Chinese Scientific Research Institute and Qinghua University) and internationally famous corporations (Toshiba, Philips, ST). In terms of branding exchange, Xinfei, one of the largest refrigerator manufacturing factories, has agreed with General Electric (GE) to sell the refrigerators manufactured by Xinfei with GE’s brand in the US market. Simultaneously, Xinfei will also sell GE’s refrigerators as its own products in the Chinese market. As a result, Xinfei can not only share the high-tech refrigerator market with GE’s products, but can also access the international market. Their aim in the near future is to develop other kinds of black and white appliances apart from refrigerators.15 With domestic partners As domestic competition increases, domestic alliances also become a good choice. In recent years, Little Swan Group and Kelon (also a middle-scale jointstock firm) became a union with an aim to alleviate the pressure exercised by Haier. Kelon’s dominating products are refrigerators and air conditioners, whereas Little Swan Group is famous for its washing machines and dishwashers. This association has given two apparent advantages: first, their products are complementary and do not compete with each other; second, due to their distant locations (one in Guangdong Province, the other one in Jiangsu Province), they can share their local sales distribution and manufacturing location. Their association includes: (1) mutual investment to promote e-business development; (2) coordination under the OEM/ODM model to gain larger cost advantages; (3) development of joint export services aimed to set up an overseas sale base, so that they can strengthen their international competitive capacity; and (4) as a natural process of strategic partner relationship, they obviously discuss their common stock interchange problems.16 Having said this, China’s home appliance industry is particularly competitive, for which the WTO impact tends to be small. Truly, WTO pressures have driven Chinese firms to use alternative production mechanisms and absorb the foreign presence more effectively. But, although foreign players can enter the market more easily, domestic competition is fierce enough to guarantee Chinese firms the largest share of the market. This is the case of Little Swan Group’s successful restructuring and positioning in China’s home appliance market, which has not just been the result of luck.
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Home appliances Main tips (1) Restructuring. Due to its high added value and short investment cycles, restructuring allows the light industry to reach large-scale economies and large corporation groups to merge with famous brands and worldwide logistics, distribution, and manufacture facilities. The domestic production of home appliances follows China’s comparative advantage in labor-intensive goods. As the industry becomes more efficient while total revenue increases, fierce competition allows only the strongest firms to survive. (2) Outlook. Home appliances play an increasing role in GDP terms (3.3% in 2002). In 2004, refrigerators and washing machines reached 20% and 25% of the world’s total output, respectively, while air conditioners rose to 64.5 million; and color TV sets increased to almost 74.5 million units, i.e. about 51% of the world’s total output. Despite this success, the rural–urban gap keeps increasing; consumption of appliances in large cities is almost 15 years ahead of that in the rural areas. (3) Competition. It is intense: overseas companies compete with domestic corporations through production cost reduction and the combination of their high technology with low labor costs and cheap natural resources (Mitsubishi Electric, LG Electric, Siemens, Samsung, Amoisonic). Despite aggressive entry of foreign firms, they represent a small market share in relative terms, due to their late entry, as the sector tends to be oligopoly-domestic-oriented under the umbrella of top brands such as Haier, Changhong, Kelon, and Midea. (4) WTO Impact. WTO pressures push domestic (SOEs) firms to adopt comprehensive mechanisms: enhance exports to offset productivity surplus; utilize their excess capacity in urban areas through growing internationalization (Haier, Changhong) or by forming strategic alliances (Little Swan); change their ownership structure (more efficiency through innovation, industrial structure upgrading, etc.), either with foreign partners (JVs; technology coordination – Changhong & Toshiba, Philips, or ST; branding exchange – Xinfei and GE); or with domestic partners (complementary production – Little Swan Group and Kelon).
Case study: Little Swan Group Interview with Mr Chai Xinjian, GM and Vice Chairman of the BOD, Jiangsu Little Swan Group The Little Swan Group Co. Ltd of Jiangsu Province owned 33 subsidiaries, including the publicly traded company, Wuxi Little Swan Shareholding Co. Ltd. Little Swan is the largest producer of washing machines in China and is among the 100 biggest enterprises in the country. Its product portfolio includes washing machines, air conditioners, refrigerators, dishwashers, dryers, freezers, industrial washing machines, and dry-cleaning machines. Little Swan’s total assets in 2003 amounted to 7.5 billion RMB (US$ 0.91 billion), with annual sales of over 10 billion RMB (US$ 1.21 billion). The company has opened branches in Japan,
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US, Germany, Indonesia, and Malaysia. It exported to more than 60 nations around the world, with an export volume of about 1,640 million RMB (US$ 200 million) in 2005. Among its 10,000 employees, there were more than 30 PhDs, 100 MAs, and 3,500 BAs. In 2003, Little Swan ranked No.1 in the market for twin-tub washing machines, surpassing Haier, and No. 2 in the automatic market, this time after Haier. In the same year, the company sold 2.6 million sets of washing machines in the domestic market, which represents a market share of 21%. Washing machines accounted for 80% of the company’s total sales, while it represented around 20% of the group total sales. In 2004, Little Swan transferred 65% of state-owned shares to the hi-tech private group SVT in Nanjing, established in 1992. History of the company The first big event in the company took place with the merger of ceramics, mechanics and electronics, which ended up in the formation of Wuxi Little Swan in 1993. A second important event took place in the mid-1980s, when Little Swan started a technology cooperation agreement with the Japanese company Matsushita. According to Mr Chai, this cooperation was a very important milestone in Little Swan’s development. It gave birth to the ‘Ai Qi’17 brand washing machine, proving very successful in the market. Before that agreement, Little Swan was totally dependent on its own technology. Another important period was the formation of four new JVs in 1996, two with Siemens and two with Matsushita. The JVs with Siemens produced washing machines, while those with Matsushita produced refrigerators. Throughout the process of JVs, Little Swan was transformed from a consumer to a producer of technology. In 1998, the company set up two joint research centers with NEC and Motorola, implying that Little Swan had to change from a purchasing technology firm to a developing technology one, jointly with large foreign companies. As Mr Chai specifies, “in 2003, we began to produce washing machines as ODM for a GE subsidiary. We did the design and sold it to Latin America, but not to China. Before then, we used to export washing machines as OEM.”
Innovation and intellectual property rights In 1996, we only had two patents. In 1997, we had 30. But now, we have more than 200 patents in washing machines only. Little Swan has proven to be an advanced organization in producing patents. There are foreign companies coming to see whether our products are copies of theirs, which is not the case. We solve these problems through negotiation. In fact,
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theirs are not a patent in the real sense, but rather an open technology. Their application for patents in China is still underway and has not been approved. On the one hand, they are testing us on whether we know the law or not. If they think our product goes against theirs, we can testify that their patent is not effective in China. On the other hand, we have come across counterfeited “Little Swan” products. The government gives us strong support in this area. If we submit a letter to the government on this problem, they will try to stop counterfeiters: they usually shut their factories down. We have a team to take care of these issues, as well as a system to apply for patents and manage brand names. This team was set up in 1996.
Mr Chai is very positive about the JVs that his company has formed over the past years: The advantage of establishing a JV very much exceeds its problems in two aspects. It pushes the company to further adapt to the global economy. If you do not cooperate with the foreign company, you cannot survive. But when you cooperate with a foreign firm, you have to accept certain risks. A JV may fail due to cultural differences, misunderstandings, or lack of trust. However, failed companies are still the minority. From our experience, 90% of our JVs have been successful. What we have lost is really little compared with what we have gained. According to Mr Chai, there are several factors to consider in making JVs successful. First, both parties should be sincere. “Their motto should be to complement each other’s shortages, but not to take advantage of each other. A cooperation that is not genuine cannot be successful.” Second, the partners must have characteristics and competencies that complement each other. Mr Chai indicates that the foreign party has advanced technology and management systems as well as a famous brand. On the other hand, he continues, “We also have our own advantages: we are more familiar with product development, distribution channels and the local market.” Finally, there is the issue of cultural compatibility. He concludes, “This is strongly related to the style of the top leader of the company. He has to be a man with an open mind. There should also be managers with a cross-cultural background who can communicate well with foreigners.” Mr Chai indicates that many failures in JVs are due to misunderstandings arising from cultural differences. Another critical element in the success of a JV is honest communication. As a long-lasting cooperation, Mr Chai gives the example of their JV with Siemens: We have been cooperating with Siemens for many years. The result has been very good. Initially, the JV lost money for five years. The foreign party changed GMs four or five times. We were very patient. We did not put pressure on the Board of Directors because of the losses.
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Another example of this cooperative style is the JV with Panasonic, “Our JV with Panasonic had been losing money for six years. Even when they wanted to retreat from the JV, we still gave them assistance. Finally, last year, the business in the US market was transferred to China and that made the business turn around. One has to be patient.”
Mr Chai Xinjian’s story I joined Little Swan in 1996, starting as an engineer. I then took various positions including project manager, manager of the technology center, assistant to the GM, associate GM, GM, and now Vice Chairman of the Board and GM of Wuxi Little Swan Company Ltd.
Governing structure Little Swan has changed from an SOE to a listed company. In 1996, it was listed in Shenzhen’s B share stock market.18 One year later, it was listed in the A share stock market. As Mr Chai’s explains, This was a big step for the changes occurred in our company structure. Before the limited company was established, the government made all the decisions. At that time, the Light Industrial Administration was in charge of our company. Now, the board of directors makes the decisions. The decisionmaking right has been shifted from the government to the board of directors.
Mr Chai’s view on the board of directors Not all board members are real board members. Some are real investors, but others are government officials. Since the company is born state-owned, the function of the board is still limited. Another problem is that there is not enough clear definition of responsibilities, rights, and obligations between management and shareholders. There is still room for improvement in our board of directors. We have three foreign directors on the board. They are one-fourth of the board and hold veto power. This is very unique in the corporate governance of Chinese companies. It is a good protection to the foreign investment. The function of the board is very important. Now decisions are made by all members, neither by the government nor by any individual. It has improved a lot in the corporate governance; however the system is not perfect. The problem lies in the composition of the board. We have 12 board members. Three of them are foreign investors, but we also have government officials. The State still owns 27% of the shares.
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Despite this improvement, Mr Chai considers there are still challenges in terms of the governing structure, We have the old three committees (Party’s Committee, Meeting of the Employee Representatives, and Labor Union) and the new three committees (Shareholder’s Meeting, Board of Directors, and Board of Supervisors). Our structure is not satisfactory. The problem is that the new three committees have not replaced the old three committees, so we now have six committees instead of three. Besides, a person can at the same time be a member of both the old and the new system. We are still in the reform phase. Our goal is to set up a structure that can respond rapidly to the market needs. On top of that, we still lack sufficient professional managers.
HR and talent retention Another critical area is Human Resources. Mr Chai very clearly expresses the challenges in this area, “In HR, we are still in urgent need for talents with multi-cultural background that can communicate well with foreigners. The second difficulty is how to remove in a proper way the people the company no longer needs.” Mr Chai explains the different actions his company initiated to overcome these difficulties, “We are searching for talents everywhere in the world. As early as in 1996, we started hunting for talents on the Internet. We did a comparatively good job in this area and that is one of the reasons why we can cooperate well with many foreign partners. We also send people to the United States for training. We have sent three groups of our management to the MBA program at the University of Southern California. We cannot inform yet the results of these actions, but at least we are doing something about this.”
Mr Chai links the success of the reform process to the chairman’s leadership, In 1996, I talked with the chairman of the board. I thought the company would have a good future and the chairman had a very clear foresight. Wuxi is a relatively small city and it is very rare to find here a chairman with such an advanced vision. I thought that I could do something important in this company under his leadership. Mr Chai considered that the opportunities for having an impact are much higher in an SOE than in a multinational, where everything is already regulated. He explains, In a foreign company, even if you take a high position, people may not listen to you. I talked a lot with my former classmates and friends working for MNCs. Of course, they can also do something in foreign companies, but they
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Home appliances have many limitations. My company offers a platform on which one can get many opportunities for growth. For example, we can cooperate with Motorola, NEC, P&G, Toshiba, GE, and other large international companies. Watching the company grow up, you will have a feeling of self-realization. Of course, you will also meet some problems, some of which originate in the system and cannot be solved. But this is also a good opportunity for ambitious people. Local and central governments give companies a lot of opportunities for development. They encourage companies to try various approaches, while those well-established companies with a long history do not offer so many opportunities. However, talent retention is still a big challenge. Mr Chai recognizes it: In order to retain my people, I must give them opportunities. For example, I recently recruited a designer who wanted to go to an automobile company first. He had been studying industrial design and there were several companies hunting for him already even before he graduated. I met him in an exhibition. He told me he would go to an auto company. I told him, “If you go to a world-level auto company, it will take you around 10 years before you can do your own designing. But if you come to my company, it will take only two years.” Here, after two years training, they can immediately work with world level companies on new products, because we are in urgent need of these kinds of talents. In two years their products may appear anywhere in the world. We want to give young people opportunities to show their talent and do something important. In addition, they can work with the first level companies in the world.
This is the opportunity Little Swan can offer to young talents. Besides, not many companies have agreements with top companies in the world. In Mr Chai’s words, China’s door has just opened and Little Swan is an ideal partner for foreign companies. Today a new employee may be working in Tokyo, tomorrow he may be in Los Angeles, the day after in Paris. They have plenty of opportunities to learn new things. We offer them a great learning environment and they have a strong motivation, including language skills and management. This is the reason why young talented people like to stay with Little Swan. Of course, income is also very important. We offer compensation that is competitive enough to attract excellent employees. In foreign companies, the average compensation is comparatively high, but in Little Swan, we only offer high income to those who prove to be excellent employees. Monthly income could be as low as 1,000 RMB (US$ 121) to some employees but as high as 20,000 RMB (US$ 2,418) to others. We also eliminate those lagging behind. Our engineers could earn around 200,000 RMB (US$ 24,184) per year, which is competitive with what it is paid in foreign companies.
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Competitive advantage According to Mr Chai, Little Swan’s competitive advantage comes from several sides. First, it has a good brand image in China. Second, it has an advantage due to the economies of scale: “Now the sales of our washing machines account for 5% in the global market.” The third reason for their competitive advantage lies in their technology development. Finally, it enjoys the cost advantage due to lower labor costs in China. According to Mr Chai, We have 15 million users; about 16% of all Chinese users have Little Swan at home. We have a well-known brand. Many people, especially old people, know our brand. Price is one of our strengths. We also have many different models: 110 models for automatic washing machines, which accounts for 25% of the total models in the market. We use different models to meet the need of different market segments. We are one of the oldest brands in China. Siemens has five years of history and the Japanese brand National has six years in China, but both have fewer models than us. People can buy Little Swan almost anywhere in China. However, multinationals such as Siemens and LG are expanding and gradually entering our markets. Mr Chai compares Little Swan to Haier, their main domestic competitor: “Haier has a strong advantage in image and very strong competence in marketing and distribution. Besides, it has a very strong advantage in corporate culture.” According to Mr Chai, Haier’s movements are difficult to predict because they are changing their business strategy quite often. Haier is now entering many new businesses, for example, mobile phones, insurance, real estate, and capital investment. Haier has also set up a factory in South Carolina, USA. China is the battlefield for domestic and international companies in consumer appliances. According to Mr Chai, In the near future, I think Chinese companies will take 60% of the market, and foreign companies such as LG, Sanyo, Siemens, Hitachi, and Toshiba, the rest. These foreign companies are growing rapidly but most of them are losing money. They are now bearing pressures from their shareholders. For example, Maytag retreated from their JV with Rongshida in Hefei Province. They have now moved their factory to India. They will import the products from India to China. Some Japanese companies are moving their factories to Hangzhou, Wuxi, and Shanghai. Toshiba moved their plant to Thailand. Siemens set up a JV with Hitachi to make washing machines in Thailand, not in China. I cannot foresee the future of these foreign companies, but as for the Chinese firms such as Haier, Rongshida and Little Swan, we are at the top. After WTO, foreign firms can greatly increase their market share in China. Mr Chai describes foreign companies’ strategy in China: “They all have different strategies. Siemens goes for high price, high quality, and low volume. They go for
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the top segment. LG is low price, normal quality, and large volume. They have the support from the electronics department, i.e. marketing with MP3, mobile phones, etc. National goes for high price, high quality, and limited volume.” While foreign companies are present in the Chinese market, Little Swan also wants to become a global company. That is one of the biggest WTO challenges the Group faces. In 2003, the company exported 500,000 washing machines, mainly to Latin America, the Middle East, Russia, and Southeast Asia. According to Mr Chai, they still do not have a capable department for global operations. He comments: “We used to be a local player. Suddenly, there is the need to expand to the world. We feel it difficult to adapt to such a large market and to so many opportunities. We find our adaptability is insufficient and therefore we miss a lot of good opportunities.” Mr Chai comments on his internationalization efforts: We are planning to produce in India. The Indian market is growing and they need our technology. Last year, we cooperated with local companies in the United States. Our company has three offices there. About 15% of our sales are exported. We have some manufacturing centers in Russia, Iran and Malaysia. We also have three assembly lines there. We closed the factory in Argentina due to the political turmoil. Exports increased 200% last year. We work mainly as OEM and that is a problem because very few people know our brand. We have not really grown yet to the stage of ODM.
Future challenges of Little Swan’s reform process Mr Chai sees some critical points in Little Swan’s reform toward the market economy, “The largest problem is the adaptability of the company to the changes in the environment. As soon as we completed the IPO, WTO came, and then the need to go global. Our organizational structure is always falling behind. We are reforming the structure and HR ceaselessly, but we still cannot catch up with the environment.” According to him, this is the largest obstacle the company faces. What is behind this obstacle? He thinks there are two factors: “One is corporate governance. But it shouldn’t be so, as our companies are all limited companies. It seems that there is still something invisible hiding behind. The second factor is our poor basis. You know, to set up something new is always much easier than to change something already in existence. We have to introduce many changes; some things can be changed while others cannot.” Mr Chai is not totally satisfied with the speed of changes that have been introduced in his company. However, he considers the environment changes even faster: The internal reform has been very quick, but still lags behind external changes. The biggest lesson is that we should have implemented the reforms faster after the plan was completed. We have worked with many consulting
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companies and received many very good plans. But before we can put them into practice, the external environment has changed once again. And it takes us much more time to devise another plan. Thus, I think we should implement the reform plan much quicker. According to him, the challenge lies in the implementation of those plans: The factors leading to the time delay in the realization of these plans are very deep rooted. The state frequently changes the policies for SOEs reform and you have to wait for them. Another factor is the SOE’s leaders and managers’ courage of bearing risks. This is a crucial problem. Any reform has risks. Maybe he has an excellent plan on his hand, but at the moment of execution, he has to evaluate whether the return can exceed the risks. Mr Chai also expands on the role of the government in the reform process: The government gives SOEs much more assistance in the moral sense, and not so much in the economic sense. Now the government cannot allocate funds or give any privileges to SOEs in the market. The only thing they can do is to give recognitions and honors such as ‘the largest tax payers’ or ‘the most advanced organization’, and so on. He admits the government gives freedom to the companies in how to approach their internal reforms, but at the end, he says, “the result depends on the qualities of the organizational leader, whether he is a man with courage or conservative.” Besides leadership, Mr Chai points out another critical success factor: corporate governance. He concludes, “I think we are now at the end of the first stage in the process of SOEs reform. I think the key point now is corporate governance.”
Little Swan Group Learning points (1) Use a JV to learn international management systems and acquire new technology. Even if the partnership does not go as expected and is finally dissolved, you have always gained something from the experience. (2) Establish your own R&D program. It will mean the future prosperity or even survival of your business. (3) Establish modern human resource systems. The key success factor is to attract and retain new talent. Your company can offer them great career opportunities and a visibility that MNCs do not usually provide. (4) Have clear leadership. Vision and determination are keys to execute the reform plan.
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Home appliances Challenges ahead (1) Governance. Professionalize the role of the BOD. Have a clear separation of responsibilities between management and the BOD. (2) Internationalization. Produce and sell in other countries. Competition in those markets will bring knowledge that can be used in the domestic market. (3) Organization. Design a flexible organization responsive to competition and environmental changes.
Conclusions and future perspectives China’s home appliance industry plays an essential role in the country’s exploitation of its comparative advantage in low labor costs, but it also envisions the internationalization of its enterprises. The WTO challenge becomes in that sense a positive pressure, despite the inevitable restructuring of the ownership structure and the search for efficiency. Counting on foreign capital remains an essential strategy, but joint work between domestic firms that may be worthy of complementary interests can also appear as a positive step in the full exploitation of China’s growing sector. After years of gradual readjustment, supply is emerging and will keep its growth trend in the home appliance market. As demand stabilizes and consumption is personalized and diversified, the demand for small electrical appliances may outpace that of traditional big ones. Due to the excess capacity, we expect price competition and quality improvement to prevail. Little Swan Group is in that sense a good illustration of future outcomes in the home appliance industry, as it combines national requirements linked to the SOEs’ process of reforms with international pressures linked to a substantial upgrade of production and management. Little Swan, in this path of transformation, wants to become a recognized home appliance brand not only domestically but also internationally. And Little Swan is not the exception but the rule among the Chinese companies in this industry. Already local brands occupy the biggest market share, while international brands are retreating to the highest segment of the Chinese market. Very soon, those international brands will face competition from the Chinese brands in their home markets. This industry seems to be the vanguard of the Chinese MNCs to come.
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Industry restructuring: Overview During Mao’s period, the authorities established an automobile industrial system oriented to the production of cargo vehicles that aimed to meet national needs in terms of economy, national defense, and required official duties. At that time, efficiency was very low and almost all purchases were under the government’s direction. Since the reforms, the auto industry has made significant progress as a result of FDI and new technology introduced into China: by 2003, FDI in the auto industry represented 2.24% of GDP (262.7 billion RMB – US$ 31.7 billion) (Figure 2.1).1 Both elements have strongly contributed to technical changes and structural restructuring of auto manufacturers, allowing the auto industry to eventually catch up with the international market, at least in terms of market share and credibility of the product. As the industry evolved, it rapidly became China’s backbone, by contributing both to the development of the national economy and to the improvement of the Chinese people’s living standards. Indeed, according to the official data provided, automobile production became the fifth largest Chinese manufacturing industry in 2003, with a total of 930.9 billion RMB-US$ 115.5 billion, surpassing 1,000 billion RMB-US$ 120.9 billion, in 2004 (Figure 2.2). This represented almost 8% of GDP by 2004 (Figure 2.3).2 This explains why, despite some cooling-down measures in 2004, the Chinese authorities have given a boost to the development of the auto industry as one of the two main pillar industries in the last 10th 5YP – the other one being real estate – in a bid to stimulate domestic demand. This boost may be viewed as a follow-up to the regulation issued by the former State Development and Planning Commission (predecessor to today’s National Development and Reform Commission, NDRC) on February 19, 1994: the Industrial Policy for the Automobile Industry aimed to guide the way forward to convert China’s fragmented and decentralized automotive sector into a national key industry, so as to improve product quality and realize production economies of scale between 1995 and 2005. Under this regulation, all foreign investment in the automotive field was to be placed under the scrutiny of the central government: from then onwards, the government would approve only those programs that conformed to the policy. However, as time went by, the Chinese government diverted from providing support to auto companies and regulating investment in auto consumption. By creating a favorable market environment, the automotive industry eventually needed to
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Figure 2.1 FDI in China’s automobile sector. Sources: SSB (2005); CEIC Data (2005).
Figure 2.2 Total output. Sources: SSB (2005); CEIC Data (2005).
develop, and therefore it became necessary to create a new automobile consumption policy by further encouraging car sales and production: although car prices dropped, fees and taxes for consumers still remained onerous. This is why we can expect China’s car industry to develop rapidly in the long run, precisely because of the boom in the demand for sedans. Indeed, automakers have introduced large numbers of new models without reservation into the Chinese market, as a way of gaining a larger market share. Needless to say that in addition to the predominant state-owned automobile production, private companies have also entered the automobile sales business (Figure 2.4): in almost all provinces, the majority of automobile sales companies have been influenced by private capital, and have therefore taken a lead in the restructuring of China’s auto industry.
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Figure 2.3 Output (% GDP). Sources: SSB (2005); CEIC Data (2005).
Figure 2.4 Ownership structure in China’s automobile sector. Sources: SSB (2005); CEIC Data (2005).
This is why the flexibility of private companies could largely renew the marketing schemes for the auto industry and the SOEs’ rigid management systems. However, the auto industry is not always necessarily attractive to China’s private capital, as the industry continues to absorb an increasing number of workers (Figure 2.5), while it requires too much capital and technology.
Industry outlook China’s automobile industry is about fifty years old but has only started to become operational since 1985. By then, there were neither imports nor FDI and the industry was limited to the three big automotive SOEs (First Automotive Works, FAW; Dongfeng Motor Corporation; Shanghai Automotive Industry
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Figure 2.5 Employment in the automobile sector. Sources: SSB (2005); CEIC Data (2005).
Corporation, SAIC) with an outdated technology, limited models, and a production only addressed to the government’s needs, almost like during the Mao days. Between 1985 and 1997, foreign participation was limited and JVs always had to be approved by the central government; prices were excessive for the average Chinese consumer, while the industry proved to be underdeveloped, undergoing huge costs; import tariffs and quotas were too high. However, Volkswagen became the exception to the rule by becoming the first investor to dominate the market for about a decade. Between 1998 and 2001 FDI was encouraged, while distribution remained under the government’s control: car models bourgeoned as productivity and profits increased geometrically. Indeed, during the Ninth Five-Year Plan (1996–2000), the auto sales volume in China increased by 6.33% annually, from 1.46 million units in 1995 to 1.83 million units in 1999. The volume of private cars grew by an annual 28.4%, from 2.50 million in 1995 to 5.34 million in 1999.3 Product variety was further improved and private purchase increased. After that, the Tenth Five-Year Plan (2001–2005) targeted an annual output volume of 3.20 million of motor vehicles, including 1.1 million cars, accounting for about 1% of total GDP. This target was centered on the structural adjustment of corporations: about 70% of domestic share had to be held by the top three groups (FAW; Dongfeng; SAIC). Of course, these changes needed an adjustment of the product structure, by increasing the number of cars, in particular dieselloading vehicles and light-diesel passenger cars; but also by adjusting the technical structure, so that China’s performance and quality of automobiles and components could eventually reach the level of similar products in the world (improvement of product safety, increase of electric fuel-supply systems for nondiesel vehicles, and therefore meeting Euro II emission standards, developing independent intellectual property rights, etc.).
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Figure 2.6 Market share of carmakers in China, 2002. Source: China Automobile News (2003). China Economic Review, Vol. 13, No. 3, March: p. 9.
Throughout the 10th 5YP, statistical changes proved to sustain such purposes. For instance, by the end of 2002, about 16 major automakers achieved more than 21 billion RMB (US$ 2.44 billion) of total profits, with almost 68% growth over the previous year. This means that figures were reversed from negative to positive during the first quarter of that year: operating profits among the 16 major automakers grew faster than the sales revenue since June 2002. Total profits of the top three groups leading the market totaled about 90% of the major automakers (Figure 2.6). Indeed, the industry’s sales income accounted for 5.2% of all industrial sales in 2002, up from 2.2% in 1990 and 4.4% in 2001. The ratio rose to 6.2% in 2003. National vehicle sales rose by a staggering 52% year-on-year during the first quarter of 2003, while sedan sales surged by an estimated 86% year-on-year during the first four months of 2003 and reached almost 6 million units sold in 2004 (Figure 2.7).4 It is also important to notice that with the increase of urban living standards a new middle class has emerged (in 2003, already more than 70% of auto buyers were private consumers), urbanization rates have accelerated (currently at 37%, expected to be about 50% in 2020), the quality of roads has improved, and consumers have become increasingly demanding in terms of safety and therefore quality standards. This overall improvement in the auto consumption environment undoubtedly contributes to a healthier national auto market, while auto investment, production, and sales increase, and the auto market therefore transforms itself from a seller market to a buyer one. However, while the related laws and regulations slowly improve,
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Figure 2.7 Total sales. Sources: SSB (2005); CEIC Data (2005).
automakers will still have more power with regard to consumers who might still tend to be discouraged by poor after-sales services and the lack of model variety. Indeed, many people hesitate to buy a car because of heavy fees and troublesome procedures: although the purchasing environment has been relatively improved, the usage of autos remains problematic. For instance, most consumers have no tools to deal with quality problems, due to the lack of corresponding policies, and they suffer high parking fees and bad road conditions. In addition, as opposed to the overall increase of car sales and production, auto financing services in China lag behind. According to the available estimates, by 2003 only 10–15% of the cars purchased in China had the assistance of financial loans; in the United States, about 80% of the cars were sold with auto financial loans.5 Motivated by the rapid development of auto production and sales, auto financial services can eventually become a large gold mine for both automakers and banks: auto agents serving as credit media need to be replaced by a direct autofinancing mode as China’s auto industry becomes increasingly mature. Indirect and direct auto-financing modes differ in the following respects: (1) The indirect auto-financing mode is a “buy-first-loan-second” mode: auto agents are responsible for credibility survey and loan eligibility assessment and have to help customers to apply for auto loans at the banks. (2) In a direct auto-financing mode, car buyers act as the party to contact the bank: they get the amount of the loan from the bank and then go to the car market to select a car; the banks also provide other related after-sales services such as car insurance and car leasing. In other words, the direct auto-financing mode is a real financial product and indirect auto-financing is not. The first bank to provide direct auto-financing in China was Pudong Development Bank, Nanjing Branch (on April 8, 2002). Presumably, more banks
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will follow suit in the near future, considering the upcoming (WTO-committed) liberalization of China’s banking system in 2006–2007. In fact, some commercial banks have started to reduce the thresholds of loaned car purchases. The China Agricultural Bank, which takes the highest share of domestic loaned car purchases, announced on September 15, 2002 that the banks’ down payment in the purchase of a car was down to 10%, from the previous 20%; the duration was eight years, instead of five; and interest rates reached 10%, the bottom level of the Central Bank. What is more outstanding is that imported cars could also enjoy this policy. Considering this context, international auto giants are eager to enter China’s auto-financing market, no matter how risky it may be. They all know the value and meaning of auto-financing services to their whole business, even if the process of opening this market is pretty slow. After all, in the near future competition will not only be confined to car models but also to auto-financing. This means that the company leading the auto-financing can eventually dominate China’s auto market. This is something domestic automakers need to bear in mind, as they tend to attach too much importance to production with detriment to sales and services. The increasing competition will undoubtedly be a pressurizing factor in this sense.
Competition Many experts deemed 2002 as the “outbreak year”: automakers speeded up the introduction of new models with updated technologies. They launched dozens of new models such as Palio, Polo, Ulio, Elysee, Aeolus, Familia, Zhonghua, Siena, Vitz, and Vios, covering up to 60% of the total market. The old situation, where several old models dominated the market, faded away. In the newly established sedan market, dozens of brands and more than 200 models emerged and subsequently heated up the competition. While some of them were replacements for older models, many were produced using new or unutilized capacity. As a result, the industry saw an increase in supply and some producers went out to promote their products aggressively. The expected result of all of this was the undercutting of other competing models, because of which there has been considerable room for China’s auto manufacturers to cut the prices of their products. On the basis of their 2002 results, Chinese car companies were amongst the most profitable in the world: market leaders such as Guangzhou Honda delivered an equity return of 52% and a pre-tax margin of 21%; even less efficient producers, such as Shanghai GM, achieved an equity return of 27% and a pre-tax margin of 17%.6 According to a research project carried by Guotai Jun’an, the average profit margin of China’s auto industry in 2002 was as high as 28%.7 In fact, in 2002, foreign businesses had a striking performance in terms of input–output capacity, operation, and earnings in China’s automobile industry: foreign automotive businesses in the whole industry increased from 8.957 billion RMB (US$ 1.08 billion) of profits to 25.051 billion RMB (US$ 3.02 billion) in total, i.e. they grew by 55.65% year-on-year and contributed 54.13% to the overall industry.8 Many examples follow this trend. This means that most automakers have enjoyed unusually high profit margins in the past few years. These are indeed about five to ten times the profit margins of automakers in developed countries.
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Nevertheless, such high levels are difficult to sustain as the market is further opened and new competitors emerge. For instance, on April 16, 2003 Shanghai VW announced an average price cut of 10% on the Passat – China’s flagship model – from 229,000–359,000 RMB (US$ 27,690–US$ 43,409) to 209,000–309,000 RMB (US$ 25,272–US$ 37,363). It also upgraded the vehicles’ interiors, including leather seats and parking remote control on different models. This was the result of competitive pressure originating from Guangzhou Honda and Shanghai GM. Both Honda and GM cut prices by around 10% and upgraded their key models in early 2003. Almost simultaneously, all other models also cut prices as a response to fiercer competition (Table 2.1). Price reductions such as the one launched in 2003 effectively spurred auto consumption, as many consumers were highly motivated by this initiative. Early that year, many new sedan models were introduced into China’s market and sold at relatively lower prices: about 100,000 RMB (US$ 12,092) to 150,000 RMB (US$ 18,138). The old models cut the prices even further, but that did not seem to influence consumers significantly: although consumption tends to be strongly motivated by price reduction, there are other conditions that equally influence the consumer’s decision, such as safety, practicability, or design. The Chinese automobile consumers then started to prove they were progressively becoming more sophisticated as the market matured and big brands such as GM or VW produced new models. As new models were introduced the influx of investment rapidly increased in the auto industry. Considering such a changing context, the government authorities Table 2.1 China automobile price cuts (June 18, 2003) Automaker
First Auto Works Hunan Chang Feng Shanghai GM Suzuki Motor Guangzhou Honda Dongfeng Citroen Shanghai GM FAW Huali Jiangxi Changhe Geely Group Suzuki Motor SAIC Chery Shanghai GM Shanghai VW Nanjing Fiat
Model
Red Flag Cheetah Sail Swift Accord Fukang Buick Lucky Angel Wagon R+ Gili Haoqing Alto Chery Buick GL8 Passat Siena/Palio
Source: Morgan Stanley (2003).
Price (1,000 RMB) Before
After
169.8 298.0 133.8 106.8 298.3 127.8 288.0 59.8 60.3 39.9 45.0 116.8 296.0 229–359 105.0
159.0 278.0 129.8 94.8 259.8 109.8 243.8 50.8 55.8 37.9 39.8 99.8 279.0 209–309 100.0
%Discount
6.4 6.7 3.0 11.2 12.98 14.1 15.3 15.1 7.5 5.0 11.6 15.0 5.7 10.0 4.8
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seriously considered issuing a new set of auto industry guidelines aimed at avoiding over-investment, covering areas such as general industry strategy, technological development, and the auto sector’s investment direction over the long term. But no matter how worried the authorities were, the 5–15% price cuts were adequate for 2003:9 despite strong demand, automakers were then unwilling to give up too much profit, as the Chinese market was still too small to offset an excessive margin reduction. It is important to notice that almost all the major automotive producers worldwide are in China’s market, either as JVs or as outsourcing: as mentioned above, they are generally interested in auto-financing services and are still in the process of searching for new collaborators and adjusting their business layout in China. Even if their ownership share does not exceed 50%, as regulated by the Industrial Policy for the Auto Industry, their advantage in brands, products, technology, R&D, and IPRs allows them to exercise more influence on China’s entire car industry. In addition, with the WTO factor at stake, their influential power could become even stronger. However, this could be more in theory than in practice, due to the increasing number of IPR lawsuits against China’s young automakers (Geely, Chery, Lifan, Shuanghuan, and Great Wall Motors), who have been accused of copyright and patent right infringement and unfair competition. Indeed, Japanese motor companies (Toyota, Honda, or Nissan), or US automakers (GM) have often been involved in lawsuits and disputes against their JV counterparts. But, in general, hearings have rarely been held in court. So far, only one case has been solved, and that has been in favor of local automakers (Geely vs Toyota).10 This is to say that the increasing levels of competition could potentially create a risky market where opportunities can often become burdensome. Despite IPR breakdowns, JVs between global and local companies still characterize China’s auto industry: almost all national automakers have been investigated by foreign giants wanting to explore the chances of establishing JVs (Table 2.2). Indeed, as JVs multiply, cars such as VW Santana, a 1970s-era model currently out of production elsewhere but in China, will see the end of their 15-year-old reign in the country. According to a report published by The McKinsey Quarterly, for global brands, the strategic issue is no longer how to enter the market but rather how to secure or consolidate profitable market shares.11 Price wars and divergent sales between MNCs such as GM (price reduction of 11.7% and sales increase of more than 25%) and VW (price reduction of 11% and sales reduction by 22%) in mid-200412 typify just one out of the many emerging conflicts in the auto industry. In other words, for MNCs in the Chinese automotive industry, success is not necessarily at hand: continued inefficiencies in the cost structure, supply chains, and distribution systems, as well as the constant influx of pirated parts and increased competition from Chinese enterprises, will likely continue to create difficulties for foreign companies. Within this context, it is important to note that China still fully supports the expansion of the nation’s three big SOE automotive groups – FAW in Jilin Province, Dongfeng Motor Corporation in Sichuan Province, and SAIC – which are trying to preserve their dominating position in automotive output in the market (Figure 2.8).
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Table 2.2 Teaming up with foreign partners Chinese manufacturers
Foreign partners
Beijing Auto Brilliance China Changan Auto Changhe Dongfeng Auto FAW Guangzhou Auto Hafei Jiangling Auto Jinbei Auto Qingling Auto Shanghai Auto Southeast Auto Wuling Auto Yuejin Auto
Daimler Chrysler, Hyundai BMW Ford, Suzuki Suzuki PSA, Hyundai, Renault-Nissan, Taiwan Yuan Motor Volkswagen, Mazda, Toyota Honda Suzuki Isuzu, Ford GM Isuzu GM, Volkswagen Taiwan China Motor GM Fiat
Source: China Association of Automobile Manufacturers (2003).
Figure 2.8 Profit contribution by 16 major automakers, 2002 (%). Source: CEInet Market Research (2003), China Auto Industry, Vol. 2, February.
The three of them enjoy advantages in sources of funds, talent, technology, R&D, sales network, and policy resources, as they hold a leadership status, especially in production of trucks and sedans. That is, while foreign giants seek cooperative opportunities in China, national automakers are in the process of mergers and restructuring. In August 2002, FAW restructured Tianjin Auto Group. This was the first restructuring in the auto industry since China’s entry into the WTO. After the restructuring, the total assets of FAW amounted to 80 billion RMB: FAW became the largest national automaker in China. Dongfeng set up a new JV with Nissan on July 1, 2003, beginning another round of production capacity expansion. However, although China’s auto industry has made much progress in recent years, it is still one with low productivity, small production size, and improper
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structure. As a result, mass integration and consolidation are unavoidable while the current car industry is still emerging and needs to be further consolidated. By means of consolidation with MNCs, the three major automakers have not only expanded product lines but have gained opportunities for cooperation with transnational conglomerates. They have also made good use of their technology and product advantages, have introduced advanced products and marketing means, and have finally enhanced their own competitive power. For example, SAIC has been expanding rapidly in the domestic market by collaborating with GM and Volkswagen AG as an equal partner: in 2002, Shanghai Volkswagen’s sedan sales amounted to 301,095 units, excelling other JVs and domestic automakers. Despite their successful practices, these three big national automakers have to admit that they do not have any advantages in technology and R&D: they lack the scale and skills to develop globally competitive new products. In that sense, it might be a good idea for global giants to outsource manufacturing to China’s automakers, even if this is not so attractive to them. In fact, the three big groups are playing the role of contract manufacturers: contract manufacturing is a less risky path for domestic automakers. Of course, this does not mean there are no chances for domestic automakers to succeed as independent auto developers and producers. Observers predict with a great deal of certainty that, despite the pressure from foreign companies, there will be ample room for domestic automakers to emerge as global players sometime in the near future: during the process, China’s automakers may consolidate into groups. Apart from the three big groups, there are also some large-scale automakers in those provinces where local governments provide large support to automakers. For instance, Anhui Province has Jianghuai, Ankai, and Qirui; Guangzhou has Guangzhou Honda and Guangzhou Wushiling; Shenyang Province includes Jinbei, Jinke, Jinbei GM, and Shenyang BMW; Fujian Province has Dongnan and Xiamen Jinlong. Many of them have built, or will soon build, a cooperative relationship with foreign automakers, as long as WTO commitments are adequately enforced.
WTO impact and challenges Although China’s auto market tends to be relatively closed, since WTO accession tariffs have been reduced from more than 40% in 2001 to 25% by mid-2006, quotas abolished by 2005, and distribution and auto finance have started to play in favor of both local and foreign producers on a fairly equal basis. This relative openness has inevitably entailed fiercer competition, lower prices, and higher quality, as mentioned above, while price wars have eroded profits, but economies in scale have helped to alleviate the decline in profits. After all, almost all car companies have cut their prices by an average of 15% and increased their production levels in order to get a bigger market share. Despite the available numbers, the State’s interference contributes to a certain confusion, as the central authorities have cut restrictions on car ownership through the establishment of a high purchase tax and the elimination of arbitrary charges and fees imposed by local governments. This situation leads us to think that the impact of WTO has not been
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as abrupt on domestic auto manufacturers as initially imagined, at least in the short term: despite the emergence of the challenge on how to solve the overcapacity outcome resulting from continuous investment, price reduction has released a large potential demand, giving rise to the rapid growth of auto demand.13 As explained earlier, China is the world’s fastest growing car market and attracts more automotive investment than any other emerging economy. This reality has placed China as the world’s fourth largest producer, after the United States, Japan, and Germany. Indeed, leading global automakers from Japan, South Korea, the United States, and Europe expand in China with a long-term perspective, considering its enormous potential, still insufficiently exploited, mostly in the rural areas. For instance, Nissan and Hyundai invested US$ 2 billion and US$ 1 billion, respectively, at the end of 2003, while Volkswagen plans to invest US$ 7 billion by 2009 to double its manufacturing capacity in China to 1.6 million units a year.14 This is indeed only the beginning of a long story of expansion.
Automobiles Main tips (1) Restructuring. Before the reforms, the automobile industry only responded to national needs with very low levels of efficiency and subject to the government’s direction; today, the auto industry has made significant progress as a result of FDI and new technology and has become a pillar industry driving the national economy. As private firms are given more scope for action, the SOEs’ rigid systems gradually disappear and are replaced by more market-oriented industrial growth. (2) Outlook. The 10th 5YP’s target for about 1% of total GDP in motor vehicle production has proven realistic, as total profits of the top three groups (FAW, Dongfeng, SAIC) totaled about 90% of China’s major automakers. While living standards increase, there should be a healthy development of China’s auto market if quality standards are reasonably targeted and financial procedures mature with the industry. (3) Competition. Before 2002, car manufacturing was dominated by the three big groups; today, new models have come out in the market and competition has increased, Despite significant price cuts in mid-2003, consumers’ preferences lead to quality variables: safety, practicability, or design; hence the major success of renowned brands such as VW or GM. The Chinese market has become a striking reference for MNCs (either through JVs or outsourcing), despite the continued inefficiencies in cost structure, supply chains, or distribution systems. (4) WTO impact. The short-term forecast tended to be negative for local auto manufacturers, but the impact of WTO has been lower than expected, due to the overall price reduction in the auto industry, and the State’s cut on restrictions on car ownership or the elimination of arbitrary charges and fees imposed by local governments. After all, the auto industry remains a fairly protected sector.
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Case study: Shanghai Automotive Brake Systems Co., Ltd (SABS) Interview with Mr Xue Jinda, Deputy GM SABS was a 50/50 joint venture between Shanghai Automotive Industry Corporation (SAIC) and Continental Teves from Germany, with a total investment of US$ 85 million. The company, which began its operations in July 1995, is located in Jiading Industrial Development Zone, northwest of Shanghai. It is the first company in China to introduce internationally advanced technology in the production of calipers and wheel cylinders. In 2003, the company had a turnover of 1.2 billion RMB (US$ 144 million), a 32% increase from that in 2002. About 58% of the products, in terms of sales volume, went to Shanghai Volkswagen and the rest were distributed between Ford–Changan, Chery, FAW, Jinbei, Shanghai GM, and other car manufacturers. In 2003, SABS’s production capacity was 750,000 units. In the China automotive brake system market, SABS occupied 60 and 40% of the market for calipers. In 2003, the company had 290 full-time workers and 127 part-time workers. As Mr Xue indicates, “in 2003, the demand of our product increased so rapidly that we had to schedule three production shifts and keep the machines running 24 hours a day.” Currently, SABS has two factories; the old one was for foundation brakes, while the new one, which was inaugurated in May 2003, was for brake actuation,15 brake hose, and electronic brake systems.
Shanghai Automotive Industry Corporation (SAIC) SAIC, one of the top three auto groups in China, is one of the main manufacturers and distributors of passenger cars, buses, tractors, motorcycles, heavy-duty trucks, and auto parts and components. Its business scope also covers automotive services and assets operations. With more than 60,000 employees in 2003, SAIC has been ranked No. 1 among the 500 biggest domestic industrial enterprises for years and is one of the 20 pilot enterprises under the special support of the central government. So far, the corporation has set up 57 joint ventures with world-renowned auto groups from Germany, the United States, Japan, the United Kingdom, France, and Italy. It has an annual production capacity of 400,000 sedans, a complete auto components supply system, and a sales network. In 2001, its revenue reached 98 billion RMB (US$ 11.8 billion), with the sales volume of its passenger cars exceeding 300,000 units and with a share of 43% in the domestic market. SAIC aims at becoming one of the world’s top 500 enterprises by the end of 2010.
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Automobiles Continental Teves The Germany Continental Group, a leading technology partner of the automotive industry, is represented in every important market with more than 120 locations all over the world and approximately 69,000 employees worldwide. Sales came to 11.2 billion Euros in 2000. Teves originally belonged to the American company ITT and was later sold to Continental in September 1998. Continental Teves is one of the largest manufacturers in the world of hydraulic and electronic brakes, stability, and chassis systems, as well as electronic air suspension systems. Until 2002, Continental Teves had 23 facilities and approximately 13,000 employees worldwide. It had four JVs in Asia in 2002. In the sector of foundation brakes, it is ranked No. 1 in the world and No. 1 in Europe’s brake actuation sector.
Managing a JV As in many JVs with a 50/50 structure, the management of SABS presents certain challenges. According to Mr Xue, JVs have in general a very unstable structure. Problems can stem from cultural disparities and different understandings toward the market. As part of the agreement between the partners, the Chinese and the German partner take turns as General Manager. Mr Xue was the GM, before becoming the Deputy GM.
Mr Xue Jinda’s story I was from one of the first batches of new university graduates after the Cultural Revolution. With a major in Mechanical Engineering, I have been working in industrial companies since the 1980s. Before joining SABS in 2000, I had spent more than 20 years in Shanghai GKN, a Sino-German JV located in Kangqiao, Shanghai Pudong. Its major product was a driving shaft. I worked as Director of the Engineering Department, Director of the R&D Center, Chief Engineer, and Deputy GM in charge of production and operations. As SAIC is the Chinese shareholder of both GKN and SABS, I was proposed to be the GM of SABS in 2000.
According to Mr Xue, a JV cannot be simply categorized as a success or a failure, There are seldom sheer failures. If the JV exists and keeps developing, then it can be regarded as successful. But behind that success, there are always stories of hardships and frictions. No JV can avoid this from happening. In our JV, we consider ourselves successful after nine years of operation with booming sales and a growing market share. But we still have many headaches and problems. It is the same everywhere.
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Mr Xue has experience working in JVs, first with Americans and now with Germans. He views American culture as flexible, whereas German culture is much stricter. According to him, one needs to maintain open communication and clear objectives for the JV to be successful. To his understanding, both partners make contributions to the JV. The local partner can offer market knowledge and relationship with government authorities. In their case, the government gave them logistical support: land, power supply, and telecommunication infrastructure. The European partner contributes with technology. As clarified by Mr Xue, European car makers in China need local parts supply since imported parts can be very expensive. In this sense, the situation in the Chinese market has changed. “Eight years ago, almost no one in China knew about ABS. Now almost everybody wants their car to be equipped with ABS. This is a new line of business in China.” As a proof of the growing importance of advanced breaking systems (ABS) is the localization of the company’s R&D and the regional headquarters of its partner in Shanghai. Mr Xue adds, “Our R&D center now has more than 30 people; only one researcher is from Europe and the rest are all Chinese. We do not develop new products here, only applications.” Mr Xue confirmed that the German partner will soon move the Asia–Pacific region headquarters to Shanghai. The commitment of the German partner is clear: Teves has four application centers worldwide: Europe, North America, Japan, and now China. We have the Xiangfan summer test-drive place and the Heihe winter test-drive place. Test drive can be very dangerous and we send our test drivers to Europe for a two-year training program. Customers want to have their cars checked. For instance, in northern China, it can be very dangerous when you drive on a road covered partially by water and partially by ice. We also put the car in an anti-interference test to see how the outside magnetic field affects the car’s electronic system. This test center is in downtown Shanghai. Intellectual property rights do not seem to be an issue for SABS: It is difficult for others to copy our products because they are specialized modules for specific cars. Maybe small companies are copying some parts, but it is only 100 or 200 pieces per year, which is insignificant to us. And our customers, large car manufacturers, only buy products directly from us.
Culture and organization One of the key issues in any JV is to create the right culture. Mr Xue clearly indicates that “Every company has its own culture. In SABS, employees come from
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Automobiles
everywhere: Europe and different parts of China. Our challenge is to blend people from different backgrounds. Shanghainese and Northern Chinese can also have totally different ways of doing things.” Quality at every level is a priority for them: Besides external customers, there are also internal customers. We teach our staff to treat colleagues as customers. We conduct a staff survey every quarter. Employees can tell us anything that comes to their mind: for instance, they may complain if they think salaries are too low. Many employees think the promotion of communication between upper and middle levels, or between middle and lower levels, or even among different departments, is very important. They want more information sharing. Since convergence toward one common culture is considered essential, communication becomes frequent at all levels: There are around 15 first-line managers in the Management Committee. Sometimes, the assistants also join the meetings. Every week we have technical meetings, market meetings, quality meetings, etc. In the canteens, we have TVs showing news about the company. We use cross-functional teams to carry out certain projects. For example, we are now using a crossfunctional team to implement a new IT system. We also use cross-functional teams for new product development. For each project we have deadlines, controls, and evaluations. If one project is very successful with innovative ideas in management or design, the company will pay a bonus to the team members. The team leader can even earn one-year’s additional salary, although this is quite rare. Until the end of December 2003, the company used an old organization chart (see Figure 2.9), which now has been changed to a new format (see Figure 2.10). Since the JV is 50/50, every shareholder has one person in the higher management. Mr Xue explains his responsibilities: I represent the Chinese party and I am responsible for the whole company, especially Purchasing & Logistics, Sales & Marketing Service, Management and Financial & Controlling Department. The General Manager is responsible for the technical departments including Industry Engineering, Production, Research & Development, and the Quality Assurance Department. The original Management Department is now separated between the General Manager’s office and the Human Resource’s Department. Maybe later on, the Finance Department will be further split into two: one for Finance and one for Controlling. Originally, Purchasing and Logistics were within one department; now they are separated into two. This year, we have just merged with another company: Shanghai Automotive Brake Actuation Co. Ltd (SABA).
Automobiles
49
Figure 2.9 Organization chart before December 2003.
Future challenges Although SABS currently occupies more than half of China’s market for brake systems, Mr Xue adds that there are more and more competitors coming in: The Bosch plant in Wuxi has a capacity of 300,000 units annually; TRW, with their plant in Hubei Province, has an annual capacity of 500,000 units; Delphi, another competitor, used to be part of GM, but now is a separate company. It has a plant in Shanghai with a capacity of 150,000 units per year. Mando, a Korean company, was a JV with our shareholder, but now they operate by themselves. Mr Xue adds that this heated competition also affects the car makers themselves: The capacities of these car makers increases by 30% or 40% every year, but their market shares keep falling because of the hard competition. Volkswagen, GM, Ford, Honda, Toyota, Nissan, Mercedes-Benz, BMW ... everybody is entering China. Now there are more than 200 car makers in China, but only five to ten of them have a volume of more than 50,000 units per year. In fact, the Chinese car market is booming: in 2002, the total output of cars in China was only 1.25 million; in 2003, the number was 2.05 million. It is possible that in 2004 the number will increase to 2.5 million, but the
Figure 2.10 New organization chart.
50 Automobiles
Automobiles
51
demand is not evenly distributed. For GM and Volkswagen, the demand exceeds their production. Some other companies work under capacity. The price of cars sold in China is much higher than that of cars sold outside China. Quite possibly, the price will fall quickly and meet international levels before 2006. The challenge mainly comes from technologies. Mr Xue sees it very clearly: With more and more international companies coming in, the price of our products can be one big problem. Imported components are very costly due to exchange rates, custom duties, transportation costs, etc. The solution is to localize more and more. However, there is also a difficulty. In Europe, the sales volume for this particular part can be 10 million pieces per year, but in China, the demand may only be 1 million. Until we have enough volume to localize the production of a certain part we must keep importing it. In the future, those with the lowest costs will dominate the market. Our priority is to reduce costs. Mr Xue’s company is trying to win this battle for costs: One way of doing this is by transferring certain low value added operations to other areas outside Shanghai. Labor costs are high in Shanghai. About 120 km away from the city, labor costs may be only half. On the other hand, we want to keep a team of high-qualified people in the company. Other operations can be subcontracted. Now our company has 300 people. The average age of our employees is 32, and 150 of the employees have received education above junior college. Guards, cleaning people, maintenance of certain tasks, and canteen service are all subcontracted.
SABS Learning points (1) Be patient and persistent when managing a JV. There are always many challenges and potential conflicts but, as long as the JV continues its operations, it can be considered a successful venture. (2) Have clear objectives for the JV. Each partner should contribute to the JV in an equitable way. Chinese partners usually contribute with market knowledge, land, and relationship with authorities. Foreign partners contribute mainly with technology. (3) Use open communication between partners. One of the challenges to overcome in a JV is conflict due to cultural differences. Open communication will contribute to building trust among partners. The ideal is to create a culture that is a blend of both partners.
52
Automobiles Challenges ahead (1) Reduce your costs. The future survival of parts manufacture for the automobile industry depends on having the lowest costs in the industry. (2) Improve your quality. While reducing costs, companies should always be attentive to offering the highest quality. That implies investing in R&D, training for employees, and establishing rigorous quality control systems.
Conclusions and future perspectives As an increasing number of affluent people have begun to buy their own cars, the industry in China is undoubtedly provided with excellent opportunities. The State Economic and Trade Commission (today’s NDRC) declared in a forecast of trends for 2003 that it expected China to produce around 3.6 million cars that year, 3.4% more than the 3.38 million produced in 2002.16 According to a report by Roland Berger, the market sales would reach one and two million by 2005 and 2010, respectively, with 1.5–2 liter private cars growing at the fastest speed. The superfluous production of the auto industry could only be eased by 2005, and then be followed by a shake up of the industry as a whole. After 2010, China’s auto market could well be dominated by a handful of manufacturers.17 At present, about 3% of China’s total population can afford to buy a sedan, particularly the middle class earning more than 100,000 RMB per annum. Another promising sector of the auto market is passenger cars: along with the quick development of the tourism industry, high-quality passenger cars will be in high demand. Besides, since 2003 the government is investing more in county road construction, for which transportation conditions will be much improved: the improvement of transportation in rural regions will greatly spur the demand for passenger cars. Although there is no doubt that the auto demand in China will continue to prosper over the next few years, some risks and challenges are also on the rise, particularly with regard to the accumulation of excess capacity. No one knows whether the investment in auto production is excessive at present, since most major automakers are currently expanding their production capacity in order to catch up with the market opportunities. However, market competition should eventually reshuffle the industry, in which small companies with a low operating efficiency, small scale, and limited foreign technology will gradually be driven out, leaving the industry even more concentrated. As our case study shows, the auto parts sector will develop following the demand for more vehicles in China: it will suffer pressure to reduce costs while maintaining or even improving quality. Partnership with foreign enterprises will give those auto parts manufacturers access to advanced technology and production systems while the foreign partner, in exchange, can have access to a huge market.
Shanghai Volkswagen Automobile Co., Ltd (1985) FAW-Volkswagen Automobile Co., Ltd (1996) Shanghai General Motors Co., Ltd (1997) Guangzhou Honda Automobile Co., Ltd (1998) Wanxiang Group Company (1990)
China FAW Group Qingdao Automobile Factory (1956) Dongfeng Peugeot Citroen Automobile Co., Ltd (1992) Jinbei Automobile Co., Ltd (1984)
Beiqi Futian Automobile Co., Ltd (1996)
China Heavy Automobile Group Company (1983)
1
6
9
10
Source: China Markets Yearbook (2004).
8
7
5
4
3
2
Company name (year founded)
Ranking
Table 2.3 Top ten automotive manufacturers
Automobile, Agricultural Vehicle Camion
Light bus
Automobile
Middle-size truck
Guangzhou Yaga ACCRD2.3VTI Auto parts
Sedan
Automobile
Santana Sedan
Main products
Jinan (Shandong)
Liaoning (Shenyang) Beijing
Guangzhou (Guangdong) Hangzhou (Zhejiang) Qingdao (Shandong) Wuhan (Hubei)
Changchun (Jilin Province) Shanghai
Shanghai
Location
SOE
Joint stock
Joint stock
Foreign funded
SOE
Collective
Foreign funded
Foreign funded
Foreign funded
Foreign funded
Ownership
7,474
7,576
8,672
9,385
10,323
11,826
13,632
18,563
30,281
36,265
Revenue in 2002 (RMB mn)
15,087
13,470
10,730
5,270
3,818
13,727
2,274
3,396
6,184
10,652
No. of employees
Automobiles 53
3
Civil aviation
Industry restructuring: Overview Civil aviation has become a crucial industry in China, considering the increase of intra-provincial and inter-provincial communications and its inherent impact on tourism and travel. In this regard, the Chinese authorities are making considerable efforts to liberalize it by further enhancing national treatment to foreign investors. In fact, China’s civil aviation industry was separated from the military only in the early 1980s: on May 25, 1982, the original Third Ministry for Machinery Industry was changed into the Ministry of China’s Aviation Industry. Although a series of major reforms was carried out during that decade, the most relevant step took place in the 1990s: the former four-level administration – comprising the national civil aviation administration, the regional administration, the provincial (autonomous, regional, and municipal) administration, and the air station itself – was changed into a two-level three-grade administrative system comprising the national civil aviation administration, the regional administration, and the provincial administration (as an agency). However, the restructuring of the civil aviation industry’s administrative system was not fully complete until the Civil Aviation Administration of China (CAAC) started to follow the US Federal Aviation model in 2001: its regional administrations stopped directly administering enterprises and undertook instead the functions of (1) macro-management and (2) safety technique management: (1) Macro-management: through the formulation of industry policies and development plans, carrying out market regulations and supervision, and being responsible for international relations; (2) Safety technique management: through the strengthening of safety supervision, flight standards, airworthiness, air traffic control, airport management, and air defense security. The aim was to have CAAC take care of the national aviation security system, but with no intervening role in the operations of airline companies. As a result, the CAAC was restructured into three groups (Air China, China Eastern Airlines, and China Southern Airlines), each one of them with assets worth about 50 billion RMB (about US$ 6 billion), and with certain levels of independence, i.e. with no
Civil aviation 55 need to report their activities and overall initiatives to CAAC. The Computer Information Center and Counting Center under the CAAC merged into a Joint Aviation Information Center. The whole restructuring involved almost 80,000 persons and assets worth about 160 billion RMB (US$ 19.3 billion) (Table 3.1). Airlines from all different localities participated in the restructuring on a voluntary basis, under the government’s guidance, in order to promote the group’s competitive advantages. For instance, after the regrouping, Air China (our case study) was able to increase its market share to one-tenth of the domestic air transportation’s total: it can now reach for the first time China’s remote Southwest – Tibet – through China Southwest Airlines, and it can also provide better services in Hong Kong, Macau, and Taiwan with the China Aviation Corporation. FDI became a priority within the industry’s restructuring. The former FDI policy in civil aviation was based on the Notice on Relevant Policies on Foreign Investment on Civil Aviation Industry (CAAC Letter [1994] No. 448, Guanyu wai shang touzi minyong hangkongye you guan zhengce de tongzhi, hereafter, Document 448). But on August 1, 2002, it was replaced by the Regulation on Foreign Investment on Civil Aviation Industry (Wai shang touzi minyong hangkongye guiding). This new regulation has since become a crucial reference in the development of the industry, due to its direct influence on the Big Three.1 Indeed, the scope for FDI was further enlarged: while Document 448 stipulated that FDI on air transport carried by SOEs could only be experimentally made in one or two airlines (China Eastern and China Southern), the new regulation expanded FDI to any of the current SOEs involved in air transportation. As regards general aviation enterprises, FDI was previously restricted to agricultural and forestry general aviation, but since 2002 FDI could participate in all general aviation fields, except for those considered state secrets. Table 3.1 CAAC airlines regrouping plan Combined/Merged airlines Air China (Beijingbased)
China National Aviation Corporation (CNAC), including Zhejiang Airlines; Southwest Airlines Yunnan Airlines; China Northwest
China Eastern (Shanghaibased) China Southern China Northern (GuangzhouAirlines; Xinjiang based) Airlines Joint Aviation Computer Information Information Center; Counting Service Center
Assets Fleet Routes (RMB bn) (planes)
Employees
56.0
118
339 (286 20,325 for local)
47.3
118
473 (383 25,109 for local)
50.1
180
606 (512 34,089 for local)
5.3
–
Source: China Civil Aviation (2001), Issue No. 5, May.
–
–
56
Civil aviation
Investment methods were also expanded: Document 448 required that foreign investment in the civil aviation industry take the form of a JV and cooperation; now, firms can launch stocks in overseas markets or through foreign-currency stocks in the domestic market. Meanwhile, restrictions on FDI proportions were eased: Document 448 required foreign ownership in civil airports not to exceed 49%; the new regulation states that “for foreign investment in civil airports, the Chinese side should take the controlling stake on a comparative basis”. Before, foreign holding stocks could not exceed 35% of the total stocks of a public air transport enterprise, while the proportion of foreign-held voting stocks should not exceed 25%; today, in a public air transportation firm, the Chinese side should take the controlling stake, while the investment of any foreign company (including its affiliate) should still not exceed 25%. For air transport-related items such as ground services, air catering, or parking lots, the proportion is negotiable. Finally, in terms of management, there are no restrictions on the Chairman’s and General Manager’s nationality. This should be handled according to Chinese corporate law. Restructuring has, in other words, turned into prioritizing civil air into a growing national industry with the increasing, but still limited, participation of foreign players. As a result of reforms, and despite its short existence, this industry is proving to grow very rapidly.
Industry outlook While in 2004, civil aviation represented about 1.2% of total GDP (Figure 3.1), in June 2004, aviation profits had grown to 5.17 billion RMB (US$ 630 million), while only two years earlier it had been just 770 million RMB (US$ 93 million).2
Figure 3.1 Civil aviation as GDP share (%). Source: CEIC data (2005).
Civil aviation 57 A new round of rapid growth took place that year: except for Post Airlines, domestic airlines earned a profit of 3.24 billion RMB (US$ 391.7 million) in total, four times what they earned in 2002.3 Already by the end of 2002, 1,176 domestic and international airlines were operating in China, according to CAAC’s statistics. Three years before that, China had doubled the world’s average growth rate: while in 1978, China ranked 33rd in the world in passenger transport volume, in 2000 it had already soared to the 6th position4 (Figure 3.2). To be more precise, between 1989 and 2002, civil aviation sustained an average annual growth rate of 17.4, 16, and 15.3% in air traffic turnover (17 billion ton-km), air passenger traffic volume (more than 105 million passengers-km), and freight traffic (more than two million tons), respectively. During this period, the average growth rate in the total air traffic from the contracting states of the International Civil Aviation Organization (ICAO) was 5.78% (CAAC’s official data). The air transportation network is also in constant expansion: by the end of 2002 China had 1,176 air routes for scheduled flights, covering a total distance of 1.64 million km (in 2003, air routes were reduced to 1,155, mainly because of SARS, while total distance increased to 1.75 million km). The 2002 figure represents an increase of 1,006 air routes and 1.90 million km in distance over those of 1978.5 In early 2004, an international air route network was established with Beijing, Shanghai, and Guangzhou as starting points, connecting five continents in the world and linking up the open cities on China’s coast with key cities in neighboring countries. Landmark aviation agreements, such as the six-year pact signed between China and the United States in July 2004, are another example of how rapidly the air transportation network is expanding: the number of airlines
Figure 3.2 Civil aviation revenue. Source: CEIC Data (2005).
58
Civil aviation
operating between both countries will more than double, increasing by nearly five-fold the number of weekly flights from the limit of 54 weekly round-trip flights (since April 1999) to 249 at the end of the six-year phase-in period.6 Major accomplishments have also been made in the construction of airports and infrastructure through public investment since the late 1990s. By 2001, 143 airports were available for air operations across the country, i.e. 66 more than in 1978. Apart from the recently built Guangzhou Baiyun International Airport put into operation in August 2004, there have been other crucial projects achieved in the short-to-medium term, such as an additional second runway at Shanghai Pudong International Airport in March 2005 or a third runway and a new terminal building at Beijing Capital International Airport, to be completed by 2007. By mid-2004, airports had already made a profit of 1.21 billion RMB (US$ 146 million), five times what they earned by mid-2002.7 Auxiliary infrastructure has also been improved in a sustained way in the last few years, as technical transformation has been accelerated in the air traffic control system. Radar coverage has been basically provided for air routes above 6,600 meters in the eastern area of Harbin–Shenyang–Beijing–Xi’an–Chengdu– Kunming. Construction has been carried out in key aircraft maintenance bases in Beijing, Chengdu, Shanghai, and Guangzhou. Large data processing and network systems such as computerized passenger seat reservations, cargo transportation, agent distribution, and business data transmission networks have been established, with access to the Global Distribution System. Occupancy rates for passenger flights also tended to increase, amounting in 2004 to about two-thirds of seats available. However, air services have not always necessarily matched demand, and domestic airlines have long been criticized for considering their profits more than services; this has often been evidenced by delayed flights and passengers’ subsequent discontent for not always getting compensated. As a result, CAAC issued in June 2004 a document stating that airlines should compensate affected passengers for delayed or over-booked flights if the trouble is the airlines’ responsibility. But this willingness was rarely applied in reality, including domestic airlines such as Air China and China Southern Airlines. At the time of writing, the only airline respecting the new regulation was Shenzhen Airlines. Last, but not least, transportation capacity also witnessed rapid growth. Since 1980, China’s civil aviation industry acquired a large number of the most advanced aircraft through financing lease or purchasing on loans. By the end of 2004, there were altogether 1,245 civil aircraft in China’s civil aviation industry.8 As expected, the faster the market grew, the more opportunities there were for other players, thus the inevitable increase in competition: China progressively opened its skies to foreign airlines, while domestic airlines needed to improve competitiveness with international flights.
