Proceedings of the International Conference on Chinese Enterprise Research 2007

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The International Conference on

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The International Conference on

hinese Enterprise Research 2007

Chief Editors  Tan Teng-Kee and Anthony S C Teo Executive Editor  Fu Xiaofang

World Scientific A partnership between Nanyang Technological University and Lien Foundation

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Published by World Scientific Publishing Co. Pte. Ltd. 5 Toh Tuck Link, Singapore 596224 USA office: 27 Warren Street, Suite 401-402, Hackensack, NJ 07601 UK office: 57 Shelton Street, Covent Garden, London WC2H 9HE

British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library.

PROCEEDINGS OF THE INTERNATIONAL CONFERENCE ON CHINESE ENTERPRISE RESEARCH 2007 Copyright © 2008 by Lien Chinese Enterprise Research Centre, Nanyang Technological University All rights reserved. This book, or parts thereof, may not be reproduced in any form or by any means, electronic or mechanical, including photocopying, recording or any information storage and retrieval system now known or to be invented, without written permission from the Publisher.

For photocopying of material in this volume, please pay a copying fee through the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, USA. In this case permission to photocopy is not required from the publisher.

ISBN-13 978-981-283-471-3 (pbk) ISBN-10 981-283-471-0 (pbk)

Printed in Singapore.

Guest-of-honour, Mr. Chua Thian Poh, President of Singapore Chinese Chamber of Commerce and Industry being presented with a token of appreciation from Mr. Er Meng Hwa, Senior Provost, Nanyang Technological University

Welcome address by Associate Professor Tan Teng-Kee, Director, Lien Chinese Enterprise Research Centre, Nanyang Technological University

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Opening ceremony of International Conference on Chinese Enterprise Research 2007 at Nanyang Executive Centre

Professor Zhang Weiying, Dean, Guanghua School of Management, Beijing University shares his insight on the “Competitiveness of Chinese Companies in the Globalization Era”

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Cambridge University’s Professor Charles Hampden-Turner presents his findings on “Teaching Technopreneurship to Mandarin-Speaking Classes: Some Early Results”

Former director, Institute of Economy, Chinese Academy of Social Sciences discusses the “Understanding of Continual Economic Reforms from Income and Wealth Distribution”

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Forum 1 - Internationalization of Banks in China (From left) Mr. Tan Khee Giap, Professor, Nanyang Technological University; Mr. Jack Niu, Deputy Group Chief Credit Officer, Standard Chartered Bank; Mr. Tan Teng-Kee, Director, Lien Chinese Enterprise Research Centre; Ms. Shen Bing, News Anchor, China Central Television; Mr. Xu Li, General Manager, Industrial and Commercial Bank of China (Singapore)

Forum 2 - Doing Business in China, by Distinguished Alumni (From left) Ms. Shen Bing, News Anchor, CCTV; Ms. Lien Siaou Sze, Member, Board of Trustees, Nanyang Technological University; Mr. Tan Tiong Huat, Managing Director, Phillips Securities Group; Mr. Wu Hsioh Kwang, Executive Chairman, Straco Corporation Ltd.; Mr. Tan Teng-Kee, Director, Lien Chinese Enterprise Research Centre; Mr. Soon Min Yam, Director, Alumni Affairs Office, Nanyang Technological University

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Top left : CCTV anchor woman, Ms. Shen Bing, facilitates the Forum Center left : Guest speakers discusses on the topic of ‘Internationalization of Banks in China’ Bottom left : Nanyang Technological University’s Dr.Tan Khee Giap elaborates on the upcoming challenges facing Chinese banks Top right : Mr. Xu Li, General Manager, Industrial and Commercial Bank of China (Singapore) and Mr. Jack Niu, Deputy Chief Credit Officer, Standard Chartered Bank Bottom right: International Conference on Chinese Enterprise Research 2007 Forum at the Singapore Chinese Chamber of Commerce and Industry

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Row 1: (From left) Ms. Fu Xiaofang, Mr. Bai Yongxiu, Mr. Zhao Shuming, Mr. Tan Teng-Kee, Mr. Anthony Teo, Mr. Charles Hampden-Turner, Mr. Zhang Weiying, Mr. Zhao Renwei, Mr. Ding Huiping Row 2: (From left) Mr. Wang Zhiqiang, Mr. Guo Lin, Mr. Fu Zhenping, Mr. Mao Yunshi, Mr. Lu Dongbin, Mr. Lawrence Wong, Mr. Ju Songdong, Mr. Bai Yanlei, Ms. Michelle Chen Row 3: (From left) Ms. Zhou Xing, Ms. Zhang Wei, Mr. Wang Dongsheng, Mr. Sikander Khan, Mr. Li Shichao, Ms. Chen Jou-Chen, Mr. Shou Yongyi, Mr. Li Tiande, Mr. Zhou Yuan, Ms. Zhang Hongfang, Mr. Wu Qingsheng, Ms. Mary Ma

Speech by Guest-of-Honour ͣNANYANG TECHNOLOGICAL UNIVERSITY 2007 Conference on Chinese Enterprise Research 13 December 2007, Nanyang Executive Centre

Speech by Mr. Chua Thian Poh President, Singapore Chinese Chamber of Commerce and Industry Associate Provost, Mr Er Meng Hwa, Representatives from China’s top universities, Teachers, students and guests, A very good morning to all! I am very privileged to be the Guest of Honour at the 2007 Conference on Chinese Enterprise Research organised by Nanyang Technological University’s Lien Chinese Enterprise Research Centre (Lien CERC). On behalf of Singapore Chinese Chamber of Commerce and Industry (SCCCI), I would like to congratulate the Centre and all concerned for successfully organising this event. With its high academic standards and unique blend of East-meets-West teaching resources, Nanyang Technological University (NTU) has been ranked among one of the world’s top 25 universities. Its predecessor, Nanyang University or Nantah, was established in 1955 with generous funding from the Hokkien Association and many first-generation Chinese from all walks of life. At that time, Nantah was the first Chinese University to be set up outside China. Today, NTU continues Nantah’s tradition of grooming outstanding professionals for Singapore. Over the decades, SCCCI and NTU have had good rapport. During the construction of NTU’s campus, SCCCI extended its support through generous contributions and positive promotion of NTU. Since then, SCCCI has continued to support NTU in many ways such as awarding scholarships to outstanding scholars. The bond between SCCCI and NTU reached a new high with the signing of the Memorandum of Understanding to collaboratively train professionals from trade and industry in China. Combining our individual strengths, together, we have sought to develop quality training programmes for leading executives from China and Singapore. In the last 30 years, China’s booming economy outshone many countries as she consistently made history with her rapid development. For example, China’s imports and exports totaled USD206 billion in 1978. In 2006, their value increased 84 times to USD1,760 billion, cementing China’s position as the third largest economy in the world. Many countries and economies have benefited from the Chinese powerhouse.

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Speech by Guest-of-Honour

The purpose of today’s conference to study Chinese enterprise is significant. The surging Chinese economy has produced a great number of successful Chinese entrepreneurs. Some of them are now established public figures, renowned for their astute capability to spot and seize hidden opportunities. They have become legends in their own right, leaving behind a trail of colourful stories. Their entrepreneurial ideas and personal growth is of great research value to professionals and scholars alike. Among them stands Dr Lien Ying Chow a well-respected figure in SCCCI, and one of NTU’s co-founders. In addition, he inspired NTU’s Lien CERC and set up the Lien Foundation. Dr. Lien’s entrepreneurial spirit and principle of giving back to society are good models for the younger generation to emulate. I am sure this year’s Conference on Chinese Enterprise Research will draw out new insights from the feats of the entrepreneurs for the second year running. The audience can look forward to inspirational presentations from the lineup of speakers. I hereby offer Lien CERC my best wishes for the conference. Thank you.

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Preface to the CERC Conference ͣANTHONY SC TEO Secretary to Nanyang Technological University ͣTAN TENG-KEE Director, Lien Chinese Enterprise Research Centre

The Lien Chinese Enterprise Research Centre is pleased to report on the second International Conference on Chinese Enterprise Research held on the 13th and 14th of December 2007. The 2006 Conference set the contextual scene of China in the post-WTO world. Half a decade after China’s entry into the World Trade Organization (WTO), the Chinese economy continues to experience double-digit growth. It has surpassed the United States as the world’s second largest exporter. By upgrading its industrial structure, China has been strengthening its position as the world’s key manufacturer. Concurrently, the nation is participating more in globalization processes through its endeavors in service industries, energy development, the mining of raw materials, environmental industries, and many other market sectors. The bold mission of the Lien Chinese Enterprise Research Centre is to come to terms with one of the most astounding phenomena of our times, the awakening of the spirit of enterprise in Greater China. It often happens that those who leave their nation develop economically first. One thinks of Chinese and Indian entrepreneurs in Silicon Valley and of the earlier growth of Hong Kong and Singapore, but when economic development becomes the prime policy of a whole nation, we witness extraordinary feats, and thanks to our sponsors of the Lien Foundation, we can record this. It is with pride that I introduce the papers in this volume. Dr. Zhao Shuming, Dean of the School of Business at Nanjing asks how China can expand beyond and within her borders without greater competency in global dynamics. To be effective China needs world-class leadership. Prof. Xu Xiaoming and Zhang Yongmei from the School of Management, Fudan University look at the break-neck speed of Chinese growth and the relevance of the Penrose effect. Can perilous growth be curbed? Dean Li Tiande and Zhang Ruiqin of Sichuan University look at labor relations, where conflicts have intensified of late. A system in which either labor or capital benefits at the other’s expense will fall short of the ideal of harmony. Prof. Sikander Khan of Fudan University looks at China’s urgent need to secure oil, gas and other energy resources, now becoming scarce and expensive as partly due to China’s rapid growth. Energy generation will need to be doubled in the coming years. Is this possible or must energy-using businesses locate themselves elsewhere?

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Preface to the CERC Conference

Prof. Lu Dongbin of Renmin University takes up the issue of merger and acquisition. The key in nearly all cases is the successful integration of the merged entity which is often difficult where a foreign unit is acquired, although there are some stellar examples of success from which we can learn—a culture that encourages mutuality and communication is essential. Dr. Guo Lin, Deputy Director of the MBA Center at Xiamen University looks at family business. This is the commonest form taken by business enterprises and the seed bed from which much of the economy grows. The culture of a family and the culture needed for business success may not be identical. Prof. Xu Jinfa and two PhD candidates from Zhejiang University take up the topical issue of “soft” power, meaning power exercised through other people’s voluntary participation. The “power” of economic development is preponderantly soft, depending as it does on customers’ willingness to buy. Prof. Wu Qingsheng and Bao Rui from Antai College, Shanghai Jiao Tong University take up the issue of “exclusive competition” between two units, both under the ownership of a single corporation, leading to overall decline in the corporation’s success. Prof. Zhou Xing and Bruce Fan of Xiamen University show that China was stronger than other nations in the region in loud exports. The second segment of the conference led by Prof. Mao Yunshi and two PhD candidates offer fascinating insights into the Chinese stock market and its effect on corporate restructuring. How can these operations be strengthened? Prof. Wang Zhiqiang and Hong Yixun of Xiamen University take up the issue of capital structure theory and discuss how well this applies to Chinese corporations. When you take into consideration longer time horizons, these often reverse themselves. Prof. Wang Dongsheng of Nankai University looks at the often difficult challenges faced by Chinese commercial bankers competing with foreign banks. Better HR policies and management development may be required. The above segment transitions to the third thematic segment of the conference addressing the shift from made-in-China (mostly manufacturing) to designed-in-China, the venue of initial conception. Fu Zhengping, Associate Dean of the School of Business at Sun Yat-Sen University, and Li Binbin, a post-graduate researcher, look critically at China’s venture capital industry, still in its infancy. Ju Song-Dong and Xu Jie, who are respectively Director and Vice Dean of the Logistics Network Institute at Beijing Jiaotong University, attempt to describe the needed organization of a Logistics network. I fear this does not do justice to all the papers and there are several more in this volume. But I have said enough. I hope to encourage you to read on. Finally as an advisor to the Centre, I would only add that we live in interesting times. I only wish I could live long enough to witness the evolving of this puzzle. If China continues its rapid growth for one more year, it will become the fastest-growing economy over an extended period in the history of the world. Perhaps we have seen nothing yet.

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Conference Highlights Speech by Guest-of-Honour President, Singapore Chinese Chamber of Commerce and Industry Mr. Chua Thian Poh

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Preface Secretary, Nanyang Technological University, Anthony Teo and Director, Lien Chinese Enterprise Research Centre, Associate Professor Tan Teng-Kee Keynote Speeches

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Competitiveness of Chinese Enterprises in the Global Era Weiying Zhang

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China’s Gradual Economic Reform in Light of Income and Wealth Distribution Renwei Zhao

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Teaching Technopreneurship to Mandarin Classes: Some Early Results Charles Hampden-Turner

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Research Papers Session 1

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Global Competitiveness for Chinese Companies

A Study on the Development of Global Competency Leadership Shuming Zhao

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Beware the Penrose Effect on High-Growth Enterprises: A Study on Controlling the Rate of Enterprise Growth Xiaoming Xu and Yongmei Zhang

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Labor Relations Under China’s Mixed Economy Tiande Li and Ruiqin Zhang

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China’s Strategy in Acquiring Oil, Gas and Other Energy Resources: A Study of Impact on FDI Sikander Khan

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Innovations in Cultural Integration: The Experience of Chinese Enterprises in Cross-National Mergers and Acquisitions — A case study of Northeast Hengli Company’s attempts at reducing cultural risks through the forging of a common identity Dongbin Lu

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The Composition and Role of Family Boards in Chinese Businesses: A Business Cultural Perspective Lin Guo

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Attaining Corporate Competitiveness Through Soft Power Jinfa Xu, Jian Du and Tao Jiang

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A Study on Excessive Competition of Chinese State-Owned Duopoly Enterprises Cases of China Telecom and China Netcom Qingsheng Wu and Rui Bao

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Competitiveness of China’s Food Exports: An Empirical Analysis Xing Zhou and Yanping Fan (Bruce)

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Financial Market and Capital Market

Corporate Restructuring Function of Stock Markets: Key Developmental Proprosals for the Chinese Course Yunshi Mao, Sidan Wu and Yuexin Jiang

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An Empirical Study on the Long-term Dynamic Adjustment of Firms’ Capital Structure in China Zhiqiang Wang and Yixun Hong

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How Chinese City Commercial Banks May Compete With Overseas Banks

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Dongsheng Wang

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City Commercial Bank Strategy in the Light of Financial Sector Liberalization Zhen Liu and Xiangjun Song

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From “Made in China” to “Designed in China”

Analysis of Trends in China’s Venture Capital Industry Zhengping Fu and Binbin Li

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Towards a Network Approach: Trends in China’s Logistics Industry Song-Dong Ju and Jie Xu

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Competing in Global Markets: A Case Study on the Wenzhou Shoe-Manufacturing Industry Yongyi Shou and Jie Wang

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A Business Model for Knowledge-Based Service Enterprises in China: The Case Study of Kunshan Joseph Z Shyu, Jou-Chen Chen and Chia-Han Yang

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R&D Collaboration and Innovation in China’s Emerging Market Wubiao Zhou

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Innovation Dilemmas of Science-Park Based Chinese University Spin-Outs (USO): A Pilot Case Study Joseph Yuan Zhou

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Bridging Universities and Enterprises: A Study on ChineseUniversity Technology Transfer Modes Shichao Li

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Internationalization and Brand Strategy

On the Internationalization of Chinese Brand: The Case of the Shaanxi Blower Group Yongxiu Bai and Hongfang Zhang

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Strategies on Brand Internationalization: A Study Based on Business Capability Huiping Ding and Xiaodong Qiu

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Enterprise Brand Internationalization in China: Challenges and Strategies Wei Zhang

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Keynote Speeches

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Keynote Speech 1

Competitiveness of Chinese Enterprises in the Global Era ͣWEIYING ZHANG Guanghua School of Management, Peking University

Ladies and gentlemen, I’m very pleased to be here attending the International Conference on Chinese Enterprise Research at the invitation of the Lien Chinese Enterprise Research Centre. Among various international conferences held outside China that I have attended, this is the first of its kind to have Chinese as the official language, so I think we cannot afford to miss such an opportunity. My topic today is Competitiveness of Chinese Enterprises in the Global Era. As you know, China has witnessed exceptionally rapid growth in the past 30 years, which I would like to illustrate with a set of comparative data. Before 1800, it took 630 years for the GDP of Europe, particularly Western Europe, to double. After 1800, it took about 50–60 years for Western Europe to achieve the same goal, and it took about 40 years for America to double its GDP. After Meiji Reform, the GDP of Japan doubled every 25 years or so. Since the 1950s, South Korea has been doubling its GDP every 12–13 years, less than 15 years. After 1978, China has been doubling and redoubling its GDP every decade, a highly remarkable growth in the human history. As is evident in these statistic results, China is narrowing the gap with developed countries gradually. When measured by the GDP per capita, the gap between China and developed countries, especially Japan, widened continually before China ushered in an era of reform and opening up to the outside world, and from then on, it has shown a steady narrowing gap. The gap of our GDP with that of South Korea was also widening in the past. Without the policies of reform and opening up to the outside world, we would not have achieved our present stable situation. To measure the development, there is a very important indicator, i.e., the changes in China’s international trade. Proportionally, our gross import and export value have reached more than 70% of the GDP, or nearly 80%, and the percentage of the export value alone in the GDP is already 37%. Compared with many other countries, it

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Competitiveness of Chinese Enterprises in the Global Era

is certain that we are developing at a rather high speed. Among large economies, such percentage may be slightly lower than that of Germany or South Korea, but the percentage of our export value in the GDP is higher than that of the United States, the United Kingdom, France or Italy. What are the implications of these figures? Does it mean that China has exceeded these countries in the opening degree of its economy. I don’t think so. Perhaps two issues remain to be considered. Before I proceed, I would like to declare that China would not have achieved its present growth without its policies of reform and opening up to the outside world. On one hand, China’s GDP may have been overestimated. I am myself convinced of that. However, another issue may be present here, i.e., when China export large quantities of goods, it gets quite low added value. Our import is measured by the gross value, while the GDP is measured by the added value. That may be of great significance, for we have big volume but small value. What has led to this situation? It may be associated with China’s position in the global value chain. Nowadays, the globalization is not merely for exporting, but the distribution of the whole value chain across the whole world. During the Industrial Revolution when Britain was the “world factory”, the distribution of the value chain might be like this (The Value Curve in the Industrial Revolution Era). As we can see, the highest growth was seen in manufacturing, while material supply at one end and sales at the other end are not very profitable. In the era of globalization or information, however, the value curve is upside down and becomes a smiling curve, as Mr. Shi Zhenrong, the founder of ACER, calls it. That is to say, manufacturing provides the least value added, while the more knowledge based and knowledge intensive designing in the upstream and the brand-oriented selling in the downstream are the most value-added. Generally speaking, Chinese enterprises are mostly in the part with the least value added. I will try to explain a model which I think may help you understand this issue. From the perspective of the market, all the competitive advantages of the businesses fall into three categories. The first category is the cost advantage, and you have it if you can make the same products with less cost than others do. The second category is the product advantage, and you must make your products different to achieve it. The third category is what we call the brand advantage. With it, the customers are willing to pay more for your products even if they are the same as others’ products. We must realize that these three aspects are of different significance in different industries and different countries or regions. To understand this, we need to understand where the value of a brand comes about. According to the theory of economics, the value mainly comes from the information asymmetry between the customers and the producers. To be short, the more foolish the customers are, the greater value a brand has. Based on the curve, you will not have much brand value if you sell potatoes, for the information is symmetrical between the buyers and the sellers of potatoes. However, in service industries, like consultation, banking, automobile services, the information asymmetry is so severe that the brand matters very much.

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To make it clear, let’s have a look at the relative importance. We will let information asymmetry be the x-axis and relative importance the y-axis, and then we can see the relative importance of cost is constantly descending while that of brand is constantly increasing. Then what are you supposed to do? What are you doing? Should you make efforts to reduce your cost or build a brand? Combine this graph with the former one and we will find out that, if you are making very simple things, like spare parts or raw materials, you should focus on building your cost advantage, but if you are producing household appliances or automobiles, brand advantage becomes important, though cost advantage still matters. If you are engaged in investment banking, the cost is not meaningful. In other words, you gain no advantage at all in competition by bringing down the cost. What matters is whether your customers trust you or not, and whether you are accepted in the market for your integrity. I think this chart is very important in helping us understand enterprises’ strategies in different markets. Another factor also has to be considered, i.e., the brand advantage is associated with the income level of the local people. If the income of most people in the region is low, people will care more about cost than brand. With their income increasing, their main concern will shift from cost to brand. In this chart, a dashed line is used to show the linear relation between the quality of products and the prices that the customers are willing to pay in an underdeveloped country. As an old Chinese saying goes, “one cent deserves one cent’s worth”, but for a group with higher income, the relation would be non-linear. That is to say, if the quality of your product is worth 10 yuan, a customer may willingly pay 10 yuan for it, bur for that of my product worth 9 yuan, he may offer only 3 yuan. When 9 yuan worth of quality cannot get 9 yuan in return, the relation becomes non-linear. This is of great significance. With all these factors taken into consideration, we will find out, from the traditional economy within a small area to the regional economy, from the national economy to the global economy, we are already in an era of globalization, and the importance of brand is getting greater and greater. Why? Because the more globalized the economy is, the farther away the customers and the producers are from each other, and the more important the trust is. In the original village economy, people were acquaintances to each other, so the brand did not weigh very much. Nowadays, what we are using may have come to us from anywhere in the world, and we do not know who has turned them out, so we cannot help but rely on the brand. Now let’s come to the competitive advantages of Chinese enterprises. As you can see in this chart, our main competitive advantage is our cost. In my subjective judgment, if we get 100 points for our costs, then we can only get 30 points for our differentiation and 10 points for our brand advantage. Such is the status of Chinese enterprises in this era of globalization. Measured by the labor cost per hour, China is a bit higher than Egypt, but when compared with other countries, especially the United States, our cost of labor per hour is only 1/20 of theirs.

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From China’s present development we can roughly perceive a characteristic of our economy, as I have mentioned above. Why are Chinese enterprises much more successful in producing spare parts than in producing consumer goods? Many Chinese enterprises are OEMs, but they usually use foreign brands. In other words, the products bearing “MADE IN CHINA” are not necessarily Chinese brands. For example, 60–70% of the microwave ovens or even furniture are from China. Within Mainland China, Chinese enterprises have displayed better performance in smaller places, but in big cities like Shanghai and Beijing, foreign enterprises have done much better than our own ones. Internationally, we have had better performance in underdeveloped countries or regions including Africa, India, Pakistan and Afghanistan than in developed countries or regions like Western Europe and America. Another remarkable characteristic of Chinese enterprises is that they are always involved in price wars, or competition purely by price. If all the players in a market are trying to win with cost advantages, price wars are just inevitable. Therefore, in this era of globalization, Chinese enterprises are generally at the bottom of the value curve. A typical example will serve this argument: if a mouse is produced in China but sold in the United States and the total profit earned is 100, the Chinese manufacturer may get only 8. This share is rather small, and most of the value added will find its way to the account of foreign branded enterprises. Hereby we can also tell that the concentration degrees of Chinese industries are very low, for a high concentration degree will never be found where there is no brand but cost advantages. For example, the number of farmers who plant potatoes is always very large, and never would a handful of so-called best potato-planters eliminate all other farmers. In the electronic and information industries of China, the top 100 players account for only 30% of the market share. In contrast, the top 100 players of a developed country will account for more than 99% of the market share. In the software industry, our top 100 enterprises account for 37% of the market share, which is also incredibly low. Here the top four enterprises account for only 10%. We may think there are many enterprises in the software industry, but large enterprises are highly dominant. In the United States, the top 100 software enterprises occupy 99.9% of the market, which serves as a sharp contrast against the one third share of China’s leading software enterprises. Therefore, high concentration degree can never be found in a market lacking brands. Further study will show that the profitability, profit margin and gross profit margin of Chinese enterprises are all very low, though what I am presenting here are some data of 2004 and the overall profitability of Chinese enterprises has been rising in the past two years. For computers, the profit margin is only 2.2%, and that of software is just 4.8%. Chinese enterprises will never invest greatly in R&D of software, but as we know, Microsoft invests 15–20% of its sales proceeds into R&D. If we take this into consideration, the actual reasonable profit margin of software of China may be negative. I perceive that this is also associated with the brand advantage.

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Track down the results and we will find that the time it takes for different advantages to build up varies. It is easy to build up the cost advantage. In terms of scale, most investments can be completed in 2–3 years. To achieve the product advantage, however, you have to build up your R&D capability, develop your understanding of the customers and improve your designing, which may take 10–20 years. When it comes to the brand advantage, you must ultimately win the trust of your customers, which may take more than 20 years or even longer. It happens that most Chinese enterprises are about 20 years old. In 2004, the well-known Chinese enterprises Haier and Lenovo each celebrated their 20th anniversary. Many others are even younger. Given this situation, it is no wonder Chinese enterprises rely on the cost advantage rather than the brand advantage. Natural as it is, we should analyze some other reasons as well. In my opinion, there exists another especially important reason, i.e., it was very easy to make money during China’s transition from planned economy to market economy. As you know, when it was very easy to make money, it was very hard for enterprises to find the enthusiasm for innovation. In other words, they felt no pressure, so they had no motivation. Whatever they do, they can make good profit, then why bother to do things in all seriousness? As I mentioned just now, Chinese enterprises are quite young, and they have no differentiation or brand strategies. We can also tell that a lot of technologies take long-term investments, where Chinese enterprises also lack the energy and momentum. Generally, Chinese enterprises are very successful in imitation but not in innovation. Of course, as some Chinese enterprises suggest, imitation may be the best innovation. It might be true in the earlier stages, but with the development of globalization, it has become questionable, for you are doomed to lose your advantage if your imitation can never be converted into your independent innovation. Presented below are some figures about R&D, for I want to emphasize a point that the real value of a brand can only come out of constant innovation, instead of advertisements. Never advertisements. In R&D, the overall investment in China has increased to 1.4% of its GDP from 1.2% in 2003. This progress is remarkably rapid, but compared with major developed countries, that percentage is still quite low. Actually, the overall R&D fund of China only equals that of several companies of the United States. This chart shows that only 28% of large or medium Chinese enterprises have R&D departments, a rather low percentage. In fact, many enterprises have got rid of their R&D departments in the past 10 years. Even in the First Automobile Works and the Second Automobile Works, there used to be R&D departments, but since they became joint-ventures, almost all their research personnel have been drained. Shown here are the proportions of research personnel in the total number of employees in large and medium Chinese enterprises. Though the number of research personnel is comparatively steady, the proportion is fairly low. Here are the proportions of R&D expenditures in total revenue of large and medium Chinese enterprises. Year 2002 is the peak year before 2004, with the proportion being 0.8%. Note that these are large and medium Chinese enterprises, rather than all the enterprises, and the large and

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medium Chinese enterprises are main forces in R&D. Here are the proportions of R&D expenses in the total revenue of different industries. The highest proportion is seen in pharmacy at 1.3%, and the industry of communication computers follows with 1.1%. All the proportions are very low. In large enterprises of some foreign countries such as the United States, the R&D expenses usually account for 3–4% or more than 4% of their total revenue, but the total R&D expenses of all large and medium Chinese enterprises account for less than 1% of their revenues. Here are some data about the R&D of the top 500 Chinese enterprises. Their R&D expenses account for only 1.05% of their total revenue, instead of 3% or 4%. We can also see that only 106 of them spend as much as 2% of their revenues on R&D. Besides, one third of the R&D investment is from 10 enterprises. That means a great many of the top 500 Chinese enterprises have no R&D at all. These figures are also very interesting. The upper chart represents the proportion of an enterprise’s advertising expenses in its total revenue, and the lower one represents the proportion of its R&D expenses in its total revenue. Between 2001 and 2003, of whatever scale the manufacturing enterprises were, their advertising expenses unexceptionally exceeded their R&D expenses. This is a common phenomenon in Chinese enterprises. When tracking down the reason, I think it is partly a matter of understanding. For example, the brand is nothing but advertising to many Chinese enterprises, so they would rather advertise than make R&D investments. This is a very wrong understanding. Another reason lies in our system. Chinese enterprise leaders think much of short-term benefit but little of long-term benefit. Advertising can yield quick returns. For example, to advertise for your products on CCTV at the beginning of a new year, and you may see increased sales within several months. If you invest in R&D, however, it may take 3 or 5 years before you can see any effect. In 3 or 5 years, the present manager of the enterprise will have long been transferred to somewhere else, so he cares little for the long-term effect of R&D. As is shown here, it is the same with the pharmacy industry. Being the industry with the highest proportion of R&D expenses in its total revenue, it also spends more on advertisements than on R&D. Pay attention to the fact that R&D expenses of the pharmacy industry in the United States account for 10.5% of the revenue of the whole industry, in contrast with 1% of China. The reversal is only seen in the graphs for such industries as communication and computer. As is shown here, the proportions of R&D expenses in the sales proceeds of these industries are higher that those of their advertising expenses, but the R&D expenses are still very limited, with the most wellestablished enterprise of the industry allocating only 1.2% of its sales proceeds in its R&D. What is the corresponding proportion of the United States? 13%, or ten times that of China when measured proportionally. This graph is also very interesting. Generally speaking, the number of patents of China is very large, but we should pay attention to some of their characteristics. One of them is that the number of patents for invention is extremely small, and a large

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proportion of the patents are for designs of exterior packaging. Another characteristic I have discovered is that about one third of them are corporate patents, while non-corporate patents, or individual patents, account for two third of them. The situation is just reversed in the United States and other developed countries, where 70% of the patents belong to enterprises, such as IBM, Intel, DELL and so on, and only 30% of the patents belong to individuals. As we know, there are two types of innovations in the modern society, one being corporate innovation and the other being entrepreneur innovation. Of course they are both very important, but at present, the corporate innovation of China is far from enough. In fact, innovation has not yet become a normal activity of any company in China, but is still more of the behavior of some smart individuals. This is going to have undesirable effect on the future development of China. Now let’s have a look at the enterprises in Zhongguancun Science Park with at least one intellectual property right or patent. In 2003, only 3.7% of all the hardware enterprises and 1% of all the software enterprises here meet this requirement. That means in Zhongguancun, the hi-tech industrial zone, a large number of enterprises do not have any patent. We may think China will face a very rigorous challenge in the future in the era of globalization, but I must say our previous success is not an usher of our future success. In other words, China’s past 30 years is a great success, but for further achievements, we must make even greater efforts. In addition, great changes are taking place in many aspects. Our advantage is the cost of labor is disappearing. How come? Among other factors, one is the emerging labor shortage in China. Almost all those employed in Chinese manufacturing are below 35, and when they are on the wrong side of 35, most of them will return to farming, hence the labor shortage in manufacturing across the country. In 2004, I predicted that the cost of labor would rise by 30–50% in China in the next 3–5 years, but it has risen by 50% in less than 3 years. It is changing rapidly. Besides, the policies of our government are also changing, especially that the new Employment Contract Law of China is coming into force as of next January, which will greatly increase the cost of labor. Of course, people’s opinions of the new Employment Contract Law will vary. Personally, I think it is not a good choice to implement such a rigid Employment Contract Law, whether for Chinese enterprises or Chinese working class, but it has been passed and is coming into force in less than a month. As social opinions are concerned, we are often talking about the pressure of unfair social distribution, but I want to remind you of some figures I saw recently. It is said that the proportion of Chinese labor cost in its GDP is constantly falling. I wonder if Prof. Zhao has a more authoritative argument. When I looked at the figures they quoted, I couldn’t help questioning them. In my opinion, the concept “proportion of China’s total wages in GDP” is completely wrong, for “China’s total wages” only involve state-owned entities, collective entities and government departments, but not private enterprises. It is no wonder at all that the proportion of this figure in China’s GDP is falling. As long as China’s private enterprises are developing, the proportion will go on falling and is not

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very meaningful. Of course, I need some specific and accurate figures, for this involves more statistics. This is another factor and means more pressure and requirements. As we know, there are also requirements on social responsibilities, such as environmental requirements, and they will also contribute to the growth of cost. Yet another factor is RMB appreciation, which seems to be inevitable and is also posing great pressure for many Chinese enterprises. What’s more, the customers are getting more demanding. To sum up all these factors, I think Chinese enterprises can no longer rely on their cost advantage and they need to develop new core competencies. This graph shows that the actual growth of wages is faster than that of the GDP in the past few years since 1999. I have tried to compare them statistically by the growth rate, which is more convincing than the absolute value. Besides, despite the low labor wages in China, the productivity is also comparatively low. Do some division and we will find out that the actual cost advantage of China is not as big as it seems. If the hourly wage of China is one twentieth that of the United States, and our productivity is just one seventh or one sixth that of the United States, then our actual cost would be only one third or half rather that one twentieth that of the United States. We must take this into account. What are we to do next? I think it is important that we turn to innovation to promote the building of our brand. Only then will we achieve the international competitiveness we need. I have to hold elaborating on this for the sake of time, but I want to emphasize the protection of intellectual property rights particularly, for you can never overemphasize it. Besides, the protection of intellectual property rights determines not only the speed but also the direction of innovation. In other words, it determines the fields for R&D. In China, running a restaurant is surely more profitable than making software. Running a large restaurant, and you will out-earn a large software enterprise; running a small restaurant, and you will out-earn a small software enterprise. It is also undoubtedly more profitable to be engaged in real estate than in hi-tech, thus causing a serious problem in the deployment of human resources, with the best talent running restaurants instead of making software. This will harm the future development of our country. Where there is innovation, the concentration degree of the industry will rise, and industry restructuring will begin, so innovation is of great significance. Furthermore, we need to educate people in the capital market, and anticorruption is very important to innovation. In modern society, even if your products are good, you will not necessarily enjoy more customers, for if the buyer can take commercial bribes, he will buy products from whoever offers the most bribes, instead of those offering the higher quality. Then who will have the momentum for innovation? That is why I say it is very important to fight against commercial bribery. I’ll show you one more graph. In fact, it is about what enterprises and entrepreneurs are doing. In 1921, Knight said that an entrepreneur means coping with uncertainty, and earlier than that, Peter had an article in German published saying an entrepreneur must be always innovating. I think up to now, our understanding of an entrepreneur basically

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has never gone beyond the concepts given by them two. Let’s see if there are any differences between Chinese enterprises and those in the United States and Europe? As far as these two concepts are concerned, there is none, for Chinese entrepreneurs are also coping with uncertainty as well as innovation. However, further analyses will reveal the differences. Uncertainty can be classified into market uncertainty and policy uncertainty. In contrast with the entrepreneurs of the United States who are mainly coping with market uncertainty, predicting changes in technology and demands of customers, their Chinese counterparts are mainly engaged in coping with policy uncertainty, predicting policies and pondering how to cope with policy changes. Innovation also falls into two categories. One is technological and business innovation, including launching of new products, new technology and new materials, and the other is institutional innovation, such as incentive mechanism and property systems. Western entrepreneurs are engaged in technological and business innovations, while their Chinese counterparts are engaged in institutional innovations. When in charge of Lenovo, Liu Chuanzhi spent large amounts of his time not on technological innovation but on institutional innovation, such as property reform, how to secure equities for core employees of Lenovo. Liu Chuanzhi’s time and efforts seemed to bring about no success, so he finally found himself in big trouble. As we can see in this graph, western entrepreneurs are in the northwestern corner, while Chinese entrepreneurs are in the southeastern corner. On the stage of future global competition, when are Chinese entrepreneurs turning their efforts to coping with market uncertainty and technological innovation and innovation of business models from policy uncertainty and institutional innovation? A series of changes must take place in China’s political system and some other fields before the arrival of that day. Finally I want to make clear a point that I am not pessimistic about Chinese enterprises. On the contrary, I take a very optimistic view of China’s economy. I am just a bit worried about Chinese enterprises. Why? We should differentiate China’s economy with Chinese enterprises. China’s economy is the economy shared by the enterprises all over the world, while Chinese enterprises belong to the economy that China itself owns. In fact, Singaporean enterprises in China are also very competitive, but they are counted as part of China’s economy in our GDP. Facing us is how well Chinese enterprises can be in the future. Some very good models should be popularized. One model I want to emphasize is that of Lenovo, and another is that of Huawei. Lenovo also started from cost advantage, but then it began to develop its Chinese version product advantage before building its brand advantage. Huawei has long been investing greatly in R&D, so it has become one of the leading suppliers of telecommunication equipment in the world. Their internationalization strategy is also well worth studying. Lenovo has adopted a strategy of acquiring international brands to approach the world. In other words, it has integrated his own cost advantage with the brand advantage of IBM, so it is very successful. Haier has been braving hardship and relying on itself to build its brand. This model is comparatively more difficult, but Haier has lived through 10 years of trial and error. If it is still on the stage 10 years later, I think it will also succeed. Among South

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Korean enterprises, some failed, but Samsung has stood out. I think Haier may belong to this model, and Huawei has adopted a forceful attacking strategy. We have another model, the Glanz model, which I myself favor. As you know, Glanz is now mainly engaged in OEM business. We call this model “Intel Inside Strategy”. Of course, Glanz is not alone. This model means, you manufacture but affix foreign labels. Take Intel chips as an example, no one see where the chips are, but since Intel is strong enough, it can require all computer makers affix a label saying “Intel Inside”, making Intel itself become a consumer brand. When it sells its chips, it is even more powerful in bargaining, so it can get even more profit. What I mean is as follows. When a Chinese enterprise like Glanz is producing major parts of the products, it become more competent, and then it can not only require “Made in China” be affixed but also “Made by Glanz”. By and by, Glanz as a brand will be established in the minds of customers, and finally it will be able to access the world market without the foreign brand. I think this is a very important strategy for Chinese enterprises. I think this is the main part of my report. It is important that we must realize, in this new era, Chinese enterprises are actually facing very big challenges. If we do not make even more efforts in innovation and brand building, our cost advantage will be disappearing. Therefore, I hope Chinese enterprises will intensify their efforts so that in the next 30 years, they can make China’s economy double and redouble every 10 years, and then I am sure China will become the largest economy in the world. Thank you!

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Keynote Speech 2

China’s Gradual Economic Reform in Light of Income and Wealth Distribution ͣRENWEI ZHAO Institute of Economics, Chinese Academy of Social Sciences

First of all, I would like to extend my thanks to the sponsor of this conference, the Lien Chinese Enterprise Research Centre, and I also owe my thanks to Nanyang Technological University for inviting me and giving me the opportunity to be here and exchange opinions on the Chinese economy with all the experts present and learn from them. My topic today is China’s Gradual Economic Reform in Light of Income and Wealth Distribution. To put the term “distribution” into Chinese, I prefer ߚ䜡˄fēn pèi˅ as in “income distribution” but ߚᏗ (fēn bù) as in “wealth distribution”. In English, the belongings or fortune are often referred to as “wealth”, which is sometimes translated into Chinese as 䋶ѻ (cái chǎn), meaning property. “Wealth” and “property” are often mixed up, and it seems that they both apply to the present circumstance. Now, allow me to probe into China’s economic reform in light of these two aspects. It has been 29 years since China began its economic reform, and it will be a whole 30 years by next year. At present, many research institutes of Chinese universities are summing up its three decades of experience, so does Chinese Academy of Social Sciences. On the basis of my previous research into income and wealth distribution, I myself also reflected on China’s economic reform, especially on our gradual reform, in an effort to summarize its achievements, locate our next challenges, and speculate on the ways to reduce the reform costs as well as to deepen it. In order to reduce the reform costs, we have adopted a gradual economic reform, which has seen a rapidly increasing inequality in people’s income and wealth in the past 20–30 years. In my opinion, it is well worth summarizing how we should view our reform costs from the perspectives of the ever widening income gap and ever worsening wealth distribution problems. I might as well begin with the characteristics of China’s economic reform, and then proceed to the issue of income and wealth distribution. In the 1990s when I was in

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America, Professor Perkins of Harvard University summarized some socialist countries’ reforms of their economic systems and listed three characteristics for what he called the Asian pattern, by which he mainly referred to the characteristics of reforms during the economic transition periods of such countries as China, Vietnam and Laos. According to him, the first characteristic was the priority of economic reform over political reform; the second was the severer poverty of Asian socialist countries as compared to former USSR and East European socialist countries, which, as we all know, were also reforming in the early 1990s; and the third was that in Asian socialist countries, more were employed in agricultural sectors and fewer in industrial ones. Surely enough, the three characteristics summarized by Professor Perkins applied to China, and now I would like to list five more characteristics for China’s economic reform on top of his. Firstly, the coverage of planned economy in China is comparatively lower. Due to the complex nature of this subject, I might as well skip it for the sake of limited time. Secondly, the starting point of China’s economic reform is somewhat lower than those of former USSR and East European countries. As far as the spectrum of the GDP system is concerned, it is centralized over there but decentralized out here, and it is planned economy on that side but market economy on this side. According to my tutor Professor Bruce, the Stalin Pattern was where the economic reforms of former USSR and East European started. In other words, they started from the third or fourth stage, while China started from the second stage, or the Quasi-military Communist Pattern. That is why I listed it as one the characteristics of China’s economic reform that its starting point is lower than those of former USSR and East European countries, but again I shall not discuss this subject in detail here and now for the same reason as above mentioned. Thirdly, China’s economic reform is more closely related to its economic development. Basically, former USSR and East European countries had already been industrialized, while China has a dual economic structure, as China’s reform has to be well combined with its development. With this drawing I am trying to show the process of China’s reform from planned economy to market economy, and here at its bottom is the reform process. China’s economic reform is closely related to its development, its development from the dual economic structure to its modern economy, or just part of it, for natural economy still prevails in its underdeveloped rural regions. A Japanese economist calls it custom economy, while most of the Chinese people tend to call it natural economy, or self-sufficient natural economy, with yet another translation being autarky economy. It takes time for China to proceed from its dual economic structure to its present market economy, so the process of its reform is closely connected with that of its development, hence another important characteristic of China’s economic reform. Fourthly, China’s reform and economic development are progressing synchronously. A professor at Chicago in the United States concluded that all reforms would be at the cost of economic growth and consumption. Based on the experience of many countries in

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the world, he found that reforms, radical or gradual, all apply to his conclusion. Gradual reforms show slower decrease, and slower restoration as well, while radical ones show faster decrease and restoration. In other words, radical reforms will go through dramatic ups and downs, while gradual ones will see gentler fluctuations. That is already proved by international experience. An advantage or characteristic of China’s reform is that its production and consumption have been constantly growing at a rate of over 9%, and sometimes even over 10%, for which Professor Weiying Zhang has already provided a great many figures. Fifthly, I find it a big characteristic of China’s reform that the radical reform is carried out here in a gradual way to reduce the cost, and I will make more comments on this. In the early 1980s when China’s reform was being discussed, we invited many experts from East Europe, and my tutor Mr. Bruce also came from Oxford to give lectures in China. He insisted that China need a radical reform instead of a gradual one. He said, the Polish had bad traffic, so they went to Britain to learn traffic rules. The Polish used to drive on the right, but they found the people in Britain did just the opposite. When they returned, they decided that their people should follow the English practice. In the end, however, half of their vehicles would drive on the right and the other half on the left, leaving the traffic in a complete mess. When Chinese people were discussing what type of reform to adopt in the early 1980s, this story of how the radical reform ended in the traffic disorder was cited as an argument, but it was just a joke. Actually, China opted for the gradual type of reform in the end. As the order was concerned, reform in rural areas was followed by that of urban areas, and coastal areas by the inland areas. As for the reform of ownership, non-public economy was first developed before the reform of state-owned economy was implemented. For the price reform, we developed a policy of “first adjusting and then releasing”, namely, at first we adjusted the prices within the planned economy by raising them and then gradually brought them close to the market prices, and finally we released them. In the 1990s, many economists began to summarize China’s gradual reform of the last decade. I still remember when my tutor Mr. Bruce visited China in the 1990s, he evaluated China’s gradual reform as successful. As a professor who helped former USSR and Poland with their reforms, he visited China in 1992, and it was then that he made the above-mentioned remark, which was also shared by many other foreign professors in favor of radical reforms. When summarized, China’s reform was mainly gradual, except that the household responsibility contract system of the 1980s in its rural areas and the price reform in 1988 showed some signs of radicalness. This is the first part of my speech. The second part is on income distribution. For income distribution, I shall say equalitarianism prevailed or was common in China. For several decades, equalitarianism was so common that the income distribution got highly unfair. Prior to China’s reform, it was a society of prevailing equalitarianism. There have been various estimates of Gini coefficients. In China, the Gini coefficient for urban areas used to be less than 0.2, and rural areas between 0.21 and 0.24, while those for other developing countries

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like India were much higher. Shown in this PPT slide are some concrete figures: the estimate of the World Bank, that of the former Director General of Statistics Bureau, and that of Professor Adelman from the University of California, all showing that the Gini coefficients of China were lower than those of such countries as India. Then what about it since the reform? Inequality is worsening. As examples, I present here the data from Statistics Bureau and also from my Institute of Economics. Generally speaking, whether in rural or urban areas, the Gini coefficients are constantly rising. Approximately, these estimates can be classified into three different categories, with the lowest estimated Gini coefficient being around 0.4, the medium about 0.45 and the highest about 0.5, but maybe I have no time to identify their particular sources for the present. The general Gini coefficient of China has seen a constant increase and has already exceeded those of developed countries, making the gap between rural and urban areas of China ever widening. In 1978, the income of the urban people was 2.5 times that of the rural people, and the situation improved in 1984 when the reform in rural areas succeeded and people there got richer at large, bringing the figure 2.5 down to 1.8. From then on, however, the gap has been continuously widening, and the figure is over 3.3 at present, allowing for some fluctuating factors. Given the general situation, I would also classify the estimates into three categories, with the lowest estimated gap between the rural and the urban areas being 1:3, the medium, 1:4, and the highest, 1:5 or even higher. The more underdeveloped a country is, the wider the gap between the two. Time permitting, I would be able to show you more data. How should we view the cost of reform in light of the worsening inequality in income distribution? In the past two or three years, the income gap in China is widening even faster, and loud controversies are heard. Some people observe that the reform is to blame, for it has spoiled the market, and the market economy will never be a solution to the problem of inequality. In my opinion, we should neither blame the reform for having spoiled the market, nor simply consider the widening income gap as the necessary cost of the reform. Personally, I think we should view the problem from three aspects. First, the widening income gap is the cost of reform. It has put an end to equalitarianism and some people have become rich by working honestly and doing business rationally and legally. These are the achievements of the reform. Second, the problem is a necessary price we paid for the reform. Taking the dual price policy in the 1980s as an example, some people did benefit unfairly from rent-seeking, but just as nothing can be accomplished in one shot, it was in fact necessary for the reform. However, the price we paid for the reform was much too high. Several examples will serve to reveal that. Since the land trade beginning in the 1990s, the land might have been bought at 20,000 to 30,000 yuan per mu, but was sold at more than 1,000,000 yuan. As I commented when discussing it with Professor Wu Jinglian, it is not only rent-seeking but also rent-creating that is involved here, i.e., the prices have been created and set, for the high price is set by the market, while the low price is set by the local governments themselves, leaving a much wider profit margin

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than that of the 1980s. It is an extremely severe problem to encourage land trade, where too much rent-seeking is involved. Another example is that the old practice is followed in the management of public vehicles. We have summarized the gradual reform, and in the late 1980s foreign economists summarized the gradual reform as incremental reform. That is to say, old practice for the old, and new practice for the new. New increment should enter the track of market and the new system, while the existing can remain in the old system. The number of our public vehicles has doubled and doubled, but the management of these vehicles is basically in the old system instead of entering the market system. This is one of our major problems and has seen extremely heated discussions. When former Premier Zhu Rongji announced a reform scheme for public vehicles in 1998, I was in Hong Kong and it was reported on Hong Kong newspapers that the use of public vehicles of China would be monetized by the end of 1998. When I returned to the mainland, however, I saw a completely different picture. Another 9 years has elapsed since 1998, and the old system still lingers, which is quite against the requirements of the incremental reform, for the new wealth has entered the old system. In China, domestic researchers have made great efforts to estimate the totals of the rent and the grey income. For example, Mr. Hu Heli observed in an article in 1989 that the total rent generated by the dual price policy of China in 1988 was over 300 billion yuan, accounting for 30% of the GDP that year. According to a research by Dr. Wang Xiaolu, the grey income of 2005 in China amounted to 4800 billion yuan, accounting for 27% of the GDP that year, as I can remember. I think these are also hot topics abroad. Nobody can say that his estimate of China’s rent and grey income is absolutely accurate, but nobody can deny that the totals must be very high. Now I will come to the issue of wealth distribution. Generally, China has gone through a process from no personal property to the present great inequality. And the wealth distribution has become a new focus of attention. Why? The Chinese have been accumulating wealth rapidly in the past 20 years. I remember accompanying a World Bank delegate to make an investigation around China in 1980 or 1981. They concluded in their report that the Chinese have nearly no personal property or property income at all, with only one exception in that some people managed to deposit what was left of their meager salaries into the banks for a little interest, which might be reckoned as the property income. However, that might as well be neglected for being too little to be mentioned. It was in the late 1980s or the early 1990s that the Chinese began their accumulation of wealth, including house property. The housing reform and financial reform have contributed to it, and the next 20 years has been a period of quick accumulation of wealth and significant polarization. What’s more, the inequality of wealth distribution among other factors has in turn led to the inequality of income distribution, either being the cause and the effect of each other, so I say the issue of wealth has become a new focus of attention. Our economic research group has developed some questionnaires. The issue of wealth distribution can be simplified into about seven sub-items, and the three major

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ones of them are housing, financial assets and land. Among the three, the housing has the largest share, accounting for 60% of the total wealth, and the financial assets follow with a little more than 20% and the land approximately 10%. So the three items come to nearly 90%, making the bulk of the wealth. Those figures show the specific items that constitute the total wealth and their percentages. The distribution hierarchy of each item can be divided into five levels from the top down to the bottom. For housing, the ratio between the lowest level and the highest level is 63:1, and for the financial asset, 29:1. Remarkably wide gaps! When measured in the Gini coefficient, it is 0.63 for the housing, 0.62 for the financial asset and 0.55 for the wealth as a whole, so the degrees of inequality in the housing and financial assets have exceeded that of the total wealth. Here are some specific indicators figured out by the decile grouping, which I cannot elaborate for now. As is evident here, the housing and financial assets are two of the seven categories of property with the worst inequality. The contribution rate of the housing factor for the inequality is 66.32%, the highest of all. Let’s make some international comparisons of the issue of wealth. Now the inequality indexes of wealth distribution in developed countries are between 0.5 and 0.9, and that of China has not yet got so high, but the Gini coefficients of developed countries are just between 0.3 and 0.4. What is the situation in China? Our financial Gini coefficient has not exceeded that of developed countries, but our degree of income inequality has got well above theirs. The inequality of personal property and income has already drawn the attention of our top decision makers’, and the sentence “conditions must be created for more people to obtain property income” was written in the report to the 17th National Congress of the Communist Party of China. I think this is an extremely important policy, or a breakthrough. It is of great significance for the Party Central Committee to declare its stress on the issue of property in its resolutions. My feeling is that, by pointing out the great significance of personal wealth (property), it not only reflects the philosophy of getting property to reside with people, but also embodies the spirit of constructing a moderately prosperous society (ᇣᒋ⼒Ӯ) It is explicitly stated that the Chinese people can obtain not only labor income but also property income, so their income can come via multiple channels. In addition, it is worthwhile to mention that stressing property income does not necessarily mean neglecting of labor income. According to a recent report published 2 weeks ago by our Institute of Industrial Economy entitled Report on Chinese Enterprise Competitiveness (2007), the labor income accounted for 53.4% of the GDP in 1990, which had dropped to 41.4% by 2005. We can see a drop of 12% in the percentage of labor income in the GDP in 15 years, though the data may be subject to further discussion. Just now Professor Zhang put forward a question, which we can discuss more. I have found no micro-data to demonstrate it, but I am sure it is a conclusion well worth researching. In

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the 1980s, the salary of a professor was encroaching his profit from his articles, i.e., his salary outweighed his profit. Now, however, his profit would be encroaching his salary, i.e., his profit has outweighed his salary. This situation deserves our attention. We should not only emphasize the property income but also the labor income. Let’s combine wealth and income, and make a comparison of them between the urban and rural areas. Shuffle the average personal property by the decile group, and the proportions of the residents in the urban and rural areas are as follows. The majority in the low income group are rural residents, while the majority of high income group are urban residents. The gap between the rural and urban areas is wide whether in income distribution or property distribution. Of course, there are also some minor differences when property and income are more specifically studied. Lastly, I would like to share some of my opinions on how to ease the inequality of income and wealth distribution. First, we should deepen the reform. Rather than the fault of the market-oriented reform, the worsening inequality is just the raised cost of the gradual reform. To pursuit the gradual reform does not mean slowing down or hindering the reform, so we should summarize our 30 years of experience and push the reform forward. We are not going in the wrong direction, but we should intensify the reform, whether economic or political reform. We should intensify the reform where the requirements of the incremental reform are not met. The inequality of income and wealth distribution is associated with problems of trading power for money, corruption and monopoly. Then how can we solve them? I think we should deepen the economic reform, and accelerate the political reform as well before we can solve the problems brought about by the power-for-money deals. Of course, this cannot be elaborated, either. Additionally, we should pay attention to the interaction between income distribution and wealth distribution. Many natives of Beijing are now buying extra houses for rent. With the rent, they will have more income, which in turn enables them to buy more property or stocks. Therefore there exists some interaction between income and property. We should prevent it from getting into a vicious cycle but try to achieve a benign cycle. Then we will have to find a turning point, the turning point where the income gap and property gap narrow, but we have not yet found it so far. In my opinion, we should find such a turning point through the reform and try to achieve a benign cycle between wealth distribution and income distribution. Furthermore, we should enhance the government’s ability of re-distribution. Redistribution is already on our schedule, and we have had a lot of discussions about it. I think we should mainly solve two problems. First, we should solve the problem of reversed re-distribution involved in the re-distribution. The problem of reversed redistribution is very severe in China. Rural areas, though poorer than urban areas, turn in more taxes but enjoy fewer subsidies. After investigating China, foreign experts said that the re-distribution of China is reversed. The re-distribution is intended “to extract the fat and make up for the thin”, as an old Chinese saying has it. I would rather not use the phrase “to rob the rich and help the poor”, which rings a tendency for violence.