Competition There are two realities that make domestic firms a little weaker than foreign ones in this industry: (1) low market share; (2) excessively high ticket prices.9
Civil aviation 59 (1) Low market share: China’s three largest airlines represent less than 50% of the Chinese market, while foreign players such as Air France, British Airways, Korean Airlines, and Air Japan have a domestic market share of 88%, 70%, 72%, and 55%, respectively. For instance, Air France’s frequency to Beijing increased from four flights a week in 1997 to the current twicedaily service. It also initiated a code-share plan with China Eastern Airlines, as Air France offers five flights from Paris to Shanghai and four flights from Shanghai to Paris every week. Meanwhile, British Airways has been offering about 18 flights to China every week, including two daily direct flights to Hong Kong and four weekly direct flights to Beijing. It has also tried to operate flights between London and Shanghai, as well as between London and other cities in China’s western areas. (2) Excessively high ticket prices: While the US GDP per capita ratio is 1:8, the ticket price per unit in China is 4:1. Thus, the ratio of Sino–US relative price per unit reaches 32:1. These two crucial factors may result from the combination of structural and contextual shortcomings in recent years. First, operations have tended to be small-scale and the competition is scattered. There are three aviation giants in the United States, of which the smallest one owns 577 aircraft. In China, there are 26 airline companies owning a total of over 500 aircraft, about half of them with less than 10 aircraft each. Second, construction has been redundant. Due to inadequate transport capacity at the initial stage of development and the high profitability of the air transport industry, various local governments have shown great enthusiasm in running aviation companies. There are now nearly 70 flying bases nationwide. The redundant construction of flying bases as well as production and welfare facilities has taken up huge sums of money. Third, there is a surplus of staff. China’s civil aviation staff has expanded at an annual rate of 10,000 people. In 2000, the number of personnel already exceeded 120,500 (total employees in Air China were 23,000 in 2002, 16,435 in China Eastern, and 17,569 in Southern Airlines in 2003) (Figure 3.3).10 Finally, huge losses have severely influenced China’s aviation industry. The majority of China’s airlines carry massive debts. Although the statistical information on airlines’ losses is often contradictory, according to the former State Economic and Trade Commission (now the National Development and Reform Commission, NDRC), the Big Three had combined losses of 80 million RMB (US$ 9.7 million) in 2001, partly resulting from the 9/11 attacks. China’s Big Three suffered 33.4 million RMB (US$ 4.04 million) losses in the cancellation of passenger air services. Other expenditures, including increased passenger insurance costs, topped 830 million RMB (US$ 100.4 million). All airlines were expected to spend 187 million RMB (US$ 22.6 million) of extra expenses for plane insurance.11 Stated otherwise, there has been an accumulation of low output, high debt, and high costs that has led China’s civil aviation industry to strictly control the industry and its domestic airlines, particularly the largest holders of the market share, the Big Three (Figure 3.4), and to facilitate the massive entry of foreign
60
Civil aviation
Figure 3.3 Civil aviation: number of employees (persons). Source: CEIC data (2005).
Figure 3.4 Chinese airlines’ share in total traffic ton-km (1999–2002). Source: Cao, Jianhai (2002), “Study on Competition and Regulation in a Natural Monopoly Industry – Example of China’s Civil Aviation”, China Industrial Economy (Zhongguo gongye jingji). Vol. 11: pp. 38–46.
Civil aviation 61 firms. However, precisely because of both the competition and the aggressive entry of foreign airlines, there is a trend in the industry to form domestic alliances, establish private airline companies, and join international alliances. Indeed, local airlines are forming alliances that allow them to compete better in such an aggressive environment. For instance, six Chinese local airlines formed in 2001 an alliance known as the China Sky Aviation Enterprises Group, comprising Shandong Airlines, Shanghai Airlines, Shenzhen Airlines, Sichuan Airlines, Wuhan Airlines, and China Post Airlines. The group currently has assets of about 30 billion RMB (US$ 3.6 billion), owns 100 planes, operates over 500 routes, and already by 2000 had together accounted for about 12% of the nation’s total passengers (more than 8 million) and 35% of earned profit (8 billion RMB, US$ 0.97 billion). Although the six airlines started to cooperate in code-sharing and transport of mail and cargo, their numbers weakened as a result of the restructuring of the industry in the early 2000s, as mergers and acquisitions (M&As) implied the reduction of local airlines to less than 10. As stated by Mr Zhou Chi, President of Sky Aviation, “the challenge for member airlines should be to expand cooperation but remain as independent corporate bodies”12 (see Table 3.2). More recently, in February 2004, the CAAC approved the establishment of the country’s first private airline, E & Net Airlines, while in May, the preparations of two more private airlines were approved for Chunqiu Airlines (chartered flight and regional airline business from Shanghai) and Ao’kai Airlines (domestic cargo transportation, logistics, and chartered flights from Tianjin) and should be functioning by late 2006. Joining international aviation alliances is the third strategy of survival considered here, as it allows Chinese firms to grab a higher international market share and therefore be connected to worldwide aviation networks and see a sharp increase in passengers. Currently, there are four major international aviation alliances – Star Alliance, One World, Sky Team, and a global alliance launched by Northwest Airlines and KLM Royal Dutch Airlines. In 2004, Air China became a Star Alliance member. But while domestic and foreign aviation firms compete, WTO does not seem to have a major impact on the industry.
WTO impact and challenges As part of the WTO opening process, China should be able to deepen its civil aviation reforms, open itself to other markets, and encourage FDI within reasonable limits. These initiatives can eventually push civil aviation firms and airports to better utilize both domestic and international resources. But there are limits: WTO allows further opening only of part of the industry’s services sector, limited basically to more access for foreign companies to aircraft maintenance, repair, and overhaul (MRO). This means that they are allowed to establish companies in China – either as joint ventures or as wholly foreignowned enterprises – to operate MRO business for Chinese or international air carriers. The true fact is that foreign companies have already been helping to
Air China (1988)
Southern Airlines (1991)
Eastern Airlines (1988) Southwest Airlines (1987) Northwest Airlines (1989) Northern Airlines (1990) Yunnan Airlines (1992) Xinjiang Airlines (1985) Post Airlines (1996) Shanghai Airlines (1985) Hainan Airlines (1993) Sichuan Airlines (1986) Xinhua Airlines (1992) Shenzhen Airlines (1985) Shandong Airlines (1994) Shanxi Airlines (1987) Wuhan Airlines (1986) United Airlines (1986) Chang’an Airlines (1993)
1
2
3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19
Source: China Markets Yearbook (2004).
Company name (year founded)
Ranking
Hongqiao Airport (Shanghai) Shuangliu Airport (Chengdu) Xianyang Airport (Xi’an) Taoxian Airport (Shenyang) Wujiaba Airport (Kunming) Diwobao Airport (Urumchi) Beijing Hongqiao Airport (Shanghai) Haikou (Hainan Province) Shuangliu Airport (Chengdu) Binhai Airport (Tianjin) Huantian Airport (Shenzhen) Yaoqiang Airport (Jinan) Wusu Airport (Taiyuan) Wangjiadun Airport (Wuhan) Nanyuan Airport (Beijing) Xianyang Airport (Xi’an)
Capital International Airport (Beijing) Baiyun Airport (Guangzhou)
Based in
Table 3.2 Top nineteen civil aviation enterprises
Affiliated with CAAC Affiliated with CAAC Joint stock Joint stock Joint stock Joint stock Joint stock Joint stock SOE SOE Joint Venture SOE SOE Joint stock Joint stock SOE SOE SOE SOE
Ownership
3,507 1,770 (in 1999) N/A N/A N/A 1,347 N/A N/A N/A N/A
12,136 N/A N/A N/A N/A N/A
19,298
15,740
Revenue in 2001 (RMB mn)
4,300 4,780 330 3,784 3,500 1,500 1,230 850 1,318 150 600 1,600 400
14,860 8,300 5,200
23,456
16,226
Number of employees
62 Civil aviation
Civil aviation 63 establish MRO companies in partnership with Chinese airlines. For example, Air China and Lufthansa were established as an MRO company – AMECO – in 1994 in Beijing. Since 2000, AMECO has provided MRO services to many air carriers that land in Beijing (for more details, refer to our case study, which refers to the cooperation between AC and Lufthansa). As is often stated by CAAC, the WTO should further allow foreign airlines to open more direct ticket agencies. Finally, as the opening of China’s airspace remains limited and no WTO rule binds the country to open it up, China will still have full rights to determine who can enter its airspace. To be realistic, the WTO has no particular effect on this industry: China already started to launch agreements some years ago with other countries on equivalent flights. The challenge appears rather in terms of expertise and, more importantly, in terms of internal management. Air China, which is preparing to compete both in China and in the international arena, is a vivid example of this particular challenge. Civil Aviation Main tips (1) 2001: Full restructuring. The Civil Aviation Administration of China prioritized macro-management and safety technique management. No direct intervention in the operations of the three biggest airline companies (Air China, China Eastern Airlines, and China Southern Airlines). 2002: FDI also prioritized. Methods: larger scope of action (participation in all general aviation fields); more investment methods (operations with stocks); more holding shares (cannot exceed 25%, but proportion is negotiable); and more management influence (always in accordance with corporate law). (2) Outlook. 1978: China ranked 33rd in the world in passenger transport volume; in 2000, it held the 6th position. Elements that have driven this industry to accelerated growth are: constant expansion of air transportation network (links between major cities, landmark aviation agreements); construction of airports and infrastructure; improvement of auxiliary infrastructure in the air traffic control system (radar coverage, large data processing and network systems, access to the Global Distribution System, etc.); higher levels of occupancy rates for passenger flights (two-thirds of available seats by 2004). (3) Competition. Domestic firms are weaker than foreign ones because of: (1) low market share and (2) excessively high ticket prices. (1) and (2) result from smallscale operations and scattered competition (airline companies have too few aircraft); redundant construction (moral hazard and waste of money by local governments); surplus staff (more than 10,000 new entrants per year); huge losses (debts, insurance costs, etc.). Solutions: form domestic alliances, establish private airline companies, and join international alliances. (4) WTO impact. Implies further opening but limited FDI encouragement. Foreign companies can only have access to aircraft MRO, while entry to China’s airspace remains under strict control and supervision. Small WTO effects: agreements between China and other countries already started before WTO entry. The challenge appears rather in terms of expertise and internal management.
64
Civil aviation
Case study: Air China Interview with Mr Sun Yu, Manager, Corporate Development and Planning Information In 2002, Air China had a total asset of 51.47 billion RMB (US$ 6.2 billion), a traffic volume of 5.17 ton kilometers, and 23,000 staff, after the merger with China National Aviation Company (CNAC) and China Southwest Airlines, and the establishment of the China National Aviation Holding Company (CNCH). It had, at that time, a fleet of 118 aircraft, most of which were Boeing, including 42 wide-bodied passenger aircraft like Boeing 747, 777, 767, and Airbus 340. The total passenger traffic volume amounted to 18 million and the operating revenue from the core business reached 23.19 billion RMB. Air China served 42% of the passengers transported by the CNCH. It operated 322 routes, 56 international and 266 domestic, offering 2,472 scheduled services weekly. Its branches can be found in Chengdu, Hangzhou, Chongqing, Tianjin, and Inner Mongolia. In addition, it had altogether 29 domestic and 48 overseas offices. The new Air China ranks first among all Chinese airlines in terms of assets. History of the company Air China was founded in 1988. Before that, the company did not have a distinct legal existence and was just part of the government activities. On October 11, 2002 the CNCH was formally founded under the guideline of the System Reform Program for Chinese Civil Aviation Industry approved by the State Council. This holding included Air China as the main company after its consolidation with CNAC and China Southwest Airlines. The new Air China was set up after combining the air transportation resources of the three airlines on October 28, 2002. Besides Air China, the holding includes Dragon Air and Air Macau.There are future plans to include other services such as aircraft maintenance, cargo, ground service, catering, and hotel business. The holding company already owns four hotels located in Beijing, Shanghai, Dalian, and Inner Mongolia. With regard to Air China’s link with CAAC, Mr Sun puts it this way: Although we now deal with CAAC, we also need to have a tight link with provincial governments. Transportation is very important to provinces. How can a province attract business if the transportation service is insufficient? Sometimes local authorities come to ask Air China for a new flight from Beijing to some of their small cities in order to attract businessmen. The infrastructure of provincial airports is acceptable but remains insufficient and entails too much waste of money. But at the same time, Beijing Airport is over-congested. We can identify three phases in Air China’s reform process. Before 1988, government and enterprise were one and the same organization: CAAC was then purely a governmental entity. In the second phase, after 1988, all airlines were fully controlled
Civil aviation 65 by the government in terms of purchase, management, income structure, and routes. Everything except marketing and sales policies was decided by CAAC. The important change came in the mid-1990s, with the formation of the China International Aviation Holding (CIAH) and the separation from CAAC. The third phase is translated into freer decision making, financial decisions, or even employment structure, trying to lay off the lowest possible number of workers through the creation of specific training programs. As pointed out by Mr Sun, the reform is going in the right direction: neither too fast nor too slow. However, the government’s intervention remains significant. For instance, its approval is still needed in the purchase of new aircraft and for the appointment of board members, especially the President and CIAH senior members. Another objective within this third phase is to go public for some part of the holding. For instance, according to the information provided by the company, Air China Cargo will go IPO by 2006. Air China owns 51% share of this cargo, China International Trust & Investment Corporation (CITIC) HK owns 25% and Beijing Airport 24%. As for the role of the CCP in the company’s affairs, Mr Sun states: Compared to five or ten years ago, [the CCP] influence is not so significant any more. But if the Party launches a new policy, it will affect all companies in the industry. However, the Party does not make business decisions, but it is still in charge of HR. Organization Air China’s headquarters is located in Beijing. There are six main departments in the company: Strategy, HR, Finance, Auditing, Safety, and Engineering. On the business operation side, there are marketing, sales, flight operations control, ground handling in charge of the check-in, ground services, cargo (which has already become an independent company), and IT. Mr Sun explains: Our structure is quite similar to any other international airline company. The Holding Company has approximately 24,000 employees after the merger of the three airlines; around 20,000 of them work for Air China. There have not been big changes in the number of employees as the business keeps growing. In terms of organization, it is expected that in the future the Holding Company will appoint Air China’s President, who is also a member of the Holding’s board. The Holding makes decisions about the strategy, IPO, and finance. The Lufthansa model Air China uses Lufthansa Airlines as a model to follow: the main origin of Air China’s reforms resides in Lufthansa’s experience. In 1992, Lufthansa suffered
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huge losses and, as a result, changed their President and privatized the company. They then divided the whole company into different entities such as passengers, cargo, maintenance, catering, ground services, and IT. In a similar fashion, the Chinese government progressively moved away from Air China’s management, and the aim was to become fully independent through IPOs in the stock market. As an example, the maintenance unit can provide services to Air China, as well as to other airlines. The same happens with cargo, ground services, and catering. The different JVs with Lufthansa have played an important role in Air China’s reform process. According to Mr Sun: The Air Catering Company was the first JV in China. Jiang Zemin, former President of China, approved this JV in 1978 when he was not even Mayor of Shanghai yet. It was a symbol of China’s opening-up. Lufthansa is our business partner. All companies in ground services are JVs. One of our purposes is to absorb new technology, new management methods, and to attract investment from our JV partner. For instance, our JV with Lufthansa for maintenance is a significant symbol of cooperation between China and Germany. According to Mr Sun, Lufthansa’s President meets the CIAH President on an annual basis to discuss the JV’s performance. He recalls the situation: At the very beginning, things were not so smooth, due to cultural differences between the Chinese and the German partner. It took several years for them to reach a common understanding. For a successful JV, you need to have a good mutual understanding and communication. Sometimes, the foreign side thinks they are always right. They should respect their Chinese partner more.
Mr Sun Yu’s story I joined Air China in 1989. At that time, I worked as a software engineer. In 1995, I moved to another department, the Corporate Strategy and Planning Department, in charge of Air China’s strategy, investment, and IT. I was in charge of the IT strategy, its implementation and monitoring. My department has become a core department in Air China. We act as consultants to our senior executives. We concentrate on where Air China should go and how we can achieve that. The air business is very complicated and challenging. If I went to a foreign enterprise in Beijing, I could not hold this position because their headquarters in the US or in Europe makes the decisions. Their operations in China have to follow their instructions. But here we make all the decisions, we create the strategy and we execute it. This is a constant learning process. In addition, I have the opportunity to work with senior consultants from the US or Europe. In no way would I be able to have this privilege if I were working for a foreign company. One has to choose between compensation and career opportunity. I am now 35 years old.
Civil aviation 67 Challenges According to Mr Sun, Air China has to confront two main challenges: one internal – HR – and the other external – competition. In addition, the airline business does not necessarily make money. That was the reason why Air China wants to separate into different services that can support its core business, following the Lufthansa model. Human Resources at Air China According to Mr Sun, HR has a long way to improve: Our HR policy, recruitment, training and performance measurement are not going too well. Some matters are still controlled by the government, and we cannot decide. We are still an SOE. Frankly speaking, we have a lot of room for improvement. There should be a great change. In Mr Sun’s opinion, HR lacks professional systems, they are merely administrators: Our senior management knows this situation. The competition today between enterprises is basically the competition for talent. Air China has a high turnover rate, which is one of our major challenges. Retention of good people is very difficult. One of the reasons why they choose to leave is higher pay, or promotion opportunities elsewhere. Air China cannot pay based on performance. I think this is one of the reasons why Air China wants to go public, so that we can link performance with compensation and promotion. We invest a lot in training.
Competition Competition is another critical area for Air China. The competition comes mainly from other domestic airlines. China’s airline industry is growing very fast, with a two-digit increase rate each year in number of passengers. This growth is in both international and domestic flights. Their major competitors within China are China Eastern, China Southern, and Hainan Airline. The situation in the domestic market is changing, as Mr Sun explains: The domestic market is regulated in routes and prices. Before 2002, CAAC was in charge of the profitability of these airlines, thus it regulated prices. But from this year on, there will be a big change. Since October 2002, CAAC is only in charge of safety, so they are beginning to deregulate prices. Now we can change our rates and the competition will be very heated. I think we
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Civil aviation will be involved in a price war, just as it happened in the US in 1978, something that totally changed the US airline industry.
The trend in China is towards more open competition and the government encourages the consolidation of domestic airline companies. As Mr Sun clarifies, The government thinks that China has had an excessive number of domestic airline companies, so it wants to consolidate the industry. In the future, we will have four airlines for all of China. But in two or three years, the number will still be about twenty. Before, each province formed its own airline. The central government has asked them to merge. In the future, there will be these three big ones plus Hainan Airline. Without the government’s leadership, this consolidation would be impossible: they are helping and pushing the consolidation process. With respect to global players, Mr Sun does not see them as a threat: Originally, Air China focused on international flights to Europe, North America, Japan, but in the last five years, we have also centered our attention on the domestic market. Now we focus on both, as foreign competition increases: in Europe, British Airways, Lufthansa, Air France, Swiss Air; in North America, Air Canada, United Airlines, and Northwest; in Japan, Japan Air or Nippon Air. All the leading airlines come to China. On the other hand, there is not an open sky in China. The Chinese government has signed bilateral agreements with other countries, which means that Air China has an equivalent right in such flights.
Future perspectives According to Mr Sun, the WTO challenge appears mainly in terms of internal management: An airline company with 100 aircraft is totally different from that with 10 aircraft. Air China will have 220 aircraft by 2007. Lufthansa has about 200–300 aircraft. We will be among the top two or three airlines in Asia. As the number of aircraft goes up, Air China will be much more complex to manage. We have the benchmark with the best airline business. After a detailed analysis, we know what we need to do. We break all these things into different projects. We have a five-year strategy, which we begin to implement from this year. It is very ambitious. Another focus of attention is the professionalization of the management levels through training and education. Mr Sun himself is taking an Executive MBA at the China Europe International Business School (CEIBS). “Yes, taking an EMBA
Civil aviation 69 is also part of the intention to improve our management. Apart from me, there are several other persons in different schools, such as Peking University.”
Project teams and change at Air China – Mr Sun Yu We use benchmarking and the best practice in the airline business. We then did a gap analysis together with consulting companies. We break our findings into different projects and use project teams that work with external consultants. I am in charge of all the coordination and supervision. I select people from different functions and bring them together to make up cross-functional teams. I give them the introduction to the different projects, tell them how to do them, and allocate responsibilities to each one of them. The team members understand the purpose of all these changes and respond very positively. All the projects cover the latest business ideas and technology. I select young people who have just graduated from university. They are very excited to have this opportunity and are very much motivated. They go to the US or Europe several times a year to visit other companies. Two members of the team returned from Lufthansa and Cathay Pacific last week, after going through their marketing and sales process. When they came back, they worked on the design of marketing and sales processes for Air China. We are selecting qualified and talented people. I am working closely with the HR and other departments in the selection of the best candidates. People resist changes. We need to have good communication channels with the general managers and work on the changes. We need to restructure the organization, change the process, data, and systems. We have to change everything. We are going to divide the task into nine teams: marketing & sales, strategy, HR, finance, maintenance, etc. At the moment, there are two or three teams. Each project has its deadline, and the whole program will last for five years. I do not know whether we will be able to finish it – it is so huge. It is a huge investment with much greater return. Other companies may have separate projects, but our company is aimed to integrate all these efforts together with a long-term view. We have all the leading consultant companies coming to Air China. We pay them 400–500 dollars per hour. As long as you are one of the best in the world and your suggestions are practical and useful for us, we will pay that money.
Meanwhile, Air China has plans for international expansion. Mr Sun predicts that the company will increase its routes and frequency: Air China’s competitive advantage over other companies is Beijing. We want to utilize Beijing as Air China’s hub. With all flights coming here from Europe and the US and going from here to elsewhere, Beijing has become a major hub. We are restructuring the whole network. Beijing is going to build a new terminal because of the 2008 Olympics. In Northern Asia, Beijing is the nearest point from Europe or United States.
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Civil aviation Air China Learning points (1) Use few but key strategic partners. In the case of Air China, the company has chosen Lufthansa as its main strategic partner, and has formed JVs and alliances with this company. When you focus on a small number of partners, you minimize the learning process as both organizations get familiar with each other. Besides, it signals a higher level of commitment than when you try numerous partners at the same time. (2) Use the stock market to advance in the reform process. It is a powerful incentive to professionalize management systems and to strengthen the role of the board of directors. It also favors more autonomy from the government. Challenges ahead (1) Dealing with the government’s intervention. The government still plays an important role in the company’s internal operations. It approves aircraft purchase and even the HR strategy of the company. (2) Coping with increasing competition, especially after price deregulation. (3) Managing rapid growth. The operation’s rapid growth rate imposes important demands on the organization. Air China is using consultants and internal teams to produce that adaptation to the increasing complexity of its business. Structural rationalization and project teams are part of the measures used.
Conclusions and future perspectives With the CAAC’s restructuring into three groups – Air China, China Eastern Airlines, and China Southern Airlines – significant progress has been made in terms of prioritizing civil aviation into a growing national industry with the increasing participation of foreign players. The rapid growth of air transportation, the constant expansion of air transport networks, the accomplishments in airport construction, and the sustained improvement in auxiliary infrastructure are obvious signs of how fast China’s civil aviation industry has been developing in the last few years. But behind this rapid growth, there are still serious shortcomings such as low-level scattered competition and small-scale operations; redundant construction; redundant staff; or huge losses that make the domestic market have low market shares and expensive ticket prices. The challenges of WTO are few, but should not be ignored: in parallel with the new regulation on FDI that allows foreign companies to invest in all domestic airlines and can increase their shareholding to 49% from the previous 35%, the subsequent aggressive entry of foreign airlines and the fierce international competition could in the near future condition the domestic market, unless expertise is gained and internal management improved. Air China, our case study, is a good example of what is happening among the companies in this industry. This company is one of the Big Three that will dominate
Civil aviation 71 the air transportation in China. It is embarked on a very ambitious effort of transformation of its structure, operations, and management systems. Simultaneously, it has to confront important challenges in this path to modernity. It has to manage a fast growing operation in a highly competitive environment, especially after the price deregulation introduced by the aviation authorities. On the positive side, Air China has a privileged position in one of the biggest air transportation markets of the world. If the company succeeds in its modernization efforts, no doubt it will be among the big world players in China and elsewhere. China’s continuing robust growth in GDP and personal income, the rapid development of its tourism industry, its entry into the WTO, the Beijing Olympic Games in 2008, the Shanghai Expo in 2010, the Guangzhou Asian Games in 2010, and the planned free-trade zone between China and ASEAN, in addition to the poverty alleviation project in the western areas, should all benefit China’s air transportation market to a larger or smaller degree. The average annual growth rate of China’s civil aviation transportation between 2001 and 2010 is expected to remain at 7% to 10%. The total traffic targets set for 2010 are 22–24 billion ton-kilometers for total traffic turnover, 120–160 million passengers, and 3.5–4.2 million tons for cargo and mail traffic. Experts predict that, by 2020, Chinese airlines will have more than 2,200 aircraft, converting China into the second largest civil aviation market in the world, after the United States.
4
Construction
Industry restructuring: Overview China’s construction sector is now crucial to the country’s economic development, while competition has become significant and aggressive as a result in part of the increasing and pressurizing demand for real estate. In general terms, the construction sector comprises establishments primarily engaged in the construction of buildings and other structures, additions, alterations, reconstruction, installation, maintenance, and repairs. Real estate – which encompasses land along with anything permanently affixed to the land such as buildings – and infrastructure investment, or supply facilities such as water or wastewater treatment, are also included. Three major laws regulate the construction industry in China: (1) Construction Law (Jianshe fa), promulgated on March 1, 1998; (2) Contract Law (Hetong fa), March 15, 1999; (3) Tendering and Bidding Law (Zhaotoubiao fa), January 1, 2000.1 The construction’s potential in China has become enormous as a result of economic development pressures (urbanization, infrastructure, etc.) and an increasing housing demand: according to China’s Ministry of Construction, the number of cities alone is expected to increase from 770 now to more than 1,000 over the next fifteen years. The total number of cities in China with more than 1 million inhabitants is 174, among which 11 cities are over 4 million, 22 are between 2 and 4 million, and 141 are between 1 and 2 million.2 It is estimated that between 1989 and 2001, total public investment in infrastructure had already reached 6,250 billion RMB (US$ 756 billion) with an annual investment of 481 billion RMB (US$ 58 billion) on average, i.e. an increase of 15% compared to the early 1980s.3 In fact, China’s 10th 5YP commitment was to increase investment up to US$ 120 billion for projects such as urban road construction (1.6 million km of roads, including 25,000 km for highways), new railway lines of over 7,000 km, another 140 new deep-water harbors (reaching a total of about 800), 40 million kW of electricity in the regions, with power lines of over 60,000 km, and so on.4 Apart from improving the entire motorway network in western China, the country’s “Go West” policy (xibu kaifa) called in 2002 for the construction of a 640 km railroad line from Chongqing to Huaihua (Anhui), as well as a 955 km rail connection from Xi’an (Shaanxi) to Hefei (Anhui), in addition to
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a new airport in Xi’an and other similar major transportation and infrastructure projects in the area.5 In any society, the housing sector is an integral part of the economic and social system. The availability and quality of housing are major indicators of a society’s standard of living and level of economic development. China started to have a housing market only after the launching of an urban housing system in the 1980s: under the centrally planned economic system, the housing industry was considered a non-commodity production sector and housing consumption was treated as social welfare, while the work unit system (danwei) governed labor relations and social services coverage, including housing, education, and medical insurance. A low rent system prevailed and urban housing was allocated under a series of rigid administrative regulations: after the Cultural Revolution (1966–76), the average living space per capita was 3.6 m2 in urban areas, lower than the 4 m2 in 1952.6 In April 1980, the former President Deng Xiaoping made a speech on housing reform, which by then had become the guiding principle on urban housing commercialization in China. Deng’s ideas can be summarized into three main aspects. First, urban residential housing was to be treated as a commodity that could be sold to and owned by urban residents, rather than a welfare or public good provided by the government or society. Second, the rent level under the low rent system should be raised to the market level in order to encourage people to buy rather than to rent housing. Third, investment in urban housing could come through multiple channels and the approach towards construction methods should be flexible. This means that the burden of accommodating urban residents was to be shared between individuals and the government. On March 19, 1998, former Premier Zhu Rongji put forward the housing reform at a press conference, pledging “all housing will be commercialized,” implying the introduction of the concept of home ownership. Ever since, housing is deemed as a consumer product and no longer as a welfare product. In order to support the housing reform, in January that same year the People’s Bank of China announced a mortgage program for individuals and ordered commercial banks to reserve up to 15% of their annual loans for private housing: as a result, compared with 1998, individual housing loans increased to 1,135 billion RMB (US$ 137 billion) in 2003, which is 26.64 times more than in 1998. At present, private housing loans account for 75–95% of China’s commercial banks’ total consumption loans.7 Individuals are now allowed to borrow as much as 80% of the value of a house for a maximum of thirty years. After the urban housing reform was launched, the real estate market became increasingly active. It is estimated that in major big cities, the youngest population has bought or will buy homes by themselves: in 2001 alone, about US$ 59.4 billion was spent on urban housing, according to official statistics. Floor space of new residential buildings in urban areas reached 598 million m2, i.e. a 26% increase over 1998. The urban households’ per capita annual living expenditure for residence was already 7,182 RMB (US$ 868) in 2004, whereas it was only 3,538 RMB (US$ 428) in 1995.8 Indeed, increased liberalization and government-sponsored privatization of the housing market has proven very fruitful in the urban areas: according to the
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Ministry of Construction, the average amount of living space for city residents is expected to increase from 9 m2 per person in 2000 to 18 m2 in 2010. The population is expected to spend 20–30% of its income on housing during the next ten to twenty years. Until now, the share has been just over 10%. Approximately 1 billion m2 of new space is being built each year in the residential construction sector alone.9 Although China’s construction market is fairly new, it is already the largest in the world in terms of development potential, degree of openness, and profitability. According to market research conducted by the consulting firm Global Insight, China was the third largest market in the world in 2002 (after the United States and Japan), with US$ 404 billion (3,341 billion RMB) in construction.10 The expansion of this industry has resulted in the increase of labor absorption, contributing much to relieving unemployment pressure. By its nature, the construction industry can push for the development of more than 50 industries, with a total employment of about 40 million, amounting to at least one-quarter of China’s total workers.11 In 2002, there were about 30 million workers in the construction industry, whereas, between 1989 and 2001, 36.69 million workers were employed, rising from 24.07 million, with an annual average increasing rate of 3.6% (which was then larger than the country’s rate of 2.3 %).12 By 2002, construction industry workers accounted for about 6% of the total national employment, compared to 4% in 1998. In Beijing, Hebei, Jiangsu, and Shandong, employment figures even amounted to 7%13 (Figure 4.1). Truly, in these last few years, the central and local authorities have been paying special attention to the construction employment factor. Since 1989, the Ministry of Construction has issued regulations on the qualifications of the administration of construction enterprises. After evaluating all
Figure 4.1 Employment in the construction sector. Source: CEIC Data (2005).
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construction firms, the Ministry decided to classify them into five different categories, ranging from grade one (yiji) to grade four (siji) in terms of current capital, number of employees, years of business operations, etc., and grade five (wuji) for all others below grade four.14
Industry outlook As stated above, the construction sector very much depends on the national macroeconomic policy, which in recent times has led to an upsurge of domestic demand and investment in infrastructure, more precisely in construction materials, construction equipment, and construction design services. Local governments, which tend to be the major investors in infrastructure, are the largest end users of construction materials and equipment. As the population’s income increases, housing demand follows suit, for which the construction sector is bound to experience at least two more decades of rapid growth.15 As investment in construction projects accounts for about 65% of total fixed assets, it is not surprising that China’s construction sector is regarded by the authorities as a pillar industry, after manufacturing, agriculture, and trade. After all, the industry represents almost 20% in terms of GDP (Figure 4.2). By the end of 1999, all construction companies already had 6.11 million items of machinery equipment, with 26.6 billion RMB (US$ 3.2 billion) in fixed assets. Between 1989 and 2004 the added value of the construction industry increased from 7.94 billion RMB (US$ 96 million) to 566.59 billion RMB (US$ 68.5 billion), with a 12.6% average rate per year, which is higher than the average annual increase of 9.3% of GDP during that same period.16 The weight of added value produced by the construction industry in GDP terms increased then from 4.7% to 6.7%. Between 1998 and 2001 there were about 680,000 construction projects in hand, while around 460,000 renovation projects had already been initiated. On a national scale, in 2002 construction projects reached 3.7 billion m2, amongst
Figure 4.2 China’s construction sector as GDP share (%). Source: SSB (2005).
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which 1.7 billion m2 were residential houses. In addition, the NDRC announced the launching of 145 key national construction projects in 2005.17 Increased awareness of problems and bad experiences in the past has resulted in a rapidly growing demand for high-quality products and services. Due to the widespread construction of multiple-story buildings, growth in the civil engineering sector has been particularly strong in the past decade. An increasing amount of site-mixed concrete is being replaced by ready-mixed concrete. The importance of prefabricated components is also increasing. The excessively rapid 28% growth of investment in property development between January and November 2002 pushed former premier Zhu Rongji to give a warning that the real estate sector in some cities was overheating. According to a report issued later that year by Crédit Suisse First Boston, residential property prices rose by 10–20% in most Chinese cities between 2000 and 2002, and it was therefore not surprising that the People’s Bank of China decided to tighten credit lines to developers as “the last straw” for the market.18 The overheating process derived from an excessive investment which continued until mid-2004, when the authorities took effective measures that restricted money flows in banking, cement, steel, and aluminum. With regard to future construction and spending, Chinese officials are currently stepping into the massive job of planning and building what may be the world’s largest construction program: Beijing’s 2008 Olympics. Apart from the (26.5 billion RMB) US$ 3.2 billion destined for the construction of the Olympic venues, Beijing will spend US$ 21.6 billion (178.6 billion RMB) to reinforce the city’s infrastructure and clean its water and air.19
Competition Despite 1997’s FDI boom in the construction sector, according to official sources, there has been a progressive decline of FDI presence since the late 1990s. By then, there were about 180 foreign construction companies acting in China, generating less than (12.4 billion RMB) US$ 1,500 million (Figure 4.3). These companies originated from 13 different countries, in addition to Hong Kong, Macau, and Taiwan: in 1998, they already contracted 381 projects up to (28.9 billion RMB) US$ 3.5 billion (Figure 4.3). Although China’s construction industry includes, by definition, three distinct categories of enterprises (SOEs, urban and rural collectives, and rural construction teams), and despite the declining significance of FDI in the sector, the latest official data also consider foreign-funded firms as representative elements in the sector’s growth (Figure 4.4). When foreign competitors entered the Chinese market, non-state-owned firms emerged like bamboo shoots. By 2000, they had already produced an output value of 500 billion RMB (US$ 60.5 billion), accounting for almost 60% of total construction output value. They also generated a profit of 10.6 billion RMB (US$ 1.28 billion), which is 85% of the total in the construction industry.20 However, despite the rapid growth of construction firms in general, there are only a few large and profitable enterprises that can
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Figure 4.3 FDI in China’s construction sector. Sources: SSB (2005); CEIC Data (2005). Note Official data reflect certain disparities in years 1998 and 2000, as we would expect to have more contractual FDI than actual FDI.
influence and lead the industry or otherwise compete in the international market. As we know, the developed countries’ experience shows that large-scale enterprise groups are crucial to the development of most industries, reflecting their level of maturity. But in the case of China, even large companies have little capability to dominate the whole market, mostly in terms of asset volume, annual income, and labor productivity. In addition, while the number of workers hired by Chinese construction enterprises is 10–20 times higher than by foreign companies, profit per capita is only 5% of that obtained by foreign companies.21 This means that China’s construction sector is still labor-intensive, whereas it should gradually move into being capital-intensive in order to increase its international competitiveness. Regardless of their weak position, it is also true that Chinese firms are increasingly getting involved in international construction projects. In 1998, among the 225 largest contractors in the world, there were 30 from China. But, due to their low ranking and lack of competitiveness, they only took 4.3% of the total contracts. The types of project considered also reflect China’s low category at this level: the Chinese companies’ income comes mainly from traditional construction installations, petrochemical projects, and transportation projects. International companies evidently grab contracts involving high technology. Until recently, most of the projects the Chinese enterprises bid for were located in the world’s less developed areas, such as Africa. As a matter of fact, China State Construction Engineering Corporation (CSCEC), parent company of CCSEB, our case study, had operations in Vietnam.
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Figure 4.4 Firm distribution. Source: SSB (2005). Note We assume “Others” includes rural construction teams. These data should be used with caution: not only are there internal contradictions within the same sources considered; they also are not comparable with data of previous years, as the statistical coverage of state-owned and urban collective-owned construction firms in the mid-1990s comprised the fourth and higher-grade construction enterprises, while the statistical coverage of rural construction teams in 1996 included township and village construction teams, which are lower than the fourth grade.
Moreover, SOEs are given preferential treatment in the concession of international licenses, for which the expansion of China’s construction sector abroad remains limited. The absence of competitive non-state-owned firms in the international market has impeded them from accumulating experience in terms of international competition. This biased situation has also contributed to the lack of self-improvement of SOEs, mainly due to the lack of (qualitative) competition. This equally applies to the situation within China’s borders: after joining WTO, competition has become even fiercer.
WTO impact and challenges According to China’s WTO commitments, wholly foreign-funded construction firms in general could be set up three years after WTO entry (2004), although those specializing in construction design, construction supervision, or tendering and bidding agencies could be established only five years after WTO entry (2006). Once they have entered the Chinese market, all of these firms benefit from national treatment in China, thus eliminating limitations in company founding conditions and business scope.22 With post-WTO progressive opening to FDI, joint ventures (JVs) and wholly foreign-owned enterprises (WFOEs) are not treated the same way: in JVs, foreign
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holders can have a majority share on firm ownership, while WFOEs are limited to contracts on projects that can only be fully funded by foreign investors, or by international financial institutions with contracts awarded by competitive bidding, or otherwise projects where FDI is 50% or more of the total costs. Projects that are “technically difficult” for Chinese firms or cannot be “executed independently” may also be awarded to such ventures.23 The opening of China’s construction industry to foreign investors has indeed become more crucial since WTO entry: forced bidding procedures, which are still obligatory for non-state enterprises, are supposed to be abolished, while minimum percentages of local production are no longer a prerequisite for investment and import approval. But, as China’s construction sector still lacks management and technological growth, FDI remains essential in this field, while there is an increasing demand of requirements on financing, management, and technology. Many Chinese construction companies, however, constrained both by lack of equipment and limited financing ability, are in great disadvantage in terms of competition with BOT (build, operate, transfer), BOOT (build, operate, own, maintain), PFI (private finance initiative), and DPC (design, purchase, construction) projects, which are now playing a crucial role in the construction market as a whole. In September 2002, as part of the WTO requirements, the Ministry of Construction and the former Ministry of Foreign Trade and Economic Cooperation (MOFTEC), now the former Ministry of Commerce, MOFCOM) promulgated the “Management Rules for Foreign-Invested Construction Companies” (Waishang touzi jianzhuye qiye guanli guiding) and the “Management Rules for Foreign-Invested Construction Design Companies” (Waishang touzi jianshe gongcheng sheji qiye guanli guiding). According to these two legal documents, foreign construction companies started to be allowed to set up operation units starting on December 1 that same year. But as construction projects in China insist that foreign contractors should set up domestic companies and obtain the required construction qualifications, foreign contractors still need to explore the possibilities of setting up companies in China. In fact, there are two areas that could potentially match sustained construction work with increasing profits for foreign firms: subway systems and water supply and wastewater-treatment facilities. According to the 10th 5YP, a total of 34 cities with a population of more than one million needed subway systems. After all, subway systems offer profitable openings for foreign companies: Chinese local ones had to defer to foreign expertise in such areas as designing systems, developing software and testing for toxic fumes, and purifying the air. Integrating subway projects can also be a profitable role for a foreign company. More fundamental is the need for water: at 96 tons per person each year, current water consumption is far below the developed world’s level of 300 tons, yet 450 of China’s 650 cities suffer from water shortages. According to the two above-mentioned legal documents, foreign-owned construction companies are constrained to specific types of construction projects, while JVs can participate in any construction project they apply for. Thus, the best choice for foreign contractors is to set up JVs with well-managed Chinese construction companies as counterparts.
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This trend speeds up the reform of large SOE construction companies, as the difficulties in reform can be largely attributed to the lack of capital and the difficulty of placement of surplus employees: foreign contractors can provide more capital to Chinese companies by holding some of their stocks. This could eventually speed up the reform of the organizational structure and operation style, thus improving their management skills. As foreign companies tap the Chinese construction market, Chinese enterprises can also explore international markets more efficiently through cooperation with their foreign partner. This is precisely the strategy followed by China Construction Second Engineering Bureau (CCSEB), our case study.
Construction Main tips (1) Restructuring. The Ministry of Construction is the main supervisor in the sector through the effective application of three major laws: Construction Law, Contract Law and Tendering & Bidding Law. These regulations allow firms to operate as commercial entities, mainly through competitive bidding. Rapid urbanization and the subsequent bourgeoning of cities have pushed for the rapid growth of infrastructure investment and the construction sector in general. Unemployment pressure is relieved thanks to the increase in labor absorption and its spillover effects on at least 50 more other sectors. The new urban housing system identifies housing as a consumer product and no longer as a welfare product, while there is increased liberalization and governmentsponsored privatization. As a result, the real estate market has become increasingly active. But even if all businesses are now free to invest in the former government’s monopoly of urban public infrastructure, most of the urban public infrastructure is still in the hands of SOEs. (2) Outlook. Construction represents almost 20% of GDP. More than 680,000 projects have reached 3.7 billion m2, with 1.7 billion m2 as residential houses. The increasing demand for high-quality products and services has driven rapid growth in the civil-engineering sector, while ready-mixed concrete has been replacing site-mixed concrete and prefabricated components have become more popular. However, excessive investment has resulted in overheating pressures with an increase in property prices of at least 20%. Despite soft-landing efforts, future construction and spending, including massive projects such as the 2008 Olympics, will continue. (3) Competition. While foreign competitors enter China’s construction market, non-state-owned firms account for almost 60% of total construction output value, generating 85% of total profit. However, only a few large and profitable enterprises can influence and lead the industry, or otherwise compete in the international market, despite their reduced capability to dominate the whole market in terms of asset volume, annual income, and labor productivity. Although China’s construction sector is still labor-intensive, it should gradually move into capital-intensiveness in order to increase its international
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competitiveness and reduce its preferential bias to SOEs in the concession of international licenses. (4) WTO impact. Since 2004, wholly foreign-funded construction firms can establish themselves in China; from 2006 onwards, the same applies to firms specializing in construction design, construction supervision, or tendering and bidding agencies. With WTO entry, forced bidding procedures, still obligatory for non-state firms, are gradually being abolished and minimum percentages of local production will no longer be a prerequisite for investment and import approval. Considering WTO requirements and the existing domestic regulations, the best choice for foreign contractors is to set up JVs with wellmanaged Chinese construction companies as counterparts. This trend speeds up the reform of large SOE construction companies: foreign contractors can provide more capital to Chinese companies by holding some of their stocks and may eventually contribute to improving management skills.
Case study: China Construction Second Engineering Bureau (CCSEB) Interview with Mr Zhang Pei, President Affiliated to CSCEC (see box below), CCSEB is a large SOE registered under the State Industrial & Commercial Administration. As early as 1993 a nation-wide survey, jointly conducted by the State Council’s Research Development Center, the Ministry of Construction, and the State Statistical Bureau, listed CCSEB as the fourth largest among the top 500 general contractors in terms of annual turnover volume, as well as the largest among the top 100 housing builders. Since its establishment, CCSEB has long been one of the leading construction and engineering companies in China, having received twelve “Luban Awards,” the highest national award in construction. Eight of its subsidiaries have been accredited for their quality systems on the basis of ISO 9002.
China State Construction Engineering Corporation (CSCEC) CSCEC was established in 1982. As the largest conglomerate building enterprise in China, it has been ranked No.1 for eight years in the appraisal of China’s top 500 service enterprises. It is also the largest international building contractor in China and has been listed as among the 225 world’s top international firms for more than fifteen years. As it is a state-owned important and back-boned enterprise under the administration of the Central Government, the president and vice presidents of CSCEC have all been appointed by the State Council. CSCEC commands eight affiliated engineering divisions (one of which is CCSEB), eight survey/design institutes, and fortyfour fully owned or holding subsidiaries. It has also established overseas business offices in 52 countries and regions.
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History of the company Early period CCSEB was formed on the basis of the fifth troop of the People’s Liberation Army in Shandong Province. It was not until 1952 that it was transformed into a civil company when the civil war between the Communist Party and the Nationalist Party had ended. The government wanted to provide new occupations for the soldiers. After building the No.1 Automobile Manufactory in Changchun (Jilin Province), the government ordered the company to move to Sichuan Province, following Mao Zedong’s orders. Fearing the outbreak of war against the former Soviet Union, Mao directed the industrial center of the country to retreat behind the so-called Third Front,24 which included seven provinces in southwestern China: Sichuan, Gansu, Guizhou, Yunan, Shaanxi, Qinhai, and Ningxia. The Third Front was then to be the country’s industrial center. While in Sichuan, CCSEB finished numerous local projects such as heavy industry plants, mountain tunnels, and some weapon factories. However, the company’s development was rather slow, due to its limited resources and available projects. In 1966 the Cultural Revolution broke out, with the subsequent social confusion and disruption of most of the economic activity in the country. Once the turmoil was over, in July 1976, a destructive earthquake hit Tangshan and almost destroyed the whole city overnight. The company, at that time with 30,000 employees, was ordered to move all its operations from Sichuan to Tangshan. Its mission was to rebuild the city. This assignment was the true start of its development as a civil construction company. After the completion of the Tangshan assignment, CCSEB no longer received new projects from the Ministry of Construction and had to seek its own projects from the market. Daya Bay nuclear power station project Following the new circumstances in the early 1980s, the company began to send people to other parts of China to look for new contracts. The first market they decided to explore was the Guangzhou–Shenzhen area. In 1986, the company obtained its first important project after Tangshan, the Daya Bay nuclear power station near Shenzhen. Due to their lack of experience in the construction of
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nuclear power plants, CCSEB set up a joint venture with two foreign partners (French and Japanese) and two local companies. Mr Zhang relates the importance of that project for his company, This project represented a breakthrough in the normal practice of CCSEB. Until then, the company used to take orders from the government, who was far more preoccupied by the progress of the project than by its total cost. A project was considered successful simply if it was finished on time and concepts such as budget, cost control or quality control were not considered as relevant. Besides, CCSEB did not need to worry about the supply of materials and equipment, since the government took care of that. The nuclear plant was the first project obtained through bidding in the open market. This was a turning point in the company’s history: from then on, it started to sense competition from other rival firms. Under the French partner’s influence, CCSEB started to become familiar with Western-type management practices, cost control, and performance guarantees. Within this learning process, cultural differences inevitably emerged.
Story 1: Coffee or insurance In the budget prepared by the French partners, there was a column for “KAFI,” with a surprisingly high amount of US$ 450,000. Failing to find the word in any dictionary, the Chinese took it for the French version of “coffee.” However, and despite repeated calculations, the Chinese were still unable to understand how the French people could drink so much coffee during the five-year project. It was not until they had a meeting that the question was courteously presented: this similar-to-coffee French word was actually the name of their insurance company KAFI, in charge of covering project risks. Since the concept of insurance had not yet been in China’s lexicon, they could have never imagined KAFI to be other than coffee.
Story 2: If it ain’t broke, don’t fix it Following the Western pattern, the only workers directly employed by the company in Shenzhen were drivers, while the rest were subcontractors. At the very beginning, the French management handed out operation manuals to all drivers and asked them to strictly follow the maintenance rules of their vehicles. One rule stated that the oil of the vehicles should be replaced at a fixed number of kilometers whether needed or not. Months later, when the Chinese Manager inspected the cars, the Chinese drivers showed them with pride, the place where they had been storing all the unused oil, boasting how much they had saved to the company. However, what seemed to be a savings to them eventually resulted in higher maintenance and repair costs. They learnt a new lesson: “When it ain’t broke, fix it”.
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Construction Story 3: Secret accounts During the whole project, the JV’s account book always showed a negative budget number, indicating they were over-expending. Every party believed this was true and tried its best to cut costs as much as possible. However, when everything was finished and the accounts closed, the French informed the whole company that they had really achieved a US$ 10 million budget surplus. Even the French partner’s plant manager knew nothing about this top-secret piece of information.
The Daya Bay nuclear power station project was very important to CCSEB’s development: not only did it bring large profits to the company, but it also created a team of excellent young people with language skills and experience of working in international operations. This team became the nucleus of Shenzhen’s branch office, set up in the early 1990s with the aim of expanding CCSEB operations to southern China. During the following years, the Shenzhen unit was good at applying the skills and concepts they had learnt from their foreign partners in subsequent local projects, including the 384-meter-high Shenzhen Diwang Commercial Center finished in June 1996, the highest building in China at that time. In its continued expansion, the company set up new branch offices in Shanghai and Beijing, the latter becoming the new head office. Overseas development The JV experience with foreign companies during the Daya Bay nuclear power station project originated important competencies for the Shenzhen branch, which was among the very few domestic construction companies to use Microsoft Project in planning and scheduling, among other advanced Western managerial skills of that time. The relative advantages of the company over other local competitors were so impressive that it soon got itself another large project: Shenzhen Mawan power station. This time, without the need of any foreign partner, the project turned out to be a huge success, and it even won the above-mentioned Luban Award. The Shenzhen branch grew incredibly fast within a few years from an initial 30-employee team to the No.1 contractor in Shenzhen. Mr Zhang adds: “At present, southern China’s market is not only well established, but has even become the largest and most profitable section of the whole company.” The good results obtained in this market have also helped CCSEB to expand into other countries. The first opportunity came from Vietnam, which, with a government very much like that of China at that time, seemed to be the easiest path to internationalization. With the experience gained in the Chinese market, the management team installed in Vietnam did an outstanding job. Mr Zhang remembers this first international operation of CCSEB: The firm set up in Vietnam followed the Western practices in organization and systems. For instance, the new enterprise was not burdened with
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unnecessary departments that most Chinese companies had at the time, and left only the departments of Finance, Human Resources, Project Management, as well as a special team for Contract Bidding. There were very few office workers and therefore it was a much simpler and more efficient organization. Most of the employees were on the construction site and very few did any office work. Instead of bringing people from China, the company recruited most of its managers from local companies. This decision was based on the idea that those local managers knew better the market and how to deal with government officials. With this rich experience, the advanced Western concepts, and a highly efficient structure, the new branch was very cost-efficient and made as its most important goal the client’s requirement and the quality of service provided. The Vietnam branch set an excellent model for other international projects of the company in places such as Iraq, Jordan, the UAE, Brunei, Botswana, Hong Kong, and Macau. In 1995, an Overseas Department was set up in Shenzhen, whose responsibility was mainly exports of goods, materials, commodities, equipment for overseas projects, and minor imports. In 1997, the Bureau enjoyed a record turnover of 6.5 billion RMB (US$ 780 million), 400 million RMB (US$ 48 million) of which was from overseas contracts.
Mr Zhang Pei’s story I joined the company in 1971, starting from an ordinary worker as a storekeeper looking after the equipment’s spare parts. Luckily, I was selected by the company to go for three-and-a-half years to Tongji University, one of the best universities in engineering in China. When I finished my studies in 1977, I returned to CCSEB which, at that time, was located in Tangshan, where the company had taken up the task of the city’s reconstruction after the earthquake. Beginning from a technician level, I was promoted to vice president of CCSEB Research Institute four years after my return from the university. The main responsibility in my new position covered the design of construction equipment such as tower plants, trucks, and cranes. The senior management of the company then had plans to develop the overseas market. Thus, English became a required skill. I was among the young men sent to a five-month intensive English course. Driven by a strong will, I was able to grasp the language in a very short time. This gave me the opportunity to participate in the Daya Bay nuclear power station project. After the completion of the Daya project, I was appointed as President of the newly established branch in Vietnam, where I spent almost seven years. Due to my performance in that country, I was offered the post of president of CCSEB in July 2001. After careful consideration, and being well aware of the sacrifices this new position would entail, I left Vietnam to settle down in Beijing with a daunting task ahead: to modernize CCSEB.
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Call for reform Most of China’s SOEs have a long history. CCSEB is not an exception. Established in 1952, the company accumulated valuable knowledge and experience from its rich past while, on the other hand, internal reform became extremely necessary and even critical for its survival. The market was not anything like in the past: both economic reforms and WTO brought a highly competitive construction market. Corporate governance In the centrally planned economy, party members occupied all of SOEs’ key management positions. Representatives from the Communist Party passed orders, supervised its work, and dealt with the staffing of the company. With the opening up of the country and the introduction of market mechanisms, nearly all projects emerged as a result of market requirements, with the party system losing its raison d’être. However, despite the changes that occurred in the business environment, the Communist Party still exercises today a strong influence on the management of most of the SOEs. As Mr Zhang Pei found out soon after his promotion, although his role was to be the president of the company his power to make certain decisions was actually very limited. He explains the decision-making process in his organization: In approaching strategic decisions, I have to go through consultation with representatives from the Party and obtain their agreement. I have to get the Party’s approval for the appointment and removal of members of my senior management team. This parallel system of management inevitably created a certain level of confusion and ambiguity in the organization. It was an established practice for employees to wait and see what others would say before acting, and avoid any possible risk. Mr Zhang believed that it was critical for the success of the reform to have clear responsibilities and authority lines in the organization if CCSEB were to survive in the existing competitive business environment. The iron rice bowl policy Before the launching of economic reforms in the late 1970s, workers spent their whole life in the same company they had been assigned to work in. Every company was very much like a large family, with its own apartments, hospitals, primary schools, middle schools, and other social facilities. Mr Zhang adds: This situation has been totally transformed in the last two decades: companies no longer offer this type of protection, and lifetime employment only belongs to the past. In addition, the government no longer assigns people to companies. Instead, they have to find available jobs in the labor market.
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As part of the reforms, new companies emerged, both private and foreign owned. These new companies lacked the heavy social burden of SOEs. For instance, among CCSEB employees, only 50–60% were active. However, the company still had to pay the income and health insurance for all employees retired or injured during their work. In addition, the company had to pay for living allowances, the schooling of the employees’ children, medical, and health fees, etc. All these social costs placed the company in a very disadvantageous position with regard to all the newly emerging enterprises in the market. One of the most important constraints CCSEB suffered was the income levels the company could offer to its employees. Mr Zhang explains the situation with talent retention: In the last five years, we have lost a wide range of employees with university education allured by better economic opportunities in the private sector. Thanks to the past system of central allocation of graduates, the company still has capable employees, most of them having already been in the company for more than ten years. This group is rather stable. However, a challenge posed by the new market rules is how to attract young capable people. But an even more important challenge is how to retain them. How can one expect talented people to join and stay in an old SOE, when the new companies with lighter social burdens can offer double or even triple the income? According to Mr Zhang, the solution is not easy, as he could not simply raise the pay level of a competent subordinate. In order to do so, he first had to consult the Party representative, who was usually reluctant, due to the fear of arousing jealousy and resentment among other workers. Tradition and culture State-owned enterprises have long been regarded as parents with life obligations towards their employees. For their employees, these companies have been the center of their lives. Their children went to the same kindergarten as other colleagues’ children. They met their future spouses in the workshop and usually got married under the witness of their bosses and colleagues. Sometimes, two generations or even three generations of a family would serve the same company. It was not unusual that the whole family was dependent on one company. This created a delicate situation in which people could not help becoming conservative and resist any change that could have implied the risk of losing their livelihood. In addition, the intermingle of families and companies created a very complex system of inter-personal relationships with nepotism and small-interest groups gaining much influence. All these factors represented a formidable barrier to the transformation Mr Zhang had in mind. For instance, if Mr Zhang reached a decision that could be unfavorable to certain persons, he would find himself surrounded by various interest groups who had this or that kind of personal
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relationship with the victims of his decision. Moreover, when discussing a new proposal, people never thought of how much a decision could potentially benefit the company, but rather whether it would impact them or their families. Employees resisted almost all kinds of possible changes and wanted the company to treat them in the old way endlessly. Internal reforms Nevertheless, the company has had little choice but to reform its organization and culture, more so considering the increasing competition in the market. By the late 1990s the government had set up the national social security system, which released some of the heavy burden on the SOEs. Encouraged by this favorable news, Mr Zhang Pei started his reform with no hesitation. However, he understood only too well that social peace was a must and therefore the reform could do nothing but take a gradual and apparently smooth course. He recalls: When I first arrived at the Beijing office, I found that there were 27 departments in the central offices. Compared with what I had in the Vietnam operation, this structure was neither cost-efficient nor time-saving. Through countless personal talks, small group meetings, and large open conferences, I eventually managed to cut down the number of departments from 27 to 13. Most of this time was spent in persuading people and dispelling their worries. After his first success, Mr Zhang was more confident about taking further steps. Since it was too difficult to create the needed competencies in the SOE, he decided to seek a bypass, finding a foreign investor who would be interested in CCSEB. After considering a French and a Japanese company among others, he decided to accept the offer of a Hong Kong firm. The main reason for his choice was that the Hong Kong partner had the same culture, mentality, and spoke Chinese. Mr Zhang thought these parallelisms would increase the chances of success for a smooth integration. On the other hand, the Hong Kong firm gained a good opportunity to enter the Chinese market through the establishment of a JV with one of the A-grade contractors in China. Not only, would CCSEB benefit from the Hong Kong firm’s modern management system, but it would also gain access to its overseas markets in New Zealand, Australia, Malaysia, and Singapore. This cooperation was thought to lead to a win–win result. The Hong Kong Company entered into one of CCSEB’s subsidiaries as the major shareholder. Meanwhile, Mr Zhang assured his fellow-workers that their company would be the final shareholder, in fear of arousing objections. CCSEB had numerous subsidiaries that were too small to survive competition. He understood that the gradual consolidation of all those subsidiaries under the Hong Kong firm’s leadership was the right way to follow. To start with, the Hong Kong party bought one of these subsidiaries. The two parties, allowing each one to merge a subsidiary on its own after some time, thus reached a contract.
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The intention of the contract was to make the merging procedure as smooth and gradual as possible, leaving the local people and the Hong Kong firm plenty of time to digest the situation. It was expected that in three years’ time they would have managed to absorb all the subsidiaries and then combine them into one big organization. Whether CCSEB would really be a final shareholder in the JV remained to be seen. Again, in order to persuade people into accepting the new investor, frequent communications were carried out at different levels. Meetings were held with frontline workers, department heads, and engineers. People at the middle level, department heads, and subsidiaries managers were the most worried. They were scared of losing their positions in the new company. Their worry was not unreasonable as Mr Zhang had already cut the number of departments from 27 to 13 and had shown his determination to have only five departments in the future, following the same structure he had so successfully implemented in the Vietnam branch. Mr Zhang expected that the renovated CCSEB would only have 100 stable employees, following the model set up in Shenzhen and Vietnam. Temporary workers hired on a project basis would form the rest of the workforce. Mr Zhang’s initial thought was to set up a new subsidiary for those thousands of people who were to be cut off from the new JV, and to transfer part of the profits generated by the new company. Years later, he could maybe find a good chance to hand the subsidiary to the government. However, the most important and pressing thing for Mr Zhang to do was to communicate with the people. He decided to talk to the mid-level first. A tough task, but unavoidable. Future challenges In the past, CCSEB could boast of its advanced equipment, its most skilled workers, its most brilliant graduates from the best universities, and so on. However, all these advantages gradually disappeared, as many private companies were rapidly springing in the market and competition was becoming fiercer with time. These young companies were more flexible in their management, especially with regard to their personnel. There is a fatal weakness in almost all SOEs: people are loyal to their bosses and not to the company. In return, promotion is based more on the relationship between the employee and his supervisor and not so much on objective results. Mr Zhang is aware of the difficulties posed by this system: “This subjective-based rather than performance-based evaluation system can lead to major losses in terms of competitiveness, mainly with regard to the blossoming of young private companies.” On the other hand, CCSEB still retains certain advantages over small companies. With a license registration fee of 300 million RMB, and being part of the state, it has had fewer difficulties in obtaining bank financing. As an A-grade contractor, CCSEB holds more favorable chances while bidding for larger projects. With the experience from the nuclear power station project, it has obviously enjoyed more advantages in bidding for international jobs. However, the market
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has kept opening up at an accelerating speed. Due to their flexibility, young companies have been more able to obtain projects through many more channels, sometimes using unethical methods. In any case, they have developed so fast that if CCSEB had not taken effective countermeasures, over a period of about ten years, the company would have disappeared. Since China’s entry into the WTO, there have been more foreign contractors in Shenzhen, where CCSEB’s most lucrative unit is located. The Shenzhen branch has a minimum number of employees and has followed the Western way in contracting personnel on the basis of project needs. At present, as foreign contractors multiply, the company’s advantage could be easily lost. After all, foreign contractors use this same procedure. Thus the golden rule for surviving in such a threatening environment full of domestic and foreign rivals resides in the restructuring and transformation of the old culture. Mr Zhang has been perfectly able to identify this shortcoming and is determined to achieve his ambition through the painful, effort-taking, but rewarding reform process. He hopes these gradual changes will eventually work and bring the company into a brighter future. CCSEB Learning points (1) When joining forces with a foreign partner, use your best people. They will learn the foreign management practices fast and bring that learning back to the group. Develop your talented people by giving them opportunities and challenging projects. (2) Use a gradual strategy for workforce adjustment. Communication and a clear vision are fundamental for gaining support to the change effort. (3) Rationalize the organization structure. Eliminate unnecessary positions and departments. Keep a core of key employees in the company while subcontracting the other activities. Challenges ahead (1) Increasing local and foreign competition. Only those that are able to rationalize their operations and gain in efficiency will survive. (2) Separation of management and interest of the Party. The Party should reduce its intervention in the management of the operations. It can play a supervisory role, though with a gradual reduction of power. Ideally, this role should be taken up by a board of directors.
Conclusions and future perspectives The International Olympic Committee’s decision to hold the 2008 summer games in Beijing has had an extremely positive influence on the construction industry’s development. The national project “Beijing 2008” will bring a modernization program worth 372.15 billion RMB (US$ 45 billion) and far more than one million jobs to the city. It will also have an effect on the transportation infrastructure in many parts of the country far beyond 2008.
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Another major project is the construction of the exhibition site for Shanghai’s Expo 2010. Shanghai will directly invest 3 billion RMB (about US$ 360 million) for the construction of the exhibition site. According to the estimates of some experts, one dollar invested in the exhibition site construction will be the equivalent of about 5–10 dollars’ investment in infrastructure construction.25 Motivated by such large benefits, Shanghai will gain from the construction of infrastructure, the expo site, and residential houses. Other cities will follow its developmental style so as to improve their dwelling environment and life facilities. If it all follows this trend, China’s construction industry should then be boosted. There is no doubt that the whole construction industry is in an excellent developing period. Every year, there are new infrastructure construction projects, while the construction of residential buildings – considered as one of the big drivers of the Chinese economy – is also expanding rapidly. The challenges are how to take advantage of the current developing opportunities and become more competitive, as well as how to compete with foreign construction companies, both in and out of China.26 CCSEB, our case study, is a good example of a gradual and smooth reform process. Acting in this sensitive industry, the SOEs need to minimize the social cost of reform while gaining in competitiveness. The construction industry provides a critically high number of jobs, mainly to low-skilled workers, those with the highest need. The government has a clear policy of reducing dramatism in the reform and the impact on those workers. CCSEB has this requirement imbedded in its strategy. Under the leadership of Mr Zhang, the company is following an intelligent strategy. Part of this strategy is its joining forces with a Hong Kong company that can bring in a modern management system and open more international markets to the firm. Mr Zhang’s formula: prudence, vision, and determination.
4,792.63 4,300.00
5,701.63 5,462.94 5,274.90 5,185.32 4,902.44 4,850.55
Source: 2002–2003 Zhongguo daxing qiye tuan fazhan baogao (Development Report of China’s Large-Scale Enterprises 2000–2003), Beijing (2004).
Private SOE
State Enterprise SOE SOE SOE SOE SOE
5,772.65
51,482.31 37,052.35 35,592.74 18,929.55 18,320.34 12,392.81 12,324.75 11,664.24 10,140.53 6,970.35 5,891.26
40,503 43,898
59,327 13,017 11,778 28,627 76,835 13,508
13,193
225,516 186,549 279,984 108,998 44,520 40,278 39,442 24,483 27,457 31,604 21,773
Guangxia Construction Group (1960s) China Gezhouba Group Co., Ltd (1970)
Chengdu (Sichuan) Shanghai Beijing Urumqi (Xinjiang) Jinan (Shangdong) Guangzhou (Guangdong) Hangzhou (Zhejiang) Yichang (Hubei)
State Enterprise
SOE SOE SOE SOE SOE SOE SOE SOE SOE SOE SOE
19 20
13 14 15 16 17 18
12
Beijing Beijing Beijing Beijing Beijing Shenzhen (Guangdong ) Shanghai Beijing Beijing Beijing Guangzhou (Guangdong) Hangzhou (Zhejiang)
China State Construction Engineering Corp. (1982) China Railway Construction Corp. (1948) China Railway Engineering Corp. (1950) China Metal Construction Corp. (1994) Zhonggang Group (1996) Shenzhen Construction Investment Co. (N/A) Shanghai Construction Group (1994) China Road and Bridge Corp. (1999) Beijing Urban Construction Group Co., Ltd (N/A) Beijing Construction Engineering Group (N/A) Guangdong Construction Engineering Group Co., Ltd (1953) Zhejiang Construction Investment Group Co., Ltd (N/A) Sichuang Huaxi Group Co., Ltd (1950) Shanghai Urban Construction Group (1996) Beijing Uni-Construction Group Co., Ltd (1992) Xinjiang Construction Engineering Co., Ltd (1950) Shandong Sanjian Group (N/A) Guangzhou Municipal Construction Group (1950)
No. of employees
1 2 3 4 5 6 7 8 9 10 11
Revenue in 2001 (RMB mn)
Company name (year founded)
Ranking
Ownership
Construction
Table 4.1 Top twenty construction enterprises Location
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5
Cosmetics
Industry restructuring: Overview As China’s cosmetics sector tends to be foreign-brand-oriented, it has a very low presence of SOEs. Indeed, the development of this industry shows the face of the New China, which no longer considers the use of beauty and care as an undesirable bourgeois feature but rather quite the contrary. In fact, the 10th 5YP development strategy in the cosmetics industry aimed “to restructure the product composition, to improve the product quality, to add production lines, to promote the product grade, to increase imports, to innovate packaging, to develop materials, and to strengthen management.”1 For this development strategy to be fulfilled, SOEs had to adapt to the changing cosmetics business environment. First of all, SOEs were compelled to increase cosmetic advertising expenditures. After all, China’s cosmetics market has tended to be highly brand-oriented: an estimated 65% of Chinese customers have already developed a defined pattern in buying their favorite brands of cosmetic products.2 Advertising and sales promotions have greatly influenced the average Chinese customer when buying skin-care and make-up products. Considering this context, the survival of SOEs in this sector will very much depend on their use of advertisements as a way of boosting their public exposure and brand acceptance. By 2001, the cosmetics and bath products sector, the second largest advertising sector in China, achieved an advertising expenditure of 10.78 billion RMB (US$ 1.3 billion). Advertising expenditure for skin-care products, female and male cosmetics, and perfumes reached 2.50 billion RMB (US$ 0.3 billion), accounting for 23% of the whole cosmetics and bath products sector. In 2001, skin-care product adverts made up a sizeable portion of the cosmetics advertising market, with up to 2.20 billion RMB (US$ 0.27 billion) in advertising investment injected into skin-care products. Advertising expenditure for female make-up reached 269 million RMB (US$ 32.5 million) that same year, while that of perfumes and male cosmetics amounted to 20 million RMB (US$ 2.4 million) and 3 million RMB (US$ 0.36 million), respectively.3 Second, R&D and marketing of new products had to be improved, for which SOEs needed to promote the product grade by attracting more high technology. Nowadays, new technologies such as biochemicals have brought revolutionary changes to the cosmetics industry. Silk fibroin, HA, AHA, EHF, Vitamin A, and
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Vitamin C are now widely used in skin care production.4 Currently, the market share of skin-care products has increased up to 36% of China’s cosmetics market, followed by hair-care products representing 30%, and make-up products 18%.5 Third, distribution channels had to be widened. Not so long ago, large stateowned department stores were the main sales channel for cosmetics, especially high-grade cosmetic products. However, in the last few years, supermarkets and specialized shops have become increasingly popular. The sales channel of cosmetic products has tended to concentrate in traditional department stores (40%), supermarkets (30%), and others (30%).6 Meanwhile, some cosmetic enterprises (mainly foreign ones) are continually attempting new retail strategies. For example, both Avon and Mary Kay shifted to a retail model from direct-sale to establishing specialized counters and shops. Additionally, Avon runs beauty corners in department stores and supermarkets, while Mary Kay’s sales promoters are continuously following training courses in combination with the selling of products.7 This type of initiative has nevertheless been rarely encountered by the SOEs. Of all the cosmetics companies established in the country, in 2003, SOEs accounted approximately for 6%, collective enterprises for 7%, private, joint stock and JVs for 49%, while Hong Kong, Macau, Taiwan (HMT), and foreign-funded firms accounted for 38% (Figure 5.1). The cosmetics market is relatively new and therefore very much dependent on foreign influence. Most SOEs in the market tend to be associated with a foreign company, for which JVs are basically taking the lead in this fragmented but rapidly growing industry.
Figure 5.1 Ownership structure in China’s cosmetics. Source: China Markets Yearbook (2005); Wang Bing (2002). Note Despite exhaustive search of data for 1997 and 1999, no official figures were found.
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Figure 5.2 Cosmetics as share of GDP. Source: China Markets Yearbook (2005).
Industry outlook Cosmetics were fairly buoyant in Ancient and Modern China (basically until the late 1940s), but they were not economically representative until the early 1990s, when their total output started to rise very rapidly. Although it represented less than 0.20% of GDP in 2003 (Figure 5.2), by 2000, the cosmetics industry already reached a sales volume of more than 45 billion RMB (US$ 5.45 billion),8 while in 2003 its revenue was more than 23.5 billion RMB (US$ 2.84 billion) (Figure 5.3). New cosmetic companies are constantly entering the market: more than 150 cosmetics producers sell more than 100 million RMB (US$ 12.1 million) worth annually. Each of the ten largest companies has a sales value of about 500 million RMB (US$ 60.5 million), including: Shanghai Jahwa Co. (our case study),
Figure 5.3 Cosmetics revenue. Source: China Markets Yearbook (2005).
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Beijing Sanlu Co., and Avon (China) Co. In 2002, Guangzhou P&G Co. captured 23% of the market, Shanghai Jahwa Co. 5%, and Shanghai Unilever 4%.9 Many Chinese brands have been well received by consumers, such as Dabao, sharing 10% of the skin-care product market and Yuxi, capturing 7.7% of the lipstick market share10 (Table 5.1). Virtually every international brand name is sold now in China, introducing the latest marketing and branding concepts. The world’s top 15 brands originating from France, Germany, US, Japan, and South Korea have set up special counters in various Chinese cities. For instance, in March 2003, Amway established its 100th special counter in Shanghai’s new Pudong area. In 2002, total imports and exports were 1,662 million RMB (US$ 201 million) and 4,284 million RMB (US$ 518 million), respectively, with increases of 14.3% and 26.6% compared with those of the previous year.11 The main export varieties were skin-care products, shampoo, and perfumes, and were exported to at least 70 different countries. As the supply of cosmetic products has increasingly diversified, the resulting demand is now responding to new profiles. Within this emerging variety, Chinese consumers can be classified into three groups:12 (1) High-income consumers in medium and large cities: prefer high-grade imported cosmetics: famous brands from Europe, US, and Japan are their favorite choice. These consumers account for 1% of the urban population: most of them are young women (including teenagers). (2) Middle-income consumers: tend to choose well-known Chinese brands. They account for 2.5% of the urban population and include middle-aged and old consumers. (3) Rural consumers: usually buy low-grade Chinese products such as facial cream and toilet water. This group accounts for about 50% of the total. These distinct patterns show how cosmetic products represent a market with significant regional differences and particular local characteristics: consumption tends to be higher in the southern and coastal areas, as opposed to the northern and western regions. Although China has a population of more than 1.3 billion and its annual cosmetics sales totaled 45 billion RMB (US$ 5.45 billion) in 2000, there is currently only about 34 RMB (US$ 4.11) per capita consumption for cosmetics, far lower than the US$ 35 to US$ 70 in developed countries. Covering more than three years, the nationally renowned Beijing-based Meilande Consulting Co. prepared a survey on cosmetics and their market share, based on the responses given by 15–59-year-old women in Beijing, Shanghai, Guangzhou, and Chengdu. The survey showed that Shanghainese women spent more money on cosmetics than those in the other three cities. The average figure for Shanghai reached 882 RMB (US$ 106.7); Beijing’s was 720 RMB (US$ 87.1); Guangzhou’s 639 RMB (US$ 77.3); and Chengdu’s 542 RMB (US$ 65.5) per year.13 Product variety contributes in this sense to the fast growth of the industry. For instance, as cosmetic companies have been offering lower prices and product positioning, they have greatly increased their market share in skin-care cosmetic
Shanghai Jahwa United Co., Ltd. (1995) Avon (China) Company (1990)
2
Suzhou Shangmei International Cosmetics Co., Ltd. (1999) Guangzhou Si Bao Fine Chemical Industry Co., Ltd (1992)
9
Source: China Markets Yearbook (2005).
10
8
7
6
5
Johnson & Johnson (China) Co., Ltd (1992) Hangzhou Marykay Co., Ltd (1994) Shiseido Liyuan Cosmetics Co., Ltd (1991) Beijing Da Bao Cosmetics Co., Ltd. (1999) Kao (Shanghai) Co., Ltd (1993)
4
3
Jiangsu Longliqi Group Co., Ltd (1996)
Company’s name (year founded)
1
Ranking
Table 5.1 Top ten cosmetics enterprises
Laifa-C’Bons
Kao (Skin care and Shampoo) L’Oréal
Dabao
Shiseido
Mary Kay
Johnson & Johnson
Liushen, Maxam, Chinfie, gf Avon
Longliqi
Major cosmetic brand names
Guangzhou (Guangdong)
Suzhou (Jiangsu)
Shanghai
Beijing
Hangzhou (Zhejiang) Beijing
Guangzhou (Guangdong) Shanghai
Changshu (Jiangsu Province) Shanghai
Location
HTM funded
Foreign funded
Foreign funded
Limited liability
Foreign funded
Foreign funded
Foreign funded
Foreign funded
Foreign funded
Limited liability
Ownership
470
528
640
666
685
952
1,316
1,447
1,549
2,509
Revenue in 2003 (RMB mn)
1,525
547
318
1,248
1,832
350
651
397
1,075
4,646
Number of employees
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Figure 5.4 Production distribution in China’s cosmetics market, 2000. Sources: Seydak (2001); Wang Bing (2002).
products. Chinese customers tend to prefer products from Japan and China that are formulated to respond to Asian skin features, such as further whitening their skin, something particularly appreciated by Asian women in general. Make-up and perfumes have also become increasingly popular (Figure 5.4). Skin-care products Largely dominated by international brand products from wholly foreign-owned enterprises with large-volume production capacities, complex marketing and sales strategies, these products captured more than 60% of the market for skincare products in 2002.14 Skin-care products tend to account for 49% of China’s cosmetics market, while hair-care products represent 22% and make-up products 11% (Figure 5.4). Shampoo and hair products have also featured in the first wave of products in China, followed more recently by creams, lotions, facial cleansers, and bathing lotions. Baby-care products China’s one-child policy has contributed to a boom market for baby-care products. Johnson & Johnson (J&J) has the largest share in this sector and advertises heavily to ensure that parents provide the very best for their babies. So far, the market for children’s skin-care products has not been fully explored, due to excessively high prices, though it should promise huge growth and profit rates in the near future.
Cosmetics 99 Aging people’s products The market for aging people should not be underestimated either: China is increasingly becoming an aging society with the share of the elderly population on the rise. At present, anti-aging products and anti-wrinkle products containing vitamin A are quite successful in the market, especially those products with a high percentage of natural ingredients and without adverse side effects.15 Men’s cosmetics Growth is bound to take place in the market for men’s cosmetics and personal care products: branding has become more important, especially for men’s skin-care, cleansing, shaving, hair, and fragrance products. Many foreign cosmetics firms have started to launch such products, with relative success. For instance, in October 2001 Shiseido promoted JS men’s cosmetics including skin care, hair care and perfume, catering for 30-year-old men and proved to be quite successful in terms of sales and net profit. Natural products The latest trend for cosmetics products is the application of natural resources as natural ingredients. Embryonic essence is very popular and has been used for many years in China, but only recently has it become a major selling point. Already, hundreds of herbal cosmetics for skin care have flooded the market: Beijing Sanlu offers a line of its Dabao lotions, which blend traditional Chinese herbs and flowers with nutrients. These products have not only been used by Chinese customers but have also been exported to over 30 countries worldwide.16 In other words, despite its early age, China’s cosmetics industry has rapidly evolved not only in terms of volume, but also in terms of diversity and quality. The question is whether domestic firms, particularly SOEs, which do not even represent one-quarter of the total market, will survive the increasingly fierce competitive pressures coming from the much more experienced foreign firms.
Competition Domestic cosmetic manufacturers are many in number but offer duplicate products with little or no new product development, struggling with aggressive foreign competition: although there are more than 3,000 separate domestic companies actively selling cosmetics in China, these local firms enjoy less than 20% of the total market share. In order to compensate for their weaker position, Chinese manufacturers focus on price competition as a strategy to win customers: most local cosmetic products are positioned as low- or middle-range products, while the average local Chinese cosmetics firm is small to medium in size with total assets accounting for 30 to 50 million RMB (US$ 3.66 to US$ 6.10 million).17 Despite the reduction of firms from 760 in 1993 to 221 in 2001 (Figure 5.5), by 2004, about
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Figure 5.5 Total number of cosmetics companies (domestic and foreign). Source: China Markets Yearbook (2005).
3,900 domestic and more than 700 foreign-invested enterprises had a license to produce cosmetics in China. This means that China’s cosmetics industry has developed not just through the encouragement of domestic growth but rather through the establishment of JVs. The reason is double-edged: on the one hand, the Chinese partner takes advantage of the foreign partner’s professional marketing and strong product design; on the other hand, foreign investors prefer to establish JVs, as the Chinese government still requires too many quality licenses for cosmetic products before granting import approval. Imported cosmetics must undergo a long and expensive testing procedure, not always necessarily applicable to domestic cosmetics: the testing and registration process takes about one year to be completed. As a result, more than 450 foreign companies have invested about 2,500 million RMB (US$ 300 million) in China’s cosmetics market over the last decade. Although the WFOEs and JVs may only account for 20% of China’s cosmetics manufacturers, they represent 80% of the cosmetics market: amongst all the foreign enterprises established in the Chinese market, there are worldwide-known brands such as Procter & Gamble (US), Shiseido (Japan), Unilever (UK), L’Oréal (France), and Henkel (Germany).18 As part of the fierce competition, brands play an important role. After all, China’s cosmetics market is highly brand-oriented: the top 10 brands reach a market share of about two-thirds (Table 5.1). Studies on the sales of cosmetics and personalcare products in large shopping malls have shown that household names, such as Oil of Ulay, Rejoice, Dabao, Yue-Sai (recently purchased by L’Oréal), Safeguard, and Hazeline are much more successful than less well-known brands.19 Despite this clear positioning, the market remains highly fragmented: as mentioned earlier, there are today over 3,000 brands of cosmetics throughout the country. However, experts predict that more than half of them will not survive,
Cosmetics 101 due to the intense competition created by many foreign cosmetics companies that are developing new products targeting Chinese consumers and that tend to be more quality- and esthetically oriented than domestic firms. For example, Ksose launched the Recipe-O line of cosmetics for the mid-to-low-end market, while the Cocool collection focused on the fashion-conscious younger generation.20 Considering its young age, the cosmetics industry is bound to be significantly affected by the WTO in the medium term, both within and beyond national boundaries.
WTO impact and challenges Exports of Chinese cosmetics are projected to climb to US$ 500 million in 2010.21 Indeed, WTO membership means more exports of Chinese cosmetics, as Chinese firms face higher competition within their frontiers. But, in order to meet international standards, production, management and R&D procedures need to be strengthened. As imported raw materials become cheaper with tariff reductions, local products should become more profitable and competitive. Although China has tended to use import tariffs to protect its cosmetics industry, the 1990s uniform tariff of 150% for all cosmetic products decreased to 45% in 2000, while WTO requirements fixed customs duties to 10% by 2005 (i.e. a reduction rate of 72.2% in five years). By 2008, tariffs should be reduced to 6.5%. Although it all depends on the overall political will, the protection of IPRs should also become a priority in this field, contributing to the end of fake products with fake brands (e.g. Jahwa case study). Despite WTO requirements, and considering the competitive nature of this industry, trade conflicts have been inevitable. A crucial one was the EU–China food–cosmetics trade conflict in 2002, resulting from the EU’s January prohibition of the entry of aquatic products (mollusks, crustaceans, frozen shrimps), rabbit meat, and honey originating from China: the EU blamed China for using a prohibited antibiotic (only for animal use – chloramphenicol – possibly causing cancer) found in imported frozen shrimps. China then criticized EU for imposing an unfair prohibition and accused it of growing protectionism. As a result, in March 2002, China prohibited the imports of EU cosmetics, claiming they could be infected by mad cow disease. Such a reaction was then viewed as a Chinese countermeasure against the excessive entry of European cosmetics in its still young industry. After more than a year of negotiations, bilateral understanding was eventually restored. Before WTO entry, foreign firms were limited from entering directly China’s wholesale and retail markets, due to non-tariff barriers such as foreign exchange controls, product standards, and quality control requirements. As import liberalization takes place, these non-tariff barriers should diminish. Nonetheless, there is no real guarantee, considering the divergent policies applied by local governments, who have already applied phytosanitary measures affecting both imported cosmetics and locally produced ones.22 The uncontrolled multiplying effect of non-tariff barriers is an impediment to a more fluent development of the industry. If the rules of the game are not respected, successful JVs could ultimately lose out. Fortunately for them, strict measures have already been taken, as proven by Shanghai Jahwa’s case.
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Main tips (1) Restructuring. Despite general fragmentation, China’s cosmetics industry has grown rather rapidly. Changes in the industry exercise significant pressure on the SOEs, as they need to increase their cosmetic advertising expenditures, improve their R&D, and marketing, and widen their distribution channels. (2) Outlook. Although still fairly young, the cosmetics industry is significant in terms of volume (US$ 2.84 billion of sales revenue in 2003), product diversity (from skin care to baby care, men’s cosmetics, use of natural ingredients, etc.), and quality (increasingly brand-oriented). (3) Competition. As a highly brand-oriented industry, it tends to be predominantly foreign, as quality and esthetics become crucial: domestic firms enjoy less than 20% of the total market share. Thus, the strategy for survival of domestic firms tends to be price-oriented. (4) WTO impact. With WTO entry, competition within boundaries forces domestic firms to increase exports. Survival of Chinese firms in the international cosmetics market can be possible only if they follow international standards, increase their production management, and pursue R&D. Tariff reductions on raw materials and cosmetics in general, and the respect of IPRs, all benefit both domestic and foreign cosmetics firms. Nonetheless, due to the highly competitive nature of the industry, domestic firms may eventually drown in the medium term.
Case study: Shanghai Jahwa United Co. Ltd Interview with Dr Liu Yuliang, Director and CEO Shanghai Jahwa Co., Ltd (Jahwa) is one of the 20 sub-companies fully or partially owned by Shanghai Jahwa (Group) Co., Ltd (the Group). After the Shanghai Industrial United Holding Company (SIUC) bought over 51% of its shares, the company was renamed as Shanghai Jahwa United Co., Ltd. With the popular Chinese slogan of “spare no effort for beauty and elegance”, it has become one of the largest cosmetics enterprises in China. In fiscal year 2002 the value of its assets totaled 1.52 billion RMB (US$ 183.8 million). Jahwa’s brands, such as “Maxam,” “Ruby,” “Liushen,” “Chinf & Chinf,” “Herbalist,” “Golf,” etc. spread to almost every segment of the market: altogether, they generated 1.36 billion RMB (US$ 164.4 million) sales income and 75.36 million RMB (US$ 9.1 billion) net profits. Its major product, Chinese eau de toilette, occupies 74.88% of the market. Both the hand cream (market share 22.82%) and the shower cream (market share 16.18%) are in China’s leading positions. Shanghai Jahwa now has more than 2,000 chain stores in Shanghai, Beijing, Hong Kong, Shenzhen, Dalian, and other big cities in China. History of the company The company’s history can be dated back to its Hong Kong original Guangsheng Company in 1898. In the early 1930s, it set up a cosmetics manufacturing plant
Cosmetics 103 in Shanghai. After the Communist Revolution in 1949, the company was nationalized and merged with three other personal care producers into a state-owned company named Shanghai Mingxing Daily Chemical Products Factory (“Jahwa” in Chinese means Daily Chemical Products). There is not much to say about the activities of the company before China’s opening to the outside world, since cosmetics were then regarded as bourgeois and contrary to socialist values. First period 1987–1994: JV with Johnson In the early 1990s, the American corporation Johnson & Johnson showed particular interest in entering China’s market and looked for the best cosmetics company in the country as a JV partner. Shanghai’s City Municipality promoted Jahwa as the potential partner J&J was looking for. After months of negotiations, J&J and Jahwa set up their JV, named Ruby Johnson Cosmetics Co., Ltd, into which Jahwa put in two-thirds of the JV’s total fixed assets, most of its key personnel, and its two most famous brands “Ruby” and “Maxam.” This agreement was a milestone in Jahwa’s history and marked the time when the company commenced its gradual process of modernization. As Dr Liu expressed, “We learned a new management style from J&J. For instance, we appointed a brand manager for the first time. This was a step totally new in the history of the company.” However, this partnership had a relatively short life. After 18 months, J&J decided to withdraw from the JV, due to changes in its global strategy, when its business focus was transferred from personal-care products to household-cleaning products. What Jahwa had initially invested into the JV were mainly its brands: Maxam and Ruby, and it therefore purchased these brands back in 1992 at a cost of 6 million RMB (US$ 0.73 million). As a result, it set up a new Jahwa. Mr Ge Wenyao, current GM of Shanghai Jahwa (Group) Co., Ltd and Chairman of the Board of Shanghai Jahwa United Co., Ltd, played a very important role in this process. He was then the vice president of the JV and the assistant GM of the newly emerged Jahwa. He designed a new development plan focused on cosmetics. The business of the Group was then expanded to cleaning, pharmaceuticals, and refined chemistry. When the JV ceased, the press described this separation as the result of misunderstandings between both partners. However, Dr Liu presents a different view: The news about the JV’s failure was all mistaken. The real reason was to be found in J&J’s change of strategy, and not to poor management or lack of cooperation. In fact, later on we cooperated again on home products. The media insisted on our lack of understanding. This is not true. However, we did make the mistake of sending the wrong people to the JV. Those people had been appointed by the government and didn’t know how to work with the foreign managers. This is a warning I’d like to give to the Chinese companies who want to establish a JV with a foreign company.
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Dr Liu stressed the importance of selecting the right management team for the JV: First, it is very important to select the right people. The best candidate from the Chinese side is someone with some Western education background; otherwise, there will be a large gap in the way of thinking. Having the right person in place, the JV should achieve a common understanding between both sides. The best JV partners are multinationals with systematic and advanced management systems. The success of the partnership lies largely on the managers you send to the JV. But the benefits of a JV are not only limited to the Chinese partner. The foreign partner should not be too dependent on the so-called social or political network of the Chinese partner (guanxi): the foreign side should select the proper partner, based on their business requirements. For the foreign party, to enter a JV at the initial investment period generates important advantages as, for instance, the Chinese partner can help in the negotiations with the authorities for getting land and the necessary licenses and permits. This can save them a lot of time and money. In addition, the Chinese partner should assist the foreign party in managing the local people. Dr Liu considers the experience with J&J fundamental in the evolution of his firm and recommends it to other SOEs: I think the JV experience is very good for SOEs. It can change people’s mindset from a planned to a market economy. When the managers [coming from an SOE] join a JV, they will soon adjust to the management style of the JV.
Dr Liu Yuliang’s story I graduated from the Second Military Medical University with a medical degree. After graduation, I started to work as a surgeon, performing normal surgery and, later on, plastic surgery. I once served as an orthopedic surgeon at a Danish hospital. After I returned to China, I joined Jahwa in 1993 as a consultant. In 1995, I was appointed Deputy Director of the Technology Center. One year later, I was promoted as the company’s Assistant General Manager, responsible for market and technology development. In 1998, the company merged with Shanghai Group of Chemicals for Daily Use and set up the Jahwa Group. I was assigned to be the Assistant General Manager of the Group, mainly in charge of purchase and acquisition. During that period, I became Chairman of the Board of Shanghai Johnson Co., Ltd; Chairman of the Board of Johnson Specialized Products Co., Ltd; and Chairman of the Board of Shanghai Naris Cosmetics Co., Ltd, a JV with a Japanese partner. All of these companies were acquired by our Group. I also became Vice Chairman of the Board of Shanghai Fine Chemicals and Technology Company, Vice Chairman and later Chairman at Shanghai Hanying Medical Co., Ltd. Later, we acquired Tianjiang Pharmaceutical Co., Ltd, in which I was the Chairman of the Board. Shanghai Jahwa invested in Hainan Linbi Mineral Water Co., Ltd, and I was also the Chairman of that Board.
Cosmetics 105 I did the Executive MBA program at CEIBS in 1999. Between 1999 and 2000, I worked as the leader of the project team responsible for the preparation of our company’s IPO. The company went public in 2001. In 2002, I returned to Jahwa as the GM.
Second period 1995: SIUC, Hong Kong enters Jahwa The second important stage in Jahwa’s history started in 1995. The Shanghai Municipality wanted to set up a “window” company in Hong Kong and appointed Jahwa to the Shanghai Industrial United Holding Co. (SIUC), asking the company to purchase 51% of Shanghai Jahwa’s shares. This agreement included listing the company in Hong Kong’s stock market. Because of this, the financial system of the company had to be modified according to the Hong Kong system. Dr Liu was actively involved in this process. He remembers, “it represented an important challenge for my company, as the accounting system [in Hong Kong] was far from that in China at the time.” As the company went public in 1996, it had to negotiate two points with the government: the formation of a board of directors and the continuity of the old management team. The company had an agreement with SIUC that its participation in Jahwa’s capital would last at least four years. During that time, SIUC would not have any decision-making power with regard to the business and daily operations. Dr Liu indicated that their only obligation to SIUC was to provide a fixed amount of ROI on an annual basis. According to the 2002 annual report of Shanghai Jahwa United Co., Ltd, Shanghai Jahwa (Group) Company, Ltd, and SIUC respectively held 28.15% of the share capital.
Dr Liu’s view on the Board of Directors There are seven people in the Board of Directors. Four of them represent SIUC, while three represent Shanghai Jahwa. In our JVs, all board members and management personnel are from Jahwa. We made a small separation and asked some people to represent SIUC. We had to let SIUC enter our share capital, as the government asked us to do so. In fact, the partnership with SIUC only existed in a virtual sense: it was not a real partner. It was a partner only in the legal documents. As far as I know, most of the boards of directors in Chinese companies are still a mere formality. It is the same in Jahwa. Our board meetings are not like those in Europe or in the US. Here, the major shareholder makes the final decision while the others just agree with him. The government’s influence exists only in the final clarification of the ownership of the company assets. It is not involved in the company’s daily operations. In order to decide the strategy of the company, I need to discuss with the board of directors, but not with the government officials. If the results are not as expected, it is my sole responsibility.
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Third period: 2001–present: Jahwa goes public in Shanghai The third period took place when the Shanghai Jahwa United Co., Ltd went public in Shanghai in 2001. The Shanghai Security Regulatory Commission has certain requirements for the internal system of companies that go public, not only in the financial area but also with regard to the managerial system. This meant another important step for Jahwa, as the company had to introduce new regulations in its corporate governance. As Dr Liu explained : As part of the new regulations, the chairman of the board cannot hold the position of GM at the same time. In my case, when I became Jahwa’s GM, I had to resign from the position of the Group’s Assistant General Manager. This third reform promoted the largest change in the management structure. Mr Ge, former GM and currently Chairman of Jahwa’s Board, was responsible for all the negotiations. He was very important in the establishment of Jahwa as a listed company in Shanghai.
Dr Liu’s view on SOEs’ leadership In terms of the selection of leaders, SOEs may have different criteria in comparison with other companies. You need to have a profound understanding of the SOE, not only with regard to its culture or functioning system, but also with regard to the hierarchical relationship between the upper and lower layers. Second, you need to have the knowledge and managerial skills used by foreign companies. But you need to apply that knowledge into the context of an SOE in a flexible way and have a good sense of the rhythm to move on. The objective of an SOE may not be as clear as that of a foreign company, which mainly wants to earn more profit. Third, in terms of mental preparation, you need to have a strong resistance to stress. The pressure comes from both inside the company and the environment. Internally, people want you to be not only an expert in management, but also a father, a saint. Externally, superiors want you to be innovative and, at the same time, be an obedient follower. I have to make everybody happy, and when there is a problem, all of them come to me at the same time. Finally, SOEs’ leaders should not care for compensation. The motivation for us comes from within, the desire of self-realization and the sense of responsibility. Despite the low income, high pressures, and misunderstandings, we continue to stay in the SOEs.
Future challenges Dr Liu is very confident and optimistic about Jahwa’s future. First, the market for fast consumer products keeps increasing in China. Despite depression in major retailing markets, the total sales volume of fast consumer products in China increased by 10% in 2002, amounting to 36.3 billion RMB. Carbonic/sports drinks ranked No. 1 with 10.4 billion RMB sales. Shampoo was No. 2, and sales totaled
Cosmetics 107 8.6 billion RMB, representing an 18% annual increase, the highest among all fast consumer products for the second consecutive year. Skin-care products, fast noodles, and washing powder were ranked No. 3 to No. 5. With the improvement of living standards, people are spending more and more money on these types of product. Second, cosmetic products have a strong local tendency. Different countries and regions have different requirements for cosmetics, due to differences in culture, customs, tastes, and even skin types. As Dr Liu indicates: You can never just carry an American product in China and hope it will sell well. The peculiarity of cosmetics gives an advantage to local companies. We can adapt to the local market much better. Jahwa keeps deep roots in this market and will continue to grow. Third, companies of fast consumer products must introduce new products regularly in order to meet the consumers’ needs. With that purpose in mind, Jahwa established a very strong R&D center. In April 2003, Jahwa’s Technical Center’s new building, worth 800 million RMB (US$ 96.7 million) in terms of investment, was put into use. The Center has 500 square meters of cosmetics testing workshops and 1,000 square meters of pharmaceutical testing workshops. There are more than 100 researchers, including 10 doctors and post-doctoral researchers working in the Center. Jahwa has allocated 3% of its total sales revenue to R&D investment. Since 1999, the company has gained 348 patents. As Dr Liu says: The developing time of our products is shorter than foreign companies. In addition to the stronger adaptability and low cost, we have obvious advantages over them. Our core competence lies in our capability to grasp, integrate and industrialize the market and technology information. However, this advantage cannot guarantee by itself the company’s future survival and success.
Rule of law – Dr Liu China has “bad debts”, as a result of the breach of contracts. But in the last few years we have become much more selective in choosing cooperators trying to take only payment in cash. China’s general legal environment is improving. Despite local protectionism, our products are distributed nationally and have met certain difficulties, but these are not very big problems. As regards intellectual property rights, we constantly find fake products. Some companies steal our technology in their product development. Even more serious, they use our brands illegally. We have a special team of 17 people working on a fulltime basis to fight piracy. We can ask help from the government, but usually this happens in remote areas of the country where the government does not have enough resources to enforce the law.
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Dr Liu does not see the future as being easy. He identifies some areas that need improving such as more transparent management systems and effective modern corporate governance: “Only with the back-up of a modern management system will we prosper in the market economy. I think this is something we need to solve step by step.” He also points out the HR system as another weak area, especially when it comes to recruitment and retention of talent. Now the group has around 2,700 employees, 1,000 of whom have higher college degrees. Still, Dr Liu explains his concerns in this area: For our company, it is not very difficult to attract talents: Jahwa has a steady growth pattern, a good image, a positive working environment, and better compensation compared to other SOEs. However, I am also wondering whether our company has become a training center. Many young people come here for training and then move on. A certain level of turnover is reasonable, but when it is too high it means there is something to improve in the design of career development for our people. We are offering more training and career opportunities to our employees. We cut off those people with the lowest performance, but before we lay them off we talk a lot with them. We offer training for those laid off and assist them in hunting for new jobs. In most cases, they find a new job. We did a smooth job in this area and did not incur any large conflict. Jahwa has implemented reforms in the direction of a more modern HR system. As Dr Liu explains: After I came back, I restructured almost everything from the management to the workers. I have changed the former management approach to the current business unit operation. I have implemented a new performance evaluation system that links compensation with individual performance. After this interview, I am going to attend a meeting on a new information management system, which we want to implement this year. Apart from the internal challenges, the company also faces pressure from major multinationals such as P&G and Unilever. According to Dr Liu, foreign companies search for a larger market share at the expense of losing money. He continues, “I have just got news that they will reduce their prices again.” Finally, Jahwa contemplates overseas expansion, although Dr Liu recognizes that they have not accomplished much in this direction. One of the reasons he mentions is the lack of resources, while another is that there is still a lot to do in such a big market as China. The company has taken some initial steps such as exporting to the Asian region. It has also established some partnerships with European companies, mainly as a way to explore those markets and learn more about cosmetics in Europe. The future is not easy but, at the same time, is very promising. Jahwa is working hard to become an important player in the cosmetics industry in China. Dr Liu is very determined to do so.
Cosmetics 109 Jahwa Learning points (1) When establishing a JV, be careful in the selection of the management team. The team should be composed of people with foreign experience so they can adapt quickly to working with a foreign partner. These people can be the foundation of future development of your organization. (2) Use the stock market as the channel to privatize your company. The stock market can not only bring fresh capital but it also forces the company to professionalize the accounting and financial systems. It will also be a catalyst for improving the corporate governance of the firm. (3) Critical role of leaders in SOE. They must have special qualities: – Profound knowledge of the SOE and its internal politics. – Experience with international management systems applicable to the SOE; – Resistance to pressure: the leader is subjected to expectations from the higher level and the demands of the lower levels. – Intrinsic motivation: their motivation comes from a sense of self-realization and service, not economic reward. (4) Invest on R&D: A key success factor is the development of new products adapted to the local needs. Challenges ahead (1) Building a brand image. Branding is necessary to succeed in this market. Local companies need to acquire the marketing savvy MNCs possess. (2) Curbing counterfeiting. Without the support of the government, police, and judicial systems, the laws brought by the WTO cannot be effectively enforced. (3) Retaining talent. The company may become the training center for big companies that can afford to pay higher compensation.
Conclusions and future perspectives China’s rising purchasing power and growing demand for personal-care products is having an impact on the cosmetics industry. The total output of the cosmetics industry has been rising rapidly since the early 1990s, and about 3,900 domestic and more than 700 foreign-invested enterprises have a license to produce cosmetics in China. China’s cosmetics market is highly brand-oriented. Household names such as Oil of Ulay, Rejoice, Dabao, Yue-Sai, Safeguard or Hazeline tend to be more successful than less well-known brands: the top 10 brands reach a national market share of two-thirds; however, at the current national level, the market share of foreign branded cosmetics is estimated at 80%, as almost all of the world-famous cosmetics brands are present in China (Procter & Gamble, Shiseido, Unilever L’Oréal, Henkel). As a result of WTO membership and international competition, exports of Chinese cosmetics can increase only if they strengthen their production, management, and
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R&D procedures within international standards. With WTO pressure, China’s SOEs need to shift an array of business patterns; increase advertising expenditure; improve product quality and packaging; further accelerate the pace of R&D and marketing of new products; and widen the existing distribution channels. Within 20 years, China should be the world’s largest cosmetics market, even though the existing market size amounts to merely 5% of the global cosmetics industry (approx. US$ 5.6 billion). Local companies (e.g. Jahwa, our case study) are trying to gain themselves a leading place in this market. These are some of the challenges they currently face: (1) To create brands well recognized and appreciated by the Chinese consumer: MNCs have the advantage of coming with famous brands and marketing savvy. (2) To avoid counterfeiting: the legislation is in place, especially after WTO; however, enforcement remains an issue until there is no overall consciousness that brand awareness and brand protection are actually two sides of the same coin. Soon, this sector will not depend so much on SOEs, leaving it to private hands and foreign players: Jahwa is a good example of an SOE that went through the reform process using the stock market, and is now gradually cutting its links with the government while trying to solve internal issues such as company governance, HR, and management systems.
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Industry restructuring: Overview China is the second largest energy consumer in the world after the United States, accounting for nearly 10% of the world’s total annual energy consumption: its energy consumption is 11.5 times that of Japan and 3.3 times that of Canada. By 2030, the International Energy Agency (IEA) predicts China will account for onefifth of the world’s total annual energy demand, as it is expected to grow at about 5.5% per year through 2020. China is also the third largest energy producer (after the United States and Russia), accounting for about 9.5% of the world’s total energy production. Production and consumption of coal, its dominant fuel, is also the highest. Its growing power generation capacity – which reached 314 million kW in 2000 – has made the country ever since the second largest global power generator.1 Although there is no agency responsible for the energy sector in China, energy responsibilities are shared mainly between the National Development and Reform Commission (NDRC) and the Ministry of Land and Resources. Any proposed energy project must be approved by the State Council, which also sets prices for coal, natural gas, and electricity. The NDRC oversees the industrial policy. Other important agencies are also involved: the State Environmental Protection Administration (SEPA), which supervises energy environmental standards; the Ministry of Commerce (MOFCOM), which evaluates projects involving foreign investment in energy; and the State Electricity Regulatory Commission (SERC), which supervises and regulates market competition in the electricity sector and issues licenses to power generators.2 Traditionally regarded as a strategic sector, China has always tended towards energy self-sufficiency. To a certain extent, this type of policy has succeeded in meeting the country’s energy needs. For instance, in 1997 energy output was equivalent to 1.32 billion tons of “standard coal”: with a consumption of 1.42 billion tons, the self-sufficiency ratio was around 93%.3 However, since the speeding up of economic reforms, self-sufficiency is no longer possible. While China has abundant coal – it supplies around 70% of its needs – the oil sector is much less developed, and hydro- and nuclear power together account for only 10% of the country’s energy needs. As domestic oil production cannot meet the country’s energy demands, which have been growing at about 20% annually,
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China has become a net importer of oil since 1993.4 More than a decade later, China’s pressuring demand for raw materials has inevitably been translated into higher world oil prices, (Figures 6.1 and 6.2). Considering its crucial importance in China’s path to economic development, key objectives of China’s 10th 5YP included the country’s most relevant sources of energy in the following terms: increase primary energy production by 21%, coal production by 17%, hydroelectric generation by 48%, and nuclear power by 266%. Considering the strategic character of this industry, the role of the State has been crucial; but in order to understand this process, we need to analyze its subsectors separately. Coal Coal being highly polluting, the government has been forced to reduce its use for energy purposes. About 33,000 small mines have been closed since 1998, as the central government decided then to focus its attention on the control of large mines, while local governments implemented plans for energy conversion from coal to natural gas, aiming to reduce pollution (in Beijing thousands of industrial boilers have been converted into gas engines in order to improve the air quality for the 2008 Olympic Games).5 That is why, despite its significance, coal has
Figure 6.1 Energy supply production. Sources: SSB (2005); CEIC data (2005). Note SCE = standard coal equivalent.
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Figure 6.2 Energy consumption. Sources: SSB (2005); CEIC data (2005).
progressively been replaced by alternative sources of energy in view of the coal mines’ outdated technology, rampant pollution, lack of safety protection, and poor management. By the end of 1999, coal production had been scaled back to 1.02 billion tons and 31,000 small coal mines were finally closed. Production in 2000 reached 951 million tons, 55% of which was achieved by the major state-owned coal mines.6 Since that year, the 520 state-owned coal mines have been merging into less than 10 major conglomerates, while most of the 50,000 small-scale and inefficient ones have been closed. Technological improvements have been undertaken, including the first smallscale project for coal gasification and a coal slurry pipeline to transport coal to Qingdao port. In addition, China has expressed a strong interest in coal liquefaction technology, and would like to see liquid fuels based on coal substitute for some of its petroleum used for transportation. A coal liquefaction facility is under construction by the Shenhua Group in Inner Mongolia: it started on April 25, 2004 and the first production line is estimated to be completed by July 2007.7 Oil In order to improve energy security, the Chinese authorities began in the early 1990s to acquire interests in oilfields abroad. Significant investments occurred in the Middle East, Central Asia, Africa, and South America. However, some of these ventures proved costly and slow to develop. Thus attention shifted back to the reform of China’s oil SOEs and closer cooperation with international oil companies and markets.8 But energy security seems to be insufficient, considering
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the risky effects of overall energy dependence from external markets. In fact, the International Energy Agency suggested to its member countries throughout the late 1980s to keep a strategic petroleum reserve equaling their 90-day domestic consumption, in order to be protected against oil price fluctuations. That is why, since the 1990s, major oil-consuming countries have adapted their energy policies to the international upheavals: for instance, in the US, oil suppliers have been diversified, the EU has increased internal cooperation in dealing with petroleum, and Japan has set up a long-term strategy incorporating energy security, economic growth, and environmental protection. If China follows suit, not only would it cease to be a scapegoat for international oil price variations, but it could be assured of energy sustainability.9 In 1998, China reformed the petroleum industry to separate regulatory and administrative functions from ownership and operations. Most state-owned oil and gas assets were reorganized into two vertically integrated firms – the China National Petroleum Corporation (CNPC) and the China Petrochemical Corporation (Sinopec). Before restructuring, CNPC was engaged mainly in oil and gas exploration and production, while Sinopec was engaged in refining and distribution. This reorganization created two regionally focused firms, CNPC in the north and the west, and Sinopec in the south, although CNPC is still tilted toward crude oil production and Sinopec toward refining. Other major state sector firms in China include the China National Offshore Oil Corporation (CNOOC), which handles offshore exploration and production, and accounts for more than 10% of China’s domestic crude production; and China National Star Petroleum, created in 1997. Regulatory oversight of the industry is now under the responsibility of the State Energy Administration (SEA), which was created in early 2003.10 In 2002, Chinese oil companies began to look at separating out some of their business units into subsidiaries. CNPC set up subsidiaries for drilling services and geological survey work, and planned to eventually spin them off through international IPOs. CNOOC also created an oilfield services unit – China Oilfield Service, Ltd. (COSL) – which was listed in the Hong Kong stock exchange in November 2002.11 Natural gas As part of the 10th 5YP’s national goals in the energy sector, the authorities planned to increase the share of hydropower and natural gas in its energy resources portfolio. For this to happen, extra pipelines and hydroelectric facilities have been built. In addition, the authorities have exercised preferential financing, pricing regulations, and tax policies to encourage investment in natural gas, which is listed as one of the key industries for China’s development. The National People’s Congress considered in addition an amendment to the Law on Prevention and Control of Air Pollution, which required a shift from coal to natural gas in cities falling below certain air-quality standards. The government also planned to create four natural-gas-producing zones – Sichuan–Chongqing, Shanxi–Gansu–Ningxia, Xinjiang, and in the South China Sea – by 2015–2020, each one of them with a projected annual production rate somewhere between 10 billion and 20 billion cubic meters.12
Energy 115 Considering that the country’s largest reserves of natural gas are located in western and north-central China, it necessitates further investment in pipeline infrastructure to carry it to the eastern cities. For instance, China has a pipeline under construction, the “West-to-East Pipeline” from natural gas deposits in Xinjiang Province to Shanghai, picking up additional gas in the Ordos Basin along the way. Shell was chosen in February 2002 as the leading firm for the project, while Gazprom and ExxonMobil hold significant stakes. Sinopec was also added as an equity partner. Construction began in July 2002,13 and operations started in early 2004. The West-to-East Pipeline could eventually serve as a trunkline, which could be extended to receive natural gas from Central Asia. Electric power The national authorities are in the early stages of formulating a fundamental longterm restructuring of their electric power sector, embodied in the National Power Industry Framework Reform Plan (Dianli tizhi gaige fangan) promulgated by the State Council in April 2002. The State Power Corporation (SPC) divested most of its generating assets and was split into 11 regional transmission and distribution companies in December 2002. The main objective of the reform was to separate power generation from transmission and distribution, and to increase the industry’s overall level of efficiency by introducing new competitive mechanisms. Electricity prices will still be regulated, but there are likely to be major changes in tariffs and the overall regulatory structure for electricity pricing. The process is at an early stage, and many of the details remain to be worked out, presumably in a soon-to-be-published electricity law (at the time of writing), superseding the one established in 1995. Nuclear power Although nuclear power is not yet a major source in China’s power generation mix (it accounts for only about 2% of total generation), the 10th 5YP established the goal of increasing electricity generation from nuclear power to 60 billion kilowatthours (kWh), up 266% from 2001. To do so, China needed to add as many as four new 1,000 MW reactors to the existing nine nuclear power plants in the provinces of Shandong, Jiangsu, Zhejiang, Fujian, and Guangdong. The plan was to build about 30 more nuclear generating units in the next two decades. There is enough technology to build small plants, whereas for larger plants with higher production capacity it has become necessary to turn to international collaborations (companies from Canada, Russia, and France are already building some plants in China). China presents the largest mid-term civilian nuclear power plant market in the world, with an estimated value of US$ 60–80 billion. In other words, as the second largest energy consumer in the world with more than a decade-long reduced capacity for self-sufficiency, China faces an overall challenge of restructuring its energy industry by adapting each one of its sectors to the upgrading of economic reforms. In addition, after several rounds of reforms, the state-owned petroleum firms have also become competing businesses in
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the market. Nonetheless, while domestic crude oil is subject to international variations, prices of oil products are still determined by the Chinese government. It is therefore necessary to clearly define which are the interests and responsibilities of the government, the SOEs, and the energy consumers. For this to happen, reforms would be essential in the pricing mechanism of oil, the dialog with oil-exporting countries, the increasing diversity of energy sources, and the improvement of efficiency in using energy. After all, the exponential growth of consumption within the country will drive the industry to larger needs, and therefore to alternative sources of energy.
Industry outlook As the energy sector has become so diversified in the last years and subsectors have followed alternative production and strategic trends, it is again necessary to observe the sources one by one separately. Coal China has become both the largest consumer and producer of coal in the world, as coal still provides about 65% of total national energy consumption. By 2003, total coal consumption was 1.53 billion tons, that is, over 28% of the world total.14 China is also increasingly seeking export markets for its coal as a way of dealing with its surplus production: in 2002 it became the world’s second largest coal exporter (after Australia). Japan and South Korea are China’s primary markets, and the country is beginning to emerge as a serious competitor to Australia for Japanese coal imports. In recent years, India has also been importing modest quantities of Chinese coal. Meanwhile, coal consumption has decreased, while oil and natural gas consumption have been increasing steadily. Therefore, major changes have taken place in China’s energy consumption structure, especially with regard to oil and gas, increasing (from 17% and 2.0% in 1991 to 28% and 3% in 2001, respectively), and with coal’s share dropping (from 76% to 62% during the same period).15 Oil In 2004 China became the world’s second largest consumer of oil products, after the United States, with a total demand of 6.5 million barrels per day (bbl/d).16 Already by 2002 China’s oil demand was projected by the International Energy Agency (IEA) to reach 10.9 million bbl/d by 2025, with net imports of 7.5 million bbl/d, making it a major player in the world oil market.17 While domestic crude oil production amounted to 181 million tons in 2005 and has been growing at an average rate of 1.8% annually since 1991, crude production of major onshore oil fields, which account for 70% of domestic production, has nevertheless stagnated.18 For example, Daqing in northeastern China, which accounts for about 1 million bbl/d of national output, is a mature field (production began in 1963), but its total results fell by around 5% in 2004.19
Energy 117 Priority is now given to stabilizing production in the east and exploring new fields in the west: the Chinese authorities expect production in Xinjiang Province to reach 1 million bbl/d by 2008. Meanwhile, offshore oil exploration interests have centered on the Bohai Sea area, East of Tianjin – which was believed by 2003 to hold more than 1.5 billion barrels in reserves – and the Pearl River Delta area.20 Indeed, China grows and oil imports increase: net oil imports rose by 669% compared to 1991, reaching levels of 81.7 million tons in 2001, particularly crude oil, which rose by 909% to 60.3 million tons during the same period. Among crude oil imports, those from the Middle East reached 33.9 million tons, accounting for 56.2% of crude oil imports.21 During the period 1996–2001 net oil imports increased by 50% annually. In 2003, oil imports increased by 28%. Net oil imports reached 2.91 million bbl/d in 2004. The upward tendency of oil imports is expected to further escalate in the future: China is bound to face an oil shortage of 155–187 million tons in 2010, and 240–295 million tons in 2020, accounting for 46.3–52.3% and 55.8–62.1%, respectively, of total world oil consumption.22 It is imperative in this sense to find stable providers or otherwise alternative sources of energy, considering the current (unstable) situation in the world, particularly in the Middle East. For instance, Australia and Indonesia have lately become priority targets for oil provisions. Natural gas Historically, natural gas has not been a major fuel in China, but given China’s domestic reserves of natural gas, which stood at 53.3 trillion cubic feet (Tcf) at the beginning of 2005,23 and the environmental benefits of using natural gas, China has embarked on a major expansion of its gas infrastructure. Most of the natural gas reserves are located in western and north-central China, and in offshore regions. Among the most important gas-producing regions are Sichuan, Daqing (Heilongjiang Province), Changqing (Shaanxi), Liaohe (Liaoning), and Tuha (Xinjiang). Annual production stands on average at around 20 billion cubic meters. The government is however striving to double its national production capacity to 40 billion cubic meters by 2005, and to triple the use of natural gas by 2010. The target for 2005 was first met as 40.8 billion cubic meters of natural gas produced in 2004.24 In recent years, China has not consumed more than 23 billion cubic meters of natural gas and the level of per capita natural gas has tended to be very low, accounting for only around 3% of total energy consumption. As part of this future plan, consumption should increase to 7–8% of the total primary-energy volume by 2010 and reach 111 billion cubic meters by 2020. This could involve an increase in domestic production and imports by pipeline in the form of liquefied natural gas (LNG).25 Electric power With reforms, China’s electric power industry has been speeding up: already by 2000, the installed capacity grew by 10 gigawatts (GW) annually; the annual average growth rate amounted to 7.68%, while the average growth rate of power production reached an annual 7.48%.26
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There are four regional power grids: (1) Northeastern China, Northern China, Eastern China, Central China, and Northwestern China; (2) the interconnected grid of four southern provinces; (3) the independent provincial grids of Shandong, Fujian, Chongqing, and Sichuan; (4) the link between central area and the provincial, city, and county levels.27 It is not surprising therefore that, by 2000, China was ranked as the second largest producer of electric power in the world (after the United States), with a total nationwide installation capacity of 314 million kW and a total generating output of 1,300 million kWh, despite having a per capita power consumption of one-thirteenth that in the United States.28 However, due to the unbalanced geographical distribution and arbitrary pricing system, the industry has been suffering from an irrational industrial structure and overproduction. A typical example is that while electricity supply lacks in the west of China, there is an excessive demand in the fast-growing eastern coastal regions, which has lately been translated into severe power shortages, mainly in Shanghai. The Chinese authorities responded to the short-term oversupply by closing down small thermal power plants and imposing a moratorium (with a few exceptions) on the approval of a new power plant construction, which ran through January 1, 2002: all small power generation facilities producing less than 100,000 kW had to be closed down. Already in 1998, 2.84 million kW had been taken offline, and another 1.8 million kW were removed in 1999.29 In order to enhance energy efficiency rates and to reduce pollution, the government has been trying to restructure the thermal power sector by concentrating on building large thermal power plants with a capacity of over 300,000 kW, as well as by using cleaner forms of energy such as gas-fired, nuclear, and hydroelectric power generators. In fact, China has the largest hydroelectric resources in the world and its total hydroelectric potential could be as much as 300,000 MWe: about 20% of national electricity is now generated from hydroelectric sources. In the first half of 2003, however, the authorities approved 30 major new electric power projects, with a total of around 22 GW of capacity. Construction then began on 17 of these projects, with a total of 18.5 GW of new capacity. The largest project under construction, by far, is the Three Gorges Dam. Despite the advantages this project entails (heavy shipping can penetrate the mainland, rail traffic can be freed, industrial development may be achieved inland), it is a highly controversial project due to environmental concerns with regard to the Yangtze ecosystem and the relocation of about 8 million people. When fully completed in 2009, it will include 26 separate 700 MW generators, for a total of 18.2 GW, making it the largest capacity power plant in the world. Another large hydropower project involves a series of dams on the upper portion of the Yellow River: Shanxi, Qinghai, and Gansu provinces have joined to create the Yellow River Hydroelectric Development Corporation, with plans for the eventual construction of 25 generating stations with a combined installed capacity of 15.8 GW. Meanwhile, China’s consumption of electricity has reportedly witnessed doubledigit growth since 1999, especially in the transportation, communication, foodand-beverage-service, and public utility sectors. Growth in Chinese electricity consumption is projected at an average of 4.3% per year through 2025.30
Energy 119 China’s total installed capacity for nuclear power generation increased from 2.1 GW in 2002 to 5.4 GW in 2003. The first generation unit of the Lingao nuclear power plant in Guangdong province began its commercial operations in May 2002, with a capacity of 1 GW. The second 1 GW generating unit began operating in January 2003. An additional 600 MW generating unit at the Qinshan nuclear power plant in Zhejiang Province began its operations in February 2002, and another 600 MW unit at the same site came online in December 2002.31 New and renewable energy New and renewable energy (NRE), such as geothermal sources, wind energy, and solar energy, are still in their early stages of growth. The 10th 5YP placed a high priority on energy efficiency, therefore increasing the application of new energies to increase efficiency, as proven for instance by the natural gas exploration both offshore and in the western provinces. According to the Ministry of Electric Power, China has a huge wind energy resource of more than 250,000 MWe. Much of this potential is concentrated in the northern and eastern parts of the country, especially on the coastline and in Inner Mongolia. Its exploitation becomes effective for grid-connected electricity power production and for use in isolated rural areas. The largest wind power facility in China is in Xinjiang Province, with more than 100 wind turbines for a total installed capacity of more than 50 MWe. The authorities have been launching all kinds of incentives for the development of solar energy through tax breaks and subsidies, which has resulted in more than 25,000 photovoltaic (PV) solar power systems throughout the country, mostly in places where there is no direct access to electricity. The largest capacity PV facilities are constructed in Tibet and have been there for more than a decade.32 As the planet heats up, China is more likely to use this type of energy, mostly in southern provinces such as Yunnan or Guangxi. In other words, the energy sector is as diverse as complex and tends to have a positive correlation with levels of economic development. Despite the timid slowdown of China’s economy in late 2004, the need for energy has placed China as a major focus for both production and consumption: the entry of foreign competitors is a clear proof of it.
Competition Competition is an intrinsic part of the energy industry’s development, more so considering the inevitable opening of the industry to foreign competition. Although slowly, the Chinese authorities have formally agreed, since WTO entry, to open up competition in 10% of its oil sector: foreign oil companies can sell to oil refineries and large customers, thus bypassing SOEs. They can sell to about 60 smaller refineries with a total capacity of 300,000 bbl/d. Refineries are affiliated with local governments and are unrelated to CNPC and Sinopec. Private companies, on the other hand, can handle 20% of oil imports, with their market
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share rising 15% a year.33 Greater competition is likely to have a larger impact on the smaller oil and petrochemical firms. After all, China’s petroleum products have tended to be more expensive than comparable foreign products (around 50% higher), while domestic refined oil prices have been about double international ones. While foreign firms are progressively entering China’s market, national firms will inevitably lose their domestic market share in the long-term (Figure 6.3).34 Although the State still controls the industry, all three largest Chinese oil and gas firms – Sinopec, CNPC, and CNOOC – established private branches through successful IPOs of stocks, essentially between 2000 and 2002. In early 2000, CNPC separated out most of its high quality assets into a subsidiary called PetroChina now the nation’s largest oil and gas producer, and carried out its IPO of a minority interest in both the Hong Kong and New York stock exchanges in April 2000. The IPO raised over US$ 3 billion, with BP as the largest purchaser at 20% of the shares offered. Sinopec carried out its IPO in New York and Hong Kong in October 2000, raising about US$ 3.5 billion. It is also listed in Shanghai and London stock markets. The three global super-majors – ExxonMobil, BP, and Shell – purchased about US$ 2 billion of these amounts. The CNOOC held its IPO of a 27.5% stake in February 2001, after an earlier attempt in September 1999 was cancelled. Shell bought a large block of shares valued at around US$ 200 million. Note that as international oil prices rise, the oil and gas production sectors’ profits will obviously increase: oil prices are a key factor for the performance of crucial firms such as Sinopec and PetroChina. In contrast to the past, China has become more open to foreign investment in the coal sector, particularly in the modernization of existing large-scale mines and the development of new ones. The China National Coal Import and Export Corporation is the primary Chinese partner for foreign investors in the coal
Figure 6.3 Ownership distribution of energy firms, 2003 (N = 9,924). Source: Zhongguo gongye jingji tongji nianjian (2004) (China Industrial Economy Statistical Yearbook), Beijing: Zhongguo tongji chubanshe. Note Sub-sectors for energy here include coal exploration, oil and gas exploration, oil processing, power, steam and hot water production and supply, and gas production and supply.
Energy 121 sector. Areas of interest in foreign investment concentrate on new technologies including coal liquefaction, coal bed methane production, and slurry pipeline transportation projects. China should be aggregating the large state coal mines into seven corporations by the end of 2005. Such firms might then seek to pursue foreign capital through international stock offerings.35 Although large foreign petroleum enterprises can eventually set up single-venture factories in China, the country’s refining industry will eventually innovate technologies by itself. After all, the government still holds majority interests in all domestic oil and gas firms, and foreign investors cannot hold seats on the boards of directors, for instance. In other words, despite the more expanded re-opening to FDI since 2001 (Figure 6.4), most large oil and gas projects in China – which are not the national priority – will involve at least one of the Big Three. In new sectors such as renewable energy, FDI is likely to be much more important: for instance, foreign wind power developers will most likely participate in large projects and wind turbines will in general be imported, as practically no domestic firm produces large-size turbines. In other words, competition has potential in the energy sector, but the direct supervision of governmental authorities may still condition price and output decisions. Despite heterogeneity, WTO challenges will eventually be a determinant factor for domestic decisions, all-in-all depending on the international context.
Figure 6.4 FDI in the energy sector. Sources: SSB (2005); CEIC data (2005).
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WTO impact and challenges As mentioned earlier, as part of WTO commitments China is bound to gradually reduce import tariffs and accept quota concessions: a drop of crude oil tariffs from 16 RMB (US$ 1.93) per ton to zero RMB, gasoline tariffs from 9% to 5%, lubricant tariffs from 9% to 6%, a drop of natural gas tariffs from 6% to zero, etc. However, import tariffs on some energy products will remain unchanged: 9% tariff on kerosene and jet fuel, 6% on diesel, fuel oil, naphtha, and LNG. The impact may nonetheless be quite heterogeneous, depending on the sector we are considering. Coal WTO entry should change the coal industry in the following terms:36 (1) Reduction of intermediate circulation costs that can help the coal’s export competitiveness in the international market: at present, China’s free on board (FOB) power coal is a little less than that of Australia’s. Taking Japan’s exports as an example, the cost insurance and freight (CIF) of China’s power coal is higher than that of Russia’s or Canada’s, but a little less than that of South Africa’s, Australia’s, or the United States’. (2) Less subsidies to coal firms: WTO provisions require clearing subsidies to SOEs. As long as small coal mines continue to exist, production costs inevitably increase and losses multiply. It is therefore necessary to promote larger economies of scale in the industry. (3) Increasing diversification of China’s export system: currently, export rights are not completely out of control. China’s Coal Corporation export volume accounts for 80% of total exports, which monopolizes coal exports. (4) Higher control levels: Chinese coal has a very unstable quality: from production to delivery to port storage, some materials such as metals, bamboo scraps, and explosives are mixed in. Up to now, China has not adopted any international standards to control its coal quality. WTO supervision should eventually eradicate this problem. Crude oil and natural gas China is committed to levy a zero tariff rate on crude oil and natural gas imports (in 2001, the import tariff rate on crude oil import and natural gas [including LNG] were 1.8% and 7.3%, respectively), to reduce tariff rates on oil products and fuel by 6%, and to gradually reduce the tariff rate on plastic products. The non-tariff barriers on the imports of crude oil and oil products are also being canceled step by step, while the oil product sales market is being opened gradually.37 No doubt, China’s WTO access has brought about many challenges to the petroleum and gas industries. As a whole, the impact on weak firms will be larger than on the stronger ones, considering the intrinsic weakness of China’s petroleum
Energy 123 firms: production costs in oil products are higher than in large global petroleum corporations (US$ 12.3/barrel vs. US$ 9.4/barrel); technological levels are too low (large quantities of petrochemicals are burned as raw materials); the product mix is of low quality (high contents of sulfur and benzene in gasoline); the ratio of reserves to development is much lower than that of the world average (in 2001, average oil ratio of the world’s top 50 petroleum corporations was 49.2:1 and the natural gas ratio was 76.3:1; CNPC’s oil ratio was 15.7:1 and the ratio of gas was 35.7:1, while the oil ratio of Sinopec was 6.1:1 and the gas ratio was 17.4:1). As a whole, WTO access will affect China’s refining industry rather negatively. Of the total 220 refining plants in 2001, 166 with capacity under 100 × 104 ton/a are bound to disappear in their totality, and most of the refineries with 100 × 104 ton/a capacity in the inner land and along the coastal areas will be seriously threatened. In addition, the refined oil sales system is the most vulnerable part of China’s oil industry: the corporations created in the time of planned economy lacked a sales network, as oil sales were under strict government control. As the domestic refined oil price begins to be in accordance with the international markets, about 40 to 50% of refining plants and sales enterprises have inevitably suffered bankruptcy after China’s WTO entry. Electric power However, WTO access should facilitate the development of China’s electric power market and expedite the opening of its generation market. Under the conditions of the ‘Power grid controlled by the government and generation plants built by the enterprises’ policy (Zhengfu kongzhi dianwang qiye fuze fadian), the government does not seem to be willing to deregulate its control over the power grid even after WTO, because it is close to economic and military security. Even though China will open its generation market to foreign investors, the opening process will be gradual, considering the critical national role the power sector plays in terms of development. Subsequently, the market share of foreign capital is still rather limited. Thus, in the short run, China’s power enterprises are not bound to be seriously affected by WTO access. In the long run, with the gradual opening of the power generation market, foreign capital will be permitted to cooperate with Chinese enterprises to develop areas where it is difficult to exploit and construct single power generation ventures. In that case, Chinese enterprises will compete at the same level with joint ventures or single ventures supported by foreigners. But China’s power industry can have a gradual intermediate phase to promote its technological innovation and enhance managerial skills while its labor absorption tends to increase with time (Figure 6.5), thus intensifying its competitiveness with regard to the foreign enterprises. WTO impact is therefore pretty diverse within the energy sector, and it will all depend on the adaptation of internal policies to international requirements. The case of XJ Group proves that such adaptation is possible, as long as market competition becomes an instrinsic part of production priorities.
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Main tips (1) Restructuring. Since 1993, China has become a net importer of oil and is no longer self-sufficient in energy. The SOEs’ restructuring process has implied crucial changes within the industry: merging of 520 state-owned coal mines into less than 10 major conglomerates and closing down of most of the 50,000 small-scale and inefficient coal mines; separation of regulatory and administrative functions from ownership and operations in the oil industry; preferential financing, pricing regulations, and tax policies for natural gas investment; separation of power generation from transmission and distribution, as well as introduction of new competitive mechanisms in the electric power sector; regulation of electricity prices in addition to changes in the overall regulatory structure for electricity pricing; finally, need for international collaborations for the development of nuclear power. (2) Outlook. Despite being the world’s largest consumer and producer of coal, China’s energy consumption structure has undergone major changes: increase of oil and gas and drop of coal’s share. As a result of oil shortage, China will presumably consume more than 60% of the world’s total oil consumption in the near future. As China is the second largest producer of electric power, large projects such as the Three Gorges Dam or the upper portion of the Yellow River should drive the country to increase its electricity consumption to an average of 4.3% per year through 2025. Nuclear power generation, along with wind and solar power, should become alternative sources of energy, although very much depending on foreign entry. (3) Competition. China has become more open to FDI in the coal sector, particularly in the modernization of existing large-scale mines and the development of new ones. Despite State control in the oil sector, Sinopec, CNPC, and CNOOC have established private branches through successful IPOs since 2000. However, domestic supply will not be able to meet rising demand, for which oil imports will rapidly increase. Meanwhile, timid opening to FDI can create further competition in alternative sources of energy such as solar power or wind energy. Nuclear power is also bound to be foreign oriented. (4) WTO impact. The impact is not homogeneous within the energy sector. In the coal sector, the impact is bound to be positive: lower circulation costs and therefore increase of coal’s export competitiveness; promotion of large-scale economies within the industry as governmental intervention is reduced; end of China’s monopoly export system; and product quality improvement. Oil and gas sectors may undergo a much more painful process, considering the intrinsic weakness of China’s petroleum firms. In addition, most of the refineries in the inner land and along the coastal areas will be seriously threatened, as domestic refined oil prices have had to be in accordance with the international markets and about 50% of firms have gone bankrupt. However, WTO access should facilitate the development of China’s electric power market and expedite the opening of its generation market.
Energy 125
Figure 6.5 Employment in the energy sector. Source: SSB (2005).
Case study: XJ Group (XUJI Corporation) Interview with Mr Wang Jinian, President and GM The XJ Group develops, produces, and sells a variety of equipment for the power industry, from relays in electrical systems to integrated systems. It originated as the Xuchang Relay Factory, which was relocated from Heilongjiang Province to Xuchang, Henan Province, in 1970. The factory moved to Xuchang in search of labor and natural resources that were cheaper than in the north of China. In 1993, it was restructured into a holding company. At the end of 1996, XJ Group came into being, with the State as its major shareholder. The net assets of the company increased from 12 million RMB (US$ 1.45 million) in 1984 to 4 billion RMB (US$ 483.675) in 2002, and the total annual profit grew from 2.1 million RMB (US$ 254,000) in 1984 to 275 million RMB (US$ 33.2 million) in 2002. Currently, XJ Group has 21 subsidiaries, including two listed companies and eight joint ventures. The group is organized into five major businesses areas, of which Power Systems is the biggest; the others are Integrated Electromechanical Equipment, Environmental Protection Engineering, E-commerce, and Financial & Asset Management (Figure 6.6). Market and competition Mr Wang very clearly states that competition is fierce in his industry: We have different competitors in different areas, such as in transformers, switches, protection devices, control devices, etc. The year before last, we asked
Figure 6.6 XJ group organization chart.