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However, the actual situation in China is often “extracting the thin to make up for the fat”. Where did this practice originate? It was Stalin and Mao Zedong who introduced it, for they wanted to develop industrialization with the surplus of agriculture. Since we began to pursuit the reform and opening up to the outside world, we have not yet got rid of this policy inertia, so an inversion remains and we are still “extracting the thin to make up for the fat”, just as we did in the age of planned economy. That is why reversed distribution still goes on. When President Hu Jintao and Premier Wen Jiabao took offices a few years ago, much has been improved, including the efforts to abolish agricultural tax and enhance the compulsory education in rural areas. However, it will take more than several years to solve the problems that have haunted us for 50 years. As long as this problem is not solved, the modernization of the whole nation will not really be realized. The modernization of some big cities alone is far from enough, so we have to solve the problem of reversed re-distribution. Reversed re-distribution is also found in cities, but I’ll have to leave it for some other occasions. Second, we still have to find a moderate re-distribution. What is moderate redistribution? As an example, our education fund accounts for less than 2% of the GDP, as compared to 4% in developed countries. I wonder when we can strive to reach that level. In my opinion, the moderate re-distribution remains to be found, and worse still, we may not even have the concept. Therefore, I think we should first overcome the reversed redistribution, and then achieve the moderate re-distribution. How can we implement the moderate re-distribution based on the economic development level and the actual status of our country? Say, what percentage of GDP should be allocated to public expenses? Such problems, though having been well discussed in the countries like Sweden, remain to be discussed in China. Now it is time for them to fit into our schedule. As you can see, still much can be done with our policies besides the few points I have just commented on briefly, but for now I’’ just stop here. That’s all. Thank you!

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Keynote Speech 3

Teaching Technopreneurship to Mandarin Classes: Some Early Results ͣCHARLES HAMDEN-TURNER Judge Business School, Cambridge University

CHARLES: For the last five years there has been Technopreneurship courses taught at Nanyang Technopreneurship Centre (NTC) and these courses have recently been taught in Mandarin as well as English and this morning, I want to tell you something about it. Firstly about me — I’m a visiting professor at NTC and a senior research associate at Judge Business School in Cambridge University. A lot of people think you can’t teach Innovation, those who do as the instructor tells them can’t be innovative, those who truly innovate do it, and they don’t simply teach it. If innovators are unique, how do you truly generalize about this? Since when do teachers learn from students? And if innovation can be taught, would not everybody do it? So, there are powerful reasons for thinking that you can’t teach innovation at all and you shouldn’t even try it. My view is that these are not so much objections as they are dilemmas. And we insist one thing about innovation — that it consistently reconciles and resolves dilemmas. For example, complying and innovating, doing and teaching, being unique and generalizing, merit and changed definitions, teaching and learning — all these are dilemmas — when you comply with all these principles, innovation results. Teaching innovation is doing something now in which the whole class joins. Certain generalities will help you create uniqueness. We can change our definitions of merit and live up to these and good teachers will gladly learn from their students. The challenge was taken up by Professor Tan Teng-Kee. Singapore is a powerful economy, but it didn’t have enough innovation, so Tan Teng-Kee started a program funded by the Economic Development Board six years ago. Teng-Kee was born in Malaysia. He’s a Nantah graduate, and a successful entrepreneur. He was a vice president of Sunbeam and Electrolux. He has an MBA from Kellogg, and a PhD from Cambridge, is director of NTC, is director of the Chinese Enterprise Research Centre and is the designer of the experiment that I am describing.

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He is first an innovator, man of action, then he was a teacher and thinker and he became what I call a reflective practitioner. It is very important to understand that innovation is not confined to the classroom, it appealed beyond the classroom to an entrepreneurial mindset which constitutes to an elaborate entrepreneurial ecosystem. It included field trips to Seattle, the Bay area, Silicon Valley, championing inventions created by the Bioengineering department at the University of Washington and Nanyang Technological University (NTU), and pitching these in front of genuine Venture Capitalists (VC), briefing by intellectual property lawyers, angel investors, government ministers and successful alumni. To reiterate my point, an annual fair in which students take booths to pitch their ideas to external judges at a campus-wide business plan competition, were always won by Technopreneurship and Innovation Program (TIP) students. Even the classroom is different. There were visits to the Chinese Heritage Center to honor the founders of the University, because they were entrepreneurs who created this university in the first place, you go back to your roots. There was the outward bound team bonding exercise, the skits, role-plays, theatrics by students, business simulation games lasting the course. 50% of time is spent in teams and prototypes of models and envisaged projects created through digital media. Teng-Kee himself is a showman. He takes off one shoe, throw it into the air, catches it and says, “I bought the shoes for $99 in New York City, the Chinese factory that makes them received $3. Today, we are going to discuss where the other $96 went and where to capture that value for ourselves.” How do we define innovation? How can we evaluate it? First, you must differentiate values in this example, Realism from Idealism — “My education has been realistic; it readies me for the world as it is. Not necessary as it might be, it is practical and effective.” It is not true or very true indeed. Next, you say “My education has been idealistic. It shows me how realities can be changed, so as to create new values. It is inspirational.” Not true or very true. We put these two opposites, the Ideal and the Real and we put them on two axes, so you have Realism on the vertical axis and Idealism and Inspiration on the horizontal axis. I want you to look at [these blue speech bubbles], on top left, we have “Hard realism which cannot afford dreams or fancies”, and at the bottom right, we have “We work with fancy ideals which have little chance of being realized.” So, you can be realistic without being idealistic, you can be idealistic without being realistic. But what we are after is the top right-hand corner: We learn how to turn our ideals into realities. Idealism and realism can also compromise in the middle. We get students to fill up these grids and the grids have 11 values that are 11 questions: 1. Training the intellect to master and organize concepts [values of realism emphasized by Universities] Training human experience, including feelings, emotions and ideals [values of idealism emphasized by TIP]

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2. Absorbing information given by instructors [values of realism emphasized by Universities] Thinking for yourself and testing your convictions [values of idealism emphasized by TIP] 3. Classroom culture resembles a level playing field for competitive efforts [values of realism emphasized by Universities] Classroom culture resembles an extended family willing each other to succeed [values of idealism emphasized by TIP] 4. Work is hard and serious, with long hours and hard challenges [values of realism emphasized by Universities] Work is playful and enjoyable, the hours slip away as we are challenged [values of idealism emphasized by TIP] 5. Career continuity and mastery are crucial [values of realism emphasized by Universities] Transformation is vital. We reinvent ourselves [values of idealism emphasized by TIP] 6. We learn to face facts however discomforting, and report these objectively [values of realism emphasized by Universities] We learn to develop mutual rapport so as to face together harsh facts and realities [values of idealism emphasized by TIP] And so it goes on. We have 11 questions in all. The problem all along has been that we stereotype innovation, and whenever we stereotype it, it eludes our grasp. Entrepreneurship and innovation cannot be clichés and they cannot be simple formulas. You can’t have a cliché and expect people to create, it is ridiculous. For example, getting emotional, anyone can throw a tantrum. Challenging your teacher, student riots do not help education as far as we know. Building a family atmosphere, that can be too cozy. Playing, pretending, and having fun is what drunken revelers do. Reinventing yourself at intervals can be self-indulgent. Developing close relationships can be a love-in. These are necessary but they are not sufficient conditions of creativity. Our conviction is that genuine innovation reconciles intellect and emotion top down, bottom up. Competing and cooperating, seriousness with play, continuity with change, report with rapport, truth with practicality, etc., and especially, Idealism with Realism, Tradition with progress. Here are the results both for Singapore and for China that I have compared — for each question, we present the positions on the grid, for NTU and TIP for Chinese universities on two dimensions: The relative degree of polarization , the percentage scoring within Reconciliation Zone and I will show you what that is, and then the number of squares occupied. Here is our first grid. On the left is the score for NTU, how intellectual is your education versus how experiential is your education and how much emotion do you feel

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about it. Notice that NTC actually beat NTU both on how intellectual is your education and also on how experiential is your education. Also, notice that 44.12% of TIP graduates are into the top right-hand corner and we call that the Reconciliation Zone. However, only 4.41% of NTU students got into the Reconciliation Zone in their normal courses at the University. And in the normal courses at the University, only 4.41% of NTU students scored 7, 8, 9, 10 on both dimensions as compared to 44.12% at NTC. Moreover, if you look at the red zones, they are: The culture is “feel-good”, “touchy feely” and at another: The atmosphere is remote, abstract and “ivory tower”. In both cases, the turnout is much higher for the university as a whole as it was from NTC. If you look at the Chinese scores, they are even more marked. The interesting thing is that when the Chinese students compare the Chinese universities with NTU with their experience and considering that this is a four-month post-graduate course up against the alma mater of the students who spent three or four years in the Chinese university, as to the four-month course of NTC, you can see that NTC has done really well out of that. Not only is it more emotional and experiential, it is also more intellectually rigorous. Let us look at it again, 41.67% of Chinese for the NTC graduates from Chinese universities got into the top right-hand corner of this grid. Now, on the second grid, we have “Learning by absorbing information”; that is by listening to a lecture and “Learning by thinking and doing for oneself ”. In this particular case, NTU scored above NTC on “Learning by listening” but far more people got into the Reconciliation Zone, 32.35% of TIP graduates got into that Reconciliation Zone at the top left-hand corner. When compared with the Chinese universities, it is even more marked. Look at the huge gain. When Tan Teng-Kee lectures or when other people in the course, including me, including Clayton Christensen who also teaches this course, when they speak, people usually absorb more information and they learn by thinking and doing for themselves. 31.67% of the Chinese students get up into that top right-hand corner. Next, on the third dimension, “Is your education like a level playing field and are you able to compete with other people, is it fair?” etc. In America, the expression “a level playing field” is very well known. However, entrepreneurial education also has to be like an extended family. How can you be simultaneously like a family and like a level playing field? What happens in this course, as far as I can tell, is that it is so diverse, so many companies are being started, so many different businesses are being created that in fact, there is no direct competition. Anything that you gain, other people do not lose because you are all doing something that is essentially different. You manage to be both a level playing field and a kind of cheering section where you are all in favor of each other. Here are the scores: Once again, you notice that 31.67% of the Chinese students managed to get into the Reconciliation Zone; these are the results for the PRC. Notice how you can corrupt anything, you can corrupt the notion of being an extended family — the family is so cozy and comforting that there is no pressure to succeed. You can ignore the bottom right-hand corner and the top left-hand corner: “Every person for him or herself ”.

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When I was at Harvard Business School many years ago in 1961, some of the students tore pages of textbooks so that other students wouldn’t be able to read; thus they will get the advantage over other people. So you can take competition far too far. The interesting thing is that there are no pathology scores for the PRC because we found that Chinese education is far more evenly balanced between the two dimensions. We found that the left and right range is much closer in Chinese education than in Singapore education, which is interesting. How does this work? How do these dilemmas work? What is the theory behind it? Here, we turn our square into a glass cube. We got the Degree of Intellectual Ordering on the vertical and the Degree of Emotional Investment [on the horizontal] and notice that we see a cyclical. On the top corner is our Reconciliation Zone and you can do that for the other dilemmas. “Developing tested convictions”, thinking and doing for one self and “Absorbing information”. We first absorb information, then you take the information into yourself and think about it, you then absorb more information, you then taken it back into yourself and finally you do both: Developing your own tested convictions and you take some of what you’ve heard the instructor say and you come to an ultimate conclusion. This also works for “Cooperating like an extended family” and competing on a level playing field. You first compete to compare yourself with everybody then you realize that you are all doing different things and you can help each other and sustain each other, then you compete again then you cooperate again. What we have in the top right-hand corner, we call “Collaborative competition” or “co-opetition” — you basically have to make out the word. Here is our next grid, what we notice when we are teaching innovation is that it is simultaneously serious and playful. It is serious because sooner or later you are going to confront the market. You are going to lose your shirt if you are wrong. But in the meantime it’s playful. It’s playful because you keep testing things out. It’s playful because you use simulations. It’s playful because you use skits and role plays. It’s playful because you are practicing and it’s enjoyable. You don’t have to belong in a classroom in NTC to realize people are having one “hellava” good time. They are enjoying themselves. But gradually the playfulness has to become serious because finally you are going to confront the market, when you confront the market, you would better be ready. We find that no student at NTU in the undergraduate program managed to reconcile playfulness and seriousness. However, 50% of the TIP students get into that top righthand corner. If you look at the PRC students, you find that 5% of the Chinese university students say their universities get them to the top right-hand corner but 36.7% of them say that NTC has gotten them there. Notice that both in seriousness and in playfulness, NTC outscores the average if the Chinese universities earlier attended. Here we are looking at the importance of continuity, the importance of mastering a career path, the importance of transformation and reinventing ourselves. If you just

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reinvent yourself, you are in danger of dropping out and turning off. If you just think of your career, you are in danger of being straight-and-narrow-career-is-everything. Notice that while NTU is more serious, more career-oriented than NTC, it is not by a statistically significant margin; they are very close and 47% of TIP students get into the top right-hand corner and only 7.35% of students of NTU normal courses. In the results of the PRC, what we see are very similar. Once again, NTC outstrips Chinese universities on both dimensions. This is very important because many people say that innovation and traditional education are enemies. We see quite clearly from these results that they contribute to one another and that they are not enemies at all. 41.67% of the Chinese students get into the top right-hand corner. We renew ourselves, we must have waves of change. These are hard truths, honest reports that support and rapport. These are two different ways of facing the truth. You are facing the truth because you are objective or you face the truth because you have got support from your friends for doing so. We find that both of these contribute to each other. 48% of the TIP students get there. Here we see the unwinding helix: Strong rapport confronts hard reports. The road to wisdom as quoted by Pier Hein “Well it’s plain and simple to express. Err and err and err again, but less and less and less”. That’s how innovation is created by endless iterations of an idea until you got it perfect. I will not weary the audience by showing all the questions because it takes too long but I would say that for all the 11 questions the patterns are very clear. The people who reconcile one or two pairs of values tend to reconcile them all. The correlation between a reconciliation is as high as 80%. We have shown that students enjoyed the course. They rated it consistently higher than university courses as a whole both in China and in Singapore. They believed that it transformed them; they believed it upheld traditional education while going far beyond this. Is that enough? No it isn’t. Did it change behavior? That is the ultimate question. The answer is: It did. 160 students among themselves started 46 new companies employing roughly half their number. Considering students go into businesses together, that means about 75 students are actually in business which they started either jointly or by themselves. All these despite having to repay debts, being interested in other fields, venture capital and acquisitions, being advised to wait and share the cost of innovation with established firms and having two years on average and undergoing the customary initial failures. We have really an extraordinary record. Here are some of the interesting comparisons between NTU and Chinese universities. On traditional values, students of Chinese universities rated above their former universities by 6.13 to 7.03. NTU scores slightly above TIP by a non-significant margin. Chinese universities score themselves 10% lower on traditional values than do NTU students. They are better balanced. Chinese universities are 6.13 to 4.84. For innovative values, NTU is much more unbalanced with 7.34 to 4.69. But for one single question, Chinese TIP students as Singaporeans reach the Reconciliation Zone. One question on which Chinese students did not reach the

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Reconciliation Zone was the question on whether their university’s authorities accepted or helped them find merit in something they created themselves and for reasons that are unknown or cannot be understood, Chinese students didn’t think that their universities would recognize what they were doing constitutes to academic merit. So, it looks as if there is a bigger gap between Chinese universities and commercial enterprise than there is in Singapore. NTU students outscore Chinese university students on innovative values by 7.99 to 7.44 — that is a non-significant margin. Chinese universities are more likely to be described as extended families that they are more familiar with, that is 5.81 to NTU’s 4.22. So, there is more of a family atmosphere in Chinese universities than there is in NTU. NTU is substantially more serious than Chinese universities by 7.54 to 6.18, but slightly less playful by 4.24 to 4.90. NTU is substantially more career-minded than Chinese universities by 7.76 to 6.21. NTU is substantially more oriented to “hardobjectivity” than Chinese universities by 7.82 to 5.94. I think that Chinese universities have more arts education relative to science and engineering and that is how it shows up. Regression analysis shows that the TIP-NTU pedagogy generates 64.2% more learning as defined by our 22 learning dimensions, while the TIP-Chinese pedagogy generates 87.4%, which is considerably higher. What are the implications of being able to teach entrepreneurship and innovation successfully? What does this really change? Does it really matter? It was the ancient alchemists’ dream that they could create gold from base metals. Alchemists for 500 years tried to do this. Literally of course, this is not possible that you could create gold from base metals. But metaphorically, it can be a dream come true because a combination of two relatively cheap metals can create something much more valuable than its parts. So, it looks like the alchemists’ dream that the ancient world is coming true. Among the implications is a New Economics beyond scarcity. Economists are right, there is always a scarcity of money, there is always a scarcity of money already made but there is no scarcity of ideas. They bounce off each other, they generate each other, they qualify each other. In this new world of innovation, there is no need to fight over scarce resources in Iraq. People think Saudi Arabia is rich because Saudi Arabia has all this oil, they are charging more for it every year, and so Saudi Arabia should be rich. Saudi Arabia has a gross domestic product (GDP) of $7000 per person and Singapore has a GDP of $34000 per person. That is five times more than Saudi Arabia. The truth is, the greatest resource known to man is between our ears. It isn’t underground, it isn’t gold, it isn’t oil, it isn’t any of these things, it is between our ears. If we can start innovating with the stuff between our ears, there is no limit to what we can create. The most valuable resource is between our ears. Universities are joined in a creative project. World problems of hunger, pollution, disease and terrorism become solvable. Why? It is because they lie between disciplines, once we can get the disciplines working together. What do we propose to do now? Well, we are making a film of this, we are making a film of the Singapore Experiment. It will start in January. There is the idea of setting

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up summer camps in China and offer franchises to our best students. We want to replicate this program in Jordan, Poland, PRC, and the Netherlands. There is a plan afoot to found Asia’s first Graduate School of Entrepreneurship in NTU. We want to create dramatized case histories in DVD of Entrepreneurship and we want to develop moving images of innovation, a process of distance learning. Basically, innovation is so complex, it is so transformative, it is so dynamic and it moves in such a subtle way that you have to use moving images in order to convey it. Once, our children’s children will probably laugh at us that we try to talk about innovation writing on a piece of paper in straight lines. So, thank you very much for putting up with me for so long.

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Session 1

Global Competiveness for Chinese Companies

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A Study on the Development of Global Competency Leadership ͣSHUMING ZHAO Nanjing University

Z

hao Shuming is Professor and Dean of the School of Business, Nanjing University, People’s Republic of China. He serves also as Senior Vice President for the International Association of Chinese Management Research (IACMR); Vice President of China Human Resource Research Association; President of Asian Human Resource Research Association; the President for Jiangsu Provincial Association of Human Resource Management; Vice President of Jiangsu Provincial Association of Business Management and Entrepreneurs; and Member of Human Resource Development Committee of Macao Special Administrative Region Government. Professor Zhao graduated from the English Language and Literature Department, Nanjing University in 1977. He received his Master of Linguistics and Education (1983) and PhD in Higher Education and Human Resource Management (1990) from Claremont Graduate University in California, the United States. He was a post-doctoral fellow of human resource management at the College of Business, Florida Atlantic University, United States in 1990–1991. Professor Zhao is an internationally known scholar in human resource management and multinational business management. He was among the very first group of scholars who introduced western human resource management theory to China. He chaired several researched projects for the National Natural Science Foundation, Ministry of Education, Ministry of Science and Technology, and Jiangsu Provincial Government. He conducted many national studies of Chinese corporations, sought to apply management theory into Chinese practice, and proposed some human resource management theories feasible to Chinese firms. He has published more than 20 books and over 200 academic papers and articles, such as Human Resource Management in Transnational Corporation (co-authored with Peter J. Dowling and Denice E. Welch, Beijing: China Renmin University, 2001); Research on Human Resource Management (Beijing: China Renmin University, 2001); The New Development of Human Resource Management Research (co-edited with Feng

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Zhiyan and Liu Hong, Nanjing: Nanjing University Press, 2002); Research on Human Resource Management Strategies in Corporate Groups (Nanjing, Nanjing University Press, 2003); Human Resource Management, 9th edition (co-authored with Robert Mathis and John Jackson, Beijing: Publishing House of Electronics Industry, 2003); Research on Human Resource Management Strategies in Corporate Groups (Nanjing, Nanjing University Press, 2003). Recently, he has received a key research project fund of one million yuan from National Natural Science Foundation of China to conduct “Research on number of issues on human resource management in Chinese enterprises under the transition economy”. He will lead his team to do the research on the impact of human resource management in Chinese enterprises from economic transition, corporate culture, innovation, and internationalization. Professor Zhao successfully organized and held five international symposia on multinational business management in 1992, 1996, 1999, 2002, and 2005. He has received awards from the States Council, the Ministry of Education, Jiangsu Provincial Government and Nanjing University. He is the co-editor of the International Journal of Cross Culture Management in the United Kingdom. In 2003 his book Research on Human Resource Management received award for China’s 13th Best Book Awards (2003) and First Prize for Outstanding Research of Jiangsu Province’s Eighth Philosophical and Social Sciences Awards by Jiangsu Provincial Government (2003). This book was also awarded the first prize from the Ministry of Education of China (2006). He was named the best administrator and professor of the year by Nanjing University in 2003.The course on “Human Resource Management” that he taught was awarded as the National Model Course by the Ministry of Education of China in 2003. He was named as one of the ten most influential management gurus in China for three years since 2004 by World Executives Week, People.com, etc. Professor Zhao was selected in 1996 by the State Education Commission of the PRC as one of the five scholars in Management from the whole nation for China’s Transcentury Excellent Young Scholars Fund. He was selected by eight ministries of China as one of the best scholars of the “National Hundred, Thousand, and Ten Thousand Talent Project” in 1997. He was also named as the first-level scholar for the “333 Trans-century Academic and Technological Chairperson Project” by Jiangsu Provincial Government in both 1998 and 2002. In 2007 he was named the Chief Scientist by Jiangsu Provincial Government. Professor Zhao has been a member of the Guidance Committee for National Business Degrees Programs of

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the Ministry of Education of China (1999–2006) and now the Vice Chairperson for the Committee (2006–2010); a review committee member of The Eighth, Ninth and Eleventh Review Committee of Natural Science Foundation of China (2000–2001, 2002–2003, 2006–2007), a committee member of The Fourth and Fifth Science and Technology Academic Committee of the Ministry of Education of China (2000–2003, 2004–2007), and a committee member of the Guidance Committee of National MBA Education of China (2003–2007). Professor Zhao has been a Visiting Professor at eight business schools around the world since 1990. He was a clinical professor at the Marshall School of Business, the University of Southern California from 1997 to 2003. He is the visiting professor at College of Business, the University of Missouri, St. Louis. He has lectured in the United States, Canada, Japan, the United Kingdom, Ireland, Germany, Australia, New Zealand, the Netherlands, and Singapore, etc. He is also an Independent Director of the Board for three companies, including KHD Humboldt Wedag International Ltd. in Germany. He is a management consultant for several Chinese and international firms. Abstract: The shortage of global competency leaders is an immense challenge for the internationalization of corporations. It is a crucial issue to cultivate and develop global competency leaders during the internationalization of companies, which requires further study in China. On the basis of a literature review on global competency leadership at home and abroad, this paper first proposes a five-level global competency leadership model incorporating a set of basic characteristics. Next, it analyzes the present situation and major problems of global competency leadership development in the internationalization of Chinese corporations. Finally, some measures for global competency leadership development of Chinese corporations are presented. Keywords: Global competency leadership; Chinese companies; Internationalization; Human resource management and development

Introduction With the further development of China’s reforms, the opening-up and the more stable establishment and improvement of the socialist market economic system, especially since China’s entry into the WTO six years ago, Chinese enterprises have already encountered international market competition. More than 400 of the World’s Top 500 Companies have invested in China, and most of them have set up managerial headquarters, manufacturing bases, and R&D centers or engineering centers in China (Zhao, 2005). In the industrial

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parks and economic development zones of the Yangtze River Delta, Pearl River Delta, Beijing-Tianjin-Tangshan, and the Bohai Sea Area, R&D and manufacturing have both realized global synchronization. With the rapid input of international capital and technology, many industries in China simultaneously face “international competition domestically and domestic competition internationally.” Increasingly Chinese enterprises are involved directly in international markets and are adopting the “going outside” policy. With the faster progress of internationalization, those enterprises are recognizing the need for more leaders with global competencies. One research study conducted in the United States on the “global best enterprises in leadership development” surveyed 300 established global companies about their leadership. The study revealed that in order to deal with the increasingly diversified and competitive markets and to ensure the sustainable development of the companies, global excellent companies are doing their best to develop sufficient high-quality leaders, so as to make up for the shortage of global leaders (Ren, 2006). While in Asia, particularly in China, with the fast economic growth, there are countless enterprises emerging and growing rapidly. As a result, we need to face an issue deserving attention and alertness — the deficiency of global competency leaders. In an era of economic globalization, information networks, knowledge socialization, population urbanization, and e-currency, China is in urgent need to develop managerial professionals with global vision and cross-cultural leadership. Therefore, developing and managing global competency leadership will become the main task of human resource management and development in today’s context.

What is Global Competency Leadership? Global competency leadership has been the focus of academia and enterprises. Global competency leadership refers to the leadership that can determine the future of business organization during its process of internationalization and globalization (Clark and Matze, 1999). Peter Drucker, the management guru, pointed out that there are two types of managers in the 21st century: one is the manager with global vision, the other the laidoff type (Drucker, 1998, 1999). According to a Fortune 500 survey, 85% of the CEOs do not think that their companies have enough leaders with global competency, while global competency leadership is the key to success for global companies (Javidan and House, 2001). What competencies should global leaders have? This has been an important question for both academia and enterprises. Several researchers have contributed to our understanding of global competency leadership. In the academic field, Brake (1997) proposed a global leadership model including three competencies: relationship management, business acumen, and personal effectiveness. Conner (2000) suggested six skills and capabilities of global leaders: to be business savvy, to know how to use personal influence, to bring a global perspective, to have strong character, to know how to motivate people, and to act like entrepreneurs.

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Liu (2002) specified that global leaders must have six characteristics including: plentiful work experience and leadership practice, deep understanding of global markets, ability to motivate employees, effective use of personal influence, emotional intelligence, and capability for cultural integration. Morrison (2000) conceptualized global competency leadership into three levels: the concept of global competency leadership, the characteristics that global competency leadership should have, and the competencies included in each characteristic. The above descriptive studies discussed the competencies that global competency leaders should have for high performance, but there are some limitations in these studies in terms of the generalizability and application of the findings due to the lack of empirical tests (Yu et al., 2003). More systematically, Moran and Riesenberger (1994) identified 12 different competencies associated with implementing global strategies. The competencies were organized into four categories or characteristics: attitudes, leadership, interaction, and cultural understanding. Each category or characteristic contains three competencies, making 12 competencies in total. The three global leadership competencies included the ability to (1) facilitate organizational change, (2) create learning systems, and (3) motivate employees to excellence. Also, the research of Black et al., (1999) on global multinational companies’ leaders identified four major context-specific factors that impacted idiosyncratic characteristics: company affiliation, managerial position, country affiliation, and functional responsibility, each of which influences the types of characteristics required for effective global leadership. In addition to those idiosyncratic competencies, the authors also identified three distinct characteristics of effective global leaders: demonstrating savvy, exhibiting character, and embracing duality, each of which is relevant to leaders regardless of the company they work for, the position they hold, their country of origin, or their functional orientation. Based on their studies on 18,000 managers from 62 countries, House et al. (1999) developed a global competency leadership model of culturally endorsed implicit leadership theories (CLT). The model includes six dimensions: charismatic/value base, self-protective, humane-oriented, teamoriented, participative and autonomous. Their studies found that cultural factors could influence global leadership competency, and different cultural backgrounds require different global leadership competencies. Their studies contributed to the cultural generalization and specialization of global leadership competency (Yu et al., 2003). It is suggested, therefore, that in order to improve the managers’ global business capability, their cultural sensitivity must be improved first (Javidan and House, 2001). In practice, multinational companies have seen the biggest demand for global competency leaders, and at the same time have fostered a large number of talented leaders with global competencies. Jack Welch (Welch & Byrne, 2001), the former CEO and Chairman of General Electric Company (hereafter GE), remarked, “The Jack Welch of the future cannot be me. I spent my entire career in the United States. The next head of GE will be somebody who spent time in Bombay, in Hong Kong, in Argentina. We have to send our best and brightest overseas and make sure they have the training that will

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allow them to be the global leaders who will make GE flourish in the future.” (Javidan and House, 2002) A successful company cannot only provide high-quality products and services, but also must cultivate numerous excellent leaders. As is well known, GE is one of the best at cultivating excellent leaders. According to statistics, among the World Top 500 Companies, 173 CEOs are former GE senior managers. GE spends approximately US$1 billion annually on training and education. Each year about 6,000 GE executives travel from different GE business units all over the world to Crotonville for training at the Welch Leadership Center. Among the mentors at Crotonville, about 50% are senior executives from GE, including former Chairman of the Board & CEO Jack Welch and the incumbent Chairman of the Board & CEO Jeffrey R. Immelt (GE Model, 2007). The key global issue for General Motors Corporation is how to transform the organization internally to become more globally competitive. Even for employees who may never go overseas, it is necessary to constantly sensitize everyone to the fact that they are in a global business (Roberts et al., 1998). In another example, 3M Company has developed a model of global leadership competencies that consist of three categories of twelve competencies (Alldredge and Nilan, 2000). The first category is referred to as fundamental leadership competencies including ethics and integrity, intellectual capacity, maturity and judgment, which should be possessed by new employees at the time of hire. The second category is the essential leadership competencies including customer orientation, developing people, inspiring others, business health and effect, which is expected to develop as employees become responsible for a function or department. The third category is the visionary leadership competencies including global perspective, vision and strategy, nurturing innovation, building alliances, and organizational agility. To summarize, I argue that those who qualify as global competency leaders are persons who can communicate in international language, understand the operating rules of global markets, have global vision and operation ability, and achieve good results. Accordingly, global competency leaders should have four basic competency characteristics: first, to explore and innovate with internationalized vision; second, to have internationalized knowledge structure and be familiar with international conventions; third, to have international communication capability and meet the needs of international economic competition; fourth, to have strong national self-confidence and sense of social responsibility. A global competency leadership model includes five levels: the first level is the basic or core global competency which is shown as no bias, open-mindedness, tolerance with ambiguity, world unity, personal interaction, emotional sensitivity, behavioral agility, inquiring mind, optimism, self-confidence, self-recognition, positive emotion, pressure management, interest diversity, self-consciousness, and relation interest. The second level is inter-personal skills. In the globalization context, leaders need inter-personal skills to conduct deep-seated communication, dialogue, and negotiation. They must also know quite well about different cultures, rites, values, and ways of thinking, so as to build teams with mutual trust. The third level is the competency to break through the boundaries of enterprises and build harmonious relations among the

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stakeholders of enterprises. The fourth level is the ability to make decisions ethically (Zhao, 2001, 2004). While considering the maximization of profit, decision makers should take it as a prerequisite not to violate social ethics and social responsibilities. The fifth level is the leaders’ systematic skills. Leaders should make long-term strategies with a systematic perspective because of the complexity of the enterprise itself and the stakeholders. Based on the five-level global competency leadership model, enterprises can offer human resource policies, plans and practices, such as leveraging reverse expatriates, delivery of in-country training and new overseas assignment, to develop competent global leaders (Mendenhall, 2007; Mendenhall and Stahl, 2000).

The Internationalization of Chinese Enterprises and the Development of Global Competency Leadership The wave of globalization has swept each corner of the commercial world. For growth, companies have to consider competing and expanding in the world markets. Globalization means that companies have to think globally while act locally. To achieve the dual goals of global strategy and local market reaction, companies need not only to form the organizational structures and strategic targets that adapt to the changeable external environments, but also to develop global leaders that can effectively implement strategies and corresponding corporate cultures (Wu, 2006). It is the latter, success at developing global leaders, which determines the success or failure of the internationalization of companies.

The challenges facing Chinese companies going global According to a survey by McKinsey & Company, China will require 75,000 top-level executives with global experience by 2010, but at present China has only 7,000 such top-level executives. It is also found that companies in many parts of Asia are affected by the insufficiency of qualified executives. The percentage of companies facing a shortage of top-level executives with appropriate global experience in Asia is as follows: in Mainland China, 45.1%; in Hong Kong, 10%; in Taiwan, 14.3%; in South Korea, 8.3%, respectively. The percentages of companies facing the turnover of executives: in Mainland China, 43%; in Singapore, 5%; in Malaysia, 4.5%, respectively. Apparently, Chinese companies are now facing the urgent challenge of insufficiency of global competency leaders (Ding, 2006). This challenge is evident in three key aspects. The first aspect is the competences gap. In today’s world, as the connection and communication between countries are continuously deepening and the clash and blend of different cultures are increasingly common, the process of globalization has demanded more competencies for executives. The incumbent leaders of most companies in China lack strategic thinking ability, global vision, the ability to do business globally, and cross-cultural operating ability. The second aspect is the insufficiency of knowledge and skills. Most leaders,

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even the executives of some well-known listed companies, have mastered only a specific field of specialty knowledge, without professional management knowledge in finance, securities, insurance, accounting, or law. The third aspect is the deficient leadership team. In many companies, there are too many low-level managers but not enough competent middle-level managers and senior-level executives. Such companies with challenges in these three key aspects are in great need of leadership talent who can understand the WTO rules, conduct international negotiations, and do business globally.

The key issues in the development of global competency leaders for Chinese companies The unprecedented competition for globalization talent, and especially the shortage of global leaders, has imposed severe challenges for Chinese companies. The globalization of Chinese companies will inevitably require the globalization of leaders. In addition to having a good understanding of the different languages and different customs, those leaders with global competency will have to understand the distinct ways of thinking, different management styles and corporate cultures in other countries. For the internationalization of companies, the training and development of global competency leadership is a critical issue that needs to be researched and explored within the context of China. Several questions should be addressed. For example, we need to know what kinds of competencies are needed in the Chinese cultural circumstances? What influences will Chinese culture have on the growth of global competency leaders of Chinese companies? How do companies help leaders who are weak at certain characteristics to become more globally competent? (Yu et al., 2003) Such questions should be answered in the internationalization of companies and be the research focus for Chinese scholars as they study global competency leadership.

The Practice of Global Competency Leadership Development Different from the training in common skills and specialty knowledge, the development of global competency leadership cannot be achieved instantly. It takes time to develop the global leadership competence; it is a process, not just a singular training activity. The development of global competence requires the ultimate change of people; only by putting people into situations which can provide relevant activators can this change happen (Mendenhall, 2007).

The approaches of developing global competency leadership As for the means of developing global leaders, global teams and short-term overseas managerial training or business trips are considered effective (Maznevski and Distefano, 2000; Oddou, 2000). Global teams are teams of managers from different parts of

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multinational organizations working together to achieve a team-specific goal that is global in its scope. There are three processes in global team development: mapping, bridging, and integrating. Mapping refers to understanding the team members’ compositional differences and accordingly recognizing their importance to build mutual relationships. Bridging is the communication across those differences to ensure that each member understands the others. Integrating refers to bringing the different perspectives and preferences together, resolving differences among them, and generating innovative, high quality approaches to the task. Short-term overseas training or business travel can help leaders accept or appreciate the concept of doing things in different ways, and provide opportunities for leaders to observe the verbal and non-verbal behaviors of individuals in the host-country. Besides, such travels can also help leaders learn to build trust with people in an open and modest way in new environments. Therefore, business trips and non-business learning can enrich global leaders’ knowledge and improve their abilities. As for Chinese companies, another effective training method is to let company leaders “go abroad”. The accumulation of working experience abroad can help global leaders have a better understanding about modern international business, which in turn will help them find the suitable ways for their companies to enter international markets. “Going abroad” also helps leaders understand the differences in management and technology between their own companies and international competitors as well as the impact of cultural difference on companies, and, ultimately, may facilitate the companies to make effective international business strategy. “Going abroad” is one process to encourage that they understand and learn the advanced foreign technology and management practices. Another effective approach for some companies would be to send their expatriate managers and project managers to EMBA, IMBA, MBA, and EDP programs in universities both at home and abroad. For example, the EMBA Program of Nanjing University School of Business in cooperation with the Johnson Graduate School of Cornell University offers students many such opportunities. First, they attend classes taught by both Chinese and American professors at Nanjing University, and then the students go to Cornell University to finish three courses and visit American multinational companies to communicate with entrepreneurs and executives. The dual-degree IMBA Program jointly run by Nanjing University and the University of Missouri-St. Louis has provided meaningful experiences for students. They take the first year’s courses at Nanjing University and the second year’s courses at the University of Missouri-St. Louis. Afterwards they will get a paid internship in multinational companies in the United States for three months, and then they return to Nanjing University to finish their MBA thesis. Such IMBA Program enables students to learn not only Chinese management but also Western management, and offers them the opportunity to work as an intern in prominent multinational companies. Another recommendation is for Chinese companies to send executives to attend some international economic or managerial forums, which can broaden their horizon and develop their international strategic thinking ability. For example, the author was honored to be

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invited to deliver a speech at the Global Forum, with more than 100 CEOs participating, held in Tokyo, Japan on 21 February 2007. The speakers at the forum were from China, the United States and Japan. The participants were from multinational corporations in Japan and the neighboring countries. The author talked about the strategic management of global enterprises, the managerial differences between Chinese enterprises and foreign enterprises, the international business environments and rules, as well as the development of global competency leadership. By participating in forums like these, leaders can benefit significantly to improve their global managerial skills. In addition, as an alternative to cultivate backup talent, internationalized companies can send managers who have been identified as having high potential for development into key future leadership roles in their organizations to overseas companies as on-site interns who will participate in project negotiation and operation, improve cross-cultural communication and problem-solving ability. Through job rotation, more interdisciplinary talents and professional talents mastering professional knowledge and foreign languages and familiar with international business practices will be developed.

The main contents of global competency leadership development In order to build high-performance organizations and to achieve high performance, an effective global competency leader must have global vision, internationalized knowledge structure, be familiar with international conventions, and master international communication ability. Therefore, global competency leaders should be developed in such aspects as language, professional ability, culture and vision through educational programs and firsthand experiential learning experiences that cultivate and emphasize these qualities.

Language ability training Language ability is the prerequisite for global leaders to communicate smoothly with foreign counterparts. The training of language ability can take the means of shortterm spoken language improvement (having native speakers as teachers) and/or IMBA programs (using English as the teaching language).

Professional ability training Global competency leaders must have strategic thinking ability, advanced managerial philosophy, abundant relevant experience, systematic thinking and ability to do things right and to do the right things. Global competency leaders also must learn how to cooperate with colleagues, gain knowledge from interpersonal communications, and spread such knowledge swiftly and effectively through their own networks. A global competency leader must have a strong desire for learning, and the skills to learn fast and continuously.

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Cross-cultural training Global competency leaders need to understand not only Chinese local cultures but also foreign cultures, customs and rituals, so that they do their jobs with skill and ease. The training in cultural consciousness can promote the global competency leaders’ awareness and appreciation of different national cultures, so that they behave properly and manage global managerial teams appropriately and effectively. Therefore, training in social cultural sensitivity, such as the differences between eastern and western cultures and the foreign-related business etiquette, is an important focus in the training of global competency leaders.

Global vision training With global vision, global competency leaders are able to appreciate the opportunity to work anywhere in the world. Companies cannot run in isolation. Benefiting from opportunities to learn the best practices from excellent overseas companies, the leaders of Chinese companies can advance their global competence in a relatively fast and easy way. The effective global vision training approaches include internships in overseas companies, visits to overseas companies, and other short-term overseas learning experiences.

Conclusion “The world is flat!” (Friedman, 2005) A leader with global competency is the favored person in the era of globalization that emphasizes a knowledge economy. The development of global competency leadership should focus on global vision and cultural training of leaders with potential, help them expand beyond narrow-mindedness, change their singular viewpoint, and local ideology, and develop a global mindset. It is imperative for global leaders to have actual experience in other countries; such is an important way to learn “global competence” and be exposed to the best global leadership practices found in companies of excellence. In doing so, global leaders can improve their ability in grasping global commercial opportunities and leading their companies in the progress toward internationalization.

References Alldredge, ME and JK Nilan (2000). 3M’s Leadership competency model: An internally developed solution. Human Resource Management, 39 (summer/fall), 133–145. Black, S, A Morrison and H Gregersen (1999). Global Explorers: The Next Generation of Leaders. New York: Routledge. Brake, T. (1997). The Global Leader: Critical Factors for Creating the World Class Organization. Chicago: Irwin Professional Publishing. Clark, BD and MG Matze (1999). A core of global leadership: relational competence. In Advances in global leadership, V1, WH Mobley (eds). JAI Press, Inc., Stamford, CT, pp. 127–161.

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Conner, J (2000). Developing the global leaders of tomorrow. Human resource management, 39(summer/fall), 147–157. Ding, Minghao (2006) Implement the priority of talents developing strategy to solve the problem of manager insufficiency. Jiangsu Corporate Management, 10, 8–9 (in Chinese). Drucker, FP (1998). Peter Drucker on the Profession of Management. Boston, Massachusetts: Harvard Business School Press. Drucker, FP (1999). Management Challenges for the 21st Century. Collins Publishers, Inc. Friedman, TL (2005). The World is Flat: A Brief History of the Twenty-First Century. New York: Farrar, Straus and Giroux. GM Model (2007). Enterprise Management, 5, 57 (in Chinese). House, RJ, PJ Hanges and SA Ruiz-Quintanilla (1999). Cultural influences on leadership and organizations: project globe. In W H Mobley (eds.), Advances in Global Leadership. Stamford, CT: Jai Press, Inc., 171–233. Javidan, M and R House (2002). Leadership and cultures around the world: findings from GLOBE: an introduction to the special issue. Journal of World Business, 37(1), 1–2. Javidan, M and RJ House (2001). Cultural acumen for the global manager: lessons from project globle. Organizational Dynamics, 29(4), 280–305. Liu, M and L Haibo (2002). Global leader development strategy. Chinese Human Resource Development, 2, 19–21 (in Chinese). Maznevski, ML and JJ Distefano (2000). Global leaders are team players: developing global leaders through membership on global teams. Human Resource Management, 39(summer/ fall), 195–208. Mendenhall, ME (2007). Speech at Global Forum in Tokyo on 21 February 2007. Mendenhall, ME and GK Stahl (2000). Expatriate training and development: where do we go from here? Human Resource Management, 39(2–3), 251–265. Moran, R and J Riesenberger (1994). The Global Challenge: Building the New Worldwide Enterprise. New York: McGraw-Hill. Morrison, AJ (2000). Developing a global leadership model. Human Resource Management, 39(summer/fall), 117–131. Oddou, G, ME Mendenhall and JB Rithie (2000). Leveraging travel as a tool for global leadership development. Human Resource Management, 39(summer/fall), 159–172. Ren, J (2006). Developing Competence Leadership Based on Corporate Strategy. Contemporary Managers, 10 (in Chinese). Roberts, K, EE Kossek and C Ozeki (1998). Managing the Global Workforce: Challenges and Strategies. The Academy of Management Executive, 12(4), 93–106. Welch, J and JA Byrne (2001). Jack: Straight from the Gut. Warner Business Books, New York. Wu, S (2006). Development and Selection Strategy of corporate internationalized managerial talent. Chinese and Foreign Entrepreneurs, 5 (in Chinese), 36–39. Yu, H, F Liluo and L Wenquan (2003). Characteristics and training of the global leaders. Advances in Psychological Science, 11(4), 446–451 (in Chinese), 36–39. Zhao, H (2005). Economic Development Report of Chinese Headquarters in 2006. Beijing, Social Science Literature Publishing House, (in Chinese).

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Zhao, S (2001). Research on Human Resource Management. Beijing: China Renmin University Press, (in Chinese). Zhao, S (2004). On Manager’s professionalization, marketization and internationalization. In Lin Zeyan’s book (eds.), Chinese Human Resource Development Report. Beijing: Chinese Labor Social Security Press (in Chinese), 442– 450.

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Beware the Penrose Effect On HighGrowth Enterprises: A Study on Controlling the Rate of Enterprise Growth ͣXIAOMING XU and YONGMEI ZHANG Fudan University

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rofessor Xiaoming Xu is the Professor of Management School of Fudan University, PhD supervisor, Chief of Management Research Institution, member of expert group of Post-Doctoral Research Centre. His Research Directions: The growth of enterprises, strategy, enterprises innovation, management theory, including general management, the growth of enterprises, marketing, the growth of privateowned enterprises and so on. Professor Xu graduated from Economy management department of Fudan University in 1982. He obtained a master degree of business management in 1987. Prof. Xu was invited to the Chinese University of Hong Kong, Singapore Chinese Chamber of Commerce & Industry, Japanese Osaka Industrial University, Macao University of Science and Technology for refresher courses and lectures. Professor Xu teaches eight postgraduate courses, including “The Growth Theory of Enterprises”, “The Strategy of Chinese Private-owned Enterprises”, “General Management Theory”, “Strategy”, “Marketing”, “Enterprise Development Theory”, “Competitiveness theory” and so on. In the scientific research aspect, Prof. Xu has presided a number of projects that were founded by National Natural Science Foundation, National Science Foundation and Shanghai Philosophy Social Sciences Foundation. Professor Xu published over 90 articles and he has written and composed 25 books, the representative works include “The growth of Enterprise — The Strategic Choices of ‘Hundred Years Old Shop’ ”, “Three Kinds of Foreigninvested Enterprises”, “The Strategy Development of Modern Enterprises”. He attained 28 awards, including 14 awards in academic research aspect.

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Professor Xu’s social positions include: Standing director of the Chinese Institute of Business Administration, executive member of the council of Shanghai Education Research Association, consulting expert of Shanghai Investment Consulting Co.

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s. Yongmei Zhang is a PhD candidate student of School of Management of Fudan University. She graduated with a Masters Degree of Management from Shandong University in 2005. Her research directions include “The growth of privateowned enterprises”, “Corporate strategy”, and “Chinese family enterprises”. Ms. Zhang has published several articles on the growth of enterprises and network in alliances. She is currently preparing a PhD dissertation on corporate strategy of Chinese privateowned enterprises. Ms. Zhang is fluent in English and can read some Japanese. She is proficient in the use of LISREL, SPSS, SAS Statistical software. She is an experienced consultant with three years of working experience in a consultancy firm. Ms. Zhang has participated in several consulting projects and academic research projects on strategy. She also teaches courses of “Management theory”, ”Marketing”, “Operation management”, “International trade” on a part-time basis. Abstract: High growth speed is one of the major aims of Chinese enterprises. In recent years, many enterprises aim to achieve “overdrive growth rates”, “expansion”, and “diversity”. Some enterprises pursue high growth speed through mergers, diversification and franchising. But most of the so-called “super high-speed developmental” enterprises have resulted in failure. This article analyzes the phenomenon of Penrose effect based on growth theory, offers the reasons behind the failure of high growth enterprises, and proposes some measures in controlling the speed of growth. Keywords: Growth of Enterprise; Penrose effect; controlling of growth speed

High-speed growth is an important target of many Chinese enterprises. Since 1990, “leapfrog development”, “speeding growth”, “expansion” and “diversity” have become the goals pursued by some companies. Many enterprises expand themselves through mergers, diversification, chain operation and so on. But many so-called “super highspeed” enterprises eventually resulted in failure after several years of rapid growth. In this paper, we analyze the resource constraints effect based on enterprises growth theory, the phenomenon of the rapid demise of fast-growing enterprises, providing some proposals and suggestions on growth management.

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Penrose Effect during Enterprises Growth Content of Penrose effect Researchers have paid attention to constraint conditions in the growth process since the birth of enterprises. As a resource-based theory, Penrose analyzes the endogenous mechanisms of expansion from an internal resources perspective. She believed that the growth of enterprises mainly depends on the effective use of internal resources (Penrose, 1959). Although external factors such as financing situation, demand level, technological innovation also can be used to explain expansion process, Penrose believes that the true motivation of growth is internal resources and managerial capacity. According to traditional economic theory, the output of enterprise comes from basic production elements such as capital, labor and others, Y = f (K, L), but the quality of services provided by the material resources depends on the managerial capacity of human resources, which coordinate and integrate internal resources in enterprises. According to Penrose’s theory, there is a bounded phenomenon of managerial capability in the process of fast-growth of enterprises. It means that rapid-expanse enterprises will experience managerial capacity bottleneck, resulting in slow growth rate in the following stage. Penrose reveals the bounded effect of managerial resources, which promotes growth in a particular stage; at the same time, will constitute a restrictive factor of growth in another. Given the imbalance in the use of resources, the utilization of resources is not always synchronized. The surplus of internal resources produces expanded momentum of enterprises. However, the efficiency of the use of resources is dependent on managerial knowledge of managers, who need time and cost to accumulate managerial capability, resulting in capabilities lagging behind the growth rate, therefore limiting the further development of enterprises (Fig. 1).

A C B

n*

C

B _

+

X A

g*

Figure 1: Penrose effect in enterprise growth.