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Energy 127 every subsidiary to carry out a ‘Top-quality’ project. Every company has to have its own ‘three-big-one-low’ product, i.e. the product with a big market, a big market share, a big output percentage, and the lowest cost. According to Mr Wang, there are too many ministries involved in the energy sector which make his business very complex, apart from the government agencies; the group also has to deal with provincial and local authorities: Now my boss is the government. XJ Group is still mainly held by the State. My party membership belongs to the province, and the assets belong to the city. It is very complex. We are responsible to the local government. If we develop well, the local government gets more funds. Our development is the development of the government. Basically speaking, we are free to make every decision, large or small. We are not required to submit the so-called achievement report to the government. At the end of the day, the government only asks for taxes. He explains the way they deal with this complexity: We set up JVs with the electricity bureau of each province. That gives us an advantage over other competitors. We offer two attractive points for those electricity bureaus. Firstly, it is our management systems. Though born as an SOE, XJ has experienced a profound transformation. The local government wants to learn from us. Secondly, we have a complete portfolio of products. We offer integrated solutions. We do not have strong Chinese competitors that can do this, but we need to develop this advantage even more. We invest 5% of sales income annually in R&D. The customer of Integrated Electromechanical Equipment is civil buildings, 40% of which are government properties. The customer of Environmental Protection Engineering is solely the government. E-commerce’s customers are private enterprises. We do E-commerce in low-voltage electrical products. We also own one asset-management company and one security company. As to foreign competitors, they mainly concentrate on integrated solutions while the local companies are active in other product lines. Mr Wang expands on the competition in China: In China, there are still few companies with integrated service capability. Only XJ is a qualified supplier of integrated solutions. Multinationals are our competitors but also our partners in certain activities. We have a JV with Toshiba in spare part automations. We have another JV with Hitachi in protection devices. We are negotiating with Siemens to form a new JV with them. Our relationship with them is excellent. We are not No.1 in China yet. I think ten more years of hard work may lead us to that position.
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With regard to the impact of WTO in his industry, he specifies as follows: WTO has little impact on us because a long time ago overseas competitors had already come into China. If XJ did not exist, the price for protection devices would have been 20 times higher than the current one. Company reform According to Mr Wang, the history of XJ can be divided into three phases: Before we moved to Xuchang, the period from 1946 to 1970, when the company started. The second period, from 1970 to 1984, was of further consolidation. Finally, between 1985 and today, we have been undergoing important reforms. Of these three stages, the last period is the most important. The average annual growth rate during this last period has been around 30% for 18 consecutive years. According to Mr Wang, there are two central issues in this last period for the success of XJ Group: constant technological innovation and improvement in management. The former refers to how the company has grown from one sole product – relays in electrical systems – to supplier of integrated systems for the power industry. The latter is tightly linked to the change of the company’s culture from a planned economy to a market economy as the most important challenge of XJ’s reform.
Mr Wang Jinian’s story I joined the company in 1968. Since then, I climbed up the career ladder from bluecollar worker, team leader, workshop leader, deputy factory leader, factory leader, to General Manager. I went to the university in 1983 and last year I got my Master’s degree in Economics. I am now the Chairman of the Board and CEO of the company. XJ is like a fleet: every ship has her own driving power. I am in charge of the direction and control of the investment and expansion of each ship. Therefore, we can march forward as a whole. All ships must be connected and need to share information and resources. Meanwhile, the development of each ship should be balanced in order to get a better development for the whole fleet. Currently, the most important task for me is to integrate the sales and R&D of the group. This is currently our weakest point. I do not foresee any big change in the organizational structure in the near future.
HR at XJ In HR management Mr Wang explains how the group went from a system based on seniority to one based on performance. He continues by saying, “We started as
Energy 129 a typical wholly state-owned enterprise. Now, we have conducted three reforms in the management system: in management level, in compensation, and in evaluation of performance.” As far as management level is concerned, Mr Wang describes the actions taken: There are two major features in the reform of management levels. First, all our subsidiaries only have one responsible person. There are no deputy positions. That way we cut down on administrative expenses. Second, we carry out an annual appraisal of all management personnel. The lowest 5% have to leave their position. These three years together, we have eliminated 82 employees in management positions. Most of them still work for the company, but in different positions, and there are also others who had to leave the company. With regard to their compensation policy, they follow two principles: First, who contributes more to the company gets more money. Second, we pay on the basis of market price. Our plant is located in Xuchang, a city in the middle of China. A worker that completes his workload gets around 800 RMB (US$ 96.7) per month. A normal technician or programmer gets around 1,500 RMB (US$ 181.4). Supervisors earn 3,000 RMB (US$ 362.7). Income varies in accordance with the industry standard. We also have companies and employees in the US who are responsible for R&D. Those senior experts get paid according to international standards. There are also people from Hitachi and Toshiba working in XJ, cooperating with us as long-term employees. Within XJ, Mr Wang says there is a very harmonious labor relationship: Frontline workers can accept the high salary of high-level employees, which is very important for the morale of the whole company. The monthly salary can be as low as 300 RMB (US$ 36.27), or as high as 60,000 RMB (US$ 7,255). When I tell our frontline worker, ‘engineers can earn 200 times more than you, so what do you think about this?’, they answer, ‘Without them, we cannot earn our salary.’ In the area of performance evaluation, Mr Wang says that XJ has implemented a very dynamic labor management system consisting of two mechanisms: appraisal system and separation procedure: Up to my level and down to the frontline worker, every employee has a monthly working plan. After he completes his monthly workload, his supervisor will evaluate his performance and give him a score. The yearly score comes from the accumulated monthly score. This yearly score is used to separate low performers.
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He continues to explain the system: The eliminating system is applied at four levels. First, the eliminating percentage of middle-level management is 8% annually. The transfer percentage of technicians is 8% annually and that for normal workers is 6%. Most of them are down-graded or moved to another position, but if their scores are still lagging behind one year later, they will be fired. This system has been in place for eight years. We use KPI (Key Performance Indicator) in evaluation and appraisal. Each unit has its own annual KPI. Then each unit passes its KPI to each team and individual. This KPI system is derived from the Balanced Scorecard system adapted to XJ. We have a very young team managing the system. These systems are mainly used in Xuchang site, where they have 4,800 employees. Mr Wang completes by saying: “We have more employees outside Xuchang, for example, 1,500 in Fuzhou, 400 in Yangzhou, 100 in Shenzhen, 100 in Beijing, 300 in Harbin, etc.” They take in more than 300 bachelor graduates annually. Throughout the company, the HR Department controls some main features: first, it makes sure that the total salary expense is in accordance with the contribution of the unit to the group; second, it manages personnel training; third, it is in charge of the hiring plan of employees with a bachelor’s degree or above. The hiring plan of employees with lower education is at each unit’s decision. Future and challenges Mr Wang sees the internationalization of XJ as the most important challenge ahead. However, this process has some roadblocks, as he explains: “The largest obstacle lies in the management team and myself. We still need to update ourselves. XJ Group is a local company and there is a lot of scope to improve if we want to be global.” The future development of XJ in the international market is mainly in other developing countries. He indicates the steps that XJ has taken in this direction: There is a huge need for our products in the developing world and there are not many companies of our scale. We see many opportunities there. In Vietnam, there are five projects under negotiation, which have a total value of US$ 500 million. In China, we have sales offices in every province. Currently, our largest markets are Southern China and Middle China. We now set off towards Eastern China and Northern China. XJ has ambitious objectives for the future. Mr Wang explains this issue with the following words: “Our objective for 2020 is to achieve RMB 155 billion (US$ 18.74 billion) sales income. Last year, our sales income was RMB 4 billion (US$ 483.6 million).” How to achieve this objective? “By a culture of unity and cooperation” is Mr Wang’s response. He adds: “Only with high motivation can we
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Energy 131
and each part of the group work together to meet the objective. My task is to keep them motivated, and give them freedom in the day-to-day administration.” Reflecting on the reform paths followed by his company, Mr Wang says: There is little to regret on our route of reform. We have been undertaking constant innovation, which most of the SOEs haven’t cared for. I think our advantages are not less than those of private companies, nor less than those of big international companies. When we cooperate with Siemens, Toshiba, and Hitachi, they are surprised to see how our HR system works. Hitachi now moved its R&D of protection devices to Xuchang, because its R&D expenses were too high, which increased the price of its products. Despite the big challenges in the reform process, Mr Wang is basically optimistic about the success of his company. He is convinced XJ will emerge as one of the big companies in the industry and this positive attitude radiates to his organization.
XJ group Learning points (1) Have a clear leadership. Vision and clear strategy are a must to transform and manage complex groups such as XJ. (2) Implement advanced HR systems. XJ has implemented a modern management system of employees. XJ’s actions are considered at three levels: first, to professionalize its management team and simplify positions (i.e. eliminate deputy directors); second, to have compensation based on performance and not on seniority; third, to establish a performance evaluation system based on KPI and the Balanced Scorecard. Challenges ahead (1) Dealing with multiple administrative levels. There are many administrative bodies involved in the energy sector: central, provincial, and local. This makes the industry highly complex and slow. (2) Increasing competition from foreign companies. These companies are extremely strong in technology. It will be difficult for local companies to survive competition in an open environment. (3) Forming a management team with international experience. Create a team able to compete with foreign firms, not only in China but also abroad.
Conclusions and future perspectives China is the world’s second largest energy-consuming country after the United States. Production and consumption of coal, its dominant fuel, are the highest in the world. Nonetheless, the use of coal has fallen quickly, even as the economy continues to expand. Domestic oil production is stagnant, but robust demand has forced
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China to import growing quantities of oil. Surging international investment is also helping to accelerate the pace of reform within China’s petroleum sector. Electric power supply overshot demand from 1997 to 1999, causing a sudden slowdown in foreign investment in the power sector. Strong growth over the past few years has begun to correct the mismatch, however, and China’s overall power consumption remains relatively low. After decades of being ignored, China’s natural gas sector seems to be bound to play a much larger role in helping the country to meet its energy needs efficiently with minimal environmental damage. WTO access affects China’s energy industry both positively and negatively. Coal intermediate circulation costs will be reduced and its export system will become more diverse; the oil and gas market should eventually open up, but challenges become crucial as the impact on enterprises making losses will be larger than on profitable ones. The electric power market should be easier with WTO, but as strategic reasons impede the full deregulation of this sector, restructuring may be slower than expected. For WTO commitments to be accomplished, China needs to restructure the energy industry through a set of specific initiatives: coal needs to be further converted into natural gas, something that the government has already been encouraging through preferential financing, pricing regulations, and tax policies; oil ought to be reorganized and its assets reduced into two vertically integrated firms: CNPC and Sinopec; electricity is bound to be further restructured through the National Power Industry Framework Reform Plan promulgated by the State Council in April 2002; finally, nuclear power could be enhanced, as China has the technology to build small plants, while dependence on foreign providers still remains crucial for larger plants with higher production capacity. Since early 2004, the debate in the Chinese media has been centered on excessive oil demand and widespread energy shortages. According to the current situation, China’s annual oil consumption will reach 300 million tons by 2010 and 400 million tons by 2020, whereas the country can produce only 200 million tons per year. As economic growth has been too accelerated in its industrial sectors since 2002, the country has fallen victim to inadequate capacity in coping with the soaring demand for electricity. For instance, the number of household air conditioners increased by almost 10 million annually in recent years. But the issue is not so much about reducing consumption but rather about making it more efficient to ensure steady improvement of production and living levels, such as increasing the public’s water-saving and energy-saving awareness. Price leverage, and also industrial and consumption policies encouraging efficient and clean energy consumption, could be adequate instruments. But, due to the lack of a power consumption policy that properly prices additional capacity demand, consumers will keep buying cheap electric air conditioners or wasting water resources, mainly in peak summer periods. Another major worry stems from the growing automobiles market: it is estimated that more than two-thirds of the country’s additional oil demand will come from the transportation sector in the next decades. After all, China is bound to become the second largest car market in the world. As long as environmental and
Energy 133 health factors are not included in the industrial and consumption policies and therefore there will simply be an increase in energy prices, this excessive rhythm of energy consumption will inevitably keep growing, but at the expense of sustainable development. Although our case study, XJ, is not strictly an energy-producing firm but rather a supplier to the industry, it is equally affected by the energy sector’s development. XJ also suffers the pressure coming from other domestic and international companies. Besides, XJ has to deal with the increasing complexity of the industry it serves. One of the points highlighted by our interviewee was the entanglement of administrative bodies XJ has to deal with. China has a very complex administrative system with three general levels: central, provincial, and local. XJ has to deal with all three, sometimes with significant conflicts of interest. Indeed, XJ is advancing in its reform process. However, there are still concerns about its future, especially when it has to compete with technological giants such as ABB, Siemens, or Hitachi.
State Power (1997) China Southern Power Grid (2002) Guangdong Power Grid Corporation (1970) Daqing Oilfield Co., Ltd (2000) Jiangsu Electric Power Company (1988) Northeast China Grid Corporation Limited China Petroleum & Chemical Corporation Shengli Oilfield Company Limited China Huaning Group Co., Ltd Zhejiang Electric Power Corporation Shandong Electric Power Corporation
1 2 3 4 5 6 7 Power Power Power
Power Power Power Oil Power Power Oil
Main product
Source: China Top Energy Enterprises by World Business Review (2005).
8 9 10
Company name (year founded)
Ranking
Table 6.1 Top ten energy enterprises
Beijing Zhejing Shandong
Beijing Guangdong Guangdong Heilongjiang Jiangsu Liaoning Shangdong
Location
SOE SOE SOE
State enterprise State enterprise Wholly owned SOE subsidiary Wholly owned SOE subsidiary Wholly owned SOE subsidiary Wholly owned SOE subsidiary Wholly owned SOE subsidiary
Ownership
45,140.87 41,427.38 39,355.68
482,951.73 125,983.38 92,503.55 85,552.40 59,447.11 54,678.00 46,887.96
Revenue in 2004 (RMB mn)
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7
Food
Industry restructuring: Overview As a developing country, China’s food industry is particularly sensitive: food products are still crucial in most Chinese consumers’ basket of goods and therefore have to be accessible to all. As in most countries, agricultural products, and therefore food, have been subject to State intervention and subsidized policies. In China’s particular case, prices have rarely responded to market forces until only recently. Macro-economic pressures have in this sense conditioned the industry’s restructuring of SOEs, as well as the distribution and sophistication of food products. Throughout the 1950s and 1970s, agricultural commodities were procured, distributed, and sold by the governmental authorities, while prices were set up by the authorities. In the 1980s, processed foods were limited, as households prepared simple meals from rice, noodles, raw produce, and meat. Distribution was then limited and inefficient. But since the mid-1980s food marketing has become one of the first sectors in China in which restructuring of SOEs was effectively translated into growing privatization: as urban food expenditures increased, a larger number of players entered the food market, from small entrepreneurs to SOEs and JVs.1 The first SOEs reforms in the grain market were launched in 1992–1993. The aim was to lift control over grain prices and grain firms’ management. But in 1994 it resulted in high levels of inflation, due to inadequate grain storage and lack of macro-control measures. Subsequently, the government’s monopoly on the food industry increased, mainly in terms of prices and production quotas. In 1998, a second reform took place: farmers could not sell surplus grain, while SOEs had accumulated huge losses of 210 billion RMB (US$ 25.3 billion). Thus, the purchase of grain ended up being monopolized by the SOEs. But this initiative also failed. Four years later, in March 2002, the State Economic and Trade Commission (today’s NDRC) and the Ministry of Agriculture jointly launched a five-year national program aimed at developing and restructuring the food processing industry, thus stimulating domestic consumption and enhancing the development of the farming industry and the farmers’ income. By June 2004, the State Council released a new Regulation on Grain Circulation Management (Liangshi liutong
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guanli tiaoli) announcing a set of measures to introduce more competition in the procurement and marketing system. In other words, grain prices and supplies are now starting to be regulated by market fluctuations, while a general increase in competition between SOEs and private companies is bound to grow. Despite governmental initiatives and the subsequent breakdown of the SOEs’ monopoly on the grain market since 1998, China’s food industry system is still relatively young, mostly in terms of distribution, while supply has increased and competition has become more sophisticated. Within this context, producers have had to confront enormous challenges. As the challenges grew, the 10th 5YP established from its very beginning a target of an estimated average annual growth rate of 10–11% in the food industry between 2000 and 2005. According to the official parameters stated in the 10th 5YP, this could only be achieved by building up world-renowned brand names and by establishing large-scale modern firms with strong R&D. As a result, the proportion of food industry output in agriculture jumped throughout most of the 10th 5YP from 30% to 50%. The combination of official targets and an emerging market demand created the need to combine food processing, farm crops production, and material base construction. This way, total production value should reach about 356 billion RMB (US$ 43 billion) by 2010, while total profits grew 5% a year from 2000 to 2005, reaching 100 billion RMB (US$ 12.1 billion) by 2010.2 Once these aims are achieved, the national food industry can be comparable to other industries within China. But this can only be potentially true if the laborintensiveness pattern of agricultural output is further developed, mainly as a result of the increasing pressures from highly competitive foreign products circulating in the Chinese market (e.g. US cereals), as land-intensive crop production (e.g. cereals) needs to be shifted to labor-intensive crop production (e.g. fish, vegetables, flowers, fruits, etc.) (see Figures 7.1a and 7.1b). Production structure changes can then eventually condition the nationwide supply of food products, in particular farm crops, as specified within the 10th 5YP’s grain production target (see below). Indeed, the 10th 5YP specified that by 2005 the output value ratio for meat processing should have increased from 4% to 10%, with total processing quantity reaching 6.4 million tons; the ratio for farm crops processing from 8 to 15%, with total processing quantity reaching 8.25 million tons; sugar output should have reached 10 million tons; dairy products 0.8 million tons; liquid milk 2 million tons; beverages 27 million tons; edible vegetable oil 30 million tons; canned food 3.8 million tons; beer 25 million tons; and salt 32 million tons. These are just a few examples of how extremely varied China’s food industry is, as it includes a few dozens of subsectors in food processing, food manufacturing, and beverage manufacturing (Table 7.1). For instance, key food-processing industries include beans, corn, potatoes, milk, meat, sugar refinement, storage and transport, beverage, convenience food, aquatic products, and so on. In order to minimize the scope of analysis, we have randomly chosen those that we think are probably the most significant in today’s Chinese consumer’s basket of goods.
Food
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Figure 7.1a Main export food commodities in value (US$ mn) (Customs statistics). Source: SSB (2005).
Restructuring is not so much concentrated in particular firms, but rather in products. As the 10th 5YP included five specific food sections derived from a more solid development of the food industry, we will consider them in more detail: (1) farm crops (bean, corn, flour, rice); (2) sugar; (3) dairy products; (4) meat; (5) others (oil, salt, beverage, canned food, brewery, yeast products, bakery, and candy).
Figure 7.1b Main import food commodities in value (US$ mn) (Customs statistics). Source: SSB (2005).
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Table 7.1 Food variations and subsectors Food types
Subsectors
Food processing
Rice milling, flour milling, rice and flour products, mixed feed, aquatic feed, other animal feed, edible vegetable oil, inedible vegetable oil, cane sugar, beet sugar, sugar, slaughtering, meat products, meat by-products, egg products, frozen aquatic products, dry aquatic products, preserved aquatic products, fish meat and fish meat products, other aquatic products, salt. Candy, pastry, biscuits, preserved fruits, other pastry and confectionery manufacturing, dairy products, canned meat, canned fruit, canned vegetables, other canned food, amino acid, gourmet powder, citric acid, yeast products, enzyme preparations, other fermented products, soy-sauce and other sauces, vinegar, condiment, seasoning oil, other spices, bean products, starch and starch products, dairy substitute, ice, starch sugar, ice cream and frozen desserts. Alcohol, liquor, beer, cooking wine, wine, fruit wine, carbonic-acid beverage, natural mineral water, fruit and vegetable juice drinks, instant drinks, other soft drinks, tea, other beverages.
Food manufacturing
Beverage manufacturing
Source: China Markets Yearbook (2005).
Farm crops Generally speaking, the 10th 5YP’s target for farm crops was to develop new products (e.g. corn for breakfast cereals or starch for instant noodles, ice creams, and corn oil) and to improve their quality and increase their exports (particularly rice). It is important to notice the decrease of state farms (nongchang) from 2,101 in 1998 to 1,928 in 2004,3 which could be due to the outgrowing migration flows of peasant workers to the cities (around 150 million), but also to the predominance of small rural family firms. Unfortunately, we have been unable to gather useful data on rural firms that would allow us a better understanding of the output distribution of farm crops. Although township and village enterprises (xiangzhen qiye, TVEs) do not concentrate on farm crops, they are indirectly linked to them through the production of rural industrial goods. Despite their stagnating number in the last few years (Figure 7.2), what has attracted our attention most is the predominance of self-employed and therefore the surge of a potential for higher productivity levels in rural industrial production, and indirectly in farm crops, essentially through the processing and manufacturing of agricultural goods (Figure 7.3). Sugar The key goals for sugar are to adjust the structure, control the total output, and strengthen the pollution control. As part of the firms’ organizational structure,
Food
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Figure 7.2 Total number of TVEs (mn). Source: SSB (2003).
Figure 7.3 Ownership structure of TVEs. Source: SSB (2003).
horizontal integration is encouraged through restructuring of assets in order to create economies of scale in the sugar sector. Although the sugar sector is diverse in terms of enterprise structure (50% of other firms are joint stocks, private and limited liabilities), within the total of 353 firms, SOEs still dominate the market (Figure 7.4). Dairy products China’s output of dairy products has increased at an annual rate of 11.6% in the past 20 years. The total revenue of liquid milk and dairy products reached 49.8 million RMB (US$ 6.02 million) in 2003, a 41% increase over the previous year.4 However, there is still a huge market to develop: today the average global dairy
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Figure 7.4 Ownership distribution in the sugar subsector (N = 337). Source: China Markets Yearbook (2005). Note We include cane sugar, beet sugar, and sugar processing.
products consumption per person is 92 kg, while for developed countries it is 258 kg. According to predictions made by the China Dairy Product Association, by 2007 the consumption of dairy products in China should increase by 15%, with milk accounting for much of that rise.5 But diary products are bound to undergo restrictive measures such as the reduction of the production of powder milk and the increase of liquid milk. For this to happen, good milk bases need to be created. At the end of the 10th 5YP, the automatic milking ratio was planned to reach 50% and milk quality was to be improved holistically. After all, SOEs and collectiveowned firms represent less than 50% of dairy goods producers, while ‘others’ (which we assume refer to joint stock firms, as they represent about 40% of China’s top ten dairy firms) share more than half of the dairy market (Figure 7.5). Cooked meat By 2005, the output for cooked meat reached approximately 4 million tons through the improvement of package conditions and meat quality. The final aim has been to increase its exports. In terms of firms’ ownership, meat products
Figure 7.5 Ownership distribution in liquid milk and dairy products (N = 584). Source: China Markets Yearbook (2005).
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Figure 7.6 Ownership distribution in meat products (N = 960). Source: China Markets Yearbook (2005).
are distributed between SOEs and collective firms (44%), while 56% accounts for foreign funded, overseas Chinese funded, joint stocks and private (Figure 7.6).6 Canned food China’s production of canned food recorded its highest annual increase in output and exports in 2001. In 2002, China produced 2.23 million tons of canned food and exported 1.4 million tons, a year-on-year increase of 25.8% and 16.9%, respectively.7 About 65% is exported to more than 120 countries and regions in Southeast Asian countries, Europe, North and South America, and Africa. China’s canned food plants mainly produce canned meat, seafood, fruits, vegetables, and other canned food: amongst all of the 493 firms in the canned food sector, there are more SOEs and collective firms (they add to 55%) than foreign and overseas Chinese funded firms (25%), while joint stock firms and others share almost half the market (43%) (Figure 7.7). Beer In 2002 China overtook the US to become the largest producer of beer in the world. The output rose by 5.7% in 2003 and then by a further 15.2% in 2004, to stand at 29.1 million tons in the latter year. The recent rise in production has
Figure 7.7 Ownership distribution in canned food (N = 592). Source: China Markets Yearbook (2005).
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been accompanied by renewed interest in China on the part of some foreign firms.8 However, the per capita consumption of beer was only 17.4 liters. While the number of beer companies has been reduced, the scale of beer manufacturers has become larger: in 2002 the average output of each company reached 68,000 tons, while the total amount of main beer producers, i.e. those achieving an output of at least 50,000 tons, totaled 84, their output accounting for 82.8% of the total. Amongst all the 504 firms, in 2003, SOEs, collective firms, foreign funded, and other companies (private, limited liability, joint stock) represented 9%, 6%, 23% and 62%, respectively (Figure 7.8).9 Soft drinks The soft drinks market scale has been growing rapidly in recent years. The total market value grew by 106.43% between 1998 and 2004, reaching a total value of RMB 39.8 billion (US$ 4.81 bn).10 The sales volume of soft drinks reached as much as 25,389 million liters. The increase in supply has been driven by rising production of bottled water, flavored and carbonated drinks, tea-based beverages and fruit juices. Foreign firms have played an active role in all these sectors. For example, sales of Coca Cola grew by 22% in terms of volume in 2004. Danone is the largest supplier of bottled water in China, although this leadership is largely owing to the purchase of successful local brands, notably the market leader, Wahaha, and the second largest bottled-water brand, Robust.11 China’s top drinks manufacturers include: carbonic-acid drinks (Coca Cola, Pepsi Cola); mineral water (Nongfu Shanquan, Robust/Lebaishi, Wahaha); fruit and vegetable drinks (Huiyuan, Luling, Coconut Palm/Yezhi); lactic acid and instant drinks (Nestle, Kraft, Novartis, Bright/Guangming) (Table 7.2). This sector being rather foreign oriented, it is therefore not surprising to observe the spectacular presence of foreign funded firms (‘others,’ including also private and joint stocks) and overseas Chinese funded firms (69%) (Figure 7.9). Summing up, although important reforms in the grain market have been launched, in general terms the food industry’s (distribution) development is fairly young in China, and restructuring is not a major issue from the standpoint of
Figure 7.8 Ownership distribution in beer (N = 504). Source: China Markets Yearbook (2005).
Table 7.2 Top ten drinks manufacturers by subsector Table 7.2a Top ten carbonic-acid beverage manufacturers Company name
Ownership structure
Coca Cola (China) Beverages Co., Ltd Guangdong Jianlibao Beverage Co., Ltd Shanghai Shenmei Beverage & Food Co., Ltd Swire Guangdong Coca Cola Co., Ltd Shanghai Pepsicola Beverage Co., Ltd Hangzhou Zhongcui Food Co., Ltd Pepsico (China) Co., Ltd Tianjin Coca Cola Beverage Co., Ltd Shenzhen Pepsi Cola Drinks Co., Ltd Nanjing Zhongcui Food Co., Ltd
Foreign funded Overseas Chinese funded Foreign funded Overseas Chinese funded Foreign funded Overseas Chinese funded Foreign funded Foreign funded Foreign funded Foreign funded
Revenue in 2003 (RMB mn) 2,165 2,048 1,449 1,287 1,271 986 914 747 718 695
Table 7.2b Top ten bottled drinking water manufacturers Company name
Ownership structure
Revenue in 2003 (RMB mn)
Beijing Coca Cola Beverage Co., Ltd Hangzhou Qiandaohu Yanshengtang Drinking Water Nongfu Spring Co., Ltd Cestbon Food & Beverage (Shenzhen) Co., Ltd Shenzhen Daneng Yili Beverage Co., Ltd Shanghai Zheng-Guang-He Drinking Water Co., Ltd Nestle Sources Shanghai Ltd Wahaha Drink (Gaobeidian) Co., Ltd Wahaha Group Caohu Co., Ltd Lebaishi (Wuhan) Food & Beverage Co., Ltd
Foreign funded Limited liability Joint stock Foreign funded Foreign funded Foreign funded
621 588 324 271 167 165
Foreign funded Foreign funded Foreign funded Foreign funded
125 121 114 114
Table 7.2c Top ten fruit and vegetable juice drinks manufacturers Company name
Ownership structure
Revenue in 2001 (RMB mn)
Beijing Huiyuan Beverage & Food Group Co., Ltd Xiamen Yinlu Food Co., Ltd Redbull Vitamin Drink Co., Ltd Guangzhou A.S. Watson Food & Beverage Co., Ltd Beijing President Drink Co., Ltd Shandong Luling Fruit-juice Co., Ltd Yantai North Andre Juice Co., Ltd Sanmenxia Hubin Fruit-juice Co., Ltd Shanghai Suntory-maling Foods Co., Ltd Huiyuan Mohafu Food Co., Ltd
Foreign funded
581
Overseas Chinese funded Foreign funded Overseas Chinese funded
580 502 403
Overseas Chinese funded Foreign funded Foreign funded Limited liability Foreign funded Foreign funded
395 322 264 241 227 210
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Table 7.2d Top ten instant drinks manufacturers Company name
Ownership structure
Veivei Group Nestle Dongguan Co., Ltd Coca Cola Bottle Manufacturer (Dongguan) Co., Ltd Kraft Tianmei Food (Tianjin) Co., Ltd Shanghai Yinglian Food & Beverage Co., Ltd Kraft Guangtong Food Co., Ltd Shijiazhuang Health Food Factory Guangxi Wuzhou Bingquan Industrial Stock Co., Ltd Tianjin Gaolegao Food Co., Ltd Daimin Food (Zhangzhou) Co., Ltd
Joint stock Foreign funded Overseas Chinese funded Foreign funded Foreign funded Foreign funded Private enterprise Joint stock Foreign funded Foreign funded
Revenue in 2001 (RMB mn) 7,109 1,157 567 373 182 165 156 152 136 60
Table 7.2e Other soft drinks manufacturers Company name
Ownership structure
Coconut Palm Group Ltd Robust (Guangdong) Food & Beverage Co., Ltd Guangdong Jianlibao Group Co., Ltd
Joint stock Foreign funded Overseas Chinese funded SOE Overseas Chinese funded Joint stock Overseas Chinese funded Overseas Chinese funded Foreign funded Foreign funded Overseas Chinese funded Foreign funded
Lulu Group Co., Ltd Guangzhou Tingjin Food Co., Ltd Junyao Group Dairy Industry Co., Ltd Shenyang Tingjin Food Co., Ltd Hangzhou Tingjin Food Co., Ltd Shanghai Suntory-maling Foods Co., Ltd Tianjin Jinmei Beverage Co., Ltd Beijing President Food & Drink Co., Ltd Fujian Tingyi Food Co., Ltd
Revenue in 2001 (RMB mn) 1,647 1,585 1,354 1,078 510 268 231 213 198 152 141 126
Source: China Markets Yearbook (2005). Note Although most of the above mentioned firms do not appear in the top twenty company food list (Table 7.4), they are extremely well-known brand names to the average Chinese consumer.
changes in ownership structure or even in corporate governance. As a result, we have concentrated more on the product than on the institutional framework. It is important to note, however, that both the product and the enterprise structure are very much conditioned by the thirst of foreign suppliers and the increasingly changing patterns of consumers’ preferences.
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Figure 7.9 Ownership distribution in soft drinks (N = 840). Source: China Markets Yearbook (2005).
Industry outlook Although the setup target within the 10th 5YP was 10–11%, throughout the 1990s China’s food industry evolved at an annual growth rate of approximately 12–14% and has represented about 9% GDP in the last years (Figure 7.10).12 In December 2001, China’s National Food Industry Association (CNFIA) stated that there were already “20 top brands” in the market: Wahaha, Guan Shengyuan, Shineway, Weiwei, Lianhua, Bright Dairy, Jianlibao, Yili, Yeshu, Sanlu, Haitian, Hengshun, Onlly, Mafei, Kang Shifu, in addition to five alcoholic beverages and cigarette brands (Table 7.1).
Figure 7.10 Food as GDP share (%). Sources: SSB (2005); CEIC data (2005).
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According to data available from Beijing Kang Kai Information & Consultancy Co., Ltd, the total revenue of China’s food industry in 2004 was 781.1 billion RMB (US$ 94.4 billion), a 35.04% increase over the same period last year. China imported food-processing machinery at a cumulative value of 332.26 million US dollars in 2004.13 Although total revenue of food processing, which is an indicator of developed nutrition methods, is much higher and develops faster than food manufacturing and beverage manufacturing (Figure 7.11), according to food experts, the ratio of agricultural output value to processed food value in China is 1:0.3, compared with 1:2.7 in US and 1:2.2 in Japan. This means that the extent of food processing is much lower than that of the developed countries. By 2020, the ratio should be at least 1:1 in order to attract more investment in this industry.14 In other words, although China ranks as the world’s largest producer of grains, oil crops, fruit, beans, meat, eggs, and seafood, the farm produce processing industry is still in its infancy and only 30% of the total output is processed before reaching markets, compared with 80% in industrialized countries.15 China is more or less self-sufficient in grain, mainly rice, but also wheat and maize. In order to maintain its grain self-sufficiency, China’s policy has normally been to keep imports to no more than 5% of consumption, in part because of the aggressive entry of cereals from trade partners such as the United States. After all,
Figure 7.11 Total food revenue (RMB mn). Sources: SSB (2005); CEIC Data (2005). Note Mfg = Manufacturing.
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Figure 7.12 China’s grain production. Source: SSB (2003); Zhonghua renmin gongheguo 2003-nian guomin jingji he shehui fazhan tongji gongbao (2004) (National Economy and Social Development Statistical Report of the PRC in 2003), Beijing: Zhongguo tongji chubanshe. Note The forecast for grain production in 2004 was made by China’s Ministry of Agriculture, as released by China Xinhua News Agency on December 26, 2003.
it is very difficult to maintain self-sufficiency in land-intensive commodities such as grain, as China has little arable land. However, due to the growing population, by mid-2004 there was already a rise of 10% in consumption and therefore increasing output levels (Figure 7.12).16 The opening of China’s retail sector in December 2004 should presumably help eliminate previous restrictions on geographic location, equity participation, and the total number of foreign invested retail enterprises. Although multinational retail giants such as Carrefour or walmart are fairly well established in the market,17 foreign investment in the retail sector remains low and concentrated on the eastern coast. Considering the country’s complex food distribution system, this situation obviously affects the food market, and competition becomes particularly aggressive between foreign and domestic firms.
Competition Despite fierce competition from the American and European food industry, China has advantages in crops such as fruit and vegetables, due to their labor-intensiveness. In order to avoid the national food industry’s collapse, in part as a result of meeting WTO demands (see section below), Chinese firms are somewhat forced to adopt different measures that allow them to be more competitive. Here, we distinguish three specific responses: national cooperation, mergers and acquisitions (M&A), and food safety. Fast food and tea products are specifically analyzed,
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considering their opposite situation in this competitive industry: while the former is purely foreign, the latter tends to be more domestic. National alliances Domestic firms can strengthen their position vis-à-vis foreign competitors by creating alliances. Although it is still a fairly new initiative, there have been successful experiments. For instance, the Yili Group and Tianjin Health Frozen Food Company teamed up in 2002 to create a new ice cream and frozen food products company, Tianjin Yili Health Enterprise Frozen Food Co., Ltd. Each one of the companies invested one million RMB in the new enterprise and provided finance, branding, human resources, and management elements. It is estimated that the annual output for this new enterprise will reach 24,000 tons, which is about 20% of Yili’s total annual output of frozen food.18 Mergers and Acquisitions (M&As) The M&A’s can be useful as a way of changing the general situation of small-scale and low production levels in the industry. For instance, Shanghai Bright Dairy & Food Co., Ltd has acquired Guangzhou Danone Yogurt Co., Ltd, a branch of the French dairy giant’s Group Danone, as its initial step into China’s southern region. The acquisition gives Bright an established distribution network in Guangdong, Hainan, and Guangxi Provinces. With this sale, Bright also received the permission to manage Danone’s brand name in China and use its technology until 2011. The operation creates a win–win situation for both sides, enabling the expansion of Bright’s fresh milk products, while ensuring Danone’s position in the high-end market.19 Food safety Although China is still developing its food industry, special attention needs to be paid to food safety. The government needs to standardize the food-processing industry, and every producer should abide by relevant regulations. By 2001, none of the Chinese food enterprises had passed ISO 4000, the Environment Management Standard, an internationally accepted standard aimed to improve quality. Environment standards have always been related to food quality and safety: the enterprises that cannot promise a manufacturing environment cannot promise food safety, and this appears as a threat to the customers’ health. To fail the standard weakens any firm’s capacity, especially at the international level. In fact, there is today a gap with developed countries in terms of food safety administration, food safety incidents frequently occurring, or export food being restricted by foreign countries. Food contamination incidents frequently occur. The so-called ‘big head disease’ fake baby milk powder scandal in July 2004 is a clear example. At least 13 babies died in eight different provinces (mostly in Anhui and Shandong) between May 2003 and July 2004 from malnutrition
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caused by milk powder containing just a fraction (1%) of the recommended amount of protein (10%) for infant milk powder. Severe malnutrition became visible as the babies’ heads grew abnormally large in proportion with the rest of their bodies. This cheap milk powder was apparently produced in Beijing, Inner Mongolia, and Heilongjiang. More specifically, two particular firms were investigated: Beijing Weir Dairy and Beijing Beierkang Dairy, and their products were pulled from shops, while 30 other brands of milk powder were also included on a blacklist. This very unfortunate situation drove the State Food and Drug Administration (SFDA), the State General Administration for Quality Supervision, Inspection and Quarantine (AQSIQ), the State Administration of Industry and Commerce (SAIC), and the Ministry of Health (MoH), as well as Premier Wen Jiabao in person, to pressure all the departments to intensify supervision over the quality of food in order to reassure the public and achieve a secure and healthy environment of consumption. Despite efforts, these undesired problems tend to be inevitable in China’s accelerated transition. Indeed, China falls behind in terms of food safety and sanitation and industry standards. There are around 8,000 different standards on toxic and harmful substances such as pesticides and veterinary drugs in food. Some developed countries, such as the United States, EU, and Japan, have thousands of standards, while China currently has 1,070 items in the food industry national standard and 1,164 items in the food industry industrial standard. Most of these standards were enacted before 2002, with the earliest one in 1981.20 This means that if China’s food industry wants to be competitive, it will clearly have to comply with the full adjustment of its food standards by late 2006 (WTO commitments). By then, relevant sectors should re-examine, revise, and merge all the food standards published before and during 2000. The proportion of China’s products adopting international standards should be raised from the 23% to 55% by 2007.21 In other words, China is on its way to perform standardization and control from the production origin. In order to ensure food safety, it needs to improve origin inspection and control, to enhance food safety administration in all stages, to extend technology cooperation domestically and abroad, and to further establish and improve food safety regulations. But competition has also emerged within a newly emerging sector that has created the supply of products that in the recent past were not part of the Chinese lifestyle: fast food. In some sense, this sector is the clearest example of a ‘surviveor-die’ type of competition. Western fast food restaurants already control a considerable market share in China. For instance, after entering the Chinese market in April 1987, Kentucky Fried Chicken (KFC) has been increasing its expansion at a rate of 70% from 1997 to 2004, with about 1200 stores in 2004. It earned 9.3 billion RMB (about US$ 1.12 billion) in 2003 itself. In the 1990s, the industry had an annual increase rate as high as 20%, including a proportion of profits between 10% and 20%.22 Despite its fast growth, fast food national production has not always been tightly matched with social demands, due mainly to scarce variety, backward production technology, and a low degree of industrialization and organization. As opposed to this general trend, foreign fast food restaurants have rapidly developed: Tricon
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Global Restaurants Inc., a US-based fast food giant, has opened about 900 KFC chain stores and has processed 240,000 tons of chicken in China. Almost all KFC stores in China make a profit and Tricon will make continued efforts to tap China’s market potential. Already in 2000, KFC stores in China purchased 800 million RMB (US$ 93.02 million) worth of raw materials at local markets.23 Another US fast-food giant, McDonald’s, has also won the trust of Chinese diners, especially young consumers. The global firm established its first China branch in Shenzhen in 1990. Although McDonald’s has been lagging behind its rival KFC, by 2004 it had opened about 600 branches all over China and was distributed amongst around 100 cities. High standards in food preparation lie behind the great success of Western fast food restaurants, together with their in-depth market research, reflected by the best locations for their outlets. As living standards increase and time is scarce for household responsibilities, it becomes increasingly common to eat in these restaurants, contributing therefore to a boom in the market. In fact, despite the slow development of Chinese fast food goods, the backward production technology, and the low levels of industrialization and organization of Chinese fast food firms, these firms have been emerging, albeit timidly. In 2003, the top three were: Shanghai Xinya Dabao (Shanghai Xinya Big Buns), Malan Lamian (Malan Pulling Noodles), and Shenzhen Miandian Wang (Shenzhen Snack King).24 Of course, no SOEs are included in this ‘Westernized’ sector (Table 7.3). Table 7.3 Top ten fast food Chinese restaurants Company name (year founded)
Headquarter
Major products
Shanghai New Asia (Group) Holding Co., Ltd (1997) Malan Pulling Noodles Fast Food Co., Ltd (1995) Shenzhen Snack King Co., Ltd (1996)
Shanghai
Steamed buns
Beijing
Pulling noodles (Lamian) Snacks
Lihua Fast Food Co., Ltd (1993) Qianxihe Group Co., Ltd (N/A) Jiansu Da Niang Dumpling Restaurant (1996) Dong Fang Dumpling King Co., Ltd (1993) Guangxi Guilinren Group Co., Ltd (2001) Wu Steel Group Fast Food Co., Ltd (N/A) Guangzhou Daxihao Fast Food Co., Ltd (1992)
Shenzhen (Guangdong) Changzhou (Jiangsu) Beijing Changzhou Harbin (Heilongjiang) Guilin (Guangxi) Wuhan (Hubei) Guangzhou (Guangdong)
Set food Breakfast, buffet Dumplings Dumplings Rice noodles Set food Set food
Source: Bian Jiang (2003), Zhongguo shangbao (China Business Herald), Sept. 30. Note The standards for the ranking include: year founded, scale of operation, No. of chain stores, distributed cities, brand influence and maturity, and development prospect and potential. The list is decided and provided by the Fast Food Committee of China Cooking Association (Zhongguo pengren xiehui kuaican weiyuanhui).
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As opposed to fast food products, there are “national goods” (as opposed to Fried Nuggets or Big Mac’s), where competition has been fairly restricted until only very recently. A crucial example may be found in tea products. The international tea-beverage market has had an annual growth rate of 17% since 2000: in Japan, there were then 200 varieties of tea, with an annual consumption totaling 3.6 million tons; in the US, tea beverages represented a US$ 2 billion-a-year industry. China also witnessed a dramatic growth: the total sales volume for bottled tea reached 1.9 million tons, a small portion of the total bottled beverage market, which stood at 15 million tons in 2000. About 6% of those sales were soda and water products.25 Competition has been scarce, due to the control exercised by particular brands such as Kangshifu, President, Suntory, Kirin, and Asahi. Xurisheng, the first domestic bottled-tea brand, sold 2.3 billion RMB (US$ 277 million) of iced black tea in 2000.26 Nevertheless, big beverage makers from both China and abroad are pushing their way into the market. For instance, Coca Cola Co. introduced Lanfeng Honey Green Tea in April 2001, a new product first launched in Hong Kong and then sold in Shanghai, Hangzhou and other domestic markets, and then later on other varieties such as Oolong Tea, Jasmine Tea, Ice Lemonade Tea, etc., exploiting at its most the huge potential of China’s bottled-tea market. Meanwhile, exactly one month after Coca Cola’s green tea debut in Shanghai and Hangzhou, the Hangzhou-based Wahaha Group, China’s largest beverage maker, announced it would also enter the tea market with its future line of bottled teas. There are obviously other products that suffer direct competition pressures such as dairy products, due to their small-scale and low production levels: already the world’s top 20 milk enterprises are in China’s dairy market. According to China’s Dairy Industry Association, in 2001 there were more than 1,500 national milk product firms, with an annual output of 8 million tons. However, 90% of them were small, with a daily output lower than 100 tons. Only twelve enterprises had an annual sales volume of over 100 million RMB (US$ 12 million).27 For instance, although Shanghai Bright Dairy & Food Co., Ltd, one of China’s largest enterprises of dairy production, achieved a sales volume of 2.2 billion RMB (US$ 265.7 million) in 2000, it is still hard for the company to compete with the world’s famous dairy brands. Nestlé, the world’s largest dairy firm, had an annual sales volume of US$ 13.3 billion, i.e. 50 times higher than that of Bright Dairy.28 In other words, national cooperation, M&A’s and food safety are three major elements that could allow domestic firms to survive in the growingly fierce competitive environment of China’s food industry, as long as standard WTO procedures are thoroughly followed.
WTO impact and challenges With WTO entry, China’s food industry opportunities and challenges are not so different to those of other crucial industries in the country, at least in general
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terms: increase of exports; improvement of organization management; foreign capital injection; adjustment of the industrial structure; entry of advanced technology; structural improvement of raw materials (i.e. cheaper imports, better quality, and more standardized raw materials); etc. As foreign companies set up branch factories in China, more high-quality goods will inevitably have an impact on the food industry. That is why the competitiveness of national food enterprises needs to be further strengthened. After all, about 30 of the top 50 international food companies have already entered China’s domestic market and exercise an enormous pressure on national production: for instance, the total production value of Nestlé and Unilever (in China) had already surpassed the total production value of China’s food industry by 2000. As far as specific products are concerned, we now provide a few examples that can best illustrate the effects of WTO. Food processing and packaging WTO entry might not change the expected 10% annual growth of food processing and packaging in the next years. Already, in the 1990s, there was a significant demand of local users for high-quality processing and packaging machines. The decline of tariffs should not in that sense have a significant negative impact on domestic products, considering the high price of overseas products. Before WTO entry, tariffs for imported food process machines were 14.5% in 2000 and 14.3% in 2001; after WTO, tariffs were reduced to minimum levels in 2001 and remain fairly insubstantial, considering the price gap between imported and domestic machines.29 The domestic products have a strong price advantage compared with the same level of imported goods. Nevertheless, while domestic equipment and technology still lag behind imported products in quality and variety, substantial opportunities for greater market penetration exist: the demand for import food processing and packaging equipment in China might reach over US$ 2 billion in the short run.30 Dairy products In 2001, the cost of domestic dairy products was 18,500 RMB/ton, while import prices were about 21,000 RMB/ton.31 At that time, as the tariff on dairy products was bound to be reduced from 25% to 10–15% by 2005, import prices reached about 16,000 RMB/ton, i.e. imported dairy products ended up being cheaper than national ones. Canned food Domestic producers of canned food can make full use of their comparative advantage in low cost labor and land to manufacture and export canned vegetables. However, the disadvantages are clear: most canned products are based on undeveloped product lines. This influences the quality and cost of canned products.
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Subsequently, with the tariff declining from 35% to 15% by 2005, imported cans are bound to surpass domestic market production in the medium to long term. Beer In the subsector of alcoholic beverages, about half of Chinese beer SOE producers with an output beyond 15 tons had already established JVs with foreign companies by 2001. Domestic manufacturers such as Qingdao or Yanjing were particularly successful in setting up famous brands and therefore making full use of their competitive advantage. Considering this situation, the forecast by 2001 was that beer imports would not share more than 5% of the domestic market in the long term, despite WTO entry.32 Wine The situation is quite different for wine: first of all, wine is not as developed as beer in terms of demand and market share. Although brands such as Changyu (SDE), Dynasty (Foreign funded), and Great Wall (Overseas funded) have become increasingly representative in domestic wine consumption, they still cannot be compared with the quality of foreign wines. Second, attracted by China’s potential, famous foreign wine brands have made attempts to enter the market, but the supply of wine tends to be larger than the demand. According to some forecasts, China’s wine demand could reach 0.8 million tons by 2010. Finally, despite high tariffs,33 in 2001 wine imports already reached 31.35 million liters and the import value reached US$ 50.525 million, with an annual increase of 4.45%. Export volume and value were 4.16 million liters and US$ 6.308 million, down 18.1% and 7.77%, respectively.34 The post-WTO tariff decline on foreign wine will inevitably have a negative impact on China’s domestic wine sector, unless quality increases. Soft drinks Foreign soft drinks firms are bound to accelerate their rate of expansion in China. Until 2002, Coca Cola had bottling plants in 24 cities and occupied 48% of China’s soft drink market. Pepsi Cola set up a US$ 8 million bottling plant in Jinan (Shandong Province), the 16th Pepsi plant in China.35 In the total industry sales income, Coca Cola and Pepsi Cola produced 3.5 billion tons of carbonic acid drink, accounting for 65.31% in 2001.36 After WTO entry, the enterprises’ degree of production concentration should be raised, as scattered small-size enterprises have a very small chance of surviving in such a competitive environment. Despite its intrinsic domestic character, China’s tea market is most likely to be filled with overseas tea beverage makers with WTO’s opening doors. China is committed to cut import taxes on agricultural products to an average of 14.5% to 15%, while tariffs on tea (green, red, and oolong tea) have been ranging between 80% and 100% but have been reduced to 24% by 2005. Due to natural environmental advantages, China’s green tea is famous for its quality, originality, and
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varieties and it occupies the most important position in China’s tea industry: China itself accounts for 90% of the world green tea market. Nonetheless, the sharp tax cuts should eventually result in the increase of tea imports, especially red tea, for which china has no specific advantage over to foreign products: after all, by 2003 red tea only represented about 6.2% of its total tea production in 2001, while green tea accounted for 73.1% and oolong tea for 10%.37 This situation has pushed domestic red tea drink makers to readapt their production structure to the increasing levels of pressure, as overseas companies have introduced their tea drinks to China in a bid to seize more market share: for instance, Coca Cola started expanding its red tea market in mid-2001, first through Lanfeng in 2001 and then through Tianyudi; Japan’s Suntory is also speeding up today to step into this market. However, there are also already well-known Chinese brands that have been struggling to keep part of their share in the tea market: Jianlibao, Robust, Huiyuan, Chundu, Yeshu, Lulu, etc.38 In other words, while food firms are pressured to optimize their internal structure, food products need to be improved in their distribution, as well as their quality and credibility, so that WTO commitments do not jeopardize their current market share. The case of COFCO is in fact a good example of a successful reform process. In the past few years the company has been able to transform itself from a heavy, overstaffed organization into an efficient and dynamic company ready to compete within China and beyond its boundaries. Leadership and determination have indeed been the major ingredients of its success.
Food Main tips (1) Restructuring. Despite reforms in the grain market, the development of China’s food industry’s distribution is fairly recent. Restructuring of SOEs is more a priority in terms of products than in terms of firm ownership structure. The 10th 5YP aimed at about 10–11% growth rate of the industry between 2000 and 2005, as long as world-renowned brand names were built up and large-scale modern firms with strong R&D were established. As official targets mingled with the emerging market demand, food processing, farm crops production, and material base construction needed to be combined. Farm crops, sugar, dairy products, meat, and others such as canned food or beverages have ever since been viewed by the authorities as crucial food sectors affecting the development of the food industry. (2) Outlook. Food processing is still insufficient in today’s China. Meanwhile, the country is still more or less self-sufficient in grain, although it will have to be prepared for further entry of foreign cereals. The industry is increasingly conditioned by foreign suppliers’ thirst and the changing patterns of consumers’ preferences. As long as factor endowments are rationally exploited, the option is to focus more on labor-intensive agricultural products, due to scarcity of arable land.
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(3) Competition. National cooperation, M&A’s and food safety are three major elements that should allow domestic firms to survive in the growingly fierce competitive environment. Rapid growth of foreign elements such as fast food restaurants, tea, and dairy products make the market increasingly challenging and may put in danger the survival of domestic firms. (4) WTO impact. China’s food industry will eventually have more high-quality goods, improve distribution, and therefore increase competitiveness levels of domestic food firms. As quality and credibility improve, WTO commitments should not jeopardize their current market share.
Case study: COFCO Interview with Mr Liu Kejian, Deputy Director of the Strategy Development Department and General Manager of Strategic Planning Division China National Cereals, Oils & Foodstuffs Import & Export Corporation (COFCO) has a long history: it was founded more than 50 years ago. In the past, it was one of the 44 largest companies under the Organizational Ministry of the CPC Central Committee. Presently, it is one of the 196 SOEs directly supervised by the State-owned Assets Management Committee. The business magazine Fortune 500 has included COFCO in its list of most renowned firms for nine consecutive years. It ranks No. 9 among China’s top 500 enterprises and No.1 in the area of cereals and oils industry. By the end of 2002 COFCO’s total assets were 42.1 billion RMB (US$ 5.1 billion), which represented a 3.2 times net increase from 9.5 billion RMB (US$ 1.15 billion) in 1992. The ratio of debt to asset is currently 53%. They export one to two million tons of rice annually. For other food products, they mainly aim at local sales, due to the Chinese market’s massive size. For example, today, 90% of their flour, oils and fats, wine, and chocolate are for the local market, while malt is 100% locally sold. Their objective now is to become a global company. History of the company The history of the company can be divided into three periods. First period (1952–1988): Trading company During this stage, COFCO acted as both a government agency and a trading company. At that time it was under the supervision of the Ministry of Foreign Economic Relations and Trade (MOFERT – renamed MOFTEC since 1993, MOFCOM since 2003). In the planned-economic system it had to fulfill the State’s import and export quota, as well as some other duties assigned by the government such as the management of food quota to Hong Kong.
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In 1988, China carried out an important reform in the import and export sector. As a result, COFCO’s 44 sub-companies located in different provinces were separated from the head office. Those subsidiaries no longer reported to COFCO but to local economic and trading committees. Therefore, COFCO suddenly shrank from a giant to just the size of its headquarters in Beijing. Mr Liu recalls that period: I can still remember that before the reorganization we had 130,000 employees all over the country. After the separation, we only had a little more than 600 employees who were all located in Beijing. The assets, operations, employees and facilities of the branches were all stripped off irreversibly. This was a very important reform in the history of COFCO.
Second period (1992–2000): Industrial group During this period, COFCO developed from a pure trading company to an industrial group. In 1992, it entered a new development stage and gradually changed from a partially business and partially administrative organization to an independent and business-oriented enterprise. The development strategy of COFCO was no longer constrained to a single activity, namely imports and exports of food commodity products. Under the planned economy, there were limitations on the amount of goods the company could import and export. After entering this new period, the limitations and quota were lifted one by one. Thus the company had to adjust its strategy from just being an import and export company towards becoming an industrial group. This transformation was done swiftly and successfully. As Mr Liu reflects, “compared with other companies in the same industry, our company had a quicker pace in the adjustment to the market.” Step by step, it evolved towards an industrial, business-oriented, and diversified group, with a clear brand strategy. According to the information provided by the company, their achievements were impressive: COFCO became No.1 in the production of oils and fats in China and No. 2 in Asia. They now import around 3,600,000 tons of soybeans annually. Their capability of oil extraction is 1,200,000 tons annually. The family sized ‘Fortune’ edible oil ranks No. 2 in the Chinese market. The ‘Great Wall’ wine holds 40% of the market share in the wine market, the leading brand in China. The sales volume in 2002 amounted to more than 62,000 tons. COFCO has a Flour Group, under which there are six flour plants. The annual production capacity for the group is 800,000 tons. China has a very large flour industry: there are more than 50,000 flour plants inside China. But any one of COFCO’s six flour plants can be the No. 1 among them. They also own a brand of chocolate, ‘Le Conte,’ whose market share in China is about 10%. Amongst the local chocolate brands, theirs is No. 1. If foreign brands are taken into consideration, they are next only to ‘Dove,’ an American chocolate brand. They are also Coca Cola’s largest partner in China. In the JV, COFCO Coca Cola
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Beverages Ltd, COFCO holds 65% of the shares. In China, they own shares in 14 bottlers of Coca Cola. They are also the largest producer of malt in the country. The malt plant in Dalian has a designed annual capacity of 300,000 tons. Furthermore, COFCO has expanded into the hotel business. They have their own hotel management company, Gloria Holiday Hotel, which not only owns the property but also manages the hotels. They had 10 Gloria Hotels in China, ranging from 3-star to 5-star. They also have their own property management company, called Gloria Property Management Company, as well as their own properties in Mainland China, Hong Kong, and the US. Finally, they have a large shipping company in Hong Kong.
Mr Liu on SOEs reforms – the role of the government The relationship during the reform between the government and SOEs is constantly changing. COFCO used to be under the supervision of MOFERT. Its major business was the import and export of food products. In 1998, we were separated from MOFERT and became independent from the government. Now the central government has established the State-owned Assets Management Committee (AMC) and we are under its inspection. The relationship between the government and the enterprises will become increasingly standardized and legalized. In the future, the AMC will just be a capital investor and we will be required to take care of the assets under our responsibility and increase their value. As a result, the company will have more autonomy in terms of operation. Now that the company has adopted a modern corporate governance mechanism, it will become more efficient. We have the President and the Chairman of the Board, who was the former President of COFCO. The board members are the President and Vice Presidents. According to the company’s internal law, the Chairman of COFCO will mainly take care of big issues and the strategy of the company, but will not be involved in its daily operations, which is the President’s responsibility. After the reform, we do not have any Vice President without concrete responsibilities, i.e. every Vice President must take either the position of the President of a business group or that of the director of a department. In other words, they have specific responsibilities. Board meetings are not fixed, they are held according to the needs of the development of the company. Sometimes, we have 1–2 board meetings on a monthly basis.
Third period (2000–present): Second reorganization In 2000, with McKinsey’s participation, COFCO launched a thorough reorganization program affecting businesses, operations, structure and personnel. Mr Liu describes the situation at that time: We used to have many problems in systems and personnel. Seeing that the company was developing very well, in order to further enhance the core competence of COFCO we decided to do a large reorganization. After that, we
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Food set up eight direct administrative units and four major business groups in Beijing Central Office. Under these four business groups, we placed 21 business units.
In the past, they had several major departments: finance, administration, personnel, etc. plus a few business departments. Under this business, departments were all their secondary and tertiary sub-companies, all of which were legal entities and had separate accounts. Some of them were outside Beijing and others outside China. As Mr Liu admits, “such an organization was unreasonable in structure and a waste of resources.” With the help of McKinsey, they reorganized the company’s structure. First, they set up a complete modern corporate governance mechanism by establishing the Board of Directors, Supervisory Board, and the Secretariat of the Board. There are four commissions under the BOD. The President is under this layer. Under the President, they established eight functional departments; the most important one was the Strategy Development Department (see Figures 7.13 and 7.14 for the old and new organizational charts).
Mr Liu Kejian’s reflection on COFCO’s reform It has been a very challenging reform. In 2000, there were many changes in personnel. Some people left their positions. Some supervisors saw their former subordinates become their bosses. Some people were moved from familiar to unfamiliar positions. These changes were very difficult and needed a lot of effort. We need to do a lot of changes in our concept, structure, operation, process, etc. We can only go forward, otherwise we will fail.
The corporation set up four business groups. The first group, Grain & Oil Import & Export, was set up mainly for those policy-required businesses such as large-volume agricultural products. The second unit is COFCO International, which is listed in Hong Kong’s stock market. Its major business is food products, such as oil, flour, chocolate, and beverages. The third business group includes the hotel and property management business. Last, the fourth group has two major functions. First, it takes care of the non-performing assets, separated from the group when the company went public. Second, it supervises investment projects with diverse results. This last division has the responsibility to turn around some of the projects while closing the irrecoverable ones. COFCO Finance is a new business group that is in the process of creation. In this group there will be insurance and financial companies. As Mr Liu declares, “We believe this new division will bring new profits to the company.” COFCO’s deep tranformation was implemented in an amazing short period of only 10 months. Mr Liu presents it very vividly: It was a huge effort. We hired a lot of auditors, lawyers and asset appraisers. You can imagine. Our company has thousands of products and numerous
Food
Figure 7.13 COFCO before restructuring.
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Figure 7.14 COFCO after restructuring.
160 Food
Food
161
assets. We need to clarify them first before transferring 75% of them to Hong Kong. Of course, we did a lot of preparation work. From the accounting point of view, we used to have 32 sub-companies, each of them with their own accounts, and we had to merge all these accounts into the one account at the central office. You can imagine how much effort we have put into the clarification of the financial issues. In addition, we also did a lot of adjustment in personnel. There are many things involved in this type of reforms. For Mr Liu, one of the biggest challenges was to change the people’s mindset, especially that of middle-managers. In order to push the reform into every layer of the organization, they made the middle-level managers aware that if COFCO wanted to develop under the new market conditions, those changes were unavoidable. Mr Liu remembers very clearly the message at that time: If we stick to the old system, the old structure, the old mentality, we will definitely lose the battle. Every one of us must comply with the needs of reform unconditionally. If your department is cancelled, you must obey the re-allocation order from the company. Maybe someone is promoted, someone is downgraded, but you must support the work of the company. The response of the organization was outstanding. Mr Liu expresses it in this way: “The 2000 reform was a deep revolution for COFCO. People throughout the company were fully committed to the reform. A lot of them worked till midnight every day.” There are still other strategic questions open to COFCO. The company is an organization that likes challenges, sets new and more ambitious objectives. They have established a new objective for year 2010; their net asset should go from the 12.1 billion RMB (US$ 1.46 billion) they had in 2001 to 24.1 billion RMB (US$ 2.9 billion). As part of this search for continuous improvement, they eagerly try to learn from other companies. As Mr Liu states: We are continuously discussing the development strategy of the company. At the beginning of the year, our chairman of the board and our president went to the US to visit big food companies and agricultural products companies, such as ADM and General Mill. We found that some of these big companies are developing mainly in the upstream business, like processing agricultural products in large quantity and not building up brands. Some others are mainly developing in the downstream business and focusing on brand building. But COFCO covers almost every phase from upstream to downstream, so we are discussing whether our future strategic focus should be put on the upstream or on the downstream. One of the strong points of COFCO is its HR management. At a time where there is a strong competition for talents, COFCO has managed to attract a group of young and competent employees. Their total of employees in 2003 was 787,
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30% being female. Employees with a college degree or above represent 63%, those with a doctoral degree, master’s degree or double bachelor’s degree 13%. Regarding the age distribution, 27% of their employees were below 30 while 29% were between 31 and 35. Put together, their employees under 35 years of age accounted for 56%. Mr Liu speaks proudly of this: Many middle-level managers in COFCO are very young compared with other SOEs in China. Our employees are younger and with higher degrees. In addition, most employees and managers are very loyal to the company. Though sometimes other companies give them higher offers, our employees are not tempted. Generally speaking, our employees regard their future in the company as very promising. They believe they can realize their career with us. Mr Li Minghua – also present at the interview – is a good example of a young talented professional who prefers to remain at COFCO despite frequent offers from MNCs: I have been in COFCO since 1993. Many friends ask me why I stay in an SOE for such a long time. I tell them there are two powerful reasons for my decision to stay at COFCO. First, the company’s development is very good and promising. Besides, I think the compensation is not bad. Of course, there may be a difference when compared with foreign companies, but I am satisfied. Second, COFCO is the leading company in the food industry in China, with a very good social reputation. Staying with COFCO, I can meet my career needs. Though it is an SOE with a long history, I find that young people can have the opportunity to be visible through hard work. For example, I’ve been in the company for only ten years, but am now already in charge of a very important department. In COFCO, I think I can fully realize my professional potential.
Future challenges The next period started with China’s entry into WTO and the internationalization of China’s market. As Mr Liu says, “In the future, our models will be the big international companies in the same industry. We are ceaselessly shortening the gaps between us through reform and adjustment.” The market has been even more challenging now. After entering WTO, COFCO must face an increasing number of international competitors. Mr Liu explains that after the success of the reform, there is an important objective ahead: to become a global company. Personally I think that among all SOEs, COFCO’s reform is very advanced, which is confirmed and recognized by the AMC, the Ministry of Commerce
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and the press in China. I think our company’s different reforms were very successful, especially the separation in 1988, going public in 2000, and the second reorganization in 2001. Now COFCO looks at the global companies in the same industry and aims to evolve according to global standards. Especially after China’s WTO entry, we need to compete with overseas counterparts on the same stage. They have a general development strategy for COFCO as a whole, as well as a detailed development strategy for each business group and unit. With McKinsey’s advice, they have modified their strategy management procedures. Every business group must state their one-year detailed business objectives and update the three-year development plan every year. The plan covers eight aspects, including their own competence, that of the competitors, future strategy in development, etc. To complement the strategy, they also have a strict individual performance evaluation system, up to the President and down to every staff level. Everybody signs a performance contract. For instance, the President is responsible for the business of the company. He divides his business plan between the four business groups. The business group further divides the business plan between the 21 business units. Every person has clearly defined responsibilities and objectives. At the end of the year, they carry out the evaluation according to the performance
Leadership If there is a person who was fundamental for the reform process, that was our Chairman Zhou Mingchen, the former President. Any reform needs a leader. A reform can either succeed or fail and there should be someone who can take the ultimate responsibility. This person is the key in the process. Last year was the 50th anniversary of COFCO. At the celebration conference, our Chairman Zhou Mingchen gave a summary of our reform since 1992. The ten years since 1992 was a large booming period for COFCO. What’s the reason? He said there were two points. First, it was the opening-up opportunities in 1992, when China established the socialist market economy. The business environment for COFCO and the other SOEs experienced a huge transformation. COFCO made the adjustments in time, which was a good preparation for the later dramatic organizational change. Although the new model hurt some individual interest, our staff generally accepted it well. Second, COFCO is a continuously learning organization. Due to the nature of our business, we are working with a lot of international companies. Even before the door of China opened to the outside world, COFCO had already been cooperating with large international companies, from which we have been learning a lot of new things. The reason why our edible oil and our wine experience great success is that we set up JVs with famous international companies. These companies not only brought profits to COFCO, but also new business ideas and models to us.
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contract. On the basis of the score obtained, they calculate the year-end bonus and the salary for the following year. If anyone cannot reach the performance goal two consecutive years, he is required to change his position. In this process of always challenging the status quo, they are considering taking in strategic partners to continue with the development of COFCO. Long ago, they already set up several JVs. In some ways, they consider themselves a pioneer. For example, in edible oil, as early as in 1990, they set up the Northern Sea Oils and Fats together with the Kuok Group in Malaysia, producing the “Arawana” edible oil. In addition, they established numerous JVs in businesses such as wine and flour. For example, the Eastern Sea Oils in Zhang Jia Gang, the current largest production base for oils and fats, is a JV with ADM, a US company, and Welma of Singapore. They have cooperated with them at the product level, which now opens the way to cooperate at the group level. Mr Liu concludes: I think that the benefit of WTO entry is more than its negative effects because we can now develop our company in the larger framework of WTO. In many industries we have strong competitors. On the one hand, we need to continuously develop ourselves; on the other hand, we must face the competition and fight back.
COFCO Learning points (1) Divide to win. COFCO best fortune was to be divided into multiple companies. They maintained their headquarters in Beijing. That was the beginning of their future development after they were freed of the burden of being a huge group. (2) Obtain external advice. Consultants can play a key role in the reform process by bringing modern systems and organization rationality to the SOE. (3) Be selective when choosing partners. COFCO has a clear strategy for its partnership, choosing only those that can have a positive contribution to the business. (4) Set clear objectives. Modern performance management systems are a must in the reform process. These are not just a change in systems but imply a change in mindsets. (5) Attract and retain talent. Do this by offering attractive career opportunities to young talented professionals. In this sense, SOEs can have an advantage over MNCs in which there are fewer opportunities for having an impact. Challenges ahead (1) Managing complexity. How to manage a multiple business organization? Companies such as COFCO are diversifying their core business. That presents a challenge for the future as the organization becomes more complex to manage. (2) Competing with the big. Be a player in the international market. COFCO has a volume that allows it to enter the international arena. This also will present new demands on the organization and the management that they will have to address.
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Conclusions and future perspectives In the last decade or so, China’s food industry has rapidly developed, with an annual growth rate of about 12–14%. It has become one of the nation’s biggest industries in terms of total output value. Nevertheless, it still lags behind international standards, mainly in terms of quality. WTO entry should create pressure on the survival of national food production. That is why it is necessary to improve national cooperation between firms, force some M&A’s and cease dealing with small-scale economies and low output, improve origin inspection and distribution control, as well as food safety administration. Otherwise, the national food industry is bound to collapse and be subject to the umbrella of foreign presence. A crucial example can be found in the lack of food processing, which is by itself an indicator of developed nutrition methods. While China’s ratio of agricultural output value to processed food value is still very low in international terms, it should eventually reach the 1:1 level to attract more business. Thus, if WTO requirements are fully addressed in terms of quality improvement and respect of international food standards, mainly food safety, there is still hope for domestic firms to survive in this increasingly aggressive food market. As part of this process, COFCO, our case study, proves to be a good example of an SOE that has been able to go through a complete process of reform: from a simple trading company with very limited autonomy and excess personnel to a will-be multinational. COFCO was able to create a modern organization in record time – in just six months, to attract and retain young talent and develop a strategy for the future. Thus, hopes for SOEs in the food sector are not yet fully lost.
Sichuan Yibin Wuliangye Group Co., Ltd (1998) Hangzhou Wahaha Group Co., Ltd (1987) Henan Luohe Shineway Group Co., Ltd (1994) Tsingtao Brewery Co., Ltd (1995) VeiVei Group (1992) Shandong Jinluo Enterprise Group Parent Company(1996) Zhucheng Dalong Enterprise Co., Ltd (1999) Guan Sheng Yuan (Group) Co., Ltd (1918) Jiangsu Yurun Food Group Co., Ltd (1993) Yanjing Beer Group Corporation (1980)
Company name (year founded)
Beer
Meat
Candy
Beer Soft drinks Ham sausage Frozen chook
Ham sausage
Milk
Distilled spirit
Main products
Beijing
Nanjing (Jiangsu)
Shanghai
Zhucheng (Shandong)
Qingdao (Shandong) Xuzhou (Jiangsu) Linyi (Shandong)
Luohe (Henan)
Yibin (Sichuan Province) Hangzhou (Zhejiang)
Location
Joint stock
Private
SOE
Limited liability
State enterprise Joint stock Collective
Limited liability
Limited liability
Limited liability
Ownership
3,120
3,141
3,578
4,036
5,775 5,029 4,839
7,097
7,591
8,285
Revenue in 2001 (RMB mn)
19,970
9,588
6.079
5,898
26,805 6,689 12,516
12,946
3,335
13,691
No. of employees
Sources: Zhongguo daxing qiye jituan fazhan baoga (2002). (Development Report of China’s Large-Scale Enterprises (Groups), Beijing: Zhongguo caizhen jingji chubanshe.
10
9
8
7
4 5 6
3
2
1
Ranking
Table 7.4 Top ten food enterprises
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8
Insurance
Industry restructuring: Overview Considered until recently a ‘luxurious’ type of industry, the insurance sector has never constituted a priority in China’s economic development. After decades of inactivity, it only came back to reality with the re-emergence of the People’s Insurance Company of China (PICC) in 1979; before that, the industry had been driven by foreign firms, mainly throughout the nineteenth century and during most of the Nationalist period – although in 1937 all related activities came to an end as a result of the Japanese invasion. In 1949, the newly created People’s Republic of China launched a general nationalization policy of the insurance industry as a whole, forcing foreign firms to leave the country. In 1959, all domestic insurance companies were also shut down, and only re-emerged after the launching of economic reforms in the late 1970s.1 In 1984, the State Council separated the state-owned PICC from the People’s Bank of China and offered standard insurance products such as life (life, health, accidents), non-life (property, autos, real estate), and reinsurance services. Between 1984 and 1998, and despite PICC’s state-owned monopoly until 1989, about a dozen new domestic insurance companies were created: the aim was to push for an increasingly competitive environment. The two largest firms were then Ping’an Insurance Co. (our case study) and China Pacific Insurance Co., which became major providers of comprehensive insurance services throughout China.2 Even with the emergence of these companies, PICC still controlled roughly 70% of the domestic insurance market in the mid-1990s. But in October 1996, to further stimulate and develop the market, PICC was divided into three independent insurance companies: China Life Insurance Co., China Property Insurance Co., and China Reinsurance Co. Two years later PICC was abolished, leaving the Chinese companies to operate independently, which came under the supervision of a newly created regulatory commission: the China Insurance Regulatory Commission (CIRC), which took over insurance regulation responsibilities from the People’s Bank of China.3 In 2001 China Life Insurance, China Property Insurance, Ping’an Insurance, and China Pacific Insurance owned 95.5% of the total market: the premium
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revenue of China Life Insurance accounted for 57% of the life insurance market, while that of China Property Insurance amounted to 73.74% of the property insurance market.4 Meanwhile, as part of China’s financial market-oriented reforms and opening to the world, China began to allow limited foreign access to its emerging insurance market. Foreign participation began in 1992 with the reopening of American International Group, Inc. (AIG) in Shanghai (founded there in 1919), although it was restricted to life and property insurance, and within the limits of Shanghai, so as to better control the speed of the insurance sector’s opening.5 As the insurance industry grew, it became imperative to establish a solid legal framework: in 1985, the State Council issued the Provisional Stipulations of Insurance Enterprises Administration (Baoxian qiye guanli zanxing tiaoli) as the sole regulation guiding the industry. Ten years later, the National People’s Congress finally promulgated a formal Insurance Law (Baoxiang fa). Currently, as the industry evolves, the authorities expect to rely on a larger number of state-owned insurance companies and companies with shares held by the State. Companies under a shareholding system could eventually achieve rapid growth and be further expanded throughout the country as long as property rights are respected, a modern legal entity management structure is established, and internal incentives prove to be effective. This is why China’s shareholding insurance companies are being encouraged: they can readjust their equity structure and attract foreign investors, non-public businesses, and listed companies to acquire their stakes. This initiative should eventually help increase their capital and payment abilities, strengthen their management structure, and promote the transformation of their operational mechanisms. So far, the Chinese government has gradually allowed insurance companies to invest in securities: in January 2000 the CIRC published a list of insurance companies allowed to invest in securities funds and the amount of money they would be limited to risk in these investments. However, qualified firms are still limited to invest a maximum of 15% of their previous year’s total assets. Companies approved at the maximum rate of 15% are: Ping’an Insurance (joint stock), China Pacific Insurance (joint stock), Tai Kang Life Insurance (joint stock), Sinosafe Insurance (joint stock), AXA-Minmetals Assurance (France), and American International Assurance (AIA) – Shanghai Branch (US). New China Life Insurance (joint stock) and Huatai Insurance (joint stock) have a maximum investment limit of 12% of their previous year’s assets. China Life Insurance (SOE), China Reinsurance (SOE), Tian’an Insurance (joint stock), Dazhong Insurance (joint stock), Yong’an Property Insurance (joint stock), Manulife-Sinochem Life (Canada), AIA Guangzhou Branch (US), Pacific Aetna Life Insurance (Netherlands), Allianz-Dazhong Life (Germany), and CITIC Prudential Life Insurance (UK) all have a 10% limit. The People’s Insurance (SOE), American International Underwriters (AIU), Insurance Shanghai Branch, and AIU Insurance Guangzhou Branch (both foreign funded) have been approved to invest 5% of their previous year’s assets since 2000.6 In other words, while the State keeps part of its supervisory role within the industry, shareholding insurance companies are encouraged and independent
Insurance 169 insurance companies emerge. This means that the establishment of a solid legal framework and a more effective restructuring of the financial and banking sector as a whole can eventually contribute to an even more dynamic industry, which now appears to be so tightly linked to the changing patterns of China’s urban society. Despite its encouraging future, there is still a long way to go, as shown by the figures below.
Industry outlook Total income from insurance premiums (both life and non-life insurance) topped 430 billion RMB (US$ 52 billion) in 2004 (Figure 8.1), where domestic companies (SOEs and non-SOEs) shared more than 85% of total values as opposed to less than 15% for foreign firms. Despite rapid growth, the insurance industry is still only a small part of the national GDP, less than 3.2% (Figure 8.2), compared to 11% in Japan and 8% in the United States.7 After all, China’s insurance market is still quite young, has a limited variety of insurance products, relatively high costs, hardly any consumer education on the role of insurance, and a lack of a sound legal environment. The CIRC estimated only a few years ago that the nation’s insurance industry in the short run should maintain a 12% growth rate, with an insurance asset of 1 trillion RMB (US$ 121 billion) by 2005. To be more specific, the forecast was
Figure 8.1 Growth in total premium revenue (1985–2003). Sources: SSB (2005); CEIC (2005). Note These are all official data. The disparity of data related to total revenue premium is huge for the same year. We have preferred to use official statistics, although they are not necessarily the most reliable in this field.
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Figure 8.2 Insurance as share of GDP (%). Sources: SSB (2005); CEIC (2005).
that the asset would be almost 3% GDP as compared with the 1.7% in 2000, while the per capita premium would grow from 127 RMB (US$ 15.4) to 230 RMB (US$ 27.8).8 The reality surpassed the estimation. According to Chinese statistics, by the end of 2005 the total insurance asset had topped 1.5 trillion RMB (US$ 181 billion), and the per capita premium reached 248 RMB (US$ 30) in 2004. As part of the 10th 5YP targets, China’s per capita GDP had to reach an annual amount of 9,200 RMB (US$ 1,112) by 2005. This target was achieved in 2004 when per capita GDP reached 10,530 RMB (US$ 1,273).9 This should be translated into a more solid foundation for the development of its insurance industry, together with the increasing number of aged people and the accelerated urbanization rate (currently at approximately 37%, expected to reach 50% in 2020) (Figures 8.3 and 8.4). Although now a little outdated, it is interesting to observe how social acceptability with regard to insurance developed a few years ago: in January 2001 the Beijing-based China Mainland Marketing Research Co. surveyed residents of Beijing, Shanghai, and 20 other cities about insurance.10 Almost 21% of those surveyed said they intended to buy insurance in 2001, and about 51% aimed to hold some kind of insurance by the end of that year. The categories of insurances most commonly held were pension insurance, medical insurance, and life insurance, amounting to 17.4%, 15%, and 14%, respectively. The percentage of those with insured property was comparatively low: only 3% held insurance on personal property, while 1.7% held auto insurance.11
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Figure 8.3 China’s pyramid of age. Source: Cai, Fang (2004), “The Aging Trend and Pension Reform in China: Challenges and Options,” China & World Economy, Vol. 12, No. 1, January– February: pp. 36–49.
Back in the summer of 2004, as natural catastrophes (floods, earthquakes) caused around 147 million RMB (US$ 17 million) losses for each one of the three to four days of catastrophe, the CIRC launched the initiative of building an insurance system by 2006 or 2007 to protect against such catastrophes. The Commission even encouraged foreign investors to participate in the formation of a catastrophe insurance system, by introducing reinsurance brokers, earthquake
Figure 8.4 China’s growing urbanization rates (%). Sources: Chinese and non-Chinese press articles; forecasting analysis devised by the authors.
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model management companies, and agricultural insurers. Currently, rebuilding after a disaster is financed by the State and donations.12 The integration of banking, insurance, securities investment, and asset management, as well as the creation of alliances between domestic insurance companies and Chinese banks – starting with the largest insurance company, China Property Insurance Co., and the largest domestic state-owned bank, the Industrial and Commercial Bank of China (ICBC) – can all provide both insurance and other financial services to their customers. But, for this initiative to be successful, access to the capital market needs to be widened: although the insurance industry had a total insured risk of 1.5 trillion RMB (US$ 183 billion) in 2002, the aggregate capital of China’s insurance companies put together was below 10 billion RMB (US$ 1.2 billion). This situation could eventually affect the companies’ ability to pay in the future, depending on how fierce competition is in this market.
Competition China’s medical and pension systems have a strong impact on the insurance companies. On the one hand, insurance products are developed according to the governmental system’s model: the State medical system is at the base, while firms complement it; the dividing line is defined by the political authorities. On the other hand, insurance systems around the country vary enormously, hence the difficulty in operating nationally in price and service standards. In fact, although competition for the pension market has become heated, governmental authorities have not so far issued any clear regulation. By the end of 2004 the number of both domestic and foreign-funded insurance companies had grown to 68, including five insurance groups, 27 Chinese-funded insurance institutions, and 36 foreign-funded institutions.13 As a result of this growth, in 2003, SOEs accounted for 16%, domestic shareholdings 26%, and foreign firms (including all kinds of joint ventures and firms from Hong Kong, Macao, and Taiwan (HMT)) 58% (Figure 8.5).14 SOEs are indeed less in number, but they dominate both the life and the non-life insurance market (Figures 8.6 and 8.7). Compared with foreign firms, the weakness of Chinese insurance companies lies in their business immaturity. However, although some products in foreign countries are very advanced, it is not so evident they can yet be fully applied in China. After all, the importance of insurance is not appreciated in the same way as in developed economies. Thus market penetration in China is still at a very low stage. That is probably why, despite their increasing market share in the last few years (Figure 8.5), generally speaking, foreign insurance firms have not been doing too well so far. In addition to the general lack of insurance culture, foreign firms have had to face significant barriers until very recently: except for AIG, which had a license in Guangzhou, foreign insurance companies were unable to operate outside Shanghai. Property companies had the option of entering the market as WFOEs, while life insurance companies were required to have a partner approved by the authorities and therefore to create JVs. However, since 2003, as part of the WTO commitments, foreign companies have been allowed to expand their business
Insurance 173
Figure 8.5 Ownership distribution of insurance enterprises. Sources: SSB (2005); CEIC (2005).
to Guangzhou, Dalian, Shenzhen and Foshan, Beijing, Chengdu, Chongqing, Fuzhou, Suzhou, Xiamen, Ningbo, Shenyang, Wuhan, and Tianjin. In fact, already by September 2001 eight European insurance companies, comprising four life and four non-life insurance, had been granted licenses to set up insurance practices in China. At the time, CNP Assurances (France), CGU (UK), and Transamerica (NL) were all granted the green light from the CIRC to set up life insurance joint ventures in open cities; France-based AXA, which operated a life insurance joint venture in Shanghai, was allowed by the market watchdog to establish a subcompany of its Shanghai joint venture; both Gerling Insurance Company (Germany) and the Allianz Group, as well as Zurich Insurance Company (Switzerland), were permitted to launch non-life practices; Royal & Sun Alliance (UK), operating
Figure 8.6 Market share for life insurance in 2001. Source: China’s Insurance Yearbook (2002).
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Figure 8.7 Market share for property insurance in 2001. Source: China’s Insurance Yearbook (2002).
a non-life company in Shanghai, also had permission to set up a sub-branch company; and so on 15 (Table 8.1). According to official statistics for 2003, foreign presence was represented mainly by firms such as: (1) AIA, the largest overseas insurance company in China, which accounted for 6.6% in the market of life insurance in Shanghai; (2) all other foreign companies – JVs had very small market shares: Manulife 1.6%, Aetna 2.2%, Allianz 0.7%. These figures are not surprising, considering Ping’an accounted for 36%; together with PICC and Pacific Insurance, the big three controlled almost 75% of the market. Despite the domestic predominance, since 2003 foreign-funded insurers have been able to access group insurance, health insurance, and old-age insurance (pension).16 Foreign firms can even hold as much as 51% of the stake in JVs, while foreign non-life insurance firms can set up solely funded subfirms in China and partners can be chosen independently. For instance, the famous BelgianDutch financial services provider bought a 24.9% interest in Taiping Life (TPL), holding a national life insurance license for all of China. Fortis paid 728 million RMB (US$ 88 million) for the equity and will expand its share up to 49% or more. Meanwhile, Winterthur Life & Pensions, the life insurance arm of the Crédit Suisse Group, has also chosen to participate in the Chinese market by taking a 10% stake in China’s fifth largest life insurer – Tai Kang Life. Winterthur Life & Pensions will support Tai Kang through technical assistance in information technology, product development, and training.17 Despite the significant advances made by foreign firms in China’s insurance industry, their presence is rather weak. In fact, the Chinese authorities seem confident that foreign insurance companies are not powerful enough. For instance, when AIC was re-opened in 1992 it had a market share of 20%, whereas the shares of domestic companies outstripped 80%.18 In other words, despite the increasing presence of FDI in the industry (Figure 8.8) compared to foreign companies, domestic firms have obvious advantages in their
AIA, China(1992 in SH, 1995 in GZ, 1999 in SZ) Manulife-Sinochem, Shanghai (1996) AIU, China (1992 in SH, 1995 in GZ, 1999 in SZ) Pacific-Aetna, Shanghai (1998) Ming’an, China (1982) CITIC-Prudential (2000) AXA-Minmetals (1999) Allianz-Dazhong (1999) Tokio Marine and Fire (N/A) Winterthur (1997)
1 2 3 4 5 6 7 8 9 10
Source: China’s Insurance Yearbook (2002).
Company name (year founded)
Ranking US Canada US Netherlands HK UK France Germany Japan Switzerland
Origin
Table 8.1 Top ten foreign insurance enterprises in China (HMT funded included)
Life Life Property Life Property Life Life Life Property Property
Major types of insurance
SH, GZ, SZ SH SH, GZ, SZ SH SZ, Haiko GZ SH SH SH SH
Chinese office
2,072 243 213 209 169 121 64 56 55 37
Revenue in 2001 (RMB mn)
Insurance 175
176
Insurance
Figure 8.8 FDI in the insurance (and banking) industry. Source: CEIC data (2005).
familiarity with the market, coverage characteristics, and marketing network. According to an old survey (2000) prepared by US Nilsson Market Investigation Co. in four cities, including Shanghai and Guangzhou, both high product prices and the unavailability of governmental guarantee pushed most of the consumers to choose domestic firms when they decided to purchase, despite the advantages of foreign companies in funds, technology and management19 (Figure 8.8). However, in 2005 the premium of foreign-funded insurers reached 34.12 billion RMB (US$ 4.13 billion), accounting for 6.92% of the total premium revenue (49.27 billion RMB or US$ 5.96 billion). In 2004, when the insurance industry was not fully open to foreign players, it was only 2% of the total market share.20 Although the initial feeling was that the trend would change quite radically in the medium to long term with WTO entry, it is interesting to notice that domestic companies tend to turn pressure into the improvement of their services by bringing their own advantages into full play, not considering the competition from abroad.
WTO impact and challenges The WTO gives the Chinese insurance industry the opportunity to access foreign capital and technology, to gain expertise in customer services, to examine potentially innovative product development, and to eventually further liberalize and deregulate the market. Domestic firms can also catch up with their foreign counterparts, face the increasing number of players in the industry with more marketoriented methods, develop intermediary services, improve their management systems, or intensify their internal legal framework. But, as the capital and financial markets have not been profoundly transformed, the WTO impact has been somewhat small, at least in the short-term.
Insurance 177 Despite its small impact, WTO accession has brought significant challenges: China’s early stage insurance industry remains far behind foreign insurance companies in terms of risk control technology, business management level, product design and innovation, as well as the quality of personnel. As foreign-funded companies increase competitive pressure on the domestic insurance industry and try to occupy the market with their ‘cheap and good’ insurance products, their advanced and specialized means, and their meticulous and thoughtful after-sale services, they will obviously aim to attract more clients and raise their market share.21 As a WTO member, China is committed to issue licenses to foreign insurance companies and there is no ceiling on the number of licenses to be issued. License requirements include being a WTO member, with at least 30 years of business experience as an insurer, having a representation office in China for at least two years, and accounting for at least 41 billion RMB (US$ 5 billion) in net assets by the end of the year prior to filing an application. In parallel, the reinsurance market was opened soon after accession: non-life insurers from abroad can now offer non-life services to overseas enterprises, as well as property insurance to foreign-funded firms in China. By late 2003, non-life insurers from abroad were offering all kinds of non-life insurance services to Chinese and foreign customers. This situation explains why basic WTO rules stand for reducing as much as possible the government’s administrative interference in economic activities and puts under significant pressure the insurance regulatory department. In this sense, it is expected that the CIRC, in line with the relevant WTO rules, should strengthen and improve the regulatory work through increasing levels of transparency, work efficiency improvement, or further openness of its management. This explains why the CIRC is taking important steps, in addition to those related to the restructuring of the industry, as discussed earlier on: first, it is strengthening its supervisory capabilities by establishing offices in Beijing, Shanghai, and Guangzhou; second, it is urgently preparing the legal framework by revising the Management Regulations for Insurance Companies (Baoxian gongsi guanli guiding) and drafting new laws, including Management Regulations for Foreign Insurance Companies (Guowai baoxian gongsi guanli guiding) and Management Regulations for Foreign Owned and Sino-Foreign Joint Venture Insurance Companies (Waizi baoxian gongsi guanli tiaoli). Put another way, as insurance companies have only a 4% profit margin from business income, they get their money mainly from setting up laws and selling policies. Summing up, although WTO impact has been rather small in the short term – due mainly to the lack of sound reform in the financial and banking sectors – it will still be a learning process for both domestic and foreign insurance firms. In theory, SOEs should be able to survive, considering the strict control on the financial sector; but in practice, their role will diminish in relative terms. After all, licenses are starting to be issued almost unlimitedly, while competition becomes increasingly aggressive. In the case of Ping’an, we will observe how the organization’s learning capability has been successfully transformed, especially in life insurance, precisely as a result of the pressure from external market factors.
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Insurance Insurance
Main tips (1) Restructuring. While the State keeps part of its supervisory role within the industry, shareholding insurance companies are encouraged and independent insurance companies emerge. The establishment of a solid legal framework and a more effective restructuring of the financial and banking sector as a whole can eventually contribute to an even more dynamic industry, which now appears to be tightly linked to the changing patterns of China’s urban society. (2) Outlook. The insurance industry becomes increasingly dependent on GDP per capita growth, and on economic and social trends of China: as the population becomes older and urbanization rates increase, the demand for insurance inevitably increases. (3) Competition. Because of the general business immaturity, and despite the superiority of foreign insurance products, market penetration in China is still at a very low stage. After all, there is a general lack of insurance culture and foreign firms have been facing significant barriers until very recently. Since 2003, as part of WTO commitments, foreign companies have been allowed to expand their business far beyond Shanghai. Already by 2001 eight European insurance companies, four life and four non-life insurance, were granted licenses to set up insurance practices in China. (4) WTO impact. Although WTO impact has been small in the short term, domestic and foreign insurance firms can eventually evolve profitably and with increasing levels of transparency once the banking and financial sectors are fully liberalized by late 2006. In fact, licenses have already started to be issued almost unlimitedly, while competition has become increasingly aggressive.
Case study: Ping’an Life Insurance Company of China, Ltd Interview with Mr Ni Rongqing, Vice GM, China Ping’an Life Insurance Company, Ltd Ping’an Life Insurance Company of China, Ltd (hereafter, Ping’an) was set up on March 21, 1988 and opened for business two months later. The company is registered in Beijing with headquarters in Shenzhen. After more than 15 years of operation, Ping’an has developed businesses covering life insurance, property insurance, trust investment, and other investments. In 2002, the company achieved total revenues of 62 billion RMB (US$ 7.5 billion) from the insurance business, representing a 33.39% increase compared to the previous year. The after-tax profit was 1.8 billion RMB (US$ 0.22 billion). By the end of 2002, their assets were calculated at 144.756 billion RMB (US$ 17.5 billion), 13.269 billion RMB (US$ 1.6 billion) being for net assets, representing a 52.32% and a 114.57% annual increase, respectively. The ratio of non-performing assets continued to be kept under 1%. In the section of life insurance, despite the market slowdown, Ping’an still managed to realize a 2.94% increase on its projected premium income for the year, which was 53.5 billion RMB (US$ 6.5 billion) and represented a 33.77% annual increase.
Insurance 179 History of the company The company started its operations in 1988 in the city of Shekou (Shenzhen), and then expanded to the Pearl River Delta in Guangdong Province. Only a few years later, its business spread to the whole country. Its name used to be Ping’an Insurance Company, but in 1992 it was changed to Ping’an Life Insurance Co. of China. Mr Ni stresses the importance of the different shareholders in the evolution of the company: The original founders were Shekou Industrial & Commercial Bureau and the Industrial and Commercial Bank of China (ICBC). Later on, our company also attracted international investors such as Morgan Stanley and Goldman Sachs Asia Investment. In 2002, HSBC entered our capital too. Now we mainly have these three major foreign shareholders. Besides, we have been cooperating a lot with Taiwanese and American firms. The strategy of the company can be divided into two main periods: Extensive period: 1988–1993 For these years, Mr Ni characterizes the company’s business strategy as ‘extensive,’ focusing mainly on market development and operation expansion. During this period, the major difficulty came from the need for expansion. At that time, competition in the insurance market did not exist at all. In a way, it was Ping’an’s entry which created it. Apart from the long-history player People’s Insurance Company of China (PICC), Ping’an was the only new insurance company in the country at that time. Mr Ni talks about the challenges in that initial period: As one of the first companies in this market, we met a lot of difficulties. The regulatory environment at that time was not very favorable; it was not easy to operate. People were not used to competing. The pressure was very strong on us. Besides, PICC used various methods to obstruct our development. In other words, in the first phase of our history, it was really difficult to start an environment with market competition, and it was also very difficult to get qualified employees at that time. Intensive period: 1994–today In 1994, as a result of the entry of new shareholders and cooperation with McKinsey, Ping’an changed its strategy from external development to internal focus and professional operations. Mr Ni explains the main developments during this phase: During the ‘intensive’ period, we separated the property insurance business from the life insurance business. We did not understand well the difference
180
Insurance between individual and agent insurance business, so we recruited many staff from Taiwan and studied foreign models. McKinsey helped us in 1994 to implement many changes. We gradually grasped the way to enhance financial profitability while maintaining financial security. We implemented a flexible management of personnel, funds and assets, and developed some new business areas.
This period of internal focus continued with the incorporation of new shareholders and a plan for going public in 2004. As Mr Ni mentions: Last year, HSBC became our shareholder. They introduced a much stronger emphasis on the company’s internal control. Besides, we planned to go public. We have the pressure from the preparation work for going public; for example, the integration of internal systems, such as the accounting system, and the definition of some operational targets. These will be our main focus this year.
Mr Ni Rongqing’s story After graduation in 1991, I joined PICC. I have been working for Ping’an since 1995. Between PICC and Ping’an, I worked for a security company for two years. Now I am in charge of the group insurance business of the Shanghai branch. I have two major responsibilities: marketing and sales, and customer service, which include establishing sales targets, profit goals, promotion of sales channel, and services to customer groups.
Organization Ping’an began as a regional insurance company and later expanded to the whole country. This growth in operations and geographical coverage has imposed fundamental changes in its organization. As Mr Ni explains: The role of headquarters now is much more important. This is one change. The second change is the separation in 1994 of property insurance from life insurance. Legally, we are still the same company, but internally the property insurance is a separate business. Under our head office there are three sub-companies: Life Insurance, Property Insurance and Trust Company. Our headquarters is located in Shenzhen. The investment center of the group is located in Shanghai. Our property insurance, trust and securities companies are all in Shenzhen. Life insurance is divided into two parts: marketing is in Shanghai, while personnel and finance are in Shenzhen. We have branches all over mainland China except Tibet. We also have a branch in Hong Kong. The most important and risky decisions, such as products and investment management, still remain as the responsibility of the group office.
Insurance 181 As to their line of business, Mr Ni mentions that their initial product was property insurance; later they added life insurance. In life insurance, there are different business units such as individual, corporate, and bank business. Mr Ni talks about his company’s business development: “At present, the sale of life insurance accounts for around 80% of our total income and this percentage is still growing. This is a result not only of China’s development, but also of the strategy of the company.” The insurance sector is heavily regulated in every country due to the financial risks that can affect the fulfillment of their obligations and even their survival. China is not an exception. Mr Ni expands on this point: The Insurance Law impacts us most, especially on the operational side. Some of our new business lines are possible thanks to the changes in the law. Inside the domain of life insurance, to begin with, there were no laws or regulations on individual life insurance. Gradually, complementary regulations and laws are being published. Regulations also affect the relationship between banks and insurance companies. As Mr Ni explains: Every insurance company has a close relationship with a bank. In the past, banks invested in the insurance company. Now, however, cross-investment among financial organizations is definitely forbidden. Ping’an’s major shareholder used to be ICBC. Of course, our relationship is very close and we get a lot of support from them. But now, because of the change in the law, ICBC no longer holds our shares. Nonetheless, these new regulations did not stop the cooperation between banks and insurers, and even opened other avenues. Mr Ni mentions how his company has been able to utilize banks to commercialize its products: “Now, we are beginning to use banks as agencies for insurance products, which is the sales model in Europe. In France and in Italy, the main products of insurance companies are sold through banks.” According to Mr Ni, Ping’an is the first company to try this channel in China and is being very successful so far. Through this model, the relationship between the insurance company and the bank is also strengthened, as Mr Ni states: The year before last, we signed a cooperative agreement with the Bank of China, covering the sales of insurance products, the sharing of customer information, the creation of customer-added value and financial service, etc. Every insurance company enjoys a good relationship with banks. Evaluation of the implemented changes Mr Ni is very positive about the reform process in his company. In his opinion, the main factor for its successful transformation lies in the organization’s
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learning capability: I think the reform in Ping’an has been very successful, especially in the field of life insurance. Though we rank No. 2 in the country, we are leading in many provincial capitals and important cities. We have been No. 1 for many years in Shanghai and Beijing. The major reason for Ping’an’s success lies in our strong learning capability. We are very good at learning from other companies, mainly from those in Taiwan, Japan, and the United States. We study them and invite their senior management here to help us. The desire for making progress and changes is very strong within the company. Mr Ni explains how Ping’an has adapted very well to the general economic transformation of China: We grasped the good opportunity in 1988; China started the “opening up” process and Shenzhen became the experimental zone. In 1992, Deng Xiaoping visited southern China and the reform surged up. At that time, we had reached a certain scale and began our professional development. Of course, there are lessons to be learnt. The business boosted too rapidly and the support lagged behind. The internal control was not very strict and there were disparities in the quality of our sales staff, all of which could damage the image of the company. We should have put more emphasis on internal training. Competitive advantages and future challenges According to Mr Ni, Ping’an’s aim is to become a financial holding group in the long run. He goes on to say: This was not possible until year 2002, due to the limits imposed by the newly emerged regulations. Now, thanks to the hard effort made by our top management, those restrictions have been lifted. Currently, the major task in front of us is the allocation of resources and the design of Ping’an’s future direction. The design of our strategy has become our major concern. With regard to the internal processes, Mr Ni thinks there is still room for improvement: I personally think that the distinction between individual and corporate business could have been clearer. The sales and service systems are very different in these two kinds of businesses. The relationship between the insurance company and the company and its employees, the obligations and rights, the management of risk, etc., is still vague. In a larger scope, we need more guidance and control over the company’s investment. The State Council has a very strict control over the use of funds.
Insurance 183 The competitive advantages of the company can be summarized as follows. The first advantage is talented people. Mr Ni explains: Our key management level is constituted by experts, many of them recruited overseas. I can say that we have the best team in China. In addition, throughout Ping’an’s more than 15 years of history, we have attracted and recruited a team of experienced, professional and diligent staff. Our employees’ motivation is very high. I regard this as our most important competitive advantage.
HR at Ping’an The educational level has become a definite requirement for employees since 1994. A Bachelor’s degree is a must for positions other than direct sales, which also take in people with at least a college degree. I do not know the exact number, but there is an obvious increase in the percentage of Master and Doctor graduates in our company. Our employees are quite young, too: take the Shanghai branch, for example; the average age is around 31. Our company has many policies to attract and retain talents, but in my view the most important way is to offer development and learning opportunities. Of course, some people leave. I can say that except for the big three, most of the management in the new insurance companies in China are from Ping’an. Whenever a new insurance company is set up, it usually approaches Ping’an for candidates. This is because we have the best and youngest staff. It is said that Ping’an is the business school for the insurance industry.
The second advantage is Ping’an’s corporate culture. According to Mr Ni, the company’s corporate culture is very well known inside the industry and is frequently featured in the press, which has a positive influence on the customers. Mr Ni feels proud of his company culture: The corporate culture of Ping’an is very attractive and advanced. For example, we have morning meetings in which we read the mission and vision of the company, sing songs, and communicate corporate news and big events. Almost every insurance company is doing the same now. Besides, we have an annual top conference, to which only the best employees can go. The third advantage lies in the company’s organization. As Mr Ni states: Compared with our competitors, we have a very complete insurance-centered operation framework. Now sales and service are still centered on products, but in the future, they will be centered on customers. Currently, all the Chinese insurance companies are contract-oriented. All the services come from the insurance contract. But in the future, it will become customeroriented. We are already doing it.
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Mr Ni sees competition in the market as the most important challenge: We are always preparing for the future competition. Ping’an has been paying attention to Shanghai for a long time. Not because sales income in Shanghai is the largest but because Shanghai enjoys a high degree of openness. Here you can find insurance companies from all over the world. If I am not wrong, the number of insurance companies in Shanghai is 19. They have their strengths in different areas. We have always been preparing ourselves and paying close attention to the performance of our Shanghai branch. We are learning a lot from overseas companies. As regards the plans for expansion in the international markets, Mr Ni is very clear: “Regarding expansion to foreign countries, I do not think that the company has such a plan in the near future. The business focus is mainly on mainland China. It’s easy to understand. Local opportunities far exceed those in foreign countries.”
Ping’an Learning points (1) Put your home in order before you grow. Before you embark in an expansion period, it is advisable you create the right structure to support that growth. Ping’an did it, with excellent results. Consultants can play an important role in this task. (2) Go to the stock market. It will be a great incentive to create and implement modern control systems in the organization. (3) Redefine headquarters’ role. Especially in an increasingly diversified organization, headquarters play a different role from single-business firms. Ping’an’s headquarters will become more of a financial holding than an executive center. (4) Form alliances with banks. Banks are a crucial selling channel for insurance products. The insurance firm that can establish these alliances will obtain a competitive advantage difficult to emulate. (5) Learn from the best. Insurance is a very competitive industry. Constant improvement and new product development are key factors to success. Challenges ahead (1) Risk management. Insurance is still an immature market and domestic firms are relatively inexperienced. Risk management is one of the factors that have the strongest impact on profitability. (2) Develop a strategy for the future. Due to the changing legislation and the entry of foreign competitors, designing the appropriate strategy becomes a challenging task. The environment changes fast and in somewhat unpredictable ways. The company that is able to adapt and grasp the emerging opportunities will be the sure winner.
Insurance 185
Conclusions and future perspectives The insurance industry is clearly dominated by SOEs. As expertise is appreciated more at the technical level than at the strategic level, the Chinese authorities give priority to the national industry. This could eventually be translated into a more effective restructuring of their firms. While economic reforms evolve and Chinese consumers accept more openly the necessity of insurance, the industry is bound to develop quite rapidly, giving special emphasis to its own national players: WTO accession offers the opportunity to national insurance companies to have more access to foreign expertise in customer services, innovative product development, financial management, quality improvement, or capital operations; but familiarity with the market and the marketing networks should eventually strengthen the role and the influence played by domestic producers. As proven by Ping’an’s case, Chinese insurance companies still face important challenges. They have to create professional management systems, especially in the areas of risk management and investment. On the organizational side, they have to clarify their structure so that they can cope with the market’s rapid growth and the growing sophistication of product offerings. Finally, they need to design strategies to cope with a highly competitive environment. After all, foreign companies with more advanced systems and product range are rapidly making themselves a place in the market. Furthermore, the legislation is still in the phase of formation and therefore causes more uncertainty to an already complex industry. Ping’an is a clear example of using the right approach: the key to success is the capacity to learn and execute; this should guarantee Ping’an a winning position in the insurance industry.
China Life Insurance Company (1949) Ping’an Insurance Company of China, Ltd (1988)
The People’s Insurance Company of China (1949) China Pacific Life Insurance Co., Ltd (1991) China Reinsurance Company (1996) China Pacific Property Insurance Co., Ltd (1991) New China Life Insurance Co., Ltd (1996) Tai Kang Life Insurance Co., Ltd (1996) Huatai Insurance Company of China, Ltd (1993) Tian’an Insurance Co., Ltd (1994)
1 2
3 4 5 6 7 8 9 10
Life Life and Property Property Life Reinsurance Property Life Life Property Life and Property
Types of insurance Beijing Shenzhen (Guangdong) Beijing Shanghai Beijing Shanghai Beijing Beijing Beijing Shanghai
Head office
State enterprise Joint stock State enterprise Joint stock Joint stock Joint stock Joint stock Joint stock
State enterprise Joint stock
Ownership
54,885 24,902 19,178 10,214 7,983 6,554 762 717
128,781 61,971
Revenue in 2002 (RMB mn)
Note PICC and China Insurance are currently being restructured from state enterprises to joint stock enterprises.
Sources: Zhongguo jinrong nianjian (2003) (Almanac of China’s Finance and Banking), Beijing: Zhongguo jinrong nianjian bianjibu; Zhongguo baoxian nianjian (2002) (China Insurance Yearbook), Beijing: Zhongguo baoxian nianjian bianjibu.
Company name (year founded)
Ranking
Table 8.2 Top ten insurance enterprises in China
186 Insurance
9
Pharmaceuticals
Industry restructuring: Overview Before the reforms, China had practically no pharmaceutical manufacturing industry. Most chemical medicines were imported or reprocessed from imported raw drugs. Now, after years of economic growth, China not only has built a pharmaceutical manufacturing system but has become a major exporter of bulk chemical pharmaceuticals to other countries, given China’s strength in this area. Pharmaceutical regulations in China are based on the Drug Administration Law (DAL, Yaopin guanli banfa). The DAL was first implemented in 1984. In December 2001, a major amendment to DAL took effect. Before then, drug approval applications had to be sent directly to the central State Drug Administration (SDA). The new amendment allowed applications to be initially dealt with by provincial or municipal authorities. At the end of 2002, a new regulation for drug registration (Provisions for Drug Registration, Yaopin zhuce guanli banfa shixing) became effective and accelerated the approval process of some categories of new drugs. The SDA became operational in 1998. It was created as part of the central government’s attempt to streamline bureaucracies in general and to consolidate various health care regulatory functions under a single authority. After its establishment it systematically reviewed all related legal documents, revising, amending, or abolishing them in accordance with current needs. It drafted new legislation, and established drug standards and a certification scheme for pharmacists. It was essentially the old State Pharmaceutical Administration of China (SPAC), with expanded roles in some areas. Following its creation, the SDA called for the rescue of debt-ridden stateowned drug enterprises through the reorganization and combination of units, the renovation of techniques to raise production efficiency, and the development of patented and high-tech products. It encouraged the establishment of large-scale trans-regional and trans-national enterprise groups, and promoted the full use of the idle production capacity of SOEs by allowing certain drug manufacturers to authorize qualified enterprises in other localities to process their products.1 The over-the-counter (OTC) catalog of the second batch of national nonprescription medicines was issued by SDA in June 2001: it declared 1,860 entries
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Pharmaceuticals
of non-prescription medicines.2 In April 2003, China’s SDA was officially converted into the State Food & Drug Administration (SFDA). In order to eliminate firms with inadequate technology, China introduced good manufacturing practices (GMP) systems, so that standards could be set to measure pharmaceutical firms: those that could not meet the GMP standards would be closed. All firms obtained this accreditation by 2004. This step was made in order to regulate and improve the development of the industry, which also benefited from the growing consumer demand in pharmaceutical products such as diabetes, cancer or hepatitis drugs, known to be the fastest growing ones, according to numerous Chinese press releases. Pharmaceutical sales in China are expected to reach 496.2 billion RMB (US$ 60 billion) by 2020, which would place China as the world’s largest pharmaceutical market. Nonetheless, investors tend to be worried about the cut in prices (about 30% for domestic antibiotics and 10% average for antibiotics covered by Western patents) resulting from the fact that only workers from SOEs and private firms have health insurance.3 In addition, while sales increase, domestic manufacturers diminish: in the mid-1990s there were more than 5,000 manufacturers, whereas in 2001 there were only a little more than 3,000, mainly due to the restructuring process of the SOEs. However, the number of enterprises has been growing steadily in recent years, reaching 5,000 in 2004 (Figure 9.1 and Figure 9.2). Restructuring of the pharmaceuticals industry is therefore proving quite effective in terms of sales and general development, in part due to the introduction of GMP systems. Such a catalyst has indeed contributed to growing industrial output and an improvement of crucial subsectors such as traditional Chinese medicine (TCM).
Figure 9.1 Total number of enterprises in pharmaceuticals. Sources: SSB (2005); CEIC database (2005).
Pharmaceuticals 189
Figure 9.2 Ownership distribution of pharmaceuticals firms (N = 3,488). Source: China Markets Yearbook (2005).
Industry outlook China’s pharmaceutical industry is the fourth fastest growing industry after the machinery, coal, and electronic industries. It is the seventh largest medical market in the world: in 2000, its pharmaceutical income was 6.8 billion RMB (US$ 0.82 billion),4 while in 2004 sales revenue reached 347.6 billion RMB (US$ 42 billion). It should become the world’s largest drug market by 2020. By the end of 2004, more than 5,000 pharmaceutical manufacturers (including foreign providers) were installed in the country, employing around 1.3 million workers.5 Indeed, its gross industrial output value in 2004 reached 401.6 billion RMB (US$ 48.6 billion), growing by 15.5% over the previous year (Figure 9.3).
Figure 9.3 Sales revenue of the pharmaceutical industry. Sources: SSB (2005); CEIC (2005).
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The size of the Western-style pharmaceuticals market was about 3,432 billion RMB (US$ 415 billion) in 2002. Although China has become one of the largest pharmaceutical markets in the world, per capita spending on pharmaceuticals still remains among the lowest: in 2002 it just accounted for 99.2 RMB (US$ 12) per capita spending. In 1998, per capita spending on pharmaceuticals was already around US$ 500 in the US, US$ 450 in Japan, and over US$ 200 in Western Europe. However, this figure is much lower in developing countries: in 2002, per capita spending on pharmaceuticals in South-East Asian countries was only around US$ 10, and just US$ 6–7 in India and Africa as a whole.6 The authorities have been emphasizing promotion and support for the modernization of TCM, not only as a way of pushing for further consumption of pharmaceutical goods, but mainly because of the advantages in knowledge and technology in TCM, for which Chinese pharmaceutical companies are engaging in R&D on herbal and TCM formulations. However, modernization is being achieved not without obstacles, considering the strong disagreement amongst TCM experts: some agree to fully re-adapt TCM to Western standards, while others advocate more the preservation of TCM’s roots. As opposed to Western medicine, which tends to be disease-oriented but is often helpless in the treatment of chronic illnesses and fatal diseases such as some cancers, the essence of TCM is to analyze the whole body’s defense system. Nonetheless, it seems that TCM may only be revived by following Western scientific models such as evidencebased medicine and the development of disease-attacking techniques and drugs. The SARS (Severe Acute Respiratory Syndrome) outbreak in 2003 became in some measure a blueprint for tight collaboration between Western-oriented and TCM-oriented scientists. Unfortunately, no effective drug was then developed.7 There are also cases of mixed types of medicines that omit Western influence. For instance, Tibetan medicine, which has a history of more than 2,000 years, is based on TCM plus ancient Indian and Arabic medicine: apparently, it has proven to be effective for digestive, heart, and blood diseases, as well as problems in the immune system, as it is made from medicinal herbs grown in areas with high elevation and therefore extreme climatic conditions. Fake drugs have tended to circulate within and beyond frontiers. In some cases, counterfeits have even posed serious health problems: in 2001, an estimated 192,000 people died in China because of fake drugs.8 According to the World Health Organization, fakes accounted in 2002 for about 8% of global supply: in some Chinese cities, almost 40% of drugs were counterfeit. In 2001, 1,300 factories were closed down for producing counterfeit products.9 Pharmaceuticals are rapidly growing overall, mainly due to restructuring and growing consumer demand. However, GDP per capita remains far too low with respect to developed economies, probably because, despite increased awareness of health matters, medical products are not yet a priority for Chinese consumers (the same phenomenon as for insurance) who may even have become suspicious towards Chinese pharmaceutical products, due to the growing counterfeiting trend. Despite the young character of this industry, pharmaceuticals have been offering an increasing diversity of products resulting from competition.
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Figure 9.4 Output growth of the pharmaceutical industry. Source: Deutsche Bank (2002), China’s Pharmaceutical Sector, September: p. 46.
Competition China’s pharmaceutical market potential has attracted many players, both foreign and domestic: the improvement of quality of life, combined with the abovementioned increasing awareness of health and health-related issues among Chinese people, has made this market especially attractive for foreign investors (Figures 9.4 and 9.5). The development of China’s pharmaceutical industry has in fact been heavily dependent on foreign investment and cooperation with big multinationals, which are developing long-term strategies to increase their market share. But whether a foreign enterprise can turn the market potential into reality depends on its previous R&D and marketing forces, as well as its adaptation to China’s real situation.
Figure 9.5 Western vs. Chinese medicine in 2002. Source: CEInet Market Research (2003).
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One of the major headaches is the requirement to include products in official reimbursement lists: employees covered by the State’s health insurance can only recuperate their costs if their medication is listed; otherwise, they have to pay themselves. This obviously means that medicines that are not listed will be more difficult to sell. The truth is that many foreign companies are particularly attracted, not only by the pharmaceutical market’s huge potential, but also by low labor costs and low land prices. That is why less industrialized provinces such as Anhui or Hunan seem most attractive to them. Some of the companies are lured by the high average profit rate in China’s biomedicine sector and other benefits of R&D localization. Nevertheless, the difficulty of restructuring SOEs to more clarified property rights tends to deter foreign venture capital; moreover, as a developing country, China is not a good market for the expensive new medicines developed through the created JVs. This is why foreign drug companies focus mainly on the development of other markets, using China more as a source of cheap raw ingredients. The most famous brands tend to come from overseas drug makers (Novartis, AstraZeneca, Pfizer, Merck, Rocher Group, etc.) holding a larger market share than their domestic counterparts. In 2002, the products of JVs accounted for 25%, while imported ones held 12% of the market. Joint ventures enjoyed a 9.83% sales profit margin, one percentage point higher than the average level. During that same time period, the SOEs also experienced a rapid growth in their sales profit margin, although this margin was still only 5.57%, about 4.3% lower than that of JVs.10 To this had to be added the presence of Western medicines in China, which by 2002 held more than half the market (Figure 9.5). However, even if China has been a major source for global pharmaceutical companies to produce bulk pharmaceuticals or generic drug preparations, over-capacity is a problem widely seen in many domestic companies. The profitability of manufacturing mass-market pharmaceuticals is shrinking despite the ever-increasing export figures, as numerous players are competing for the low-margin and lowend sector. Thus, provided Chinese pharmaceutical companies still lag behind in R&D, an appropriate strategy would be to manufacture bulk pharmaceuticals in the near to medium term: despite this evidence, R&D seems to be the path chosen by local companies, either consolidating with foreign giants or independently. At the same time, private pharmaceutical companies tend to have high profit margins. Some of them are especially good at marketing and cost control, for which they have gained competitive advantage in the industry. Despite great pressure from SOEs, private companies had more than 30% annual profit growth.11 According to China’s NDRC, there were already 691 private pharmaceutical companies in existence by 2002. However, private companies face many difficulties such as small-scale economies, low R&D level, and insufficient investment. At least, with the WTO-related requirement of deregulating the drug market in 2003, market competition has kept prices low, and private firms have a wider scope of action. The WTO impact can in this sense be fairly significant in terms of property rights, but not have much effect on a rapid increase of foreign firms, considering the aggressive competition, but mostly considering the still far-too-high prices of manufactured medical products.
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WTO impact and challenges About 97% of medicines produced by domestic Chinese interests in recent years have been imitations of internationally patented drugs.12 Chinese companies put in average 2% of sales revenue into new drug development; the figure in developed countries is 20%.13 International pharmaceutical companies are unwilling to introduce innovative drugs into the Chinese market, because they worry that Chinese companies often pirate their products and, by these means, will then compete in the market. We expect (and hope) WTO to help foreign investors to succeed in the market in this respect, in terms of IPRs protection, more R&D, and lower tariffs. The Chinese government’s commitment to protect IPRs has forced national companies to either develop new drugs themselves or copy the drugs whose patents are to expire, given the large amounts of investment, high technology, and long periods of time to develop new drugs by oneself. In fact, in our case study, we understood that Synica has chosen to do research for foreign companies only, due to the lack of IPR protection in China. Although many domestic firms are concerned about the emergence of a patent law resulting from WTO pressures that could potentially hurt most of the pharmaceutical manufacturers, some hold a positive perspective on the future of domestic companies: IPRs protection fosters an efficient market that will pay back to those companies that invest in R&D. This initiative will surely attract an increasing number of MNCs and will eventually push China’s strongest and most innovative players to meet the challenges needed to survive in this market. However, a crucial factor that influences R&D activities is finance: developed nations generally have high R&D levels due to their fairly well-developed capital and financial markets. Most drug firms in China usually rely on their internal funds or on the government’s subsidies to fuel the large R&D expenditures: the lack of research funds indeed slows down new drug development that could potentially be achieved by domestic firms. Tariff reductions (from 14% in 2002 to 5.5–6% after WTO entry) for imported drugs benefit consumers, as foreign products become cheaper, but also harm domestic producers in the short term, until they improve marketing and distribution in the long term. This WTO step encompasses also the opening of OTC retail sales of approved medicines, benefiting the retail sector, allowing more access to medicines, and improving health-care and well-being. Up to now, more than 85% of all pharmaceuticals were sold by hospitals, which tended to use their pharmacies as a source of cash, mostly when health care subsidies started to be cut off. As a matter of fact, in August 2004 the Ministry of Health declared it would issue a new policy later that year to gradually withdraw state capital from public hospitals, though maintaining minimum a of 51% stake. Unfortunately, we have been unable to find a solid proof of this statement. In other words, WTO elements such as IPRs, R&D, or lower tariff levels should benefit both consumers and investors in the long term, as long as structural adjustments take place at the financial level. Our case study, Synica, is actually a
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special example, as it holds a privileged position within the Chinese Academy of Sciences and has therefore more access to R&D. Pharmaceuticals Main tips (1) Restructuring. The rescue and reorganization of large-scale pharmaceuticals groups by the SDA first and the SFDA later, as well as the introduction of GMP, have given the industry a boost: sales revenue now increases while domestic manufacturers diminish, and therefore efficiency has become a must. (2) Outlook. Despite the decreasing number of domestic pharmaceuticals firms as foreign firms enter the market, there are currently more than 5,000 pharmaceuticals manufacturers employing around 1.3 million workers. Despite low per-capita spending in international terms (more than 40 times less than in developed countries), TCM, due to its advantage in knowledge and technology, is encouraged as a way of enhancing consumption levels. (3) Competition. Although not as brand-oriented as cosmetics, this industry attracts overseas brands, which tend to hold the largest market share, in addition to Western medicines, which hold more than 50% of the total. Over-capacity being a problem in many domestic companies, profits of manufacturing massmarket pharmaceuticals shrink despite increasing exports, as players compete for the low-margin and low-end sector. The heavy dependence on FDI and the cooperation with big MNCs might be an impediment to moving ahead, as foreign drug companies focus mainly on the development of other markets, using China more as a source of cheap raw ingredients. (4) WTO impact. Internationally patented drugs are exposed to the permanent risk of being imitated by domestic firms. The WTO and the implied lower import tariffs may harm domestic producers until marketing and distribution are improved, but may also allow for cheaper foreign pharmaceutical products, the opening of OTC retail sales of approved medicines, increasing levels of IPRs protection and R&D, as long as financial support for research funds continues to increase.
Case study: Shanghai Synica Co., Ltd Interview with Professor Zheng Chongzhi – President and CEO Currently, Shanghai Synica Co. Ltd (hereafter, Synica) is one of the top 10 enterprises among all those affiliated to the Chinese Academy of Sciences. Synica is a large-scale high-tech corporation, mainly engaged in chemical synthesis technology, environment protection, and biomedicine industry. Originated as part of the Shanghai Institute of Organic Chemistry (SIOC), which has been affiliated to the China Academy of Sciences since 1959, Synica has been experiencing its development together with the opening up of China. Since 1997, it has successfully developed many patents, including medicine components. Synica’s net profit has been increasing steadily in recent years: 12 million RMB (US$ 1.45 million) in 2000, 15 million RMB (US$ 1.81 million) in 2001, and 16 million RMB
Pharmaceuticals 195 (US$ 1.93 million) in 2002. On July 26, 2003, Synica went listed in Shanghai’s stock market, issuing 30 million public shares at the price of 7 RMB (US$ 0.85) per share, thereby increasing its total registered capital to 760 million RMB (US$ 91.9 million).
The Chinese Academy of Sciences The Academy was established on November 1, 1949. After more than 50 years of development, it has been recognized as the nation’s primary academic institution and R&D center in natural sciences and high technology. It researches on missiles, spacecraft, genes and clone technology, nanotechnology, super computer servers, etc. The Academy has 11 branches in Shenyang, Changchun, Nanjing, Wuhan, Guangzhou, Chendu, Xi’an, Kunming, Lanzhou, Xinjiang, and Shanghai. It also has 84 research institutions, 1 university, 2 colleges, 4 information centers, 3 technical support organizations, and 2 journals. In addition, it invests in 430 hi-tech companies in 11 industries, including 8 listed companies.
History of the company Synica has its origins in the Experiment Factory created by the Shanghai Institute of Organic Chemistry (SIOC) in 1959. At that time, the factory had two main tasks: to apply SIOC’s research outcomes and to sell small quantities of pilot products. However, Professor Zheng declares, “At that time, there was not a single company in China interested in the utilization of their research output.” The situation lasted for almost 30 years until 1985, when the Experiment Factory was restructured into the SIOC Development Company. Professor Zheng adds: Before 1985, the factory was totally dependent on the State. It just needed to produce and wait for the money to come from the Administration. However, since 1985, the State stopped allocating money to the factory. Gradually, the factory developed into a company. Though it was still fully owned by SIOC, it operated independently and was accountable for its own profits and losses. Professor Zheng has been in charge of the SIOC Development Company’s transformation since the mid-1990s. At the beginning, we faced many problems: low sales revenue, overstaffed, no market strategy, etc. In 1995, the company was on the fringe of bankruptcy. At that time, the company had around 500 employees; the yearly sales revenue was only 13 million RMB (US$ 1.57 million), total debt 15 million RMB (US$ 1.81 million), total assets 10 million RMB (US$ 1.21 million). Our assets were lower than our debts. The company had experienced losses for three consecutive years. The yearly loss in 1995 was 800,000 RMB (US$ 96,735.2). We could barely meet our obligations. Thanks to SIOC, which gave us funds, the Development Company was saved from bankruptcy.
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I graduated from Xiamen University in 1964 from the Department of Chemistry and from there I joined the SIOC. Starting as a researcher on probation, I took various positions including research assistant, project member, project leader, leader of the research office, associate researcher, associate professor, professor, and tutor of graduate students. I have been working in SIOC for 39 years since 1964. My research area includes organic chemistry, bio-chemistry, and computer chemistry. Since 1996, I have taken up managing responsibilities, apart from my research job. I was promoted to be the head of SIOC in 1999 and have been in Synica since 1996, when it was still under the name of SIOC Development Company. I was then both the Chairman of the Board and the GM. Later on, I resigned from being SIOC’s leader, and because SIOC holds 65% of Synica’s shares the post of Chairman of the Board was taken up by the following leader of SIOC. I have been working as GM ever since. Now my major responsibility is management, and no longer scientific work.
Professor Zheng started a number of actions to straighten the company. “I was here on May 8, 1996. I spent half a year on internal reorganization and adjustment. Meanwhile, I changed the name of the company to Shanghai Synica Corporation.” These initial measures had an immediate impact on the company’s performance. Professor Zheng explains: In 2000, three years after I took over, there was a visible improvement in our results. In 1996, the yearly production output per person was 34,000 RMB (US$ 4,111), in 1997 it was 64,000 RMB (US$ 7,739), in 1998 it was 120,000 RMB (US$ 14,510), and in 1999 it was 240,000 RMB (US$ 29,021). In 1996, the amount of foreign currency we made was almost 2.1 million RMB (US$ 250,000) and in 1999, it increased to 71.12 million RMB (US$ 8.6 million). While the sales revenue in 1996 was a little more than 10 million RMB (US$ 1.2 million), in 1999 the yearly net profit had already exceeded it. The amount of taxes we generated was 20 million RMB (US$ 2.4 million), almost doubling the net profit. The total salary and bonus for an average employee in 1996 was around 700 RMB per month (US$ 85); in 1999, it that was more than 1,500 RMB (US$ 181). Our net assets increased from negative to 17 million RMB (US$ 2 million) in 2000. Financing During Synica’s initial period, we never had any assistance from the government, nor from SIOC. Later on, when we set up the holding company and were in need of a loan, we received support from the city government. At that time, we wanted to transform our board to be more entrepreneurial. The city authorities came to visit
Pharmaceuticals 197 our company and asked whether there was anything they could do to help us. I told them we needed funds. Our major shareholder, SIOC, could not give us a loan because it was a public organization. So the city government agreed to lend us 300,000 RMB (US$ 36,275.7) for one year. We repaid it in full the year after. In addition, they gave us a lot of short-term credits. The Shanghai Science Commission, the district government, and the city government frequently came here to visit us. They were always willing to help us.
Professor Zheng remembers the situation he found when he took charge of Synica: The first problem I met was personnel. In 1994 and 1995, 75% of employees with a college or university degree had left the company. Almost all of the talented persons were gone. We were left with the old employees and those that were only familiar with old-fashioned methods. The second problem lay in products. All the products we had were developed more than 10 or 15 years ago. We did not have any new products, nor new technology to be transferred. In addition, we did not have our own R&D team, and therefore no capability for innovation. Finally, the company bore a huge debt. The company’s assets were insufficient to repay the debt as we did not have enough funds. To sum up, we had no assets, no product, no talented personnel, and no cohesion among employees. Even worse, the whole management team did not have a sense of market economy and competition. The task ahead was daunting but Professor Zheng had a clear idea of how to tackle those problems. Let’s see how. Step 1: bringing the people together How was it possible to transform a dying company into a very profitable operation? Professor Zheng started the transformation process, launching direct actions to employees. His objective was to convey a new leadership style based on respect and consideration of their needs: The first thing I did was to try to bring people together since I believed that things would be very difficult without people’s commitment. But how could I unite them? I joined the company on May 8, 1996 and on June 2 I held a meeting where I announced that each employee would every day get lunch from the company. At that time, salaries were very low, and we didn’t provide lunch at work. Our workers had to bring their lunch from home. So I promised to give them lunch. In addition, we distributed working clothes, hats, and goggles to everyone for health protection and safety.
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This new style continued with more actions: It was getting hot in June, and the chemical plant was usually closed for inspection on hot days. In order to encourage our employees, and although the company did not have much money, I decided to send them on holiday. Thus, we divided them into three groups and we sent them to a hotel by the Dianshan Lake, one of the famous places in Shanghai’s outskirts. During the holidays, I exchanged ideas with them, shared with them our plan for the company, and asked them to have confidence in the company’s future. In that soothing environment, it was much easier for us to communicate with the employees and they also found a chance to be heard. Gradually, the trust of employees increased as they saw hope for the company. An important element in this process was to bring the Communist Party on board. Professor Zheng relates his actions towards the Party: We took advantage of the Party system to facilitate the transformation process. We got in touch with the Party members first, got their trust, and asked them to set an example to the rest of the employees. We asked them to help us to encourage other people and asked them to persuade other employees. This was very good for the company. And today we can say that what we promised to the employees years ago has all been realized. Now our workers really trust us. Professor Zheng followed a policy of gradual personnel adjustment without using traumatic measures: I have never fired any worker. The only two exceptions were due to a serious infringement of company rules. The first worker kept smoking in the working area against our repeated reminder. The other one slept during working hours. I punished the second worker with one month off the job. Except for these two, I have never asked a single worker to go. It is against our social responsibility to lay off employees. On the contrary, I also absorb laid-off workers from other organizations. HR at Synica Today, employees with a college degree and above account for 10% of the total, including PhDs and MAs. All our workers have senior–middle school education or above and have taken the training of middle-level technicians organized by our company. Retention of talents is a very difficult task in Shanghai. At first, we recruited inexperienced labor from the university as we thought they were better, but now we think we made a mistake. They tend to use our company as a springboard, especially non-Shanghai residents.
Pharmaceuticals 199 Since our company has a good name and the reputation of being part of SIOC, they can soon move on to foreign companies. When they came they were green hands (inexperienced), but after two to three years’ training, they were well prepared to move on. I have changed our policy: we now recruit experienced staff only, who are around 30–40 years old. This company is not a training center, and we should get the return of the money we pay. We no longer hire people without working experience.
Step 2: defining the strategy “Where was our developing basis? How could we find the opportunities to develop Synica?” Those were some of the questions in Professor Zheng’s mind. He had the daunting task of transforming his organization from a research institution to a profitable business. Professor Zheng continues: I studied SOEs and small companies in towns and villages, observing the differences between foreign companies and Chinese companies. I tried to find out why Chinese companies, SOEs or small companies in towns and villages could not compete with foreign companies. I found that foreign companies had very good systems, while Chinese companies lacked them. China has very good research institutes, but not good factories. There was not an effective bridge between them. Our mission was to build that bridge. I was professionally born in a research institute. I understood them very well. The main issue was how to secure the future viability of the company: All of us were wholly devoted in pursuit of the development of the company. We needed innovation. We decided to form our own R&D team. Therefore, we recruited some doctors to chair our R&D center. Since then, 100% of the increased part in export volume has come from new products, 90% of our products are for exports, and all of the increased volume has come from new products. The second issue in Professor Zheng’s mind was the design of Synica’s strategy: “We paid a lot of attention to the design of a new strategy.” In the development of a strategy for Synica, Professor Zheng started a process of pondering on his company: The first question was how to position ourselves in the market and how to organize our product portfolio, considering our strengths and weaknesses. In the initial period of the company, this was the key problem. We could have lost all if we did not follow the right strategy. After an exhaustive analysis, I thought we should target the overseas market, and not so much the local market.
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Throughout the 1990’s, the Chinese market lacked any regulations, and the competition was chaotic and mainly price-based. According to Professor Zheng: Our company is located in Shanghai, therefore our labor costs are higher than others’. Besides, all the investment we made in R&D also increased our cost. We couldn’t compete on price with the small companies in towns and villages. Furthermore, we are a company affiliated to the Academy of Sciences. At that time, the market economy was not very mature and there were high barriers and serious industry protectionism. As a company affiliated to the Academy of Sciences, we would have met resistance from industry if I had targeted the local market. We also had a serious shortage of funds. The ‘triangle debt’ was prevalent in China. If we had been entangled in it, we would have soon gone bankrupt. Most of our managers were researchers, scientists, and intellectuals, not real managers. It was a big problem for us to deal with the deregulated and unregulated market. We saw a lot of challenges in the domestic market that were beyond our capability. After this initial analysis, Professor Zheng saw Synica’s opportunity in the foreign market: Comparatively speaking, taking a look at the global market, we had our own strength there. First, we had the brand advantage of the Academy of Sciences. Secondly, similar companies in China did not have R&D capability, while we did. Our R&D capability was very attractive to the international companies due to its low cost. Thirdly, we could guarantee our quality because we had SIOC and a good team of senior analysts for quality control. In addition, we could avoid the threat of being entangled into the ‘triangle debt.’ As to price, though we were more expensive than companies in towns or villages, we were still low by world standards. Thus, we decided to turn to the global market. The next decision to make was with regard to the product portfolio. Professor Zheng explains: As it fitted in to our specialty, we initially proceeded with refined chemical products. First of all, we had the pool of talents from the SIOC in this special field. Then, refined chemical products needed low investment. If one product failed, we could immediately move to another product. Usually, a project with 1 or 2 million RMB (US$ 120,919 or US$ 241,838) in investment could yield several million RMB in output. Chemical products had a good profit, low investment, low risk, and short developing cycle. Finally, it was the right timing. More and more large multinationals outsourced to companies in developing countries. In this way, we did not produce final products and therefore did not need advertising, which was an advantage for a company like us with a serious shortage of funds. Meanwhile, we could use others’
Pharmaceuticals 201 patents to protect our own technology. You know, the companies in towns and villages were experts in stealing technology. IPRs at Synica In IPRs, we have always been the target of all small companies in towns and villages. How to manage our technical personnel has always been a big problem. This is the reason why we do not want to develop local products but instead do business with foreign companies. We try to control it at every stage. For example, we sign a confidential agreement with new employees; therefore, we will get the right to take initiatives when trouble arises. Whether we could get the evidence and win the case in court is another issue. At least we have the right from the law. Before we start a project, we ask employees to sign the confidential agreement once again, for which we also pay compensation. A certain part of our salary is to compensate for the confidentiality clause. Then we carry our IPR education to all our staff. In addition, we try to separate purchase, sales, R&D, and production to different geographical locations.