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Growth of managerial capability In Figure 1, the abscissa presents the growth speed of enterprise; the vertical axis represents the growth rate of managerial capacity. Point X means that certain growth is still achievable in a given amount of managerial capacity. Curve AA means that the growth of managerial ability promotes business growth effectively. Because the accumulation of internal managerial resources is limited by cost and time, when existing managerial capacity is insufficient, the enterprises would recruit personnel to fill the management capability gap. However, the training and integration with managerial style will take up time and energies, incurring dynamic adjustment costs, thus restricting the growth speed of enterprise (Foss, 1998). Curve BB shows the trend. Given the growth rate of internal managerial resources, through curve AA minus curve BB, we obtain the actual growth rate - curve CC. That is, when the growth rate of internal managerial resources is at n* point, the maximum growth speed of enterprises will be at g* point. Penrose effects can be divided into two effects: driven expansion effect and binding effect. Driven expansion effect means that managerial capacity plays a positive role in promoting growth. The curve AA illustrates the driven expansion effect. But with the rapid growth of enterprises, when the scope of material resource is over the managerial capacity of managers, inadequate managerial capacity will constrain business growth. Binding effect will show up. Managerial capability and business growth rate are negatively correlated in this stage. Therefore curve CC shows a ‘backward-bending’ trend across the break point.

Penrose effect inflicts a significant impact on large-scale enterprises Penrose effect shows up differently in large-scale enterprises and small enterprises. In large-scale enterprises, marginal management services decline more significantly (Fig. 2), the growth curves A″ is more steep, and the curves B″ is more flat. Curve C″ shows the actual growth path. n** means that the growth rate managerial capability is at its optimal growth point, g** refers to the optimal growth rate of enterprises. It is obvious that the growth rate of large-scale enterprise (g**) is less than the small-scale enterprise (g*) when they achieve the optimal growth point. Therefore we believe that large-scale enterprises should pay more attention to the Penrose effect. This is because large scale is disadvantageous in introducing external management resource and using internal resource adequately. In other words, the larger the enterprise, the greater the constraints and restrictions in improving management resources. With the constraints of growth management capacity, the growth of largescale enterprise is more susceptible to a downward growth trend in long term. At the same time, large-scale enterprises require a longer time if they wish to recover from the negative impact of the Penrose effect. Firstly, management capability

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Small-scale enterprise

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Large-scale enterprise

+ Growth of managerial capability

Growth of managerial capability

A

C

B

+ A''

C''

n* B''

n**

p

Growth of enterprise

p" X

g*

X''

g**

Figure 2: Penrose effect on different size enterprises.

plays a more important role in large enterprises than in medium–small size enterprises. The introduction of external managerial resource will decentralize the energy of existing managers, resulting in a huge impact on the growth of large-scale enterprises. Secondly, the recruited managerial resources have to go through a long process of learning, integrating with the management team before releasing management capabilities. The complex systems, inefficient communication channels, out-dated corporate culture, and others will bring barriers on mutual understanding and adjustments for the new management resources in the large-scale enterprises.

Empirical test of Penrose effect Researchers have performed a large number of case studies and econometric analyses on the Penrose effect. Sheen analyzes the growth process of 4,000 manufacturing plants of Massachusetts, United States (Shen, 1970). The result showed that expansion of scale would generate profits in a short time. However, a growth downturn occurred in the subsequent period. The Penrose effect is tested using empirical data. Orser performed similar research in 2000 (Orser et al., 2000). Analyzing 1004 Canadian enterprises, Orser found that 3/4 of the enterprises could not achieve consecutive growth in more than two years. In recent years, researchers verified the Penrose effect with different indicators. Tan and Mahoney (2003) studied Japanese-funded enterprises in the United States in 2003. They collected 120 Japanese companies in 1978–1990 in the United States as samples. They selected two four-year cycles in measurement: the first four years since their establishment and the following four years. They found most enterprises couldn’t achieve sustainable high-speed growth in both two periods. Penrose effect is more

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obvious in the industries with high globalization levels, intensive tacit knowledge and trade union. Their research shows that the Penrose effect adversely affects international business and strategic management areas.

Theoretical Analysis of Failure of Fast-growing Enterprises Over the past decade, Chinese economy has entered a new round of high-speed growth. Some private enterprises began to pursue so-called “super high-speed development” in a good macroeconomic situation. At the end of the last century, there was a pick up in mergers and acquisition activities in the Chinese capital market. However, some large conglomerates, such as “Delong”, “HongYi”, “TuoPu”, have collapsed in a few years after rapid expansion. Their failure can be well explained by the Penrose effect.

The impetus of expansion In early stages of business growth, the entrepreneurs play a very important role in finding business opportunities. The managers are driven not only by maximizing profits, but also by the combination of resources during business expansion. When the internal resources are abundant, the surplus managerial capacity will become the impetus of expansion, the enterprises tend to expand. In this stage, the driven expansion effect of management resource will stimulate business growth.

The binding effect of management resource Many changes happened during the period of high-speed growth, such as purchase of more production facilities, increased number of employees, high inventory levels, acceleration in cash outflow, sales growing faster than the growth rate of production capacity, lagging management capabilities in coordination and control. The Bason College of the United States surveyed hundreds of founders and presidents, whose enterprises achieved annual growth rates of over 30%, identifying a set of problems during periods of high-speed growth. The Presidents pointed out a set of prominent phenomenon during periods of high-speed growth: overloading opportunities, excessive capital, inconsistency between cash consumption rate and recovery rate. They found that, with the rapid growth, it was difficult to establish an effective control system. The inconsistency emerged in accounting, inventory, procurement, transportation, counting and so on. If it cannot be dealt within time, the inconsistency is likely to lead to operation confusion and even to eventual collapse. For example, Tsingtao Beer Co. Ltd grew rapidly after raising nearly 1.6 billion from capital market in 1993. It acquired nearly 50 breweries from 1993 to 2001, guided by the rapid expansion strategy. Complex organizational structure required the management

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to shape up in tandem; however, its management capabilities lagged the rapid increase of material resources, resulting in declining profits. Its stock price fell from 8 Yuan to 1 Yuan in 2001. Until the new executive took measures in controlling the expansion scale, the company was stuck in the high-speed trap. In their rapid growth period, enterprises have sufficient funds for purchasing plants, equipments, and other material resources. At the same time, the management of allocation and integration is growing with difficulty. However, the management capacity of managers cannot be improved correspondingly in a short time. There are two main reasons: Firstly, the managerial level of existing managers is constrained by their own education experience and knowledge, which is difficult to improve in the short term. Secondly, training and integration with new managers would spend time and energy of existing managerial groups, which would reduce the entire management services level. The faster the rate of enterprise expansion, the more obvious the constraint effect on managerial capability. Therefore, if companies ignored the issues of inadequate managerial capability during expansion, the cumulative management resource would be depleted, producing the decline of the enterprises. This phenomenon is more pronounced during the development of Chinese private-owned enterprises, which have a similar development process: rapid rise and rapid decline, demonstrating the trilogy of “establishment, rise, and decline”.

The Necessity of Controlling the Growth Rate The growth of enterprises is also the process of exploring appropriate path based on their own resources and abilities. Generally growth-oriented enterprises refer to those that have sustainable capability on tapping unused resources, in the long run (such as more than five years).a Only when enterprises maintain potential capability in aspects such as in future productive capacity, asset size, market share and profit and so on, can they be deemed to be growing. If an enterprise is only growing in sales or profit, the production capacity and asset size are not growing correspondingly, it does not constitute a growthoriented enterprise in a strict sense. Therefore, within the constraints of an enterprise’s internal resources, companies cannot achieve rapid growth only through unlimited recruitment. The enterprises will face the double challenges of adverse selection and moral hazard during growth. Adverse selection means increasing difficulty in finding suitable employees, allocating them to appropriate positions and providing adequate supervision. As the business grows faster, managers have less time in considering whether the candidates are appropriate, then the rate of choosing inappropriate candidates is higher. a Introduction by «Report on the development of chinese medium-small growth-oriented private enterprises in 2003». Written by the project group of «Research on development of medium-small enterprises». 2004.

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Moral hazard refers to new employees who are often lacking in incentives. So the enterprises often employ supervisory personnel (such as administrators) to manage new staff, ensuring that they are diligent. This practice will produce bureaucracy in organization and high cost of internal managerial resources. Adverse selection and moral hazard compel the enterprises to control growth rate, striking a balance between the consumption of managerial resources and the growth of enterprises.

Proposals on Growth Rate Controls Sustainable growth means keeping reasonable growth rate based on internal managerial resources, not seeking maximum growth rate. Therefore, we opposed seeking growth for its own sake and ignoring the efficiency of internal management resources. So the enterprises should strike a balance between growth rate and the quality of growth.

Maintain a growth rate of management capacity higher than that of expansion As the Penrose effect demonstrates, internal managerial capacity determines the limitation of growth. Therefore enterprises should maintain the growth rate of management capacity higher than the growth rate of expansion. In Fig. 3, when the curve of management capability is higher than the curve of expansion, the enterprise is in its earnings space. C0, C1, C2 are the intersections of the growth curves B0, B1, B2 (in different scales) and curve AA (managerial capacity curve). The enterprises are well balanced at point C0, the intersection of B0 and AA. If the enterprise scale is over q, the internal management capacity will be difficult to support expansion. The growth rate will decline, entering into the deficit space between AA and B0.

Growth of scale

B1

B2

B0 Enterprise Scale

A Managerial Capability q Earnings space

Deficit Space

C1

A

C0 Balance Point

D2

D1

D0

Time

Figure 3: Analysis on Deficit space and Earning space.

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Cultivating internal management teams Within the enterprise, in addition to the entrepreneurship of founders, the management teams are important sources of managerial resources, which constitute the foundation of internal cooperation and coordination, as important organizational capital. The management teams’ professional experience and managerial skills decide the growth potential of enterprises. Therefore, the management teams are one of most valuable resources in enterprises. There are two ways to establish management teams: internal and external. Although the external way could alleviate the scarcity of human resource in a short time, but it requires a long period of inspection, training and cultural integration, which will bring about high dynamic adjustment costs. Cultivating management teams from internal employees is low-cost, low-risk; constitutes a form of incentive mechanism; but it also expends much time in screening and promotion. Therefore, the enterprises should pay attention to cultivating management teams before expansion, making good preparation for fast-growing process.

Entrepreneurship: The need to transition from the non-rational to the rational phase At the start stage of the enterprises, entrepreneurship played a crucial role, whose risk preferences, personality, innovative talent, knowledge show great impact on enterprises. However, when companies come into the diversified stage, restricted by entrepreneurs’ education background and experience, the traditional management style may be unsuitable for growth. Moreover, in most places of China, they have not built good external markets of introducing professional managers. The companies cannot find good managerial service from the external way. Therefore, the entrepreneurs should upgrade their knowledge and managerial ability in time, especially in fast-growing enterprises. Firstly, the entrepreneurs should update their knowledge continuously, improving the capability in dealing with risk and opportunity. Secondly, entrepreneurs should maintain the spirit of innovation, promoting the spirit of innovation to production capability, achieving sustainable development of enterprises. Thirdly, entrepreneurship should transplant to the enterprise culture, putting individual personality rooted in formal systems.

Strengthen the construction of the professional managers markets There is a basic hypothesis implied in the Penrose effect: an effective external professional manager’s markets. When internal managerial resources are inadequate, the enterprises could recruit professional managers from external markets. Therefore, the construction of

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managerial resource market is a necessary condition for sustainable growth. Government should take measures on cultivating good market environment for absorbing professional managers.

Conclusion This paper analyzes the constraints effect of managerial resources during the highspeed growth of enterprises, which could result in enterprises descending into a low growth stage because of the excessive costs of managerial resources. In the long term, the growth of enterprise is a dynamic evolution process from unbalanced to balanced resources. The companies may re-enter the high-speed growth stage after overcoming the managerial capability bottleneck. But overall, management capabilities decide the quantity and quality of services of other resources, restricting the speed of business growth. Therefore, enterprises need to accumulate managerial capacity in order to achieve sustainable growth.

References Foss, NJ (1998). Edith Penrose and the Penrosians. Druid Working Paper, No. 98–1. Orser, BJ, S Hogarth-Scott and AL Riding (2000). Performance, firm size, and management problem solving. Journal of Small Business Management, October, 42–58. Penrose, E (1959). The Theory of the Growth of the Firm. Oxford: Oxford University Press. Shen, TY (1970). Economies of scale, Penrose effect. Growth of plants and their size distribution. Journal of Political Economy, 78(4), 702–716. Wang, Qingxi (2004). Enterprise resource and Business growth [J]. Journal of Business Research, 15(8), 109–110. Xu, Zongling and Yanhua Li (2005). Expand study on “Penrose Effect”. Journal of Central University of Finance and Economics, 3(5), 67–70. Yang, Du (1996). Research on growth of Business. China People’s University Press, Beijing. Zhang, Baogui (2006). Research on Penrose effect and relax way during expansion [J]. Journal of Modern Management Science, 154(1), 34–35.

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Labor Relations Under China’s Mixed Economy ͣTIANDE LI and RUIQIN ZHANG Sichuan University

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rofessor Li Tiande is the Professor and Dean of School of Economics, Sichuan University, China. He was also the Dean of College of Economics and Management, Sichuan University from 1995 to 1997. Prof. Li obtained his PhD from Department of Economics, Sichuan University in 1997. The research and teaching areas of Prof. Li are: Labour & Social Security System; Statistics in World Economy; World Economics; International Finance. At the PhD level, Prof. Li teaches theoretical research on world economics and theoretical research on international finance; at the Masters level, he teaches statistics of world economics, theoretical research on world economics and theoretical research on international finance. Prof. Li is the council member of China Association of European Studies, Association of International Finance in Central & Southwest China, Committee of Finance Studies of China Association, Association of Finance in Sichuan Province, and also the fellow of Scientific and Technical Consultative Group of Sichuan Provincial Government. Prof. Li’s major publications are: On the Environment and Effect of Foreign Direct Investment in West China, Sichuan University Press, 2003; Study on World Economy, Sichuan University Press, 2000; On the Control of Money Supply, Sichuan University Press, 2000; World Economy Towards the 21th century, Sichuan University Press, 1997; On International Finance, Sichuan University Press, 1994; GATT & China’s Economy, Sichuan University Press, 1993; Statistics in International Trade, Sichuan University Press, 1992; On World Economy, Sichuan University Press, 1992. Professor Li led and participated various research programs, such as A Financial Study on Money Washing and its Countermeasures — a state program in social science in 2005; Impact of WTO on Sichuan’s Major Industries and Countermeasures — a key program in social science in Sichuan Province in 2003; Patent System and Improvement of Competitiveness in Sichuan — sponsored by China’s State Bureau of Intelligence Property Right in 2003.

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In the past five years more than 30 essays have been published in various academic journals.

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s. Ruiqin Zhang is currently a postgraduate majoring in World Economy, School of Economics, Sichuan University. From 8 January 2007 to 15 June 2007, she studied in the University of Gavle in Sweden as an exchange student majoring in Industrial Economy. Her undergraduate campus life was also spent in School of Economics, Sichuan University, majoring in International Trade. Ms. Zhang has been awarded many times for her excellent professional performance, such as 1st grade scholarship of Sichuan University, Excellent Student of Sichuan University, National Scholarship and the Mitsubishi Bank Scholarship, etc. Ms. Zhang is a fluent English speaker, and has been awarded the Special prize in 2004 National English Contest for College Students. She participated in the research of projects since she was a postgraduate. She took part in the research of a major project granted by the State Social Science Fund: the cyclical and non-cyclical fluctuation of world economy and the early-warning mechanism construction of Chinese economy as a formal member of the 1st subproject, conducting research on the economic cycle theory. In September 2007, she had the opportunity to be a formal member of the project “Research of the Debt Problem of Finance Department of Chengdu High-tech Industrial Development Zone”. She is now mainly in charge of the investigation of the target zone’s debt situation. She will be submitting a report based on the results thereafter. Ms. Zhang enjoys traveling, listening to music, skating and playing badminton. She also enjoys watching football and basketball.

Abstract: In recent years, with the advent of China’s economic reforms, particularly SOE (state-owned enterprise) reforms, the mixed ownership economy has been growing rapidly. At the same time, labor relations in China have changed a lot. Under the current socialist market economy system framework, the actions of state-owned and private enterprises are becoming more homogenous. Be they public or private enterprises, the intensification of labor conflicts has become a major obstacle to a harmonious society. Labor relations tend to intensify, and the conflicts more acute. In the past, we refused to admit or overlooked the complexity of this problem, whether consciously or unconsciously, when in actual fact labor conflicts have intensified in the whole country. Within the first quarter of 2007, there were 75,000 labor disputes cases involving 142,000 workers at all levels for the arbitration committee to deal with. In the long run, we must set up an efficient mechanism which can coordinate the interests of both parties (labor and capital),

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strengthen the management function of the government, speed up the construction of relevant labor-relation laws, implement the law strictly and abolish the old ideas of both enterprises and workers so as to solve the labor conflicts, establish harmonious labor relations, and allow the economy to develop in a sustainable, stable and harmonious manner. Keywords: Mixed ownership economy; Labor relation; Labor conflicts; Solutions

Introduction Definition of labor relations Generally speaking, labor relations only refer to those in private enterprises, it is a conception on the relations between capital and labor, and the mutual rights and obligations between employees and employers necessary to realize the production process. In this labor relation, employers are owners of capital, and employees are owners of their labor; employers maximize profits, while employees maximize wages. On the one hand, they are contradictory because costs and profits are contradictory, one side cannot realize its interests without the existence of the other side. Hence, it is only through coordination of the two parties, can the equilibrium point be found. The use of the term “labor relations” was initially in the context of class confrontation and interest conflicts between employers and employees. However, labor relations in this article refer to those in all enterprises of China’s socialist market economy, not only in nonpublic owned ones. Actually, although we have been accustomed to refer to labor relations generally as those in private enterprises, there are now few differences between labor relations in public ownership enterprises and in private enterprises after public owned enterprises have been reformed, and the only difference is that they have different capital providers. Nevertheless, labor relations in our mixed ownership socialist market economy do not result in class confrontation, as the two sides only stand for different production factors, i.e., capital and labor; the conflicts between them are mitigated by laws and social culture.

Conflicting labor relations vs harmonious labor relations Labor relations conflict includes dominant conflict and recessive conflict; it indicates large divergences of the two parties’ interests, objectives, and expectations. In a dominant labor relations conflict, employees quit, go on a strike or resist; employers shut down factories, punish or fire employees. In a recessive labor relations conflict, employees go slow, become absent from work, or show a bad performance; employers elbow out or deal with employees arbitrarily. A harmonious labor relation means that the two parties co-produce products or service in an employment organization, observe the system and rules that they negotiate

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and set, and stipulate in a formal collective contract or labor contract the rights and obligations of each party. Specifically, there are two modes: will harmonious and nonwill harmonious. For the former, the two parties trust each other, cooperate and share information with each other, employees tend to be active and creative, and the enterprise has high production and good performance. For the latter, the two parties have some divergences in interests, objectives and expectations, but are forced to cooperate fairly and actively with each other.

Status Quo of Labor Relation in China’s Multi-ownership Economy Actions of public-owned and private enterprises tend to be similar With the development of reform, the number of non-public enterprises, fields they occupied and labor force they absorbed all have increased quickly. Meanwhile, SOE reforms that aim to decrease its number, improve its quality have also reduced the proportion of SOEs in national economy. Well then, does employee identity have any major differences in different ownership enterprises? What about labor relations? Traditional theory deems that there is no exploitation in public-owned enterprises, employees get payment according to their work, put in the best and enjoy high salaries, and enterprises have good performances; while in private enterprises, it is the opposite. However, with the development of economic system reform, nowadays actions of the public-owned and the private enterprises tend to be quite similar. In the few remaining SOEs, buying employees’ working year and abolishing workers’ mastership identity are also going on. Meanwhile, unemployment insurance is put into practice in all enterprises without any ownership discrimination. All the changes lead to disappearance of the workers’ identity difference in different ownership enterprises. At the same time, out of considerations for a steady income, workers increasingly think more in terms of enterprise performances and enterprise scale instead of enterprise ownership, and this fact has effectively proved the aforementioned similar-action tendency. Actually, it’s not difficult to understand the similar-action tendency: firstly, under the socialist market economy framework, for one thing, there is no difference with market’s adjustment function to different ownership enterprises which have equal status in a market economy; for another thing, whatever ownership it is, the enterprise is an organization that pursues maximum profit; so there is no difference in their profit pursuit behavior. Secondly, under socialist market economy, whatever ownership it is, all the enterprises want to get workers they need at the minimum expense; in the meanwhile, workers only care about which enterprise can give them the highest payment for the same labor, but not about what kind of ownership it is. Workers’ pursuit of maximum payment for the same labor and fluidity of labor will surely lead to the “average salary rate”, that is, the same payment for the same

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work, which means workers can have the same payment with the same work in different ownership enterprises. Since there is no difference with worker’s payment in different enterprises, then the saying can’t be true that “payment in public-owned enterprises is distributed according to work while that in private enterprises is distributed according to productive factors, which is the monetary representation of labor value”. Even if we admit it’s true, the so-called difference actually is meaningless, it’s only a theoretical abstraction or a deductive conclusion, and it can’t change the fact that they are practically the same.

Problems of labor relation in China’s mixed ownership economy In reality, labor conflicts are getting more acute in China, and the number of labor dispute cases is very large. According to the Department of Labor and Social security’s statistics of the 31 provinces, autonomies, Xinjiang production construction corps, and cities that are directly under the jurisdiction of central government, there were 314,000 labor disputes cases involving 744,000 workers for the arbitration committee at all levels to deal with in 2005, among which, there were 19,000 collective labor dispute cases involving 410 workers, and 92.3% of the cases had been concluded. Besides, the Committee dealt with 94,000 more cases that weren’t put on record.a The Labor and Social Security Development statistics Newspaper (2006) indicated that there were 447,000 cases for the Committee to deal with in 2006, and increased by 9.9% compared with 2005, among which, 130,000 cases weren’t put on record, while 317,000 other cases involving 680,000 workers were. Among the 317,000 documented cases, there were 14,000 collective labor dispute cases and involved 350,000 workers.b All the above statistics show that there are many complicated problems within the enterprises, especially private enterprises of China. Generally speaking, the problems mainly are as follows: (1) Labor contract signing rate is low, and the labor contract itself is not normative. It’s popular for enterprises in China, especially private enterprises, to hire employees with no contract. According to the investigation, some employers don’t want to sign a contract with the employees so that they can fire them at any time without any legal punishment; some enterprises treat their employees differently, that is, with managers and technological workers, they sign a contract with them, but with ordinary workers, they don’t. Furthermore, the contract of large number of enterprises is not normative, because it unilaterally emphasizes obligations of the employees and thus put the labor contract out of action. (2) Social security covering rate is low. Insurance of the private enterprises only covers few fields, mainly endowment insurance, and there are almost no enterprises a b

http://www.molss.gov.cn/gb/ywzn/2006-06/08/content_119054.htm. The Labor and Social Security Development Statistics Newspaper, 2006.

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providing fecundity insurance, medical insurance, unemployment insurance and accidental injury insurance for their employees. It’s relatively a better case in this aspect with the SOEs. (3) Working condition is bad and unsafe. Owing to the small scale, working condition of the enterprises, especially those in their early stage, is really bad and unsafe. First, workers are overburdened to work overtime; secondly, the salary is low, and often in arrears or deducted for no reason; thirdly, working condition is unsafe, lacking necessary safety and protection measures. (4) Efficiency of the labor union is low. More and more infringement and labor dispute cases indicate that the labor union is very weak in protecting worker’s rights, and can’t fulfill its objectives in the Labor Law or the labor union’s regulations. With the SOEs, there are labor unions, but few can exert any overarching influence; with private enterprises, there are usually no labor unions, and even if there is, it lacks the ability to coordinate labor relations. To sum up, infringement of employees’ rights is the main form of labor conflicts in China’s enterprises, while at the same time, more and more employers and their property are threatened due to labor disputes, especially for the private enterprises. Therefore, we must protect the employees’ rights on the one hand, and also give some attention to protection of the employers’ rights on the other hand, so that we can settle the labor disputes of enterprises in China, establish harmonious labor relation, and thus ensure the sustainability of China’s economic development.

Reasons of Labor Conflicts in China’s Mixed Economy At present, under the mixed ownership co-existing framework, reasons for labor conflicts in China are complicated: some are systematic reasons, while some are not; some are historical reasons, while some are practical reasons. To conclude, the main reasons are as follows: First, relative strength between the two parties is off-balance. According to W. Arthur Lewis, in underdeveloped countries, if there is enough surplus agricultural labor while there is inadequate capital to absorb it, then payment for the labor will be low in quite a long time, and thus make it hard to realize an equal labor relation due to the imperfect labor market structure. Nowadays, China’s labor force market is in a state of surplus, and especially, most private economy is at the beginning stage of development, so the weakness of Chinese labor is even more obvious, and it’s mainly embodied in the following aspects: (1) Labor relation is not equal. Owing to the fact that capital in China is relatively rare while labor is ample, the strong capital-weak labor state of affairs will last for a really long time. According to the investigation and analysis of Social Security Department, until May 2006, there were 0.15 billion rural labor going out to work, and 0.1 billion rural labor working in the cities. Experts predict that, in a certain period, if there is no

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big change in the government policy, the rural labor force will increase by 5 million on average every year.c (2) Labor relation is not stable. For the moment, most enterprises in China are in the labor-intensive industry, and in order to react to adverse market changes, they often reduce the number of assets or human resources specially to retain flexibility in price, product amount and salary adjustment. Therefore, most enterprises lack long-term, steady labor relation development strategy; this thus led to labor relation problems, such as not signing contracts, decreased expenses in safety and employee training, or failing to pay employees on time. (3) Labor is unorganized. Imbalance between supply and demand, low quality of the labor structure lead to the result that enterprises not only have much options in labor choosing, but also can decide the distribution form unilaterally. A majority of employees can only latch on to the enterprises, and thus make them compete with each other more than uniting together. Besides, under the influence of traditional culture, employees often try to please their employers instead of solidifying employee unions to improve their status. Therefore, this unorganized status elevates the position of the capital owner vis-à-vis labor, and employee’s working conditions and legal rights cannot be adequately expressed in an organized way. Secondly, there is obvious “failure” in government intervention. Government’s management belief and action are inconsistent with the objectives of public interests. Due to the deficiency of China’s achievement-based assessment system, Chinese government at all levels often only pursue economic acceleration and regard it as the core objective, and thus have cognition mistakes. Regional government are often worried that intervening in enterprises’ infringement of employees’ rights might influence economic development, and strengthening regulations of private labor relation might make employers transfer capital and invest in other places, and then influence the realization of native GDP increase and tax collecting objectives, and finally influence their own achievement assessment results. Some even think that employer’s exploiting employees and infringement to employee’s rights is the necessary price of economic development. With this motivation, some regional government take no action or little action on enterprises’ infringement. At present, the market economy system of China is imperfect, and government should have played a major role in coordinating labor relation; however, government’s action has further strengthened employer’s dominating status in labor relation instead. Thirdly, there are systemic inadequacies, and relevant laws and regulations are imperfect. We acknowledge that the passage of “Labor Contract Law of the People’s Republic of China” by the Standing Committee of the People’s Congress in the 28th Conference (will be put into practice on 1 January 2008) has greatly offset systemic c

Sharp Register Grimes: Social Problem Economics [M]. Beijing: Renmin University of China Press, 2000.

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inadequacies; however, labor legislation of China is still relatively slow, other laws that are relevant to rural workers’ rights like “labor Employment Law”, “Social Insurance Law”, “Labor Supervision Law”, and “Labor Disputes Settlement Law” have not come into being at all. Besides, the existing laws and regulations pertaining to labor relations are imperfect, and are mostly some labor standards; a complete legislation system is deeply lacking. What’s more, the existing laws and regulations of China fall behind the status quo of enterprise labor relation development, and lack maneuverability. Meanwhile, the labor relation adjusting system basically takes particular labor relation as adjusting objectives, and hasn’t provided any legal base to form collective labor relation adjustment mechanism according to requirements of market economy development. Fourthly, labor supervision is inadequate. According to statistics of the Department of Labor and Social Security, up to the end of 2005, there were 3 , 201 labor security supervision institutions, and 20,000 professional supervisors.d According to international standards, there should be one supervisor for every 5,000–10,000 people, and even if we take the ratio as 10,000 to one supervisor, there is still a shortage of at least 7 , 476 supervisors. Under these circumstances, it will be hard for the labor supervision department to overlook or investigate enterprises’ execution of laws and policies on labor contract, payment, and labor protection. This reality makes the labor relation situation even worse: employers can do whatever they want and employees’ rights can’t be protected, and thus labor relation tends to get fiercer, labor disputes increase, and some places even have employees appealing to higher authorities for help. Fifthly, organizations of the two interest parties are problematic. On the one hand, labor union is really weak in protecting worker’s legal rights. In reality, its function is only confined to routine tasks, such as disbursing workers welfare allowance on certain festivals or participating in the aftermath of fatal work accidents; its main functions, that is, negotiating and right protecting functions have been extremely weakened. Moreover, some labor union chairman might even be arranged by the employer, but he would hardly be independent, thus the labor union is actually rather a tool management uses to improve economic benefits than an organization to protect employees’ rights. On the other hand, employers always dominating in the labor market, and regional governments’ objectives diverging with public management objectives meant that employers face weak opponents in labor conflicts; without strong external pressure to form an organization, it develops even more slowly.

Ways to Solve Labor Conflict Problems in Enterprises of China One of the most important points of establishing a harmonious society is to make the labor relations harmonious. Due to the above reasons we’ve stated, labor relations in the enterprises of China tend to get acute, labor disputes increase. Not only have labor d

The Department of Labor and Social security: China’s labor and Social Security Situation [ N ]. China Social Security Newspaper, 2002–05–09.

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conflicts damaged the employees’ interests, they’ve also influenced the employers’ interests and enterprises’ development, and hampered the quick development of economy. In the long run, labor conflicts will also become an unsteady factor, and hamper the operation and development of national economy. Therefore, to settle labor disputes and establish harmonious labor relation is one weighty question that China faces. To settle labor disputes, soften labor conflicts, and coordinate labor relation, we have to base on China’s own situation, consult other countries’ mature, feasible practice, and gradually establish a long-term efficient mechanism that can coordinate the two parties’ interests. To be specific, we should get down to the following aspects: Firstly, we should strengthen government’s responsibility in coordinating labor relation, make full use of its monitoring and regulating function, establishing harmonious labor relation. (1) Transform government’s management beliefs, correct government’s objectives. To begin with, government should reform its civil servant assessment standards, transform it from emphasizing economic acceleration and growth index into truly accelerating development of social economy and improving the whole society’s welfare, and regard establishing harmonious labor relation as an important task of establishing a harmonious society. At the next stage, government should change its viewpoint of achievement and economic development, such that the aim of productivity development is to improve the welfare of its people as a result of developments in economy, politics and culture. What’s more, we should establish the new thinking that coordinating labor relations serves to improve the investment climate, reduce social costs, and it’s good for the harmonious development of economy and the society. Finally, government should emphasize that enterprises, especially private enterprises, take on corporate social responsibility. (2) Accelerate construction of relevant laws and statutes, and regulate market action and market order. According to the problems of labor-relation related laws, on the one hand, relevant department should modify and improve certain laws and regulations that are not in line with the recent development of labor relation; on the other hand, they should enact laws on labor relation coordinating mechanism and laws emphasizing employees’ interests, such as “Strike Law”, “Accidental Injury Compensation Law”, “Disease and Disable Security Law”, “Labor Supervision Law”, “Minimum Wage Law”, “Labor Action Law”, “Labor Dispute Arbitration Law”, etc., try their best to be specific in content, and pay attention to supervision system and dispute settling system in implementations. What’s worth mentioning is that China has already had a very good beginning: on 29 June 2007, “Labor Contract Law of the People’s Republic of China” has been passed by Standing Committee of People’s Congress in the 28th Conference, and will be put into practice from 1 January 2008. It’s been another milestone in the social security law construction history, it has adhered to the basic framework of the labor contract system that was stipulated in “Labor law of the People’s Republic of China” which was put into

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practice since 1 January 1995, also according to problems that existing labor contract system has encountered in the enforcing process, such as some enterprises not signing up written contracts as is prescribed in the law, abusing probation and labor dispatch, and restricting workers’ freedom to choose and legal flowing of labor, etc., it has emphasized the legal obligations of enterprises’ not signing contracts, regulated labor dispatch, and strengthened protection for workers on probation. For instance, it stipulated in the 7th article that “An employing unit has established labor relationships with laborers from the date of use of labor services”e; the 17th article specifically stipulates what terms and conditions should be contained in a labor contract, and thus strengthens its maneuverability; the 25th article stipulates that “Unless in the circumstances prescribed in Articles 22 and 23 hereof, no employing unit may agree with the laborer on the full responsibility of liquidated damages by the laborer”,f which means employees could terminate their contract with employers without worrying about paying for breaching expenses for the first time. Of course, the law has also added certain articles to protect employers’ rights and interests according to the reality, which shows that the law is aiming to establish and develop harmonious steady labor relations, and accelerate the construction of a harmonious socialistic society. In order to protect employers’ business secrets, accelerate innovation and fair competition, the law first stipulates competition confinement system; in order to accelerate enterprises’ structure adjustment and participation in market competition, the law legally loosens the terms and conditions for employers to terminate a labor contract, etc. Even so, China still needs to strengthen and accelerate construction of relevant laws, and make it better and normative. (3) Strengthen enterprise supervision. Labor supervision is an important way for the government to intervene in matters concerning labor relations and protect worker’s interests, and also an important means to guarantee labor law can be practically enforced. According to development of native enterprises, each region should properly add labor supervising force, go on a periodic inspection to check on enterprises’ execution of labor contracts, strengthen daily management intendance, and try to settle labor disputes within the enterprise, so as to reduce social costs and prevent labor disputes from evolving into some malignant incidents. Secondly, we should accelerate formation of the two parties’ collective negotiation organization, especially the independent strong labor union. (1) Establish and develop a strong labor union. To begin with, we should establish all kinds of labor union and absorb as many employees as possible. Although establishing rate and membership of the labor union is not the key factor that decides whether labor union can play a big role in coordinating labor relation, we have to establish strong independent labor union that truly stands for employees’ interests in the first place to change the obvious adverse status of one single employee in labor relation. In China, e f

“Labor Contract Law of the People’s Republic of China” (2007) the 7th article. “Labor Contract Law of the People’s Republic of China” (2007) the 25th article.

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there exist certain problems, for example, management scale of some enterprises is small, number of employees is small, enterprises’ managing scale being small, extraneous workers have high fluidity, labor union is weak in protecting employees’ rights, etc., and according to the above problems, we could choose to establish different organizational forms of labor union, like industry labor union, regional labor union or associated labor union, etc. In particular, many private enterprises’ employees come from peasants; they don’t have much collective consciousness and the habit to organize. Therefore, native governments should adopt certain stimulating mechanism to attract employees to join labor union. For example, government can provide some service discounts for the employees that have joined labor union, or prescribe that such problem as employers’ firing employees or changing salary should be reported to industry or associated labor unions and put on records to examine, and thus unify the interests of employees and labor union. In turn, we should establish independent strong labor union. After all kinds of labor unions are founded, government should transform its focus to strengthen independence of labor union, intensify cadre training, improve collective negotiation ability and work efficiency, and thus enhance its member protecting function in establishing, enforcing employee salary standard and settling labor disputes. (2) Accelerate formation of employers’ organization. The core of labor relations is that the two parties have equal rights and interests. Only when their strengths are balanced on the whole, can there be a harmonious situation. Therefore, we should also establish employers’ organization besides a strong labor union. At present, the government can reorganize the organizational resources such as existing industry association, accelerate development of employers’ organization through the innovation of organizational principles, and establish the other important entity in labor relation adjustment system. Thirdly, transform the old idea of both enterprises and employees, and establish harmonious enterprise culture. (1) Enterprises should play a major role in establishing a harmonious labor relation. To begin with, owners and managers of enterprises should establish correct managing belief, and look to the long-term development of enterprises. In order to improve enterprise economic benefits, get more profits, enterprises should respect, understand, care about the employees, and by alleviating workers’ burden, improving workers’ living condition, stimulating workers’ activity, enterprises can be stronger, bigger and last longer with the harmonious cooperation with workers. Following that, enterprises should strengthen their legal consciousness, pay attention to, observe and execute relevant laws, regulations, standards and statutes, respect employees’ personality, and truly protect employees’ legal rights and interests in all the respects of labor relation. (2) Employees should also make great efforts to establish a harmonious labor relation. For one thing, employees should actively learn some basic legal knowledge, strengthen their consciousness to protect their rights and interests legally, and prevent their rights and interests from being infringed on this basis. For another thing, employees should form a good habit which will do much good to themselves and others, that is, as

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workers of the enterprises, they should establish the idea that enterprises’ performance has everything to do with themselves; as members of society, they should create wealth for all while enjoy social affluence. Lastly, China could also learn from international practices and set up a labor court, an important institution to settle labor dispute cases. Till date, China does not have any special labor court. The existing system to handle cases of labor dispute is one of “one arbitration and one adjudication”; labor arbitration refers to prepositive legal proceedings. It is extremely inefficient for a party to go through arbitration and adjudication procedures in turn. Therefore, China could also follow the lead of international practice and set up a labor court, so as to protect the rights and interests of weaker elements in society, ameliorate destabilizing factors, and accelerate social development.

References Ansel Miree, Sharp (2006). Economics of Social Issues (M) (Translated from English to Chinese by Qingwang Guo, Weiwei Ying et al). Beijing: Renmin University of China Press. Labor Contract Law of the People’s Republic of China (2007). Liang, Qihui (2005). Government’s Orientation in Coordinating Labor Relation in Private Enterprises, Development of Economy and Society, vol. 3, No 11. Liu, Ying (2006). Construction of Coordinating Mechanism of Labor Relation in Private Enterprises, Scientific Socialism, No. 6. Liu, Ying (2006). Government and Labor Relation in Private Enterprises, Changchun Normal College Transaction (Social Science Edition), vol. 25, No. 6. Min, Zhenglian (2005). Coordinate labor relation in enterprises and accelerate social harmony. Productivity Research, No. 2. Ministry of Labour and Social Security, National Bureau of Statistics: the Labour and Social Security Development Statistics Newspaper (2006). Published on 2007-05-18. Project Team of Sichuan Provincial Party School, Investigation and Research on Status quo, Tendency, Solution of the Labor Relation in Sichuan Province, Transaction of Sichuan Provincial Party School, No. 1, 2006. Qin, Lu (2005). Problems and Solutions of Labor Relation Existing in Private Enterprises, Exploration of Economic Problems, vol. 9. Qin, Luoyue (2006). Property of Capital and Labor Relation, Haerbin College Transaction, vol. 8. The Department of Labor and Social Security: China’s labor and Social Security Situation (2002). [N]. China Social Security Newspaper. Date 2005-05-09. Xue, Lianhai (2007). Strategical Thinking on Harmonious Function of Labor Relation in Private Enterprises of China, Economy of Special Zone, vol. 2. Yang, Junqing (2005). Establish new Labor Relation in Non-Public-Owned Enterprises, China Operation Economy, vol. 6. Yao, Xianguo (2007). Coordinate Labor Relation, Establish Harmonious Enterprises, Zhengjiang Economy, No. 2.

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China’s Strategy in Acquiring Oil, Gas and Other Energy Resources : A Study of Impact on FDI ͣSIKANDER KHAN Fudan University

D

r. Sikander Khan is the Professor and had been the former Dean of Stockholm University School of Business for nearly nine years and Chairman of the Board for seven years. Dr. Khan received his PhD from Stockholm University. At present he is the Professor at the Fudan University School of Management, Shanghai, China. He specializes in industrial strategies and policies,project and risk management, brand management and international marketing, competitive intelligence, entrepreneurship and innovation process, M & A, FDI, joint ventures, knowledge-based outsourcing, and technology transfer, and has undertaken substantial empirical research in these fields. He has published over 50 papers and 4 books, and has frequently lectured on these topics at universities and organizations worldwide. Dr. Khan moved to Shanghai this January 2007 with his family. He has been teaching during the last three years in China as fly-in and fly-out faculty for various universities. Dr. Khan has worked for nearly ten years as Chief Technical Advisor for United Nations Industrial Development Organization (UNIDO) in many parts of Asia and Africa. He has also worked for five years on FDI projects in Japan. Since 2005, Dr. Khan is working as a senior advisor for several prestigious Business Schools such as the Stockholm School of Economics (EQUIS accredited), and Uppsala University, Universidade Nova de Lisbao, (EQUIS accredited), Portugal, NMIMS in Mumbai and Korea — EU EMBA, Seoul in designing and delivering their Executive MBA Global and Senior Executives Training Programs in China, India and various other countries in the world. He has been the Program Director for several Executive Training Programs among other in the Chinese telecommunication industry (Motorola and Ericsson). Professor Khan speaks 10 languages and has travelled to over 150 countries.

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Dr. Khan is Chairman of the Sweden Asia Business Education Center (SABEC). He sits also as the Board member of STCC (Sweden Thai Chamber of Commerce) and the Advisory Board of Shanghai University MBA Center. He is also a member of the International Advisory Board of Groupe ESC Rouen, Rouen School of Management, France, Institute for Integrated Learning in Management (IILM), New Delhi, India, and Superior University, Lahore, Pakistan. Dr. Khan is a Standing Member of the Council of Guangdong Academy of Social Sciences, China, Chairman of Peak Education AB and Board member of Fianchetto Venture Capital AB, Life Science Investment Management. Abstract: During the last two decades China has been experiencing a rapid economic growth. In 2007, the GDP is expected to grow at an annual rate of nearly 11%. This rapid economic growth requires, among others, vast amount of energy and industrial raw materials. Current estimates indicate that about 20% of China’s energy needs cannot be met and that it will be necessary to double energy generation capacity every decade to meet rising demand. Since 1999, China is a net energy importer and China’s energy production has been insufficient in meeting the country’s energy consumption demands. China is investing heavily in developing oil and gas fields in and outside of China. Large investments have been made in M & A not only in energy resources, but also in acquiring other strategic industrial raw materials. Heavy investments have been made in developing harbors, LNG facilities, railway lines, oil and gas pipelines in and outside of China. China is also facing environmental and pollution challenges due to its heavy reliance on coal and aging SOEs industries and fuel inefficient transport sector. Inflation is rising in China, government has imposed penalty on industries exporting goods using scarce energy resources and other strategic industrial raw materials. At present, for exporting goods that utilize scarce industrial and energy resources, companies have to pay from few percent to nearly 40% extra export duties in form of penalties. This peculiar situation makes the situation unbearable for foreign companies who invested in large capital intensive high-tech plants in China for supplying their products to the Chinese market and to the rest of the world. Several of these companies are now planning to move out of China and locate their production facilities including R & D elsewhere. Furthermore, these companies see no need to have manufacturing facilities in China, since the import duties are very low for goods imported into China which are energy intensive or high-tech. This paper examines in detail the short and long-term implications for China’s economic development. Keywords: Energy resources of China; FDI in China and foreign companies in China

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Introduction China’s GDP since 1978 has kept growing at a speed of nearly 10% per year. In 2007, the GDP is expected to grow at an annual rate of 11%. Total GDP for 2006 was 20 trillion Yuan (US$ 2.7 trillion). Per capita GDP stood at US$ 2,042 in 2006, up US$339, or nearly 20%, over that of the previous year (see Fig. 1). China’s inflation hits 10-year high of 7.1% in October 2007. During the past three years the Chinese Yuan has appreciated against the dollar by over 7%. Annual wages are increasing at a rate of 10% per annum.1 GDP of coastal provinces in china (2006): 1. Coastal North Heilongjiang

Xinjiang

Gansu

Inner Mongolia Ningxia

Qinghai

Jilin Liaoning Beijing BEIJING Hebei

3. Coastal South

Tianjin

Shanxi Shandong

Shaanxi Henan Tibet

Beijing: Rmb772.03 billion Tianjin: Rmb433.80 billion Hebei: Rmb1161.37 billion Shandong: Rmb1549.073 billion

Jiangsu

2. Coastal East Jiangsu: Rmb2154.80 billion Shanghai: Rmb1029.70 billion Zhejiang: Rmb1564.983 billion

Shanghai Hubei Anhui Zhejiang Chongqing Jiangxi Hunan Guizhou Fujian Yunnan Guangxi Taiwan Guangdong Hong Kong The total GDP of these provinces Macao and city is about 64.75% of the Hainan national GDP in 2006. Sichuan

Fujian: Rmb750.163 billion Guangdong: Rmb2596.855 billion Hainan: Rmb105.243 billion

Figure 1: Distribution of GDP in China. 2

China’s trade surplus reached US$ 185.65 billion over the first nine months of 2007, surpassing the total for last year, which was US$ 177.47 billion. Inbound FDI in 2006 has been about US$ 60 billion, whereas outbound M & A (mergers and acquisitions) during the same year were US$ 17.3 billion.2 According to the People’s Bank of China, the foreign exchange reserves reached US$ 1.43 trillion at the end of September 2007, up 45% from the same period last year. Over the first nine months of 2007, US$ 367.3 billion was added to China’s foreign exchange reserves. In September 2007 alone, forex reserves rose by US$ 25 billion.3

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On 28 September 2007 the People’s Bank of China inaugurated a state forex investment company called China Investment Corporate Ltd. (CIC), with a registered capital of US$ 200 billion. The CIC is set up to make better use of China’s huge foreign exchange reserve.1 Every year about 20 million persons move from rural areas to settle down in urban cities. This rapid urbanization and fast economic growth requires, among others, vast amount of energy and industrial raw materials. Current estimates indicate that 20% of China’s energy needs cannot be met and that it will be necessary to double energy generation capacity every decade to meet rising demand. China is a net energy importer and China’s energy production has been insufficient in meeting the country’s energy consumption demands since 1999. 4–6 Today the price of electricity (kWh) for industrial use in China is nearly the same as in Western Europe.

Research Questions The paper is basically divided into two parts. The first part of the paper deals with how China is going to obtain its energy resources both domestic and international for the next decade. The second part of the paper deals with the impact of energy shortages and scarce strategic industrial raw materials will have on FDI in the Chinese high-tech industry. Q. 1 What is China doing domestically to obtain new energy resources and at the same time taking various measures to increase energy efficiency, save energy and develop alternative energy sources? Q. 2 What is China doing internationally to obtain new energy resources and how these energy resources are being transported to China? Q. 3 The shortage of scarce energy resources and other strategic industrial raw materials in China is putting tremendous constraints on export industries. How is this phenomenon affecting the FDI to China? Q. 4 What recommendations can be given to foreign companies in China which are investing in energy intensive industry and also utilize scarce strategic industrial raw materials? What will be the long-term implications for the development of Chinese high-tech industry?

Research Methodology The paper uses both secondary and primary sources. Interviews have been carried out with government and municipal officials. Moreover, visits have been made to various energy intensive plants using strategic industrial raw materials. Visits have also been made to power plants, harbors and various other logistic centers dealing with railways, harbors and other transport means for carrying energy resources both in and outside of China. The author is a member of the European Union Chamber of Commerce in China for Logistics, Energy and Automobile Working Groups.

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Results China’s current situation regarding domestic energy resources From 1978 to 2006, China’s GDP grew at an average annual rate of nearly 10% while its annual energy consumption only grew at an annual speed of about 5%. However, the trend has changed since 2001. Due to the rapid growth in energy consumption, the levels of which have been growing faster than China’s GDP, there have been widespread shortages of electricity. Increasingly smoggy skylines and rapidly depleting resources mean China is struggling to diversify its energy generation and at the same time establish increasingly efficient and environmentally friendly methods of production. 4 The China State Council announced plans in March 2007 to invest 100 billion Yuan, or US$ 13 billion, to build the largest Asian facility to make diesel fuel from coal. The facility in the north-western region of Ningxia is scheduled to begin operations in 2020 and be capable of producing 75 million barrels of diesel fuel a year. 7

China’s current non-renewable energy sources (fossil) Coal remains China’s primary resource for energy production, accounting for approximately two thirds of its power generated. Thermal energy sources such as coal, gas, and oil fired power stations make up over 82% of overall use while hydroelectric and nuclear energy accounts for only 18% in 2006 (see Figs. 2 and 3). 8 We see during the last couple of years that due to severe pollution from coal fired power stations, China has increased the consumption of oil. However, this is an expensive alternative to cheap domestic coal. The price of oil per barrel has been fluctuating recently on the world market between US$ 90 and 99.

Natural Gas 3%

Water Power 7%

Petroleum 23%

Coal 67%

Shares of energy sources in primary energy consumption 2003 Source: Coal industry statistics 2005

Figure 2: Chinese energy use by type. 7

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Energy Imbalance, lack of Oil Primary Energy

Industry Heating Railway Thermo-Electricity

Coal 1.9B. Ton 68% pollution Hydro 7% Nuclear <2% DaYa Bay QinShan

Crude Oil 23% 300 M. Ton import 140 Mt Natural Gas 2.6% 20B.cubic

Electricity Generation 78% 16% 2% 4%

Transportation Industry

Heating

pipeline, oil field, -Figure 3: China’s energy imbalance. 8

China’s Yangtze “Three Gorges Project” which is the largest water control project in the world is expected to be completed by 8 August 2008, i.e., one year ahead of schedule. The installed capacity is 18,200 MV. 9 At the start of the project in 1992 the electricity production was expected to provide 6% of the total energy requirements of China. In 2008, it is expected to provide nearly 3% of total energy requirements of China.

The demand for oil in China Until 1992, China was a net exporter of oil, but domestic production potential has been largely exhausted and production has not increased with demand. 10 The gap is met by imports, which, at 3.6 million barrels per day, currently represent approximately 50% of consumption. By 2025, imports are forecast to more than triple to 10.9 million barrels a day, and will exceed 70% of total consumption. At present the rate of increase in oil consumption is half million barrels per day as compared to last year. 11,12 The rapid growth of Chinese oil-intensive industrial, petrochemical, and manufacturing sectors and the rapid expansion in the use of the personal automobile have made China pass Japan to become the world’s second largest consumer of oil in 2004. Last year, China surpassed Germany as the world’s third-largest vehicle maker. In 2007, China’s vehicle production will reach 8.5 million units and vehicle exports are expected to increase by about 50% as compared to 2006. 1

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China has not yet been able to make large refinery investments, although there are huge future refinery construction plans. Much of China’s existing refining capacity is aged and designed to refine the waxy high quality oil that is produced domestically. 13 For the next decade China has to continue import crude and refined petroleum from both the OPEC and non-OPEC producers. There is a major speculation that China’s and India’s rising oil use is one of the main factors driving international oil prices. China has been carrying out major structural reforms during the last decade in making its oil industry internationally competitive. Most of this sector is government owned with some foreign investment. China has huge state owned oil companies (SOEs) which are vertically integrated: • China National Petroleum Corp. (CNPC): handles all onshore oil exploration and production. • Chinese National Offshore Oil Corp. (CNOOC): handles all offshore exploration and production. • China National Petrochemical Corp. (Sinopec): handles all refining and marketing. Presently it is also investing in overseas exploration and production assets. • China National Chemicals Import and Export Corporation (Sinochem): handles all international trade in crude oil and petroleum products. China is also developing its natural gas sector, which currently constitutes about 3% of its total demand. In June 2006, China became a natural gas importer with the opening of the Guangdong Liquefied natural gas (LNG) import terminal, which is supplied mainly from Australia. In the future, natural gas imports are likely to grow, with additional LNG import terminals and pipelines under consideration that would link demand centers in China to supplies in Russia, Central Asia and Pakistan (Gwadar). China has recently intensified the construction of several nuclear power plants. Recently, the French firm Areva secured a contract to build two nuclear reactors in Southern China. The deal with the China Guangdong Nuclear Power Corporation (CGNPC) is worth € 8 billion (US$ 11.8 billion). 14 Finally, China is in the process of developing a strategic reserve. The first phase, to be completed in 2008, will hold about 75 million barrels, which will be slightly less than ten days of Chinese oil consumption. Two additional development phases are planned, each of which would have a capacity of about 176 million barrels. China’s stated policy goal is to have strategic stockpiles equal to 90 days consumption.