Large multinationals were a good choice for several reasons, as Professor Zheng explains: Large MNCs had a very good reputation and did not have the ‘chain debts’ problem SOEs have. What was more important, this initial strategy was the first step in my further objective of producing final products. Refined chemicals could develop into medicines or fertilizers. We could easily go from intermediate products to final products. Professor Zheng saw the main objective in this initial phase as to form the necessary financial reserves to facilitate the future growth of Synica: “We let others earn much more money while we’d rather be satisfied with less but with small risk. To me, avoiding risk was more important than earning money.” This financial objective was of critical importance for Professor Zheng: We were starting up a company without any reserves. We were in the initial stage of accumulating capital. Any little failure could kill us. We needed to be very cautious in our investments or projects. We first needed to control risk and then to find the way to make money. My team and I were all researchers without any managerial experience. We were working, exploring, and learning at the same time. We were totally relying on ourselves. This new approach needed a different working style based on cooperation among different members of the organization. Professor Zheng indicates: I emphasized that the technician, engineer, and researcher needed to work together on projects. I also emphasized that the researching, engineering,
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Professor Zheng’s plans had excellent results. The dying company he took in his hands became a successful business. He recounts: When somebody asked me whether the development of the company was because of SIOC, I said yes and no. Yes, because we came from SIOC. No, because we had never brought any research outcome from SIOC. Our company had a common language and understanding with research institutes, while most of the companies in China didn’t. Besides, we set up the R&D center on our own, which was totally independent from SIOC. SIOC belongs to the government and is mainly doing basic research while our R&D center was doing applied research. The outcome of SIOC went for publication, while ours went for production and the market place. Therefore our approach was totally different. When SIOC obtained the research outcome, they had finished their job, whereas when we got ours, our work had just begun. Step 3: going public Once Synica was profitable and had good business perspectives, it was time to take a step forward in the transformation of the company: going public. Professor Zheng explains the process: Ever since the holding company started to function, we expected to enter the stock market. Initially, we planned to go listed on the main board; however, the municipality thought that Shanghai had very few hi-tech companies and encouraged us to go listed on the entrepreneur’s board. After we failed to enter the entrepreneur’s board, we returned back to the main board. Synica Holding Co., Ltd, established in September 2000, owns 95% of the shares of a subsidiary. The parent company has 300 employees, while the subsidiary has 180. The subsidiary is mainly used as a production base. We now have altogether together three plots of land. Our headquarters and R&D are based in the engineering research center, both in downtown Shanghai, while all the production is located in the Jinshan Chemical Industrial area, in Shanghai’s outskirts, about 50 km south of the city center. Professor Zheng adds: Before, we were 100% owned by SIOC, but we needed to bring in new capital. We had to separate ourselves from the parent entity. We are among the
Pharmaceuticals 203 first hi-tech companies approved by the State to go to the stock market. We successfully went through the evaluation of the main board of experts. Unfortunately, the Chinese stock market began to go down. We went through the evaluation on September 11, 2002. We thought it would be better to go on the stock market the following month. Professor Zheng remembers the preparation process necessary to go to the stock market: We had to deal with the Security Regulatory Commission. Production had to improve steadily. This was a priority. Besides, our chemical plant is the environmental protection ‘model unit’ in China. We also improved the company’s management and production systems. We clarified its ownership and examined its legal structure. Professor Zheng recounts the whole process: “All this took a long time. The whole organization and systems were redesigned, but the most critical task was to have a good development plan for the company.”
Managing a JV We have a very small JV with a Japanese company. Though it is very small, its future is bright. China will become one of the bases for micro electronic products. For example, Taiwan’s microelectronic industry has moved to Shanghai, Beijing, and Hangzhou. The core of microelectronics was of course semiconductors, but there were also some highly pure chemicals needed. Five years ago, we began to pay attention to this industry, which turns out to be crucial today. It used to be 100% imported. We invested US$ 600,000 in a small company with a Japanese partner to explore this market. This year we might increase the investment to $2 million. In order to have a successful partnership, we first need to have good communication amongst managers. Second, any JV needs to consider the commercial factor. After all, cooperation between companies comes from the balance of interests. Without it, a good relationship is just empty words. Thus we must keep paying attention to our partner’s interest. We must also give profits to our partner and to ourselves, of course. Third, at the beginning of any JV, all possibilities need to be taken into consideration. We have to be prepared for potential problems. Both parties should calculate returns on investment carefully and foresee all kinds of problems. Both parties have to be sure who should bear the responsibility if the JV fails. Finally, once the JV is set up, both parties should be wholly devoted to it and try their best to realize the promises made before. Our cooperation has already lasted for three years and the trust is increasing. The foreign party is willing to transfer more technologies to us. We have more technical cooperation with Japanese companies while acquiring more business with American companies.
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Future and challenges When asked about the future, Professor Zheng replies: Our market expansion progress is still too slow. The reason is that we have paid too much attention to the global market. When foreign investors first entered China, we had not yet occupied the local market and developed products to meet local needs. Until now, on the local market, our expansion capability was still weak. Meanwhile, we are now facing competition from India, Chinese private companies, and SOEs on the global market. Another area to improve is on efficiency and cost control: Our efficiency is not high enough while our costs are really high. The reason why we have been developing successfully these years is because we have good market positioning and technological innovation. This brings him to another challenge area: Our weakness in efficiency is linked to the weakness in management. Market, innovation, and management have been the three factors we have been concentrating on all these years. Our company has a bias towards technology, but what we lack is MBA talents, those well prepared in marketing, management, finance, and law. Our company does not lack technical talents but managers, young capable managers. He continues: Our success comes from R&D; however, it is very difficult to keep the efficiency and effectiveness of the R&D team. Very often, the team works slowly with unclear results. The management of the R&D team becomes a very serious problem. When successfully solved, it should become the engine of the company’s development. Badly dealt, it could kill the company. In fact, there are still a lot of problems that remain to be solved. Now, investment into R&D accounts for 12% of the total investment. In addition, we have been paying close attention to the market. However, our market expansion is still not very successful and really lags behind. The development of the company still faces crucial challenges. Professor Zheng has very ambitious plans for the future of Synica: Now we are transferring our production base to the Jinshan Chemical Industrial Area. We have bought 133,333 square meters of land there, and have built up a factory of 33,333 square meters. Within one year or two, we will transfer all the production activity from Shanghai to Jinshan. The funds from the stock market are also for that purpose. We will set up a new R&D
Pharmaceuticals 205 center in Shanghai. We have also established a customer service center in the United States. The next step is to build a technology integration center there and transfer some of the R&D activities. Right now, while we are steadily expanding the global market, we need to gradually explore the local market. We are now recruiting marketing talents who can help us. Professor Zheng concludes by saying: I have never believed there are dying industries. Some people say that textiles is a dying industry, yet nobody can do without clothes. If you equip a textile company with modern technology, it can still be a good business. China has had too many dying companies just because they don’t have new products and lack capacity to innovate. We need to bring good innovation systems to China. Innovation also includes innovation in management and mindset. Synica Learning points (1) Win the heart of your employees. Professor Zheng put employees’ respect and well-being on top of his priority list. Even in dire moments, he made the effort to help his employees. This paid off in later stages of his company’s development. (2) Use the Party as your channel to reach the workers. When embarking in an ambitious reform plan, open and intense communication with the Party is a must to gain the support of the rest of the employees. When presented with reasonable measures, they usually listen. (3) Don’t be overambitious. It is better to draw realistic development plans in line with the possibilities of the organization. Synica was prudent and preferred a slower pace of growth that they could manage. Control your risk, even if that means lower profits. (4) Aim at the international market. You will suffer less pressure on prices, better payment terms, and respect for IPR. (5) Use the stock market as the final test of a successful reform. Synica waited until they were ready before going public. Challenges ahead (1) Control costs. Especially when you are thinking of going into the domestic market. The pressure on prices makes competing with other local companies very difficult. (2) Counterfeiting. IPR protection is a key factor in the future viability of Synica and other research intensive companies. The future of research in China by Chinese companies depends very much on effective enforcement of anticounterfeiting laws. (3) Attract and retain talented employees. Especially at management level. Companies such as Synica have to compete with MNCs and other Chinese companies with a relatively scarce supply of talent.
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Conclusions and future perspectives Pharmaceutical regulation in China is still important, mainly under the watchdog of the SFDA, and GMP systems were set up in 2004 as part of the regulation and improvement of the industry. But while sales increase, manufacturers (mainly small SOEs) diminish, and private firms play an increasingly important role in the market, thanks mainly to the high profit margin levels, as well as marketing and cost control, for which they have gained competitive advantage in the industry, despite great pressure from JVs and SOEs. Foreign competition could be an impediment to their growth in this sense, but in fact they tend to focus mainly on the development of other markets, using China as a source of cheap raw ingredients. As China’s WTO commitment to greater protection of IPRs should improve the situation for foreign companies, it has also become harsher for local companies with little R&D capacity. As a result, competition between pharmaceutical manufacturers progressively intensifies, while inefficient producers are being eliminated. Experts believe that the best strategy for China’s pharmaceutical companies is to manufacture bulk pharmaceuticals in the near to medium term, relying on the competitive advantage of lower production costs. But whatever strategy local companies adopt, China’s pharmaceutical market should eventually become a large stage where domestic firms and MNCs compete together, making the market increasingly prosperous. After all, China’s pharmaceutical industry should become the fourth largest pharmaceutical market in the world by 2010 and perhaps the world’s largest by 2020, given its large and wealthier population who show an increasing concern for health care. As TCM is supported by the government, producers should benefit most from meeting international standards and improving their medicine quality. Synica, our case study, is an outstanding story of how to transform a dying company into a promising business. In this case it was due to wise leadership, having a person with vision, able to develop a realistic development plan, and prudent execution. In his success recipe, Professor Zheng put respect and support to his employees as one of his priorities. This created the necessary trust fundamental for the accomplishment of the company’s goals. Besides, Synica has been able to create its own niche in the extremely competitive research field. Thus, despite the many challenges ahead, if full restructuring is done appropriately while R&D further expands, there can be many other Synicas in China’s pharmaceutical industry.
Shanghai Pharmaceutical Group Co., Ltd (1996) Shanghai Fosun Group Co., Ltd (1992) China National Pharmaceutical Group (1998) Guangzhou Pharmaceutical Holding Limited (1996) Tianjin Pharmaceutical Group Co., Ltd (1997) 999 Group Co., Ltd (1991) Harbin Pharmaceutical Group Holding Co., Ltd (1989) North China Pharmaceutical Group Corp. (1996) Xinhua Lukang Pharmaceutical Group Co., Ltd (1966) Nanjing Medical Co., Ltd (1994)
1 2 3 4 5 6 7 8 9 10
Shanghai Shanghai Beijing Guangzhou Tianjin Shenzhen Harbin (Heilongjiang) Shijiazhuang (Hebei) Jining (Shandong) Nanjing (Jiangsu)
Location 15,068 10,117 9,913 8,815 8,389 7,147 6,559 6,299 4,626 1,501
Revenue in 2003 (RMB mn)
Joint stock Private State enterprise State enterprise State enterprise State enterprise State enterprise State enterprise State enterprise Listed company
Ownership
Sources: Based on the ranking from Zhongguo Jingji Maoyi Tongji Yianjian 2004 (China Economy and Trade Yearbook 2004) and China Markets Yearbook (2005).
Company name (year founded)
Ranking
Table 9.1 Top ten pharmaceutical manufacturers
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10 Steel
Industry restructuring: Overview During Mao’s Great Leap Forward, steel was already a fundamental element in China’s economic priorities, whether for good or bad. Today, as China rapidly grows, import needs have followed suit, while international prices are progressively becoming conditioned to China’s strong demand for steel. The truth is that China’s steel industry lacks economies of scale and its industry concentration is much lower than in most countries: in 2004, only 26 steel manufacturers produced more than three million tons of steel,1 which is the minimum international threshold output for steel companies to reach economies of scale; the existence of many small mills has led to repetitive production and an irrational industrial structure. As a result, in 2003 the authorities shut down more than 60% of the country’s public steel companies: SOEs and collective-owned enterprises in the steel smelting sector were reduced to 63 (24% of the total). Similarly, SOEs and collective-owned enterprises in steel rolling were reduced to 486, accounting for only about 20% of the total number of firms within this subsector (N = 2,429) (Figure 10.1). Apart from closing mills, mergers are now strongly encouraged by both the central and local authorities: as it is economically irrational to have each one of China’s 31 provinces maintaining a steel sector, merging needs to go beyond administrative boundaries. In 2000 the authorities launched an aid package of more than 59 billion RMB to the steel industry, especially to the Big Four companies (Baosteel, Angang, Wugang, and Shougan),2 involving technological upgrading.3 But large-scale M&As can entail social risks in the process of China’s transition. After all, China’s steel industry already employed about three million workers in 1990. For instance, Handan Steel Co. (Hebei Province) may be one of China’s most efficient producers: at 103.5 tons per employee per year, according to government figures, with a total of 16,224 employees by 2004.4 But the truth is that labor absorption has been drastically reduced in general terms while unemployment rates have inevitably grown geometrically for the sake of the industry’s survival (Figure 10.2). The Chinese government is conscious that the future of steel in China can only make progress with efficient firms. Outdated technology, low quality, and polluting steel production have progressively been replaced by more environment-friendly
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Figure 10.1 Ownership distribution in the steel sector in 2003 (N = 2,429). Source: China Markets Yearbook (2005). Note Subsectors for steel include here steel smelting and steel rolling.
and cost-competitive technologies: in 2003, Chinese steel companies built new facilities and adopted technologies while phasing out old ones. According to the China Iron and Steel Association (Zhongguo gangtie xiehui), technological upgrading of projects needed at the time to be included in major domestic steel companies, in order to increase iron smelting and steel making capacity.
Figure 10.2 Employment in the steel sector. Source: CEIC Data (2005)–data are only available as far as 2000. Note For some inexplicable reason, in all the data sources used, employment figures were missing for the years 1991 and 1999.
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Before the reforms, all transactions took place through State appropriation and the government fixed prices. This system has changed gradually, as State interference has been undermined by increasing price fluctuations that respond directly to market mechanisms. For instance, in order to facilitate the flow of commodities, the first non-ferrous metals exchange was set up in January 1992 in Shenzhen, China’s largest special economic zone. Later that year, the first national metals exchange opened in Shanghai. The establishment of these institutions laid the foundation of commodity trade in China and has eventually benefited steel producers. In other words, in comparison with other countries, China’s lack of economies of scale and low industry concentration in its steel industry has pushed the authorities to launch probably the harshest process of SOEs restructuring in the country: efficiency comes first, even at the expense of workers. But, in the long term, old unproductive and polluting firms are being replaced by more environment-friendly and cost-competitive technologies that should potentially place Chinese steel producers in a stronger position in terms of commodity trade. The question is whether the need for further steel imports could eventually weaken domestic producers.
Industry outlook While steel production represented about 6% GDP in 2003 (Figure 10.3), China’s output of crude steel and finished steel products had grown by 6.6% and 8.1% in 1980 and 1999, respectively, largely outgrowing world steel output.5 The capacity
Figure 10.3 Steel as share of GDP (%). Sources: China Markets Yearbook (2005); CEIC data (2005).
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of steel production surged in the first half of the 1990s, with rapid investment growth (Figure 10.4). Then China overtook Japan, and became the largest steel producer in the world in 1996.6 In 2001, the output of crude steel, iron, and steel products amounted to 1.49 billion, 1.45 billion, and 1.57 billion tons, respectively.7 The gross industrial output value of China’s steel industry accounted for 6.73% of the country’s total gross industrial output value in 2003, respectively.8 While steel production used to be concentrated in the northeastern region (Liaoning, Jilin, Heilongjiang), with time the East has become the center of China’s steel industry, as production gets geographically closer to consumers and export destinations. The structure of finished steel products is biased towards low-end products. In 2004, long products such as sections and wires reached 133.8 million tons, accounting for about 56% of China’s steel products, whereas flat products such as sheet and tube amounted to only 107.3 million tons.9 This production structure somewhat reflects China’s steel consumption pattern: generally speaking, long products are mainly used in the construction industry and flat products in the manufacturing sector (Figure 10.5). Long products are less capital-intensive than flat products.
Figure 10.4 Ex-factory price indices of industrial products in the metallurgical industry. Source: SSB (2003). Note This table reflects the trend and degree of changes in general of ex-factory prices of all industrial products during a given period, including sales of industrial products by an industrial enterprise to all units outside the enterprise, as well as sales of consumer goods to residents. It can be used to analyze the impact of ex-factory prices on gross output value and value added of the industrial sector.
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Plate-pipe ratio Continuous casting ratio
Figure 10.5 Varieties and quality of products. Source: SSB (2003). Note The continuous casting ratio is the ratio of qualified continuous casting steel output to total output, which reflects the quality of the steel product. The plate–pipe ratio is the ratio of plate steel products to pipe steel products, which reflects the technology improvement in steel manufacturing.
Consumption of finished steel products exhibits higher volatility than production. Steel consumption is essentially linked to the country’s economic cycles, particularly investment cycles. For instance, consumption weakened sharply in the mid-1990s, due to the general investment slowdown. But, as investment increased in 1999, consumption recovered. China’s steel major users include the sectors of construction, machinery, transport, mining, electrics, metals smelting, and processing. The link with transport equipment, domestic appliances, and housing is particularly tight in this sense. Though large in aggregate terms, given that per capita steel consumption in China was about currently 230 kg in 2004,10 there is more room for the steel industry’s growth. The country’s ongoing industrialization and urbanization process and the West Policy underlie the basic demand for steel products in China in the coming decades: expected higher economic growth should underpin continuing recovery of steel demand. Steel demand should maintain a medium-term growth of about 5%, on the basis of a 7.5–8% growth rate of the economy. According to MOFCOM’s forecast, China’s
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steel consumption should increase to about 357 million tons in 2005, a 14.4% increase over 2004. Initial predictions were that China could become the world’s largest steel consumer and would continue to push for international prices to go up. However, as shown below, the exact opposite has been taking place: there has been an overcapacity, and therefore a rapid decrease of prices. In line with demand trends, prices of steel products rose rapidly in the late 1980s and early 1990s, but then declined continuously until 2000. The dumping of steel products from Russia and South Korea exerted ever-increasing pressure on prices. However, prices strongly rebounded in 2000 as a result of demand recovery, the government’s output-restricting efforts, and anti-dumping procedures. By 2004, the domestic supply of steel amounted to 296 million tons, 62.2 million tons more than in the previous year.11 Steel price is so volatile that the price range could be as much as several thousands RMB in one year. Take the example of 2005, where the wholesale price of hot-rolled sheet in Shanghai was 4,144 RMB (US$ 501) per ton in November, i.e. a reduction of 34.5% from the peak level of 6,330 RMB per ton recorded in April that same year.12 China’s steel industry as a whole has been profitable, due to government support before and during the reforms. But, as mentioned earlier, by the late 1990s profits had declined sharply in accordance with weakened demand and lower prices. In line with demand and prices, profits began to pick up in 1999 and recovered strongly in 2000. In 2005, despite the increased output and sales, Chinese enterprises, having enjoyed profits during the beginning of the year began to suffer losses later, in November. This was mainly due to the dramatic fall of steel prices: 80% of the country’s steel makers had reported losses since October that year.13 It is, in other words, a fragile industry, very much subject to the overall economic context.
Competition The continued flow of FDI into overheating industries such as steel, cement, aluminum, and real estate has not blocked the government’s efforts to control these areas, as these cooling steps are mostly financial ones. They include raising bank reserve requirements and curbing loans to these sectors, but they do not ban investment in these industries: despite their big impact on domestic companies, the effect is very small on foreign investors, who can actually gain huge profits in such overheated industries.14 In fact, the central government is keen on attracting FDI for further technical and management expertise that can be used to improve China’s domestic firms. For instance, BlueScope Steel Ltd, Australia’s leading steel company, recently announced the construction of a major flat steel metallic coating and painting facility in Suzhou Industrial Park (Jiangsu Province). In the last few years, the government has been encouraging the establishment of JVs. In fact, the steel industry’s equity market has already been largely opened to foreign investors: currently, there is no limit on foreign ownership in foreignfunded steel enterprises. This could indeed be viewed as an opportunity for
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China to use the appropriate resources for a large-scale restructuring of assets. It would force steel enterprises to make innovations in technology, management, and services, to optimize and upgrade the industrial structure, and to build up their long-term advantages in competition. Baosteel is a crucial example of internationalized operations implementation, as we will get the chance to observe in our case study. In the past, China’s steel production fell short of demand. The shortage worsened while the economy was rapidly growing in the 1980s. This is the reason why net imports of flat products have become increasingly substantial since the early 1990s. The gap between China’s steel imports and exports narrowed in 2004, when China imported 29.3 million tons of steel products, a drop of 7.87 million tons from the 2003 figures (i.e. 21.2% year-on-year). This was the first year-on-year drop in China’s steel product imports over the past six years: in 2004 China’s steel product exports increased by 104.6% (or 6.06 million tons) to 14.23 million tons.15 China’s imports of finished steel reflect the country’s limited capacity to produce high-quality products. China’s major foreign steel suppliers have traditionally been Japan, Russia, South Korea, Brazil, Germany, Turkey, Italy, and, more recently, Ukraine and Kazakhstan. Given the technology-intensiveness, of china’s steel industry, flat products will continue to be the economy’s bottleneck in the next decade or two, in which China will continue to be a significant international flat steel buyer (Figure 10.6). Another vital aspect to China’s steel trade is the supply of raw materials, in particular iron ore. China’s domestic iron ore is of poor quality and major steel plants require a consistent shipment of large volumes from abroad. The still poor domestic transportation system, mainly the railway system, constrains the flow of iron ore from major producers to end users, and hence prevents the largest steel plants from operating at their full capacity. As a result, the actual import requirement may be larger than expected. Since 1999, China has become a net importer of flat steel, the demand rising by an average of 17% annually, compared with just 2% for the rest of the world. To some degree, the problem of worldwide steel overcapacity could in the future
Figure 10.6 Domestic share and import share of steel in China’s domestic market (2004). Sources: CEIC Data (2005); Cygnus China Industry Monitor (2005).
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be solved by China’s increasing demand for steel. But the reality is that domestic firms may cover such demand if national economic growth slows down, and then China will become a net exporter instead. Nonetheless, most of the increase in China’s demand will be met more by domestic producers and not so much by foreign ones, as domestic producers are expected to expand the overall capacity of their existing plants by 10 million tons a year through 2010 and China’s emergence as the biggest steel consumer may not reduce the global overcapacity as much as expected by 2010.16
WTO impact and challenges The Chinese steel industry is at a crossroads since China’s WTO accession. As a leading steel producer, consumer, and importer, China is committed to opening its steel market to global competition. This brings both new growth opportunities and challenges for Chinese manufacturers. Generally speaking, steel exports will benefit from the modernization process of the industry, which is expected to speed up. After WTO entry, China’s steel exports should receive reciprocal treatment from other WTO member countries with a reduction in tariffs as well as non-tariff barriers on exports, while the inexpensive labor and land costs can help exports of low-end steel products. In recent years domestic steel prices have been close to international prices, being even lower than those in developed countries. In particular, some Chinese special metal resources, such as tungsten, molybdenum, titanium, barium, and rare metals, kept their competitive advantage in the international market. In addition, WTO membership should enable China to seek redress for antidumping and other unfair trade practices through formal WTO mechanisms, while the more open environment should help standardize the Chinese steel-trading sector with increasing transparency. In fact, safeguard measures on steel imports are the largest benefit China has achieved since WTO entry. Instead of being severely affected, as previously anticipated, China’s iron and steel industry has mastered methods of how to protect its self-interests. For instance, US initiated its Trade Law ‘Section 201’ in early 2001, imposing a three-year tariff quota restriction and 30% tariffs on imports of major steel products. In this international steel trade dispute, the EU, Japan, and South Korea adopted protective measures to shield the domestic steel market from the impact of imports. The Chinese authorities also announced on November 20, 2002 that they would impose final safeguard measures on the imports of five kinds of steel products – HR sheet, CR sheet (strip), color-coated plate, non-orientation silicon steel, and CR stainless sheet – for a term of two-and-a-half years. This has made clear China’s stance in providing transitional protection to its iron and steel industry. Safeguard measures should create a comparatively relaxed environment for China’s iron and steel industry to complete its industrial restructuring. Within the l0th 5YP, the authorities have constructed several plate production lines as a follow-up to those that are already functioning: Tangshan steel’s sheet production
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line; Handan steel’s second-phase plate production line; Wuhan steel’s HR plate line; AnShan steel’s second CR production line; Benxi steel’s second CR line; and Baosteel and Hualing’s CR and HR plate production lines. Of course, time is needed for the market to digest these capacities. However, China’s WTO entry has lowered the threshold for similar foreign quality steel products to enter the country and to pose a threat to the iron and steel industry’s development. In other words, safeguard measures offer the industry a chance to gain time and adjust its own product mix while seeking future development. More FDI and exposure to the steel industry should also speed up the pace of the industry’s modernization, with an increased flow of foreign technology and management methods. However, WTO entry will also bring serious challenges: (1) Biased impact of tariff reductions: the impact of tariff reductions is large overall, with a certain negative bias towards high-end products. Given that the average tariff on steel products was lowered by more than 50% in 2002, the overall impact of tariff reductions on steel products should be robust.17 Consequently, the cost of imported steel products per ton should decline to about 100 RMB by 2007. For example, the import cost of 0.5–1 mm CR plate, whose import tariff declined from 8% to 3%, will decrease to 140 RMB; <3 mm HR flat products, whose import tariff lowered from 6 to 3%, will also decrease to 55 RMB. (2) Greater impact of the elimination of the import registration system: licensed and quota control over steel imports were already abolished in 1992, while in 2005 the quantity-restricting import registration system was eliminated. This is expected to be a greater driving force for steel imports into China. In fact, domestic consumers are demanding higher quality steel in ever-larger quantities, while China’s domestic industry has great difficulty meeting their requirements, due to insufficient re-rolling (i.e. value adding). (3) More competition: the relaxation of import and export barriers should lead to more intense competition in the Chinese steel industry. The statespecified trading system implies that import business on steel products is only conducted by a number of state-specified trading houses that have been able to conduct trade business since 2003: any enterprise with a registered capital of at least five million RMB can apply for trading rights. (4) No real comparative advantage in the steel industry: China’s finished steel productivity per employee is approximately 37 tons per year, whereas in the developed economies this figure is close to 400 tons. The modern steel industry is capital- and knowledge-intensive, which does not really match with China’s comparative advantage in low labor costs. The iron–steel ratio (energy cost per steel) in 2001 was 1.02, higher than the world average of 0.5–0.7.18 The finished steel products/crude steel ratio is slightly higher than in other countries, partly due to the imports of steel sections and plates. The plate–pipe ratio is more than 20% lower than the world level.19 As for equipment, only about 25% of China’s steel-making equipment reaches
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international standards: 60% of the equipment is qualified for meeting domestic demand, one-third of which is classified as domestically advanced. There is about 20% of backward equipment, most of which represents overcapacity and will soon become obsolete. China’s high-cost steel production has obviously reduced the products’ competitiveness in the domestic market. With China’s entry into WTO, national firms need to cut their production costs in order to compete with their offshore producers. In 1999, China topped the world ranking in total crude steel production with 123.7 million metric tons. A merger between Baosteel and Shanghai Metallurgical Group propelled the Shanghai Baosteel Group to No. 7 in the world rankings and the only Chinese producer in the top ten list. On July 14, 2004, Fortune’s 2003 Global 500 Magazine announced that Shanghai Baosteel Group Corp. was ranked No. 372, with an annual revenue of 120.4 billion RMB (US$ 14.548 billion). In fact, our case study of Baosteel’s reform process has put special focus on the workforce adjustment, becoming therefore a clear example of how the ‘iron rice bowl’ – a system of lifetime employment including a low salary, while job security and income levels were not linked to the individual’s performance – has come to an end.
Steel Main tips (1) Restructuring. The lack of economies of scale and the low industrial concentration have resulted in repetitive production and an irrational industrial structure. Restructuring of steel SOEs has driven almost 60% of the total to be shut down, mainly through M&As, despite social risks. Technological upgrading projects should push for increasing iron and steel making capacity. (2) Outlook. China has been the world’s largest steel producer since 1996, when it overtook Japan. Traditionally located in China’s northeast, the steel industry now tends to concentrate on the east coast, closer to consumers and export destinations. Low-end products predominate in finished steel products: longsteel products (construction) tend to be less capital-intensive than flat ones (manufacturing). Output levels of the former (60% of total output) are far more significant than the latter. Steel consumption is tightly linked to the country’s investment cycles, for which potential is significant, especially considering the ongoing industrialization and urbanization process. As China increases steel consumption, competitors worry for higher world prices. However, steel demand should potentially be overcome by domestic producers. (3) Competition. Overheated industries, including steel, tend to attract FDI, as they suffer very little effect from the government’s intervention in cooling down the economy. In addition, the Chinese government shows particular interest in the foreign presence for the benefit of domestic firms, mainly in terms of
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technical and management expertise. Considering there is no limit on foreign ownership in steel foreign-funded firms, a large-scale restructuring of assets could eventually take place, mostly in terms of innovation and increase of competitiveness. But China will still remain a flat steel buyer for some years, unless its capacity for producing high-quality products increases. (4) WTO impact. The steel industry can benefit from WTO entry in terms of modernization, speed, increase of transparency, FDI, and therefore more foreign technology, as well as an improved management system and more safeguard measures on imports. However, challenges are important, as WTO regulations will exercise significant pressure on domestic firms: tariff reductions are significant in high-end products, for which pressure is even higher for domestic firms; as production costs decrease, Chinese firms will need to become more competitive in the international arena.
Case study: Baosteel Group Enterprise Development Corporation (BGE) Interview with Mr Xu Nan, GM of BGE and Vice Chairman (Member Company of Shanghai Baosteel Group Corporation) Shanghai Baosteel Group Corporation (hereafter, Baosteel) is the largest steel producer in China and sets foot in diversified industries such as trade, finance, equipment manufacturing, information, chemical industry, and so on. Baoshan Iron and Steel Co., Ltd Baosteel’s holding company, has been successfully listed at the Shanghai Stock Exchange since 2000. The annual sales income of the Group reached 110 billion RMB (US$ 13.2 billion) in 2003. Baosteel’s current annual steel production capacity of 20 million tons is ranked fifth in the world. According to World Steel Dynamics,20 Baoshan Iron and Steel Co., Ltd was ranked the second of the most competitive steel producers globally (Figure 10.7). History of the company Baosteel Group, originally the Baoshan Iron and Steel (Group) Company, built its first production facility in December 1977. This first facility attracted an investment of 12.8 billion RMB (US$ 1.55 billion). In 1980, the project was postponed for two years when the government at that time considered other investments more urgent for the improvement of the people’s quality of life. The company finally began production in September 1985. A second phase was built and began production by the end of 1989. The total investment for both phases was 30 billion RMB (US$ 3.6 billion). The third phase of the project began in 1995, with a total investment of 62.3 billion RMB (US$ 7.5 billion), next only to that of the Three Gorges project. The third phase was put into use at the end of 2001.
Steel
Figure 10.7 Baosteel Group.
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As early as 1993–1995, the Central Government planned to merge Baoshan Iron and Steel (Group) Company and Shanghai Iron & Steel Holding (Group) Company. Faced with the challenge of global competition, Baoshan had an increasing need for capital and resources, while all of the ten subsidiaries of Shanghai Iron & Steel were losing money, with the highest deficit being 920 million RMB (US$ 111.2 million). In November 1998, Baoshan acquired Shanghai Iron & Steel Holding (Group) Company and Shanghai Meishan (Group) Company. The name of the company was then changed to Shanghai Baosteel (Group) Company. One of the most important challenges the group was facing was an excessive number of employees. The company had inherited the so-called iron rice bowl system and gradually transformed this system into one more adapted to the new market rules. Baosteel Group Enterprise Developing General Co. (BGE) BGE was established in 1986 when Baosteel was still the Baoshan Iron and Steel (Group) Company, which was then the first SOE to separate its secondary activities from the core business. At that time Baosteel had 33,000 employees for an annual steel output of 12 million tons, a production level higher than other fellow companies in China, yet still too low when compared with overseas companies. The reason behind the decision for the restructuring was to streamline operations so they could compete with foreign companies on the same basis. BGE was set up to take over the group’s welfare activities. According to Mr Xu, BGE’s General Manager, “this separation was very professionally done and earned great applause from the State’s SOE Reform Committee,” He adds: “there are still many SOEs learning from our experience.” BGE received 14,000 employees from Baoshan at that time. As a result, the steelmaking unit was run by 17,000 employees, more in line with international standards. Smaller subsidiaries, equipment manufactures, and trading companies took another 2,000–3,000 employees. BGE had three major responsibilities. The first task was the logistics of employee services, including running 36 canteens, arranging employee housing and shuttle bus services, offering medical care, as well as maintaining dormitories and the company’s green areas. There were in total five subsidiaries and 5,500 employees working in these activities. The second task was more related to production work. As Mr Xu indicates, “We followed the Japanese example and offered subcontracted services to other units, such as packaging of finished products, maintenance of factory and facilities, factory roads, seashores, anti-fire equipment and airconditioning, and final product storage. These activities employed 6,000 people.” The third task dealt with the treatment of by-products, such as steel residue. Mr Xu considers this a critical part of BGE’s activities: One ton of iron used to generate 330 kg residue, now the amount is reduced to 280 kg. Baosteel consumes 10 million tons of iron annually, which generates 2.8 million tons of residues. Residue recycling is good for the environment
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and we also make some extra revenue from its reutilization. For instance, coal-driven electricity plants give off coal powder, which is then transformed by us into construction material. He continues: There is a total of 13 subsidiaries working under BGE. We are on one hand the investor and on the other hand the coordinator of all these subsidiaries. BGE is the only one with direct communication with the steelmaking factories of the group. Thus, we centralize the activities of our subsidiaries. Mr Xu feels very proud of his company’s achievements. What was in principle the group’s deadwood is currently generating profits, “Last year, the sales volume of this company reached 7.2 billion RMB (US$ 870 million), generating 210 million RMB (US$ 25.4 million) of tax and 198 million RMB (US$ 23.9 million) of net profits after tax.”
Mr Xu Nan’s story I joined Baosteel in 1982. After the Cultural Revolution, our country restarted the national university entrance examination. I was lucky enough to leave Heilongjiang Province to pursue higher education. I was among the first batch of university graduates after the Cultural Revolution. On graduation, I was assigned to Baosteel. In 1984, I was the first among all new graduates to be promoted to the ‘Chuji’ level.21 At that time, Baosteel was still in the construction stage and had not yet begun production. It started production on September 15, 1985. As a brand new company for China, Baosteel attracted many visitors every year. I was later transferred to the GM’s office in charge of external affairs. In that responsibility, I had the honor to meet important leaders of China, including Deng Xiaoping. I stayed in that position until 1990, the fifth year of Baosteel’s operation. I told my boss I wanted to do something related to my major, which is steelmaking. So I was promoted to Assistant Manager in a steelmaking factory, and later became its General Manager. In 1994, I was promoted to Director of Production in Baosteel. In August 1996, I was assigned to this company, the Baosteel Group Enterprise Developing General Company (BGE). My predecessor had been sentenced to 12 years’ imprisonment resulting from a bribery of 240,000 RMB. I had already had experience in welfare services when I was elected chief of the housing committee in 1985. I was then in charge of the housing allocation facilities to Baosteel employees. I gained a lot of popularity among the employees. That was one of the reasons I got my current position. The allocation of housing facilities is one of BGE’s duties. In 1999 I joined the EMBA program at CEIBS. It is a part-time program, which was very convenient for me. That program has greatly helped me in my current job.
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Mr Xu refers to the iron rice bowl system: Baosteel was one of the first in separating social duties (housing, accommodation and healthcare) from core activities. We have already advanced a lot. The allocation of housing stopped in year 2000. We now have a new system. We open a housing account for each new hire and deposit 17% of their salary into it. For those employees that have already received apartments from the company, they still need money to maintain and improve their houses. Therefore, there is also a housing account for them with a smaller percentage of their salary. Mr Xu continues: “They can use those funds whenever they need them. They can now choose to buy any apartment they like. We don’t tell them which one to buy anymore.”
Change in mindset It is hard for old employees to change their mindset. We experienced many unexpected detours in this process. For instance, the price of apartments in Shanghai goes up much quicker than we expect. Thus, the housing allowance we establish is always insufficient. Then we decided to purchase cheap land, build houses ourselves and sell them to our employees at zero profit. You must have seen a lot of apartment buildings with the logo of Baosteel on them. They were built by our company and sold to our employees. But, in this way, we could not help our employees change to the market-oriented mindset: they were still dependent on the company. In addition, this system has created new problems. First, the property management fees. Buildings in different areas charge different management fees. One may only be charged 0.5 RMB/square meter while another may be charged 1.5 RMB/ square meter. Then those employees paying more obviously tend to complain. They refuse to pay and ask the company to compensate them for the extra charge. Second, whenever a property needs renovation, they come to us for money. The company can never get rid of these troubles. SOEs in China are people oriented. Popular leaders are those who have a good rapport with the people. Our leaders hold a paternalistic attitude and want to take care of the employees as if they were their own children. However, this is not good for the new market competition. I once saw a Japanese film about the life of foxes. When the son fox grows up, the father fox bites the son until it leaves the family. We feel that it is wrong for the employees to always depend on the company. We should act like the father fox. This will make many people unhappy but we don’t have another choice if we want to be competitive.
SOE staff redundancy: The biggest challenge In November 1998, Baosteel was set up after the merger between Baoshan Iron and Steel (Group) Company and Shanghai Iron & Steel Holding (Group) Company. The new company had a total number of 168,000 employees, while its
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steel production capacity was only 17 million tons. Compared with the situation of Baoshan, where 33,000 employees produced 12 million tons, there was an ostensible decline in productivity and an acute problem of excess labor force. As a result, Baosteel decided to implement an ambitious reallocation plan. The process still continues, as Mr Xu indicates: Currently, the group has 110,000 employees. The ideal number is 50,000, so we are still using the reallocation program. We are putting 500 million RMB (US$ 60.5 mn) every year into this program. They use a gradual process. First, they offer early retirement to those who are close to the required age.22 Also, those with physical impediment are offered early retirement. From that day on until the legal retiring age, the company pays the basic salary but no bonus or contribution to social security. When they reach the legal retiring age, they are then transferred to the government welfare system. Second, the company creates new jobs for redundant workers. Mr Xu explains their job creation program: We set up several property management companies and assign some of our employees as guards, gardeners, or mechanics. We also provide food catering for schools. For example, the Second Military Medical University, the elementary and middle schools in Baoshan District, and Changzhen Hospital all contract their canteen service to us through a bidding process. We also set up some supermarkets and employ our staff there. Their objective is to absorb the excess employees through the development of the group. He adds, “Our company senses a great pressure. It is like riding a bicycle. If we stop pedaling, we fall. Only if we keep on pedaling and even pedal faster can we be secure.” Why make all these efforts? Mr Xu recognizes that they could use a drastic and much faster way of reducing staff, just by firing people: We do fire some, but only if there is a reason, such as gambling or stealing. The number is very limited, no more than a dozen every year. The majority do not do anything wrong, so if we fire them it will create a negative image for the company. We try to find a better way. China’s SOEs have always been closely integrated to society. So we cannot simply transplant the Western system of firing people. We have a responsibility towards society. That is a central part of our values. Another activity aimed to ease the process of labor reduction is to offer training to employees with obsolete skills. Mr Xu explains: Baosteel has formed a group with 100–300 redundant employees. We call them the redundant team. They are paid 1/3 or 1/4 of their original salary.
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Resistance to change People used to visit or write complaining letters to the higher management. But nowadays, the redundant group has become a major threat to those workers with a position. They are afraid that if they complain too much, they will be placed into the redundant group. As a result, they began writing anonymous letters to the higher management, saying that some managers have excessive salaries or are corrupt. Generally speaking, the change is well accepted by the young generation, while the old employees feel that they are treated unfairly. They say that when they joined the company their salary level was very low, but the starting income for new employees is much higher. I tell them that young employees have different conditions. The newcomers are no longer long-term employees; they only get 3, 5, or 10-year contracts. The iron rice bowl time is over.
HR at Baosteel The company Previously had two departments responsible for personnel management. One was in charge of labor administration and salary payment while the other was in charge of communication with employees. In the new structure, these two departments have been merged into one. As for the role of the Communist Party, Mr Xu adds: Usually in SOEs the management are all Party members. However, the role of the Party is decreasing and will mainly serve as a monitor function in the future to ensure that the management is loyal to the employees, the company, and the country. Mr Xu adds: This monitoring function is very important because, in SOEs, the management of the companies is far from the real owner of the assets. The owner of Baosteel is in Beijing. Unlike the Board of Directors in the West, the BOD in China is still a virtual idea. So we need to rely on this monitor function to make sure managers are not placing their own interest beyond the interest of the company.
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The company is promoting a new generation of employees. As Mr Xu explains: Young people have a high rate of being promoted if they show real competence. This is also good for the development of the company. But the problem still exists. There are usually two or three candidates applying for the position of GM. While one of them finally wins out, the others are usually appointed as his vice managers. But we found out that these vice managers are not willing to support their former competitor. So in most cases, we have to transfer them to other subsidiaries or departments.
Talent retention Baosteel usually takes in 500–700 university graduates every year. All these young graduates want personal development and opportunities for further education. Baosteel has a complete training system. We send them to domestic and overseas training centers, for example, CEIBS. Some employees leave 2–3 years after they gain experience in managing large projects and overseas training. It is very easy for them to get a job with a higher salary from other companies with the experience and education they received from Baosteel. We have taken several measures to reduce the turnover rate. First, we have reduced the number of employees with a university degree. We also prolong the probation period to test their loyalty. Second, we try to hire experienced people from other companies. The problem is that the sense of loyalty is very low in these people too. They move on again very quickly after joining Baosteel. Third, we keep a percentage of their income as security insurance. This applies to technical workers and managers only. This accumulated money remains unpaid until the retiring age or when their contract expires. If they leave before the date, they lose that money. For a person in my position, the accumulated amount of money could reach 1 million RMB (US$ 120,918).
Future challenges According to Mr Xu, Baosteel has two major advantages. First, it separates its secondary activities from the core industry, which has largely enhanced the productivity level. He explains: For one job, if we can finish it with two workers, we will never let five workers share the load. We would rather ask the remaining three to stay home and increase the working efficiency of the two on duty. We want to compete with foreign companies on the same basis. Second, Baosteel applies the most advanced technology and equipment in its operation, together with advanced management systems. Mr Xu explains it thus: “That is the reason why we can develop so fast. Though the advanced technology
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and equipment is very expensive, it can yield high-quality products. Therefore, the large investment can generate large benefits in return and decrease the gap between Baosteel and advanced foreign companies.” He recognizes that their weak point is a certain lack of innovation. He continues: saying, “The number of patents we have produced do not match a company of our size.” Finally, they have an advantage in labor costs. Mr Xu indicates: “The total labor costs account for only 10% of our total cost, which gives us an important competitive advantage. However,” he adds, “we still need a new company culture of constant quality improvement.” Exports are another important point in Baosteel’s development. Although the US government has imposed trade restrictions on steel products, Mr Xu thinks those restrictions are just temporary. His reasons are clear: “The steel industry is labor intensive and creates some environmental problems. While the US are trying to stop our exports, they cannot afford the environmental price and high labor cost.” He continues: I believe Baosteel’s future is very prosperous. Currently, 15% of our output is exported, mainly to East and West Asia, Europe, and a little to the US. Actually, the demand of the local market has already surpassed our capacity. However, our company has a policy that at least 10% of our products should be exported to the developed market, including Japan and Europe, in order to test the quality of our products by international standards. We do not have many local competitors. This is also changing as China is following the US example of setting up protective measures for its steel industry. It will therefore become difficult for Korean, Japanese, and Taiwanese companies to export their products to China. As a result, those foreign producers are beginning to change their marketing strategy, investing in JVs or wholly-owned companies in China. These are Baosteel’s potential competitors.
Baosteel Learning points (1) Focus on core activities and separate secondary business. This way, you concentrate your efforts and resources on making your core business competitive with regard to international competition. (2) Use soft tactics to eliminate the iron rice bowl policy of the past: (a) Go for smooth workforce adjustment where possible. Baosteel formed a subsidiary to gather redundant employees. They then made this subsidiary selfsufficient and even obtained benefits. (b) Give freedom of choice regarding housing and other social benefits. This liberates the firm from the responsibility of parenting employees.
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(3) Be present in the international arena, even if the Chinese market can absorb the entire production. By keeping a presence in the international markets, you will gain experience and knowledge by competing abroad. Challenges ahead (1) Cost reduction and labor productivity. This is a fundamental step to keep the competitive edge as opposed to international competition. (2) Talent retention. Probably one of the most challenging tasks, due to the high demand for talent from domestic and foreign companies.
Conclusions and future perspectives Both during China’s previous heavy-industry-oriented strategy (1949–1976) and today’s reforms, steel has always been considered a politico-economic priority. As market mechanisms evolve, the steel industry has been quickly shifting in parallel with the country’s rapid economic growth. In 1996 China overtook Japan and became the largest steel producer in the world, while in 2001 it became the world’s largest steel consumer. These significant trends will obviously affect sectors such as construction, machinery, transportation, mining, electrics, metals smelting, processing, as well as transportation equipment, housing, and domestic appliances, especially considering the ongoing industrialization and urbanization process and the progressive development of the Western areas of the country. Nevertheless, due to limited capacity to produce high-quality products, and given China’s steelmaking technology intensiveness, the country will continue to be a significant flat steel buyer in the international market. After WTO entry, China’s steel exports should receive reciprocal treatment from other WTO member countries with a reduction in tariffs as well as non-tariff barriers on exports, while the inexpensive labor and land costs can help exports of low-end steel products. However, it is quite possible that the impact of tariff reductions will be biased toward high-end products; the elimination of the import registration system will be more pronounced; lifting the ‘specified trading’ system, or opening up domestic distribution markets as well as relaxing the conditions on foreign investment, could all in all have adverse effects on China’s steel domestic production and therefore exercise an increasing pressure on the survival of SOEs. Economies of scale can in this sense only be effectively brought up if large M&A acquisitions take place. Despite social risks, the steel sector will not remain unprotected, and we expect strong government support, particularly with regard to the Big Four (Baosteel, Angang, Wugang, and Shougang). Our case study Baosteel represents an example of one the most critical issues in the reform process for most SOEs: dealing with excess workforce. As an SOE, they pursue the policy of not laying-off all those redundant employees, so as to
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avoid social unrest. Baosteel’s strategy can be regarded as a good model to follow, as it is accomplishing its adjustment in a smooth and peaceful way: its restructuring has proven successful through the creation of a subsidiary dealing with redundant workforce. After all, the firm not only reduced the number of employees in its core business, therefore gaining in productivity, but was also able to obtain profits in the subsidiary. In addition, Baosteel included human considerations for those redundant employees who were able to receive a more just treatment.
Baoshan Iron and Steel Stock Co., Ltd (1982) Anshan Iron & Steel (Group) Company (1916) Shougang Group (1919) Wuhan Iron and Steel (Group) Company (1958) Beitai Iron & Steel (Group) Co., Ltd (1971) Jiangsu Shagang Group Co., Ltd (1975) Taiyuan Iron and Steel (Group)Co., Ltd (1934) Ma’anshan Iron and Steel Co., Ltd (1993) Benxi Iron and Steel (Group) Co., Ltd (1905) Tangshan Iron and Steel Group Co., Ltd (1944)
1 2 3 4 5 6 7 8 9 10
Source: China Markets Yearbook (2005).
Company name (year founded)
Ranking
Table 10.1 Top ten steel enterprises
Shanghai Anshan (Liaoning Province) Beijing Wuhan (Wuhan) Benxi (Liaoning) Zhangjiagang (Jiangsu) Taiyuan (Shanxi) Ma’anshan (Anhui) Benxi (Liaoning) Tangshan (Hebei)
Location Joint stock SOE SOE SOE State enterprise Limited liability State enterprise Joint stock State enterprise State enterprise
Ownership
44,158 31,442 27,274 27,313 22,376 20,402 17,241 15,667 15,458 14,866
Revenue in 2003 (RMB mn)
15,710 120,628 66,106 85,362 23,215 9,853 43,392 43,814 72,220 39,782
No. of employees
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11 Telecommunications
Industry restructuring: Overview The telecommunications industry is one of the most crucial ones for China’s modernization process, not only in GDP terms but also, fundamentally, because of its impact on other industries (almost 7% of GDP in 2004, Figure 11.1). As in most European countries, but as opposed to the United States, China’s telecommunications sector has traditionally been one of the most protected national industries: the industry still remains in the hands of the State, despite the gradual liberalization resulting from restructuring in 1998. However, the rapid emergence of private firms has also contributed to changing its profile, as competition increasingly becomes the norm, not so much in terms of interconnection but rather in terms of products offered. Within this sector, there are both service suppliers and equipment suppliers, which we will carefully consider in this chapter. While service suppliers are constituted by the SOEs, equipment suppliers include not only the SOEs but also WFOEs and private firms. Before the institutional restructuring in 1998, China’s postal and telecom services were under the administration of the Ministry of Post & Telecommunications, while telecom equipment manufacturing was mainly controlled by the Ministry of Electronics Industry. Today, China’s telecom industry is under the supervision of the Ministry of Information Industry (MII), a merger of both ministries. In July 1998, the State Council approved the MII’s restructuring plan, following the guidelines of separating administration and services, redefining institutional functions, breaking up monopolies, protecting competition, as well as matching responsibilities with necessary power. On December 3, 2002, when Hong Kong opened the Exhibition of Asia Telecommunications, Mr Wu Jichuan, Minister of MII, gave his own opinion on the industry: “China’s telecom industry has successfully avoided the IT crisis that has been pervading the world. This may be largely attributed to incomplete competition in the Chinese IT market.”1 This statement becomes increasingly crucial, considering the tight link between telecom activities and IT development in general. As the United States and Europe experienced the IT crisis at the beginning of this century, many Chinese experts decided to apply the specialization of the telecom industry by considering one piece of evidence: since 2000, the total market
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Figure 11.1 Telecommunications as share of GDP (%). Sources: SSB (2005); CEIC Data (2005).
value of the United States’ IT companies has shrunk by about US$ 2 trillion, while China’s has remained at a growth rate of approximately 21%. This reality has led people to believe that supervision of the telecom industry is necessary and helpful. However, in those places where the IT crisis was most serious in 1997–98, regulatory bodies believed that this downturn was not the result of less regulation and more market openness; after all, competition was traditionally believed to be the best way to provide better public services and more options. After 2002, consensus was far from evident, not only in those countries that were most affected by the IT crisis, but also in transitional countries such as China; thus the dilemma on how to draft a sustainable law on telecommunications. Chinese experts stated then that if there was no straightforward agreement, there was no need to enact the law hastily, since laws cannot be changed frequently. As a result, the drafting process of the law became secondary while more discussion and research were implemented. It was then believed that opening the market and introducing competition would probably induce an over elaboration of the network. In fact, using Minister Wu Jichuan’s words, “one of the most important reasons for the Chinese telecom industry to be experiencing a prosperous development despite global recession is that over-construction has been controlled through the strict regulation of the government.”2 Considering these circumstances, it is easier to understand the restructuring process of China’s telecom service providers. In February 1999, the State Council issued the restructuring plan for China Telecom; in December 1999, January and June 2000, respectively, China Mobile, China Netcom, and China Satellite were created. Restructuring was also approved for China Unicom. After the whole operation, there were two or more (state-owned) companies in each telecom business area, initializing a competitive market environment. As a result, there are
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now six telecommunication service providers in China: China Telecom, China Unicom, China Mobile, China Netcom, China Railcom (renamed China Tietong), and China Satellite Communication (ChinaSat). China Mobile is China’s largest telecom operator as well as the world’s largest mobile phone operator by number of subscribers: in 2004 the total revenue of the telecommunication industry for all operators grew 12.6% year-on-year to 518.8 billion RMB (US$ 62.7 billion).3 In order to understand how restructuring has evolved for each one of these six service providers, we need to identify them separately. China Telecom China Telecom is the country’s primary telecom company. It is responsible for the development, construction, operations, and maintenance of the public telecom network, and operates most of the voice, data, and paging networks in China. China Telecom was divided in May 2002 into two geographical areas: Southern and Northern China, although the latter was later on assigned to China Netcom. On November 14–15, 2002, it launched an IPO at both the New York and Hong Kong stock exchanges. Despite, or more precisely because of, the division between Southern and Northern China, China Telecom currently has 21 provincial branches and holds about 70% of the national transmission network assets owned by the former China Telecom. Unlike China Unicom and China Mobile, China Telecom does not have a national mobile license. This is why it has launched other new services, intensifying its competition with the two listed mobile operators: China Telecom is giving mobile phone users the option to switch incoming calls made to their cellphones to fixed lines both at home and at the office, implying users can avoid paying the fee normally charged to their mobile account when they receive a call. As Unicom builds business in the mid- to high-end market, Little Smart (Xiaolintong), developed by China Telecom, is gaining momentum among low-end mobile subscribers; after all, it is a citywide wireless service that does not require expensive infrastructure to function. China Unicom The company provides mobile communications, paging, long distance, and data services. It is the second largest mobile phone operator in China. Although founded in 1994 by the Chinese government as the first competitor to China Telecom, it initially lacked public financial support and developed rapidly through alternative financing methods and in 1999 it was listed in the Hong Kong and New York stock exchanges. In 2002, China Unicom launched its Code Division Multiple Access (CDMA) service4. Although at present it operates both CDMA and Globle system for Mobile Communication (GSM)5 – which is the company’s main revenue source – it will still take some time for CDMA to replace GSM.
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China Mobile China Mobile Communications Corporation was founded on April 20, 2000. The corporation has been listed in Hong Kong and New York and acts as a holding company of China Mobile Group (Hong Kong) Co., Ltd. China Mobile has in fact been in operation since 1987, when mobile telephones were first introduced in the country. Thanks to the construction and expansion in the 1990s, it put in place an integrated communications network offering large coverage, diversified services, and high communications quality. Currently, it mainly supplies mobile telephony, data, Internet Phone (IP), telephony, and multimedia services. As China’s No. 1 mobile player, China Mobile has always acknowledged the threats posed by China Unicom and Little Smart’s services; for instance, as a way of competing with Little Smart, China Mobile launched a new discounted service in Chongqing in March 2003 to offer limited features through its GSM network at a lower price. China Netcom China Netcom Co., Ltd (CNC) is a facilities-based broadband telecom operator. The company provides services and solutions to meet the broadband telecom needs of businesses and individuals. Its core business includes Internet broadband access and integrated telecom services to residential and corporate customers. It was founded in August 1999. The company closed its first round of private equity placements in February 2001, raising 2.7 billion RMB (US$ 325 million). In 2002, it became the owner of China Telecom in ten provinces of Northern China, for which it appeared as a spin-off of China Telecom, although, as China Telecom, China Netcom does not have a mobile license. China Railcom (renamed as China Tietong) Although China Railway Communication Co., Ltd (China Railcom) had been a carrier for railway communications under the Ministry of Railways (MOR) for 50 years, on December 26, 2000 it became a large state-owned telecom operator and started to operate as the second largest fixed telecom network in China (after China Telecom). The company is headquartered in Beijing and operates in all 31 provinces. It began to provide public services with a registered capital of 10.3 billion RMB (US$ 1.24 billion). By 2003, revenue was 7.1 billion RMB (US$ 860 million), with an increase of 41% from the previous year, representing 1.4% of China’s total telecom revenue, and had 35 billion RMB (US$ 4.2 billion) in assets, employing 70,000 people. In January 2004 it deterred from MOR and became an independent operator. However, most of its services will likely continue for railways, which puts the company in a less competitive environment.6 In early August 2004 China Railcom was transformed into China Tietong Group Co., Ltd. As Railcom was constrained with funding and carried a heavy
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debt, this move has exempted China Tietong from a total of 2.38 billion RMB (US$ 286 million) debt, which will help the firm deal with increasingly fierce competition. It has also enabled China Tietong to compete directly with the nation’s five other major telecom operators – China Telecom, China Netcom, China Mobile, China Unicom, and China Satcom. However, China Tietong will have a long way to go, as the latest government figures indicate that China Tietong accounted for only about 1.5% of the total market share, a tiny figure compared to China Telecom’s 31.1% and China Netcom’s 16.1%. However, China Tietong is determined to become a strong telecom operator by 2009, through larger amounts of investment and upgrading of its infrastructure.7 China Satellite Communication (ChinaSat) ChinaSat was founded on December 19, 2001 as an initiative launched by the Chinese Post Office and a number of leading satellite sector companies, in order to develop satellite communication. In 2003, ChinaSat signed an equity transfer agreement with the first listed telecom operating enterprise – Unicom Guomai Communications Co., Ltd. Later that year, on December 19, as the State-Owned Assets Supervision of the State Council gave its official approval, ChinaSat merged with China Siwei Surveying and Mapping Technology. Although ChinaSat is one of the six national operators, it does not offer any direct residential services: most of its customers are telecom operators, banks, securities brokerages, insurance, TV companies, and the military. After undergoing restructuring, ChinaSat wanted to give an image of an extended service provider rather than just a satellite operator, by entering the distance education market using a satellite to broadcast coursework and training materials. Despite its unsuccessful attempts to enter the ground service market and its application for a mobile operator license, ChinaSat intends to launch overseas IPOs.8 The final result of the national telecom restructuring plan has been translated into a fairly coherent distribution of sales in the market, as shown in Figure 11.2. In other words, China’s 1998 nationwide telecom restructuring plan has been relatively successful, although there are still difficulties on how to draft a law on
Figure 11.2 China’s telecom carrier’s market share in 2004. Source: Paul Baddie Communication (2005).
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telecommunications, due to disagreements on the role played by the regulatory body. All of China’s six telecommunication service providers share the total market, but there are alternative sources of growth of the industry such as new networks, service quality, and brand development, apart from growing internationalization trends.
Industry outlook China’s telecom industry witnessed strong growth, particularly between 1997 and 2002. In August 1997, China’s fixed-line telephone network became the second largest in the world, with over 100 million lines in switching capacity. A modern telecommunication network connected throughout the world was then built and supported by cutting-edge technologies; this network can now provide diversified telecom services within the whole of China. As we know, in 2002 the worldwide IT industry was badly hit by the slowdown in the global economy. Although the impact was not particularly significant in China, the investment in fixed assets by China’s telecom operators reached 203.5 billion RMB (US$ 24.6 billion), i.e. about a 24% drop from 2001’s 275 billion RMB (US$ 33.3 billion).9 Despite this transitory reduction, the accumulated rate had been 1,050 billion RMB (US$ 127 billion) since 1999. Fixed assets totaled 1,350 billion RMB (US$ 163 billion), i.e. as much as 2.8 times that of 1997. In 2002, 130.16 million mobile phones were sold, with a year-on-year increase of 43%, the industry’s revenue reached 462.6 billion RMB (US$ 56 billion), with a 14% year-on-year increase, while there were 95 million new-added users, far beyond the total of users in 1997.10 By the end of 2003 China had 263.48 million mobile phone subscribers, i.e. about five-fold that of late 1990s, while by March 2005 this number peaked to 344 million with a mobile penetration rate of 25.9%.11 On April 8, 2002, China Unicom officially started the public subscription of CDMA network services, as opposed to the GSM system which until then was the only one in existence. Although at that time it was decided that both CDMA and GSM were to be used in parallel, two months later there were only 1.2 million CDMA subscribers.12 It was widely thought that China Unicom would be unable to reach the goal of 7 million sets that same year. However, a big surprise occurred: by August, China Unicom’s CDMA users had surpassed 2 million and by the end of that same year the annual goal was finally reached. This situation entailed a hard war for China Unicom. Many mobile phone makers increased their CDMA phone output after March 2002, alleviating the shortage of CDMA phones, which had been troubling Unicom for months. The full supply also decreased the price of CDMA phones to the so-called accepted level by ordinary consumers. To attract more subscribers, China Unicom subsidized CDMA handsets; this is probably the reason why Unicom can normally reach its annual goal. But China Unicom cannot afford subsidization indefinitely. Since 2003, it has tacitly diverted to the competition in service quality and brand development, thus increasing this way customer satisfaction and loyalty. For instance, China Unicom chose Yao Ming, China’s most famous basketball player, to be its main publicity image.
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Indeed, the CDMA and GSM network will largely increase the chances for CDMA and China Unicom. In order to achieve this, at the time this book was written, China Unicom was intended to test a system designed to link the world’s two systems: although both systems are currently incompatible, Qualcomm Inc. a US developer of CDMA, will supply specific test equipment to Unicom’s office in Suzhou (Jiangsu Province). By the end of 2005, China Unicom boasted 32.722 million CDMA subscribers, but the capacity of its CDMA network exceeded 70 million subscribers. Meanwhile, the company’s GSM subscriber population reached 95.072 million, about three times its CDMA subscriber population.13 The numbers will make China Unicom the second largest CDMA operator (after Verizon in the United States) and the third largest GSM operator in the world (after China Mobile and Vodafone Group in the UK).14 In China, major equipment vendors now include Huawei (private firm), Zhong Xing (listed SOE), Da Tang (listed SOE), Alcatel Shanghai Bell (our case study), Nortel, Cisco, Ericsson and Siemens. In China’s market, domestic firms such as Huawei and Zhong Xing are strong leaders both in price and services, in part because they have made progress developing foreign markets, an activity that accounts for a large part of their total revenue. Nonetheless, the internationalization process of China’s IT has on occasions encountered legal problems. Huawei’s case is indeed the most famous (or infamous) one. Huawei was founded in 1988. It competes in more than 40 foreign countries, including Germany, Russia, Spain, India, Singapore, Thailand, Korea, and Brazil. In January 2003, US-based Cisco Systems, the world’s top producer of Internet switches and routers, announced it had filed a lawsuit in Texas against two US subsidiaries of Huawei Technologies for allegedly copying everything from operating software to user manuals. Huawei denied the charges, claiming that it was a staunch supporter of IPRs and that Cisco was using the suit to enhance its market position. Certainly, Cisco’s lawsuit came only six months after Huawei set up a subsidiary in the United States. With time, while dispute settlement evolved, Huawei was set aside from the US market, until they eventually reached an agreement. Undoubtedly, Cisco now takes Huawei and other Chinese competitors seriously, while litigation has become part of a strategy to oppose Chinese IT firms in general.15 But, coming back to Huawei’s evolution, in 2002 its annual sales amounted to 2.2 billion RMB (US$ 0.27 billion); although the total sales decreased by 300 million RMB (US$ 36.3 million), the sales in overseas markets increased by 25%, reaching 550 million RMB (US$ 66.5 million).16 On March 20, 2003, Huawei and 3COM set up a JV aimed to develop and sell network telecommunication products all around the world, competing with Cisco. For Huawei, collaborating with 3COM created a way of connecting with the world market; for 3COM, it was also a chance to tap China’s high-end market and build up a sales channel within China, now the most promising telecom market in the world. The collaboration between both companies could also be viewed as Huawei’s defending action to gain more power in the lawsuit. To sum up this case, it seems clear that for Chinese enterprises such as Huawei, to play in the international markets on a fair basis is not an easy task: the most
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important barrier to break is the technology monopoly, so that Chinese companies can effectively enter the global markets within the process of their integration into WTO. Despite Huawei’s complex experience, Zhong Xing’s case can compensate for its competitor’s relative loss of credibility. Zhong Xing Telecommunications is the largest CDMA equipment producer in China. It is not only at the frontline of CDMA2000 and Wideband Code Division Multiple Access (WCDMA) technologies, but it is also, amongst China’s equipment producers, striving to gain a share in the global market. In 2003 Zhong Xing signed a contract with India’s largest telecom service provider BSNL, as a way of providing equipment and service solutions for BSNL’s CDMA WLL (CDMA Wireless in Local Loop network). This is the first time Chinese CDMA products have been used in India. More contracts also come from Pakistan, Brazil, and some other developing countries. The key of Zhong Xing’s success in recent years could reside in the right choice of its business focus. It has realized how difficult it is to exceed Huawei in digital telecommunications business, which drives it to divert to another promising area: CDMA2000. By collaborating with China Unicom, Zhong Xing has won large numbers of contracts. When Zhong Xing decided to divert to CDMA, the MII was considering developing the CDMA business. This situation created a very good opportunity for Zhong Xing. Thanks to the MII’s support, Zhong Xing quickly gained its advantage in mobile telecommunications, becoming the major winner in CDMA equipment business. In June 2002 Zhong Xing successfully developed its 800 MHz CDMA 1X (CDMA with one carrier wave) system. This new system not only led the mobile base station system technology to develop; it also provided a qualified technology to accommodate other countries’ telecom systems. In September 2002, in collaboration with China Unicom’s Hainan branch, Zhong Xing proposed a solution integrating CDMA 1X network and wireless Local Access Network (LAN). Later on, in December 2002, Zhong Xing upgraded the solution by adding High Data Rate (HDR) technology into the system in order to improve the service quality of today’s CDMA network. All these steps reflect Zhong Xing’s particular advantage in the telecom technology network.17 Da Tong is the third crucial player in the industry – it proposed the consolidation of Time Division-CDMA (TD-CDMA), which is the first 3G (third generation) telecom standard developed by Chinese specialists and accepted by the world. In mid-2000, TD-CDMA was certified by the International Telecommunications Union (ITU) as one of the three primary 3G platforms (the other two are WCDMA in Europe and CDMA2000 in the United States). Without this paradigm, China would have had to adopt the US CDMA2000 or the European WCDMA. In other words, it would have had to pay large amounts of money to buy equipment from foreign companies and pay for annual patent fees. But the MII realized the need to support local standards. In October 2002, the Ministry allocated 155 MHz of spectrum for use by Time Division Synchronous CDMA (TD-SCDMA). However, it was not easy for Da Tong to put the new
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paradigm into effect: even if Da Tong gained governmental support, it takes time to commercialize the TD-CDMA. The truth is that Da Tong has joined hands with Shanghai Bell Alcatel, Motorola, and Lucent in developing TD-SCDMA since 2005, giving it further capacity to compete with other operators.18 Truly, competitors are too strong with regard to the WCDMA, but China has an ally including 27 telecom companies such as Ericsson, Nokia, and Alcatel. Some big names (Lucent, Motorola) are in the CDMA2000 group. In contrast, the group favoring TD-CDMA includes only eight members, and there are not many big names. Since the local paradigm remains largely underdeveloped, it is most likely that the MII will eventually issue licenses to both TD-CDMA and other paradigms. So far (by early 2006), the MII has not made any clear claim about which paradigm to endorse. It may be reasonable to wait for some time, as the MII itself is still on the learning curve on 3G. Indeed, timing is not too good: in 2002, China launched 2.5G services, which faced a slow acceptance from the public. Thus, the large potential of China’s telecom market is not a guarantee for 3G. According to a report prepared by the State Council’s Research Development Center in 2003, it was then believed that 3G still had a large expansion space.19 Given China’s increasing personal income and need for telecommunication services, high quality data services, which appear to be 3G’s main advantage, were not amongst the consumers’ major requirements. As a result, the report claimed that it was a clever decision to wait for some time before adopting 3G, therefore giving TD-CDMA an opportunity to improve itself. Indeed, the timing of license awards will depend on the test results of China’s TD-CDMA technology.20 In other words, although the telecom industry has rapidly evolved in terms of innovation and access, there are still numerous challenges from a technological standpoint – challenges that keep growing considering the increasing levels of competition.