What measures are taken to energy efficiency, save energy and develop alternative energy resources? It is common that blackouts occur in most of the country’s 32 provinces, autonomous regions, and municipalities. Due to high growth rate in energy demands, China is facing acute shortages of energy. The government has been putting great efforts to obtain additional energy supplies through domestic production and imports. Priority is now

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being given to alternative and renewable energy resources. The government has set up compulsory targets, requiring the entire country to reduce energy intensity by 20% in unit GDP production by 2010. The challenge China is facing now is to improve energy efficiency and develop renewable energy resources to ensure that China in a decade or two can become more or less self sufficient in energy resources. China has taken significant steps towards improving energy efficiency. 7 • Increase resource productivity per ton of energy, iron and other resources by 25%. • Decrease energy consumption per unit of GDP by 18%. • Improve average water use efficiency for agricultural irrigation by up to 50%. • Raise reuse rate of industrial solid waste above 60%. • Increase recycle and reuse rate for major renewable resources by 65%. • Reduce total discharge of major pollutants by 10% in 5 years. China is a huge country with rich renewable energy resources including wind, solar, biomass, hydro, and geothermal assets. It is also the second largest coal consumer in the world. Due to both environmental and economic pressures, China is seeking ways to restructure its energy supply.15 In the future, renewable energy will become a crucial tool for enabling sustainable development.

China’s recently enacted Energy Conservation Law highlighted the importance of end use energy efficiency and standards and label programs. By focusing on manufacturers, energy efficiency standards can effectively remove most inefficient energy consuming products from the market place while guiding the market competition toward higher energy efficiency.

What is China doing internationally to obtain new energy resources and how are these energy resources being transported to China? The growing imbalance between demand and domestic supply gives the following choice to China: • To develop oil and natural gas resources in China • Increased reliance on Persian Gulf and other crude oil suppliers that are distant from China despite the geopolitical risk • Construction of a major oil and natural gas overland pipeline from Kazakhstan and Turkmenistan and • Construction of facilities and pipelines to allow the importation of natural gas from east Siberia or liquefied natural gas (LNG) from Southeast Asia, West Asia and the Middle East As a major oil consumer, China has turned outward, cultivating bilateral relationships with states that can provide oil, gas and other strategic raw materials. China at the same time wants to benefit from supply source diversification.16 Major countries • Middle East (Iran, Iraq, Oman, Yemen, Syria, Saudi Arabia)

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• • • • • • • •

North Africa (Algeria, Libya) Russia and Central Asia (Kazakhstan, Turkmenistan) Southeast Asia/Australia (Indonesia, Thailand) South America (Venezuela, Ecuador, Peru, Bolivia, Colombia) Canada Australia West Asia (Pakistan and India) Sub-Saharan Africa (Sudan, Nigeria, Angola, Gabon, Congo (Republic of), Madagascar) In 2006, Angola surpassed Saudi Arabia as China’s largest oil supplier. China’s oil imports from Kazakhstan and Russia have considerably increased in 2007 as compared to 2006.1 Despite the extensive supply diversity, nearly 70% to 80% of China’s future oil imports are forecasted to come from the Middle East and North Africa. China’s three major state owned oil companies — CNPC (Petrochina), China Petrochemical Corporation (Sinopec), and China National Offshore Oil Corporation (CNOOC) — have invested significantly in the Middle East.16 The six-member SCO (The Shanghai Cooperation Organization) — including Russia, China, Kazakhstan, Kyrgyzstan, Tajikistan and Uzbekistan — has also become an important player in providing oil, gas and strategic raw materials to China. SCO has turned from the old Silk Road across Central Asia into an energy Road. In 2005, the SCO added Mongolia, Pakistan, Iran and India as official observers. Half the world’s population lives in member or observer members of SCO. Cooperation in fuel, energy and transport is expected to bring great benefits to all these countries (see Fig. 4).

Figure 4: Present and planned oil and gas pipelines in Central Asia, Middle East and West Asia.

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Pakistan is expected to serve as an “energy corridor” between producers and consumers, since possible oil and gas pipelines from Iran and Central Asia to China and India are planned to pass through Pakistan. China is also exploiting rich natural resources in its Xinjiang province which connects China with Central Asia. In 2005, the oil pipeline from Kazakhstan to China (Aterlao–Kenjiyaker–Atasu– Alashankou) began to carry oil. The handling capacity of the pipeline is 20 million tons per year, which was a significant increase from the annual amount of 500,000 tons being shipped via railways. Plans are to construct gas pipelines from Uzbekistan and Turkmenistan to China. These pipelines, intended to have an annual handling capacity of 25–40 billion cubic meters, will help to increase the small percentage of gas employed by China’s current energy structure. If connected with the Xinjiang-Shanghai Gas Pipeline, the pipelines will also contribute to the implementation of China’s West Development Strategy and Energy Eastward Transportation Program. Japan and South Korea, both of whom can take part in this project, will be entitled to a portion of the gas transported by the pipelines. It is important to note that no maritime security is required in these projects.13 China’s Ministry of Commerce has published financial data on outbound foreign direct investment (Statistical Bulletin of China’s Outward FDI): • 2003: US$ 1.38 b out of a total of US$ 2.58 b mainly went to oil, gas and black metals • 2004: US$ 1.80 b out of a total of US$ 5.50 b mainly went to oil, gas and black metals • 2005: US$ 1.68 b out of a total of US$ 12.30 b mainly went to oil, gas and black metals China and CNPC have spent a significant amount of time and money in recent years acquiring upstream oil assets in Kazakhstan, as well as investing in the construction of the Kazakh-China oil pipeline. The pipeline’s current capacity is 200,000 bpd, but it could be expanded to 400,000 bpd through the addition of new pumping stations.13 Turkmenistan is constructing a natural gas pipeline to China. China’s energy officials at the National Development and Reform Commission (NDRC) approved in September 2006 the construction of a natural gas pipeline from Xinjiang to Guangzhou to transport natural gas from Turkmenistan. According to the agreement, Turkmenistan will supply China with 30 bcm of natural gas annually starting in 2009.

How is FDI to China affected due to shortage of energy and strategic industrial raw materials? Inflation and wages are rising in China. Government has imposed penalty on industries exporting goods which are using scarce energy resources and other strategic industrial raw materials (see Fig. 5). At present, for exporting goods that utilize scarce industrial and energy resources, companies have to pay from few percent to nearly 40% extra export

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duties in the form of penalties. Moreover foreign companies are penalized since the Yuan has appreciated more than 7% compared to 2 years ago. This currency appreciation is expected to continue. The price of industrial electricity (kWh) is now nearly the same as in Western Europe. Furthermore, due to shortage of talents, the qualified labor turnover is extremely high in China (10% to 30%).

Nickel LME - cash - USD/kg

Steel scrap; MB shredded FOB Rotterdam Monthly average - USD/ton 50 350

40

300 30

250 200

20

150

10

100 50 01- 01- 02- 02- 03- 03- 04- 04- 05- 05- 06- 06- 07- 07jan jul jan jul jan jul jan jul jan jul jan jul jan jul

0 01- 01- 02- 02- 03- 03- 04- 04- 05- 05- 06- 06- 07- 07jan jul jan jul jan jul jan jul jan jul jan jul jan jul

Copper - Metal Grade A LME - Cash - USD/kg

MOLYBDENUM - Europe drummed Molybdic Oxide / MB - Monthly average - USD/kg 10 100

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20 0 01- 01- 02- 02- 03- 03- 04- 04- 05- 05- 06- 06- 07- 07jan jul jan jul jan jul jan jul jan jul jan jul jan jul

0 01- 01- 02- 02- 03- 03- 04- 04- 05- 05- 06- 06- 07- 07jan jul jan jul jan jul jan jul jan jul jan jul jan jul

Figure 5: Metal prices.1

Due to tremendous shortage of power, practically all the provincial authorities have started to cut power on regular basis with short notice. Foreign companies with various types of furnaces have been forced to close their plants for two or more days to save energy. Most of these companies have not yet invested in expensive back-up generators and are severally affected when they are forced to close their furnaces. To re-start these furnaces it takes another one week of extensive electricity utilization in order to catch up with normal production. All of these companies are facing unnecessary costs. This peculiar situation makes the situation unbearable for foreign companies who invested in large capital intensive high-tech plants in China for supplying their products to the Chinese market and to the rest of the world. Several of these companies are now planning to move out of China and locate their production facilities including R&D elsewhere. Furthermore, these companies see no need to have manufacturing facilities in China, since the import duties are very low for high-tech goods imported into China and particularly, if they are energy intensive and using strategic industrial raw materials.

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Recommendations to Foreign Companies in China and Long-term Implications for the Development of Chinese High-tech Industry Recommendations to foreign companies in China We have observed the following: • Shortage of energy and strategic raw materials will continue at least for the next couple of years. Price of energy and strategic raw materials will continue to rise. • Inflation will continue to rise. • Yuan will continue to appreciate. • Wages for middle managers will continue to rise with high labor turnover. • Export duty penalties will continue to increase. Despite the rising cost in China foreign companies should continue to invest in China as long as the investment is to meet the needs of the domestic market. The domestic market will continue to grow with high economic growth rates. If the investment in China is also to meet the needs in and outside of Asia then it does not make sense to invest in China. In the latter case, other alternative investments should be taken into consideration such as India, Vietnam and Thailand.

Recommendations to Chinese policy makers To attract FDI in China, it is of utmost importance to resolve the shortage of energy in China. One alternative is to invest heavily in rich renewable energy resources including wind, solar, biomass, hydro, and geothermal assets. Higher investments in nuclear plants are also necessary. Moreover, China must remove export duties in the form of penalties on exports of goods utilizing energy and strategic industrial raw materials. If this is not done, then these types of high-tech investment will end up elsewhere, such as in India, Thailand or Vietnam. This will have long-term implications on the development of China’s high-tech industry.

References Carbon Monitoring for Action (CARMA) (December 2007). Center for global development. Washington, DC (http://Carma.org). China State Council (2005, 2007). Beijing. China’s Yangtze Three Gorges Project Development Corporation (CTGPC 2006). Yichang, Hubei, China. CIA (November 2007). The World Fact Book. Washington, DC. Douglas, K, M Nelson and K Schwartz (September 2006). Fueling the dragon’s flame: How China’s energy demands affect its relationships in the Middle East. USA.

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Energy Information Administration (EIA) (December 2007). Washington. http://www.eia.doe.gov. Eurasia Group (October 2006), China’s overseas investments in oil and gas production. New York. European Commission (February 2007). Future Opportunities and Challenges in EU — China Trade and Investment Relations 2006 –2010. Brussels. Lam, NM and JL Graham (2007). China Now: Doing Business in the World’s Most Dynamic Market. New York: McGraw-Hill. Le Monde (20 November 2007). Paris, France. National Bureau of Statistics (NBS) (March 2007). China Energy Statistical Yearbook 2006. Beijing: National Bureau of Statistics of P.R. China and Energy Bureau of National Development and Reform Commission of P.R. China, China Statistics Press. National Bureau of Statistics (NBS) (2007). China Statistical Yearbook 2007. Beijing: China Statistics Press. People’s Bank of China (November 2007). Beijing. Shanghai Daily (2007). Various issues from September to December 2007. http://www.shanghaidaily.com [September to December 2007]. Soliga, R and A Jaffe (2004). China and Long-range Asia Energy Security: An Analysis of the Political, Economic and Technological Factors Shaping Asian Energy Markets. USA: Rice University. UN Yearbook (2007). New York.

Glossary Explanations of the terms used throughout this report.

● % Fossil: The percentage of total electricity that is generated by the combustion of coal, oil, or natural gas.

● % Hydro: The percentage of total electricity that is generated by hydroelectric power facilities.

● % Nuclear: The percentage of total electricity that is generated by nuclear power facilities. ● % Other Renewable: The percentage of total electricity that is generated by the use of wind, solar, biomass, geothermal, captured heat, or hydrogen energy.

● MWh Energy: Annual megawatt-hours of electricity produced.

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Innovations in Cultural Integration: The Experience of Chinese Enterprises in Cross-National Mergers and Acquisitions A case study of Northeast Hengli Company’s attempts at reducing cultural risks through the forging of a common identity ͣDONGBIN LU Renmin University of China

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rofessor Dongbin Lu entered Renmin University of China in 1987 as a PhD candidate in industrial economics and obtained his Doctor’s degree in economics in 1991. He started working as a lecturer at Renmin University of China after graduation. He was deputy chief and chief of the Industrial Economics Teaching and Research Section, dean of the Industrial Economics Department, and vice dean of the School of Business Administration at Renmin University of China. He was awarded the titles of associate professor and professor in 1993 and 1996, respectively, and became mentor to doctoral and postdoctoral students since then. Up to now, he has already eight doctoral students in economics and management and 222 master students under his guidance graduated. Professor Lu is also part-time professor of Beijing Jiaotong University, researcher engaged by special arrangement of Jinan University, standing director of China Machinery Enterprise Management Association, vice director of China Industrial Economic Association, and ndustry expert of Beijing Brain Power Group. Professor Lu was an exchange scholar and taught in Tokai University of Japan, Niigata University of Japan, Korea University, Feng Chia University of Taiwan, and Fu Jen Catholic University of Taiwan. Professor Lu has a wide range of research interests, especially in interdisciplinary researches involving many areas such as economics, management, and sociology. He

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published 8 books including Analysis on China Industrial Organizations and Comparative Management of International Enterprises, as well as 80 research papers such as “New Trend of Chinese Strategies on Transnational Corporations”, “Researches on Private Enterprises Participating in Mergers & Acquisitions, Restructuring and Integration of Stateowned Enterprises” and “Cultural Integration and Synergic Development in International Mergers & Acquisitions and Restructuring” on many journals and newspapers including Journal of Renmin University of China and Guangming Daily. Abstract: Generally speaking, Mergers and Acquisitions (M&A) deal with many factors such as the establishment of M&A strategies, selection of target enterprises, evaluating the value of enterprises, negotiation and signing of contracts between the parties concerned, and integration after M&A. Compared with domestic M&A, international M&A operate in a more complicated environment, are affected by more factors, suffer more risks, and enjoy fewer opportunities to succeed. Many empirical researches reveal that integration is a key to successful M&A. If integration were to fail, even the best strategy cannot be executed, nor can the value of the target enterprise be realized or mutual promises kept. This might result in conflict, dilemma, or even failure. How can integration then be effective? A common topic of interest is cultural integration at home and abroad. Some say that Chinese enterprises lack international experience in M&A. If conflict arising from cultural differences is not properly handled, cultural integration cannot be adequately achieved and the M&A will fail. The key lies in identifying what the best culture is and the sources of such a culture. The innovative integration of Hengli Hi-tech Development Company in Northeast China after its acquisition of German Kelch & Links Co., Ltd. shows that cultural differences may not bring about conflict. The key lies in enhancing mutual recognition and shortening the cultural gap. Therefore, in integration of development strategies, human resources, R&D, financial management, and marketing channels, Hengli focused on forging a common identity, communication, win–win solutions, and respect. After successful integration, it made rapid progress. Identity refers to recognition and acceptance. In relation to different cultures, a common identity can be forged by showing affability towards others, particularly those similar to oneself. It is a matter of reconciling differences, particularly cultural ones. It can be said that cultural differences exist as a matter of fact, which require mutual understanding, acceptance and recognition to shorten the cultural distances between people. The best culture can only be created by learning from each other’s strong points to offset their weaknesses and by mutual recognition. Neither the buyer nor the seller can say that they represent the better culture and force the other party to accept it. They can only achieve recognition and build the culture needed for successful cooperation through communication. This paper discusses model selection in international M&A integration on the basis of an extensive literature review. It stresses that in order for Chinese corporates

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to be successful in international M&A integration, it is necessary to be grounded in practical concerns and to constantly innovate. The paper then analyzes the way in which Hengli innovated their cultural integration in international M&A. It also points out that the basis of innovation is risk identification; the path of thinking is to enhance recognition; and the approaches of implementation are process control, i.e., to start with communication, aim at win–win solutions, and result in respect. Lastly, it emphasizes that performance integration depends on multi-effects. The paper has about 10,000 words. Keywords: Hengli; Trans-national mergers and acquisitions; Integration; Mutual understanding.

Introduction Generally speaking, Mergers and Acquisitions (M&A) deal with many factors such as the establishment of M&A strategies, selection of target enterprises, evaluating the value of enterprises, negotiation and signing of contracts between the parties concerned, and integration after M&A. Compared with domestic M&A, international M&A operate in a more complicated environment, are affected by more factors, suffer more risks, and enjoy fewer opportunities to succeed. Many empirical researches reveal that integration is key to successful M&A. If integration were to fail, even the best strategy cannot be executed, nor can the value of the target enterprise be realized or mutual promises kept. This might result in conflict, dilemma, or even failure. How can integration then be effective? A common topic of interest is cultural integration at home and abroad. Some say that Chinese enterprises lack international experience in M&A. If conflict arising from cultural differences is not properly handled, cultural integration cannot be adequately achieved and the M&A will fail. The key lies in identifying what the best culture is and the sources of such a culture. The innovative integration of Hengli Hi-tech Development Company in Northeast China after its acquisition of German Kelch & Links Co., Ltd. shows that cultural differences may not bring about conflict. The key lies in enhancing mutual recognition and shortening the cultural gap. Therefore, in integrations of development strategies, human resources, R&D, financial management, and marketing channels, Hengli focused on forging a common identity, communication, win–win solutions, and respect. After successful integration, it made rapid progress. Identity refers to recognition and acceptance. In relation to different cultures, a common identity can be forged by showing affability towards others, particularly those similar to oneself. It is a matter of reconciling differences, particularly cultural ones. It can be said that cultural differences exist as a matter of fact, which require mutual understanding, acceptance, and recognition to shorten the cultural distances between people. The best culture can only be created by learning from each other’s strong points

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to offset their weaknesses and by mutual recognition. Neither the buyer nor the seller can say that they represent the better culture and force the other party to accept it. They can only achieve recognition and build the culture needed for successful cooperation through communication.

The Status Quo of Researches on Cultural Integration in Cross-national M&A Integration in cross-cultural M&A refers to the process of integration in management, human resources, and culture when the merging company goes abroad to acquire a foreign company. The object of M&A integration may be the merged company or a newly established company after the merger. Alexandra Reed Lajoux said in his monograph, “The Art of M&A: Integration”, that “Not all the buyers and sellers welcome integration after the merger”, “Due to constant changes in industry and technology, we feel it hard to define whether a company is in the ‘internal’ or ‘external’ part of the core field in the new company. Actually, we cannot define it.” “What is the possibility of a successful merger? Is it true that most M&A of companies fail in the end? The answers lie in the definition of failure. When failure is defined as extreme situations, e.g. if failure is defined as bankruptcy settlement, the failure possibility is low — under 20%; when it is defined as failing to realize the set financial objective such as net profit or the obvious increase in return on equity, the failure possibility is high — up to 80%.”1 It is important to define the success and failure of cross-national M&A integration. Jeff Badrtalei and Donald L Bates (2007) pointed out “When we look at the past mergers with a critical eye, we can easily find out factors contributing to M&A and their failure.” These factors are apparently correlated with organizational culture. This is the key barrier at every stage of the merger between Daimler and Chrysler, the problem persisting in the ensuing years as well. Based on the experience and lessons learned from the merger case of Daimler–Chrysler, the author stresses “avoiding similar mistakes in solving the problems of organizational culture in M&A and promoting the success of M&A in the setting of economic globalization”.2 In fact, paying attention to the issue of cross-national M&A integration of Chinese companies is closely linked to the “Go Abroad” practice of Chinese companies. On one hand, we should pay attention to the M&A integration of transnational companies entering China; on the other hand, we should pay attention to the M&A integration of Chinese companies going abroad. Although such researches lag behind those produced overseas, they have their own characteristics and offer very good practical reference and experience. 1

Alexandra Reed Lajous, The Art of M&A: A Merger, Acquisition, & Buyout Guide. 1st ed. China Financial and Economic Publishing House, July 2001. 2 Jeff Badrtalei, Donald L Bates. Effect of Organizational Cultures on Mergers and Acquisitions: The Case of DaimlerChrysler. International Journal of Management, June 2007.

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Qiu Yi (2006) pointed out that “With the promotion of economic globalization and the continuing development of transnational M&A of enterprises, transnational M&A accounted for 81% of global foreign direct investment up to 2000. Transnational M&A has gradually become a method of enterprises to develop international market and gain foreign resources; more and more companies use it as an important strategy of development. After entering the 21st century, Chinese enterprises began to aggressively enter the foreign market by means of transnational M&A. International researches on the problem of integration after M&A started earlier; but in recent years, with the development of market reform, some Chinese scholars began to pay attention to the research after M&A. Most of the researchers placed emphasis on the integration of business, culture, personnel, system, and capital; and attributed the failure of M&A to issues such as the ‘adaptation’ of strategy and organization of the two companies, cultural conflict, and lack of value synergy.”3 How should we find out the problems encountered in the M&A of Chinese companies? Chen Jing (2007) pointed out that the main issues at present are: the poor legislations governing foreign investments — they do not conform to international legislations, such that the investing company does not enjoy adequate rights; the multidepartment correlation and the classification examination system of foreign investment are complicated, suffers from low efficiency and lacks coordination, thereby impeding the smooth development of transnational M&A and the overall planning of the direction, focus and scale of investment; there are many differences in transnational M&A, so the regulation and supervision of overseas state-owned assets are urgently needed; because the current system of China cannot meet the needs, the supervision is weak, leading to a drain of state-owned assets; corporate accounting management system of China is not up to the standard of foreign countries; moreover, some overseas companies forge financial statements and conceal information advertently to evade taxes, which cause confusion, misgovernment and information distortion in financial management; the foreign exchange management system of China lacks flexibility; the approval process of foreign exchange investment is rigid and prolonged, which to a great extent restricts the scale of foreign M&A of enterprises, increases transaction cost, even loses out on opportunities; in recent years, Chinese government, other countries and international organizations signed several bilateral or multilateral agreements to further protect the interests of foreign transnational enterprises investing in China, but failed to effectively support Chinese enterprises in transnational M&A activities; the financing of M&A is difficult — domestic intermediary organizations do not provide adequate support; limited human resources with sufficient operational experiences; in particular there is no clear cognition of risk precaution and resistance; and the integration efficacy after M&A is particularly weak.

3

Qiu Yi, Dissertation. Huadong Normal University. 2006.

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These problems have drawn the attention of Chinese departments concerned. Chen Jian, assistant to Minister of Commerce, said: “Five issues must be studied on transnational M&A of Chinese enterprises.” The five issues are: we must highly stress the difference between international market operation and domestic market operation in international M&A, and concentrate advantageous resources on the work of integration; transnational M&A must have good internal and external opportunities to reduce management risk and obtain the best economic effects; learn and apply popular international financial tools and methods to put together approaches such as cash payment, directional issuance, and share payment for reducing the risk and cost of M&A; enhance the capability of transnational management; grasp core resources of production and management; train a pool of international personnel who can skillfully utilize international rules, humanity rules and legal rules to promote the localization of the enterprise and create a good environment for the development of the company; develop transnational M&A step by step to the target market based on the policy of “from easy to difficult and advance steadily”, and expand abroad gradually.4 However, what is the main issue. Carl Davidson and Ben Ferrett (2007) said “to enhance the R&D ability, M&A have some unique characteristics different from strategic variables in market competition and appeal instinctively. For example, when the inside employees make profit, the outside people make losses. And the final result is that there are more people inside than outside. These results are contradictory to those of traditional models studying the capability of market gain by M&A alone. Those traditional models are regarded as violation of instinct, for sensitivity is more effective in analyzing the competitive models of market.”5 Wen Minghu (2000) pointed out “the diversification of culture determines the diversification of management models. Management itself is a culture; culture and management are symbiotic in nature.”6 Liang Yanjun et al. (2006) stressed that “cultural integration in M&A of enterprises is a tough mission. Objectively speaking, the experience of Chinese enterprises acquiring foreign companies is not sufficient. If we don’t study carefully the cultural difference in M&A and treat seriously the cultural conflict arising from cultural difference, we cannot gain quality cultural integration and the international M&A of Chinese enterprises will be full of difficulties or even ruined.”7 Wen Feng (2004) pointed out in studying certain factors influencing the functional mechanism of corporate culture and M&A performance that differences in corporate culture affect M&A performance in complicated ways. It is not at all a linear correlation. It is influenced by many factors, among which there are mainly three: Degree of integration. Nahavandi and Malekzadeh (1988) pointed out that the strategy driving M&A decides the degree of mutual “overlapping”. When the degree of “overlapping” 4

China Oilnews. May 8, 2006. Page 005. Carl Davidson (University of Nottingham), Ben Ferrett (Michigan State University), Mergers in Multidimensional Competition. The London School of Economics and Political Science, 2007. 6 Corporate Economy. December 2000. 7 Chinese and Foreign Corporate Culture, January 2006. 5

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is high, the possibility of cultural conflict is big. For instance, in bilateral M&A, owing to the difference of business, there is more independence and less chance for cultural conflict. However, in correlating M&A, top management of the merging company will generally want to realize synergy through integration. Besides, employees of the merged company will have to accept the corporate culture of the merging company. Relatively smaller scale. Penrose (1959) and Shrivastava (1986) thought that the more similar the scales of the two companies, the more difficult for the merging company to know every field needed to integrate. But Walter (1985) and Mirvis (1984) held the view that when the scale of the merged company is smaller than the merging company, the demand and benefits of its employees may possibly be ignored. Tolerance of Multiculture. When the merging company is tolerant of different cultures or when the merged company is also tolerant toward foreign culture, the negative influence of the difference of corporate culture on the performance of M&A is reduced. The representatives holding this point of view are Cartwright and Cooper (1993). They objected to the opinion that the merger between special cultures would be disasters. They insisted that the merger between different cultural backgrounds can also be a happy corporate marriage. They quoted Handy’s classification of corporate culture and analyzed the possible matching degree of corporate cultures of the companies. Haspeslaph and Jemison (1991) pointed out that “the value of M&A was created after the transaction.” That is to say, no matter what is the announced motive of the merger, e.g., to get synergy or enter into new markets, it must be realized through the integration process.8 Cultural integration must solve the problem of “cultural conflict”. Zhang Ouxiang (2003) stressed that mutual influence, penetration or reform, and two or more different styles of corporate cultures decided the dual characteristics of the corporate culture of the merged company, i.e., uniqueness and multiness, positiveness and passiveness, gradualism and converseness. The co-existence and interaction between the two characteristics often result in “cultural conflict” — value conflict, conflict in concept and method of management, decision-making conflict after companies of different management systems merge, management style conflict, psychological conflict, etc.9 It is not easy to tackle the problems of cultural conflict. Wu Qi et al (2006) said that the cross-cultural integration of Chinese enterprises faces two prominent problems. One is that the cultural difference between Chinese enterprises and those of developed countries obviously adds to the difficulty of integration; the other one is that the merged foreign company rejects the corporate culture of Chinese companies.10 The key to tackling these problems lies in the innovation of cross-cultural management. Dang Xinghua et al. (2006) pointed out when talking about “the content of cross-cultural management innovation in the internationalization process of Chinese 8

Wen Feng, Huazhong University of Science and Technology, Dissertation. 2004. Economic Review, July 2003. 10 China Entrepreneur, 3–4, 2006. 9

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enterprises” that innovation is reflected in the following aspects: a good cross-cultural management concept, identification of cultural differences, respect of different cultures, promotion of communication between different cultures, good use of the advantages of different cultures, guidance and promotion of the development of different cultures, strengthening of cross-cultural coordination, and implementation of the localized strategy.11 Charles Terranova (2007) also stressed that “Fair or not, corporate culture has always been regarded as the main reason for the failure of M&A.” He also put forward ways on how to help managers play their own roles in future M&A to increase the chances of successful M&A through descriptions of the process of evaluating and communicating on corporate culture of the two companies.12

The Selection of Integration Models of Cross-national M&A What integration models in M&A should be chosen to guarantee its success? Everyone noticed first of all the management style of cross-cultural managers in transnational companies. Huang Bangyan (2004) surveyed with questionnaires and interviewed more than 100 foreign managers and 70 of their Chinese colleagues of more than 80 transnational corporations, finding that they “put their culture first, but never ignore adjusting their management behavior in light of the Chinese culture.”13 That is to say, cross-cultural mangers are very careful in selecting the integration model. To further study the influential dimension of model selection, Li Guangming (2006) adopted the case analysis system to study the content and model of integration after cross-national M&A of Chinese manufacturing companies up to the present moment. He thought that besides reinforcing systematic M&A and making detailed survey before M&A, Chinese enterprises ought to correctly analyze and study the resource features of the two M&A companies and fully consider the differences in the organizational cultures and national cultures between them to make the right decision in selecting a model which is logical, effective, timely, proper, and suitable for the integration of its resources after the merger and increase the success rate of cross-national M&A.14 Zhao Shuming (2005) pointed out that effectively eliminating cross-cultural differences between the two M&A companies is key to a successful transnational M&A. Most traditional researches on the cultural integration in M&A paid more attention to analyzing enterprises. However, with the rapid development of Chinese enterprises joining the global economic integration, much analysis on the cultural conflict of enterprises cannot meet the need of transnational situation. Therefore, it is of great importance

11

Journal of Shanxi Financial and Economic University, August 2006. Charles Terranova, “Assessing Culture During an Acquisition”. Sun Micros Organization Development Journal, summer 2007. 13 Huang Yanbang•Dissertation. Fudan University. 2004. 14 Economic Problems Research, May 2006. 12

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for Chinese enterprises to focus on the transnational perspective to discuss the strategy of integrating cultural difference in transnational M&A.15 Jin Can (2005) specifically analyzed the influencing factors in the model selection of cultural integration, including the goal of M&A, the target company to be merged, the type of M&A, and the difference in corporate culture and cultural rigidity. Three dimensions must be considered: the first dimension being the cultural difference between the merging company and the merged company; the second being the cultural rigidity of the target company; and the third being the cultural weakness of the merging company and the target company.16 While Wu Qi, et al. (2006) warned that visible factors such as behavior and other ideas and rules of the game or organizational behavioral standards, thoughts and assumptions proving to be true and given to employees, and core value and belief should be paid attention to.17 We must pay more attention to the implementation of the strategic objective of M&A in selecting integration models. Haspeslaph and Jemison (1991) pointed out “The value of M&A is created after the transaction.” Schweiger further pointed out that the integration process after M&A is very complicated. It has three dimensions: technology, politics, and culture, all of which have close correlation with the strategy of M&A.18 Wang Fenghua stressed issues such as “cultural difference cost and cross-cultural transaction cost evaluation” to enhance the performance of integration.19 What models do cross-national integration present? It varies with focus of research. Berry (1982) called all cultural integrations “acculturation”, asserting that the two merged parties follow four models of acculturation: Integration — through mutual penetration and concession to form a blended culture with the cultural characteristics of both companies. The objective is to obtain a culture with the superior qualities of both cultures. However, the prospect of cultural blending is sometimes hard to predict, e.g. there may be strong conflict and hostility. This model is fit for the situation when the merged companies wish to maintain their own culture and organizational identification, as well as independence. Assimilation — normally means that the culture of the merging company replaces the culture of the merged company, and the merged company is completely assimilated into the other company. Under extreme circumstances, it is the controlling side which makes the decision of integration and sends its own managers to substitute for the original top management. Seihl and Ledford called this “plundering” integration. If the merged company was not in a good financial condition before the merger, this may be a more reasonable model. But in fact, most of the merged companies tend not to adopt this model. Separation — This is to restrict the contact of the two sides and

15

Journal of Nanjing University (Social Sciences), May 2005. Jin Can, Master Degree Thesis, Central South University. 2005. 17 See also 8. 18 See also 6. 19 Productivity Research. October 2006. 16

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retain independence for the two cultures. When the employees of the merged company want to keep their own culture and reject the culture of the merging company, it can be adopted to avoid serious conflict. In the meantime, the connection between the functional departments in the two companies and other contact are few and sedulously limited. Deculturation — When the employees of the merged company neither cherish its own value nor accept the culture of the merging company, the cultural and psychological tache between employees will rupture, and their value and behavior will also turn into confusion. This is called Deculturation.20 Pan Ailing (2004) considered the differences of both national culture and corporate culture of the two M&A companies and put forward integration models to be chosen: fusion model, transplantation model, impregnation model, grafting model and autonomy model.21 Wu Qi et al. (2006) noticed the attractiveness of the culture of the merging company and the identification of self-culture of the merged company, thinking it can be divided into: assimilation model, integration model, confusion model, and autonomy model.22 Niu Lijuan (2006) pointed out that effective cultural integration should aim to determine the breakthrough point of the two cultures compatible with each other based on the degree of change in the two corporate cultures and controlling degree of the merging company over the new company. Through the breakthrough point, the integration of core and noncore levels of the two cultures will be strengthened. Thus, we may obtain the following: implantation cultural integration, maintaining cultural integration, amalgamation cultural integration, and promotion cultural integration. In practice, we can combine these and form various models to accomplish the mission a single model cannot do.23 Li Guangming (2006) thought that in terms of vertical dimension, the systems of merger and integration can include systematic integration model and nonsystematic integration model; in terms of horizontal dimension, the focus of integration after M&A can be industrial chain oriented integration model, technology integration oriented model, and capital integration oriented model; in terms of time dimension, the speed or rhythm of integration includes slow integration model, fast integration model, and medium-speed integration model; in terms of space dimension, the degree of integration and the transfer, dispersion and sharing of resources between organizations include full integration model, intensive style integration model, extensive style integration model, and confused style integration model.24 The selection and promotion of integration models. Pan Ailing (2004) pointed out that in the selection of models during the process of integration, the following stages must be paid attention to: “the exploration stage, the collision stage, the adaptation stage, and

20

See also 6. Nankai Management Review, June 2004. 22 See also 8. 23 Journal of Yunnan University of Finance and Economics. August 2006. 24 International Economics and Trade Research. September 2006. 21

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the innovation stage.”25 Li Guangming (2006) emphasized that Chinese enterprises should understand their own task, vision, and value; set a goal for company development; analyze the internal and external environment and resource advantage of their company; reasonably choose the strategy and model of transnational management; and implement the strategy of transnational M&A cautiously. Besides reinforcing systematic M&A and making detailed survey before the merger, Chinese enterprises ought to correctly analyze and study the resource features of the two M&A companies and fully consider the differences of organizational cultures and national cultures between them to make the right decision in selecting a logical, effective, timely, and proper model suitable for the integration of its resources after the merger and increase the successful rate of cross-national M&A.26 Chen Chunhua et al. (2002) said that the cultural integration after transnational M&A of Chinese enterprises cannot be accomplished in one move — it has to be done gradually. The integration strategy after M&A generally can be carried out in three steps: first of all is to stabilize business, next is to increase the operation efficiency and competitiveness, and finally is to look for approaches of making more profit globally.27 Studies on cultural integration in transnational M&A of Chinese enterprises are primarily empirical in nature. When studying the integration model after M&A of Chinese manufacturing enterprises, Li Guangming (2006) adopted the case analysis system to study the content and model of integration after M&A of Chinese manufacturing enterprises and made detailed classification analysis.28 Ling Dan et al. (2006) studied the cultural integration process of SGMW for three years, and analyzed in depth how it determined management rules, management style, company spirit, ethical norms and development goal, as well as how it established and perfected its corporate culture system.29

The Innovation of Hengli on the Cultural Integration in Cross-national M&A Hengli is located in Harbin city — the old industrial base in northeast China. Its main products are standard cutlery, general measuring tools, NC cutters, and tools system. Its products have more than 200 varieties and more than 5000 specifications. Some of them have won national gold and silver medals. The brand is also very famous. The products are sold to more than 30 countries and regions such as the United States, France, Japan, and Canada. As on the 156 key projects of “the first five year plan”, Hengli Company is the leading precision measuring implement manufacturers. In 1999, it underwent asset reorganization and in July 2003 it completed its reforms. Hengli has passed

25

See also 18. See also 21. 27 Sino Foreign Management. May 2002. 28 See also 21. 29 Automobile Industry Economy. September 2006. 26

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ISO9001:2000 quality system certification. It prides itself with the following slogan: “starts with technological innovation, sets the goal of zero defective products, insists on reform and development, and aims at meeting the needs of customers”. Now it has become the base of production and scientific research with advanced technology in the tools and measuring tool industry. It has the widest range of products, has the most extensive specifications, and their products have the best quality in the same industry of China. Kelch-Links is located in Schrondorf, an important industrial town in Germany. The headquarters of the world famous Mercedes-Benz is also in this town. This place is a cluster of world class technologies and products. The technology of key components of machine tool and tools of Kelch-Links in the international industry is most advanced. Its products such as tool presetters, tooling systems, and HSK shank are worldwide advanced. Kelch-Links owns 21 patents, 2 of which are significant invention patents. It has the sole right of use of its trade mark in the world. Kelch-Linsks has production base and sales network worldwide. From the perspective of Hengli, the pressure of internationalized existence and development forced them to “Go Abroad”; in the case of German Kelch-Links, the German economy recovery could not bring it back from the brink of death. The business of Kelch-Links has been declining since 2001 and sustained repeated losses. After four years’ struggle, it had to request for “bankruptcy protection” from German government, which was implemented in October 2004. Against this backdrop, the successful merger of Kelch-Links by Hengli Company is very logical. The entire process of this merger took place in a short span of time. It took only less than half a year from their exchange visits when they have preliminarily reached an agreement to detailed investigations, negotiations, contract signing, registration and operation of a new company in Germany. This does not mean that everything went smoothly before and after the merger without any risk. They faced the challenge of cultural integration after the merger. Then, how did Hengli Company innovate its cultural integration after cross-national merger?

Basis of innovation: Risk identification At that time, the main risks Hengli faced were legal risk, management risk, personnel turnover risk, risk in sales channel stoppage, etc. The legal risk came from German legal regulations for foreign companies merging German companies in many fields, involving so many fields and being so rigid that Chinese companies could not have imagined. The first thing to be clear about is the German system of “trusteeship”. What is the bankruptcy protection procedure and what legal regulations are there in lawyer trusteeship? What constitute intangible assets in Germany, and how are patented technologies including important inventions protected? How is the exclusive right of trade mark applied worldwide? How should the intellectual

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Premise: value recognition Innovative way of thinking of innovation

Cultural innovation on transnational M&A

Basis of innovation: risk identification ˜Î–i‹ÆR+

Key: Seek for winwin solution

Root: Synergetic cooperation Goal of innovation Communication

Performance innovation

Implementation

Win-win solution

Respect

Diagram: The integration concept of Hengli Company in cross-national M&A

property right be dealt with involving computer software exclusive copyright and source program, domain names and websites, all series designs of the company’s products, and technological documents? What laws can be applied to protect the R&D ability and results of new products and the intellectual property resources of engineers and technicians? The merged company has four branches in the United States, Switzerland, United Kingdom, and Czech. These branches are still in operation at present but not included in the assets sold this time. Then how should the related market channels be dealt with legally? The human resources restructuring after the merger need the understanding of German labor law and the stipulations of reducing staff. What are usual practices for leasing the workshop and offices of the merged company? Can loans be applied to local banks if capital flow is needed after operation? Obviously, it is difficult to go forward without committing a fatal mistake if these legal issues are not clarified. Management risk was reflected in the uncertainty of a stable production and operation situation after the merger. This initially is a question of timely payment of the merging fund and relevant formalities. Inventory problem is the next one to be tackled. For example, when actual inventory increases, who is to bear the extra charge for the additional inventory? Can the 16% value added taxes incurred in asset transaction as required by German taxation department be exempted in practice? Can loans be obtained from local banks to guarantee sufficient operation fund? The risk of personnel turnover. The merged company possesses first class patent technology in the world and has a strong R&D ability. All these should be attributed

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to their high quality personnel. Whether personnel turnover can be prevented not only impacts integration, but also decides the potential for corporate development. Therefore, in the process of integration, Hengli on one hand needed to solve the problem of employees not hired by the new company. On the other hand, it must know very well the state of its current employees and labor contracts and adjust the structure of the reemployed personnel according to the requirements of the new plan. If there is any one who doesn’t want to be re-employed, it must be made clear who will be responsible for taking on them and compensating Hengli. The more austere task was that these measures had to be approved by the labor organization. The risk of sales channel stoppage. The breakthrough point helping Kelch-Links which is applying bankruptcy protection out of difficulty is sales. Therefore the sales channel cannot break down. The problems here are whether they can retain the exclusive right of using its original brand worldwide; whether they can control and grasp the production and supply right of their original products worldwide; and whether they can obtain the stock option of the above sales institutions through main contracts. If further integration plan is made after the detailed survey of the new company, then before the integration the new company must keep business relations with them. This means whether the new company can take the initiative of work and reduce the operational risk of the new company.

Innovation in way of thinking: Enhancing identification How shall integration risk be reduced? The innovative idea of Hengli is enhancing identification. Firstly, value identification is regarded as the premise of successful integration. According to Hewitt: “Respect and assimilate the cultural distillation of the merged company. It can only lead to resistance and personnel turnover to simply destroy a unique and cultured value.” Respect helps identification, avoid conflict, and enhance coherence. Secondly, the key to successful integration is to seek and realize a win–win solution. Both Hengl iand Kelch-Links expect to gain through integration. As soon as a new benefit community is formed, it is hard to say who the winner is and who the loser is. What should be watched for is the positioning of entrepreneurs, managers, and employees. Entrepreneurs concern about the development of the company, and managers and employees care about their existence and future development. Therefore, the win–win result should be good interaction between corporate development and the career development opportunities of managers and employees. This is reflected by the improvement and development of the company’s performance. Thirdly, the root of successful integration is harmonious coexistence and synergetic cooperation. The famous synergetic expert Hermann Haken said that synergy can be understood as the “science of synergetic cooperation”. He stressed that synergy studies

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group behavior which refers to “those seemingly mutually conventional behavior of people”, “group behavior forms an automatic reaction to make an individual hard to get rid of its manipulation”, and “the decision may not be made out of favor or hostility, but the condition formed in groups.”30 That is to say, the new interest community must be established through synergy and cooperation. Integration contributes to collective behavior that is consensual and pro-active. This behavior in turn strengthens the new group and guarantees sustainable development of the company after the merger.

The implementation: Getting a good grasp of procedures The procedure includes three stages: begin with communication, seek for win-win solution, and succeed in respect.

Recognition starts with communication “Detailed survey” is the important foundation of M&A negotiation and integration. However, for Hengli, the time for detailed survey was only over two months. It is almost impossible to gain recognition. They realized that there were many barriers and little time to communicate directly with Kelch-Links. So they hired a pool of experts at home and abroad, and built a platform of communication with the target company to gain recognition. The experts Hengli invited included American consultants, domestic professors who are experienced experts and renowned in the same industry at home and abroad. They are familiar with not only the industry but also the technological development of the world. Through their communication with Kelch-Links, it is easy to obtain consensus in terms of technology. The vice president sent by the German company of China General Technology (Group) Holdings, Ltd. is acquainted with Germany, is a master of project operation, speaks fluent English, and has strong comprehensive organization and coordination ability. The predatory accounting firm, Deloitte & Touche, is one of the four biggest accounting firms in the world. It is prestigious and trustworthy. The three German lawyers are experts. Especially, the lawyer in labor law is one of the famous lawyers in Germany. What is worth mentioning is that the purpose of communicating through this platform is not to figure out who is right or wrong, but to identify proposals favorable to this merger and integration. When problems were encountered in project planning and coordination as well as in finance and investment, the experts would put forward recommendations. Especially when communication was needed in German corporate law, contract law, labor law, taxation, and issues on reversing losses, German experts would offer help which contributed to mutual understanding and created conditions for recognition.

30

Hermann Haken, “Synergism–The Secret of Nature”, Chapter 12.

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Recognition is gained through win–win solution The most sensitive topic in the merger negotiation and integration was the coordination of interest. On account of the difference in status and power between the two companies, it is difficult to realize “win–win”. Hengli did a lot of work for seeking a win–win solution. First of all, they thought and solved problems in strict conformity with international practices. For example, through the main contract they gained the exclusive right of using the trade mark and intellectual property rights, source programs of computer software, domain names and websites, all series of blueprints of its products, and technological documents worldwide. They also streamlined sales channels through controlling and mastering the production and supply rights of the target company worldwide and purchasing the stock option of the above sales institutions. These are in accordance with international practice and accepted by the target company. Secondly, they considered the interest of the target company. Kelch-Links is a family firm. When it comes to the leasing of workshop and office equipments of the new company, they must sign a leasing contract of ten years with the family. Hengli fully considered the factors and suggested that the rent for the first year be 25% lower than the local market; from the second year, the rent will be a little lower than the local market; and in the following years, the rent will be adjusted with the local inflation index. This was quickly accepted by the German company. Lastly, they sought win–win solutions in view of the future. This merger and integration are beneficial for both sides. The new company has a promising future. The low cost advantage and market advantage of Hengli Company created chances for Kelch-Links to bring into play its technological advantage and market channel advantage, which brought the new company back from making losses in a short time. The expert team of Hengli, the company trade union of Kelch-Links, most of the employees, the creditor committee, the Kelch-Links family, and the trusteeship lawyers all reached an agreement which provided solid foundation for recognition.

Recognition resulted in respect “Everyone enjoys equal respect”. This is the same to both parties. Therefore, respect becomes the touchstone of a true and long lasting recognition. The main measures Hengli took are: Firstly, never let the other party feel “lost”. Hengli made it clear that the nature of merging Kelch-Links is to acquire its assets instead of the whole company. This policy was implemented through the entire process. Therefore, the merging company and the merged company established the new company together. Besides the president and financial director from Hengli, the new company hired German professional managers as foreign managers working together with expatriate managers of Hengli. They adopted “the system of double manager responsibilities”: The German manager is in charge

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of production and operation, while the Chinese manager is responsible for financial supervision. The German manager reports to Hengli headquarters every week and the headquarters send instructions to management of the new company via internet video. This basically stabilized the production and operation order and strengthened the “sense of belonging” of Kelch-Links employees. Secondly, strengthen the cooperation with the company trade union of Kelch-Links. Worker placement is a tough issue. They carefully and patiently negotiated with the labor organization and reached an agreement in redundancy and working time. The employees hired by the new company should be arranged by the trusteeship lawyer. In the contract, they further made clear the duties and obligations of the trusteeship lawyers. What more, at the last stage of the merger, a German company offered a higher price to compete with Hengli Company but failed. One of the main reasons was that their employee package was not as appealing as that of Hengli Company. Respect is critical, especially in managing the relationship with the company trade union. Thirdly, bring the new company and employees as quickly as possible into the culture of Hengli Company. As one of the 156 key projects of “The First Five year Plan”, Hengli Company is the leading precision measuring implement manufacturer and has profound cultural connotation. In terms of the quality of its employees, Hengli pay more attention to “politeness to others, rigidity to self; cherishing property, loyalty to work; honesty and faith, unity and devotion”; and in terms of its management concept, it stresses “pursuance of excellence and first class”. Its company spirit is to “make progress everyday”. These obtained recognition from the new German company which is noted for its preciseness. The fifth sports meet of Hengli this year was historically grand. The new German company organized a team to take part in it and received a warm welcome.

Integration of performance: Multi-effects M&A is productivity. Hengli has made leap-forwarding development after the merger and gained the effect of 1 + 1 > 2. Enterprises rely on products and products rely on development. Hengli Company constructed their product development platform by means of integration after M&A. The jointly developed series of products were put into production one after another. Core technology is not bought. The R&D people of Hengli participated in designing the products. They caught up with the most advanced technology in the world, broadened their eyesight, grasped methods, and enhanced their capability. Hengli Company was clear about why they can do now but they could not do in the past; how did other companies invest in R&D; and how should they prevent their technology and patent from being copied? These problems which they could not have encountered in the past are now waiting for them to settle. Their jointly produced products participated in international exhibitions and drew broad attention. Most importantly, their technology

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and products own intellectual property rights, which mean they really increased their innovation abilities. The competition of products and R&D is reflected in market competition. The cooperation of Hengli and Kelch-Links realized market interaction and created a new pattern of global competition. By making good use of and integrating their original market advantages, the two companies not only reinforced their original market advantages but also jointly planned to develop new markets. They have more customers and market share. After the merger and integration in March 2005 and till the end of 2006, the main economic indices such as production output, sales revenues, taxes and new products have quadrupled since 2002. Its development is making leaps and bounds, and has since become one of the leading companies in China’s tools. The focus of market competition is brand. Hengli Company realized that for a country, brand is a reflection of comprehensive national and economic power. To some extent, the emerging process of a country’s economy is the developing process of its brand. If there is no powerful brand, a country has to stay at the bottom end of international distribution of labor, lack competitiveness, and lose benefits in international exchange. For a company, brand is the comprehensive reflection of the internal value of its products. It is not merely a mark and a brand, but quality, efficiency and competitiveness. Brand is also a kind of intangible asset which is more valuable than tangible assets. Based on the above concept, Hengli Company in 2004 was recognized with the “Award for National Machinery Industry Quality Management”, “Model Quality Efficient Company of National Machinery Industry”, and “Award for Customer Satisfied Products National Machinery Industry”. In 2006, it won prizes for “China Famous Brand” and “Top Ten Annual Brand of China (for Machinery) in World Market”. This is the praise for the company’s leaders and employees who look at quality as their life and dedicatedly produce the best product and famous brand. The profits after the merger are the most convincing. The blueprint resulting from this is also heart shaking. The sales revenue of Hengli in 2007 increased dramatically. The first half year increased 19.7% than the same time in 2006; taxes in 2007 increased 12% compared with the same time in 2006. In the first half of 2007 they have completed 61% of their yearly plan. By the end of “the tenth five year plan”, when planning its “the eleventh five year plan” blueprint, Hengli Company made internationalization strategy one of its development strategies. Integration after the merger offered Hengli opportunities to implement its internationalization strategy. All types of products of Kelch-Links coincide with its key development items set in its “the eleventh five year plan”. Through integration, Hengli not only obtained the core technology, brand, sales channels, and important clients of Kelch-Links, but also helped enhance its technological level. It can be called a “tridimensional innovation of technology” which spurred the technology of its products of the same sorts to become one of the world advanced. Today, Hengli Company has become more and more well known internationally. They implement their “Go Abroad” strategy vigorously, and actively explore international

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markets. Within merely a year in 2006, its export to Germany and Europe increased by more than 20 million Yuan.

Conclusions and Discussion Hengli’s successful integration with Kelch-Links is instructive on how to think about a few key questions.31 For example, someone says “The experts of M&A found an important rule through studying large numbers of M&A cases: the success of M&A depends on what the merging company can bring to the merged company, instead of what it can get from the merged company. It is this rule that made some Chinese enterprises fail.” That is to say, it is the main reason contributing to the failure of integration after M&A of Chinese enterprises. The practice of Hengli Company proved that no matter what the merging company or the merged company gets from the M&A, it is bidirectional. It is a question of whether a new “supply and demand relationship” can be balanced. Therefore, it needs to deliberate whether “this important rule” exists. Another example, “After merging the PC business of IBM, Lenovo moved its headquarters to the United States Vice-President Ward, who was in charge of IBM’s PC business, became its CEO. Half of its top management and key posts came from IBM. This is certainly true for the stability of the company and customers, but someone may ask painfully: “If everything is the same with the original IBM, how can the PC business of IBM reverse losses into profits?” From the practice of Hengli Company we can see that the so-called “old way” has seen some “new change” albeit gradually instead of drastically. How ought the original situation be turned around depends on the new composition of forces. To cite another example, “All facts reflect an essential reason, i.e., Chinese companies as merging companies could not bring to the new company a ‘Chinese factor’ to be more competitive after the merger. In fact, these failed companies were not defeated by Chinese enterprises, but by the third enterprise. Under these circumstances, Chinese enterprises dare not take over as a winner. Thus, they must accept the requirements of the merged company: employees cannot be fired; salary cannot be reduced; management system cannot be changed; and the whole management is even controlled by the merged company.” This would get Chinese enterprises into trouble. We do not discuss what the “Chinese factor” is. For the merging company, it is taboo to “call itself winner”. “According to the opinion of the famous American researcher in transnational corporation, Perlmutter, transnational enterprises in its beginning stage is ‘ethnocentrism’. Apparently, the situation of Chinese transnational enterprises is just the opposite.” That means that Chinese enterprises have a feeling of “inferiority complex” which should turn into 31

Qing Hefang & Wang Chengjun, “Corporate Mergers and Acquisitions Under the Curse of Failure”. IT Times. http://www.sina.com.cn. 7 July 2005.