Competition Within China’s telecommunications industry there are two groups of players: (1) providers (mainly domestic and SOEs); (2) equipment suppliers (with strong competition between SOEs, private, and WFOEs). Here we will concentrate fundamentally on equipment suppliers, where competition is particularly strong, but differs according to whether we are talking about local or foreign competitors. On the one hand, local competitors understand China: no communication obstacles with the government, local authorities, or local clients; cost advantages; rapid and flexible response to market requirements; despite products not being the most advanced, there is a general ability to adjust them to meet the customers’ needs; special attention is paid to customer services; etc. Another important advantage lies in their ownership structure: many companies are private, and compared with SOEs they are better suited to the IT (particularly telecom) industry, considering they have a quicker decision-making process.
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On the other hand, overseas companies have other types of advantage: technology; management; global resources; etc. These advantages are an inspiring motto for local companies learning how to run global operations. But the truth is that the rapid rise in market share enjoyed by local players at the expense of foreign players has created fears for an excessively aggressive price war.21 Although foreign firms at first appeared to dominate the telecom market, domestic firms did significantly well in 2002: listed companies such as ST Xiaxin (JV), TCL (SOE), Ningbo Bird (private), and Kejian China (from SOE to private through MBO22) generated a high sales revenue and profit, despite the global slow development of the telecom sector throughout that year, while they acquired an increasing and continuous market share, reaching almost 40% by late 2002 (Figure 11.3).23 Indeed, despite the top positions of Nokia, Motorola and Siemens in the Chinese mobile phone market, the market has progressively been grabbed by Chinese producers, particularly in terms of equipment suppliers.24 This progress can be explained by two major reasons: (1) Chinese producers have turned from quantity to quality competition; (2) some of the major producers have tapped the high-end market. For instance, TCL, the leading multimedia consumer electronic products manufacturer in China, has been particularly successful in marketing a model of mobile phones with diamonds for high-end consumers.
Figure 11.3 Mobile phone producers’ market share, by sales (1999–2002). Source: Ministry of Information Industry (2003). Notes a According to HSBC (2003), domestic brands reached 23% of market share in terms of sales in 2002, but were bound to reach 50% by 2003. b Chinese brands include the most representative in terms of output: TCL, Ningbo Bird, Legend, Eastcom, etc. (refer to Table 11.2, including the top 20 firms).
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Nonetheless, the improved situation for Chinese mobile phone producers does not only stem from price advantage: their familiarity with the global mobile phone production competition at the international level is also a crucial factor. Chinese producers have realized that the labor cost advantage will eventually fade out, as international big names set up factories within China (Nokia in Beijing, Motorola in Tianjin, and Ericsson in Nanjing, amongst others). As a result, China’s mobile phone producers are turning to better post-sale services and fashionable appearance designs. Considering these trends, it is interesting to observe how different alliances have been emerging between TCL and other foreign firms within this industry. On November 3, 2003, TCL International Holdings Limited (“TCL International”) and Thomson announced the signing of a binding Memorandum of Understanding (MOU) to form a JV named TCL International–Thomson Electronics for the development, manufacturing, and distribution of television sets and related products and services. TCL is the major shareholder, with an equity stake of 67%, while Thomson holds the remaining equity stake of 33%. The formation of this JV was finally completed during the summer of 2004. On April 26, 2004, TCL Mobile Communication Co., Ltd (“TCL Mobile”) and Alcatel announced the signature of an MOU to form a JV with special focus on R&D, sales, and distribution of mobile handsets and related products and services. Both firms have complementary markets, strong branding, manufacturing synergies, an increased range of product offering, and a combined R&D. The JV was then 55% owned by TCL Mobile and 45% by Alcatel. However, the marriage did not last long, due to the heavy loss in the first half-year of the JV operation. As a result, in May 2005 TCL decided to acquire the 45% share held by Alcatel, which terminated the four-year JV contract between the two companies. Evidence showing how Chinese producers have been making progress is that more than half of the consumers seem to prefer to use mobile phones produced by Chinese companies (hence their larger market share in terms of sales). According to a variety of surveys estimating Chinese consumers’ levels of satisfaction with mobile phones carried out throughout the last few years, the appearance of mobile phones is playing an increasingly dominant role: diversified and fashionable appearance design helps to attract the attention of consumers and therefore set up a good brand image. Somehow, mobile phones have become more of a fashion product than a durable good. However technology is more important, which is why weakness in R&D, or lack of technology, could hinder the progress of domestic producers. Last but not least, there is the development of distribution systems: since competition has become stronger, the self-managed distribution system could be substituted by a well-organized agency system. Despite all of these consumers’ preferential variables, as mentioned earlier, competition between telecom service providers was already quite fierce in 2002 through price wars. As opposed to the previously dominant monopoly and rigidity throughout the country, this trend could be seen as a positive result of the industry’s restructuring. But the truth is that vicious price wars and overcompetition impeded the sector from growing more effectively, since the price
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wars distorted normal price levels. In other words, this type of war lowered the credibility of telecom services and generated low expectations on future service quality and prices amongst customers. This trend, together with oversupply and rising inventory, somewhat damaged the healthy development of the industry, particularly among mobile handset suppliers. In early 2005, Motorola cut the price of one of its mobile phone models from 980 RMB (US$ 119) to 342 RMB (US$ 41), which caused a new price war wave on mobile phones: some manufacturers have even had to cut their unit price at an average rate of 30% since the beginning of 2005.25 As we know, before the first partition in 1998, there were only two major service providers: China Telecom and China Unicom. Price wars were then unthinkable: China Unicom was far behind China Telecom in terms of equipment, services and customers. After restructuring, in each telecom service area competitors vary in numbers: in the fixed telecom service market, there are four players (China Telecom, China Netcom, China Railcom, and China Unicom), while in the mobile telecommunication service market there are two players (China Mobile and China Unicom). All the players tend to intrude into each other’s markets. The most radical competition on CDMA and 2.5G mobile telecom seems to exist between China Mobile and China Unicom. In order to gain the CDMA market, China Unicom has attracted customers by providing CDMA mobile phones for free. Although this measure has ultimately increased China Unicom’s market share, it has also worsened the fierce price war in the industry. Interconnection is another major element in the increasingly competitive environment: it underlies the quality of telecommunication services. Currently, interconnection is plaguing the telecom industry, as in many regions it is difficult to call from one to another telecom network: the unfair charging system between different telecommunication networks may be an explanation. With regard to the service providers, it is a difficult-to-solve problem: on the one hand, both the MII and consumers require the service provider to establish telecommunication networks; on the other hand, the market share of some service providers will diminish due to the connection with other service providers. Some of the largest players will not lose much by not interconnecting with one another, since there is an evident lack of incentives to do so. Small players, however, very much rely on such a procedure as a way of attracting potential consumers: they are the parties that could eventually benefit from such an initiative. Indeed, if such steps were effective, it would surely enlarge the total telecom market, and could eventually benefit all service providers. Although the current inter-network charging system is not so fair to some of the service providers, this does not mean things will not be changed. Since interconnection is a trend that no one can eliminate, service providers need to consider carefully how to gain benefits. Both the regulatory organizations and the players in this industry have the obligation to refine the system and make it fair to all parties. Besides, each service provider is responsible for providing quality services to consumers; otherwise, the market will squeeze them out. Building a cooperative concept amongst service providers could be the key for solving this problem.
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It is therefore evident that China’s telecom industry has changed significantly in the last years: there is no longer a dominating company, and players have gained competitiveness. As a result, the former policies designed to support newcomers are now outdated: major service providers have already taken part in the fierce competition and no longer need support from the MII. Consequently, the ministry’s main responsibility needs to be focused on the supervision of all players, thus contributing to a more standardized competition. Finally, it is important to note that the central authorities are making efforts to develop rural areas, due to their large potential. This will raise telecommunication needs, economic development will boost, and telecom firms will have more opportunities. However, as service providers are largely involved in price wars in urban areas, fixed telecommunication service providers do not invest enough money in the rural areas, mainly due to lack of funds. Hopefully, such potential will attract service providers, who would not want to overlook such a promising profit source. Summing up, competition is fierce but needs to be handled properly so as to avoid a loss of credibility of the telecom market. Foreign providers play an important role, but domestic players, including both operators and equipment suppliers (SOEs, but mainly private firms), are bound to cover an increasing share of the market and may eventually hold the industry in its entirety. Indeed, despite WTO entry, access for foreign telecom players remains fairly restricted.
WTO impact and challenges Following China’s entry into the WTO, the MII aimed to facilitate competition in the telecom sector as a way of opening it to FDI (Figure 11.4). This initiative
Figure 11.4 FDI in the telecommunications industry. Sources: MII data, CEIC Database, MOFCOM data. Note No data were available for contractual FDI in 2004.
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accelerated the drafting of laws such as those governing FDI, E-commerce, and information security. The MII even announced that the government would actively invite investment from both domestic and overseas sources to enter the telecom market at the market levels of operators and equipment suppliers. Such an announcement was especially indicative of the effort that was already being made to standardize and legitimize the country’s information industry even before China’s WTO entry. In addition, the entry of SMEs, particularly value-added services (VAS) providers, into the telecom sector was actively encouraged. However, foreign firms are still restricted from investing in Chinese telecom service providers, including VAS operators. In addition, as VAS remain unclearly defined, there are many loopholes and the limited significance that regulators place on VAS companies has allowed FDI in this providers’ sector to be overlooked. Within such a context, WTO commitments in the telecom sector (including both operators and equipment manufacturers) can be summarized as follows: (1) Domestic and international fixed-line telecommunications: for the first three years after accession (2004), foreign investors could hold up to 25% equity in Beijing, Guangzhou, and Shanghai. Five years after accession (2006) that number increased to 35% (including 14 cities, apart from the original three). Six years after accession (2007) foreign investors will be allowed 49% equity across the entire country. (2) Gateway facilities: China agreed that gateway facilities (aimed to ease the access to all telecom operations) can be established, subject to the approval of an independent telecommunications authority (and in accordance with the principles set out in the WTO’s Basic Agreement of Telecommunications Reference Paper). (3) Internet, satellite services, and other services: China permits these services to be opened within the same schedule as domestic and international fixedline services. Internet content services were opened according to the schedule for value-added and paging services. China now also allows cross-border standard mail-order services. (4) Mobile services: same conditions as for fixed-line telecommunications. (5) Value-added and paging: foreign investors could hold up to 30% in Beijing, Guangzhou, and Shanghai upon accession, up to 49% in those and 14 other cities one year after accession (2002), and up to 50% across China two years after accession (2003). (6) Regulation: China agreed to abide by the WTO’s Basic Agreement of Telecommunications Reference Paper and its guidelines on regulatory principles, transparency, independence, national treatment, and market access limitations to radio spectrum. While committing itself to periodic bilateral negotiations on interconnectivity fees, the government also agreed that future trade talks should reconsider the question of equity ceilings, as well as an increasing liberalization of the industry as a whole (Table 11.1.)
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Table 11.1 China’s schedule for telecom liberalization Mobiles
Year
Up to 25% ownership in Beijing, Shanghai, Guangzhou (B, S, G) Up to 35% foreign ownership in B, S, G + 14 cities* Up to 49% foreign ownership in all China
2002 2003 2005
Fixed-line (including IDD)
Year
Up to 25% foreign ownership in B, S, G Up to 35% foreign ownership in B, S, G + 14 cities* Up to 49% foreign ownership in all China
2002 2006 2007
Internet content providers
Year
Up to 30% foreign ownership in B, S, G Up to 49% foreign ownership in B, S, G + 14 cities* Up to 50% foreign ownership in all China
2002 2003 2004
Internet service providers
Year
Up to 25% foreign ownership in B, S, G Up to 35% foreign ownership in B, S, G + 14 cities* Up to 49% foreign ownership in all China
2002 2006 2007
Value-added services and paging
Year
Up to 30% ownership in B, S, G Up to 49% ownership in B, S, G + 14 cities* Up to 50% ownership in all China
2002 2003 2004
Source: Paul Budde (2004), “China – Major Telecommunications Players”, Communication Pty Ltd. August. CEIBS Database. Note *Chengdu, Chongqing, Dalian, Fuzhou, Hangzhou, Nanjing, Ningbo, Qingdao, Shenyan, Shenzhen, Xiamen, Xian, Taiyuan, and Wuhan.
In addition to all WTO commitments, it is clear that as the Chinese government has gradually removed entry barriers, it is increasingly supporting operators by enabling more handset models to be offered at competitive prices (Figures 11.5 and 11.6). Also, China’s new position as a WTO Information Technology Agreement (ITA) member since April 2003 allows the country to stop being in the disadvantageous position of only undertaking responsibilities without enjoying rights: the 1996 ITA requires participating countries to eliminate import tariffs on some 180 information technology products. This new position should help China’s IT products to enter overseas markets, as well as to promote the development of China’s IT industry.26
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Telecommunications Main tips (1) Restructuring. China’s nationwide telecom restructuring plan was launched in 1998 under the supervision of the newly created Ministry of Information Industry. The aim was to separate administration and services, redefine institutional functions, break up monopolies, and protect competition. Despite governmental initiatives, difficulties arose on how to draft a law on telecommunications, due to disagreements on the role played by the regulatory body and the fear of over-opening the market and introducing competition: this could induce an overelaboration of the network. As a result of restructuring, there are now six telecommunication service providers in China: China Telecom, China Unicom, China Mobile, China Netcom, China Railcom, and ChinaSat. (2) Outlook. The industry’s best momentum was right after restructuring, particularly between 1998 and 2002. Mobile phone makers increased their CDMA phone output through methods such as subsidized CDMA handsets (China Unicom), but also through diversion to competition in service quality and brand development. In addition to Alcatel Shanghai Bell (ASB), our case study, three major equipment vendors (Huawei, Zhong Xing, and Da Tong) have now become crucial players in the industry: they are strong leaders in price and services, as well as in innovation. The MII’s support for local standards has also helped towards a smoother growth of the industry, particularly for mobile phones, which are after all the major current source of income and potential. (3) Competition. Despite the different competitive advantages of local and foreign players in the industry, what counts more in telecom (mainly mobiles) competition is the product itself, in addition to interconnection compatibility: mobile phones have become more of a fashion product than a durable good; brands are still the key for success; but design, functionality, and after-sales services are becoming increasingly significant. Certainly, as vicious price wars and over-competition grow, the sector has difficulties in developing more effectively, due to resulting loss of credibility. Also, as former policies designed to support newcomers are now outdated and there is no longer a dominating company, players gain in competitiveness and the support from the MII is no longer essential. (4) WTO impact. The acceleration of drafting of laws in relation to FDI, E-commerce, and information security, as well as the encouragement of VAS providers, has created a new framework for China’s telecommunications, despite the remaining obstacles for the creation of WFOEs.
Case study: Alcatel Shanghai Bell Co., Ltd Interview with M. Yuan Xin, Chairman of the Board The company was established in 1984 under the name of Shanghai Bell Telephone Equipment Manufacturing Company. Initially, it was a JV with Bell Telephone Manufacturing (BTM), a Belgian company affiliated to International Telephone & Telecommunications (ITT). In 1987, BTM was acquired by the French multinational Alcatel. Twelve years later, in 1999, Shanghai Bell Co., Ltd was finally set up.
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Figure 11.5 GSM handsets – market shares of major vendors (early 2003). Source: CCID (a consulting firm under the MII). Quoted in HSBC (2003).
Figure 11.6 CDMA handsets – market shares of major vendors (early 2003). Source: CCID (a consulting firm under the MII). Quoted in HSBC (2003).
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On October 23, 2001, Alcatel signed an agreement with Shanghai Bell to purchase the total of 8.35% shares owned by the Belgian company and 10%+1 shares from the Chinese party for US$ 300 million. After that, the total amount of shares owned by Alcatel increased from their initial 31.65% to 50%+1. The new Alcatel Shanghai Bell (ASB) was born on May 28, 2002, the first telecom company in China with the foreign partner as the major shareholder. Since then, 2002 was bound to be a fruitful year for ASB, as total sales amounted to US$ 1.15 billion and enjoyed a profit of US$ 30 million. It achieved an export volume of US$ 90 million and generated a tax of US$ 60 million. The contract value of ASB reached US$ 1.3 billion in 2002. Among its 6,000 employees, 1,800 were working in the field of R&D. History of the company Shanghai Bell was set up in 1984 with lucky number 8 as its business license. It was the first JV in China’s telecom industry. As Mr Yuan comments: We were one of the first JVs approved by the State. Our company is a successful case of a JV growing during the Chinese economic reforms. Our business has experienced a big boom with the development of telecom services in China during recent years. We are one of the pioneers as well as beneficiaries of that growth. The ‘Pioneering Stage’: 1984–1989 At that time, the company had a poor performance and was losing money. Under the planned economic system, the State banking system provided the necessary financial support and allowed the firm to survive during difficult times. Mr Yuan refers to the changes related to the State’s role: Now the government can only design macroeconomic policies and does not provide individualized assistance anymore. In the past, as reforms were launched, the government’s support was very important. The Bank of China offered us a very important loan when we were actually undergoing a very difficult moment. Their help was not only financial, but also commercial. They invited clients from various postal and telecommunication administrations to our company for discussions, seminars, and placing orders. During this pioneering period, the company itself was continuously learning and absorbing new input. We sent people out to study abroad and we imported new technology. The ‘Developing Stage’: 1990–1995 Mr Yuan remembers how market forces developed: Initially, it was a typical seller’s market, as demand largely exceeded supply. The business went crazy. Our major challenge at that time was how to
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According to Mr Yuan’s words, this was a “production-oriented” period. In order to expand capacity, they established new facilities in Quyang, Jiangwan, and Shanghai. After more than two years of construction work, Shanghai’s factory started producing in 1995. According to Mr Yuan, that was a big milestone in the history of the company, “The opening of the new factory in Shanghai made us the world’s No.1 producer of distant control switches.” The main feature during this period was the expansion of productivity. Third stage: end of the 1990s During this period, market conditions developed and more competitors appeared. Consumers had more alternatives to meet their needs. In addition, the government’s intervention in the economy was diminishing. Mr Yuan refers to that period in these terms: There was an increasing number of local competitors, including JVs and private companies. Almost everything, including technology, was advancing. The seller’s market conditions of the previous period soon changed. The supply exceeded the demand and it became a buyer’s market. The big challenge was how to change Bell from production-oriented to market- and service-oriented. This was our major focus. Some of the most crucial measures were the reinforcement of a national sales and service organization: Our marketing and service functions used to have only 29 employees. Before ASB was established, we had a team of 1300–1400 employees in sales and marketing. Almost one-third of the total labor force was assigned to that function. We moved all the before- and after-sales services closer to our customers. Fourth stage: today and tomorrow In terms of future perspectives, Mr Yuan uses these words: I think the company has entered a new stage. It faces fiercer competition, the globalization of the economy, and the huge evolution in the needs of clients and therefore of the investment effort. Our company is also implementing the so-called “change to another track and adjust the internal system” action. The company has become more diversified. Our concept is to establish a
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long-term strategic partnership with our clients. Summing up, ASB advances step by step and ceaselessly.
Mr Yuan Xin’s story I joined the company in 1985 as one of its first members. My major was Computer Science. At that time, like many others, I had the dream of becoming a computer or a telecom expert. However, I decided to go on the managerial path. In 1990–1992, I took a full-time MBA program at Beijing–CEIBS. In the past 17–18 years, I have been working in different departments within the company, including production, logistics, purchase, marketing, customer services, investment, and development. I am currently Chairman of the Board as agreed by the two shareholders. I started to occupy this position when the JV was first launched in mid-2002. Before the new JV, I was Chairman of the Board in Shanghai Bell and Executive Deputy GM on behalf of the Chinese partner. Later on, the job became more focused on execution and implementation. Now, as Chairman, I concentrate my attention on the long-term development strategy and key business decisions.
Organization – inspiration from foreign models When the company was initially established in 1984, it replicated ITT Bell’s model of organization. Mr Yuan explained that being a new JV gave them some advantages: We avoided many of the problems associated with traditional SOEs. At that time, we also employed some foreign technical experts, whom we called technical assistants (TAs). Every Chinese manager had a TA. They could learn from each other and help each other to improve. During the second stage, when the company’s business focus was production oriented, the operations and related departments accounted for a very large part in the organization. The main departments included workshop and manufacturing, logistics, purchase, production localization, and engineering. Marketing was very small: “The customers were waiting in lines outside the gate.” R&D was also small. The whole business was mainly centered on manufacturing. The third stage implied a change in direction: it changed its focus from production to market. They set up 31 sub-companies in every province and divided the market into eight sales and services sections. They also established eight overseas offices. As Mr Yuan explains: The company moved its organization closer to the market. Although the original customer services function only existed in the headquarters, we moved it closer to the market. Every sub-company had its own customer service.
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Telecommunications We also thought of investing more into R&D and more market-oriented projects, and therefore meeting the customers’ needs. We called these projects “two wings”; one is marketing and services, the other one is R&D. The purpose of these two wings was to help manufacturing to develop in the right direction. This meant a great change in our organization.
During the fourth stage, the structure was reformed to support the diversification strategy. Mr Yuan says: We are now facing a diversified market with many different products. We have created business units, such as mobiles, transmission, data, terminals, etc. We also have two very powerful support departments: sales and R&D. The general direction of the structure is market oriented. We place customers at the top of the organizational structure. This product diversification was started when the company became market oriented. They now have seven business units. When they were production oriented, the company had only one main product. Currently, their product lines have been further developed and are much more complete. According to Mr Yuan, ASB is a very successful JV: I think there are many factors for the successful JV experience. First, we received the government’s support when reforms were initially launched. Second, we had a very good cooperation with our foreign partner. Although many JVs failed as a result of the disagreements between the parties involved, we had a very good relationship with the former ITT Bell and now Alcatel. The degree of mutual trust is very high. Third, this JV has an outstanding degree of localization in manufacturing, R&D, and management team. Fourth, the JV has a comparatively quick response toward changes in the environment. The committed and hard – working people from both partners are also an essential element. If we had not changed, we would not exist today.
HR at ASB We now have 4,800 full-time employees and approximately 1,400 part-time workers. Amongst them, 80% have a bachelor’s degree and above. It is a comparatively young workforce: the average age is 29. We have 1,500 people working in R&D. The ratio of investment into R&D to sales for Alcatel Global is 12%. We are now working towards this direction, increasing R&D investment. We will concentrate on core businesses with high added value. For the remainder, we will seek strategic partners. This is a high-tech industry. It requires a high level of education. That explains why our employees are comparatively young. In the future, in order to guarantee and improve the quality of our staff, we will combine internal training with external
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recruiting. The objective is to have the right people who are competent enough to take responsibility for the company’s globalization. More than 99% of our employees are Chinese but we are a multinational company, and we therefore welcome highly qualified overseas expatriates, especially in technical positions. Meanwhile, we need to train our local staff. They are, after all, a critical factor for the future of our company. For instance, we send high potential local personnel to Alcatel Global. Meanwhile, we ask overseas experts to come to China to mentor local employees. Talented persons have two expectations. One is a competitive compensation and benefit. We want to improve our compensation and we need a complete evaluation system to eliminate low performers. The second expectation is to give them development opportunities. We also need to pay attention to the enforcement of company values among our staff.
Corporate governance The new ASB is now a private company limited by shares. According to the current Company Law, they had to establish a board of directors (BOD). Every party has four board members representing them, which makes a total of eight members. Mr Yuan explains the governance of the company: We have a board of supervisors that audits the BOD meeting. Under the BOD, we have some permanent commissions in charge of strategy, HR, and auditing. There is also an executive commission formed by the company’s senior management. The BOD’s responsibility is to make important decisions on strategic and operational issues, to examine the work of management, to listen to their concerns, and to make sure they are working under the BOD’s directions. One of the main achievements of this system, according to Mr Yuan, is the separation of the governance of the company from the management and operational sides. Mr Yuan goes on: The strategic planning commission studies long-term strategy issues. Some members of this commission are also BOD members. The HR commission is responsible for evaluating the senior management team and designing HR policies. The auditing commission’s responsibility is to independently check the operations and financial situation on behalf of the BOD. The system of separated responsibilities is still not mature, as Mr Yuan recognizes: Currently, the frequency of our BOD meetings is still too high, but this is because the company is relatively new. Generally, we hold one meeting every
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Telecommunications two to three months. Sometimes, our decisions also include the execution. Later on, I think the BOD should pay more attention to strategic decisionmaking and long-term development, giving more freedom of execution to our management team. In ASB, we have a very neat separation between the BOD and the GM’s responsibilities. I never attend the weekly or monthly executive meetings. Beginning this year, we are going to have a meeting with the GM on a quarterly basis. If everything goes smoothly, we could even restrict meetings to once every six months.
Chairman of the Board The responsibility of the Chairman of the Board is well defined in the Company Law. First, he has to call on the BOD meeting. Second, decision making on important issues, including investments, long-term agreements, important personnel appointment, etc., need to be made Third, he has the responsibility to give regular reports to shareholders about the general situation of the company. Meanwhile, the Chairman has the right to supervise the GM’s work. The characteristics of a qualified Chairman are: 1 Familiarity with the operations of the company. 2 A fairly long working experience in the industry and a good sense of the industry’s development trends. 3 Good cooperation with all board members and ability to influence them. 4 Good working relations with the main shareholder groups. The BOD is a very important decision-making institution and the chairman must have the qualities of a good leader. Decisions are made by consensus, by all board members. Every board member has a different background and has his or her own ideas and style. The Chairman is the BOD’s team leader. As a member of the board he represents shareholders, but as the Chairman he must represent the whole company. He should unite everybody towards one direction.
With regards to the composition of the board, Mr Yuan thinks the members should bring different experience and backgrounds: Different board members have different contributions to the board. For example, a financial expert in investment, a business leader in one industry, or a professional on the public function. They must have different backgrounds, and will therefore enrich the group decision. With reference to the convenience of having independent board members, Mr Yuan is very clear: We are not required by the Company Law to have an independent board member. All our board members represent the two shareholders. Of course,
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if we think that an independent opinion can benefit the company, we would invite an outside expert. But currently, we don’t think it is necessary, as our current board members have a very varied business background. If we decide to go public, then, according to the Company Law, we will have an independent board member. Despite the legal framework, independent board members in China are not really independent. They advise the board and do not play the real role of a full member. The law is not very clear on this and does not define responsibilities for the independent members, nor their compensation. If legal responsibility has to be taken, certain benefits should also be given. If well done, the system of independent board members can be very good. Mr Yuan continues: I am also the Vice Chairman of a listed company in Beijing. We have an independent board member: a university professor. The problem is that he does not have the same responsibility as the other board members and does not receive compensation in return. The current system is not complete. If we need an expert to make a more precisely correct strategic decision, an independent director might be much helpful to us. He can be an expert in IT or finance depending on the company’s needs. The question is whether the independent director is responsible for his decisions or not. Mr Yuan offers his opinion on the future role to be played by the board, both in the company and in China, in general: I think the BOD needs to focus on long-term planning and communications between shareholders and management. The BOD should leave the day-today issues to the management team. SOEs in China do not have a real BOD. They only have the ‘three old committees’: Party Committee, Labor Union, and Employee Representatives’ meeting. The GM takes care of everything. There is no transparency in important issues. It is important to have welldefined responsibilities for the BOD and management. Their level of authority and responsibility should be very clear. What is the GM’s responsibility? What kind of decision can the GM make? We [at ASB] have a very clear division of responsibilities. Mr Yuan concludes his analysis on the BOD in Chinese companies: In many companies, real decisions are made by the president or the GM, while the board is just a nominal body. The power in some SOEs is still very much centralized. If everything goes well, then there is no problem. But if there is a wrong decision, it is then very difficult to define whose responsibility it is. In a traditional SOE, they ask Party members to be board members. Most of them are appointed according to their political connections.
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Future challenges Mr Yuan makes some comments on ASB’s future: The largest challenge Shanghai Bell has is to keep up its consistent development. Though the company had a very large R&D investment, the transfer of its output to the market’s needs was unsatisfactory. We have tried many approaches to keep the development of the company. For instance, we made agreements with universities; we contacted local companies and overseas companies for OEM business; etc. We had both successful and unsuccessful experiences. Unfortunately, the cost of the unsuccessful experiences exhausted a lot of our resources and even damaged our image on the market. This is one of the reasons why we suggested making some adjustments in the ownership to integrate us into Alcatel Global rather than developing everything on our own. This way, we can develop our business much quicker. With regard to their cooperation with university research centers, Mr Yuan does not have a positive opinion: Although the State promoted the link between university research institutes and manufactories, there were some problems. Universities focus on learning while manufactories are more market oriented. Very often, the result is that the customer’s needs are not satisfied. Whenever there is a problem, the universities claim it to be under the manufacturing sector’s responsibility, and vice versa. Besides, the agreement between the two parties is very loose. It is not like a joint venture in which partners assume a risk. As opposed to this trend, the integration with Alcatel Global offers great advantages to ASB; for instance, in terms of open access to the group technology and research. Mr Yuan considers this a critical aspect for the future development of ASB: In the agreement with Alcatel Global, there is a special chapter on intellectual property rights (IPRs). Alcatel Global used to transfer technology to us, but now, as a member of the group, we can share their technology database. In China, the outcomes of R&D activities will be patented locally. This is a crucial point. Later on, if ASB cooperates with other companies within China, it needs IPR agreements, too. We need to do more work in this field. Currently, we have a legal department in charge of IPRs issues. Some Chinese companies are very passive in this area. For instance, in one company I know, the entire R&D department moved to another company, together with their research. To be honest, when our company started, we also headhunted researchers from universities or institutions. Mr Yuan explains his views about the future development in ASB business: In the world, IT and information industry have reached a maturing and selfadjusting stage after a rapid booming period. In China, this is still emerging
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and booming. We want to grasp the opportunities involved with China’s WTO entry. We must develop both the local and the overseas markets, while leveraging on our local and global resources. In addition, we need to have a quick response towards changes, and this way be able to meet the requirements of the whole industry. Our main challenge now is to find the best way to maximize our advantages in resources and develop in the local and global markets. He adds: Our company needs to combine the advantages of local and foreign companies. As a joint venture, our performance should not be worse than the local state-owned or private counterparts on the domestic market. From the foreign partner point of view, we should do better than them alone, therefore; 1 + 1 > 2. Our mission is to localize the global partner while globalizing the domestic partner. An important part of the company’s future development refers to the overseas expansion. As Mr Yuan explains: Our overseas expansion is two-fold. First, as an Alcatel Global member, we should take a major responsibility as China’s group industrial center. This is not only for the local market, but also for its global operations and R&D. In order to do this, we must be competitive enough within the group. Otherwise, other units would say: “Why do I need to come to China? Why do I need to come to ASB? I could look for better deals in India or South America”. We need to be strong and become an important industrial center in Alcatel Asia-Pacific. This responsibility is huge. Mr Yuan sees this globalization process as an important part of their strategy: We have been exporting to Asia-Pacific, and recently, we entered the African market. We are now debating the possibility of entering Russia. Why can’t we enter countries that other Chinese companies have already explored? Besides, we can leverage on the resources of Alcatel Global, which has a network covering 123 countries. We do not need to establish new offices or branches. When entering a foreign market, a Chinese company needs to set up its own brand, but we already have one: Alcatel. Within China, we use Shanghai Bell as a brand, considering it has more than 10 years of history. This year, our export volume could represent 20% of total sales, doubling that of last year, which was 10%. ASB’s future seems splendid and provides a very good example of a complete transformation from an SOE to a global player. However, the future is not free of challenges. Mr Yuan concludes, “We still have a lot to improve, including people and management systems.”
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Learning points (1) Start the JV organization from scratch. Do not transfer the organization of an existing company. Instead, create a new organization. Then you can establish new systems and assign the right personnel. It is much easier to operate a new organization than to change an old one. (2) Focus on market needs. ASB did this by giving more power to Marketing and Sales. Those two departments are in close contact with the customers’ needs. Manufacturing has to follow the Marketing and Sales lead. (3) Create an effective Board of Directors. The board represents the interests of the shareholders. Their main role is to supervise the management team while giving them freedom to execute. A critical member of the BOD is the Chairman. He or she has to be familiar with the operations of the company, must have a good knowledge of the industry trends, and work well with the other board members and shareholders. Challenges ahead (1) Enhance R&D. This is probably the main challenge for companies in the telecommunication equipment industry. There are strong international competitors in the industry and one of their strengths is R&D. For domestic companies it is critical to innovate in order to survive in the long run. (2) Dealing with globalization. In the long run, the domestic firms have to be able to compete in the international markets. That will require changes in their management systems and talented employees with adequate international experience.
Conclusions and future perspectives In only four years, China’s telecommunications industry underwent one of the most crucial restructuring processes through reforms. Although SOEs still play an important role in telecom growth, their role is increasingly being undermined by the rapid decision-making reactions of private firms that tend to adapt much more easily in this constantly changing industry. The results have been quite positive as a means of ending monopolies, but have also featured aggressive price wars that could ultimately endanger the credibility of the industry and impede its current dynamic growth. At the same time, domestic players are gaining market share and are adopting new marketing strategies to attract consumers. Although by 2005 China had approximately 500 million phone users, including both cellular and fixed-line customers (which is more than the combined total in the EU), China’s telecom industry’s rapid development could ultimately decelerate in the medium to long term, considering China’s telecom equipment market is a buyer’s market: telecom operators are buying less and have much bargaining power on purchasing equipment prices. Equipment producers need to
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identify opportunity products and adjust the production accordingly. This way, they are bound to be much more successful. Special focus on the future growth of mobile data services and IP data services can therefore be a good strategy. In the long term, while the global telecom industry recovers, China’s telecom equipment producers face a precious opportunity to tap the international markets and compete globally. According to IDC (an IT service company), new emerging markets such as Russia, Malaysia, or Indonesia will have a large increase in telecom investment. This trend could indeed be an opportunity for China’s telecom equipment producers. As proven by our case study, Shanghai Bell has indeed taken such an opportunity. Alcatel Shanghai Bell, our case study, is an example of an SOE that went through the whole reform process, from SOE to a private company fully competitive in the domestic and international market. ASB’s success is partly due to the excellent level of understanding and synergy between the Chinese and the foreign partner. From the Chinese authorities’ point of view, ASB is considered a Chinese company; from Alcatel’s point of view, ASB is part of their group. Thus, Alcatel Shanghai Bell has reached a perfect symbiosis of local and foreign interests. As Mr Yuan Xin, Chairman of the Board, expressed in this case, “Our mission is to localize the global partner while globalizing the domestic partner.” Given the results obtained so far, we can say mission accomplished.
China Mobile Group (2000)
China Telecom Group (1994)
Haier Group Company (1980)
China Netcom Group (2002) China Unicom Ltd (2000) TCL Holdings Co., Ltd (1982)
SVA Electron Co., Ltd (1987)
Panda Electronics Group Co., Ltd (1936) Hisense Corporation (1962)
Huawei Technologies Co., Ltd (1988)
1
2
3
4 5 6
7
8
10
Shenzhen (Guangdong)
Qingdao (Shandong)
Nanjing (Jiangsu)
Shanghai
Beijing Beijing Huizhou (Guangdong)
Qingdao (Shandong)
Beijing
Beijing
Headquarters
Collective
SOE
Joint venture SOE
SOE Listed SOE
Collective
SOE
SOE
Ownership
21,670
22,113
26,327
30,686
75,257 66,987 38,204
80,648
141,417
170,362
Revenue (RMB mn)
12,496
10,623
8,355
N/A
150,000 38,700 18,212
30,687
300,000
64,320
No. of employees
Appliances, mobile phones Mobile data service
GSM mobile telephony service Telephone and Little smart Appliances, mobile phones Fixed-line networks GSM, CDMA Color TV, mobile phones Color TV, mobile phones Mobile phones
Major products
Sources: CCID IT Statistics Selection (provided by CCID Datasource Co., Ltd); Top 100 IT enterprises in 2004, released by MII (provided by CCID Datasource Co., Ltd); China Electronic Enterprise, Electronic Product Database (provided by CCID Datasource Co., Ltd).
9
Company name (year founded)
Ranking
Table 11.2 Top ten telecom enterprises
258 Telecommunications
Motorola (China) Electronics Ltd (1992) Beijing Nokia Mobile Telecommunication Ltd (1995) Shanghai Siemens Mobile Telecom Co., Ltd (1993) Dongguan Nokia Mobile Phone Co., Ltd (1995) Beijing Ericsson Mobile Telecom Co., Ltd (1995) Tianjin Samsung Telecom Technology Co., Ltd (2001) Beijing Panasonic Telecom Equipment Co., Ltd (1992) Nokia (Suzhou) Electronics Telecom Co., Ltd (1998) Nanjing Ericsson Panda Mobile Terminal Co., Ltd (1998) Langchao LG Digital Mobile Communication Co., Ltd (2001)
Company name (year founded)
Suzhou (Jiangsu) Nanjing (Jiangsu) Yantai (Shandong)
Beijing
Tianjin
Dongguan (Guangdong) Beijing
Shanghai
Beijing
Tianjin
Headquarter in China
1,131
1,531
1,857
2,258
2,447
4,968
10,295
10,719
17,733
45,332
Revenue in 2002 (RMB mn) Wholly foreign owned Joint venture Joint venture Joint venture Joint venture Joint venture Joint venture Wholly foreign owned Joint venture Joint venture
Ownership
Source: KKC China Enterprises Database, provided by Beijing Kang Kai Information & Consultancy Co., Ltd.
10
9
8
7
6
5
4
3
2
1
Ranking
Table 11.3 Top ten foreign-funded telecom enterprises (major mobile phone manufacturers)
308
727
400
789
408
815
801
2,724
1,844
12,177
No. of employees
CDMA mobile phones
Mobile phones
Mobile phones, telephones Telecom equipments
Mobile phones
Mobile phone base
Mobile phones
Mobile phones
Mobile telecom equipments Mobile phone base
Products
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12 Conclusions: Final summary
This long journey has allowed us to discover how the Chinese State-owned economy has been pulling itself out of the pernicious situation inherited from the past. While the Chinese authorities implemented a long list of changes in the national general socioeconomic framework, economic reforms have proven to be an experiment that can hardly be described in a book. Within such limitations, we have done our best to illustrate such an experiment through eleven crucial industries involving eleven different firms. As with all experiments, China’s SOEs reforms have been exposed to unpredictable results, some more positive than others. These results inevitably parallel China’s greatest achievements in allowing the country to further concentrate on labor-intensive sectors, and allowing a growing middle class to expand consumption trends, becoming the first FDI worldwide absorber. There are still, however, unresolved challenges such as the unliberalized banking sector, a distorted enforcement of the legal framework, and an increasing social pressure stemming from China’s growing unemployment rate. This means that the economy as a whole undergoes enormous pressure, for which the State-owned sector is deeply affected by policy initiatives at all levels, including output, employment, and growth priorities. Indeed, as thoroughly explained in our book, it is important to bear in mind that SOEs reforms are part of an interdependent reform system. Within this context, the SOEs reform process is viewed from a double-edged perspective, combining macro- and micro-priorities, for which it has been necessary to combine the initiatives and policies addressed by the Chinese authorities with all the different steps made by the protagonists – SOEs’ senior managers – who have been subjected to the pressure of implementing such policies. They constitute after all the greatest bulk of the agents of reform. Whether the implementation of their own initiatives can be identified with an accelerated process of privatization or with a progressive elimination of the interference of the Chinese Communist Party in terms of decision making, the aim is quite clear: SOEs should no longer be a burden to China’s growing economy. In order to have a clearer understanding, we summarize our findings below: (1) Industry summary: how SOEs’ reforms have been conditioned in all eleven industries by internal and external factors.
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(2) Firms summary: the most relevant learning points from the experience undergone by all eleven firms in their internal adjustments throughout the restructuring of SOEs. (3) Final comments.
Industry summary As a whole, all eleven industries have different levels of response to China’s overall economic performance, with particular reference to SOEs reforms. We consider here three specific areas to better appreciate such a statement: (1) Industrial growth and restructuring process; (2) Competition perspectives; (3) WTO impact. Industrial growth and restructuring process Despite different reactions to economic reforms, all eleven industries have in general successfully responded to SOEs reforms and the required structural adjustments. For instance, the home appliances industry has pursued the country’s comparative advantage in labor-intensive goods, and its restructuring process has allowed the industry to reach large-scale economies, and large corporation groups to emerge with famous brands and worldwide logistics, distribution, and manufacturing facilities. A parallel situation applies to the automobiles industry which, before reforms, merely responded to national needs with very low levels of efficiency and subject to the government’s direction. Today, FDI and new technology have allowed improved output levels and the sector has been boosted so as to become a pillar industry driving the national economy. As private auto firms are given more scope for action, the SOEs’ rigid systems progressively disappear and are replaced by more market-oriented industrial growth. In parallel, while living standards increase, there should be a healthy development of China’s auto market, as long as quality standards are reasonably targeted and financial procedures mature in parallel. For other means of transportation, the trend has also responded to the new necessities of the economy. In the case of civil aviation, its accelerated growth can be associated with the constant expansion of the air transportation network (links between major cities, landmark aviation agreements), the construction of airports and infrastructure, the improvement of auxiliary infrastructure in the air traffic control system (radar coverage, large data processing and network systems, access to the Global Distribution System, etc.), as well as higher levels of occupancy for passenger flights (two-thirds of the seats filled by 2004). Since the full restructuring of 2001, the Civil Aviation Administration of China has had to prioritize macro-management and safety technique management, reducing in general terms direct intervention in the operations of the three biggest airline companies (Air China, China Eastern Airlines, and China Southern Airlines). A crucial industry in terms of potential growth but slightly complicated restructuring can be found in telecommunications. China’s nationwide telecom restructuring plan was launched in 1998, under the supervision of the newly
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created Ministry of Information Industry (MII). The aim was to separate administration and services, redefine institutional functions, break up monopolies, and protect competition. Despite governmental initiatives, difficulties arose on how to draft a law on telecommunications, due to disagreements on the role played by the regulatory body and the fear of over-opening the market and introducing competition, pushing therefore an over-elaboration of the network. The industry’s best momentum was in fact right after restructuring, particularly between 1998 and 2002: mobile phone makers increased their CDMA phone output through methods such as subsidized CDMA handsets (China Unicom), but also through diversion to competition in service quality and brand development. The MII’s support for local standards also helped towards a smoother growth of the sector, particularly for mobile phones, which are after all the major source of income and potential. Another booming industry that follows growing patterns is construction, considering the new urban housing system that now identifies housing as a consumer product and no longer as a welfare product, while there is increased liberalization and government-sponsored privatization. On such a basis, firms can operate in this industry as commercial entities, mainly through competitive bidding, at least on paper. Rapid urbanization and the subsequent bourgeoning of cities have indeed pushed for the rapid growth of infrastructure investment and the construction sector in general. Unemployment pressure is relieved thanks to the increase in labor absorption and its spillover effects on at least 50 other sectors. But even if all businesses are now free to invest in the former government’s monopoly of urban public infrastructure, most of the urban public infrastructure is still in the hands of SOEs. The increasing demand for high-quality products and services drove the rapid growth in the civil engineering sector, where readymixed concrete replaced site-mixed concrete and prefabricated components became more popular. Excessive investment resulted in overheating pressures with an increase in property prices by at least 20% between 2002 and 2004. An industry dependent on construction, namely steel, has envisaged similar patterns of transformation, due to its lack of economies of scale and the low industrial concentration, which have resulted in repetitive production and an irrational industrial structure. Restructuring of steel SOEs has driven almost 60% of the total to be shut down, mainly through mergers and acquisitions (M&As), despite social risks. Technological upgrading projects should eventually push for increasing iron and steelmaking capacity. In addition, steel consumption is tightly linked to the country’s investment cycles, for which potential is significant, more so considering the ongoing industrialization and urbanization process. We could also associate another ‘traditional’ industry such as energy with a more conservative forecasting. After all, since 1993, China has become a net importer of oil and is no longer self-sufficient in energy. The SOEs’ restructuring process has implied crucial changes within this sector, such as the merging of 520 state-owned coal mines into less than 10 major conglomerates and the closing down of most of the 50,000 small-scale and inefficient coal mines; or other changes are the separation of regulatory and administrative functions from
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ownership and operations in the oil industry, as well as preferential financing, pricing regulations, and tax policies for natural gas investment, or even the separation of power generation from transmission and distribution, together with the introduction of new competitive mechanisms in the electric power sector or the search for international collaborations for the development of nuclear power. Younger industries where there is still general fragmentation, such as cosmetics, have also shown rapid growth in terms of volume (more than US$ 2 billion of sales revenue already in 2001), product diversity (from skin care to baby care, men’s cosmetics, use of natural ingredients, etc.), and quality (increasingly brand oriented). In fact, changes in this sector exercise significant pressure on SOEs, as they need to increase their cosmetic advertising expenditures, improve their R&D and marketing, and widen their distribution channels. This is not to say that all young industries proceed on an equal basis. For instance, while the State keeps part of its supervisory role within the insurance sector, shareholding insurance companies are encouraged and independent insurance companies are emerging. The establishment of a solid legal framework and a more effective restructuring of the financial and banking sector as a whole should eventually contribute to an even more dynamic industry, which now appears to be tightly linked to the changing patterns of China’s urban society: the insurance sector indeed becomes increasingly dependent on GDP per capita growth, as the population becomes older and urbanization rates increase, so the demand for insurance should inevitably expand. A similar trend would apply to the food industry, where, despite reforms in the grain market, food distribution is fairly recent and SOEs restructuring is more a priority in terms of products than in terms of firm ownership structure. The 10th 5YP aimed at about 10–11% growth rate of this sector between 2000 and 2005, while world-renowned brand names were built up and large-scale modern firms with strong R&D were established. As official targets mingle with the emerging market demand, food processing, farm crops production, and material base construction need to be combined. Farm crops, sugar, dairy products, meat, and others such as canned food or beverages are viewed by the authorities as crucial elements in the food sector, while food processing remains insufficient. Another health-related industry, pharmaceuticals, has undergone a whole rescue operation and reorganization of large-scale pharmaceuticals groups by the State Food and Drug Administration (SFDA). On this basis, the introduction of good manufacturing practices (GMP) has given the industry a boost: sales revenues increase, while domestic manufacturers decrease, and efficiency becomes a priority. In other words, the most protected industries (automobiles, civil aviation, telecommunications, construction, steel, insurance, energy) undergo sophisticated restructuring methods despite the general need to follow new patterns of industrial growth; while younger and less protected sectors (cosmetics, food, pharmaceuticals, home appliances) tend to adapt more easily to the new demands, despite their overall lower performance in terms of domestic output and successful restructuring. As industrial growth affects restructuring, competition perspectives vary with the degree of restructuring and, of course, market openness.
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Conclusions: Final summary
Competition perspectives It is not surprising to observe that competition levels are tightly correlated to the industry’s level of openness. For instance, while the home appliances sector has become more efficient and total revenue has increased, fierce competition has allowed only the strongest firms to survive: foreign companies compete with domestic corporations through production cost reduction and the combination of their high technology with low labor costs and cheap natural resources (Mitsubishi Electric, LG Electric, Siemens, Samsung, Amoisonic). However, despite the aggressive entry of foreign firms, they represent a small market share due to late entry; after all, the industry tends to be oligopoly-domestic-oriented under the umbrella of top brands such as Haier, Changhong, Kelon, or Midea. In the growing and crucial industry of automobiles, big groups tended to dominate the sector before restructuring. Once the industry was further opened in 2002, new models emerged and competition arose, particularly through significant price cuts by mid-2003. However, despite price cuts, consumers’ preferences seem to lead toward quality variables such as safety, practicability, or design; hence the major success of renowned brands such as VW or GM. Indeed, the Chinese market has become ever since a striking reference for multinationals (either as JVs or outsourcing), despite the continued inefficiencies in the cost structure, supply chains, and distribution systems. The year 2002 was also when the civil aviation industry prioritized FDI through a larger scope of action (participation in all general aviation fields), more varied investment methods (operations with stocks), increasing holding shares (cannot exceed 25%, but proportion is negotiable), and more management influence (always in accordance with the Corporate Law). Despite progress, domestic firms have tended to be weaker than foreign ones because of: (1) low market share and (2) excessively high ticket prices. (1) and (2) result from small-scale operations and scattered competition (airline companies have too few aircraft); redundant construction (moral hazard and waste of money by local governments); surplus staff (more than 10,000 new entrants per year); and huge losses (debts, insurance costs, etc.). In order to overcome these weaknesses, measures have been launched to form domestic alliances, establish private airline companies, and join international alliances. A different story applies to the construction industry, where domestic nonState-owned firms account for almost 60% of the total construction output value, generating 85% of the total profit, but only a few large and profitable enterprises can influence and lead the industry or otherwise compete in the international market, despite their capability to dominate the whole market in terms of asset volume, annual income, and labor productivity. China’s construction sector is still labor intensive, whereas it should gradually move to being capital intensive in order to increase its international competitiveness and therefore overcome the preferential treatment given to SOEs in the concession of international licenses, which obviously limits the expansion abroad. Since 2004, wholly foreign-funded construction firms can establish themselves in China; from 2006 onwards, the
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same should apply to firms specializing in construction design, construction supervision, or tendering and bidding agencies. As a highly brand-oriented industry responding to a higher demand in quality and esthetics, cosmetics tend to be predominantly foreign: domestic firms enjoy less than 20% of the total market share. Thus, the strategy for the survival of domestic firms tends to be price oriented and should in principle give preference to the export-oriented sector. However, survival of Chinese firms in the international cosmetics market can only be possible if they follow international standards and increase their production management and R&D. A massive dependence on external sources also applies to the energy industry. All three largest Chinese oil and gas firms – China Petrochemical Corporation (Sinopec), China National Petroleum Corporation (CNPC), and China National Offshore Oil Corporation (CNOOC) – have successfully held IPOs since 2000, albeit with State control in the oil sector. However, despite being the world’s largest consumer and producer of coal, China’s energy consumption structure has undergone major changes due to the increase of oil and gas and the drop of coal’s share. Considering the oil shortage, China will presumably consume more than 60% of the world’s total oil consumption in the near future. Nuclear power generation, and also wind and solar power, should become alternative sources of energy, although this very much depends on foreign entry. It is expected that domestic supply will not be able to meet the rising demand, for which oil imports will continue to increase rapidly. An industry increasingly conditioned by foreign suppliers’ thirst and the changing patterns of consumers’ preferences could be food. As long as factor endowments are rationally exploited, the option is to focus more on labor-intensive agricultural products, due to scarcity of arable land. However, national cooperation, M&As, and food safety are three major elements that should allow domestic firms to survive in the increasingly fierce competitive environment: the rapid growth of foreign elements such as fast food restaurants, tea or dairy products make the market increasingly challenging and may put in danger the survival of domestic firms. Because of general business immaturity and despite the superiority of foreign insurance products, market penetration in China’s insurance industry is still at a very low stage. After all, there is a general lack of insurance culture and foreign firms have been facing significant barriers until very recently. Despite their restricted entry, since 2003, as part of the WTO commitments, foreign companies have been allowed to expand their business far beyond Shanghai. By September 2001, eight European insurance companies – four life and four non-life insurance – were granted licenses to set up insurance practices in China. Although domestic pharmaceuticals firms are increasing in number, foreign firms are entering the market: there are currently more than 3,500 pharmaceutical manufacturers employing around 1.11 million workers. Although not as brand oriented as cosmetics, this industry attracts foreign brands, which tend to hold the largest market share in addition to Western medicines, which hold more than 50% of the total. Despite low per capita spending in international terms (more than 40 times less than in developed countries), and considering its advantage in
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knowledge and technology, traditional Chinese medicine is encouraged as a way of enhancing consumption levels. However, over capacity has proven to be a problem in many domestic companies, while profits of manufacturing massmarket pharmaceuticals shrink despite increasing exports. After all, players compete for the low-margin and low-end sector. The heavy dependence on foreign investment and the cooperation with big multinationals might be impediments to moving ahead, as foreign drug companies focus mainly on the development of other markets, using China more as a source of cheap raw ingredients: internationally patented drugs are exposed to the permanent risk of being imitated by domestic firms. As China increases steel consumption, competitors worry about higher world prices. This is why steel demand could potentially be overcome by domestic producers. Overheated industries including steel tend to attract FDI, as they suffer very little effect from the government’s intervention in cooling down the economy. In addition, the Chinese government shows particular interest in the foreign presence for the benefit of domestic firms, mainly in terms of technical and management expertise. Considering there is no limit on foreign ownership in steel foreign-funded firms, a large-scale restructuring of assets could eventually take place, mostly in terms of innovation and increase of competitiveness. Even if progress has been made, China will remain a flat steel buyer for some years, unless capacity for producing high-quality products increases dramatically. Despite the different competitive advantages of local and foreign players in the telecommunications industry, what counts more in telecom (mainly mobiles) competition is the product itself, in addition to interconnection compatibility: mobile phones have become more of a fashion product than a durable good; brands are still the key for success; but design, functionality, and after-sales services are becoming increasingly significant. Certainly, as vicious price wars and over-competition grow, the sector has difficulties in growing more effectively, due to resulting loss of credibility. Also, as former policies designed to support newcomers are now outdated and there is no longer a dominating company, players gain competitiveness and the support from the MII is no longer needed. Summing up, although it appears to be blurred in some cases, we can state that there are industries that are at risk of being absorbed by foreign competitors in the short term (cosmetics, steel, energy, food) or with some difficulties in the longer term (automobiles, civil aviation, construction, pharmaceuticals, telecommunications), while others remain in a strong position in terms of domestic output and market share (insurance, home appliances). Despite an apparent correlation between State control and degree of competition, the logic of these patterns could be more strongly linked to economic endowments, industry maturity and, of course, the response given to WTO entry. WTO impact The WTO pressures have pushed the domestic SOEs to adopt comprehensive mechanisms in the home appliances industry such as enhancing exports to offset
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productivity surplus; utilizing excess capacity in urban areas through growing internationalization (Haier, Changhong) or through forming strategic alliances (Little Swan); changing their ownership structure (more efficiency through innovation, industrial structure upgrading, etc.), either with foreign partners (JVs; technology coordination – Changhong & Toshiba, Philips or ST; branding exchange – Xinfei and GE); or with domestic partners (complementary production – Little Swan Group and Kelon). The picture may not be so clear in the case of automobiles. After all, when China entered the WTO, the forecast was rather negative for local auto manufacturers, but as time has gone by WTO impact has proven to be less damaging, precisely because of the generalized price reduction in the industry. Most plausibly this is due to the remaining high quotas, which after all protect the domestic industry vigorously, at least in the short term. The WTO factor has implied further opening but limited FDI encouragement in civil aviation: foreign companies can only have access to aircraft maintenance, repair, and overhaul (MRO), while entry to China’s airspace remains under strict control and supervision. However, the main challenge is in terms of expertise and internal management. Regulations are much stricter in the case of construction as part of WTO compliance: forced bidding procedures, still obligatory for non-State firms, should eventually be abolished and minimum percentages of local production should no longer be a prerequisite for investment and import approval. In this sense, FDI remains essential, due to the increasing demand of requirements on financing, management, and technology, which are elements that domestic firms still lack. Considering this context, two areas could potentially match sustained construction work with increasing profits for foreign firms: subway systems, and water supply and wastewater-treatment facilities. Considering the WTO requirements and the existing domestic regulations, the best choice for foreign contractors is to set up joint ventures with well-managed Chinese construction companies as counterparts. This trend speeds up the reform of large SOE construction companies: foreign contractors can provide more capital to Chinese companies by holding some of their stocks and may eventually contribute to improving their management skills. In cosmetics, the WTO impact plays a positive role in terms of market openness: reduction of trade barriers and the respect of intellectual property rights benefit both domestic and foreign cosmetics firms. Nonetheless, as an extremely competitive industry, domestic firms may eventually drown in the short to medium term. WTO impact is not homogeneous within the energy industry. In the coal sector, the impact is bound to be positive: lower circulation costs and therefore increase of coal’s export competitiveness; promotion of large- scale economies within the industry as governmental intervention is reduced; end of China’s monopoly export system; and product quality improvement. Oil and gas sectors undergo a much more painful process, considering the intrinsic weakness of China’s petroleum firms. In addition, most of the refineries in the inner land and along the
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coastal areas are seriously threatened, as domestic refined oil prices have had to be in accordance with the international markets and about 50% of firms have gone bankrupt. However, WTO access should facilitate the development of China’s electric power market and expedite the opening of its generation market. As predicted, China’s food industry should eventually have more high-quality goods, improve distribution, and therefore increase levels of competitiveness for domestic and foreign food firms. As quality and credibility improve, WTO compliance should not jeopardize the current market share, despite aggressive foreign entry. Although the WTO impact on the insurance industry has been small in the short-term – while the financial and banking sectors do not undergo significant reforms – it will still be a learning process for both domestic and foreign insurance firms, even if the State’s watchdog role is bound to increase. After all, licenses are starting to be issued almost unlimitedly, while competition becomes increasingly aggressive. WTO and the implied lower import tariffs may harm domestic pharmaceuticals producers until marketing and distribution are improved, but may also allow for cheaper foreign pharmaceutical products, the opening of OTC retail sales of approved medicines, increasing levels of intellectual property rights protection, and R&D, as long as financial support for research funds develops further. The steel industry could benefit from WTO entry in terms of modernization, speed, increase of transparency, FDI and therefore more foreign technology, as well as an improved management system and more safeguard measures on imports. However, challenges are important as WTO regulations exercise significant pressure on the domestic firms: tariff reductions are significant in high-end products, for which pressure is even higher for domestic firms; as production costs decrease, Chinese firms will need to become more competitive in the international arena. WTO entry implies an accelerated rate of drafting laws in the telecommunications industry in relation to FDI, E-commerce, and information security, as well as the encouragement of VAS providers. It also creates a new framework for China’s telecommunications, despite the remaining obstacles for the creation of wholly-foreign-owned enterprises. This is how we can understand the Chinese government’s gradual removal of entry barriers, the adaptation of its new position as an ITA member, which allows China’s IT products to enter overseas markets, and the promotion of the development of China’s IT industry. Despite some differences between all eleven industries, it is clear that restructuring of SOEs is an inevitable result of internal factors such as industrial growth, but also of external factors including (domestic and foreign) competition levels and a whole new regulatory framework conditioned by WTO compliance. As long as the State tightly controls some of these industries and restructuring is not fully achieved, there will still be different responses to globalization patterns that could stop China from becoming a big player in terms of economic efficiency and output performance. This trend applies not only to economic industries in general but also to particular firms, where basic conditions such as decision making, corporate governance, R&D, human resources, and competitiveness tend to be lacking.
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Firms summary The direct experience of eleven restructured firms provides us with an indicative picture of how varied the methods can be in terms of improving their decisionmaking structure, their management systems and, no doubt, their competitiveness. In order to avoid excessive bias, we have selected the eleven companies from large corporations (e.g. Baosteel, Air China), to small- and medium-size firms (e.g. Jahwa, Synica), including different human players, from presidents and chairmen of the board to general managers. While Alcatel Shanghai Bell’s study focuses on the role of the Board of Directors, Baosteel deals with the iron rice bowl policy, Air China with the role of strategic partnership, COFCO with the organization turnaround, and most of them deal with JVs as a key element of their modernization, as well as the role of the stock market as an instrument for a successful reform. Finally, there are two common issues in most of the cases studied: the international vocation and the bottleneck created by the scarcity of management talent. One important clarification to make is that reform does not necessarily mean privatization but modernization. Some of the companies studied aim ultimately in their reform process to become private enterprises (Jahwa, Little Swan), while others will probably still remain in the hands of the Chinese State for a long time to come (Air China, Baosteel). One common element to all companies is that reforms allow them to create the conditions in their organizations so they can successfully compete in an emerging market economy. There are several lessons we can draw from the companies studied, as there are common mechanisms that have been used to further achieve reforms: (1) partnerships and strategic alliances; (2) rationalization of the organization structure; (3) creation of modern HR systems; (4) stock market as the proof of successful reform; and (5) top leaders’ commitment. Partnership and strategic alliances It seems to be a common practice to use joint venture agreements with foreign partners as a catalyst for modernization. In general, our SOE senior executives were well aware of the challenges of making a JV successful. As the Chinese say: same bed, different dreams. Despite all the difficulties of managing JVs successfully, SOE executives were in general satisfied with their JV experience, even if some of the partnerships ended in divorce. After all, foreign partners bring new technologies, recognized brands, international business networks and, most important, they serve as role models to local managers, as in the case of Mr Zhang Pei, President of CSCEC. His early experience of working in a joint project with a French contractor allowed him to confidently take his next job as being responsible for the Vietnam operations of his company. Finally, his success in Vietnam was one of the key elements for him to become the president of his company and the leader of the reform process. Also, in this SOE, a JV with a Hong Kong company is the mechanism used to gradually modernize CSCEC.
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Dr Liu Yuliang, CEO of Jahwa, the cosmetic company, referred in his interview to their JV with J&J, which ended in divorce. Dr Liu considered this JV, the first they formed, as a milestone in their reform process. As he indicated, they even created the position of brand manager for the first time in the history of Jahwa. Another good example is Air China. This company, through their partnership with the German airline Lufthansa, has created the conditions for modernization. As one of the managers stated, “We have to learn from the best.” Another benefit most of our cases mentioned is that the JV is a force that leads to a separation between the political and the company’s interests. Namely, the company is no longer at the service of the Party but becomes rather more centered on the business, due in great part to the influence of the foreign partner. There are several good practices we can draw from our study: (1) When forming a JV, start from scratch: by creating a new organization, one can break the dense network of interests and favors that usually exist in the old type of SOE. (2) Send your best people to the new JV: they will learn fast the foreign management practices and this will benefit the whole SOE. As in the case of Mr Zhang Pei, these people can be the next generation of leaders SOEs require to succeed. (3) Be aware of the cultural differences between partners: try to create an atmosphere of trust with your partner. Conditions to do so are clear rules, agreed objectives, and open communication. Remember that both sides are in the partnership to gain something. Rationalizing the organizational structure One of the daunting tasks most of the SOEs have to confront is the streamlining of their organizations. Most SOEs have complex, if not confusing, structures. There is a myriad of departments inherited from the planned economy. Furthermore, there is a myriad of superfluous positions as Deputy Director or sub-department directors with no clear responsibilities. This process of rationalization is a delicate task, as most Chinese value titles as a demonstration of status. Any change in title or position would mean losing face in front of colleagues and relatives. Thus, one of the first tasks the new SOE leaders need to face is to further rationalize and clarify their organizational structures. The food company, COFCO, used consultants to facilitate this process. In an amazingly short period of time, they were able to implement the new organization with little resistance. The leader of COFCO was personally involved in pushing the reorganization forward. As part of the implementation process, he was frequently communicating with the new organization and clearly justifying the need for change. To a certain extent, COFCO had no choice: to change ... or perish. As one of the managers stated: one has to organize the house before growing.
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There are several practical lessons we can draw from this experience: (1) Use consultants to guide you in the reorganization process. (2) Have the clear support of the top leader. (3) Use extensive communication to win the minds and hearts of your people. Creation of modern HR systems The creation of a modern HR practice is indeed tightly related to the previous point. Transformation implies the abandoning of the old iron rice bowl policy based on employment from cradle to grave, where the company cared for all the needs of the employee, namely, housing, health, education, pension, etc. Despite the progressive breakdown of the iron rice bowl system, there is a tacit consensus amongst the SOE managers to avoid drastic staff reduction. Instead, they favor gradual adjustment through retirement and voluntary separations. In the case of Baosteel, the strategy used was to separate redundant employees by creating a service company. Initially, the objective was to clean the core business from excess staff so to present better productivity data. However, the surprise came when the service company started to generate profits for the group. The service company, through trial and error, also started to reduce the social burden of the group by giving the property title of the houses to their occupants. The new generation of Chinese employees is gradually adapting to the new rules, and fewer and fewer people expect their companies to provide for those extra services. Instead, they demand better economic conditions and increasing scope to make their own decisions regarding private matters. The HR transformation implies going for a system based on seniority and connections to a system based on merit. Naturally, there are no pure merit systems, even in the most advanced societies in the West. However, the Chinese system is moving from an almost pure seniority system to a mixed one. Together with this transformation, there is a new emphasis made on career planning and development that were almost neglected in the past. A good example is the case of XJ, where its Chairman, Mr Wang Jinian, has promoted modern tools of performance management as the balanced scorecard. The modernization process is not easy and will probably require a generational change. However, the old generation is in general well aware that the sustainability of their companies depends on new ways of operation. Do not forget that, in many cases, their pensions depend on the continuation of their companies. This, on the other hand, is also a burden for many SOEs. As Mr Zhang Pei, President of CCSEB, clearly stated, this is a burden that foreign and private companies do not have. There are several conditions for HR transformation: (1) Go for a gradual labor adjustment and abandonment of the iron rice bowl policy: there are two powerful reasons for this. First, the Chinese government wants to avoid any type of social unrest. The second reason is
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moral in nature, as the old generation of employees simply played according to the rules of their time and cannot be blamed for the new conditions. (2) Implement HR tools such as performance management, career development, and promotions based on merit not on seniority: Again, this represents a radical cultural transformation and will probably need a generational change to really materialize. But first, steps have to be taken. The sooner, the better. Using the stock market as a milestone of successful reform Many of the executives interviewed consider going public, using the stock market as the final proof of a successful reform and their greatest achievement. There are many successful examples of companies in our sample that made their way to the stock market. Dr Liu Yuliang mentioned that when they went public, using the Hong Kong stock market, the company had to modify its reporting and accounting system. Little Swan also referred to changes in the company before it went public. Mr Chai, from Little Swan, mentioned the establishment of a Board of Directors as important, since it resulted from becoming public by shares. Before, it was the Light Industry Administration that took the main decisions in his company. In the case of Alcatel Shanghai Bell, it became a private company limited by shares that also required the establishment of a Board of Directors. In general, the stock market is not the culmination of the reform process, but an important milestone. It conveys several benefits: (1) Influx of new capital. (2) Professionalization of accounting and reporting practices according to international standards. (3) The creation of a Board of Directors, which is the first step in the separation of the business from the control of the political power. Leadership commitment Probably one of the most critical elements for a successful reform is the presence of a leader with the vision and stamina to carry the reform forward despite the numerous hurdles in the way. One of the presidents interviewed mentioned how limited his decision-making power was, as he could not even decide the members of his management teams. Previous connections with government officials made it almost impossible to replace low-performing managers. Dr Liu, from Jahwa, mentioned how top executives in SOEs suffer pressure from above – to deliver expected results; from below – workers and from outside – competition. In his words, everybody expects the top executive to be an expert in management, act as a parent and a saint, be innovative and, at the same time, an obedient follower. According to Dr Liu’s experience, SOE leaders must possess certain characteristics: (1) They need to have a profound understanding of the business, the culture, and the power structure.