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superiority complex. It needs to be considered whether this can be introduced abroad as the “Chinese factor”. The new Lenovo policy set forth after Lenovo acquired the PC business of IBM is “honesty, respect, concession” which conforms to that of Hengli Company. Qiao Jian, the Chinese who is in charge of the cultural integration of Lenovo, said: “We don’t think it a better way to sit down and quarrel. Why don’t we adopt a way everybody accepts? Foreign employees shouldn’t think that Chinese employees don’t want to set a more challenging objective just for over fulfilling their task and getting more bonuses. While Chinese employees shouldn’t think that foreign employees try to avoid taking responsibilities by finding excuses for not finishing their workload. We should accept the differences between the two cultures.” He also stressed that differences like these can be ignored only if the regulations of the company were not breached, but the premise is that no one regarded the other as unreasonable. Concession is a wise means of thinking and handling problems. Practice proves that when a company is in its cultural integration stage, it must by all means tell everyone that the company after the merger is a new organization, not the original merging company.32 Thus, we can draw the following conclusion: cross-cultural integration of M&A is both a science and an art. We need to study not only the general rules of cultural integration, but also the different integration practice. The most important issue is innovation. Innovation depends on the soft approach. It is the soft approach that Chinese enterprises must embrace in order to ensure successful cultural integration in M&A.

References Badrtalei, BJ (2007). Effect of organizational cultures on mergers and acquisitions: the case of DaimlerChrysler. D L International Journal of Management, 24(2), 303 (ABI/INFORM Global). Bartlett, CA (2000). Transnational Management. Northeast Financial University Press. Bartlett, C and S Ghoshal (2000). Transnational Management: Text, Cases, and Readings in Cross Border Management, 3rd Ed. McGraw–Hill. Beamish, P, A Morrison, P Rosenzweig and A Inkpen (2000). International Management: Text and Cases, 4th Ed. McGraw–Hill. Charles, G (2004). Successful Mergers, Acquisitions and Strategic Alliances: How to Bridge Corporate Cultures. Renmin University Press. Cross-cultural Management (2003). The Theory of Culture, Vol. 1, G Redding and BW Stening (eds.). Cheltenham, UK; Northampton, MA: Edward Elgar Pub. Cross-cultural management (2003). Managing Cultural Differences. Vol. 2, G Redding and BW Stening (eds.). Cheltenham, UK; Northampton, MA: Edward Elgar Pub. Davidson, C and B Ferrett (2007). Mergers in multidimensional competition. The London School

32

Zhang Yijun, Zhang Chu, “Compromise is Wisdom”. China Business Newspaper. 25 June 2007.

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of Economics and Political Science 2007, Economica (2007), 74, 695–712 (doi:10.1111/ j.1468-0335.2007.00595.x). Gannon, MJ (2002). Understanding Global Cultures, 2nd Ed. Sage Publications. Harris, PR and RT Moran (2002). Managing Cultural Differences, 6th Ed. Gulf Professional. Hill, CWL (2002). International Business, 3rd Ed. McGraw–Hill. Hill, CWL (2003). Global Business Today, 3rd Ed. McGraw–Hill. Hodgetts, RM and F Luthans (2000). International Management: Culture, Strategy, and Behavior, 4th Ed. McGraw–Hill. Li, R (2004). Merger and Acquisition. China Financial and Economic Press. Ma, C (2004). Cross-cultural Management of International Corporations. University of International Business and Economics Press. Noe, RA, J Hollenbeek and B Gerhart (2000). Human Resource Management, 3rd Ed. McGraw–Hill. Terranova, C (2007). Assessing culture during an acquisition. Sun Micros Organization Development Journal, 25(2), 43 (ABl/1NFORM Global). Thompson, AA Jr. and AJ III Strickland (2003). Strategic Management: Concepts and Cases, 13th Ed. McGraw–Hill. Torre Jose, DL, Yv L Doz and T Devinney (2000). Managing the Global Corporation: Case Studies in Strategy and Management, 2nd Ed. McGraw–Hill. Yan, Wenhua (2000). Psychology Sychology of Cross Cultural Enterprise Management. Northeast Finance University Press. Zhang Q (2005). M&A Forum 2005. China Economic Press.

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The Composition and Role of Family Boards in Chinese Businesses: A Business Cultural Perspective ͣLIN GUO Xiamen University

Professor Lin Guo is a thinker, researcher, consultant, teacher, trainer, and writer on Entrepreneurship and Small Firm Growth. Chinese SMEs, particularly family SMEs, are his main research objectives. His parallel interests include strategy management studies, trust, and leadership. At present, he is working at the MBA Centre of the School of Management, Xiamen University, China. Prof. Guo publishes and conducts research via XECEL Centre — Xiamen-Essex Centre for Entrepreneurship Education. It is a co-research center founded by Xiamen University and Essex University in the United Kingdom, with an international network of academics, consultants, entrepreneurs, and like-minded inter-disciplinary associates, with support from various companies. Partnership, collaborative work, and the critical principle of communicative action guide have enhanced his open-ended and very inter-disciplinary approach to research, teaching, and practice. Professor Guo graduated from the University of Science and Technology of China with Bachelor and Master Engineer degrees in Automatic Control in 1983 and 1985. His research project on a computer expert advisory system for adequate fertilization of wheat fields in China won the second prize at National Science and Technology Progress in 1988. In 1998, Prof. Guo received the Brendan O’Regan scholarship from the University of Limerick, Ireland, for his PhD studies. He was awarded with the PhD degree at the end of 2001. His research during that time focused on the relationship of general trust, structure, and growth of SMEs. Prof. Guo’s skill in qualitative and quantitative analysis was also established during that period. Professor Guo is a member of the Academy of Chinese Management, a member of both Chinese Marketing Association, and Entrepreneurship Education and Study Association. He has completed several research projects in

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the last five years.They include:Research on the Internalization of Chinese SMEs, Owner-Manager’s Trust, and Its Influence on the Structure and Growth of Chinese SMEs. His research projects in process include: Board’s Composition: Institution or Resource Perspectives? In the past 10 years, Prof. Guo has published 40 journal and conference articles. Professor Guo live and work by the principles of collaborative networking and communicative action. He has over 22 years of diverse international experience in China, Ireland, United Kingdom, and North America. This included consultancy, teaching, lecturing, training, curriculum development, new ventures, team leadership, research and managerial roles, and not forgetting the joys and tribulations of the University of Life. Now Professor Guo is Associate Professor and Deputy Director of the MBA Centre, School of Management, Xiamen University. He is also Director of Xiamen-Essex Centre of Entrepreneurial Education, Deputy Director of Strategic Research Centre of Xiamen University. Abstract: What defines a family business? Many studies argue that it is the influence the owning family has on decision-making and operations of a firm. The extent and manner of such an influence depends critically on family business culture, the extent to which family and business values overlap, as well as the family’s commitment to the business. Survey data on 117 unlisted small and medium sized Chinese family businesses form the basis of this study. Analysis showed that there is no relationship between family business culture and performance. However, the family’s commitment to the business affects the board composition, working style, and roles of control, service, and family affair management. Comparatively, the influence of overlap between family and business values on the board is less significant, compared to the ratio of the family members in the board and the extent of board involvement in family affairs. Finally, the results indicate that the number of the family members involved in business management affects the family business culture. Keywords: Family business; Board of Directors; Corporate culture

Introduction It has become increasingly common for family businesses to set up a board of directors. Surveys show that 26% of Chinese private businesses had a board in 1993 and 74.3% in 2004 (China Business Times, 2005). At the same time, the boards of family businesses are attracting increasing attention from the academia (Nie Zheng’an, 2004). Many scholars believe that an efficient board has a positive influence on the performance of the business.

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However, practical results show that our understanding remains extremely limited in the workings of the boards of non-listed family businesses, particularly the composition and role of the boards of family businesses in the context of Chinese culture. Family businesses are distinguished from general businesses by family influence on the business. In a family business, the family exerts a significant influence on the decision-making and operations of the business. However, as a family business is a complex organization, it’s extremely difficult to measure the extent and the quality of family influence on the business (Klein, et al., 2005). They consider business culture an important family enterprise element. However, existing research is mostly concerned with some contingency variables which are easy to measure, such as the proportion of shares held by the family, and the generation of ownership and generation active in management. In general, current research is lacking on the influence of the family on the board of the business from the perspective of family business culture. This paper will examine the influence of family business culture on the composition and role of the board. The research targets non-listed small and medium-sized family businesses in China, as such businesses represent the majority of Chinese business at present and it is meaningful to investigate them. This research will not only enrich related theories of family businesses and corporate governance, but also help family business managers to work out an effective resolution to the problems encountered in growth business. The findings of the research will also deepen our understanding of the relationship between Chinese culture and business management. This paper consists of five sections. The first section is an introduction of the research topic, the second section reviews related literature, the third section presents research models, the fourth section describes research methods and provides a data analysis, and the last section presents the conclusions of the research.

Literature Review Board composition and role The composition of boards describes their specific characteristics and decides their operating efficiency (Huse, 2000). Composition variables that frequently occur in research include the size of the board, CEO duality (CEO hold the position of chairman of the board of director), and the proportion of inside and outside directors. The significance of research on the composition of the board of a family business largely derives from the practical needs of the family business. First, boards are playing an increasingly important role in the governance structure of family businesses. Some scholars argue that boards may even have a more important role in small family businesses than in large companies (Johannisson and Huse, 2000). Second, board composition is the focal point of research efforts on boards, as it influences the role of the board and thus the performance of the business.

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The views and expectations of a board’s role in a business depend on who evaluates board performance (Gabrielsson and Winlund, 2000). Some businesses have different stakeholders, and they influence the decision-making of the board (Huse, 2000). From the shareholders’ perspective, the role of the board is to supervise the performance of the business. However, as far as the CEO and the management team are concerned, they hope that the board can play a greater role in helping them fulfill their tasks. For a family business, one of the roles of the board is to be involved in the management and arrangement of family affairs and to coordinate their relationship with company management (Carlock and Ward, 2001). Some scholars suggest that the board has a strategic role of assisting the business with assessing, formulating, and implementing strategies. Nevertheless, some other scholars argue that the strategic role of the board is linked to its control role, i.e., reviewing and supervising the company’s strategic decision-making (Fama and Jensen, 1983; Gabrielsson and Winlund 2000); other roles, such as providing suggestions for the company’s development and external liaisons, can be regarded as the service roles of the board (Pfeffer, 1972). Research has found that the composition of boards and their roles in businesses are influenced by various factors, including business size, age, and life cycle, which are business characteristics; industry and geographic location, which are environmental characteristics; and internal and external stakeholders such as the family, management team, banks and venture investment institutions (Zahra and Pearce, 1989, Jensen, 1993: Huse, 2000). For family businesses, many scholars think that among the various factors that influence board composition and role, one important variable is the family’s influence on the business (Klein, et al., 2005; Li Xinchun and Ren Lixia, 2004). As a family business is a complex organization, it’s extremely hard to measure the extent and the quality of family influence. Astrachan et al., (2002) proposed the application of a scale that assesses family influence via the measurement of three dimensions or subscales: Power, Experience, and Culture. In this Family Influence on Power, Experience, and Culture (F-PEC) scale, Power refers to dominance exercised through financing the business and leading and controlling the business through management and governance participation by the family; Experience refers to the summed experience that the family brings into the business and is operationalized by the generations in charge of management and ownership; and “Culture” refers to the overlap of business and family values and the family’s commitment to the business. The first two dimensions are explicit variables which are readily discernable and measurable, whereas family culture is an implicit variable which is not easy to discern and measure. Some scholars argue that existing research efforts are largely concerned with the influence of the first two explicit variables on the board of the family business, while the implicit influence of family business culture on the board is neglected (Chua et al., 1999; Birley, 2001). They suggest that to find out more about the complex family business organization and potential family influence, it’s important to examine family visions, intentions, and culture in order to identify family influence on the business.

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Family Business Culture and Board Composition and Role Astrachan et al., (2002) argue that family business culture mainly consists of two components: the overlap of family and business values and the family’s commitments to the business. Higher value’s overlap and family’s commitments mean greater influence from the family in family business culture and greater family influence on the business. Family business culture is comprised of the business’ deep-rooted values, as they show what is perceived by the family and the business as being the most important (Koiranen, 2002). Only when the family and the business share the same values and missions can the business be classified as a family business. Carlock and Ward (2001) suggest commitments are an integral part of business culture, which includes three key factors: individuals’ trust and support for the organization’s objectives and visions, determination to contribute to the business’s growth, and wishes to maintain longterm relationship with the business. The core family values represent the foundation of business commitments. A family which is highly committed to the business exerts a significant influence on the business, which explains why the family’s commitments and visions depend on the family’s views of what is the most important. The formation of family business culture is a highly complicated and timeconsuming process (Klein et al., 2005). It is the core value of the key business manager that usually forms the essential part of business culture, as these values are integrated into the internal structure of the business. However, business culture is different from entrepreneurs’ personal values; for example, a family business’s values or culture tends to show greater influence on its earlier managers rather than current ones. Corbetta and Salvato (2004) point out that family business culture has an influence on board composition. The influence of family business culture on board composition is premised primarily on variables such as the proportions of outside directors and CEO duality, which describe the independence characteristics of the board. High consistency between family and business values and high family commitments to the business will reduce agency costs and decrease the board’s independence requirements; thus, the proportion of CEO duality is high, the proportion of outside directors in the board is low, and the proportion of family directors is high. Corbetta and Salvato argued that there is no significant influence of family business culture on the board size, which represents the board’s access to resources. Some other scholars, however, think differently. Johannisson and Huse (2000) examine a family business’s requirements for its board from the perspective of managerial ideology. They argue that three ideologies co-exist in a family business: managerialism, which is concerned with institutionalization; entrepreneurialism, which is concerned with innovation; and paternalism, which is concerned with family interests. Managerialism accentuates the necessity of the business to improve its managerial capabilities in the increasingly institutionalized social environment; entrepreneurialism reflects the need

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for the business to innovate in the internationalized and competitive environment; and paternalism emphasizes the influence of the need for the family life to continue its existence on the business’s sustained attention to family interests. The process and outcome of the interaction of the three ideologies influence board formation. Johannisson and Huse argued that managerialism-dominated businesses tend to recruit more outside directors, entrepreneurialism-dominated businesses are reserved about recruiting outside directors, while paternalism-dominated businesses are in between. As such, this paper presents the following hypotheses: Hypothesis 1: Family business culture influences the proportion of outside directors, family directors, and CEO duality, but has no significant influence on board size. This includes: Hypothesis 1a: The greater influence from the family in business culture, the lower the proportion of outside directors on the board. Hypothesis 1b: The greater influence from the family in business culture, the lower the proportion of family directors on the board. Hypothesis 1c: The greater influence from the family in business culture, the more likely for the business to merge CEO and Chairman positions. Hypothesis 1d: Family business culture has no significant influence on the size of the board. Corbetta and Salvato (2004) argue that family business culture mostly influences the board’s control role, and that the board’s service role, such as the provision of resources, depends on the influence of the family’s experience dimension on the business, such as the number of generations involved in the business. Dyer and Singh (1998) find that when all people involved share the same ideals, opportunism will be effectively inhibited, while information sharing will be tremendously increased. Shared ideals can help resolve clashes and contractions arising from the business’s strategic decisionmaking process and bring individuals’ objectives and actions in line with organizational objectives and actions. This means that the higher overlap of family and business values and family members’ commitments to the business, the lower the requirement of the business for the board to perform a control role; thus, the board’s roles will be more service oriented. Another major role of the boards of family businesses is to take part in the management of family affairs. As families stress kinship and are mostly concerned with their members, they generally resist changes. In comparison, in order to survive and thrive in market competition, a business must focus on performance, pay attention to the external environment, and work out ways to capitalize on changes. Due to different concerns, clashes often occur between the family and the business. Excessive concern with the family will inevitably undermine the business’s competitiveness. Over-emphasis

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of the business will only serve to reduce devotion to the family and eventually lead to estrangement among family members. Carlock and Ward (2001) suggest that the board of a family business also serves the role of striking a balance between the family’s wishes and the business’s needs, defining family values, and ensuring the commitments of the family and the management team to the business’s future development. Thus, the higher overlap between family and business values and family members’ commitments to the business, the lower business’s expectations for the board to help the business to maintain a balance between family and business wishes. As such, this paper presents the following hypotheses: Hypothesis 2: Family business culture influences the roles of the board. This hypothesis includes: Hypothesis 2a: The stronger influence from the family in business culture, the weaker the control role of the board. Hypothesis 2b: The stronger influence from the family in business culture, the greater the service role of the board. Hypothesis 2c: The stronger influence from the family in business culture, the weaker the role of the board in managing family affairs.

Research Design Data used in this research have been obtained from questionnaire surveys conducted by the author between April and May 2006 in China. The samples in this search comprise non-listed small and medium-sized businesses. Surveys targeted chairmen or director/ general manager of businesses with a board of directors. Many scholars suggest that the status of entrepreneurs as the core is a prominent characteristic Chinese family businesses. Due to their strong inclination to rule of man/woman, Chinese businesses exert an overall influence on their culture, value orientation, and governance behaviors. Although it takes time to clearly define an organization’s values, the core values of key personnel often form the essence of business culture. Thus, this paper believes that the information provided by the respondents of the surveys gives a fair reflection of the status quo of business culture and the board. A total of 212 questionnaires were recovered, and 117 of them were classified as valid after screening. The majority of the survey samples mostly came from Fujian Province (83.2%), with the rest from Zhejiang, Beijing, and Guangdong. Geographically, 37.4% of the samples originated from large and medium-sized cities, 23.5% from small cities, 37.4% from counties, townships and villages, and 1.7% from rural areas. The surveyed businesses had average annual sales of RMB 135.91 million and an average workforce of 551. Of these businesses, 83% were in the manufacturing industry, 6% in the service industry,

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11% in other industries. The majority stakes of 81% of the businesses were held by families, and the boards had an average of five members. All sample boards had directors who are family members, and, on average, 62.5% of the board members were family directors. Huse (2000) argues that there is no significant difference between the most common variables used to describe the composition of the boards of family businesses and those used in research on large-scaled listed companies. For the ease of comparison with the board composition of large-scaled listed companies, this research has used four common board composition indicators: board size, which describes board membership; the proportion of family directors, which describes the proportion of family members against the total membership of the board; the proportion of outside directors, which describes the proportion of outside directors against the total membership of the board; and CEO duality. The question that described the board’s control and service roles comes from the research by Gabrielsson and Winlund (2000). The 5-level Likert Scale was used for measurement. The board’s control role primarily describes its supervisory function and consists of five questions, with a Cronbach’s alpha of 0.7436. The service role consists of seven questions, with a Cronbach’s alpha of 0.8567. Involvement in family affairs management function describes the extent of the board’s involvement in family affairs management. The questionnaire included the 12 questions designed by Klein et al. (2005) for measuring family business culture. It has been tested in the United States, Germany, Australia, Britain and Europe, and its external validity has been proven. Three of these questions measure the overlap of family and business values and concern the family influence on the business, the values shared among family members, and the values shared between family and business, with a Cronbach’s alpha of 0.7414. Nine questions measure family commitments to the business, involving family members’ support, loyalty, and pride, benefits from the family business, family members’ endorsement of the family business’s goals and strategies, concern with the family business’s fate, involvement with family business activities, understanding of decisions regarding the family business’s development, and help for the business to the achieve success, with a Cronbach’s alpha of 0.9073. The total 12 questions that measure family business culture have a Cronbach’s alpha of 0.8943. Table 1 provides the results of a correlation analysis between family business culture and contingency variables. The results show that family business culture is a stable variable with no significant correlation with performance, ownership structure, firm’s age, or size. The only exception is that they have a significantly positive correlation with the number of family members involved with the business. A likely explanation for this result is that the more family members involving in business management, the higher the overlap of family and business values, and the higher the family members’ commitments to the business.

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Table 1: Correlation matrix of family business culture and contingency variables Mean 1 1 Family value

3.27

2 Family commitment

3.97

2

3

–.130

.012

4 Profit growth

21.75

–.164

–.035

5 Family ownership

81.44

.024

.152

6 CEO ownership

52.60

8 Family member in business

2.30

6

7

8

.490** 1.00

31.30

8.26

5

1.00

3 Sale growth

7 Firm’s age

4

1.00 .916** 1.00 .135

–.229* –.102 –.028

–.008

.235*

.163 .300*

1.00 .447** 1.00

–.137

–.122

–.130

.450** .310**–.020

–.074

.098

–.173

1.00

–.304** .183

1.00

Pearson correlation coefficient 2-tailed: *p < .05; **p < .01.

Analysis and Results Family culture and board composition The results of the correlation analysis of family business culture and board composition variables are shown in Table 2. No correlation is found between family culture, including its two sub-variables, and the proportion of outside directors and the board size. Hypotheses 1a and 1d are rejected. The results show that there is a significant positive correlation between business culture (including family values and family commitments) and the proportion of family directors; Hypothesis 1b is hence supported. This indicates that the stronger influence from the family in family business culture, the higher the proportion of board directors who are family members. Another likely explanation is that the greater number of family directors on the board, the stronger the influence from the family in business culture.

Table 2: Correlation matrix of family business culture and board composition Mean 1 1 Business culture

3.79

2 Family value

3.27

3 Family commitment

3.97

4 Board size

5.01

5 Proportion of Family directors

62.50

6 Proportion of outside directors

12.20

7 CEO duality

42.70

2

3

4

5

6

7

1.00 .73** 1.00 .95**

.49** 1.00

–.0302 –.02 .33** –.06 .21*

.35**

–.03

1.00

.27** –.53** 1.00

–.12

–.03

–.00

–.02

1.00

.09

.22

.08

.06

.00

1.00

Pearson correlation coefficient 2-tailed: *p < .05; **p < .01.

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As CEO duality is measured with the ordinal scale (1 represents CEO duality and 2 stands for CEO non-duality) and analyzed with independent-samples t-test (see Table 3). The results show there is a significant difference (p < 0.05) in the family’s commitments to the business between CEO duality and non-duality firms. However, no difference is found in the overlap of family and business values. This indicates that in a business with CEO duality, family members’ commitments to the business are low; hence, Hypothesis 1c is rejected.

Family business culture and board role Correlation analytical results (Table 4) show that family business culture has a significant positive correlation with the control, service, and family affairs management roles of the board of the family business; hence, Hypotheses 2a and 2c are rejected while Hypothesis 2b is supported. The influence of the two sub-variables of family business culture on the role of the board is further analyzed. The analysis reveals that family members’ commitments to the business have a significant positive correlation with the three roles of the board, indicating that the higher family members’ commitments to the business, the greater the control, service and family affairs management roles served by the board in the business. Furthermore, the results also show that the overlap of family and business values only

Table 3: Family business culture comparison: CEO duality and non–duality samples CEO duality

CEO non-duality

Mean comparisons Δx

t

df

67

–.24

–2.25*

115

67

–.152

–.996

67

–.268 –2.437*

Tested variables

x

s

N

x

s

N

Business culture

3.66

.628

50

3.90

.519

Family value

3.18

.797

50

3.34

.827

Family commitment

3.81

.679

50

4.08

.511

Note: * = p < .05; ** = p < .01, Test of significant in two-tailed. Where x : = Mean value, Δx = Mean difference value, s = Standard deviation, df = Degrees of freedom, N = Sample size.

Table 4: Correlation matrix of family business culture and the role of the board 1 1 Family business culture

2

3

4

5

6

1.00

2 Family value

.95**

3 Family commitment

.73**

1.00 .49**

4 Control role

.263**

.147

.272**

5 Service role

.250**

.050

.299**

.737**

6 Family affair management role

.390**

.344**

.268**

.431**

1.00 1.00 1.00 .259**

1.00

Pearson correlation coefficient 2-tailed: *p < .05; **p < .01.

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has a significant positive correlation with the control and service roles of the board. This indicates that family members’ commitments to the business have a greater say in the role of the board. Gabrielsson and Winlund (2000) proposed a model of the role of the boards of small and medium-sized businesses. They argue that board task performance is influenced not only by board composition, but also by board’s working style. Board working style includes both the degree of involvement that directors have in the board during meetings (board member involvement) and the formal structures that exist to formalize and make the board’s work more effective (board working structure). The involvement of board members during the board meeting is affected by directors’ knowledge and skills, preparedness and commitments to board meetings, and independence towards the management. The degree of involvement of directors in board’s meeting influences the quality of board task performance (Gabrielsson and Winlund, 2000). Board working structure refers to the dimensions of the board’s organization and focus on the rules that exit to make the board work more efficiently. Such working structures are measured by the formal board routines, the frequency of board meetings, and the formal evaluation of boardroom performance. Research in China has found that the working style of the boards of family businesses influences the role of the boards in family businesses; board members’ knowledge and skills and formal board routings are vital for the board to perform its control role; but the business’s family affairs management role is mostly influenced by the proportion of family directors (Lin, 2007). In order to further account for the influence of family business culture on the role of a board, data on board working style, which has been collected from the survey, is used to analyze the correlation between family business culture and board working style. The questionnaire on board working style is sourced from research by Gabrielsson and Winlund (2000). As shown in Table 5, the results of the correlation analysis indicate that the overlap of family and business values and board working style are not significantly correlated, and that board working style is mostly influenced by family commitments. Table 5: Family business culture and board’s working style 1 1 Family value

2

3

4

5

6

7

8

1.00

2 Family commitment

.490** 1.00

3 Knowledge and skills

.043

.358** 1.00

4 Preparations and commitment

.108

.296** .487** 1.00

5 Independence

.051

.212** .541** .670** 1.00

6 Formal board routines

.130

.275** .515** .648** .647** 1.00

7 Formal evaluations

.169

.325** .275** .365** .452** .583** 1.00

8 Frequency of meetings

.054

.054

.074

.079

.161

.092

.203** 1.00

Pearson correlation coefficient 2-tailed: *p < .05; **p < .01.

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Finally, the hypotheses in this study were tested by linear multiple regression analysis. Dependent variables in the regression model include: control, service, and family affairs management role. Independent variables were included in two steps. The first are the power dimension variables in the F-PEC model, including the proportion of shares held by the family, the proportion of shares held by the CEO, the size of the board, the number of family directors on the board, and the number of family members involved in business. The regression equation does not contain the experience dimension variables of the F-PEC model as the majority of Chinese family businesses are still under the control of first-generation entrepreneurs. The outcome of this regression is presented as I in Table 6. The second is the two sub-variables of family business culture: the overlap of family and business values and family commitments to the business; the outcome of this regression is presented as II. SPSS11.5 software is used to analyze the data and the results of linear multiple regression are found in Table 6. The differences in multiple R2 and adjusted R2 between I and II are shown in Table 6. The results show that the power dimension variables in Regression Equation I can barely account for the three roles performed by the board. Regression Equation I, however, shows that the board’s family affairs management role is mostly influenced by the proportion of family directors, and that the higher proportion of family members on the board, the greater the board’s role in family affairs management. The results of Regression Equation II show that, after adding the family business culture variable, the value of R2 increases significantly after adjustment, and the board’s control,

Table 6: Results of regression analysis Board role

Control

Equations

I

II

I

II

I

II

Constant

3.763

2.475

3.328

2.013

3.199

1.194

Family ownership

–.188

–.247

–.080

–.164

–.067

–.076

.115

.158

.113

.158

.012

.045

CEO ownership Board size

Service

Family affair management

–.101

.075

.104

.115

–.253*

–.204*

Proportion of family director

.116

.118

–.057

–.024

.329*

.279

Family member in business

.111

.046

.160

.108

.000

–.075

Family value

–.029

Family commitment R square 2

Adjusted R F F sign

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–.158

.354**

.196

.431**

.159

.042

.148

.034

.175

.142

.217

–.005

.089

–.013

.117

.100

.162

.898 (.485) 2.503 (.021) .723 (.607) 3.051 (.006) 3.384 (.007) 3.962 (.001)

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service, and family affairs management role are largely accounted for. The results of the regression analysis support the finding of correlation analyses that family commitments are positively correlated with the board’s control, service and family affairs management roles in the family business, indicating that the influence of family business culture on the board mostly originates from family members’ commitments to the business.

Conclusions and Implications Noting that many scholars have identified family influence on board composition and role, this paper has targeted the board of directors of non-listed small businesses in China for research in the hope of understanding the influence of family business culture, a key factor of family businesses, on boards, thereby contributing to a deeper understanding of the operating means of Chinese family businesses and how business management standards can be improved. The research has found that the bulk of the influence of family business culture on the boards of businesses originates from family members’ commitments to the business, and that only a small part of the influence comes from the overlap between family and business values. One of the possible explanations is that the validity of the sub-scale for measuring the overlap of family and business values from F-PEC scale is problematic. The questionnaire contains three questions: “Your family has influence over the business” “Your family members share similar values” and “Your family and business share similar values.” Cliff and Jennings (2005) argue that the measuring questionnaire lacks validity; for example, the question “Your family members share similar values.” actually does not measure the overlap of family and business values, but the overlap of family members’ values, and these two are possibly uncorrelated. This indicates that future questionnaires require further improvement. Family members’ commitments to the business influence the proportion of family directors on the board and the proportion of CEO duality. Higher commitments mean more family members on the board, larger proportion of CEO non-duality, greater control, service and family affairs management roles for the board, and, correspondingly, higher involvement of directors in board’s meeting and greater formalization of the working structure of the board. The analytic results show that family members’ commitments to the business are an important indicator for measuring the family’s influence on the business. On the other hand, however, the research has found that the number of family members involved in business management is positively correlated with the family’s commitments to the business; the more family members involved in business management (including top managers and the directors of the board), the greater the family members’ commitments to the business, indicating that the number of family members involved in business management is closely linked to family business culture; nevertheless, the cause-and-effect relationship between the two requires further research.

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Many scholars believe that the greatest difficulty with research on family businesses lies in how family businesses are defined, arguing that the dichotomy of family businesses and non-family businesses is flawed. Many researches have started to pay greater attention to how family influence on businesses can be measured, instead of simply classifying businesses into family businesses and non-family businesses (Cliff and Jennings, 2005). This is because they believe that that family influence on businesses should be measured from multiple perspectives and continuous angles. Many researchers have adopted the F-PEC scale developed by Astrachan et al. (2002) to establish the concept of family businesses from the perspectives of power, experience and family business culture and to understand family influence on businesses. However, the application of this particular scale should be tested in various cultural contexts. The results of this research have, to a certain extent, proved that in the context of Chinese culture, the culture dimension of the F-PEC scale has considerable applicability, but requires further improvement. Admittedly, this research contains certain weaknesses. First, the questionnaire survey of this research targeted company CEOs or Chairmen. As their assessment of board operations and roles may be affected by personal factors, more company managers should have been surveyed in order to obtain more accurate information. Second, data used in this paper have been have been sourced from cross-sectional research via questionnaire surveys. Such data can barely provide a clear explanation for the causeand-effect relationship between family business culture and the board’s working style and roles. Future research requires more case studies with follow-up analyses.

References Astrachan, JH, SB Klein and KX Smyrnios (2002). The F-PEC scale of family influence: a proposal for solving the family business definition problem. Family Business Review, 15(1), 45–58. Birley, S (2001). Owner-manager attitudes to family and business issues: a 16–country study. Entrepreneurship Theory and Practice, 26(3), 5–19. Carlock, RS and JL Ward (2001). Strategic Planning for the Family Business: Parallel Planning to Unify the Family and Business. Houndsmill, New York: Palgrave. China Business Times (2005). The survey result of the Chinese private enterprises in 2005. http:// finance.sina.com.cn/g/20050203/00441343694.shtml (in Chinese). Chua, JH, JJ Chrisman and P Sharma (1999). Defining the family business by behavior. Entrepreneurship Theory and Practice, 23(4), 19–39. Cliff, JE and PD Jennings (2005). Commentary on the multidimensional degree of family influence construct and the F-PEC measurement instrument. Entrepreneurship Theory and Practice, 29, 341–347. Corbetta, G and C Salvato (2004). The board of directors in family firms: one size fits all? Family Business Review, 17(2), 119–134. Dyer, JH and H Singh (1998). The relational view cooperative strategy and sources of interorganisational competitive advantage. Academy of Management Review, 23(4), 660–679.

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Fama, EF and MC Jesen (1983). Separation of ownership and control. Journal of Law and Economics, 26, 301–325. Gabrielsson, J and H Winlund (2000). Board of directors in small and medium-sized industrial firms: examining the effects of the board’s working style on board task performance. Entrepreneurship and Regional Development, 12, 311–330. Huse, M (2000). Boards of directors in SMEs: A review and research agenda. Entrepreneurship and Regional Development, 12, 271–290. Jensen, M (1993). The modern industrial revolution: exit, and failure of internal control systems. Journal of Financial, 48, 831–879. Johannisson, B and M Huse (2000). Recruiting outside board members in the small family business: an ideological challenge. Entrepreneurship and Regional Development, 12, 353–378. Klein, SB, JH Astrachan and KX Smyrnios (2005). The F-PEC scale of family influence: construction, validation, and further implication for theory. Entrepreneurship Theory and Practice, May, 321–339. Koiranen, M (2002). Over 100 years of age but still entrepreneurially active in business: exploring the values and family characteristics of old Finnish family firms. Family Business Review, 15(3), 175–187. Li, Xinchun, and Lixia Ren (2004). Family intention and governance behavior of private-owned firms in China. Journal of Sun Yatsen University (Social Science Edition). 44(6), 239–270 (in Chinese). Lin, G (2007). Examining the effects of the board’s working style on board role performance: an empirical study on the Chinese family business. Proc. of the Paper presented at the 4th International Symposium of Corporate Governance, Tianjing. Nie, Zheng (2004). A literature review on the governance structure of family business. Economics Perspectives, 12, 102–105 (in Chinese). Pfeffer, J (1972). Size and composition of corporate boards of directors: the organization and its environment. Administrative Science Quarterly, 17, 218–229. Zahra, SA and JA Pearce (1989). Boards of directors and corporate financial performance: a review and integrative model. Journal of Management, 15, 291–334.

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Attaining Corporate Competitiveness Through Soft Power ͣJINFA XU, JIAN DU and TAO JIANG Zhejiang University

P

rofessor Xu Jinfa was born in 1946, Shaoxing City, Zhejiang. He obtained both his Bachelor and Masters degrees in Industrial Economy from Renmin University of China, and continued to pursue his PhD in Management Engineering at Zhejiang University in 1986. Prior to joining the education sector, Prof. Xu worked at the Qianli Steel Mill in Inner Mongolia Autonomous Region from 1969 to 1978. From 1982 to date, Prof. Xu is a Professor at Zhejiang University’s School of Management. He was awarded the Special Subsidy of State Department in 1995. Professor Xu was formerly director of Center of Research in Enterprise Development of Zhejiang University.At present, Prof. Xu holds position as incumbent director of Center of Research in Enterprise Development of Zhejiang University, committeeman of the Consulting Committee of Economy and Construction of Zhejiang Province; vice-chairman of the Enterprise League of Hangzhou; vice-chairman of the Entrepreneur Union of Hangzhou; vice-chairman of the Marketing Association of Hangzhou; consultant of the Industrial Economy Union of Hangzhou; independent director of Zhejiang Conba Group; independent director of Zhejiang Longsheng Group. Professor Xu’s research interests include: Business Administration, Management Engineering and Corporate Governance.

D

r. Jian Du pursued his PhD in business management from Zhejiang University under the supervision of Prof. Jinfa Xu. Dr. Du works at Zhejiang Xinhua Accountant as a CPA Certified Asset Evaluator and Certified Tax Agent of China. With his profound knowledge on Chinese private businesses, Dr. Du is responsible for business evaluation and consultancy, providing valuable professional services to Chinese businesses. He has been in-charge of hundreds of projects on evaluation, consultancy, and audit.

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Jian Du is keen to get to know like-minded individuals to discuss on methods to enhance the competitiveness of Chinese private businesses.

M

r. Jiang Tao received his Bachelors degree in Electrical Engineering from Zhejiang University in 2002, and his Masters degree from the Management School of Zhejiang University in 2005. Mr. Jiang is currently pursing his PhD at the Management School of Zhejiang University.

Abstract: This article discusses the nature and mechanism of corporation soft power and analyzes the relationship between soft power and competitiveness. Keywords: Soft power; Resource; Capability; Competitiveness

The term soft power was first put forth by Joseph Nye, Dean of Kennedy School, Harvard University and former defense minister of United States in 1920s. Basically, it is concerned with national soft power, referring to actions aimed at exerting influence upon peoples of other nations through invisible, non-coercive means including cultural, ideological, and policy forces. Currently, soft power is regarded as one of the most important criteria to measure a country’s strength by scholars in both East and West, and is seen as an indispensable prerequisite for a nation aspiring to become a world power. In the era of globalization, competition among countries is increasingly taking the form of competition among their businesses enterprises, and some of such competition has crossed national boundaries. The concept of soft power has naturally been extended to the business arena. High performing multinational companies, in particular, are taking soft power as a vital strategy in their bid to win social trust, secure market share, and maintain their competitiveness. This is a new trend of multinational corporations which at the same time poses new challenges to China’s business enterprises’ efforts to become internationalized. This article discusses the definition, structure, and mechanism of soft power. The author argues that corporation soft power refers to the ability of a corporation, as the subject of social behavior, under certain competitive circumstances, in achieving its own goals and meeting the identified needs from stakeholders, on the basis of possessing and using specific resources, in using attractive means to acquire value identity from stakeholders as objects so that they produce the corporation’s expected behavior. In the past, we accord special attention to hard power such as product, capital, and technology, which is essential. But soft power such as brand, culture is not given enough focus. Today, in the backdrop of international competition, research of soft power has become a pressing problem. Such researches have important implications for our companies in their bid to become bigger, stronger, and last longer.

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Power and Soft Power The term soft power put forth by Joseph Nye (1990) was defined as the ability to make others desire what you want and to establish preference. Nye also emphasized that this ability (Nye and Keohane, 1998) tends to be associated with intangible power resources, such as culture, ideology, and institutions. In other words, it attempts to use attractive behavior to make others believe in or agree with some rules, ideas, and political systems, finally making them behave in the way you desire (Fig. 1).

Resource 1

Resource 2

Realized power

Potential power

Other’s behavior

Power conversion Resource ...

Figure 1: Power conversion.

Nye’s definition to soft power was based on his profound understanding of the concept of power. Combining the resource-based view with the behavior-based one, Nye proposed that the possession of resources only endows companies with potential power, but not realized power which is measured by the changed behavior of others. It still needs the capacity to convert potential power to realized power, which Nye called power conversion. Using a poker game to illustrate, having a strong hand in a poker game does not necessarily result in victory. Further, Nye divided the power into hard power and soft power according to both the nature of the behavior and the tangibility of the resources. From the perspective of behavior, Nye regarded command power behavior which rests on coercion or inducement as “hard”, and regarded co-optive power behavior as “soft”, which rests on the attractiveness of one’s culture and ideology. At the same time, Nye thought that Co-optive power tends to be associated with soft power resources like organizational capacity, whereas command behavior is usually associated with hard power resources like population. Nye insisted that both types of power are important. He thought it is as important to attract third parties so as to force change through threats or the use of military or economic weapons. But he also believed that in the era of globalization and information, soft power will become more important, given the rising cost of information and need for credibility.

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Enterprise Soft Power Currently, corporation soft power is drawing growing attention from domestic scholars. However, its basic concept still lacks clear definition, and links have not been established with other existing concepts like corporation ability, competitive capability, and competitive advantage. Drawing upon Nye’s ideology and research by later scholars, we hold that corporation soft power is an ability system and is endogenous. But it can also be shown externally as restructuring of corporation resources and competitive advantage, which lead to the evolution of corporation competitiveness. The significance in putting forward the notion of corporation soft power lies in its emphasis on the part in a corporation ability system that is often neglected or yet to be developed, but actually is the very part that is becoming the key factor to meet the future needs of social development, promote corporation’s growth and maintain its competitive advantage. More importantly, such restructuring will inevitably bring about the transformation in corporation’s strategic thinking and mode of behavior. Then, what exactly is corporation soft power? We believe corporation soft power refers to the ability of a corporation, as the subject of social behavior, under certain competitive circumstances, for achieving its own goals and meeting the identified needs from stakeholders, on the basis of possessing and using specific resources, in using attractive means to acquire the value identity from stakeholders as objects so they produce the corporation’s expected behavior. This definition embodies the three aspects of the connotation of corporation soft power. First of all, we define a business corporation as a social actor. That is different from the economic man in neoclassical economics who seeks maximum profits, different from the contract person with limited rationality in the transaction cost theory, and also different from the assumption of resource aggregate and ability aggregate in corporation ability theory. A business corporation in essence is a “social institution” rooted in society and community and influenced by public interests. Therefore we see a business as a legal person embedded in society. It does not only have the motivation of seeking maximum profits, but also the need for community life and achieving identity. For instance, corporation’s attention to its credit standing and prestige is not only for the cost reduction in long-term transaction process but also acts out of an endogenous sense of mission and morality from the corporation and entrepreneurs. Precisely because of that, a corporation possesses personality trait. Society does not only distinguish a corporation by its product differentiation. Instead, a corporation’s personality has become an important index for its identification. That calls for corporation’s close attention to the building of its personality. Secondly, we stress that corporation soft power is one of its competitive means. Whether it’s for domestic or international competition, soft power can be one but not the only alternative competitive strategy. The softness or hardness of the power should not be seen as contradictory, but rather complementary and integrated. There should

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be “softness within the hardness and hardness within the softness”. The reason for our current emphasis on the application of soft power is diversified, covering a number of political and economic aspects. One of the key points is the fact that in its path to become internationalized the hard power of “made in China” is met with frequent resistance from European and Northern American countries, forcing our corporations to reconsider the competitive means and methods to reshape the international image of “made in China”. Compared with top-class multinational-corporations, our corporations are still lacking in soft power. There is a significant lack of investment in ideological aspects like brand name, environment, humanities, and traditional virtues of the Chinese nation. Finally, we hold that the core of soft power is to “acquire value identity”. For corporation, that is to achieve value identity among stakeholders. Although what Nye stressed was “to attract”, we believe that “attract” to be only a superficial phenomenon. What underlines is the identity in value, namely, in its pursuit of values, the corporation must achieve resonance from its stakeholders. Only then, can corporate behavior built on aforementioned value pursuit attract a following and support from stakeholders. Here, value identity refers to commitments, implementation, acceptance and approval built on voluntary basis by corporation as subject and stakeholders as objects. In this way, the corporation does not impose its will upon stakeholders, nor does it passively meet the demand from them. The corporation respects the will of the object but at the same time maintain its leading position, through seeking common points while reserving differences.

The Mechanism of Soft Power According to Nye’s definition, the forming of soft power is a process of conversion from the potential to the realized. The discussion of soft power in this article could be seen as a further step to Nye’s structure. The author put forward the core factors involved in the process, studied the relationship among them, and discussed the function of entrepreneurs in that process (Fig. 2). We can divide the process of soft power into three sub-processes, which is the period of fostering, converting, and realization. There are many factors in different subprocesses. At the same time, we cannot ignore the function of entrepreneurs because the entrepreneurs and enterprises are closely bound up, especially in private companies. We considered the entrepreneurs as the motile factors in the process of soft power. First of all, the value of companies was formed posterior to the individual philosophy of bosses. Therefore, if a company wants to establish attractive value, the boss must firstly possess advanced thought. Secondly, potential soft power depends on the system, behavior, and image, which act as carriers to diffuse soft power. The entrepreneur was the fugleman in the society, so he must pay attention to the control and exertion of his own behaviors. Finally, we must focus the shaping of entrepreneur image, because the entrepreneur, especially the family entrepreneur or family leader represent the image of

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Potential Soft Power Process Establish Attraction Test Value of Factors Firm

Influence Function Culture of of Boss Entrepreneur

Power Convert

Carrier

Test System Behavior Product Image Influence Style of Boss

Realized Soft Power Communica tion Process

Impulse Innovation Cohesion

Outcome of Gain the the identity of behavior of stakeholders objects

Value Identity

enhance Influence Charm of Boss

SC HC OC RC

Competitiveness Improvement

SC : Social Capital HC : Human Capital OC : Organization Capital RC : Reputation Capital

Figure 2: Mechanism of soft power.

the whole enterprise, sometimes the reputation of entrepreneur even larger than that of enterprise. Therefore, when we talk about the attraction of enterprise, we cannot ignore the function of entrepreneur’s image. Sometimes, the identity of stakeholders came from the identity to entrepreneur rather than to enterprise, so the attraction of companies cannot be isolated to that of entrepreneurs.

Corporation Soft Power and Competitiveness Porter argues that corporation competitive power refers to the ability of a corporation, taking a global strategic stance, in engaging competition in international market. Local scholar Wang Hecheng holds that it refers to the comprehensive ability of a corporation under competitive market conditions, in realizing its own values on the basis of creating values for its clients, through fostering its own potentials and capacity, and making comprehensive utilization of them. It is clear that corporation’s competitive power is a comprehensive system built on the corporate strategy. With the putting forward of soft power as an endogenous capability from the corporation, our understanding of both the soft and hard aspects of corporation competitive power covering resources, ability, and competitive advantage will be enhanced (Fig. 3). From the perspective of structure of corporation competitive power: (1) Resources are the basis of corporation competitive power. Under the effect of soft power, the structure of corporation resources will be gradually intenerated. Scholars like Wernerfield and Barney believe that particularity of a corporation’s inner resources leads to the differences in the competitive advantage among businesses. And only special resources and ability, i.e., so-called strategic resources, can bring a corporation

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Competitiveness

Command

Behavior

Attract

Hard Advantage Soft Reputation

Brand

Service

Function

Price

…

Tangible

Capabilities

Intangible

Hard

Resources

Soft Culture

Modern

Technolory

Entrepreneur

HR

Capital

Fixed Asset

Material

Pre-modern

… Time

Past-modern

Figure 3: Structural hierarchy of competitiveness.

unconventional benefits. Such strategic resources, in most cases, appear in the forms of tangible or intangible resources uniquely possessed by the corporation. They are believed to be able to meet the VIRN characteristics, i.e., valuable, inimitable, rare and nonsubstitutable. In the past, the competitive advantage of a corporation was often based on such tangible resources like raw material, production scale, and capital. The corporation was keener on acquiring, developing, and reallocating its tangible resources. But now the transactions and circulation of tangible resources have become more convenient, can be more easily imitated by competitors and the original competitive barrier has become fragile. That prompts the corporation to gradually shift its focus on the building of intangible resources. What the potential soft power of a corporation stresses is a kind of capability to build preferences, whose functional targets are corporate resources like ideology including concepts, culture and even subideology. In the future competition, these resources will play an ever important role, becoming the key for a corporation’s sustainable development. Different from tangible resources, these intangible resources, while are closely related to soft power, are often not of the rare variety. This is shown by the following two points: first, intangible resources will not be depleted through the corporate normal production, rather they can be used repeatedly; second, the aforementioned resources seek to be shared, and it wished to be shared broadly. This

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new type of strategic resource possesses new VISAN features, i.e., valuable, inimitable, sharable, attractive, nonsubstitutable. However, such intangible resource can hardly be obtained through external transactions, but must only be built through corporation’s self-cultivation. (2) Ability is the source of competitive power. Corporation soft power serves to supplement corporation ability system. Mahoney and Pandian argue that ability means turning the corporate resources into activities; whereas domestic scholar He Xiaogang believes that resources alone cannot automatically create values. Only through certain behavior from the corporation can it be transformed and hence activated, while this behavior process (including when, where, and by what means, etc.) is the process of using such ability. The process of building of potential soft power of a corporation and its transformation towards actual soft power both require the participation of relevant ability. That is what Scholar Noya referred as the ability to establish preferences and attract others. The advocate of soft power has raised new demand for the traditional ability system based on value chain analysis. In the past, the corporation’s focus on production capacity, technological strength and sales power were competition-oriented, with a clearly defined goal, namely, to beat its rival and grab market share within the limited space of the industry sector. Such ability tends to associate itself with hard power. But now, with the change in the ways and contents of social identity, the corporation’s existing ability finds itself insufficient to deal with current problems. With the gradual shifting of its strategic thinking from the traditional win–lose perspective towards win– win perspective, the corporation needs more and more new elements like assimilation and reform through persuasion to enrich its ability system. The corporation will strive more for the proper socialization of its behavior. Precisely because of this, the ability of the entrepreneur and socializing power of the business is drawing increasing attention from researchers. We believe that they will become the leading ability in the ability structure of soft power. New ability dimensions like innovative power, inspiring power, image power and influencing power and other recessive ability will gradually become dominant. Meanwhile, corporation volition-oriented one-way communicative skill will give way to customer volition-oriented two-way communicative skill. Behavior performance will gradually change from the hard forms of price wars, advertising wars, and others to behaviors for more social responsibilities. (3) Advantage of competition is the static reflection of competitiveness. The soft power opens fresh competitiveness for the business, pushing forward the evolution of its competitiveness. Business competitiveness relies essentially on a set of certain favorable conditions or status. In the past, enterprise competitiveness was often based on production scale, cost and patents. What it adopted was self-oriented unilateralism. The company’s competitive advantage tended to be shown in hard characteristics. However, in the current information age, with society and individuals exerting stronger influence, scholars like Rindova, Fombrun believe that social cognitive factors are increasingly impacting the company’s competitive advantage. If not properly dealt with, the hard power of the

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enterprise may not win social recognition, and may even encounter resistance. While its soft power, built through the development of intangible strategic resources, with emphasis on the softening of the enterprise’s mode of behavior, enterprise can be assisted in gaining identification from the stakeholders, establishing new competitive barriers like brand name and prestige, so that company competitive advantage can gradually be transformed from tangible to the intangible variety. In short, because the notion of enterprise’s soft power transforms the company’s capability system into a source of competitiveness and hence brings about relevant changes in enterprise resource system and competitive advantage, the company’s competitiveness structure is thus endowed with both soft and hard components. So the emergence of company’s soft power heralds a new orientation for the evolution of company competitiveness, which bears great significance for company’s current in-depth understanding and grasp of the future evolution of competitiveness and, consequently the adjustment of its strategic thinking.

References Barney, JB (1991). Firm resources and sustained competitive advantage. Journal of Management, 17(1), 99–120. Barney, JB (2001). Resource-based theories of competitive advantage: a ten-year retrospective on the resource-based view. Journal of Management, 27(1), 643–650. Dahl, RA (1996). Who Governs? Democracy and Power in an American City. New Haven, Connecticut: Yale University Press. Kak, A and Sushil (2002). Sustainable competitive advantage with core competence: a review. Global Journal of Flexible Systems Management, 3(4), 23–38. Mahoney, JT and JR Pandian (1992) The resource-based view within the conversation of strategic management. Strategic Management Journal, 13, 363–380. Noya, J (2005). The symbolic power of nations. Place Branding, 2(1), 53–67. Nye, JS (1990). The changing nature of world power. Political Science Quarterly, 105(2), 177–192. Nye, JS and R Keohane (1998). Power and interdependence in the information age. Foreign Affairs, 77(5), 81–94. Peteraf, MA (1993). The cornerstones of competitive advantage: a resource-based view. Strategic Management Journal, 14, 179–191. Rindova, VP and CJ Fombrun (1999). Constructing competitive advantage: the role of firmconstituent interactions. Strategic Management Journal, 20, 691–710. Wernerfelt, BA (1984). Resource-based view of the firm. Strategic Management Journal, 5(2), 171–180. Xu, JF, H Xie, T Jiang and CM Li (2006). Nation’s Soft Power and its Means Extension in Economic Competition. China National School of Administration: China Archives Publishing House (in Chinese).

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A Study on Excessive Competition of Chinese State-Owned Duopoly Enterprises: Cases of China Telecom and China Netcom ͣQINGSHENG WU and RUI BAO Shanghai Jiao Tong University

D

r. Wu Qingsheng is the Associate Professor of Department of Marketing, Antai College of Economics and Management, Shanghai Jiao Tong University. Prof. Wu obtained his PhD from Antai College of Economics and Management, Shanghai Jiao Tong University in 2002. Associate Professor Wu’s research fields are Marketing, Strategic Management and Brand Management. The publications in referred journals and books include: Strategic Brand Management of Real Estate Enterprise (2006), A Institutional Stud on Economic Growth Difference of Developing Countries (Regions) (2005), Marketing Planning (2007), Improved Model of Factor Analysis of Economic Growth and Empirical Study (Journal of Shanghai Jiao Tong University) (2001), A Further Study of Problem and Solutions Concerning Capital Management Companies in China (Journal of Shanghai Jiao Tong University) (2001), A Factor Analytic Model of Economic Growth Basing on Domestic and Foreign Resource and a Positive Study of Korean Economy (Journal of Dong Hua University) (2001), etc. The representative programs of company consulting and research in recent years are: Report on Marketing Study and Access Strategy of Greater China for Mood Media Ltd (2006–2007), Report on Developing Strategy and Brand Planning of Carnations Ltd. In China Mainland (2006), Report on Brand Structure and Marketing Strategy of Hisense Group (2006), Report on New Product Marketing Strategy of Kodak Medical Group in China (2006), Report on Marketing Strategy of Dulux Group in East China (2005), Report on Key Accounter Management Model of Shanghai Bell-Alcate (2005), Report on 11st Five-Year Strategy Planning of SIIC (Shanghai Industrial Investment Co. Ltd.) (2005), Report on Direct Sale and Distribution Channel Management of Danfoss Co. Ltd (2004), Report on Customer Service Strategy of Marketing Centre of Baosteel Group (2004), etc.

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Associate Professor Wu’ productions of most projects (results or method) are applied in MBA teaching.

M

s. Rui Bao is a postgraduate of Antai College of Economics and Management, Shanghai Jiao Tong University. Ms. Bao achieved academic excellence and was awarded “Academic Achievement Scholarship” from 2003 to 2005, and the “Excellent Student of Shanghai Jiao Tong University” form 2003 to 2004. Ms. Bao was an intern in Budweiser, GE, Education Fund and Financial Engineering Institute of Shanghai Jiao Tong University. Ms. Bao is a diligent, careful patient and has a desire to challenge herself. She has excellent leadership capability and interpersonal skills, be able to getting along well with others and have good team spirit.

Abstract: Based on the demand function and social welfare function, making use of the Cournot equilibrium and Stackelberg equilibrium approaches, we analyze the condition, process and corresponding results of excessive competition between two monopoly enterprises owned by a single organization. Theoretical analysis shows that, if the leading duopoly enterprise continues to increase its market share, total profit, net asset yield and average profit of customer of the two enterprises as a whole will decline, and social welfare will reduce at the same time. Following that, in the case studies of China Telecom and China Netcom, we analyze their business data, and the empirical results support our theoretical conclusion. The empirical results show that, since China Telecom Ltd. has been in the dominant position, if it were to continually increase its market share, total profit, ROE and average profit of customer of the two enterprises as a whole would decline. Keywords: Duopoly competition; Excessive competition; Social welfare; China Telecom; China Netcom

Introduction In the past years, many Chinese industries were completely monopolized by one stateowned enterprise. In order to break this monopoly situation, the central government tried to set up two or more state-owned enterprises in each industry and created a competitive environment. For example, in the fixed-line communication industry, there were China Telecom and China Netcom, and in the mobile communication industry, China Mobile and China Unicom, and in the oil industry, Pectro China and China Petroleum & Chemical. Situations of the aviation industry and power industry were similar. These firms of one industry were belonged to different departments of the central government. In other words, these firms were held by different investors of state-owned assets. This

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situation served to ensure reasonable competition of a certain degree between these firms. Nowadays, after state-owned shares of these firms were all held by the Stateowned Assets Supervision and Administration Commission of China (abbreviation as SASAC), the controlling shareholder of the two or more state-owned monopoly enterprises in one industry is the same one, the SASAC. Thus, reasonable and healthy competition of some degree among these firms held by one investor could be broken easily, and these firms could go to two possible extremes: either collusion or excessive competition. If the decisions of these companies comply effectively with the principle of maximizing benefits of the shareholder, collusion of these companies is more likely to maximize benefits of the shareholder. On the other hand, collusion will debase their operational efficiency and reduce social welfare. If the mutual controlling shareholder is “absent”, these firms may struggle for the controlling position of the industry, and it is easy to cause excessive competition and harm the interests of the shareholder. In addition, excessive competition may bring about a negative influence on the long-term potential development and social welfare. For the purposes of illustration, and without sacrificing generality, we assume that there are just two firms in the duopoly industry and the two state-owned firms are controlled by the same shareholder (SASAC). In this paper, we select the fixed-line communication industry of China and its two key firms, China Telecom and China Netcom held by the same shareholder (SASAC), as examples to analyze the condition, process and corresponding results of excessive competition in the situation of duopoly. Suggestions for management will be proposed after our analysis.

Model and Methodology Decision and profit analysis Firstly, we need to define the demand function, Q = m – nP (m > 0, n > 0), m to refer to the maximum demand when price is zero; n indicates the slope of the curve. Since it is a linear demand function, we assume m and n are both constants. The demand function can be expressed as: P = a – bQ (a = m/n > 0, b = 1/n > 0) see Fig. 1. Assuming the monopoly companies are T and N (China telecom and China Netcom) their products are non-differential in nature, and the integrated strengths are at a similar level. They all rationally aim to maximize profits. If we define Q as the total quantity of the customers Q = q1 + q2 (q1 is defined as the customer quantity of T; q2 refers to customer quantity of N; integrated price P is the descending function of total customer quantity of Q). Namely, inverse demand function as P(Q) = a – bQ = a – b (q1 + q2) (a > 0, b > 0). If both T and N select q1* q2* as the total customer quantity to maximize profits, the approach of getting an optimal solution is to obtain

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P P = a−bQ

Q

Figure 1: Demand function.

the first derivative for the profit functions of each company, and let them be zero * * to get the result basing on Nash equilibrium q1 = q2 = (a − c) / 3b, the profits of each company are π1 (Q* ) = π2 (Q* ) = (a − c) ^ 2 / 9b , namely Cournot Equilibrium (π 1: profit of company T, π 2 : profit of company N ). If there is distinct overall strength difference between company T and N, company T as a market leader, its customer quantity is selected as q1a, company N decides its optimal customer quantity q2 after knowing about the decision of company T. The profit function is as π 1 = q1 × (a − bq1 ) − cq1 (c: average cost per user, normally the cost of T and N are the same). After optimal first deviation calculation, q1* = (a − c) / 2b ; maximum profit is π1 (Q* ) = (a − c) ^ 2/8b . Similarly, after calculating first deviation of optimal profit function of company N, q2 = [(a − c) − bq1]/2b, putting the value of q1* into this function, we can get q2* = (a − c)/4b, maximum profit is π 2 (Q* ) = (a − c) ^ 2 /16b . This is named as Stackelberg equilibrium. It is clear to see the profit of company T in Stackelberg equilibrium is more than that in Cournot equilibrium, while profit of company N in Stackelberg equilibrium is less than that in Cournot equilibrium. The main reason is that company T in Stackelberg equilibrium enjoys the “strength of first mover”. Cournot equilibrium describes the Game relationship between the two monopoly enterprises with similar strength, while Stackelberg equilibrium describes the dynamic Game relationship between the market leader and follower. Company N is not willing always to be the market follower, and company T willing to keep its stable market leader position for the long term. Therefore, during the process of coordinating the Game, company T prefers to choose the Stackelberg equilibrium and company N prefers to choose the Cournot equilibrium.

a

In reality, normally company T decides the market price P by its integrated strength, and obtain the customer quantity as q1; if the mutual controlling shareholder of company T and N is “absent”, the market leader, company T, will take the market share and the business scales as the first target but not profit, because usually the state-owned companies with large business scale and market share can get more resource and support from government.

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In the following paragraph, we motivate our discussions by choosing different equilibrium for company T and N.

Decision analysis for company T For company T, the profit function is

π 1 = Pq1 − cq1 = (a − bq1 ) − cq1 = −bq12 + (a − c)q1

(1)

c: average cost per capita, therefore ∂π 1 = −2bq1 + a − c ∂q1 Making

(2)

∂π 1 = 0, we can get ∂q1 q1* =

a−c 2b

(3)

Decision analysis for company N For company N, the profit function is

π 2 = [a − b(q1 + q2 )]q2 − cq2 = −bq2 2 − bq 1 q2 + (a − c)q2

(4)

Making the discussion more easily and clearly understood, also because products from company T and N bear no distinct differences, we assume that they have the same average cost per capita (in the real world, considering the economics of scale and low marginal cost in the land-line telecom industry, this assumption sounds reasonable). From (4), we can get ∂π 2 = −bq2 < 0 ∂q1

(5)

Therefore, the profit of company N may decrease, corresponding with the market share expansion of company T. From (4), it also shows ∂π 2 = −2bq2 − bq1 + a − c ∂q2

(6)

Putting (3) into (6), and making (6) equal zero, we can get q 2* =

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a−c 4b

(7)

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Profit analysis for investors Mutual investor for these two companies (such as China Telecom and China Netcom have the same controlling shareholders, SASAC) has total profit as (result from (1) and (4) combination):

π = π 1 + π 2 = −b(q12 + q2 2 ) + (a − c)(q1 + q2 ) − bq1q2

(8)

From Q = q1 + q2 ⇒ q2 = Q − q1, (Q: total quantity of customers, it is not constant, and will increase with the market expansion in telecom industry):

π = −b[q12 + (Q − q1 ) 2 ] + (a − c)Q − bq1 (Q − q1 ) = −bq12 + bq1Q − bQ 2 + (a − c)Q

(9)

Making first deviation for (9): ∂π = −2bq1 + bQ ∂q1

(10)

Considering whether it is negative, positive or even zero, we can get ⎫ ⎧ 1 ∂ (π t + π n ) < 0⎪ ⎪q1 > Q ⇒ 2 ∂ q 1 ⎪ ⎪ ⎪ ⎪ 1 ∂ (π t + π n ) = 0⎬ ⎨q1 = Q ⇒ 2 ∂q1 ⎪ ⎪ ⎪ ⎪ 1 ∂ (π t + π n ) > 0⎪ ⎪q1 < Q ⇒ 2 ∂q1 ⎭ ⎩

(11)

π1 + πn

1/2Q

q1=2/3Q

q1

Figure 2: The profit for mutual shareholders.

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When q1 > Q/ 2, if the market share of company T still increases, the profit of the mutual shareholder will drop; when q1 > Q/ 2, the profit of mutual shareholder will rise (Fig. 2). Combining (3) and (7): Q = q1* + q2* =

3(a − c) 4b

(12)

When company T reaches the optimal profit level, we can get the following result from (3) and (12): 2 1 q1* = Q > Q 3 2

(13)

It means that by the strategy of company T the mutual shareholder cannot reach the optimal profit level. Basing on general economic theories, a single investor who has invested in two companies in same industry may gain the optimal profit or maximum profit by the strategies from these two companies, but not maximum profit for only one company. If the mutual investor is “absent”, the specific company (especially for the company with more strength) will adapt its strategy to achieve its own target and harm the interests of the shareholders. In this article, we call it “unfavorable competition”. If the duopolies under “unfavorable competition” with the mutual shareholder (SASAC) in same industry do not achieve the state-owned asset profit maximization, but social warfare maximization, the strategy is still reasonable. The reason is that the stateowned companies have the responsibility not only for obtaining the profit maximization, but also for increasing the social welfare and serving society. We will continue to analyze the impact of enterprise strategic influence on social welfare.

Analysis for social welfare We will utilize welfare function by Cable1 to engage in further analysis: 1 U (q1 , q2 ) = a (α q1 + q2 ) − (bα q12 + bq2 2 + 2γα q1q2 ) − c(α q1 + q2 ) 2

(14)

γ (0 < γ < 1) is the effect of the product crossing price, it reflects the indicator of the product difference of these two companies. The larger value of γ indicates the lower differential degree; vice versa. α (α > 1) influence coefficient of company T. From Q = q1 + q2 ⇒ q2 = Q − q1, we can get the efficient function as 1 U (q1 , q2 ) = (a − c)(α q1 + q2 ) − ⎡⎣bα q12 + b(Q − q1 ) 2 + 2αγ q1 (Q − q1 ) ⎤⎦ 2 1 1 1 2 = (αγγ − α b − b)q1 + [(a − c)(α − 1) + Q(b − αγ )]q1 + (a − c)Q − bQ 2 (15) 2 2 2

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Making the first deviation for (15): ∂U = (2αγ − bα − b)q1 + (a − c)(α − 1) + (b − αγ )Q ∂q1

(16)

Let (16) be zero, we can get q1* = When q1* <

(a − c)(α − 1) + (b − αγ )Q bα + b − 2αγ

(17)

1 Q, 2

U, (πt + πn)

q1*

1/2Q

Figure 3: Relationship between social welfare and profit (1).

When q1* =

1 Q, 2

U, (πt +πn)

q1* = 1/2Q

Figure 4: Relationship between social welfare and profit (2).

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When q1* >

137

1 Q, 2

U, (πt + πn)

1/2Q

q1*

Figure 5: Relationship between social welfare and profit (3).

Discussion about the effectiveness of competition From the above sub-figures of Fig. 3, we find when q1* = Q / 2, the strategy of company T will maximize the benefits of the shareholder and the social welfare simultaneously. This is the most optimal scenario and also by occasion. Normally the situation is shown as Fig. 3 or Fig. 5, the point representing the maximum benefit of shareholders appears either on the left or right of that of the social welfare. Without losing generality, we now focus on the scenario shown as Fig. 3.3 and engage in a deeper discussion. If the strategy point of company T is on the left of the points of maximum profit and maximum welfare, i.e., company T continuously expands its output (market share), it will bring about benefits for shareholder and social welfare. Therefore, it is defined as “effective competition” (see Fig. 6); if the strategy point of company T is on the right of the points of maximum profit and maximum welfare, i.e., benefits for shareholder and social welfare increase and decrease asynchronously. It is still rational, especially for state owned companies, because they may strike a balance between profit U, (πt + πn)

1/2Q

q1* Effective Competition

Rational Competition

Excessive Competition

Figure 6: Effectiveness of Competition.

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pursuit and welfare. It is defined as “rational competition”; if the strategy point of company T is outside both the points of maximum profit and maximum welfare, i.e., company T has hurt the benefits of shareholder and social welfare, the output (market share) of company T is out of expectation. Therefore, it is defined as “excessive competition”. Comparing (3) with (13), we can draw a conclusion that the optimal strategy of company T will hurt the benefit of the shareholder. It will be still rational if it is not beyond the point of maximum welfare; otherwise, it is the “excessive competition” as mentioned.

Empirical Analysis This article chooses the duopoly of the Chinese land-line telecom industry—China Telecom and China Netcom to illustrate. (To facilitate our discussion, we ignore the influence of China TieTong due to its insignificant market share.) Firstly, we collect financial information from annual reports of these two companies as shown in Table 1: Comparing with data in year 2005 and 2004 from above, in year 2005 the value of q1/Q decreases, i.e., when the market share of China telecom shrinks, the total profit of the mutual investor will increase; comparing with data in year 2006 and 2005, in year 2006 the value of q1/Q increases, the market share of China Telecom increased as well, and it caused the total profit of mutual investor to drop. This result matches what we Table 1: Operation data of China Telecom in recent years China Telecom

Sale Revenue (Million RMB)

Net profit after tax π1 (Million RMB)

Customer Quantity (Thousand) q1

Customer Quantity Growth rate (%)

Equity E1 (Million RMB)

2006

175,093

27,225

433,778

13.93

203,873

2005

169,310

27,954

380,741

23.01

182,961

2004

161,212

28,076

309,518

–

160,619

Remark: China Netcom went public in 2004, so we analyze using the data since.

Table 2: Operation data of China Telecom in recent years Sale Revenue (Million RMB)

2006

86,921

11,141

145,781

9.10

73,978

2005

85,861

14,114

133,617

54.29

63,010

2004

83,494

2,699

86,601

–

64,595

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Net profit after tax π2 (Million RMB)

Customer Quantity (Thousand) q2

Customer Quantity Growth rate (%)

Equity E2 (Million RMB)

China Netcom

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A Study on Excessive Competition of Chinese State-owned Duopoly Enterprises

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Table 3: Operation data from the Perspective of the Mutual Investor (Central SASAC) Mutual Customer Customer Total Market Profit Total Total Total ROE Investor Quantity Quantity Customer share of Per Profit Profit Equity π 1 + π 2 ˄ᡩ䌘 (Thousand) (Thousand) Quantity China Capita π 1 + π 2 Growth (Million E1 + E 2 Џԧ˅ q1 q2 (Thousand) Telecom (RMB) (Million Rate RMB) (%) Q = q1 + q2 q1/Q RMB) (%) (%) 2006

433,778

145,781

579,559

74.8

66

38,366

–8.8

277,851

13.8

2005

380,741

133,617

514,358

74.0

82

42,068

36.7

245,971

17.1

2004

309,518

86,601

396,119

78.1

78

30,775

–

225,214

13.7

have analyzed using models of shareholders benefit as mentioned before. Meanwhile, it can also be verified by other financial indicators, such as the ROE of the mutual investor and profit per capita, both of them have the same growth trend as that of the mutual investor’s profit. All these indicators verify the validity of our models (Tables 2 and 3). Since it is difficult to obtain the real value of social welfare, it is hard to confirm whether the market share increase from year 2005 to year 2006 caused the decrease in social welfare. If social welfare decreases, it is still effective competition; while if shrinking benefit of the shareholder brings about a drop of social welfare, it should be regarded “excessive competition”. The question on how to measure the real value of social welfare will be the topic of further research.

Conclusion If the industry is in a state of duopoly by two state-owned companies and these two companies have the same controlling shareholder (e.g. SASAC), when this controlling shareholder is “absent” during their strategic decision-making process, i.e., these two companies make their strategy based on their management target independently (e.g. one may aim to pursue the position of a market leader), it is possible to hurt the controlling shareholder’s total profit generated from these two monopolies and dilute social welfare. This competitive strategy does not meet the benefit requirement of shareholders, and also dilute the social welfare (for state-owned enterprises, one of the important missions is to create social welfare), resulting in “excessive competition” as discussed earlier in this article. The authors illustrate the conditions and corresponding results of “excessive competition” basing on the demand function and social welfare function, using the methodology of Stackelberg equilibrium and Cournot equilibrium. After a model-based analysis, the authors take on the actual case studies of China Telecom and China Netcom as examples to elicit evidence supporting the earlier conclusion using data. In this example, China Telecom obtains the market leader position and continues to expand its market share, causing the decrease of the total profit level of

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these two companies, as well as ROE and profit per capita; if China Telecom, which is in a the dominant position, shrinks its market share appropriately, the total profit level of these two companies, ROE and profit per capita will increase correspondingly. To conclude: in the scenario of a duopoly dominated by two state-owned enterprises in a single industry, in order to enhance the ROE on the state-owned asset and provide more benefits for the purposes of social welfare, the central SASAC will need to balance the strength of these two companies to be at a similar level, or try to influence the companies’ key strategy decisionmaking process. Otherwise, it may encounter suboptimality in terms of the ROE on state-owned assets and social welfare.

Reference Cable, J (1994). Current Issues In Industrial Economics. The Macmillan Press, London. China Netcom Group Corporation (Hong Kong) Limited, Annual Report (2004, 2005 and 2006). China Telecom Corporation Limited, Annual Report (2004, 2005 and 2006). Gao, H (2006). Microeconomics, 2nd Ed. Beijing: China Renmin University Press. Liu, X and Shiyun Shen. The Welfare Analysis of Duopoly Firms Based on RCE. Chongqing: Chongqing University of Post and Telecom, 400065. Lu, Y. Games analysis about price competition between China mobile and China unicom. Shanghai: Shanghai University of Finance & Economics, 200439.

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Competitiveness of China’s Food Exports: An Empirical Analysis ͣXING ZHOU and YANPING FAN (BRUCE) Xiamen University

D

r. Xing Zhou is a PhD graduate of China Renmin University; Professor of Administration School of Xiamen University, Director of Center for Strategy Studies of Xiamen University; Vice President of the Industrial Standardization Association of Xiamen City; and ISO9000 Registered Auditor of IRCA and CQC. From 2002 to 2003, she was a visiting scholar of McGill University supported by China National Scholarship Council. In McGill she focused my study on International Business and Management Skill. In 2002, my project about “The latest development in Economics — the research in Experimental Economics” was supported by China National Social Foundation. In 2006, Dr. Zhou’s project “How to Construct the System of China Food Safety based on HACCP” was supported by China Ministry of Education. In addition, she has attended and was also incharge of several items supported by National or Provincial Funds. In 2006, she was selected to participate in “The Elitist Training Plan in the New Century” by China Ministry of Education. Dr. Zhou focused her studies mainly on Economics, Quality Management and International Business Analysis. In Xiamen University, she teaches Economics, International Business and Certification on International Management System for undergraduate students, graduated students, MBA, MPAcc and PHD students. So far, more than 30 of her articles have been published in the China’s Key Journal.

r. Yanping FaN (Bruce) is a post-graduate student of Xiamen University’s School of Management. Mr. Fan is majoring in marketing. His main research fields include is Customer Relationship Management (CRM) and International Business and passed TEM-8.

M

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Abstract: Using parameters such as raw food export data, food export increase ratio, international market share and normalized trade balance (NTB) of China, Japan and the United States between 1995 and 2005, we conclude that in terms of its food exports, while China still maintains a comparative advantage, international competitiveness is showing signs of weakness. Keywords: China; Food Exports; Normalized Trade Balance (NTB); International competitiveness

Introduction China is a traditional agrarian country, its output of primary products and processed food rivals the top producers of the world. However, we still mainly depend on primary processed products; the degree of refining is not high enough. According to international conventions, it is generally regarded that the degree of processed primary food determines the scales and competitiveness of food industry. At present, the ratio of processed products value and primary products value in developed countries is 3:1, while in China, it’s only 0.5:1; the volume of highly processed foodstuffs constitutes over 70% of total in developed countries, while in China it is only 8%; the degree of processing in developed countries is over 80%, while in China it is less than 5%. All of the above imply that there exists a huge gap between developed countries and China in the degree of processing. Since China entered WTO in 2001, according to the non-discrimination rules of WTO, many member countries had cancelled certain unfair rules towards China’s food exports. Our food products increased its share of the global market and enjoyed more fair trade opportunities. But, there are still some developed countries and international organizations who install technical trade barriers to restrict China’s food exports, citing security regulations, technical standards as concerns. Recently, there are more cases of exported food being rejected for the reason of not complying with relative technical standards established by importing countries. For example, in August 2006, three batches of Wulong Tea exported to Japan were rejected as a result of its Wepsin content exceeding Japanese standards. This led to all exported Wulong Tea being tested each time. Till April 2007, there were 24 cases of high Wepsin content; this has brought great damage to our tea exports to Japan. The focus of international food competition lies in the limitation towards residue of various pesticides, chemical substances and heavy metal. Many countries have established multifarious standards and regulations to limit import. Till now, it is inconclusive as to how great such an impact will be. This article tries to quantitatively analyze the difference of export food competition before and after entering WTO, account for the reasons for such differences, and offer some suggestions for policy responses.

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Competitiveness of China’s Food Exports: An Empirical Analysis

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Part I. Analysis of Trends in the Competitiveness of China Food Exports Selection of competitiveness index There are several ways to evaluate international competitiveness of an industry. Some scholars suggested that in a market economy, industry international competitiveness is best measured and assessed by the market share of products (Daniel, 1984; Fuyongjianyi, 1973). Some found the rank of export volume to be the most important measure (Tian Pingping, 2007). Jin Bei, researcher of China Social Science College, advocates choosing NTB, Relative Export Advantage Index, RCA and International Market Share to compare industry’s international competition among different countries, based on Economic Competition Advantage Theory (Jin Bei, 2003). With an eye to existing research achievement and the feature of food industry, we choose the following index to analyze international competition of our food industry: Export Increase Ratio Advantage Index, Ratio of Food Export in Total Export, Food Net Export Value, Food International Market Share and NTB. These indices include the main aspect of food export. Export Increase Ratio Advantage Index measures the degree of export competitiveness of an industry; the Ratio of Food Export in Total Export reveals the contribution to commercial export by the food exports of one country. Through computing and comparing these indices, we can draw preliminary conclusions on the International Competitiveness of Food Exports of a particular country. The reason we do not choose RCA index lies in that the relative amount of food exported to single country is not that large. The data we calculated has little comparative meaning. In addition, we compare the same index with Japan and the United States, for the United States has the largest food import amount and is one of the biggest fresh food exporters. By contrast, Japan’s food relies mainly on imports and 99% originate from China. Meanwhile, the new regulations established by FDA and the Positive List System of Japan exert great influence on our export food, so we also calculated the relative index of both countries.

Analysis of statistical indices View on China food exports The volume of China food exports has been increasing since 1990. From 1995 to 2005, the amount reached 22.48 billion US dollars from 9.954 billion, an increase of 2.26 times and 22.6% yearly. After entry into WTO, the numerical value went up faster. The amount of 2005 was 1.76 times of that of 2001, 35.20% yearly, among which octopus, carapace, mollusk and relative products rose by 1.88 times, 37.59% yearly; coffee, tea, coco, flavoring and relative products 1.82 times, 36.36% yearly. We found that the scale of China food export expanded greatly, and the increase ratio accelerated.

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Export Increase Ratio Advantage Index of China’s Food Industry As there is a wide variety of food exports, we only calculated the total food export increase ratio advantage index using data from the Custom Statistical Almanac (in Table 1). Judging from values in Table 1, we can see that although the value of food export increased yearly, the ratio of it in commercial export amount decreased from 6.7% in 1996 to 2005’s 3.0%, which has a great deal to do with the processing mode of our food industry. These days our food industry still mainly focuses on primary processes, which is highly labor-intensive. As a result of a higher degree of refining and technical progress in developed countries, our traditional advantage was tapering off. According to the statistics, the food items of the 3rd and 5th articles constitute the heaviest proportion among China’s food exports. (The 3rd article refers to seafood such as octopus, crustacean and invertebrates; the 5th article refers to vegetables and fruits.) Annual export ratio of these two articles in total export goods was between 1.0% and 2.0%. However, before China’s entry into WTO, this ratio can reach 2.0%; after WTO, the ratio was about 1.0%, this is due to the fact that both articles belong to labor-intensive industry. After WTO, our comparative advantage was decreasing.

Table 1: China’s Export Value and relative value during 1995–2005 A

Year

B Food Export (thousands, US$)

C Total Export (thousands, US$)

D

B/C (%)

1995

9,954,117

148,779,565

6.6

1996

10,231,201

151,047,526

6.7

E

F

G

Increasing Rate of B/C (%)

Increasing Rate of C (%)

Export Increase Ratio Advantage Index

2.78

1.52

1.26

1997

11,074,999

182,791,655

6.0

8.24

21.02

–12.78

1998

10,612,547

183,809,065

5.7

–4.17

0.56

–4.73

1999

10,458,225

194,930,865

5.3

–1.45

6.05

–7.5

2000

12,281,714

249,202,551

4.9

17.43

27.84

–10.41

2001

12,777,201

266,098,029

4.8

4.03

6.78

–2.75

2002

14,620,743

325,595,970

4.4

14.42

22.36

–7.94

2003

17,531,126

428,227,767

4.0

19.91

31.52

–11.61

2004

18,864,250

593,325,581

3.1

7.6

38.55

–30.95

2005

22,480,341

761,953,410

3.0

19.17

28.42

–9.25

G=E–F Source: China Custom Almanac, author complied.

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Furthermore, our annual Food Export Increase Ratio Advantage Index lay below 0, except 1996. In 2004, it dropped to –30.95, which suggested the trend from another aspect. From 1995 to 2005, the index changed greatly, especially in 2003 and 2004, the value was –11.61 and –30.95, respectively, as a result of the 2003 SARS outbreak in which China was seriously affected, leading to the slowdown of the food export increase ratio. The increased value was only 1.33 billion US dollars, much less than the 2001–2005 average of 4.498 billion US dollars.

Comparing market share of the International Food Industry In the marketing literature, market share is the most direct index of tangible goods. Michael Porter (1990) argues that export competitiveness directly depends on export value and DI (direct investment) of certain industry in one country. There are two major sorts of export food, fresh food, such as vegetables, fruit and fresh seafood, and processed food, including meat-products and cans. From Tables 2 and 3, we can figure out that from 2001 to 2005, our fresh food net export values were below 0, except 2002, which meant trade deficit existed in our fresh food export. The average value of deficit was –383,4270.8 (US dollars, thousands). International market share of fresh food was about 4% and the rank fluctuated around the seventh position, while export value per person dropped to 140th, the same as that of Japan, as a result of our large population base. Table 2: Statistics of three countries’ fresh food (thousands, US$; %) A

B

C

Year

Country

Net export

2001

Japan United States

–30,642,431 8,191,994

2002

2003

2004

2005

D

E E F Export International Rank of C value per Rank of E market person share 177 2

14 138.7

122 36

0.7144 15.906

G Rank of F 27 1

China

–210,894

136

7.5

143

3.8485

7

Japan

–30,355,266

177

7.2

144

0.3559

45

United States

7,077,737

3

135.4

38

China

1,231,460

17

8.4

140

Japan

–32,089,395

177

8.2

United States

10,632,257

1

155.2

15.087

1

4.1322

7

145

0.3443

46

40

14.9223

1

China

–2,028,801

166

9.9

142

4.2117

6

Japan

–35,542,810

177

9.3

148

0.3451

45

United States

8,446,259

4

157.6

42

13.4991

1

China

–9,397,123

173

9.7

146

3.6772

9

Japan

0.3598

45

–34,617,128

177

10.4

147

United States

5,860,421

6

158.9

43

12.731

1

China

–8,765,996

173

11.2

143

3.952

8

Source: WTO website, author complied.

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Table 3: Statistics of three countries’ processed food (thousands, US$; %) A

B

C

Year

Country

Net export

Japan

–14,924,254

153

12.9

–3,304,179

150

75.5

China

3,722,413

6

5.1

111

2.8145

11

Japan

–14,918,130

153

13.3

100

0.6744

27

2001 United States

2002 United States

D

E

E

F

G

International market share

Rank of F

96

0.7082

28

52

9.275

Export Rank of C value per Rank of E person

1

–6,776,636

152

72.4

52

8.3262

2

China

3,690,781

8

5.9

111

3.0004

9

Japan

–15,807,060

153

13.8

101

0.5936

30

–10,210,201

152

75.4

56

7.3775

4

2003 United States China

3,290,644

8

6.7

117

2.9153

11

Japan

–18,108,763

153

15.4

101

0.5755

30

2004 United States

–13,347,773

152

78

59

6.6941

4

China

3,094,845

11

8.2

118

3.1097

10

Japan

–19,732,429

153

16.3

103

0.5696

32

–15,821,906

152

80.6

56

6.5161

4

5,530,176

6

9.7

113

3.4654

8

2005 United States China

Source: WTO website, author complied.

Compared to the United States, Japan’s annual fresh food export also experienced trade deficit, with an average value of –32,649,406 (US dollars, thousands), almost 10 times that of China. According to the statistics, we knew that Japan’s food consumption tied to import very tightly and export was almost impossible, in the context of Japan’s national situation. The United States was on the opposite side. Its average fresh food export trade surplus value was about 8,041,733 (US dollars, thousands), holding the top rank in the world, as well as the international market share, which reflected the competitiveness of its fresh food exports. By contrast, the net export value of processed food was below 0, with an average value of –9,892,319 (US dollars, thousands). However, in total, there is still a net trade surplus in US food exports. Now let us turn to processed food. During 2001–2005, trade surplus existed every year in the item net exports, with an average value of 386,5771.80 (US dollars, thousands), which implied that China’s processed food enjoyed a certain relative comparative advantage in the international market. However, we should not ignore the fact that our market share was only about 3%, and world rank was about the 10th. All the statistics suggested that international competitiveness of China’s processed food is not that good. Although we still had some comparative advantage, the refining degree was not high enough to build a superior reputation for our products in international markets.

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Table 4: NTB vs. Trade Modality, Trade Structure and International Division NTB period

−1 > NTB > −0.3

−0.3 > NTB > 0.3

0.3 > NTB > 1

Trade modality

Trade between industries

Trade within industries

Trade structure

Import

International division

Vertical division

Horizontal division

Vertical division

Integrated judgment

Import — vertical

Horizontal division (import) (export)

Export — vertical division

Trade between industries Export

Source: Shuming Xu, Analysis of Development and Influence Factors of Industry International competition [R]. Business School, Taiwan University, Doctoral Thesis, 2000.

NTB The following formula was the calculation of NTB: NTB =

export − import . NTB > 0, export + import

means the country is net export country, whose production efficiency is higher than international average level and has strong export competition. The closer NTB goes to 1, the stronger the export competition of goods will be, vise versa. Some scholars called NTB as Trade Specialization Coefficient, for it can stand for the trade modality, trade structure and international division, which were illustrated in Table 4. We had calculated NTB of China, Japan and the United States from 1995 to 2005, listed in Table 5, from which we can figure out that China’s NTB stabilized since 1997, fluctuating around 0.44. In 1994 and 2003, it reached the peak value of 0.49 and dropped a lot in 2004 due to the impact of SARS, and rose to some degree in 2005. According to Table 4, China’s food industry belonged to Export — vertical division since 1996, which suggests that our food exports are converging with those of developed countries. Table 5: Food import and export value (thousands, US$) and NTB Year

China Import

Export

United States NTB

Import

Export

Japan NTB

Import

Export

NTB

9,954,117 0.24

18,588,985 41,662,259 0.38

24,851,958 1,387,789 –0.89

1996 5,671,361 10,231,201 0.29

20,206,757 45,218,364 0.38

24,933,105 1,240,278 –0.91

1997 4,304,252 11,074,999 0.44

22,049,755 39,707,272 0.29

22,455,898 1,275,741 –0.89

1998 3,787,475 10,612,547 0.47

22,011,774 34,564,268 0.22

20,595,275 1,261,414 –0.88

1999 3,619,666 10,458,225 0.49

22,451,636 30,616,271 0.15

20,908,263 1,330,512 –0.88

2000 4,758,318 12,281,714 0.44

23,505,657 33,344,428 0.17

21,553,874 1,232,786 –0.89

2001 4,975,703 12,777,201 0.44

23,616,229 33,061,413 0.17

20,618,793 2,158,406 –0.81

2002 5,237,783 14,620,743 0.47

23,947,236 31,552,804 0.14

20,551,361 1,289,728 –0.88

2003 5,959,959 17,531,126 0.49

28,191,020 36,450,230 0.13

22,654,044 1,327,466 –0.89

2004 9,154,405 18,864,250 0.35

31,321,690 37,504,473 0.09

25,450,885 1,455,232 –0.89

1995 6,131,474

2005 9,387,991 22,480,341 0.41 Data source: FAO and WTO website, China Custom Almanac, coordinated by author.

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In contrast, let us turn to Japan and the United States NTB of United States started to decrease in 1995, to 0.09 in 2004, while Japan’s lay between –0.8 and –0.9, with little changes. The NTB indicator thus shows that American’s food export advantage has weakened continuously since 1995. Due to a small land mass and low arable land per capita, Japan’s NTB is a small negative, and suffers from a low food export advantage, as it is a mainly import-oriented country. Besides, from Table 6, NTB of 3rd and 5th articles goods, accounting for a major percentage in China’s food exports, decreased yearly since 1998, although it remained at the level of 0.45, which implied that the export advantage of both articles goods was weakening. The stricter pesticide residue standard set by developed countries played great role in this change. The permitted chemical residue was gradually reduced, which brought great trouble to China’s food exports. As their NTB values were below 0 since 1998, the export advantage of the 2nd and 8th articles goods was very weak, which is consistent with the current situation that the refining degree is not high enough. Although the values of export of the 00th, 01st and 07th articles were not high, their NTB were all over 0.5, which suggested they have relatively strong export advantage. However, similarly with other articles, their NTB had the same decreasing trend. The only difference was that the degree of their drop was not as high as others, suggesting that our traditional food export advantage was weakening slowly. As we discussed above, during 1995–2005, although the value of our export food increased, the ratio in total commercial goods export decreased, which meant that the development of our food industry did not keep pace with that of other industries. Traditional advantage of China’s food export is weakening slowly. The export increasing ratio of food was lower than that of total commercial goods, meaning that the development of the food industry is falling behind our total export development.

Part II. Accounting for Declining Competitiveness of China’s Food Exports During 1995–2005, even though our export volumes increased steadily, there are various reasons that account for a declining competitiveness. The author believes that the reasons for the falling of China export food competitiveness are mainly:

Gradual worsening agricultural ecological environment, affecting the developmental prospects of the industry As a developing country, the foundation for our agricultural ecological environment is weak. The three industrial and living wastes pollute the origin of planting, aquaculture seriously and influence the quality of raw materials for food directly. In addition of the abuse for agricultural chemical, animal medicines and harmful beverage additive lead to the remarkable issues of exceeded remaining agricultural chemicals and animal medicines.

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Table 6: China’s Food NTB Article

Name

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

Food & livestock

0.238

0.287

0.44

0.474

0.486

0.442

0.439

0.472

0.493

0.347

0.411

00

Live stock

0.864

0.824

0.841

0.78

0.709

0.973

0.816

0.731

0.472

0.201

0.502

01

Meat & meat-product

0.867

0.797

0.786

0.771

0.351

0.316

0.407

0.359

0.287

0.528

0.517

02

Dairy and egg product

0.008

0.152

0.144

03

Fish, crustacean and invertebrate and their processed products

0.649

0.653

0.757

0.881

0.541

0.502

0.504

0.484

0.476

04

Grains and processed products

0.233

0.389

0.403

0.495

0.308

0.558

0.703

05

Vegetable and fruit

0.825

0.803

0.794

0.775

0.726

0.69

0.718

0.708

0.679

0.686

06

Sugar, sugar-product and honey

0.053

0.125

0.293

0.171

0.281

–0.08

0.15

0.28

0.133

0.156

07

Coffee, tea, coco, flavoring and processed products

0.725

0.766

0.75

0.767

0.708

0.808

0.657

0.698

0.654

08

Feedstock

09

Miscellaneous food

Source: China Custom Almanac, author complied.

–0.85 0.896 –0.42 0.746 –0.09 0.558

–0.66

–0.56 0.554

–0.7 0.616

–0.05

–0.73 0.685

–0.36

–0.44 0.484

–0.43

–0.5 0.33

–0.47

0.703 –0.31 0.357

–0.46

–0.28 0.42

–0.53

–0.21 0.334

–0.52 0.478 –0.35

–0.29 0.162

–0.45 0.446 0.113

–0.45 –0.51

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Food safety has been a worldwide problem. In recent years, western developed countries enhanced the control and audit strength on substances such as epidemic, forbidden (limited) agricultural and animal medicines, hormone and environment protection. As a developing country, our food export is facing a serious challenge.

The overall level of development for food industry is low; sustainable development lacks follow-through Currently, the overall development level is still too low for our food industry. For the enterprise structure, most of them are middle or smaller companies; there are quite few big companies and lack of enterprises with competitiveness and international famous brands. Up to now, our food industry is still mainly individual workshops which for a long time are still located in the low level circle. The clear process for high-tech industrialization has yet to be formulated, sustainable development lacks follow-through.

Government Control System lacks efficiency and a scientific approach As a developing country affected by a planned economy system, our standard and technical rules and regulation system for food are far from perfect. There is still a reasonable gap with developed countries. The allocations of resources by food control department are unreasonable, the intersection and division of work for each management organizations are not properly mapped out, which cause the food control management to suffer from a lack of efficiency and a scientific approach. These shortages also seriously influence the international competitiveness of China’s food exports.

International market is encountering “intangible” trade barrier Currently, in order to restrict foreign food into their markets, many countries raise their importing threshold one after another and set technical trade barrier in a disguised way, such as Japan’s Positive List System, USA’s FDA test and the European Chemical product registration, evaluation, license and REACH system regulations, etc. Distinct from other trade restrictions measurement, the critical characteristic of technical trade barriers, especially food technical trade barriers, is its method of concealment. Once it happens, the influence will be huge and the losses cannot be avoided. Technical trade barriers faced by the food industry include requirements on the quality, level, component, label regardless of safety, package regardless of safety and qualification evaluation, etc. Also, security requirements such as agriculture chemistry and animal medicine, residue of harmful substances, plants and animal epidemic diseases, etc. are included. Technical trade barrier has already been the main and most efficient measurement for developed countries to protect their agriculture. Judging from the

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recent situation of Chinese food exports, it can be said that technical trade barriers have inflicted huge losses on the Chinese food export industry. The indirect losses are hard to estimate. Technical trade barrier issues are threatening the sustainable development for our food industry.

Part III. The Countermeasures and Suggestions to Improve China Export Food Competitiveness The improvement of China export food competitiveness is a complex systematic project, which requires a multitude of countermeasures. Therefore, we need to:

Actively push for the implementation of an international food safety management system International food safety management system, ISO22000 standard is taking the nucleus of HACCP system issued by CAC, which, including the precondition plan of HACCP and incorporating management system elements, brings forward the criterion of safety management and operation requirement for the whole process from the raw materials supply management to the final consumers eating safety guarantee. The major characteristics for international food safety management system are: bringing links such as raw materials, production, additive, package, sales and so on into supervision, avoiding and eliminating damages for the whole food production chain “from farm to table”, reducing food safety risk and putting an end to the food safety accidents and providing the guarantee for consumers’ health. Food safety management system is suitable for any organizations engaged in production, manufacturing, package, stock, transportation, sales or production and sales for all kinds of human consuming food and its raw materials. The implementation of international management system will definitely accelerate the implementation of our food origin control, improve the reputation for our export food on the international market, also assist our food enterprises in breaking through the technical barriers of developed countries and facilitate the development of our food export trade.

Keeping up with changes in international standards in a timely fashion, advocate for greater use of international standards in technical and environmental issues To remedy the current dire situation for China food exports, we need to firstly, gradually improve our legislation on standardization; enhance the legal and regulatory framework on issues related to primary products, food safety, sanitation, environment protection, geography; improve compliance with WTO rules, international standards; ensure that the quality of our food safety and hygiene standards comply with the increasingly strict

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requirements of international market. Secondly, promote greater use of international standards; partake in the drafting, revision and coordination of international standards actively; match domestic standards with international standard incrementally, meanwhile, carrying out international certification energetically. Thirdly, carry out standardized production, including standardized base construction, standardized production process, standardized management mode, standardized inspection system, and standardized tracking. Fourthly, set up TBT, SPS notification, consultation, coordination system and information channel. We could leverage on government functions, take advantage of the WTO system, enhance consultation and negotiation with countries that have imposed trade barriers without adequate technical or scientific basis, and push for the removal of these barriers. At the same time, we need to set up a tracking mechanism that is timely and has a reasonable evaluation system, focusing on important export products restricted by other countries, tracking and collecting intelligence and information from those countries that have imposed trade barriers, release information in a timely way and provide information service for food export enterprises and decision-making bodies of the government.

Improve communication between domestic supervisory departments, reforming the mode of supervisory inspection Cases of food contamination at source have invited concern and worry of many overseas import countries. It is therefore imperative to, through the coordination of the State Council, improve the communication of the various supervisory departments with their agricultural counterparts, clarify responsibilities and work allocation on issues such as medicine management, residue management in animal farms, etc. Departments in charge of safety standards in food exports ought to coordinate with their counterparts in charge of public sanitation and food hygiene, in their supervisory work on food enterprises and food logistics chains. The mode of supervisory inspection ought to move away from the current method of inspecting samples of finished products, to supervising the entire process of food production through sample-based inspection. In addition, supervisory departments ought to conform to international standards, and at the same time, pay greater attention to the local peculiarities of the importing countries, the unique risks involved, in order to improve on our abilities to overcome technical barriers set by developed countries, thereby increasing the competitiveness of our food export sectors.

More R&D investment, raise the overall quality of food products In responding to technical trade barriers, there are two types of actors, the producers and the regulators. Producers are chiefly responsible for the quality of the food products, while the government, as a regulator, can only facilitate.

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With stronger competition of primary products in international market, improving the quality of food products is the sure way to overcome trade protectionism, broaden access to international markets and bring about economic benefits. To achieve this goal, we need to improve the management styles of the processed food enterprises, and improve the professional standards of employees, increase investment to R&D, optimize the production structure and create a new structure emphasizing higher value-added and comprehensive research, and extend the industry chain. These measures would directly improve the international competitiveness of our food exports.

References Bei, J (2006). Analysis of China’s manufacturing international competitiveness after WTO. China Industry Economy, 10. China Custom Almanac (1995–2005). FAO Statistics. http://www.fao.org/waicent/portal/statistics_zh.asp. Hu, Xiaopeng (2005). Research on international competitiveness of china’s processed food industry. Agricultural Economic Research, 1. Huang, Guansheng (2007). Research on suggestions and technical trade barrier of primary product. Agricultural Economic Research, 5. Porter, M (1997). Competition Advantage. Beijing: Huaxia Press. Tan, Yingping (2007). Research on International Competitiveness of China Steel. China Standard Press, 2. WTO (2001–2005). International trade statistics. http://www.wto.org/english/res_e/statis_e/ its2005_e/its05_bysector_e.htm.

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Session 2

Financial Market and Capital Market

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Corporate Restructuring Function of Stock Markets: Key Developmental Proposals for the Chinese Course ͣYUNSHI MAO, SIDAN WU and YUEXIN JIANG Sun Yat-sen University

P

rofessor Yunshi Mao is National Committee Member of Chinese People’s Political Consultative Conference, director of International Business and Marketing Research Center and PhD supervisor for international business, Sun Yat-Sen University. He was specially appointed State Degree Committee Member and State Natural Science Foundation Committee Member. His research interests focus on the strategy of multinational companies and foreign direct investment, enterprise growth and corporate restructuring. He was granted an MBA degree in Catholic University of Leuven (Belgium) in 1983 and a PhD in World Economics, Wuhan University (China) in 1993. In 1998, he opened the first post-doctorate research station for business administration in south China. He has been to the United States, United Kingdom, France, Canada and Germany on multiple occasions to conduct research and give lectures. He has had more than 30 books and 130 academic papers published, including “Global Corporate Restructuring: Case Study and Reorganization of Chinese Enterprises”, “Corporate Restructuring and Competition Advantages”, “Top 50 Corporations in Guangdong: Growth and Restructuring”, “Strengthening the Function of the Stock Market that Facilitate Corporate Restructuring and Constructing a More Efficient Capital Market”, “A Study of the Loss in and Reconstruction of China’s Listed Companies”, “An Institutional Comparison of Corporate Restructuring”, “Growth and Competence Evolution of Chinese Excellent Enterprises: A Study Based on Cases”, “Investment Strategy of Multinationals in China”, “Business Strategy of Multinationals in China”, “Multinationals’ Divestment from China: Behavior, Process, Motivation and Cases”, “Strategic

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Competition of Multinational Enterprises and Foreign Direct Investment”, “Topics in Business Economics”, ”Economics of the Firm”, etc.

M

s. Sidan Wu is a PhD candidate in corporate management in the School of Business at Sun Yat-Sen University, China. She received her Master of Business in International Business from the Faculty of Business, Economics and Law at University of Queensland, Australia. Her research interests involve the multinationals’ strategies and foreign direct investment, corporate restructuring and acquisition integration.

M

r. Yuexin Jiang is now studying for his PhD at Business School of Sun Yat-Sen University, Guangzhou. His research interests focus on International Business Management, Enterprise Growth and Restructuring, and Corporate Governance, with Prof. Yunshi Mao as his supervisor. In 2002, he obtained a B. S in Business Management in Sun Yat-Sen University. From then on, he had been a teacher of education management and graduate students’ administrative assistant in School of Business Sun Yat-Sen University until 2004. As a main research member, he participated in the application and completion of several research projects from the Education Ministry of China, the Soft Science of Guangdong Province, etc. He published some books and papers such as “The Classic Case of Corporate Governance”, and acquired excellent graduate student scholarship many times.

Abstract: This paper investigates the functional problem of the Chinese stock market and reviews the domestic and foreign literature on the stock market’s functions such as resource allocation and corporate restructuring. On this basis, we suggest that it is necessary to facilitate the stock market’s function of corporate restructuring. Accordingly we analyze this viewpoint from aspects such as innovations of the stock market, mechanisms of the stock market in facilitating corporate restructuring, and a comparison of stock market functions between the United States and Japan. Finally, we offer some suggestions on how to strengthen the function of the Chinese stock market in facilitating corporate restructuring, reducing market risks and promoting the establishment of capital markets. Keywords: Stock market function; Corporate restructuring; Resource allocation

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Introduction Since its humble origins the Chinese stock market has undergone difficulties and hardships for more than 15 years and played a key role in invigorating economic development and economic institutional reform. Accompanied by the basically completed equity-divisionreform and the promulgation of a series of policies and rules of law in recent years, Chinese stock market is realizing strategic transformation and accessing an entirely new period. According to reports of the People’s Bank of China, the financing amount of domestic nonfinancial institutions through the stock market was merely 105.3 billion Chinese RMB (or US$13.9 billion using by the then exchange rate) in 2005 but reached 224.6 billion RMB (or US$22.6 billion) in 2006; the percentage of stock financing over the total financing amount increased from 3.4% in 2005 to 5.6% in 2006 (TPBCa, 2006; TPBCc, 2006). Currently, the establishment of capital market has become a significant part of the construction of market economic system in our nation. However, theoretically and practically, inconsistent viewpoints exist in the understanding of the function of stock markets and the workings of these functions. The study of international literature on the functions of capital market mainly focuses on the allocation of social financial capital, involving the transformation and adjustment of capital among the units of the market, the modes, measurements, efficiency and determinants of capital in withdrawing from the market, the differences among countries and regions of capital allocation (Shaw, 1973; Bettis and Prahalad, 1983; Wurgler, 2000; Beck and Levine, 2002). The domestic studies concentrated more on the exertion of stock market’s investing and financing function. Other functions of the stock market such as risk pricing and resource allocation also received a certain amount of research. Generally speaking, however, the understanding of the domestic studies on the stock market’s functions is not comprehensive and the identification of the functions is quite inconsistent. More importantly, this paper surveys the short-comings of existing studies on the classifications of stock market’s functions. For example, among the five functions of the capital market (Zou et al., 2006), namely, the function of reflecting information, the function of systematic innovation, and the function of resource allocation do not belong to the same layer and thus are not of a paratactic relationship. Furthermore, the domestic literature does not emphasize the stock market’s function in facilitating corporate restructuring (FCR) when discussing the operation and performance of the stock market. In addition, the studies on corporate restructuring mainly focus on the M&A with little attention to other restructuring means such as the divestiture, spin-off, split-up, swap and delisting. We propose that, with the allocation of social capital as the core function of stock market, the function of investing and financing is the allocation of stock market’s increment capital, whereas the FCR function aims to allocate the stock capital of the stock market. Based on the long-time study on the issue of corporate management, the author recommends that more effort be paid to the FCR function of the stock market

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so as to promote the establishment of capital markets. This paper will discuss the FCR function of stock market from three aspects, involving the current situation of FCR function in Chinese stock market, the market mechanism in realizing this function and the comparison of the FCR function between the American and Japanese stock market. Finally, relevant suggestions will be presented for the future development of China’s stock market.