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(2) They must have a good knowledge of the management systems of foreign companies. (3) They must show a strong resistance to pressure coming from both within and without the organization. (4) They should be motivated by internal factors. Pay is low, relative to the commercial market, while workload is heavy. They should be motivated instead by a sense of accomplishment and self-realization. As for the challenges SOEs are still facing, they can be summarized in three: (a) Talent recruitment and retention. (b) Corporate governance. (c) Research and development. Talent recruitment and retention One of the most repeated objectives for the companies studied is to grow and become international players. Closely linked to that strategic objective is the acquisition of the right talent and the creation of top management teams with international experience. Given the extraordinary growth of the Chinese economy and the influx of foreign investment, most companies suffer what has been coined the ‘war for talent.’ This term, initially applied to multinationals, is also acknowledged by many of the SOEs included in this book. The retention problem is caused, first, by the imbalance between demand and supply of talents. When there are so many alternative jobs waiting in the market, it is difficult to be loyal to one organization. Second, the lack of modern HR practices. Mr Sun Yu, from Air China, admitted that training, performance management, and other HR systems are not very professional. HR departments in SOEs are most often mere administrators. Third, the uncompetitive compensation, especially if compared with foreign enterprises. Dr Liu, from Jahwa, complained that his company had become a training center due to the lack of stability of the young talent in his organization. Professor Zheng, from Synica, informed us how his company has decided not to hire new graduates from universities any more. Instead, they only hire experienced people in their 30–40s. Those with family obligations are less prone to job hopping. A good example is COFCO, the food corporation, which has been able to curb its talent turnover. This consists of a number of measures: (1) Career opportunities: talented employees will remain when they see there are good career opportunities ahead. (2) Competitive compensation: compensation does not need to be the highest in the market but at least be in line with the average. (3) Opportunities to make a difference: actually, this is a major advantage compared to multinationals. The decision centers of SOEs are located in China, so there are more chances to influence the life of the company than when the decision center is located 10,000 km away.
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Corporate governance The role of the Board of Directors is a frequently repeated theme. Mr Chai, from Little Swan, affirms that the role of the BOD is still limited. The main problem, in his view, is the lack of clear separation of responsibilities between shareholders and management. Although he recognizes that the establishment of the BOD is a step in the right direction, there are still interferences by the political power and too much involvement of the BOD in the operations of the company. Dr Liu, from Jahwa, thinks that BODs are still mere formalities in many organizations. Usually, board decisions are dominated by one board member while the others follow. Mr Liu Kejian, from COFCO, adds that one of the benefits of the BOD is the gradual separation from the influence of administrative departments of the government. It is a gradual process and we should not expect things to be completely different from day one. According to Mr Liu, the BOD meets once or twice a month, which is still too frequent compared to the normal practices in other countries. Mr Zhang Pei, from CCSEB, refers to the still important influence of the Party in the management of the company. In his view, a clear separation is needed between management and political power. An interesting case is that of Alcatel Shanghai Bell. As we mentioned, ASB is a private-owned company limited by shares. The foreign partner, Alcatel Group from France, owns the majority of the company. In that capacity, they established a BOD that can be a model of functioning for other companies. Mr Yuan Xin, Chairman of the BOD, states that in ASB there is a clear separation between the management and the BOD. The latter meets around four times a year and, in his opinion, that is still too frequent. The objective is to reduce the number of meetings even more. There is also a clear separation of responsibilities. While the BOD pays attention to strategic decisions and long-term development, the management takes care of the implementation and daily operations. He even declares that he never attends the meetings of the executive team. Mr Yuan enumerates several qualities a chairman of the BOD should possess: (1) Familiarity with the company operations. (2) Work experience in the industry, and a good sense of future trends. (3) Good cooperation with other board members and the ability to influence them. (4) A good working relationship with shareholder groups. Research and development One of the most repeated challenges by the executives interviewed was the increasing competition in their markets. This competition is not just coming from abroad, from foreign companies, but also from within China, other SOEs, and the dynamic private sector. There are many factors that facilitate the sustainability of
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the business. Some of those were mentioned before: efficient organization, talented people, professional management systems, etc. But a critical factor for success in the market economy is innovation. Alcatel Shanghai Bell puts R&D as its central piece in the company’s strategy. This policy is also shared by Little Swan, in the home appliances industry, and Synica, in chemicals and pharmaceuticals. All of them consider R&D as a key component of their strategies. One challenge these companies face is the pervasive problem of counterfeiting. China already has the reputation of being the major center of counterfeiting on the planet. And, despite the common belief that counterfeiting is mostly suffered by foreign companies, the most important victims of counterfeiting practices are other Chinese companies. In the case of Little Swan, Mr Chai Xinjina informed us that his company has a team of people just detecting and fighting counterfeiters. A peculiar case is Synica, in the chemical and pharmaceutical industry. Its president, Professor Zheng, told us that his company does not usually sell its research to other Chinese companies but to foreign buyers. His reasons were very clear: foreigners pay better in terms of price and honor their debts, and in general respect intellectual property rights. Professor Zheng shared with us his measures to avoid leakages of their IPR: (1) Include a confidentiality clause in all new labor contracts. This will not avoid the problem, but at least the company would have some legal tools to sue the offender. (2) Carry out IPR training with all your staff. Make them aware that stealing company secrets is a crime. (3) Separate processes and methods so that no one has access to all the information. Summing up, the final goal of SOEs reforms is to change the company culture from a planned economy to a market economy mindset. Stated otherwise, while the planner was king in the past, now he has been substituted by the customer. This is a fundamental mindset change that still has a long way to go in China’s state-owned economic context.
Final comments The substance of this book has been the result of extensive research work and fieldwork interviewing. Of course, it is always easier to write about what has happened than what will eventually take place. We have tried to look back and understand the development of SOEs reforms, which have achieved enormous progress in the last years but still have a long path to cross. China is not the only country in the world undergoing this type of reforms – most transitional economies, such as Russia or some of the new EU member states, as well as South-East Asian economies, are undergoing a similar reform process of their
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state-owned sector. The difference between China and other transitional emerging economies is that China is subject to the international pressure of having established herself as a leading economy in terms of trade and economic growth. If reforms are translated into a genuine improvement of the economy overall and a more suitable management and corporate governance system, it would not be surprising if it became a blueprint for smaller countries undergoing a similar process of economic transformation. It is just a matter of time.
Mr Xue Jinda Deputy GM
Shanghai Automotive Brake Systems Co., Ltd (SABS) Shanghai
– Be patient and persistent when managing a JV – Have clear objectives for the JV – Have open communication between the two partners
Interviewee
Company
Learning points
Location
Automobiles
Industry
– Use few seasoned strategic partners – Go public
Beijing
Air China
Mr Sun Yu Manager, corporate development and planning information
Civil aviation
Table 12.1 Case studies: Learning points and challenges
– Use your best people with your foreign partner – Gradual strategy for workforce adjustment – Rationalize organization structure
Beijing
China Construction Second Engineering Bureau(CSCEC)
Mr Zhang Pei President
Construction
– Select carefully the management team for your JVs – Use the stock market to privatize your company – Critical role of the leader – Invest in R&D
Shanghai
Shanghai Jahwa United Co., Ltd
Dr Liu Yuliang Director and CEO
Cosmetics
Xuchang (Henan province) – Leadership, vision and clear strategy – HR systems
XJ Group Corporation
Mr Wang Jinian President
Energy
(Continued)
– Divide the company into multiple companies – Useconsultants – Be selective when choosing partners – Have clear objectives – Attract and retain talent
Mr Liu Kejian Deputy Director of the Strategy Development and GM of Strategic Planning Division China National Cereals, Oils & Foodstuffs Imp. & Exp. Corp. (COFCO) Beijing
Food
Conclusions: Final summary 277
– Reduce your costs – Improve quality
Home appliances
Mr Chai Xinjian GM and Vice Chairman of the BDO Wuxi Little Swan Co. Ltd.
Jiangsu province
Challenges
Industry
Interviewee
Location
Company
Automobiles
Industry
Shenzhen (Guandong province)
Ping’an Life insurance Co., of China Ltd.
Mr Ni Rongqing Vice GM
Insurance
– Dealing with government intervention – Increasing domestic competition – Rapid growth
Civil aviation
Shanghai
Professor Zheng Chongzhi President and CEO Shanghai Synica Co., Ltd.
Pharmaceuticals
– Increasing domestic competition – Separation between management and politics
Construction
Table 12.1 Case studies: Learning points and challenges—cont’d
Baosteel Group Enterprises Developing General Co. Shanghai
– Manage complex organization – Compete with global companies
Food
Shanghai
Alcatel Shanghai Bell Co., Ltd
Mr Yuan Xin Chairman
(Continued)
Telecommunications
– Dealing with complex public administration – Increasing competitions – Management team with international experience
Energy
Mr Xu Nan General Manager
Steel
– Building a brand – Counterfeiting – Talent retention
Cosmetics
278 Conclusions: Final summary
Home appliances
– JV as learning mechanisms – R&D critical for future – Modern HR systems – Clear leaderships
– Define the role of BOD – International expansion – Organization reform
Industry
Learning points
Challenges
– Risk management – Develop strategy for the future
– Organize before growing – Use stock market to foster change – Redefine HQ role – Form alliances – Learn from the best
Insurance – Win your employees’ hearts – Use the Party as your channel to reach workers – Be realistic about the future – Aim at the international market – Use the stock market as the final test of a successful reform – Control costs – Protect your IPR – Attract and retain talented employees
Pharmaceuticals
Table 12.1 Case studies: Learning points and challenges—cont’d
– Focus on your core activities and separate secondary business – Use soft tactics to eliminate the iron bowl policy of the past – Be present in the international market – Reduce costs and increase labor productivity – Retain talent
Steel
– R&D – Increasing global competition
– Start JV from scratch – Focus on market needs – Create an effective
Telecommunications
Conclusions: Final summary 279
Notes
Introduction 1 Burstein and de Keijzer (1999); updated references and press releases collected by the authors. 2 For further information on SASAC’s role, refer to http://www.sasac.gov.cn, as well as to Fernández-Stembridge and Huchet (2006). 3 BearingPoing (formerly KPMG Consulting) was split from KPMG in 2000 after the Enron’s scandal. It was listed in NASDAQ in February 2001. Since then, BearingPoint made the consulting unit in each country be listed. In August 2001 China KPMG Consulting was split from KPMG as an independent entity and changed its name to BearingPoint (BP) in 2002. BP offers full scale professional service to business strategy, business process, IT implementation, company development and outsourcing. In 2003, they opened a Global Development Center in Shanghai, Zhangjiang Hi-tech Park, which became an integral part of their global business. About 85% of their clients in China are SOEs, 5% are private companies, 5% are foreign companies, and 5% are governmental organizations. Mr. Bryan Huang, President of Bearing Point Greater China, was interviewed by the authors in April 2003. 4 Much of this section is based on Fernández-Stembridge (2003). 5 The household registration system (hukou), officially created in the late 1950s, was first set up as a way of distinguishing the inhabitants of the rural areas from those of the urban areas. Later on, it became a method of control, impeding the free movement of peasant workers wanting to move to the cities. 6 Cai Fang (1998a). 7 Lardy (1998: 23) and Johnston (1998). 8 China’s reform strategy since 1978 has often been described as a set of policies following a double track, implying the conjunction of a traditional planned system and a tendency towards a market economy in the allocation of economic resources. With this system, SOEs can sell that output exceeding the quotas established at a market price and plan their levels of output according to the response shown by the market. A great bulk of this system is characterized by the coexistence of two types of prices: one being established by the State (low) and the other one by the market (high). The effects of this strategy became more evident by the end of the 1980s (high inflation rates, corruption, etc.). Lin, Cai & Li (1996: 291–292) and Naughton (1995: 7–8, 114). 9 Jin (2001). 10 Bearing Point Interview, April 2003. 11 Mr. Liu Yishun, Chairman of the Board and President, China Capital Investment and Management Co., Ltd (CCIM); Member of the Drafting Group of the State-owned Assets Law, National People’s Congress. The CCIM was founded in 2001 to develop investment banking in China, by investigating the role of investment banks in mergers,
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reorganizations, and SOEs financing, while helping SOEs during their transition, and eventually by being able to gain the necessary experience to draft the State-Owned Assets Law. Although CCIM is a state-owned company, it is not affiliated to any Ministry, despite the direct support given by the leaders of the People’s Congress, the Ministry of Finance, or the Ministry of Machinery, among others. Interview done by the authors in June 2003. 12 Summary drawn from the interview to Dr. Bryan Huang, President of Bearing Point Greater China, April 2003. 13 From the interview to Mr. Liu Yishun, Chairman of the Board and President, China Capital Investment and Management Co., Ltd (CCIM); Member of the Drafting Group of the State-owned Assets Law, National People’s Congress. Interview done by the authors in June 2003. Chapter 1 1 These are all data provided in the Tenth Five-Year Plan – Qing gongye shi-wu guihua (Tenth Five-Year Plan on the Light Industry), Beijing: Guojia jingmaowei hangye guihua si (Industry Planning Department, State Economic & Trade Commission). 2 Yang Minglai (2000), “Shi lun wo guo rushi hou jiadian shichang de fazhang qvshi” (Development Trends of the Home Appliance Market after WTO Entry), Hebei University Journal of Economics and Trade, Vol. 22, No. 3, pp. 84–87. 3 These data are those included in the China Markets Yearbook (2003). Please note there are other references that offer alternative numbers. For instance, Lin Jiang (2002), “Made for China: Energy Efficiency Standards and Labels for Household Appliances”, Sinosphere, November Issue. Manuscript from the Lawrence Berkeley National Laboratory. In their report, total sales revenue in 2000 was US$ 14.4 billion. 4 SSB (1981 and 2003). 5 SSB (1981 and 2003). 6 Yang (2000) 7 Refer also to Lin Justin Yifu (2000), “The Impact of WTO on the Domestic Manufacturing Industry”. Working Paper, China Center for Economic Research (CCER), Peking University. 8 Ye Bingxi & Pang Yahui (2004), “2004-nian Zhongguo jiadianye ba da yuyan” (“Eight Prophecies of China’s Home Appliance Industry in 2004”), Zhongguo jinying bao (China Operations News), January 12; McKinsey Consulting Ltd, various reports. 9 Siemens documents. Notice however that these data include also telecom profits. 10 National Light Industry Information (2001) (Quanguo qinggong xinxi). Extracted from the database of China Infobank. 11 China Markets Yearbook (2003). No updated data was available in China Markets Yearbook (2005). 12 Yang (2000) 13 Much has been written on Haier as a model of Chinese internationalized firms and on its president Zhang Ruimin as a model entrepreneur. There are at least a few hundreds of academic articles, case study analyses, and media references to Haier’s case. For a first approach, refer to the webpage www.haier.com 14 For more details, refer to the firm’s webpage: http://www.changhong.com 15 Wei Guihua (2001). 16 Wei (2001) 17 In Chinese, this means “Loving Wife”. 18 B shares are quoted in foreign currency. In the past, only foreigners were allowed to trade B shares. Since March 2001, mainlanders can also trade them. They differ from A shares in many operational aspects, such as minimum investment, minimum transaction amount, and commission percentage.
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Chapter 2 1 China Automotive Industry Yearbook (2004), China Automotive Technology Research Centre, and China Automotive Industry Association, Beijing. 2 China Automotive Industry Yearbook (2004). 3 China International Economic Consultants (CEIC) (2002), “Outlook on the Auto Industry in China”, http://www.friedlnet.com/0009–009.html 4 HSBC (2003), “China Automobiles: The Impact of SARS – to Date and to Come”, May 14, p. 2. 5 Chinese press reports. 6 Deutsche Bank Report (2003), “China’s Auto Sector: Profitability Check”, May 21, p. 2. 7 Zhang Xin (2003), “The Average Profit Margin of China’s Auto Industry to Decrease by 10%”, Huaxi dushi, January 10. 8 China Association of Automobile Manufacturers (CAAM) (2003), “China’s Automobile Industry 2002”, Auto Herald (weekly newspaper). http://site. securities.com 9 HSBC, Op. Cit.: p. 5. 10 Liu Li and Yu Qiao (2004), “IPR Disputes Fueled by Automakers”, China Daily, September 6 and various Chinese press reports. 11 Gao, Paul (2002), “A Tune-Up for China’s Auto Industry”, The McKinsey Quarterly, No. 1, p. 3. 12 CNN News data. 13 McKinsey, New Horizon (2004), MNC’s Investment in Developing Countries – An Overview of China’s Automotive Industry, www.mckinsey.com 14 The Asia-Pacific Automotive Sectors: A Company and Industry Analysis (2004), Mergent Inc. May. 15 Actuator refers to a mechanical or electrical device used to bring other equipment into operation. Sometimes it is called a servomotor. It commonly refers to the equipment used for the automatic operation of brake valves in car or train brake systems. 16 “Government to Put a Brake on Production” (2003), China Economic Review, Vol. 13, No. 3, March, p. 9. 17 Top European Consultancy, “China’s Auto Market to Top 1 Million by 2005” (2002), July 18, http://www.auto21st.com Chapter 3 1 Xiao, Jing (2002), “About the Regulation on Foreign Investment on Civil Aviation Industry”, China Civil Aviation Administration document. 2 Da, Shan (2004), “CAAC Approves Two More Private Airlines”, China Daily, June 9. 3 Cao, Desheng (2004), “Airline Profits Jet Up this Year”, China Daily, July 27. 4 Wang, Zhi, Wang Zhong, and Zhong Xiong (2000), “The Development of China’s Civil Aviation Industry and Opening to the Outside World”, Working Paper presented at the Sino–U.S. Civil Aviation Symposium, Washington, DC, October 16. 5 SSB (2003). 6 Cao, Zhe (2004), “Landmark Pact Expands Airliner Routes with US”, China Daily, July 21. 7 Cao Desheng (2004). 8 SSB (2005). 9 Liu, Jiehong (2002), “Shixi woguo minghan congu de libi ji duice” (On the Advantages, Disadvantages and Counter Measures in China’s Civil Aviation Re-Organization), Shaanxi RTVU Journal,. Vol. 4, pp. 71–74. 10 In 2004, British Airways had a total of almost 52,000 employees, while Air France had a little more than 71,600.
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11 Efendioglu, Alev M., and William L. Murray (2002), “Changes and Challenges in the Airline Industry in China”, University of San Francisco, manuscript. 12 “Six Chinese Airlines Enter Alliance” (2001), China Daily, May 9. Chapter 4 1 Jin, Dejun (2002), “WTO Beijing xia de Zhongguo jianzhu ye” (China’s Construction Industry Under WTO), DRCNET, CEIBS Database, June 5. 2 China Population Statistics Yearbook (2005). 3 Lv, Xianru (2002), “Zhongguo jichu jianshe hangshi guomin jingji jichu” (China’s Infrastructure Construction Paves Ways for the National Economy), Guangming ribao (Guangming Daily), October 15. 4 “Guomin jingji he shehui fazhan dishige wunian jihua gangyao” (2001) (Outline for the 10th Five-Year Plan on National Economic and Social Development), Guojia jingji yu fazhan weiyuanhui (National Development and Reform Commission), March 15. 5 Lv (2002). 6 Chen, Xiangming and Gao, Xiaoyuan (1993), “China’s Urban Housing Development in the Shift from Redistribution to Decentralization”, Social Problems, Vol. 40, No. 2, May, p. 3. 7 Zhang, Liwei (2004), “Zhongguo zhuzhai dichan diya daikuan zhengjuanhua you lianda wuqu” (Two Misconceptions on how to Secure China’s Housing Mortgage), Caijing shibao (Chinese Financial Times), July 31. 8 SSB (2005). 9 Zhang (2004). 10 Tuchman, Janice L. (2003), “Business Rules Are Changing For Contracting in China”, Engineering News-Record, December 22. 11 Shen, Yang (2003), “Zhongguo zhuzhai jianshe you sishi nian fazhan kongjian” (China’s Housing Construction Enjoys Forty Years of Development), Zhongguo fangdichan bao (China Real Estate News), February 10, p. 1. 12 Xinhua Infolink Development Co., Ltd (2002), The Construction Industry: Creating A New Age, October 21, CEIBS Database. 13 Xinhua Infolink Development (2002). 14 China’s Ministry of Construction (1989), Chengshi zonghe kaifa gongsi zizhi dengji biaozhun (Rating Standard of Urban Development Enterprises), September 23 (Official Regulation). 15 Shen, Yang (2003). 16 SSB (2005). 17 Xinhua Infolink (2002); Press reports (2005). 18 “Does China have 10m Slaves?” (2003), The Economist, January 30. 19 Kosowatz, John J. (2002), “China Starting To Crank Up Work For 2008 Olympics In Beijing”, Engineering News-Record, October 28. 20 “Quanguo jianzhuye chanzhi feiguoyou qiye zhan liucheng” (2000) (Non-StateOwned Enterprises Produce 60% of Total Output in China’s Construction Industry), Jingji ribao (Economic Daily), June 23. 21 China Securities Research Co., Ltd (2001), Construction Industry Report, October 14. CEIBS Database. 22 Lv, Qingxiang and Wang Faxin (2003), “Miandui WTO de Zhongguo jianzhuye duice” (Countermeasures on China’s Construction Industry after WTO Entry), Zhongguo jianshe xinxi (China Construction Information), October 15. 23 Jin, Dejun (2002), “WTO Beijing xia de Zhongguo jianzhu ye” (China’s Construction Industry Under WTO), DRCNET, CEIBS Database, June 5. 24 The First Front includes the coastal area under the largest war threat in the 1960s. The Third Front refers to the hinterland, which was thought to be the safest place. The Second Front includes the provinces between the above two fronts.
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25 Zhao, Jianhu and Li Peng (2002), “2010 Shanghai shibohui touzi jiang chaoguo 30yi meiyuan” (Investment for Shanghai’s World Expo in 2010 will Exceed US$ 3 billion), Zhongguo xinwenwang (China News Network), September 13. 26 Cheung, Richard C. and Jimmy Hexter (2004), “Building on China’s Construction Boom”, McKinsey Quarterly, No 2. Chapter 5 1 Qing gongye shi-wu guihua (Tenth Five-Year Plan on the Light Industry), Beijing: Guojia jingmaowei hangye guihua si (Industry Planning Department, State Economic & Trade Commission); China Cosmetics & Detergents Report (2002), Eurofo Business Media (http://iiichina.net), Vol.1, No.1, April; All China Marketing Research Co., Ltd (2000), “Research Report on the Chinese Cosmetic Industry”, June, Beijing: China–ASEAN Business Council. 2 Pro Re Nata, Inc. (2002), “China’s Booming Cosmetics Market”. http://www. prorenata.com 3 “Cosmetics Advertising Expenditure Soared Last Year” (2002), Zhongguo jingji xinxi wang (China Economic Information Network), CEIBS Database, limited access. 4 Tian, Xu (2000), “China’s Beauty Market Becomes More Radiant Still”, Hong Kong Trade Development Council, December. 5 Wang, Bing (2002), “Cosmetic & Toiletries Market in 2002”, Zhongguo jingji nianjian (Almanac of China’s Economy), Beijing: Zhongguo jingji nianjian chubanshe. 6 Wang, Bing (2002). 7 Seydak, Joanna (2001), “China’s Cosmetic Industry”, Dezan Shira & Associates Ltd. 8 Seydak (2001). 9 Euro-China Business (2002), “Cosmetics War Between Chinese, Foreign and Joint Venture Products”, Beijing. http://www.ec3286.com 10 Xiao, Ziying and Xiao Ming (2002), “Zhongguo huazhuangping gongye” (The Chinese Cosmetic Industry), Riyong huangzhuangping gongye (Detergent & Cosmetics Industry), Vol. 25, No. 2, pp. 8–12. 11 China Markets Yearbook (2004). It has been impossible to find more updated figures. 12 Euro-China Business (2002). 13 Xiao and Xiao (2002). 14 Pro Re Nata, (2002). 15 Pro Re Nata (2002). 16 Wang Bing (2002). 17 Wang Bing (2002). 18 Pro Re Nata (2002). 19 Tian (2001). 20 Tian (2001). 21 Chinese press articles. 22 InterChina Consulting Ltd (2003), “Business Environment 2003”, Internal Report. Chapter 6 1 Zhang, Allan (2001), “China’s Energy Industries: Part I”, Re: Business, July Issue, PriceWaterhouseCoopers. 2 Lynch, Richard (2004), An Energy Overview of the People’s Republic of China, US Department of Energy, Washington DC, August 12. 3 Lynch (2004). 4 Guo Sizhi (2002), “Oil Security: A Crucial Strategic Issue For the Economic Development of China”, Working Paper from the Institute of Electrical Engineers of Japan (IEEJ), September Issue.
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5 Ghini, Anna Lisa (2002), “The Chinese Quest for Energy”, Asia Times, April 12. 6 Zhang (2000) 7 Niu Yan, and Dai Xuedong (2004), “Shenhua meiyehua xiangmu kaigong” (Shenhua Coal Liquefaction Project is Under Construction), Eerduosi ribao (Eerduosi Daily, Inner Mongolia Newspaper). August 26. 8 Logan, Jeffrey (2000), “Chinese Energy and Carbon Dioxide Trends at the Turn of the Century”, Working Paper from the Pacific Northwest National Laboratory. 9 Zha Daojiong (2004), “Oil Reserve Key to Energy Security”, China Daily, August 11. 10 EIA (2003). 11 EIA (2003). 12 Zhang (2000). 13 EIA (2003). 14 EIA (2005). 15 EIA (2003). 16 EIA (2005). 17 Guo (2002). 18 Guo (2002). 19 EIA (2005). 20 EIA (2005). 21 Guo (2002). 22 Guo (2002). 23 EIA (2005). 24 CEIC (2005). 25 Zhang (2000). 26 Shi Zulin and Xu Yugao (2000), “Impact of China’s Accession to the World Trade Organization on China’s Energy Sector”, Working Paper at the Development Research Academy for the 21st Century, Tsinghua University, Beijing. 27 Shi and Xu (2000). 28 Zhang (2000). 29 EIA (2005). 30 EIA (2005). 31 EIA (2005). 32 Lynch (2004). 33 Lynch (2004). 34 Zhang (2001). 35 EIA (2005). 36 Although updates have been considered, most of the WTO section is primarily based on Shi and Xu (2000). Please refer to this text for further details. 37 For more details, refer to the “Protocol on the Accession of the People’s Republic of China” (2001), Compilation of the Legal Instruments on China’s Accession to the World Trade Organization, Beijing: Falü chubanshe: pp. 2–14. Chapter 7 1 Gilmour Brad and Fred Gale (2002), “A Maturing Retail Sector: Wider Channels for Food Imports?”, China’s Food and Agriculture: Issues for the 21st Century, US Department of Agriculture, Economic Research Service, Report AIB-775. 2 “Development Blueprint for the Food Industry” (2001), Zhongguo shangqing kuaixun (Business Alert – China), Hong Kong Trade Development Council. Issue 4, April 15. Updated through press reports. 3 SSB (2005). 4 China Markets Yearbook (2005). 5 “China Milk Market Boom Predicted: Beijing, Shanghai are Leading Markets” (2002), China Food Trends, Issue No. 4, February: pp. 4–5.
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6 We assume that “others” include private and joint stock firms. These figures do not appear explicitly in the official data on total number of firms (China Markets Yearbook). The collection of data on the top ten firms in the cooked meat sector allows us to appreciate that joint stocks represent more than 40% and private firms 10%. 7 “China’s Canning Sector Breaks Records in 2002” (2003), Zhongguo nengfu chanpin jiaoyi shichang (China Agricultural Sideline Product Market). http://www.caspm.com 8 EIU (2005). 9 China Markets Yearbook (2005). 10 Soft Drinks in China: A Market Analysis 2005, Access Asia Limited. 11 EIU (2005). 12 China Food and Agricultural Services (2001), People’s Republic of China Food Processing Sector Report 2001. Report prepared for the US Department of Agriculture, Foreign Agricultural Service, ATO-Shanghai, December. 13 “China to Promote Key Food Processing Industries” (2002), Renmin ribao (People’s Daily), August 22. 14 There are many institutions that undertake applied research on food in developing economies. For detailed analyses, please refer to the Institute of Food, Science and Technology in London (www.isft.org), the Food Institute in New Jersey (www.foodinstitute.com), or the World Health Organization (www.who.org), amongst many others. These data may be found at the China Food and Agricultural Services (www.cnfas.org). 15 “China to Promote (...)” (2002), op.cit. 16 “Eating Disorders” (2004), The Economist, July 24: p. 26. 17 Carrefour’s annual sales in 2003 reached 13.4 billion RMB (US$ 1.62 billion), a 25.7% increase over the previous year. Walmart, with annual sales of 5.85 billion RMB (US$ 708.0 million) in China during 2003, has already opened 33 outlets throughout China and plans to open several dozen more in the short term. 18 “Sector News. Dairy Market: Yili Group Intends to be China’s Leading Ice-Cream Brand” (2002), Zhongguo shipin tianjiaji wang (China Additive Industry Information Network), June 10. 19 “Sales Give Dairy Producer a Solid Base Down South” (2003), Zhongguo nengfu chanpin jiaoyi shichang (China Agricultural Sideline Product Market). http://www. caspm.com. 20 Qin, Zhenkui and Tang Guangjiang (2002), “Status and Prospect of China’s Food Imports & Exports Safety”, Paper presented at the Workshop on ‘Agro-Food Safety Issues’ at the China Council for the Promotion of International Trade Specialized Sub-Council of Agriculture (CCPIT-SSA), Beijing, October 9–11. 21 Qin and Tang (2002). 22 Fast Food Market Report (2001), Shanghai: Friedl Business Information and Partners: pp. 1–4. 23 “KFC Chain Stores Grow to 500 in China” (2001), Zhongguo jingji xinxi wang (China Economic Information Network), October 13. CEIBS E-database. 24 The ten most famous Chinese fast food brands are published by the Fast Food Committee of China Cooking Association (Zhongguo pengren xiehui kuaican weiyuanhui). 25 “Nation’s Bottled Tea Market Thriving” (2001), Zhongguo jingji xinxi wang (China Economic Information Network), July 23. CEIBS E-database. 26 “Nation’s” Bottled Tea ...” (2001). 27 “Dairy Industry Faces Competition” (2001), Renmin ribao (People’s Daily), November 28. 28 “Dairy Industry ... (2001). 29 Zhongguo jixie gongye nianjian (2001) (China Machinery Industry Yearbook), Beijing: Jixie gongye chubanshe. 30 Bai, Mu and Zi Yin (2003), “Woguo baozhuang jixie shichang zongtan” (China Packaging Machinery Market Review), Zhongguo paozhuang gongye (China Packaging Industry), No. 1, pp. 18–20.
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31 Wang, Wei (2001), “Jiaru WTO yu Zhongguo shipin gongye fazhan” (WTO Accession and the Development of China’s Food Industry), Shipin keji (Food Science and Technology), No. 3, pp. 1–3. 32 Wang, Wei (2001): pp. 1–3. 33 Import tariffs on wine were: 65% before WTO entry, 44.6% in 2002, and 14% in 2004. 34 Zhao and Li Peng (2002): pp. 163–165. 35 “Sector News: Agriculture Food & Beverage” (2002), CCBC Business Trends, www.ccbc.com/Business Trends/ November 2~8, 2002, Vol. 1, Issue 40: p. 2. 36 Zhao and Li Peng (2002). 37 Jiang Yongwen (2003), “Woguo chaye de anquan zhiliang xianzhuang” (Quality and Safety Status of China’s Tea), Nongye keji xinxi cankao (Agricultural Science and Technology Information Reference), Issue 107, March 1. 38 “Zhongguo chaye fazhan xianzhuang” (2004) (Development Status of China’s Tea Industry), Xiaofei ribao (Consumption Daily), May 11. Chapter 8 1 Yuan Chang (2001), “WTO Accession for China—Potential Impact on the Insurance Industry”, Article presented at the conference on “Financial Sector Reform in China”, Harvard University, September 11–13. 2 China Concept Consulting Co. Ltd. (2004), “The Post-WTO Insurance Frenzy”. Online Report. 3 Allison, Tony (2001), “Risks and Rewards in China’s Insurance Market”, February 16, Asia Times. Special Report. 4 Wan, Lihong (2002), “China’s Insurance Market”, Zhongguo jingji nianjian (Almanac of China’s Economy), Beijing: Zhongguo jingji chubanshe. 5 Yuan (2001). 6 Allison (2001). 7 CEIC data (2005); Allison (2001). 8 Deng, Gang (2001), “China to Boast an Insurance Asset of a Trillion RMB in Five Years”, Renmin ribao, January 16. 9 CEIC data (2005). 10 CEIC data (2005). Size of the sample was unavailable. 11 Auto insurance itself is not compulsory, considering it is a type of commercial insurance: social insurance is compulsory whereas commercial insurance is not. As a result, we cannot provide a complete list of China’s compulsory commercial insurance. However, on May 1, 2004, new compulsory insurance was released within the new Traffic Safety Law (Daolu jiaotong anquan fa): the Third-Party Responsibility Compulsory Insurance for Automobiles (Jidongche disanzhe zeren qiangzhi baoxian), which compensates victims of accidents caused by auto owners. Nonetheless, according to a survey carried by the CIRC in early 2004, reality proved that only 30% of this commercial insurance is covered. The situation can only be changed after an effective implementation of compulsory insurance. For more details, refer to “Jindongche sanzhe zeren zhangsheng yipian” (2004) (Premium for Third Party Coverage Responsibility Insurance Increases), Jinghua shibao (Beijing Times), May 13. 12 Chinese press releases. 13 Infobank (2005); CEIC data (2005). 14 CEIC data (2005); SSB (2005). 15 CEIC data (2005); SSB(2005). 16 Sa, Ginka (2000), “China’s WTO Entry and the Insurance Market Access”, Nippon Life Insurance Research Institute, No. 144, pp. 30–33. 17 China Concept (2004). 18 “Kaifang baoxian shichang bingfei ‘yilangrushi’” (To Open the Insurance Market Isn’t Tantamount to “Inviting a Wolf into your House”) (2000), Renmin ribao (People’s Daily), June 15.
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19 Kaifang “ … ” (2000). 20 Xinhua News Agency, Jan. 17, 2006, DRCNET. 21 Hao, Yansu (2001), “Ba Zhongguo baoxian shichang dangao zuoda: zhuanjia tan rushi” (Making Chinese Insurance Market a Bigger “Cake”: Experts on China’s WTO Entry), Renmin ribao (People’s Daily), October 26. Chapter 9 1 CEInet Market Research (2003), “China’s Medicine Industry in 2002”, Beijing CEINet Corporation, April 27. 2 SunFaith China Ltd (2003), “Business Report on Traditional Chinese Medicine”, June 20: p. 5. 3 Warrington, Hannah and Matthew R. Miller (2004), “China: Top Drug Market by 2020?”, International Herald Tribune, August 11. 4 Xinhua News Agency (2003), “China to Become the Largest Medicinal Market in the World”, China Economic Information Service Center, July 1, p. 1. 5 Beijing Kang Kai Information & Consultancy Co., Ltd (2003), 2002-nian du yiyao zhizao ye hangye dianping (Pharmaceutical Industry Review and Analysis in 2002), May 22; Forecasting by Dezan Shira & Associates Ltd., a Beijing-based adviser to overseas companies. 6 CEInet Market Research (2003), “China’s Medicine Industry in 2002”, Beijing CEInet Corporation, April 27: p. 1. 7 Chen, Zhiyong (2004), “New Ideas Needed to Revive TCM”, China Daily, August 18. 8 According to the Shenzhen Evening News, quoted in: Peter Goodman (2002), “China’s Killer Headache: Fake Pharmaceuticals”, Washington Post Foreign Service, August 30. 9 Goodman (2002). 10 Goodman (2002). 11 Xinhua Infolink Development Co., Ltd (2003), Pharmaceutical Industry Report, May 31. 12 Feldman, Seth (2002), “China’s Big Pharmaceuticals: The Issue of International Property Rights in China”, Harvard Asia Pacific Review, Spring, Vol. 6, Issue 1, p. 24. 13 “Chinese Pharmaceutical Industry to Develop More New Drugs” (2002), Asia info Daily China News, August 5, p. 1. Chapter 10 1 CEIC Data (2005). 2 Baosteel is the country’s most modern and profitable steel producer. It is the key production base for China’s high value-added steel products such as cold-rolled sheets (stainless sheets and color-coated/silicon steel sheets), which are highly in demand by the automobile and appliances industries (for more details, refer to our case study); Angang is second only to Baosteel in terms of total production capacity. Self-sufficient in raw materials, it is also one of the major producers of higher grade steel and key supplier to the domestic markets; Wugang and Shougang rank third and fourth, respectively. Wugang has also upgraded its product mix towards high-end products rapidly, while Shougang is the country’s major producer of wire rods. 3 Standard Chartered (2000), “Impact of WTO Entry on China’s Steel Industry”, report presented at the Economic Forum, Hong Kong Trade Development Council, September. 4 CEIC data (2005). 5 Standard Chartered (2000). 6 Wu, Yanrui (2000), “The Chinese Steel Industry: Recent Developments and Prospects”, Resources Policy, Vol. 23, Issue 3, September, pp. 171–178.
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7 Liu, Hanzhang (2002), “Jiaru WTO dui Zhongguo gangtie qiye de yingxiang ji celue fengxi” (Impact on China’s Steel Industry after WTO Entry and Strategy Analysis), Zhongguo gongye jingji (China Industrial Economy), Vol. 5, pp: 36–41. 8 CEIC Data (2005). 9 Calculation based on CEIC data (2005). 10 Calculation based on CEIC data (2005). 11 CEIC data (2005). 12 SHK (2005), China’s Steel Sector, CEIBS database. 13 Cygnus data (2005), “Steel”, December, CEIBS database. 14 Dai, Yan (2004), “Analysts: Foreign Capital Inflow Offers Economic Lift”, China Daily, August 2. Quotation from Zhao Jinping, Expert at the Research and Development Centre, State Council. 15 Cygnus (2005). 16 Bekaert, Frank, Christophe François and Ruben Verhoeven (2004), “The China Factor in Global Steel”, The McKinseyQuarterly, August 18. 17 Schedule CLII – People’s Republic of China, Compilation of the Legal Instruments on China’s Accession to the World Trade Organization, Beijing: Falü chunbanshe: p. 390; Liu (2002). 18 Liu (2002). 19 Standard Chartered (2000). 20 World Steel Dynamics is one of the leading steel information service providers, established in the US. WSD regularly publishes reports on steel prices, costs, supply, demand, and finance in the steel industry over the world. 21 One of the junior levels in the hierarchy of the Administration System of China. 22 At the time of writing this case, the legal retirement age for manual workers was: female 50, male 55; for office workers it was: female 55, male 60. Chapter 11 1 Wang, Xiaobing (2003), “Dianxin ye shi wei shi ji” (Opportunities and Risks for the Telecommunications Industry), Cai Jing Magazine (Finance Magazine) , May 10, pp. 90–92. 2 Wang (2003). 3 MII(2005). 4 Code Division Multiple Access is a second generation mobile service that allows users not to pay for incoming phone calls. 5 GSM is currently utilized by most of China Unicom and China Mobile subscribers. 6 China Tietong (former Railcom) online’s official website: www.crc.net.cn 7 Chen, Zhiming (2004), “China Tietong to be Officially Launched in Early August”, China Daily, July 23. 8 “Progress of China’s Information Industry in 2003” (2004), IT Annual Report, September; Paul Budde (2004), “China – Major Telecommunications Players”, Communication Pty Ltd. August. CEIBS Database. 9 Chen, Allen, and Craig Watts (2003), “The Mainland’s Telecom Investment Picture for 2003”, Norson Telecom Consulting, No. 2: p. 2. 10 MII’s official webpage: http://www.mii.gov.cn 11 BuddeComm Telecom Market (2005). 12 “Zhongguo liantong CDMA de yonghu yijing tupo 200 wan” (2002) (China Unicom Boasts Two Million CDMA Users), Nanfang dushi bao (Southern Metropolis Daily), August 27. 13 Xinhua News Agency (2006). 14 “China Unicom Subscribers Top 100 Million” (2004), China Daily, May 11. 15 “China Industry: Cisco vs. Huawei” EUI ViewsWire, May 29 (2003).
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Index
Administration for Quality Supervision, Inspection and Quarantine (AQSIQ) 149 Aetna 174 Air Catering Company 66 Air China 63, 269, 270, 273; competition, 67–8, 70; future perspectives, 68–70; government intervention, 70; history, 64–5; human resources, 67; JV, 66–7; Lufthansa model, 65–6; organization, 65; project teams, 69; rapid growth, 70; stock market, 70; strategic partners, 70; Sun Yu, xxiii, 64–70 airports 58 Alcatel Shanghai Bell Co. Ltd. 236, 269, 272, 274, 275; board chairman, 250; board of directors, 256; case study, 245–56; chairman of board, 252; corporate governance, 251–2; fourth stage, 250; future challenges, 254–6; future development, 254–5; future perspectives, 256–7; globalization process, 255, 256; history, 247; HR and ASB, 250; IPRs, 254; JV, 256; market needs, 256; organization, 249; overseas expansion, 255–6; pioneering stage, 247–8; product diversification, 250; research and development, 256; third stage, 248; today and tomorrow, 248–9; top ten enterprises, 258; top ten foreign enterprises, 259; Yuan Xin, xxiii, 245–56 Allianz 174 AMC. See Asset Management Companies (AMCs) Amoisonic 19 Angang 208 AnShan 216 AQSIQ. See Administration for Quality Supervision, Inspection and Quarantine (AQSIQ) Asian Financial Crisis 9
Asset Management Companies (AMCs) 8 automobiles 33–53; case study, 44–53; competition, 39–43, 44, 264; employment, 36; FDI, 33–4; foreign partners, 42; future perspectives, 52–3; industrial growth and restructuring process, 261; industry outlook, 35–9; industry restructuring, 33–5; JV, 41; market share, 37; outlook, 44; output percent GDP, 35; ownership structure, 35; price cuts, 40; profit contributions, 42; profit margin, 39; restructuring, 44; top ten manufacturers, 53; total output, 34; total sales, 38; WTO impact, 43–4, 267 Avon 94, 96 Baosteel Group Enterprise (BGE) Development Company 208, 214, 217, 269; case study, 218–27; change resistance, 224; cost reduction, 227; excess workforce, 227; exports, 226; future challenges, 225–7; HR, 224–5, 271; mindset, 222; new generation, 225; SOE staff redundancy, 222–4; steel, xxiii; talent retention, 225; training programs, 224; Xu Nan, xxiii, 218–27 beer 141–2, 153 Beijing Beierkang Dairy 149 Beijing Sanlu Co. 96, 98 Beijing Weir Dairy 149 Benxi 216 BGE. See Baosteel Group Enterprise (BGE) Development Company big head disease’ fake baby milk powder scandal 148 black good enterprises; top ten 15 BlueScope Steel Ltd. 213 board chairman: Alcatel Shanghai Bell Co. Ltd. 250
Index 301 board of directors (BOD): Alcatel Shanghai Bell Co. Ltd. 256; chairman qualities 274 BOD. See board of directors (BOD) BP 120 Bright Dairy 145 Bright/Guangming 142 CAAC. See Civil Aviation Administration of China (CAAC) canned food 141, 152–3 career opportunities 273 CCSEB. See China Construction Second Engineering Bureau (CCSEB) CDMA phone output 235 CEIBS. See China Europe International Business School (CEIBS) Chai Xinjian xxiii, 23–6, 274, 275 Changhong 12–13 China Construction Second Engineering Bureau (CCSEB) 80, 274; case study, 81–90; corporate governance, 86; future challenges, 89–90; history, 82–5; internal reforms, 88–9; iron rice bowl policy, 86–7; reform, 86; tradition and culture, 87–8; Zhang Pei, 81–90 China Dairy Product Association 140 China Europe International Business School (CEIBS) 68 China International Aviation Holding (CIAH) 65 China International Trust & Investment Corporation (CITIC) 65 China Iron and Steel Association 209 China Mobile 232 China National Aviation Company (CNAC) 64 China National Aviation Holding Company (CNCH) 64 China National Cereals, Oils, & Foodstuffs Import & Export Corporation (COFCO) 269, 273; after restructuring, 160; case study, 155–62; complexity, 164; external advice, 164; food, xxiii; future challenges, 162–63; history, 155–62; industrial group, 156–57; leadership, 163; Liu Kejian, xxiii, 155–62; partners, 164; before restructuring, 159; second reorganization, 157–64; trading company, 155–56 China National Coal Import and Export Corporation 120
China National Offshore Oil Corporation (CNOOC) 114, 120, 265 China National Petroleum Corporation (CNPC) 114, 120 China Netcom, Ltd (CNC) 232 China Oilfield Service, Ltd. (COSL) 114 China Pacific Insurance Co. 167 China Petrochemical Corporation (Sinopec) 114, 265 China Property Insurance Co. 172 China Railway Communication Co. Ltd. (China Railcom) 232–4 China Satellite Communication (ChinaSat) 232–3, 234–5 China’s Coal Corporation 122 China Siwei Surveying and Mapping Technology 234–5 China Sky Aviation Enterprises Group 61 China’s National Food Industry Association (CNFIA) 145 China Southwest Airlines 64 China State Construction Engineering Corporation (CSCEC) 77, 81–2; construction, xxiii; Zhang Pei, xxiii China Telecom 232, 241 China Tietong 232–4 China Unicorn 232–3, 235, 241 Chinese Academy of Sciences 194–5 Chinese medicine; vs. Western medicine 191 Chunlan 12–13 CIAH. See China International Aviation Holding (CIAH) CIF. See cost insurance and freight (CIF) Cisco 236 CITIC. See China International Trust & Investment Corporation (CITIC) civil aviation 54–70; case study, 64–70; competition, 58–61, 63, 264; employees, 59, 60; FDI, 55; future perspectives, 70–1; as GDP share, 56; high ticket prices, 59; industrial growth and restructuring process, 261; industry outlook, 56–8; industry restructuring, 54–6; investment methods, 56; low market share, 59; military separation, 54; outlook, 63; restructuring, 63; revenue, 57; top enterprises, 62; total traffic, 60; WTO impact, 61–3, 63, 267 Civil Aviation Administration of China (CAAC) 54–5; regrouping plan, 55 CNAC. See China National Aviation Company (CNAC) CNC. See China Netcom, Ltd. (CNC)
302
Index
CNCH. See China National Aviation Holding Company (CNCH) CNFIA. See China’s National Food Industry Association (CNFIA) CNOOC. See China National Offshore Oil Corporation (CNOOC) CNPC. See China National Petroleum Corporation (CNPC) coal 112–13; industry outlook, 116; WTO impact, 122, 267 Coca Cola Co. 142, 151, 153–4, 154–6 Coconut Palm/Yezhi 142 COFCO. See China National Cereals, Oils, & Foodstuffs Import & Export Corporation (COFCO) competition 264–7; Air China, 67–8, 70; automobiles, 39–43, 44, 264; civil aviation, 63, 264; construction, 76–8, 80–1, 264–5; cosmetics, 99–101, 102, 265; energy, 119–21, 124, 265; food, 147–8, 155, 265; home appliances, 18–9, 23, 264; insurance, 172–6, 177; nuclear power, 265; pharmaceuticals, 191–2, 194, 265; steel, 213–4, 217–8, 266; telecommunications, 238–242, 245, 266; XJ Group Corporation (XUJI Corporation), 125–6, 131 competitive compensation 273 construction 72–92; case study, 81–90; competition, 76–8, 80–1, 264–5; employment, 74; FDI, 77; firm distribution, 78; foreign competition, 90; foreign partners, 90; future perspectives, 90–1; industry outlook, 75–6; industry restructuring, 72–5; JV, 79–80; organization structure, 90; outlook, 80; restructuring, 80; top enterprises, 92; workforce adjustment, 90; WTO impact, 78–81, 267; Zhang Pei, xxiii consumer goods: owned per 100 urban households 18 contract responsibility system (CRS) 4–7 cooked meat 140–1 corporate governance: Alcatel Shanghai Bell Co. Ltd. 251–2 corporate governance mechanism 10, 274 COSL. See China Oilfield Service, Ltd. (COSL)
cosmetics 93–110; aging people’s products, 99; baby-care products, 98; case study, 102–9; competition, 99–101, 102, 265; future perspectives, 109–10; industrial growth and restructuring process, 262; industry outlook, 94–9; industry restructuring, 93–4; men’s, 99; natural products, 99; outlook, 102; ownership structure, 94; product distribution, 98; restructuring, 102; revenue, 95; share of GDP, 95; skin-care products, 98; top ten enterprises, 97; total companies, 100; WTO impact, 101, 102, 267 cost insurance and freight (CIF) 122 Credit Suisse Group 174 CRS. See Contract responsibility system (CRS) crude oil: WTO impact 122 CSCEC. See China State Construction Engineering Corporation (CSCEC) Dabao lotions 98 dairy products 139–40, 151, 152 DAL. See Drug Administration Law (DAL) Danone 142 Da Tang 236 Deng Xiaoping 21, 73, 221 Dongfeng Motor Corporation 41 Drug Administration Law (DAL) 187 economic indicators 2 economic transformation 1–2 electric power 115–6; industry outlook, 117–9; WTO impact, 123 energy 111–34; case study, 124–33; coal, 112–3, 116, 122; competition, 119–21, 124, 265; consumption, 113; crude oil, 122; electric power, 115–6, 117–9, 123; employment, 124; FDI, 121; future perspectives, 131–3; industrial growth and restructuring process, 262; industry outlook, 116–9; industry restructuring, 111–6; natural gas, 114–5, 117, 122–3; new and renewable energy, 119; nuclear power, 115–6; oil, 113–4, 116–7; outlook, 124; ownership distribution, 120; restructuring, 124; supply production, 112; top producers, 134; WTO impact, 122–5, 267
Index 303 Ericsson 236 ExxonMobil 115, 120 fast food restaurants: top ten 150; Western, 149 FAW 41 FDI. See foreign direct investment (FDI) financial system reform 10 firms 269–275; partnership and strategic alliances, 269–270; restructured 269–270 food 135–166; beer, 141–2; canned food, 141; case study, 155–162; competition, 147–8, 155, 265; cooked meat, 140–1; dairy products, 139, 140; export commodities, 137; farm crops, 138; future perspectives, 165; GDP, 145; grain production, 147; industrial growth and restructuring process, 262; industry outlook, 145–7; industry restructuring, 135–45; meat, 141; mergers and acquisitions, 148; nutritional alliances, 148; outlook, 154; processing and packaging, 152; restructuring, 154; safety, 148–51; soft drinks, 142–4; sugar, 138; top ten enterprises, 166; total revenue, 146; TVE, 139; variations, 138; WTO impact, 151–2, 155, 268 foreign direct investment (FDI) 18; automobiles, 33–4; civil aviation, 55; construction, 77; energy, 121; insurance, 176; telecommunications, 242 Fortis 174 Gazprom 115 General Electric (GE) 22 Ge Wenyao 103 globalization process: Alcatel Shanghai Bell Co. Ltd. 255, 256 Global Restaurants Inc. 150 good manufacturing practices (GMP) 188, 262 grain 147 green tea 151 Group Little Swan 29; See also Little Swan Group: Chai Xinjian, xxiii; home appliances, xxiii Guangdong Xinde Science & Technology Group Co. Ltd. 20 Guangdong Zhigao Air Conditioner Co. 20
Guangsheng Company 102–3 Guangzhou Danone Yogurt Co. Ltd. 148 Guangzhou P&G Co. 96 Guan Shengyuan 145 Haier 12–13, 21, 22, 23; vs. Little Swan Group, 29 Haitian 145 Handan Steel Co. 208, 216 HDR. See High Data Rate (HDR) Hengshun 145 Henkel 100, 109 High Data Rate (HDR) 237 HMT. See Hong Kong Macau Taiwan (HMT) home appliances 12–32; case study, 23; competition, 18–19, 23, 264; with domestic partners, 22–3; employment, 16; firms ownership structure, 20; foreign partners, 22; as GDP share, 16; industrial growth and restructuring process, 261; industry outlook, 13–18; industry restructuring, 12–13; outlook, 23; restructuring, 23; tips, 23; total number, 17; total revenue, 17; WTO, 20–1, 23, 266–7 Hong Kong Macau Taiwan (HMT) 94 household registration system 30 HR. See human resource (HR) system Hualing 216 Huawei 236 Huiyuan 142 human resource (HR) system 10, 31; Air China, 67; Alcatel Shanghai Bell Co., Ltd, 250; Baosteel Group Enterprise (BGE) Development Company, 224–5, 271; creation, 271–2; Little Swan Group, 27; Shanghai Synica Co., Ltd, 198–9; transformation, 271–2; XJ Group Corporation (XUJI Corporation), 128–30, 131 ICAO. See International Civil Aviation Organization (ICAO) ICBC. See Industrial and Commercial Bank of China (ICBC) IEA. See International Energy Agency (IEA) independent decision-making system 9 Industrial and Commercial Bank of China (ICBC) 172 industrial growth and restructuring process 261–4
304
Index
insurance 167–86; case study, 177–85; competition, 172–6, 177; FDI, 176; future perspectives, 185; industrial growth and restructuring process, 262; industry outlook, 169–72; industry restructuring, 167–9; market share, 173, 174; outlook, 177; ownership distribution, 173; pyramid of age, 171; restructuring, 177; revenue growth, 169; as share of GDP, 170; top ten enterprises, 186; top ten foreign enterprises, 175; WTO impact, 176–7, 177, 268 International Civil Aviation Organization (ICAO) 57 International Energy Agency (IEA) 111, 116 international market: Shanghai Synica Co. Ltd. 205 International Telecommunications Union (ITU) 237 iron rice bowl policy: BGE 226 IT crisis 231 ITU. See International Telecommunications Union (ITU) Jahwa 270, 272, 273, 274 Jianlibao 145 Jinian Wang xxiii, 124–33 Johnson & Johnson (J&J) 98 joint ventures (JV) 31, 270; Air China, 66–7; Alcatel Shanghai Bell, 256; automobiles, 41; bourgeoning of, 18; construction, 78, 79–80; with Johnson and Shanghai Jahwa United Co. Ltd, 103–5; Panasonic, 26; Shanghai Automotive Brake Systems Co., Ltd, 46–7, 51; Shanghai Jahwa United Co. Ltd, 109; Shanghai Synica Co., Ltd, 203; Siemens, 25 JV. See joint ventures (JV) Kang Shifu 145 Kejian China 239 Kelon 22, 23 Kentucky Fried Chicken (KFC) 149 Key Performance Indicator (KPI) 130 KFC. See Kentucky Fried Chicken (KFC) KLM Royal Dutch Airlines 61 KPI. See Key Performance Indicator (KPI) Kraft 142
labor; BGE 227 LAN. See Local Access Network (LAN) leadership 31; commitment, 272–273 LG Electric 19 Lianhua 145 light industry 13 liquefied natural gas (LNG) 117 Little Smart (Xiaolintong) 232 Little Swan Group xxii, 21, 23, 272, 274, 275; board of directors, 26; competitive advantage, 29–30; future challenges, 30–2; future perspectives, 31–2; governing structure, 26–8; vs. Haier, 29; history, 24–5; HR, 27; innovation and intellectual property rights, 24–5; JVs, 24–6; talent retention, 27–8 Liu Kejian 155–62 Liu Yuliang 270, 272, 274 LNG. See liquefied natural gas (LNG) Local Access Network (LAN) 237 L’Oreal 100, 109 Lufthansa 63 Lufthansa model: Air China 65–66 Luling 142 Mafei 145 major durable consumer goods: owned per 100 urban households 18 Malan Lamian (Malan Pulling Noodles) 150 Manulife 174 Mary Kay 94 McDonald’s 150 meat 141 Meidi 12–13 Meilande Consulting Co. 96 Memorandum of Understanding (MOU): formed TCL International-Thomson Electronics 240 MII. See Ministry of Information Industry (MII) milk products 151 Ministry of Commerce (MOFCOM) 79, 111 Ministry of Electronics Industry 256 Ministry of Foreign Trade and Economic: Cooperation (MOFTEC) 79 Ministry of Health (MoH) 149 Ministry of Information Industry (MII) 256
Index 305 Ministry of Post & Telecommunications 256 Ministry of Railways (MOR) 232 Mitsubishi Electric 19 mobile phone: market shares 239 mobile phone producers: improved situation 240 MOFCOM. See Ministry of Commerce (MOFCOM) MoH. See Ministry of Health (MoH) MOR. See Ministry of Railways (MOR) Motorola 239 MOU. See Memorandum of Understanding (MOU) National Development and Reform Commission (NDRC) 111 national goods 151 National Power Industry Framework Reform Plan 115 natural gas 114–15; industry outlook, 117; WTO impact 122–3 NDRC. See National Development and Reform Commission (NDRC) Nestle 142 new and renewable energy (NRE) 119 Ningbo Bird 239 Ni Rongqing xxiii, 177–85 Nokia 239 Nongfu Shanquan 142 Nortel 236 Northwest Airlines 61 Novartis 142 NRE. See new and renewable energy (NRE) nuclear power 115–16; competition, 265 oil 113–14; industry outlook, 116–17 One World 61 Onlly 145 organizational structure: rationalizing 270–71 overseas expansion: Alcatel Shanghai Bell Co. Ltd. 255–56 Panasonic 19; JV, 26 People’s Insurance Company of China (PICC) 167 Pepsi Cola 142, 153–54 PetroChina 120
pharmaceuticals 187–207; case study, 194–205; competition, 191–2, 194, 265; future perspectives, 207; industrial growth and restructuring process, 262; industry outlook, 189–91; industry restructuring, 187–8; outlook, 194; ownership and distribution, 189; restructuring, 194; sales revenue, 189; top ten manufacturers, 208; total enterprises, 188; WTO impact, 193–4, 194, 268 PICC. See People’s Insurance Company of China (PICC) Ping’ an Life Insurance Company of China, Ltd. 167, 184; banks, 184; competitive advantages and future challenges, 182–84; extensive period, 179; headquarters, 184; history, 179; intensive period, 179–180; Ni Rongqing, xxiii; case study, 177–85; organization, 180–81 Procter & Gamble 100, 108, 109 professional management systems 10 project teams: Air China 69 Qualcomm Inc. 236 Re-Employment Project (REP) 7 REP. See Re-Employment Project (REP) research and development 31, 274–5; Alcatel Shanghai Bell Co., Ltd, 256; in-house, 10 restaurants: Western fast food 149 risk management: Ping’ an Life Insurance Company of China, Ltd. 184 Robust/Lebaishi 142 Ruby Johnson Cosmetics Co. Ltd. 103 SABS. See Shanghai Automotive Brake Systems Co., Ltd (SABS) SAIC 41, 43 SAMPO 22 Sanlu 145 Sanyo 22 SASAC. See State-owned Assets Supervision and Administration Commission (SASAC) SDA. See State Drug Administration (SDA) SEA. See State Energy Administration (SEA)
306
Index
SERC. See State Electricity Regulatory Commission (SERC), SFDA. See State Food & Drug Administration (SFDA) Shanghai Automotive Brake Systems Co. Ltd (SABS); automobiles, xxiii; continental TEVES, 46; cost, 52; culture and organization, 47–8; future challenges, 49; JV, 46–7, 51; organization chart, 49, 50; partners, 51; quality, 52; Xue Jinda, xxiii, 44–53 Shanghai Bright Dairy & Food Co. Ltd. 148, 151 Shanghai Industrial United Holding Company (SUIC) 102, 105 Shanghai Institute of Organic Chemistry (SIOC) 194 Shanghai Iron & Steel Holding (Group) company 220 Shanghai Jahwa United Co. Ltd. 95, 96, 101; brand image, 109; cosmetics, xxiii; future challenges, 106–9; goes public, 106; history, 102–3; JV, 109; JV with Johnson, 103–5; Liu Yuliang, xxiii, 102–9; R&D, 109; retaining talent, 109; SIUC, 105; SOE leaders, 109; stock market, 109 Shanghai Meishan (Group) Company 220 Shanghai Mingxing Daily Chemical Products Factory 103 Shanghai Synica Co. Ltd. 273, 275; bringing people together, 197–8; case study, 194–205; costs, 205; counterfeiting, 205; employees, 205; financing, 196–7; future and challenges, 204–5; history, 195–7; HR, 198–9; IPRs, 201; JV management, 203; Zheng Chongzhi, xxiii, 194–205 Shanghai Unilever 96 Shanghai Xinya Dabao (Shanghai Xinya Big Buns) 150 Shell 115, 120 Shenzhen Miandian Wang (Shenzhen Snack King) 150 Shineway 145 Shiseido 100, 109 Shougan 208 Shunde Jinke Electrical Appliance Co. Ltd. 20 Sichuan Changhong Electric 21, 22 Siemens 19–20, 236, 239; JV, 25 Sinopec 120. See also China Petrochemical Corporation (Sinopec)
SIOC. See Shanghai Institute of Organic Chemistry (SIOC), Sky Team 61 SOE. See State-Owned Enterprises (SOE) soft drinks 142–4, 153–4 SPAC. See State Pharmaceutical Administration of China (SPAC) SPC. See State Power Corporation (SPC) Star Alliance 61 State Administration of Industry and Commerce 149 State Drug Administration (SDA) 187 State Electricity Regulatory Commission (SERC) 111 State Energy Administration (SEA) 114 State Environmental Protection Administration (SEPA) 111 State Food & Drug Administration (SFDA) 188, 262 State General Administration for Quality Supervision, Inspection and Quarantine 149 State-owned Assets Supervision and Administration Commission (SASAC) 3 State-Owned Enterprises (SOE): challenge 273; globalization, 10; obstacles, 1; reforms, 1, 5–6, 18, 21, 260–1; waves, 5–6 state-owned sector: policy initiatives, 260 State Pharmaceutical Administration of China (SPAC) 187 State Power Corporation (SPC) 115 steel 208–9; case study, 218–27; competition, 213–214, 217–218, 266; domestic share, 214; employment, 209; ex-factory price indices, 211; future, 227–8; industrial growth and restructuring process, 262; industry outlook, 210–13; industry restructuring, 208–10; outlook, 217; ownership distribution, 209; product quality, 212; restructuring, 217; rolling, 208; smelting, 208; top ten enterprises, 228; WTO impact, 215–17, 218, 268; Xu Nan, xxiii stock market 272; Air China, 70; Ping’ an Life Insurance Company of China, Ltd. 184; Shanghai Synica Co. Ltd, 205 ST Xiaxin 239 SUIC. See Shanghai Industrial United Holding Company (SUIC) Sun Yu xxiii, 64–70, 273
Index 307 Tai King Life 174 Taiping Life (TPL) 174 talent: BGE 227; COFCO 164; recruitment and retention, 273–74 Tangshan 215 tax system reform 10 TCL 239 TCL International Holdings Limited 240 TCM. See traditional Chinese medicine (TCM) TD-SCDMA. See Time Division Synchronous CDMA (TD-SCDMA) tea 151, 154 telecommunications xxiii, xxiii, 250–9; case study, 245–6; CDMA handsets, 246; competition, 238–42, 245, 266; domestic and international fixed-line, 242; FDI, 242; gateway facilities, 242; GSM handsets, 246; industrial growth and restructuring process, 261–2; Internet, satellite services, 242; liberalization schedule, 244; market share, 234; mobile services, 242; outlook, 235–8, 245; regulation, 242; restructuring, 245, 256–7; as share of GDP, 231; value-added and paging, 242; WTO impact, 242–5, 245, 268 telecom service providers: restructuring process 231 Tenth Five-Year Plan (10th 5YP) 8, 12 Three Gorges Dam 118 Tianjin Health Frozen Food Company 148 Tianjin Samsung 19 Tibetan medicine 190 Time Division Synchronous CDMA (TD-SCDMA) 237 Township and Village Enterprises (TVEs) 7 TPL. See Taiping Life (TPL) traditional Chinese medicine (TCM) 188–190 Tricon Global Restaurants Inc. 149–50 TVE. See Township and Village Enterprises (TVEs) unemployment rate 260 Unicom Guomai Communications Co. Ltd. 234
Unilever 100, 108, 109 urbanization rates: China 171 Verizon 236 Vodafone Group 236 Wahaha Group 142, 145, 151 Wang Jinian 271 WCDMA. See Wideband Code Division Multiple Access (WCDMA) Weiwei 145 Western fast food restaurants 149 Western medicine: vs. Chinese medicine 191 WFOE. See wholly foreign-owned enterprises (WFOE) white good enterprises: top ten 14 wholly foreign-owned enterprises (WFOE): construction 78 Wideband Code Division Multiple Access (WCDMA) 237 wine 153 Winterthur Life & Pensions 174 World Trade Organization (WTO) 2, 266–8 Wugang 208 Wuhan 216 Xiaolintong 232 Xinfei 22 XJ Group Corporation (XUJI Corporation) 130–3; administrative levels, 131; company reform, 128; competition, 125–6, 131; future, 130–1; group organization chart, 126; HR, 128–30, 131; Jinian Wang, xxiii, 124–133; leadership, 131; management team, 131 Xue Jinda 44–53 XUJI. See XJ Group Corporation (XUJI Corporation) Xu Nan xxiii, 218–27 Yeshu 145 Yili Group 145, 148 Yuan Xin xxiii, 245–256 Zhang Pei 269, 274; construction, xxiii Zheng 273 Zhongshan Ganglian Huakai Electrical Appliance; Products Co. Ltd. 20 Zhong Xing 236, 237