Corporate Restructuring Function in Chinese Stock Market The Chinese stock market has grown from the crevice of a planned economy and is plagued with systematic imperfections, as can be seen from the following four aspects. First, equity divisions have led to poor liquidity of stocks. Second, the incompleteness of information disclosure, low transparency of market operation and fragility of market supervision have resulted in the distortion of information signals and dysfunction of capital pricing. Third, frequent intervention by the government (Wei, 2001) and severe black transactions (Xiao, 2005) fail to offer a marketized-institutional guarantee for mass investors. Fourth, the lack of entry-withdrawal mechanism for stocks makes it difficult to allocate social capitals effectively to the high efficient enterprises and industries. Statistics illustrated that, up to now, only 50 listed enterprises or so have been withdrawn from the domestic stock market, which does not correspond to the current poor performance of our listed companies. By comparison, the amount of companies that withdrew from the U.S. stock market was only 30 in 1999 but rose to 135 in 2004; by the end of 2005, a total of 10% enterprises had delisted from the U.S. stock marketa. Such comparison demonstrates that the systematic imperfections in our stock market have led to the inefficient resource allocation and made it difficult to facilitate the corporate restructuring. More importantly, the M&A integrations of the domestic listed companies have yet to reflect the optimization of resource allocation, not merely far away from the normal M&A objective (Zhang, 2004) but becoming the instrument in tunneling the listed companies’ resources (Wu, 2006). Virtually, the M&A activities of listed companies in the Chinese stock market are passive with the aim to resuscitate loss-making companies. Zhang (2003) conducted a research on 1216 M&A integration events (of the domestic listed companies) that occurred during 1993–2002. The empirical study showed that the M&A integration did create value for the target companies but caused a negative impact on the shareholders of acquiring firms. Consequently, the comprehensive effect (or the social net effect) between the target firms and acquiring firms is unclear. The statistic analysis of Zhang (2004) revealed that the mainstream of the so-called restructuring of the domestic listed companies is nonessential corporate restructuring — which aims a

With regard to accounting fraud events such as Enron, the United States Congress has enacted the Sarbanes-Oxley Act to safeguard the benefits of American investors. Since then, an increasing number of listed companies have withdrawn from the U.S. stock market.

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at protecting the shell b and assigned sharesc of one company, encircling capital, and sensationalizing in the secondary market (some terminology used in the Chinese stock market) — and few strategic restructuring activities have been conducted in a real sense for their companies in a dire predicament. Despite the considerable changes in the recent years, there still exists the trend of emphasizing more on financing but less on restructuring. This has adversely influenced the long-term sustainable development of the stock market. Given the inherent functions of stock market in investing and financing, the FCR function requires more nurturing, construction and improvement in terms of institutions, legislation and regulations. When investigating the corporate development history, we found that transformation and reorganization constitute a continual process. Studies demonstrate that the strategy of expansion and pluralism prevailed in the 1960s and 1970s, enjoying high accolades. The excessive pluralisms and expansions, however, have generated a series of problems which fortunately have been corrected rapidly and promptly in the 1980s in the financial market by various restructuring means such as hostile takeover threats of hostile takeover and leveraged buyout (Blair, 1999). Nevertheless, ever since the mid-1990s, survival crises have still occurred continuously in worldwide large corporations, requiring persistent reorganization to cure ailments of large enterprises and to re-establish their competitive advantages. Referencing the history, experience and lessons of the developed countries, we suggest that driving the FCR function of stock market has significant implications in activating the current stock capital, optimizing the scale and structure of the stock and increment capital, raising the stock market’s efficiency, and guaranteeing the rapid and steady development of our stock market.

b

The biggest advantage of listed companies is that they can collect capital in a large scale in the securities market so as to facilitate the rapid growth of the company scale. Thus, the listing qualification of listed companies has become a certain “scarce resource” and the so-called “shell” is the listing qualification of listed companies. Due to the incomplete transformation of operational system or the poor management, the performance is not satisfied and thus a company will lose the ability and right of further collecting capital in the securities market. To fully take advantage of the “shell” resource of this listed company, restructuring the listed company’s asset is a must. Hence, ‘buying the shell of the listed companies for listing’ or ‘borrowing the shell of the listed companies for listing’ are two asset-reorganization means, by which to reallocate the “shell” resource of the listed companies, with the aim to list in the securities market indirectly. c Here refers to reissuing assigned shares. It is a method of the listed companies who collect capitals from their original shareholders by the means of reissuing more assigned shares when requiring funds to enlarge productive and operational scale. When assigning new shares, the listed companies must correspond to a series of conditions, mainly including (1) no less than 12 months after the past time of issuing shares; (2) the assigned shares are limited to circulation shares; (3) the listed companies are profited in a succession of two years and the return on net asset of the listed companies is more than 10% in a succession of three years. However, usually a good project is unlikely to gain profit in one to two years. Consequently, listed companies will further engage in some short-term behaviors to capture the qualification of reissuing assigned shares.

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Innovations of the Stock Market and the Mechanism of FCR Innovations of the stock market in FCR Facilitating corporate restructuring by solving the inseparability of company — decreasing transaction costs and accelerating business Inseparability refers to the input of production factors in the business activities that are not unlikely separated out of physical properties. For example, when a crane of ten tons is used for goods weighing two tons, it is impossible to divide the crane into five parts and use one-fifth for work. In reality, not only does the inseparability exist in the equipment and facilities, but a variety of costs (e.g., labor cost) cannot be separated, partially or entirely, with regard to some kinds of economic activities (Mao, 2005a). As such, the entire or partial assets (when used as inputs of production factors) of an enterprise suffer from inseparability as well. This means that, in practice, the assets (referred to as the tangible assets including the workshop, land, equipment and facilities) of the enterprise cannot be taken apart. Thus, the takeover deals or businesses can only be conducted in their entirety among firms. One of the innovations of stock market is offering the marketplace varied ways for companies to conduct businesses. Through asset securitization, the means of shareholding make it convenient to realize the transferring, transaction and liquidation of corporate ownership. It is this free transference of shareholding that enables the shareholding-companies to establish and develop. It helps to accelerate deals among enterprises, decrease transaction costs, form an enterprise-owned market and a variety of investment bodies, which accordingly facilitates corporate restructuring and enables the optimization of resource allocation.

Facilitating corporate restructuring using the stock price as an “indicator” The most basic function of stock market in a developed financial system is risk pricing. It enables investors to distinguish the superior from the inferior according to the price and tendency of stocks. A good-performance enterprise will be supported and purchased by the investors so as to achieve sufficient resources to accomplish business expansion and integration within and across its industry, whereas a sub-par enterprise will be abandoned and sold out by the investors. As a result, the performing companies will increase continuously in value whilst the underperforming firms will be acquired by other firms or eliminated from the market, realizing the optimized allocation of social resources. The intrinsic value-added attribute of capital and the survival of the fittest mechanism of corporate restructuring can direct capital to high efficiency enterprises and industries. This makes it possible for cross-district and cross-industry M&A integration with the

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result of changing the market structure of industries. Such influences, in an effective market, will be reflected directly on the stock price (Fama, 1991). The study of Scherer and Ross (1990) showed that since the relieving of aviation industry control regulation in 1978, a large quantity of M&A events have occurred. In order to enhance the market power, enlarge the market scope, raise the operational efficiency, or overcome the entry barriers ever forbidden by control regulations, the U.S. aviation corporations have strong motives to acquire other aviation firms by M&A activities. These changes in strategies have affected all market participants, involving the acquirers, target firms, and the existing or potential rivals.

Mechanism of stock market in FCR From the historical and innovation points of view, the basic function of shareholdingownership is to raise capital. This financing function has been broadened greatly by the establishment of stock market, one of the innovations of the capital market, and become marketized. Accompanied with its further development and innovations, stock market has played an increasingly important role in the FCR function. The mechanism of such function can be summarized into the following three fields.

In relation to new increment assets in the stock market, essential restructuring by listed companies has facilitated the reallocation of resources When a company’s stock applies for listings (including new shares reissuing or shares allotment), it must comply with certain conditions that involve improving the corporate governance framework and establishing a series of institutions in terms of information disclosure and accounting standards referred to listed companies. The key lies in fundamentally transforming and reorganizing the resources and systems of the whole enterprise. From this point of view, the corporate listing itself is a process of “modification” and “package”, which helps to promote the optimized distribution of a company’s resource. Moreover, selecting part of the high-value assets of an enterprise for listing will accelerate an overall reorganization in ranges of business portfolio, organization and finance. For instance, the overseas listing of China Petroleum has not only raised huge quantities of funds, but driven itself to conduct a profound corporate reorganization according to the requirements of modern enterprise systems. Such reorganization has transformed its operational and administrative system thoroughly. In fact, it is in accordance with the requirements of international capitals and referencing the experience of similar global large petroleum corporations that China Petroleum establishes the standards in separating the core and noncore business portfolio, the corporate legitimate governance framework, administrative structure, performance evaluation standards, and management encouraging system.

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Given the large amount of stock assets, the motives and pressures — discovering and disclosing the agency-problem and transforming the inefficient management or takeover — facilitate corporate restructuring Concerning the huge amount of stock assets, an effective stock market can decrease and eliminate the inferior-quality firms whilst increase and reinforce the high-quality companies by means of takeover, M&A, divestiture, spin-off, split-up, swap and delisting. Meanwhile, if the agency-problem is too onerous (i.e., the agent cost is too high) or the operation and management is poor, it will be uncovered and disclosed in time. Accordingly, on the one hand, the company may face the threat of being acquired. On the other hand, the board of directors is motivated to react swiftly and employ measurements such as corporate restructuring or changing management personnel to deal with the poor performance of the company. These will help upgrade the quality of the stock assets in the stock market, improve the corporate performance and optimize the structure of the stock assets.

The realization of FCR function of stock market is closely associated with features of the corporate governance framework The efficiency of the capital market bears a close relationship with the improvement and features of corporate governance. According to the OECD Principles of Corporate Governance (2004), corporate governance is only part of the larger economic context in which firms operate that includes, for example, macroeconomic policies and the degree of competition in product and factor markets; the corporate governance framework also depends on the legal, regulatory, and institutional environment. The term ‘corporate governance’, however, is often employed narrowly in discussing the structuring and rights of the board of directors or the rights and prestige of shareholders in making decisions in the board. Blair (1999) explained the term with a broader meaning and concluded it as an organic integration of law, culture and institutional arrangements. Such integration could determine what the listed companies can do, who supervise them, how this supervision is conducted, how to allocate the risks and returns caused by the activities they are involved in. Since 2002 the occurrence of a series of events such as the bankruptcy of Enron Corporation in the United States and the scandal of Snow Brand Milk Products in Japan has stimulated people to re-examine the connotation and importance of corporate governance. Investors call for a more transparent and effective corporate governance framework. Their investing confidence is closely related with the improvement of corporate governance framework whilst the degree of corporate governance also influences the stock performance of companies. Therefore, the formulation and implementation of a set of principles of corporate governance (that consist of elements of independence, transparency, justification and responsibility) will determine the operation efficiency of the stock market and affect the realization of FCR function in the stock market.

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Institutional Comparisons between the United States and Japanese Stock Markets in FCR When investigating stock markets worldwide, we found that they are highly similar in the function of financing, but heterogeneous in the efficacy of the FCR function. The stronger competitiveness of American firms compared to that of Japanese enterprises can be attributed to two important reasons. The first being the silicon-valley mechanism that has given birth to a multitude of world-class corporations (including many firms listed in the NASDAQ), while few large-scale enterprises have been established in Japan since 1980s. The other reason is related to the corporate restructuring launched by nearly all U.S. old-brand corporations since the 1980s, which helped a large quantity of enterprises not only tide over survival crises but rejuvenate and regain competitive advantage. Comparatively corporate restructuring plays a more significant role. For example, the two-decade restructuring in General Motors directed by Jack Welch has generated huge profits, equivalent to that of three new Microsoft (in terms of cumulative revenue of sales in the same period). The restructuring of IBM from the mid-to-late 1990s not only reversed losses of 16.8 billion US dollars, but also rebuilt the competence, which is equal to the creation of two new Microsoft. In contrast, those Japanese corporations who ranked in top positions in the world between the 1980s and early 1990s, though suffered from severe crises, failed to conduct corporate restructuring promptly. (Mao’s study (2005b)) showed that corporate restructuring in Japan lags the United States by 20 years. In fact, the stock markets of these two nations are quite different in the development mode and degree, the institutional background, the scale and efficiency, therefore leading to differences in the motives and pressures of the FCR function.

The superior efficiency of the stock market in United States drives corporate restructuring The highly effective institutional system of the U.S. stock market Overall, the financial system of the U.S. is market-oriented and direct finance occupies the predominant position in the nation’s financial construction. For instance, the loans offered by the U.S. banks to firms in 2004 accounted for 40% of these firms’ total financing amount. The total market value of the listed companies in United States constitutes 136.5% of its GDP in 2005 and reached US$19.3 trillion in 2006, accounting for 38.1% of the total U.S. stock market value. In particular, the transaction volume of the New York Securities Market is US$21.8 trillion, amounting to 31.2% of global stock transaction amount and ranking the first in the world. Furthermore, as the world’s largest securities market, the U.S. stock market is a multidimensional and risk-dispersed market system. It consists of the Main Board Market (New York Securities Exchange, shorten as NYSE), Creative Board Market

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(shortened as NASDAQ), Regional Stock Exchange, OTC Bulletin Board (Over the Counter Bulletin Board, shortened as OTCBB), and National Quotation Bureau (NQB, including the market quotation from the Pink Sheets and Yellow Sheets). Consequently, such a multidimensional construction satisfies the different financing preferences of companies of various scales. Not only various firms are being provided with dozens of financing channels, investors are offered with more choices in the capital market and their benefits can be better safeguarded. In addition, the U.S. stock market is known for its ample capital liquidity. The information disclosure is strict, standard and prompt and the market operation is highly transparent. Resources can be allocated effectively according to the market mechanism. Most of the investors are relatively rational and mature and dynamic balance is retained between the speculative and investing behaviors in the market. The market is able to offer the firms effective price evaluation and the capitals can flow to the highly efficient firms.

Active takeover market in the U.S. stock market facilitates corporate restructuring The highly effective securities market forms the basis for an active takeover market. Thus the high-effective institutional system in the U.S. stock market has turned itself into one of the most active takeover markets in the world. It is the frequency of the takeover events in this stock market that has resulted in the various motives and pressures over the U.S. enterprises to devote to corporate restructuring activities. This in turn accelerated the corporate reorganization and the optimization of resource allocation. Above all, from the end of 1980s, the capitalism of investors has revived in United States and the sunk rights of shareholders have returned to the shareholders, which provided opportunities for other managements to takeover and control the firms. Theoretically, the stock market can be regarded as an instrument for external supervision and some kind of power in controlling the companies. In fact, the agency-problem was discovered to be severe since the early 1980s in this nation. U.S. firms traditionally take the shareholders-interest-maximization as the priority, while the management tended to put their interest-maximization as the main objective. If such an inconsistency could not satisfy the shareholders of one company, they would take actions and thus offer acquirers opportunities to takeover and control this company. When the market-value of the company’s assets is higher than its book-value, it is quite attractive for acquiring firms to sell out the company’s assets or its independent business-portfolio with the price several times higher than its book-value through a takeover firm. Such pressure forced the company to launch restructuring activities in an effort to increase its own value so as to reduce the acquirers’ buyout incentives. Moreover, pressed by the shareholders, the management had to push for corporate restructuring in order to improve the corporate performance and thus raise the share price; otherwise, executives would face the threats

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of personnel changes. In the United States resignation or dismissal news about the highranking executives are commonplace. For instance, not long ago Michael Snyder, the CEO of Vonage (the Service Provider of U.S. VoIP) had to quit his position due to unsatisfactory performance. In the month of March 2007 alone, U.S. corporations have announced personnel changes of 103 CEOs. Furthermore, the active intervention and increased shareholding of institutional investors have increased the threats of takeover and buyout of the listed companies. The concentrative shareholding of large institutions has enabled them to supervise the behaviors of corporate management and drive the managers to behave according to the shareholders’ interests. To preserve the value of the stock price, institutional investors will employ active intervention in an underperforming company and force the board of directors to, by changing the chief executive, thoroughly transform the fundamental strategy and key personnel with the aim of guaranteeing the benefits of institutional investors. Historically, American institutional investors have enhanced the takeover wave in two aspects. First, they were the major investors of a variety of junk bonds, a key funding component of takeover transactions. Second, they injected sizeable sums for leverage buyouts — such capitals financed the small-scale acquirers when the large companies were near bankruptcy at the end of the takeover wave (Mao, 2005b). In the United States speculative behaviors such as takeover and buyout constitute threats as well. Asset restructuring and M&A are always one of the hotspots in the stock market in which also give birth to some impressive good-performance stocks. It is known that long-term investment is the important guarantee for the steady development of the stock issuing companies. The speculation behaviors consist of passive factors such as gamble and fraud with higher risk, but investors can gain profits in a short time. This attracts nearly all investors, which directly stimulates the growth and prosperity of stock market and in turn attracts more investment capital. Due to tax regulation, sensationalizing in the secondary market in the name of restructuring often occurs, fostering the sensationalizing of junk stocks and the speculative phenomena. Moreover, the ‘Rational Apathy Problem’d of target company’s shareholders encourages venture arbitrage-dealers to hold a large quantity of shares in a short time so as to takeover or acquire the company. If the company were to underperform, it is very likely to become the hunting target of these arbitrage dealers. Hence such speculative behavior will also threaten the listed companies and impose great pressure over the management.

d

The Rational Apathy Problem refers to, before a stockholder’s voting to approve or not the company’s decisions, the cost of receiving information for making the rational judgment is larger than the benefit received from the voting. See Robert Charles C. 1986, Corporate Law, Little Brown & Co. 390–394.

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U.S. corporate governance framework is conducive to uncovering agency-problems with prompt reactions The corporate governance framework in the United States is based on the Equity Theory of Shareholders and the market plays a key role in corporate management. The highly dispersive shareholding is the distinguished feature of the American corporate governance framework. In such shareholding structure, individual shareholders have to pay high cost to supervise the management. Thus shareholders usually change their stock formation and use the vote-by-foot way to influence the capital market. They try to comprehend and evaluate the performance of management according to the corporate changes in the capital market, so as to affect the operational decisions of the company. In the meantime, since half to two-thirds directors in the board are from the exterior and the institutional investors are actively involved in the management, it is easier to discover how severe the agency-problem is and to make prompt reactions. For instance, Blair (1999) revealed that, from the end-1992 to the end-1993, American Express, Borden, General Motors, IBM, Kodak, and Westinghouse saw the dismissal of their general managers because their board directors were not satisfied with the declining price of their corporate stocks. Therefore, the U.S. corporate governance framework is of an archetypal marketorientation which helps to detect the agency-problem. Those underperforming enterprises will inevitably be confronted with bankruptcy or M&A integration. In the United States the corporate takeover threats, exterior directors, and reward-system corresponding with the performance of a company’s own stock have shaped the corporate governance framework into an organic balance mechanism.

The motive of FCR is lacked in Japanese market Japanese Bank-oriented financial system In Japan the financial system is dominant by large-size banks. Company financing relies more on indirect financing (i.e., bank loans) and less on direct financing ways (e.g., stock and company bonds). For a long time, of the total external financing amount of Japanese enterprises, bank loans have accounted for over 80% while the direct financing merely hosted a little more than 10%. In 1996 the total loans from Japanese banks hosted 97% of its GDP whereas the total value of Japanese securities market only accounted for 61.2% of the GDP in 1998. Although this is related to the 1997 Financial Crisis, the total market value of Japanese listed companies simply occupied 105.1% of the GDP even at the end of 2005 (TPBCb, 2005), with a large contrast to the rate in the United States that year (136.5%). In fact, the Japanese financing modes have been influenced strongly by the government and thus the function of market mechanism is quite limited, both in breadth and depth. Despite being the second largest securities market in the world, the degree of international financing and capital liquidity is not corresponding to the

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economic development and the international status of the nation. In Japan the majority of capital allocation is conducted through the banks and the capital-allocation function of stock market is a far cry from that in the United States for two reasons. On the one hand, Japanese families invested little in the stocks and bonds. Even in 1989, the most prosperous year of stock market, the stock investment only accounted for 13.8% of the total individual financial assets, much lower than that of Americans (23.3%) (JSBOMOF, 1991). Most of the families and individuals prefer to deposit their money in banks and these banks bear the capital-allocation function for the long term. On the other hand, within the complex structure of the immense industrial groups generally known as keiretsu that came into being with a long history, almost every company has maintained close relationships with a core bank. This, frankly, determines the Japanese banks play a significant role in the long-term capital allocation.

Prevailed cross-shareholding in Japanese stock market inhibits corporate restructuring The inter-corporate penetration leads to the prevalent cross-shareholding among companies and between companies and banks. Usually 60% to 70% of corporate stock is possessed by their creditors (referred to the banks or insurance companies that offer the firms with loans and insurance) or other commercial firms. For instance, Toyota is the firth largest shareholder of Sakura Bank with 2.6% stock in hand whilst 5% stock of Toyota itself is hold by the Sakura Bank (Dore, 2000). Such a structure results in the capital-allocation function of Japanese stock market being a far cry from that of U.S. stock market. Particularly, the cross-shareholding has severely destroyed the transparent principles of stock market and blocked information disclosure. Consequently, not only is the agency-problem not easy to be discovered, but a lot of information cannot be disclosed as normal even when some crises occurred in the companies. In addition, the steadiness of corporate shareholding resulting from cross-shareholding not only largely reduces the takeover or buyout possibility by other firms, but seriously obstructs the companies who should announce bankruptcy from actual bankruptcy.

Japanese corporate governance framework inhibits the discovery of agency-problems and discourages prompt reactions to such problems Based on the Equity Theory of Stakeholder, the Japanese corporate governance framework is featured with positive interior-control (Mao, 2005). The corporate- shareholding and the bank-oriented institution in Japan is an internal self-restriction mechanism. The considerable concentration of corporate-ownership in the Japanese stock market and the high percentage of corporate-shareholding have stabilized the formation of shareholders and reduced the turnover rate of stocks. Moreover, the directors of board mainly come from the senior management of the companies without the active intervention of institutional investors. Accordingly,

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the corporate authority is inclined to the management who officiates as decision-maker and holds passive attitude in disclosing company information. Meanwhile, the market has minimal impact on the managers; thus it is difficult for the former to uncover the seriousness of the agency-problem and to react promptly. Therefore, in Japan where the ownership market is not advanced enough, up to now the firms mainly rely on their respective core banks to supervise their senior managers. When the operation of one company underperformed, its core bank will send its directors to the company and change the high-ranking executives or conduct corporate restructuring. In summary, not only is the efficiency and effectiveness of stock market in Japan much lower than that in the United States, but the corporate framework in Japan is not as dynamic as that in United States. This caused the Japanese enterprises to lag behind in the reaction of restructuring and reform is not as sufficient as that of U.S. firms. Even under the enormous pressure resulted from the Asia Financial Crisis the Japanese firms are passive in conducting corporate restructuring.

Suggestions for Reinforcing the FCR Function of Stock Market In an effort to further promote the establishment of the capital market, the government has enacted a series of policies and rules of law in recent years, such as enhancing the supervision, upgrading the quality of listed companies and accelerating the listing process of the entire assets of the enterprise. The year 2006 has witnessed the State Council’s promulgation of 16 items of policies and regulations related to the stock market and China Securities Regulatory Commission (CSRC). In 30 January 2007 the CSRC released the Methods for Managing the Information Disclosure of Listed Companies to develop the all-round education for the fund-investors. Along with the basically completed equitydivision-reform of our stock market, the capital market will face sufficient promising development opportunities. Here we present the following thoughts and suggestions with regard to the FCR function of our stock market.

Enhancing supervision and institutionalization; ensuring proper financing activities on the stock market Some scholars suggested when the utilization of capital raised in market suffers from low efficiency or inefficiency, a larger-scale collection of capital does not reflect performance but instead is a cause for concern. Moreover, a number of parent companies, as the major-shareholder of their listed companies, have utilized their listed companies’ capital for self-survival. Such phenomenon existed in 58% of listed firms investigated by CSRC in 2002, with the total capital amount reaching 96.7 billion RMB — much more than the total financing amount of listed companies from the securities market that year. In

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2003 there are 623 listed companies whose capital was infused with a sum of 57.7 billion RMB. Although the amount of infused capital decreased to 50.9 billion RMB in 2004, such problems were still serious. As a result, the listed firms suffered from declining performance and lapsed into operational predicament. Hence, it is necessary, on the hand, to increase the understanding of listed companies; on the other hand, to reinforce the supervision work and provide guidance when enacting policies and rules of law.

Directing the market by reinforcing, restructuring and by increasing the multitude of restructuring means Corporate restructuring involves dozen of measures such as greenfield activities, M&A, divestiture, spin-off, split-up, asset swap, downsizing, downscoping, leverage buyout and market internalization. The aim is to construct new business portfolios, new district distributions, new asset-and-debt structures, and new organizational systems (Mao, 2004). Although the annual reports of our listed companies have somewhat demonstrated their corporate restructuring activities, the focus is often on M&A. Comparatively, be they the number, scale or measures of the corporate restructuring, our listed companies are far from those in the stock markets of developed countries. Hence a more systematic information disclosure and analysis is required on the corporate restructuring activities with policy direction. In addition, we should establish a better delisting mechanism for companies so as to facilitate the stock market’s function in selecting the good-performance companies and optimizing resource allocation.

Uncompromisingly opposing, punishing and eliminating nonessential restructuring The target of restructuring is to overcome the corporate crisis, strengthen the enterprises, and raise market share. Thus the restructuring of finance, assets and organization should be conducted first from the business portfolio restructuring. For a considerable long time, our listed companies have no essential restructuring, but nonessential restructuring which aims at protecting the shell and assigned shares of one company, encircling capital, and sensationalizing in the secondary market. The non-marketized operation of M&A activities among listed companies is quite severe and consists of a considerable amount of black transactions and transactions among affiliated enterprises. Other nonessential restructurings include the report-form restructuring (by canceling debts after verification and swapping assets with other firms so as to make balance sheet pay off), restructuring activities at the end of one year in a hurry, and some short-term behaviors in restructuring. All these request to enhance the supervision and punishment so as to eliminate or decrease nonessential restructurings.

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Further improving corporate governance framework Even though a number of domestic companies have listed in the stock market, they haven’t transformed the operational mechanism. Thus, further efforts are required to improve the corporate governance framework with regard to the formation, responsibility and function of the board of directors and the qualification and diathesis of the directors as well. Only by this way can the board make prompt reactions when their companies are underperformed. Accordingly, the interaction between the stock market and the effective corporate governance will enable the market to play a gradually significant role in FCR.

Effectively exerting the function of institutional investors in the stock market In the developed capital markets, institutional investors can actively supervise the management and participate in the company decision-makings. This will help decrease the opportunistic behaviors of the management, raise the utilization efficiency of the companies’ interior resource and thus upgrade the market value of companies. By holding and selling a variety of stocks, institutional investors can disperse risk and change investment structure. Their frequent adjusting of investment structure in the stock market frankly will impose external pressure on the corporate management and help facilitate the corporate restructuring and perfect resource allocation. Nevertheless, some studies show that the domestic investing-fund institutions have quite serious herd behaviors and certain nearsighted behaviors. They have no strong consciousness in participating in the corporate governance and position themselves as passive shareholders, which intensifies the price fluctuation to some extent. Although the domestic and foreign institutional investors are different from each other in investment behaviors for complex reasons such as the institutional heterogeneity in different stock market and the difference in mutual investment culture, Chinese stock market, whose domestic economy is in the newlyindustrial transforming process, must strive to facilitate institutional innovations so as to standardize and develop institutional investors. Therefore, on the one side, we should positively enlarge and enhance the institutional investors, encouraging the establishment of professional venture-investment companies in accordance with the rules of law, in an effort to facilitate their active functions in the stock market and corporate restructuring. On the other side, it is necessary to upgrade the qualification, credit and professional quality of institutional investors; and conduct essential supervision and guidance in terms of the license qualification, fund source, investment direction and risk control. This can form a survival of the fittest mechanism for them and help to develop their qualities, which eventually improve the quality of listed companies. In addition, we should pay more attention to the investors’ returns; upgrading the diathesis of stock market participants, especially the ordinary individual

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shareholders and fundholders; enhancing their ability in mastering and analyzing the information of stock market; and strengthening their risk awareness. These measures are significant to the stability and development of our stock market in the long run.

Conclusion Since the enacting of Notice about Some Issues related with the Equity Division Reform of Pilot Listed Companies in 29 April 2005, China has launched equity division reform, followed by the dramatically rapid development of the domestic stock market. The Shanghai’s composite index climbed amidst wide fluctuations from 1254.32 in 13 April 2005 to 5552.30 in 28 September 2007, a fourfold increase within two and a half years. Meanwhile, the total stock market also rose continuously from the low of 2963.7 billion RMB in 21 July 2005 to more than 21 trillion RMB in 9 August 2007, exceeding for the first time the GDP level. The upsurge of the Chinese stock market has attracted widespread attention from the government, the market, as well as domestic and foreign institutions, but also aroused the worry and suspicion among a segment of scholars and experts. Nonetheless, we should acknowledge that bubbles and risks come hand in hand with the stock market; we are now presented with the best opportunities in facilitating the basic construction of the Chinese stock market. Accompanied with the basically completed equity division reform and the promulgation of a series of policies and rules of law, Chinese stock market is realizing a strategic transformation and accessing a thoroughly new period. Based on the long-term establishment of the capital market, the Chinese government must grasp the opportunities and further enhance market guidance so as to facilitate institutional improvement. For this reason, currently we ought to, by driving the establishment of capital market, strengthen the function of corporate restructuring to diminish market risks. As the Chinese stock market has merely developed for no more than 16 years, there is a tendency to focus more on financing but less on corporate restructuring in our stock market. This is not advantageous to the optimization of resource allocation, which in turn increases the risks of our stock market. To reduce such risks effectively, therefore, we should reinforce corporate restructuring so as to upgrade the competitive advantage of listed companies and optimize the allocation of stock capital in our stock market.

References Beck, T and R Levine (2002). Industry growth and capital allocation: does having a market- or bank-based system matter? Journal of Financial Economics, 64, 147–180. Bettis, RA and CK Prahalad (1983). The visible and the invisible hand: resource allocation in the industrial sector. Strategic Management Journal, 4, 27–43. Blair, M (1999). Ownership and Control: Rethinking Corporate Governance for the Twenty-First Century. Washington: Brookings Institution Press.

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Chandler, A (1996). Strategy and Structure: Chapters in the History of the American Industrial Enterprise. Maryland: Beard Books. Dore, R (2000). Stock Market Capitalism: Welfare Capitalism. Japan and Germany versus the Anglo-Saxons. Oxford, UK: Oxford University Press. Fama, EF (1991). Efficient capital markets. Journal of Finance, 46, 1575–1617. JSBOMOF (Japan Securities Bureau of Ministry of Finance) (Ed), (1991). Japanese Security Market. Tokyo Financial Press (in Japanese). Mao, Y (2004). Global Corporate Restructuring — Case Study and Reorganization of Chinese Enterprises. Dongbei University of Financial and Economics Press (in Chinese). Mao, Y (ed.) (2005a). Corporate Economics. Dalian: Dongbei University of Financial and Economics Press (in Chinese). Mao, Y (ed.) (2005b). An institutional comparison of corporate restructuring. Academic Research, 6(34), 41–147 (in Chinese). OECD (2004). OECD Principles of Corporate Governance. Paris: OECD Publications Service. Scherer, FM and D Ross (1990). Industrial Market Structure and Economic Performance, 3rd Ed. Boston: Houghton Mifflin. Shaw, E (1973). Financial Deepening in Economic Development. New York: Oxford University Press. TPBC (The People’s Bank of China) (2006a). China Financial Stability Report. Bejing: TPBC. TPBC (The People’s Bank of China) (2005b). International Financial Market Report. Bejing: TPBC (in Chinese). TPBC (The People’s Bank of China) (2006c). International Financial Market Report. Bejing: TPBC (in Chinese). Wei, Y (2001). Statistical analysis on the policy effects on Shanghai’s stock market. Statistical Research, 2, 52–55 (in Chinese). Weston, F, K Chung and S Hoag (1990). Mergers, Restructuring and Corporate Control. New Jersey: Prentice Hall. Wu, X (2006). China’s Capital Market after Share Division Reform. Beijing: China Renmin University Press (in Chinese). Wurgler, J (2000). Financial markets and the allocation of capital. Journal of Financial Economics, 58, 187–214. Xiao, L (2005). Empirical studies of black transactions in Chinese stock market. Finance and Economics, 6, 26–29 (in Chinese). Xing, T (2003). Research of the Problems in the Chinese Capital Market. Dalian: Dongbei University of Financial and Economics Press (in Chinese). Zhang, X (2003). Do mergers and acquisitions create value?: evidence from Chinese listed companies. Economic Research Journal, 6, 20–29+93 (in Chinese). Zhou, D, J Zhao and Y Chen (2006). Multi-Dimensional Selections and Innovations of Chinese Capital Market. Beijing: People Press (in Chinese).

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An Empirical Study on the Long-term Dynamic Adjustment of Firms’ Capital Structure in China ͣZHIQIANG WANG and YIXUN HONG Xiamen University

Z

hiqiang Wang is a professor of finance at School of Management, Xiamen University. Prof. Wang holds also the assistant dean of Institute for Financial and Accounting Studies at Xiamen University. His research interests include asset pricing, corporate finance, market microstructure, and the role of information in capital markets. He has published in all of these areas. He is currently working on several issues, including: the short-term and long-run effect of IPOs timing on firms’ capital structure, the dynamics partial adjustment of firms’ capital structure, the role of convertible securities in corporate finance. ProfessorWang joined the faculty of the school of Management in 1998 to teach Corporate Finance and Valuation for MBA students, he also consults for many corporations. Education PhD, Xiamen University, School of Business, 2001 MS, Xiamen University, Department of Mathematics, 1991 BS, Xiamen University, Department of Mathematics, 1988

M

r. Yixun Hong has a BS degree from College of Crop Science at Fujian Agriculture and Forestry University during 1999 and 2003, and he is an enrolled postgraduate at Xiamen University now. His research interests include corporate finance, capital market and corporate governance.

Abstract: Dynamic capital structure theory suggests that firms have target debt ratios and other factors such as financial deficit, market timing, implied debt ratio may lead observed capital structures to deviate from the targets. Because of adjustment costs, firms will not make adjustment immediately and completely when there are deviations. The decisions whether to adjust the debt ratios and the adjustment magnitude will be based on the tradeoffs between the costs and benefits of the adjustment. Based on the latest achievements of capital structure theory

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and empirical research, this paper constructs a comprehensive model to pursue the long-term dynamic path of capital structure adjustment of listed firms in China. Firstly, we estimate a Tobit regression model to predict the target debt ratios and construct a variable — leverage deficit as an independent variable in the second step regression which is scaled by the difference between the target debt ratios and the observed debt ratios; then we use the partial adjustment model to examine how capital structure can be influenced through dynamic adjustments. The results indicate that financial deficit, market timing and stock price changes indeed lead to deviations between the observed debt ratios and target debt ratios. In particular, stock price changes have the strongest influence on capital structure changes. We find also that their effects are partially reversed over long horizons. These empirical results suggest that firms’ capital structures tend to move towards their target debt ratios over time although their histories strongly influence their capital structures. Keywords: Target capital structure; Financial deficit; Market timing; Implied debt ratio JEL Classification: G32

Introduction The theory of capital structure has been dominated by the search for optimal capital structure. Based on the views of optimal capital structure, we can classify capital structure theory into two antithetic classifications. Static trade-off theory suggests that firms have what is often referred to as a target debt ratio, which is determined by various tradeoffs between the costs and benefits of debt versus equity, and if the observed capital structure deviates from the target, firms will make a complete adjustment. To the contrary, Pecking order theory suggests that firms prefer internal to external finance. When outside funds are necessary, firms prefer debt to equity. According to the Pecking order theory, the firms have no target debt ratios, the financial deficits will result in the deviations from their target debt ratios. In the early time, the theory of capital structure is the controversy between the static trade-off theory and the pecking order theory by and large. Scholars have found some different powers that can cause the deviation from the target capital structure recently. For example, Baker and Wurgler (2000) study equity market timing and find that firms are more likely to issue equity when their market values are high, and to repurchase equity when their market values are low. Equity market timing not only has a short-term effect on capital structure but also a long-term effect. Capital structure is the cumulative outcome of past attempts to time the equity market. The inertia theory put forth by Welch (2004) argues that, if there are target capital structures, firms should issue and repurchase debt and equity to counteract the mechanistic effects of stock returns on their debt-equity ratios when the equity is scaled by market value, but his findings show that despite fairly active net issuing activity, firms fail to rebalance their capital, and allowing deviations from their targets to remain.

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Though varied in points of view, the above theories can only observe partial picture as to how the capital structure is decided. How can one have a “panoramic view” that integrates all these partial characteristics? Dynamic trade-off theory makes such an attempt. Dynamic trade-off theory argues that firms have target capital structures indeed, but there are also some facts such as financial deficit, market timing, stock price changes which will cause the firms to deviate from their target capital structure. Because of adjustment costs, when there are deviations, firms will make a tradeoff between the marginal benefits and the marginal costs of the adjustments before the decision as to whether to make an adjustment and the magnitude of that adjustment. How does dynamic trade-off theory show the complete picture of the decisions behind firms’ capital structure? How do the influencing factors affect the capital structure decisions? When testing the effects of the influencing factors, most of the existing empirical research literatures of capital structure limit themselves to a (few) factor(s). Obviously, it is somewhat one-sided. This paper constructs a comprehensive model to pursue the longterm dynamic trace of capital structure adjustment of the listed firms in China. Firstly, we estimate a Tobit regression model to predict the target debt ratios, and then we use the partial adjustment model to examine how financial deficit, market timing, stock price changes, leverage deficit and the changes in the target debt ratio influence the dynamic adjustment of capital structure over five years and ten years. To highlight the economic significance of our results, we estimate the standardized regressive coefficients of the same variables. The results indicate that over long horizons firms move towards their dynamic target capital structures significantly. At the same time, financial deficit, market timing and stock price changes indeed lead to deviations between the observed debt ratios and target debt ratios. Though the effects of market timing persist, it is not significant. We find that all the deviation effects are partially reversed. The innovations of the paper are as follows: (1) Classify the influencing factors of the capital structure decisions into two powers, one power will make the firms move towards the target capital structures, the other will result in the deviation from the target capital structures. And then, study the long-term effects on capital structure of the two factors comprehensively. (2) Estimate a Tobit regression model to predict the target ratio as OLS regression cannot be used to analyze the non-normal data. (3) Use a bootstrapping technique to determine the statistical significance of the estimated coefficients to deal with the problem of heteroskedasticity and autocorrelation that may be induced by including observations in overlapping periods.

Research Design Methodology In the first step we construct a proxy for the target leverage ratio, LT, as the predicted value from a regression of debt ratios on trade-off variables employed in prior cross-sectional

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studies. Next, using this target leverage proxy, we construct a leverage deficit variable as the difference between the target leverage ratio and the leverage ratio at the beginning of the period (L − LT). We also construct a variable of changes in the target debt ratio for the reason that the firms will adjust their targets over the time. If firms have a tendency to move towards their target debt ratios, then firms that have leverage ratios that are lower (higher) than their targets are likely to experience future increases (decreases) in their debt ratios. We use Leverage deficit and change in target to trace the dynamic character when firms move towards their targets. The existing literatures mainly adopt three criteria for the target capital structure ratio: industry averages (Lev, 1969), the historical mean of the debt ratio for each firm (Shyam-Sunder and Myers, 1999), and the most important one which is based on the capital structure theory, and predicted by a regression model (Fama and French, 2002; Flannery and Rangan 2006; Kayhan and Titman, 2007, and so on). Theoretically speaking, the last one is more scientific. We estimate a Tobit regression model that regresses the debt ratio on a set of variables that we use to proxy for firm characteristics. These variables have been suggested in the previous literature as proxies for the benefits and costs of leverage (Titman and Wessels, 1988; Rajan and Zingales, 1995; Fama and French, 2002, and so on). Concretely speaking, these variables are profitability (EBITDA), asset tangibility (PPE), firm size (SIZE), and the market-to-book ratio. In addition, we include industry dummies to capture the industry-specific determinants of leverage not captured by the above variables. Specifically, we use the industry classification which is issued by China Securities Regulatory Commission in 3 April 2001. In the second step, we make an empirical research on the long-term dynamic adjustment of firms’ capital structure. Based on empirical research literatures, we use financial deficit, market timing, stock price changes to trace the characters of capital structure adjustment of the listed firms besides leverage deficit and the changes in the target debt ratio.

The financial deficit variable The financial deficit, equal to the amount of external capital that is raised, plays a central role in both Myers’pecking order effect, as discussed in Shyam-Sunder and Myers (1999) and Frank and Goyal (2003). The interpretation of the pecking order hypothesis, described in Shyam-Sunder and Myers (1999) and Frank and Goyal (2003), is that since debt is likely to be the marginal source of financing, firms with high financial deficits are likely to increase their debt ratios. Our definition of financial deficit is simply the net amount of debt and equity the firm issues or repurchases in a given year. Specifically, the financial deficit (FD) is defined as the sum of investments (I), dividends (D), and changes in working capital (ΔWC), net of net cash flow (CF). This sum, described below, is identical to net debt issues (Δd) plus net equity issues (Δe). In other form, it is equal to net total assets (ΔA) minus net retained earnings (ΔRE)

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FD = ( Δe + Δd ) /A = ( ΔWC + I + D − CF) /A = ΔA / A − ΔRE / A

179 (1)

Timing measures Baker and Wurgler (2002) develop a timing measure which is the “external finance weighted-average” market-to-book to study the timing effect, and they found that the resulting effects on capital structure are very persistent, capital structure is the cumulative outcome of past attempts to time the equity market ⎛ t −1 ⎞ M/Befwa,t −1 = ⎜ FDS × (M / B)S ⎟ ⎝ s=0 ⎠

∑

t −1

∑ FD

r

(2)

r=0

If firms time the equity market to issue more equity when the values are overrated (high M/B), the M/Befwa will be high. For purposes of computing this variable, we set the minimum weight to zero. The purpose of not allowing negative weights is to ensure that we are forming a weighted average. In any event, a zero weight just means that the variable contains no information about the market valuation in that year.

Implied debt ratio Welch (2004) constructs a variable, which he calls the implied debt ratio (IDR) to measure the mechanical relation between market leverage ratios and stock returns. And he finds that stock return has a significant effect on the debt ratio of firms and the effect will persist for a long time. Many other proxies such as tax costs, expected bankruptcy costs, earnings, profitability, market-book ratios, uniqueness, market timing and so on fail to explain much of capital structure dynamics when IDR are accounted for. And in the long term, stock return plays a much more important role in explaining capital structure than other variables. Welch suggests that stock return is the primary known component of capital structure and capital structure changes. Kayhan and Titman (2007) show that firms’ stock returns which measured as the cumulative log return on the stock over the previous five years and the IDR have an effect on capital structure changes in short term, but over long horizons these effects are partially reversed. If stock price changes have strong influences on capital structure changes indeed, we will find that there is a positive relation between the IDR and changes in the leverage ratio. As there are non-circulation stocks in China, and non-circulation stocks account for a large proportion, it is improper to examine the influence on capital structure changes of stock price changes by firms’ stock returns which are measured as the cumulative log return on the stock. This paper adopts IDR to test the effect of stock price changes. Take non-circulation stocks into account, the IDR during time t and time t−5 is IDR t =

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D t −5 D t − 5 + E t − 5 × (1 + r[ t , t − 5] ) + EU t − 5

(3)

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where D, E, r and EU are, respectively, the book value of debt, the market value of equity, the five-year cumulative stock return and the value of non-circulation stocks (scaled by net assets per share multiply the amount of non-circulation stocks). In the second step, we estimate three OLS regressions with no-intercept in three stages to test the contemporaneous effects, sustainable effects and reverse effects of the two powers, respectively. The reason why we use the no-intercept model is that the dependent variable is the change of capital structure, when all the independent variables are equal to zero, that is to say, if there are not power that can cause the changes of the capital structure, the dependent variable should be zero. When we adopt standard OLS regression models, we find that the intercept is not significant, and the F-value, the R2 and the Adj-R2 are smaller. The unreported results suggest that the two kinds of model have the same conclusion. In addition, we use a bootstrapping technique to determine the statistical significance of the estimated coefficients to deal with the problem of heteroskedasticity and autocorrelation that induced by including observations in overlapping periods in the second step. We estimate the confidence intervals of the variables by bootstrapping technique, and determine the statistical significance.

Data Our sample consists of firms listed in the Wind Data-base at any point between 1993 and 2006. We only include the firms with their IPO before 31 December 1993 due to our long-horizon analysis. We exclude financial firms from the sample. We also removed the firms that issue stocks in Hong Kong and other countries to avoid the difference between different capital markets. In addition, we restrict the sample to include firms with a book lever below 1. Our sample is further restricted to include firms with positive prime operating revenue. The firms with the missing data also are excluded. In the end, we get two datasets, one dataset is an unbalanced panel containing 819 firms with at least 5 years of contiguous observations, and the amount of observation is 3,418; the other is also an unbalanced panel containing 186 firms with at least 10 years of contiguous observations, and the amount of observation is 453.

Empirical Models and Analysis Predicting target capital structure Research models We estimate a Tobit regression model that regresses the observed market leverage on a set of variables that we use to proxy for firm characteristics. The definitions of the independent variables show in Table 1.

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Table 1: Variable definitions Variable

Data name Total assets − total liabilities + deferred taxes + convertible debt

Book equity (B) Book debt (D)

Total assets − book equity

Market equity (M)

Price × Common shares outstanding + net assets per share × the amount of non-circulation stocks

Book leverage

Book debt/total assets

Market leverage

Book debt/(total assets−book equity + market equity)

Asset tangibility (PPE)

(Inventory + fixed assets)/total assets

Profit (P)

EBITDA/total assets

Size (SIZE)

Ln(Total assets)

Growth (M/B)

(Total assets − Book equity + market equity)/total assets

financial deficit (FD)

FD = Δe / A + Δd / A = ΔA / A − ΔRE / A

Leverage deficit (Ldef )

Ldef t − 5 = L t − 5 − LTt − 5

The changes in the target debt ratio (ΔTarget)

ΔTarget t − 5 = LTt − LTt − 5

Tobit regression model is as follows: L t = α 0 + β1M / B t −1 + β 2 PPE t −1 + β 3 Pt −1 + β 4SIZE t −1 + ε t +

∑ βInd. dum

(3)

Empirical results and analysis Based on the maximum likelihood estimation, we get the results of our estimation as reported in Table 2.a The result shows that the fitting degree of the model is pretty good, and the parameter estimates of all the variables are significant. The model is proper in predicting the target capital structures.

Contemporaneous effects test Research models This section examines how financial deficits, market conditions, IDR, leverage deficit and the changes in the target debt ratio relate to changes in leverage. The timeline of the observations, research model and the regression specification is as in Fig.1. L t − L t − 5 = β1FD[ t , t − 5] + β 2 TIME [ t , t − 5] + β 3 IDR t + β 4 Ldef t − 5 + β 5 ΔTargeet t − 5 + a

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∑ βInd.dum + ε

t

(4)

The statistics for the industry dummies are suppressed for this table and the following ones.

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Table 2: Tobit regression results Variable

Estimate

Intercept

–0.6749 (–13.99)***

M/B

–0.1011 (–28.93)***

PPE

0.0574 (5.65)*** –0.3133 (–18.23)***

P

0.0565 (26.53)***

SIZE

0.1431 (122.78)***

_Sigma Log likelihood Prob.>X

3957

2

0

Note: in the bracket is the t-value, *** represents the significance at 1% level. Measure the leverage deficit (Ldeft − 5 = Lt − 5 − L Tt − 5)

Measure the changes in target

(Δ Targett − 5= LTt− LTt − 5)

Measure the changes in leverage (Lt − Lt − 5)

t−5

t

History variables: FD[t, t − 5] (financial deficit) Time [t, t − 5] (timing), IDRt (implied debt ratio)

Figure 1: Contemporaneous Effects.

The dependent variable is the change in leverage between year t and t − 5. FD[t,t − 5] is total external financing between year t and t − 5. TIME[t,t − 5] is “external finance weightedaverage” market-to-book between year t and t − 5. IDRt is the implied debt ratio at period t. Ldeft − 5 is the difference between leverage and target leverage at t − 5, where target leverage is proxied by the predicted value of the leverage ratio. ΔTargett − 5 is the difference between target leverage at t and target leverage at t − 5.

Empirical results and analysis Table 3 reports the coefficient estimates obtained from the regressions of changes in market leverage on our proxies for market timing, pecking order, stock price changes,

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the leverage deficit and the changes in the target debt ratio. From Table 3 we will find that all the variables are significant except the timing measure.b And the relations between the dependent variable and the independent variable are accord to what we have expected. The evidence indicates that these variables have important effects on changes in the debt ratios. To highlight the economic significance of our results, we also estimated the standardized regressive coefficients. Specifically, we examine the effect of one standard deviation change in the independent variables on changes in the debt ratios. For example, a one standard deviation increase in financial deficit increases leverage by 0.3709; a one standard deviation increase in leverage deficit decreases leverage by 0.4770. The evidence indicates that financial deficit, IDR, leverage deficit and the changes in the target debt ratio have important effects on changes in the debt ratios, while the effects of market timing relatively are minor. And IDR has the largest effect that a one standard deviation increase in IDR increases leverage by 0.7254. Table 3: Contemporaneous effects Variable

Parameter Estimate

FD[t,t − 5]

0.1788

0.0200

0.1275

0.2301

0.3709

− 0.0148

0.0099

− 0.0402

0.0106

− 0.1018

TIME[t,t − 5] IDRt

Standard Error

95% Conf. interval

Standardized Estimate

0.4432

0.0279

0.3714

0.5150

0.7254

Lt-5-LTt − 5

− 0.8959

0.0364

− 0.9895

-0.8023

− 0.4770

LTt- LTt − 5

0.6942

0.0353

0.6035

0.7849

0.3770

F Value

465.12

R-Square

0.6876

Pr>F

<.0001

Adj R-Sq

0.6861

In addition, the result shows that firms tend to reduce the deviation from the target capital structure five years age at a rate of 90%. It indicates that firms tend to move towards their dynamic target ratios at a faster rate.

Sustainable effects test Research models In the previous section we showed that financial deficit, market timing and IDR have significant effects on capital structures. In this section we examine whether there are the

b

The confidence interval based on normal distribution is wider than the confidence interval of quantile for bootstrap. When we adopt the confidence interval of quantile for bootstrap, we find that market timing is significant at 10% level in the contemporaneous effects model, and the other results have no changes.

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sustainable effects. Specifically, we test whether firms’ histories measured in the first half of the ten-year period (from years t − 5 to t − 10) affect how leverage ratios change over an entire ten-year period (from years t to t − 10). We include history variables observed in the second half of the ten-year period (from years t to t − 5) for the reason that these variables can also affect the leverage ratios changes over an entire ten-year period. Again, we estimate coefficients with a no-intercept model and estimate the standardized regressive coefficients at the same time. If there are the sustainable effects, the relation between the variables measured in the first half of the ten-year period and the leverage ratios changes over an entire ten-year period will be the same as the corresponding contemporaneous effects. The timeline of the observations, research model and the regression specification is as in Fig.2. Measure the leverage deficit (Ldeft − 10 = Lt − 10 LTt − 10)

Measure the change in target (ΔTargett − 10 = LTt − 10 LTt − 10)

Measure the change in leverage (LTt − Lt − 10)

t

t − 10

t−5 First half History variables: FD [t − 5, t − 10] (financial deficit), Time [t − 5, t − 10] (timing), IDRt − 5 (implied debt ratio)

Second half History variables: FD [t, t − 5] (financial deficit), Time [t, t − 5] (timing), IDRt (implied debt ratio)

Figure 2: Sustainable Effects.

L t − L t −10 = β1FD[ t −5, t −10] + β 2 TIME[ t −5, t −10] + β 3 IDR t −5 + β 4 FD[ t , t −5] + β 5 TIME[ t , t −5] β 6 IDR t + β 7 Ldef t −10 + β8 ΔTarget t −10 +

∑ βInd. dum + ε

t

(5)

The dependent variable is the change in leverage between year t and t − 10. FD[t − 5,t − 10] is total external financing between year t − 5 and t − 10. TIME[t − 5,t − 10] is “external finance weighted-average” market-to-book between year t − 5 and t − 10. IDRt − 5 is the implied debt ratio at period t − 5. FD[t,t − 5] is total external financing between year t and t − 5. TIME[t,t − 5] is “external finance weighted-average” market-to-book between year t and t − 5. IDRt is the implied debt ratio at period t. Ldeft − 10 is the difference between leverage and target leverage at t − 10, where target leverage is proxied by the predicted value of the leverage ratio. ΔTargett − 10 is the difference between target leverage at t and target leverage at t − 10.

Empirical results and analysis Table 4 reports the coefficient estimates obtained from the regressions and Table 5 is the sustainable effects schematic table. We can see that the relationships between the

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variables in the first half of the ten-year period and leverage ratios changes over an entire ten-year period is somewhat different from the contemporaneous effects. Financial deficit and IDR have no persistent effects. Though market timing effect persists, it is not significant. In addition, we find that the leverage deficit measured in the distant past has a significant effect on leverage changes even after controlling for the changes in target debt ratio. A one standard deviation increase in leverage deficit measured in ten years ago decreases leverage by 0.3355. It is obvious that firms tend to adjust towards a target. Table 4: Sustainable effects Variable

Parameter Estimate

Standard Error

95% Conf. interval

Standardized Estimate

FD[t – 5,t – 10]

– 0.0542

0.0298

– 0.1308

0.0225

– 0.1161

TIME[t – 5,t – 10]

– 0.0163

0.0109

– 0.0444

0.0119

– 0.1235

IDRt – 5

– 0.5382

0.0608

– 0.6946

– 0.3819

– 0.7274

0.1513

0.0268

0.0823

0.2203

0.2835

– 0.0112

0.0132

– 0.0450

0.0226

– 0.0758

FD[t,t – 5] TIME[t,t – 5]

0.6286

0.0564

0.4837

0.7735

1.1724

– 0.5603

0.0794

– 0.7643

– 0.3564

– 0.3355

0.9118

0.1174

0.6099

1.2136

0.4862

IDRt Lt – 10–LTt – 10 LTt – LTt – 10 F Value

67.75

R-Square

0.7393

Pr>F

<.0001

Adj R–Sq

0.7284

Table 5: Sustainable effects schematic table Contemporaneous Effects

Sustainable Effects

sign

sign

FD

+

−

TIME

−

−

IDR

+

−

Ldef

−

−

ΔTarget

+

+

Variable

Reverse effects test Research models The results in the previous section indicate that financial deficit and IDR have no persistent effects and market timing effect persists, but it is not significant. In this section, we provide a more direct test to examine whether the effects of these history variables are later reversed. Specifically, the no-intercept model allows us to examine how the firms’ histories (from years t − 10 to t − 5) affect leverage ratios

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changes over the subsequent five-year period (from years t − 5 to t). We also include history variables observed in the second half of the ten-year period (from years t to t − 5). If the history effect reverses, we expect the coefficient on the lagged history variable to have the opposite sign as the corresponding contemporaneous history variable. The timeline for the regression that we estimate is described as in Fig.3. Measure the leverage deficit (Ldeft − 5 = Lt − 5 − LTt − 5)

t −10

Measure the change in target (ΔTarget t − 5 = LTt − LTt − 5)

t

t−5 First half History variables: FD [t − 5, t − 10] (financial deficit), Time [t − 5, t − 10] (timing), IDRt − 5 (implied debt ratio)

Measure the change in leverage (Lt − Lt − 5)

Second half History variables: FD [t, t − 5] (financial deficit), Time [t, t − 5] (timing), IDRt (implied debt ratio)

Figure 3: Reverse Effects.

L t − L t −5 = β1FD[ t −5, t −10] + β 2 TIME[ t −5, t −10] + β 3 IDR t −5 + β 4 FD[ t , t −5] + β 5 TIME[ t , t −5] β 6 IDR t + β 7 Ldef t −5 + β8 ΔTarget t −5 +

∑ βInd. dum + ε

t

(6)

The dependent variable is the change in leverage between year t and t − 5. FD[t − 5,t − 10] is total external financing between year t − 5 and t − 10. TIME[t − 5,t − 10] is “external finance weighted-average” market-to-book between year t − 5 and t − 10. IDRt − 5 is the implied debt ratio at period t − 5. FD[t,t − 5] is total external financing between year t and t − 5. TIME[t,t − 5] is “external finance weighted-average” market-to-book between year t and t − 5. IDRt is the implied debt ratio at period t. Ldeft − 5 is the difference between leverage and target leverage at t − 5, where target leverage is proxied by the predicted value of the leverage ratio. ΔTargett − 5 is the difference between target leverage at t and target leverage at t − 5.

Empirical results and analysis Table 6 reports the estimates of these regressions. We can see from Table 7 that the coefficient on the lagged history variable has the opposite sign as the corresponding contemporaneous history variable. The result indicates that there are the reverse effects. The history variables can be viewed as an additional proxy for the leverage deficit since they represent variables that lead firms to move away from their target debt ratios. For example, when the financial deficit is high, the leverage deficit is expected to be high, which implies that future changes in the debt ratio are likely to be negative. From

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the analysis above, we consider that firms have taken actions to counteract the effects which have caused the deviations from the target leverage several years ago. In addition, Table 6: Reverse effects Variable

Parameter Estimate

Standard Error

FD[t–5,t–10]

– 0.0878

0.0264

– 0.1557

– 0.0198

– 0.1856

0.0064

0.0146

– 0.0311

0.0439

0.0478

– 0.3061

0.0569

– 0.4523

– 0.1600

– 0.4081

0.1663

0.0284

0.0933

0.2392

0.3072

– 0.0071

0.0158

– 0.0478

0.0335

– 0.0478

0.7650

0.0550

0.6236

0.9064

1.4074

– 1.1057

0.0800

– 1.3114

– 0.9000

– 0.6372

0.8895

0.1015

0.6287

1.1503

0.5102

TIME[t – 5,t – 10] IDRt – 5 FD[t,t – 5] TIME[t,t – 5] IDRt Lt – 5 – LTt – 5 LTt –

LTt – 5

F Value

62.24

R–Square

0.7226

95% Conf. interval

Standardized Estimate

Pr>F

<.0001

Adj R–Sq

0.7110

Table 7: Reverse effects schematic table

Variable

Contemporaneous Effects

Reverse Effects

sign

sign

FD

+

−

TIME

−

+

IDR

+

−

Ldef

−

−

ΔTarget

+

+

leverage deficit is very significant even after controlling the changes in the target leverage and the standardized regressive coefficient is considerably large, it shows the fact that firms tend to move towards their target capital structure indeed.

Robustness Test There is little agreement about that about whether one should consider market or book leverage ratios. So we use book leverage as the robustness test in this paper. We exclude the IDR since stock price changes have no economic impact on book leverage. The unreported results suggest that the effects of financial deficit, leverage deficit and the changes in the target debt ratio are significant except market timing in the model of contemporaneous effects test. The result of sustainable effects test shows that financial

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deficit has a sustainable effect but market time does not. We also find that the effects of financial deficit and market timing are both reversed, but the significances of these variables are weaker than when we measure capital structure by market leverage. In the three models, the proxies for trade-off theory all exhibit strong significance. In a word, when we use book leverage, the conclusions are basically consistent with market leverage.

Conclusion If firms achieve their target capital structure, the cost caused by leverage deficit is dependent on the importance of the target capital structure. If the target capital structure is important, the cost of deviating from the optimum will be quite large and firms will rebalance the actual capital structure at a faster rate and move towards the target capital structure. If target debt ratio is much less important, capital structures are likely to be strongly influenced by transaction costs and market considerations that can temporarily affect the relative costs of debt versus equity financing. Under these circumstances, firms rarely reduce the deviation from the target capital structure and even take no actions to counteract the effects which had caused the deviations from the target. The results of this paper indicate that firms have target capital structures, and that target capital structure is the primary influencing factor of capital structure decisions. Though financial deficit, market timing and IDR cause the deviations from the target capital structure, the effects of financial deficit and IDR are not persistent except market timing. In addition, we find that the Sustainable Effect of market timing is not significant. We also find that their effects are partially reversed over long horizons through the reverse effects test. These empirical results suggest that firms have taken actions to counteract the effects which have caused the deviations from the target leverage in previous years. In addition, we find that the target capital structure has a strong economic impact on how firms adjust their debt ratios and firms tend to move towards their target ratios at a faster rate. The results provide further evidence on the significance of the target capital structure when firms undertake decisions on capital structure.

References Baker, M and J Wurgler (2002). Market timing and capital structure. Journal of Finance, 57(1), 1–32. Baruch, L (1969). Industry averages as targets for financial ratios. Journal of Accounting Research, 7(2), 290–299. Efron, B (1979). Bootstrap methods: another look at the Jackknife. Annals of Statistics, 7, 1–26. Efron, B (1987). Better bootstrap confidence intervals (with discussion). Journal of the American Statistical Association, 82, 171–200. Fama, E and KR French (2002). Testing trade-off and pecking order predictions about dividends and debt. Review of Financial Studies, 15(1), 1−33.

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Flannery, MJ and KP Rangan (2006). Partial adjustment and target capital structures. Journal of Financial Economics, 79, 469–506. Frank, M and V Goyal (2003). Testing the pecking order theory of capital structure. Journal of Financial Economics, 67(2), 217–248. Kayhan, A and S Titman (2007). Firms’ histories and their capital structures. Journal of Financial Economics, 83, 1–32. Rajan, RG and L Zingales (1995). What do we know about capital structure? Some evidence from international data. Journal of Finance, 50, 1421–1460. Shyam-Sunder, L and SC Myers (1999). Testing static tradeoff against pecking order models of capital structure. Journal of Financial Economics, 51, 219–244. Titman, S and R Wessels (1988). The determinants of capital structure. Journal of Finance, 43(1), 1–19. Welch, I (2004). Capital structure and stock returns. Journal of Political Economy, 112(1), 106–131.

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How Chinese City Commercial Banks May Compete With Overseas Banks ͣDONGSHENG WANG Nankai University

D

r. Wang Dongsheng is currently the Associate Professor of Nankai University and the Deputy Director of their Finance Department. He is also the General Secretary of Finance Department and Insurance Department. Dr. Dong is also a consultant at the National Asset Management Committee of Tianjin, governor of the Financial Institution of Tianjin and the Futures Society of Tianjin. Dr. Dong’s researches mainly focus on Corporate Finance Commercial bank’s operation and management. He has also published monographs on the Banking and Financial Management field since 1994, including “Research on the futures options markets” — economic management publication, “Financial Management” — Harbin Industry University publication and “Management of Financial Institutions” — Northeast China University of Finance and Economics publication.

Abstract: In China, the development of city commercial banks is facing many opportunities and the challenges. This article points out that city commercial banks face many questions such as rapid development in the finance sector amidst poor corporate profitability. In order to solve the above problems, this article proposes that city commercial banks put forth a comprehensive developmental strategy plan, including a viable human resources management strategy. Keywords: City commercial bank; Company management; Developmental strategy; Risk management

Strong economic growth in the 20 years since the opening up of China accorded a highly conducive environment for local commercial banks, propelling the finance industry to new heights. With the reform of the Chinese banking system, the financial sector has undergone profound changes. The city commercial bank as representative of the archetypal Chinese city financial institution is becoming stronger by the day in part due to strong support from the current Chinese government. Meanwhile, with the

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deepening of economic reforms, enterprises and individuals developed more sophisticated needs for financial products and financial services. These developments provided more opportunities for Chinese city commercial banks. After the opening of the finance industry at the end of 2006, the overseas bank will have the same opportunity to compete with the local banks. Because of marketoriented management systems and advanced risk managerial experience of the former, the Chinese city commercial bank will be subject to strong competition. In recent years, Chinese financial institutions such as the city commercial banks experienced great difficulties such as the following: • Small scale and low asset quality • Absence of the risk consciousness and weak risk management • Lack of the talented staff • Non-advanced management technique • Non-comprehensive kinds of financial service As a result it is imperative for city commercial banks to carry out urgent comprehensive reforms, and transform themselves into modernized finance enterprises which can more forcefully confront competition from overseas banks.

A Key Developmental Problem Since the first city commercial bank was founded in 1995, there are now 119 city commercial banks. General assets have expanded from less than 500 billion yuan to 2600 billion yuan. Annual profit rose to 13.6 billion yuan from 1 billion yuan; the nonperforming loan came down from 34% to 10%; capital adequacy ratio increased to 2.7% from negative territory. In the past ten years, city commercial banks have made great efforts to shake off the survival crisis, and have now embarked onto a new stage endowed with ample developmental opportunities. However, in competition with overseas banks, the Chinese commercial bank still suffers from weaknesses in management systems, internal control and risk management.

Favorable financial position but weak ability to generate profits Although the profitability of Chinese city commercial banks has improved gradually, in relation to a peer comparison of 12 joint-stock commercial banks, the former underperforms in areas such as total asset earning ratio, net asset earning ratio. There is larger difference if compared with overseas banks in developed countries. Furthermore, the average cost income proportion of city commercial banks is presently 30%; in terms of operating expenses, including necessary expenditure such as personnel training and improvements of technology systems, the total cost of the commercial banks has been increasing; this will no doubt affect profitability of the city commercial banks.

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The sole business model did not change In the recent years, the city commercial bank’s income structure tended to become more varied because of the demand impetus, but due to various disadvantageous factors, the Chinese city commercial bank suffered from poor service innovation development. The sole structure of incomes has yet to change; tradition income coming from interest margin still constituted the main income of the city commercial bank. The business model is unitary; high dependency to the interest from loans is one of main reasons for poor profitability. Interest from loans is main income origin of the city commercial bank. Besides that, the income from bond investment composes approximately 15% of the total income; the income from inter-bank activities is undergoing a declining trend, contributing approximately 8% of the total income; the sum of the three constitutes approximately 90% of the total revenue. The most important non-interest income is the intermediary business income, which accounts for less than 10% of total turnover.

Improved asset quality, but the non-performing loan rate remained high At the same time, operational risk was declining with the fall of the non-performing loan rate to 5%, the capital sufficiency ratio of capital was maintained above 8%, the gap of the special preparation for the loan losses was reduced by 22.6 billion yuan, loan loss preparation sufficiency of capital was increased by 42%. Data from the Banking Regulatory Commission also demonstrated that by the end of the first quarter of 2007, the remaining non-performing loan was to the tune of 65.96 billion yuan; the nonperforming loan rate was 11.5% in the first quarter of 2005, but was 7.59% in the first quarter of 2006, and now is only 4.52%. But the average 5% of the bad asset ratio is the same as Hong Kong, which is a far cry from the 1% bad asset levels in the American banking industry. There is now an urgency to reduce the bad asset rate among Chinese city commercial banks. In the arena of non-performing loans, the non-performing loan loss reserve fund is insufficient, the preparation coverage is minimal. According to loan classification standards, the city commercial banking industry’s non-performing loan loss reserve fund was still insufficient for the damage-class loans, and is insufficient in covering losses from the possible non-performing loans.

As the service scale expands, the commercial banks are facing pressures to supplement levels of capital The property scale is not big, the capital is insufficient, risk management ability is weak. To solve these problems, the city commercial bank needs to supplement their capital

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urgently. Because the absolute volume of the capital is excessively low, they are restricted by the “Commercial Banking law” and are limited in loaning proportions to both the average and high net-worth individuals. These aspects weaken the city commercial bank’s competitiveness. At the same time, the low rate of capital sufficiency means that city commercial bank’s risk management ability is weak; that does not favor the city commercial bank’s long-term development. The majority of city commercial banks have already got rid of the survival crisis gradually through more than ten years of hard work; now they face a new developmental opportunity. The city commercial banks have entered the fast expansion period to adapt for the national economy’s fast development since 2000. However, because of the low ability to generate profit, the city commercial banks cannot generate enough capital by themselves; at the same time, the financing channel is also limited; therefore, their capital cannot grow in line with property expansion. The capital sufficiency drops ceaselessly, unable to adequately match scale expansion. According to the Banking Regulatory Commission’s new capital sufficiency management policy, the city commercial bank’s capital sufficiency must attain a designated standard by the stipulated time; otherwise they will face severe punishment such as property scale limitation. This is a stern test for the city commercial bank. The Shanghai Bank supplements their domestic capital successfully by distributing the secondary debt. It became the first city commercial bank to release secondary debt. In the aspect of core capital supplement, increasing the stocks of the original shareholders or introducing the new strategic investor are two feasible methods. But now, as a result of the peculiar circumstances of the city commercial bank, it is very difficult for the original shareholder to continue to increase investment at times, so the introduction of new strategic investors becomes the important way for the commercial bank to supplement their capital. Starting from 2003, some of the city commercial banks began to try to raise money from the direct capital market. In total 119 city commercial banks, besides the Nanjing Commercial Bank and Ningbo Commercial Bank, Bank of Beijing and other banks were positively preparing to raise money in the direct capital market, but most city commercial bank cannot satisfy the high standards of the direct capital market. For the investment from the mutual-enterprise and the foreign company, they chose partners with an earnest work attitude, have very strong competitiveness and strong market share, rather than those who “make a last-ditch effort” to impress.

The city commercial bank still has lots of problems in management systems, internal control, risk management and so on Because of historical and practical reasons, the Chinese city commercial bank is a far cry from the real modernized commercial bank not only in terms of its management systems but also in the property arrangement systems. In particular there are significant flaws

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in the bank property arrangement system, that not only constitute a serious hindrance for the commercial bank to become modernized and international, but is also the main reason behind the bank’s massive non-performing loans. Considering the situation of our country and existing policy environment, the union reorganization and introduction of strategy investor methods only can be used to enhance the corporation management and internal control level in the big city cities, it is not useful in the small cities.

Service variety and business region are restricted by our country’s finance policy There are some restricted policies in the service variety and business region for the city commercial bank, which constitute the disadvantageous factors for the city bank’s development and the product innovation. For example, some city commercial banks still could not draw up the banker’s bill independently, that affected customer settlement; services such as consolidating the fund of society guaranteed, health insurance and providing the entrusted loan can only be done by the state-owned bank, that limited the city commercial bank’s service scope. The majority city commercial bank only can do business in their own cities; that also does not favor the city bank spread loss, bad assets and does not favor the creation of the fair competition environment.

Staff quality is in need of improvement Along with the city commercial bank’s fast development, the staff’s quality is having difficulty keeping up. The structure of the bank and the skills of the staff need to be renewed and enhanced.

Speed up the property system reforms and institutional revolution; establish a modern commercial bank institutional framework and operational mechanism Confronted with competition form overseas banks, the Chinese commercial city bank must wake up to the reality and conform to international convention and the market economy’s intrinsic requests, through reforming its own property system and the operational mechanism to realize the property system transformation and innovation. This is a basic roadmap for the city commercial bank to strengthen its own competitive power. The city commercial bank must develop according to the demands of the modern enterprise; through the establishment of the property system, the city commercial bank will establish a genuine corporation management system and the company operational mechanism. In addition, it needs to: maintain a “divided” power structure, carefully

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separating the implementing agency, the operating unit and the cognizant agency while keeping them in mutual check and balance; establish a form bank government organization composed of a general meeting of shareholders, the board of directors, president (manager level) and the board of supervisors; exercise the decision-making power, carry out power, the right of management and the supervisory authority effectively; construct effective decision-making mechanism, restraint mechanism and the incentive mechanism. Thus the corporation management system will become the most basic property right configuration of organization. Only then can systemic malpractices of Chinese city commercial bank be changed, a commercialized management be realized and overall competitiveness enhanced.

Improve city commercial banks’ organizational structure, promote transformation of its management system Due to historical reasons owing to China’s economic system, Chinese city commercial banks’ organizational structure and the management system bear certain administrative features in areas such as regionalization of its exterior organizational structure, backward internal management and operation systems. Although the commercial banks have made some progress in organizational reforms and “revolutionized” its management systems in the past few years, compared with developed country’s modern commercial bank, they still have a long way to go. As a result, developmental capacities of the Chinese city commercial bank are severely curtailed. Therefore, it is essential to study the organizational structure and management mechanisms of global banks, and relate them to banking reforms within China. This would enhance the competitiveness and development prospects of Chinese city commercial banks.

Promote the financial service innovation; enhance competitive power of the city bank To speed up product innovation, expand the service channel, Chinese commercial banks must insist on the principle that the client’s interest is more important than other things; the city bank should speed up the innovation of bespoke financial products and the services. Firstly, we can promote city bank’s business innovation according to the demands of the new customers, adjust the management and business model which was formed in the traditional system, enhance the productivity of capital, perfect the financial service mechanism, and raise the effectiveness of operation, support the non-state economy vigorously, and cultivate new profit growth. Next, develop private finance service. First, we need to subdivide the market according to the customer’s age, preference, property and so on. Provide differentiated service to different customers. Let the service change from the identical to the specialized.

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Second, we need to enrich the kind of financial service, enhance the added value of the financial product, provide “versatile” service for the customer. Third, we must establish a customer services center, and provide private wealth management services. Furthermore, we need to develop intermediary businesses, take the advantage of capital, outlets, human resource and credit, expand the intermediary businesses without using the bank’s own capital and increase the bank’s income. At the same time, we must pay more attention to the trend of cross-product management and intensify the study in asset securitization, financing, investment, mergers and acquisitions, so we can seize the opportunity to promote the bank’s core competitiveness.

Establish the persistent effect mechanism for the maintenance of capital sufficiency After the WTO protection period, Chinese city commercial bank must comply with conventions of the international bank, the low capital sufficiency is a disadvantage for the city banks in risk management, enhancing competitiveness and implementing internationalization strategy. Therefore strengthening the capital sufficiency management is one of most important tasks which must be done. The capital sufficiency is an indicator of results. Its improvement and enhancement mainly rely on expansion of the bank’s capital in a short time but in the long run it mainly depends upon the improvement of the asset quality. The capital collection’s channel is varied, besides internal accumulation, the exterior stockholder’s rights financing or bond financing may solve the core capital and the attached capital insufficiency separately (Fig. 1).

Control the increasing of the non-performing assets

Get rid of the history non-performing assets effectively

Keep the capital sufficiently on the right level

Enhance the profit making ability

Expend Long-term debt or stockholder's rights

Figure 1: The main measures to raise the capital sufficiency.

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First, seek the opportunity to raise the fund in the stock market and introduce the strategy investor and folk investor positively. Attraction of the internal and external capital and establishment of opening stockholder’s rights structure are the characteristics which the international banks have. The city commercial bank must speed up the establishment of the corporation management system, attract strategic investor and the folk capital vigorously, and promote the stockholder’s rights structure multiplication and the increase of total capital. Second, utilize many kinds of channels, enhance the attached capital quantity. The increase in attached capital is the effective way for the commercial bank to keep the capital. According to the request of Barthel agreement, secondary bonds can be looked as attached capital if they are less than 50% of the core capital. In developed countries, most of the commercial bank’s secondary bonds account for more than 40% of the attached capital. But in China, the attached capital is just a small part of the total capital, the purchasing power of the individual investor and the institutional investor are immense, so it is very easy for the commercial bank to release secondary long-term bonds. Furthermore, we should adjust asset structure and improve property quality. It is a common problem that high risk business developed too fast. That is also a main obstacle to the maintenance of capital sufficiency. The city commercial bank must study other commercial banks’ experience, pay more attention to adjust and optimize the asset structure, arrange a possible property development plan and increase the proportion of low risk services. The city commercial bank should explore intermediary businesses such as bond repurchases. On the base of capital optimizing, control risk assets effectively, reduce the risk of total assets, and achieve the capital sufficiency in the transition-period which was prescribed by the Banking Regulatory Commission.

Establish comprehensive risk management system To solve China Commercial bank’s property quality problem, it is necessary to not only consider how to deal with the existing bad credit property, but also to establish an effective system to prevent the addition of new bad assets. That requires the advanced experience of the overseas banks to establish a scientific credit property risk safeguard system. The concrete measure includes: (1) Study the overseas commercial banks’ successful experience and establish a mutual connection system. (2) Distinguish between the type of the risks, enhance the ability of risk management. (3) Utilize different kinds of asset management method to avoid risk. (4) Pay more attention to client management and risk management, guaranteeing that own credit property risk is in the threshold. (5) Perfect risk management organizational structure. (6) Strengthen the market risk management, establish a dynamic risk assessment model. The foundation of the establishment of the risk management mold is that of a complete database, so we must collect and reorganize the historical data which is dispersed in various departments as soon as possible. (7) Establish a scientific authorization system and system of personal responsibility. In

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brief, the Chinese city commercial bank can solve the problem of the property only by the establishment of a perfect credit property risk management system.

Work hard to introduce and develop professionals, and establish a “people oriented” human resource management mechanism Competition between modern banks is really the competition for talent; successful management of a city commercial bank is not only attributable to a flexible system and mechanism, but also to right and moderate management policy, the strengthening of internal controls. What’s more, the core behind human resource lies with executive ability. The city commercial bank should have a leadership team that has very strong rallying power, and a good staff team. In order to strengthen and improve the human resource management, and to modernize traditional personnel management, the city commercial bank should establish a “people-oriented” human resource management concept. Consider talent as an important resource, and systematically plan for the human resource, improve employee training performance management, salary management, and staff career management. By establishing and improving the human resource management mechanism, city commercial banks can guarantee the realization of their development strategies. Chinese city commercial banks should adopt different modes and channels to select talent according to the personnel structure, institution structure, development needs and cost. While selecting talent, the city commercial bank should consider paper qualifications as well as ability, especially working capability, working attitude, and sense of duty, adhering to the principles of openness, equity, competition and meritocracy. In other words, flexibly selecting and attracting talent in an all-rounded way. While attracting and training high-level professionals, the city commercial bank should also improve the mechanism of encouraging and managing talent. Only in this way, can the city commercial bank attract talents improve the standards of its staff and overall competitiveness.

Strengthen the construction of corporate culture, and establish modern commercial banking management concept step by step By learning from successful company experiences both domestically and abroad, in the long run, company management need not only system management but also corporate culture to guide, encourage and restrict the behavior of staff, and cultivate cohesion and solidarity. To achieve the development goals, the city commercial bank should attach great importance to the corporate culture, should blend the process of cultivating and constructing corporate culture to the development process, cultivate the corporate spirit, forge common values, establish a good corporate brand, and realize the development strategy. Corporate culture is the ultimate target, the value standard, the basic faith and the behavior criterion that has been cultivated and adhered to by the staff during the initial

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and subsequent development. It is the synthesis of theoretic culture, corporate culture and the institutional culture. Thus, the city corporation bank should develop its own culture, forge cohesion and solidarity to adapt to fierce competition. The city commercial bank should implement culture construction according to the following tenets: Firstly, it is the common aim of the staff. With a clear aim in mind, we can strengthen the staff’s positive attitude, initiative, and creativity, allow the staff to relate their work to the realization of the company aim, and transform the bank’s management to everyone’s concrete responsibility. Setting the highest aim is the core of the staff’s cohesion and solidarity, the intensive expression of the company’s common value, the start and the terminus of culture construction. Secondly, establish a strong company spirit. The city commercial bank should intentionally cultivate its personnel’s professionalism, promote understanding of institutional history, traditions, behavior, and cultivate a sense of self-devotion. Thirdly, promote a conducive environment. It includes two aspects: firstly, establishing a favorable communal atmosphere, such as a friendly work environment, an enterprising atmosphere, the pioneering atmosphere. Secondly, it means establishing its very own special atmosphere that is characteristic, outstanding, and exemplary. It is reflected in all the aspects of the bank’s activities. So establishing a corporate culture of excellence is the important precondition and the basic guarantee of the success of Chinese city commercial banks in the future.

Implement scientific innovation, enhance technical levels A successful bank is not only an enterprise rich in funds, but also is a technologyintensive enterprise. In the aspects of management and operations technology, the Chinese city commercial banks must make full use of the latest developments, carrying out technological innovation omni-directionally. Innovate property debt managerial techniques, raise the utilization of capital efficiency and the level of capital profitability; innovate cost management and control technology, improving profitability; innovate risk management technology, lowering risk levels; innovate banking IT and computerization, intellectualized transaction, settlement technology, establishing a more flexible and more convenient bank; innovate customer analysis and management techniques. Through a series of technological innovation, commercial bank’s managerial and administrative expertise and core competitive ability have been enhanced. On the one hand, the commercial bank should establish the idea of giving priority to the high tech and information technology. Making full use of technical resources, engage in research and development ventures in new finance products, such as online services, self-help banks, handset banks, providing omni-directionally, and multi-level “financial supermarket” for customers, deepening the commercial bank penetrability. On the other hand, it should pay special attention to the foundation of network construction, developing and utilizing computerization information technology construction positively, through automation,

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management informationization, and construction of a new financial computerization system. It ceaselessly enhances transaction computerization, the service network, management modernization quality and the construction of a new computerized bank system. Facing arduous overseas bank competition, Chinese city commercial bank needs to enhance its competitiveness through complete systems engineering, not only reform the commercial bank’s internal factors, but also to deal with inhibiting external factors through a reform package, thereby improving the Chinese city commercial bank’s external environment. In summary, while facing more and more intensive market competition, in order to stand firm in the tide of economic globalization and to achieve a competitive advantage, China’s city banking industry should speed up own equity system reform advancement, establish regulatory supervision, galvanize the internal drive, promote a self-development and self-restraint mechanism in line with modern banking standards, so as to meet the requirements of a market economy, and comply with international convention. Be utilitarian and customer-centric, raise managerial and administrative expertise and levels of service innovation. Only in these ways, can Chinese city commercial banks promote their competitiveness and sustainable development comprehensively.

References Dermine, J and YF Bissada (2003). Asset and Liability Management: A Guide to Value Creation and Risk Control. China Financial Publishing House. Huang, Wenshou and Hu Dan (2007). A discussion of China’s commercial banks’ competitive ability. Huabei Finance, 6. Wei, Chunqi and Zhu Feng (2005). Competitiveness of Commercial Banks. China Financial Publishing House. Yang, Gaolin (2004). Innovations in Financial Services of Modern Commercial Banks. China Financial Publishing House. Zhang, Yong, Zhou Qiong and Wang Jing (2006). A research and diagnosis on the competitiveness of China’s commercial banks. Wuhan Finance Monthly, 9.

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City Commercial Bank Strategy in the Light of Financial Sector Liberalization ͣZHEN LIU and XIANGJUN SONG Tsinghua University

M

r. Liu Zhen was born in 1976. He is currently a PhD candidate at the Tsinghua School of Economics and Management, Beijing, majoring in Political Economics. He is also a Vice Secretary-General of Research Center for Public Assets and a member of World Association for Political Economy (WAPE). Mr. Liu’s research interests include: theory of public asset and supervision on national asset, etc. Mr. Liu obtained his Bachelor degree in Engineering in 1999, from the Mechanical Engineering Department of Tsinghua University. He was appointed as an instructing adviser in Students’ Affairs Division in Tsinghua from 1999 to 2001. From 2001 to 2004, he was granted test-exemption entrance to pursue his Masters degree at the School of Economics and Management,Tsinghua University majoring in Finance, under the supervision of Professor Zhu Wuxiang. Since 2004, Mr. Liu has been under the supervision of Professor Wu Dong for his PhD studies.

Released papers • Comparison of National Asset Management Mode and the Application in China, National Asset Management, Vol. 2, 2006. • New Country Construction: Experience from Korea and the Practice in China, Practice and Theory in Special Region, Vol. 4, 2006. • Economics? Mathematics? Reflection on Mathematical Economics, International conference on “Rethinking The Role of Philosophy In The Global Age” (Vietnamese), 2006. • The Constraints of Ideology and the Dilemmas in the Globalization of China’s State-Owned Enterprises, International conference on Chinese Enterprise in Post-WTO Era., NTU, 2006. • On the Development Status of the Newly Arisen Stratums and Their Causes in China. The 2nd forum of the World Association for Political Economy (Japan), 2007.

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r. Song Xiang Jun is from Taipei, Taiwan. In 2005, Mr. Liu began pursuing his PhD inTsinghua School of Economics and Management, Beijing, majoring in Political Economics. His current research interests include: theory of public assets and supervision on national assets, and comparing the two sides of the strait of state-owned enterprises etc. Mr. Song graduated from the SS Department of NCCU, Taiwan in 1999, and obtained his Master degree from China Research Institute of TKU, Taiwan in 2000. He worked in Legislative Yuan in Taiwan as a Congress Assistant, Director Bill; Caring Foundation Executive Director, Corporate Consortium; the Development and Co-operation of Cross-Strait, Vice-Executive Director of the Foundation, Corporate Consortium. Since 2005, he is pursuing his PhD in Economy Department, Tsinghua SEM and majors in economics.

Released papers • “Privatization of public enterprises in Taiwan”, School of Economics and Management of Tsinghua University Doctoral Forum, 2006. • “Study of system units of China”, TKU, 2000 Abstract: With the end of the WTO transition period, China’s financial industry will be fully liberalized. This paper reviews the development of city commercial banks in China and the background behind banking industry liberalization, summing up the challenges and opportunities faced by city commercial banks, as well as the issues pertaining to their inter-regional development, corporate re-organization, market positioning, branding, introduction of foreign strategic investment, and stock listing. A six-part analysis of strategic choices confronting city commercial banks is then presented. Keyword: Commercial banks strategy

With the end of the WTO transition period, foreign finance institutions will be accorded the same treatment as their domestic counterparts. The function of the mechanism of market competition will, therefore, become more apparent. While market competition will be to the foreign banks’ advantage, local banks will be hit adversely, especially the city commercial banks that tend to be smaller in scale (Li and Ming, 2003). The liberalization of the banking industry is a part-and-parcel of China’s opening up reforms. What is the impact on city commercial banks? What are some of the strategies the banks can adopt in response? These are the key points of the thesis.

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Developmental Situation of City Commercial Banks A “city commercial bank” refers to a bank whose businesses are mainly concentrated in an area, and the principal objective of the bank is to provide local services; the bank is built up from the merger of commercialized credit associations, and its capital originates from companies, institutions, citizens, and finance located in the city of its headquarters. It is a local, joint stock commercial bank, an institution with a unified compliance system; the bank is responsible for its own management, decisions, profits, losses, risks, and restrictions. Its characteristics are discussed as follows: 1. It is a joint stock commercial bank that originated from the merger of city credit associations; 2. It is a finance institution that is local in nature. This is embodied at the structure of its capital stock, the distribution of its branches, business activities, and service objectives; 3. Its main clients are small/middle companies and citizens, and provides services to the local economy; 4. It is small in scale (Po, 2005).

History of the city commercial bank The original form of the city commercial bank is that of a city credit association from 1980s. In early 1980s, the collective and private economies form the basis to build up city credit associations. From 1980s to 1990s, the number of city credit associations rose to 3,000, but at that time there existed great risks in these associations. Then, in the middle of 1990s, the central government decided to reform city credit associations, and build up city commercial banks through mergers. In this reform, the local government acquired 25–30% of shares, and the remaining 70–75% shares were owned by companies, mainly non-state-owned companies, as well as individuals. The city commercial bank’s development has experienced two transformations that are discussed below.

The first transformation — city commercial bank rebuilt as city co-operative bank On 7th September 1995, the State Council issued a “Notification on building up city cooperative banks” (State Issues [1995] No. 5); the notification recommended building up the city co-operative banks using the joint-stock system gradually in large and middle cities; the new bank will be based on the withdrawal or merger of the old city credit associations. City enterprises, residents, and local finances can become shareholders; Beijing, Tianjin, Shanghai, and Shenzhen were chosen as the experimental cities. In June 1996, with the approval of the state council, the PBOC (People’s Bank of China) city co-operative bank working committee decided that the system city cooperative banks will extend to 35 large cities and 60 prefecture-level cities. In December 1997, using the earlier developmental framework, the state council authorized another 58 prefecture-level cities, e.g., Dongguan.

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The second transformation — from city co-operative city-to-city commercial bank On 13th March 1998, approved by the state council, PBOC combined with state commercial and industrial administration bureau issued the notice to standardize the nomenclature of city co-operative banks to (name of city) city commercial banks — city commercial bank in short. Up till the end of 2004, there were 113 city commercial banks all over the country; total assets were 1693.8 billion CNY, including loans totaling 904.5 billion CNY; the total liabilities amounted to 1636.1 billion CNY, including all types of deposits totaling 1434.1 billion CNY; realized profits in 2004 was 8.2 billion CNY; owners’ equities amounted to 57.7 billion CNY. By the end of January 2006, the number of city commercial banks increased to 117. Total assets increased from 500 billion to 2 trillion CNY; profits also jumped from 1 billion to nearly 10 billion CNY; bad loans ratio decreased from 34% to below 10%; capital sufficiency ratio emerged from negative territory to 2.7%.1

Existing problems faced by city commercial banks After decades of development, the city commercial banks have grown to a sizeable scale; in some cities, commercial banks have expanded their operations through various means. In September 2004, CBRC (China Banking Regulatory Commission) issued a notice, “Enhance regulation, push ahead reforms, and development of city commercial banks”; the notice mainly emphasized the near-term developmental direction of city commercial banks; it aimed to rein in risk control of high-risk city commercial banks within three years, as well as speeding up the development of higher quality banks. Looking back on the development of the city commercial banks, we found that their existing problems are as follows:

Highly polarized differences between regions In different regions, the city commercial bank is built up from varying numbers of city credit associations; the largest number can be nearly 100, and the smallest consists of only a few associations. Meanwhile, there are large regional variations in economy growth and financing levels. Nowadays, major cities in the eastern region that enjoy rapid growth grows so fast, but those of the west and the middle region are falling behind. As a result, there exists serious polarization within city commercial banks. As of 2003 end, according to statistics, there are two banks whose assets are beyond 100 billion CNY: 14 between 50 billion CNY and 100 billion CNY, 19

1

Speech of Tang Shuang Ning’s on China city commercial bank development forum, January, 2006.

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25,000

20,000

15,000 Amount of Asset

10,000

(Billion CNY)

5,000

0 2001

2002

2003

2004

2005

Figure 1: 2001–2005 Total assets of city commercial banks.

between 10 billion and 20 billion, and 75 below 10 billion. The largest bank owns 193.4 billion; the smallest one owns only 0.911 billion, whereas the largest bank owns 212 times more than the smallest one (China Finance Annual Report, 2003) (Fig. 1). A survey by Financial Research Bureau of the State Research Center of city commercial banks in 20 cities of 3 provinces shows that within four years, from 2000 to 2003, the total assets of city commercial banks have increased 1.58 times in the middle provinces, 2.15 times in the western provinces, and 2.75 times in the eastern provinces. Apparently, the efficiency of the bank’s performance is seriously polarized. Those in the eastern provinces are better than the middle ones, which are in turn better than the western ones. Such differences not only exist in different areas but also in different banks of the some areas; the trend is becoming increasingly stronger.

Low social prestige After the banking reforms, the banks oriented themselves as “the citizen’s bank”, and tried to build up their prestige among citizens, but it seems to have a little effect. The main reason was due to the contagion effect of the Asian Financial Crisis, which originated in Southeast Asia, resulting in the depreciation of currencies, and bankruptcy of banks. All these things made the people to realize the importance of risk control. The Development Bank of Hainan was shut down, and the Guangdong International Entrust Company went bankrupt. Some banks experienced payment crises. These developments led to a doubtful attitude among the citizenry towards the prestige of small and middle finance institutions.

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Small market share If we examine the market structure of China’s state-owned commercial banks, there exists a high degree of monopolization. These banks have a vast network and branches all over the country and a strong capacity in retail businesses. They dominate the commercial banking in China. The trading businesses of city commercial banks are highly restricted; there is no reasonable division of labor with big four state-owned commercial banks; the businesses of the former are highly concentrated in traditional deposits, loans, and collection; intermediary businesses only account for a small proportion. As the big four state-owned banks employ the policy of universal cash saving and withdrawing, most city commercial banks can only operate cash saving and withdrawing in a particular region, thereby losing many potential local clients.

Low-capital sufficiency ratio, and limited channels of capital supply By the end of January 2006, the capital sufficiency ratio of city commercial banks is only 2.7%. Based on CBRC’s notice, “Regulation of Commercial Banks’ Capital Sufficiency Ratio” issued at the beginning of 2004, if the commercial bank’s capital sufficiency ratio cannot attain 8% by the year 2007, it will have to obey stricter regulations. Based on the regulations of the Basel Council, commercial banks can get capital supplies from subsistence profits, enlargement on capital and stock shares, public offering, issuing hypo-bonds, and convertible bonds etc. However, this does not bode well for city commercial banks. By the end of September 2007, only the Beijing Bank, Ningbo Bank, and Nanjing Bank were listed on the stock exchange; most of the city commercial banks experience many difficulties in financing themselves (Table 1). Consequently, most city commercial banks can only depend on subsistence profits, and enlargement on capital and stock shares to get capital supplies. One can imagine that the city commercial banks will be trapped by the problem of “insufficient capital”.

Unreasonable stock property structure, imperfect corporation administration, and weaknesses of internal control and risk management In order to control the local finance risks, when building up the city commercial bank, the requirement of the government is that the local finance should hold about 30% shares, institutions should hold no more than 10%, and an individual should hold no more than 2% of the total capital stock. This resulted in an unreasonable stock property structure: local governments participate in the bank too much; actually, they are in a position of “the biggest and the only stock holder”; capital stock is centralized in the hands of one or several big stock holders; the capital stock holding proportion is very large at state-owned enterprise or state-owned joined stock enterprise, yet the share of private companies, individuals, and foreign stock holders is very small.

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Table 1: Capital stock changes of city commercial banks which are listed on the stock exchange. Proportion of capital stock Data as of

Beijing bank

Nanjing bank

Ningbo bank

19-9-2007 31-12-2005

19-7-2007 30-6-2007

19-7-2007 31-12-2006

Proportion of total capital stock (in %)

100

100

100

100

100

100

Proportion of immobile stock (in %)

—

100

—

100

—

100

Proportion of initiator stock (in %)

—

100

—

100

—

80.6

Proportion of initiator state-owned stock (in %)

—

—

—

—

—

—

Proportion of initiator state stock (in %)

—

15.75

—

27

—

13.17

Proportion of initiator state-owned institution stock (in %)

—

—

—

10.98

—

10.63

Proportion of initiator domestic institution stock (in %)

—

45.56

—

29.96

—

43.94

Proportion of initiator foreign institution stock (in %)

—

24.9

—

24.2

—

12.2

Proportion of initiator natural person stock (in %)

—

13.79

—

7.86

—

0.65

Proportion of Internal staff stock (in %)

—

—

—

—

—

19.4

Proportion of mobile stock (in %)

100

—

100

—

100

—

Proportion of mobile A share (in %)

100

—

100

—

100

—

Proportion of temporary mobile A share (in %)

4.82

—

8.57

—

6.3

—

Proportion of actual mobile A share (in %)

14.45

—

25.72

—

11.7

—

Proportion of restricted sell stock (in %)

80.73

—

65.7

—

82

—

Reason for stock change

Initial public offering

—

Initial public offering

—

Initial public offering

—

(Source: http://www.cnlist.com/GSZL/ssgs.)

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Unclear market orientation, lacking in distinct business features The orientation of city commercial banks is always to “provide services to local economy, small and middle enterprises, and citizens” from the beginning. But actually many of the banks embark on the strategy of following the market; their businesses are no different from the big banks, so, they have no distinctive business features; the businesses are unable to enhance their advantages and avoid their disadvantages.

Lacking in product differentiation, low level of science and technology, and weakness in innovation capacities For a long time, most of the city commercial bank’s product variety is unchanged from the credit association era; when compared to state-owned banks and stock commercial banks, there are still large gaps. Firstly, the lack of production variety, for example, at the level of corporation finance businesses. There are only three types including deposit, loan, and clearing; but in stock commercial bank, they can provide overdraft, finance supply chain, off-shore business, and corporate cash management etc. Secondly, the low level of science and technology; this is manifested in hightech products such as banking card, electronic banking, individual cash management, and web banking etc. Take web banking as an example, where city commercial banks’ web bank can only perform some simple functions such as inquiry, transfer, and payment, but for the joint stock commercial bank, it can handle more complicated functions such as loan, purchase and foreign exchange, cash management, and web clearing center. Lastly, the weakness of innovation capacity. Restricted by the level of technology and quality of human resources, city commercial bank’s capacity for innovation is lower than joint stock commercial banks; if this situation remains, the city commercial bank will find it hard to develop. To sum up, although the city commercial bank has made much progress since its formation, but for in terms of system and policy, there still exist many problems, especially since China’s entry into WTO, the traditional structure of the banking industry had been broken up, the primary issue is how the development of the commercial banks can be sustained under these circumstances.

Background of Bank Sector Liberalization There has been a great change in China’s banking industry from 2002 to 2006. On 11th December 2001, China joined the WTO and promised that after two years, foreign banks which are granted licenses can do businesses in the CNY currency. After five

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years, China will open up the banking industry in phases, but will still restrict the stock ownership, regions, and areas of business for foreign banks.2

History of China’s banking liberalization During the five years transition period, China kept its promises, pushing through banking industry liberalization gradually and in an orderly fashion. In response, foreign banks accelerated their development. Five years after China’s entry into WTO, the number of foreign bank’s business institutions increased from 190 to 312, or a net 122 after correcting for merged banks. In this period, the main liberalization measures are as follows: Implement earlier commitments tied to WTO entry. From the day China joined WTO, all foreign currency businesses were opened up for foreign banks; the regions for the CNY business were enlarged from Shanghai, Shenzhen, Tianjin, and Dalian to all over the countries gradually; enlarged the clients type from foreign institutions and foreigners to the Chinese enterprises and Chinese citizens gradually. While loosening restrictions to foreign banks, the restriction that foreign banks’ liabilities of CNY cannot exceed 50% of liabilities in foreign currencies was canceled; loosened the restriction of the proportion of deposit obtained from domestic clients; canceled imprudence restrictions of foreign banks’ operations in China, gradually according to foreign banks, the same treatment as local banks.

Current status of the opening up of China’s banking sector By the end of December 2006, 14 sole foreign-owned and joint capital banking institutions were registered in China, and setting up 19 branches and subsidiaries; the foreign banks of 22 countries and regions set up 200 branches and sub-branches in China’s 25 cities; 186 foreign banks of 42 countries and regions set up 242 representative offices in 24 cities of China. Amongst the institutions of a commercial nature, there are 168 Asian ones, accounting for 54%, including 102 from Hong Kong, 19 from Japan, 17 from Singapore; there are 77 European institutions, accounting for 25%, including 21 British and 15 French; there are 32 North-American institutions, accounting for 10%, including 26 American, and 6 Canada; in terms of the regional distribution, 100 foreign banks were set up in Shanghai, accounting for 32%; 40 in Shenzhen, accounting for 13%; 37 in Beijng, accounting for 12%; 28 in Guangzhou, accounting for 9%; 17 in Tianjin, accounting for 5%; 16 in Xiamen, accounting for 5%; 74 in various others, accounting for 24% (Fig. 2). In recent years, foreign banks have quickened their development in middle, west, and north-east regions, setting up 30 commercial institutions in these regions, accounting for 10% of all foreign banking institutions. According to China’s regulations, foreign bank’s branch, sole capital bank, and joined capital bank are commercial institutions, after authorization 2

Schedule of China finance industry opening after entry into WTO, economic observe journal, weipu information http://www.cqvip.com.

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East China South China North China Middle China South West China North East China

Figure 2: Distributing proportion of foreign banks by region. (Source: http://www.pay4.cn)

they can perform businesses such as deposit, loan, clearing, trusts, and insurance etc. They can also apply for the right to do CNY businesses if they are qualified in terms of opening timings, the status of profits, and prudent operation. In the meantime, China encourages finance innovation in the foreign banks, permits foreign banks to engage in finance derivative products, Qualified Foreign Institutional Investors (QFII) security businesses, private cash management, off-shore businesses, web bank, and so on, multiplying the products and services of foreign banks. By the end of December 2006, foreign banks are involved in more than 100 types of products; 115 foreign banks are permitted to engage in CNY businesses. The total assets of foreign banks in China come close to 103.3 billion USD, accounting for 1.8% of China’s total banking assets. The composition of assets are as follows: 39.7 billion USD in all deposits, 61.6 billion USD in loans, 67.6 billion USD in foreign exchanges, 17.8 billion USD in deposits, 35.9 billion USD in loans, 278.8 billion CNY in assets, 170.6 billion USD in deposits, and 200.3 billion CNY in loans.

Impact on City Commercial Banks from Finance Industry Liberalization In the 20th century, China’s commercial bank system can be divided into three parts: state-owned banks taking up most of the market shares, namely those involving state credit and state organizational networks; joint stock commercial banks constitute the domestic middle market, especially that of the young, in part due to their technological sophistication and superior services; city commercial banks take up the market shares of the small and middle-sized companies, in virtue of their local expertise, delivering niche services for small and middle enterprises. But having entered into the 21st century, especially since the WTO entry, the market share has changed; a new system of commercial banks is forming as a result of the following developments: 1. Successful reform of state-owned banks; 2. Formation of a new joint stock commercial bank; take Bohai bank and Zhejiang commercial bank as examples;

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3. Transformation of rural credit associations into co-operative commercial banks, an experiment involving eight provinces; 4. Setting up of China post saving bank and 5. Entry of foreign banks such as Citibank and HSBC, setting up branches, or investing in Chinese banks.

Negative impact on commercial banks Firstly, market share of city commercial banks will be affected. City commercial banks are mainly located in large and middle cities; foreign banks are also setting up their offices at large and middle cities, resulting in an overlap. In recent years, the high performance of city commercial banks lies in their centralized business around the central cities, but after the entry of foreign banks, their profit will be decreased. Target clients of city commercial banks are small and middle enterprises, but due to the foreign banks’ abundant funds, advanced technology, and good services, they will attract some basic clients of city commercial banks — the high-quality small and middle enterprises. According to the WTO agreement, foreign banks will obtain licenses to operate CNY businesses; it is predicted that the market share of foreign banks’ foreign currency deposits and CNY deposits will be increased to around 15% and 10%, the market share of foreign banks’ foreign currency loans will exceed by one third, and the share for CNY loans will reach 15%, hence the share of city commercial banks will be decreased. The most important impact on the Chinese commercial banks is the foreign bank’s strategy of client resource exploitation; this will result in an intense competition. At present, many Chinese commercial banks’ clients are being eyed by foreign banks, even listed as the clients they want to have in the medium and long-run. The plan of the foreign banks is based on the action of its business and product strategy. They try to maximize technological developments and innovation, in order to market the clients of Chinese commercial banks. Therefore, if the Chinese commercial banks were to retain their clients, they should upkeep the relationships they already have. Besides, they need to satisfy the needs of their clients through innovation on finance businesses and products. Meanwhile, after the entry of foreign banks into China, their exploitation of regions have an impressive impact on the Chinese commercial banks too. In the cities, the foreign bank is a big competitor to the Chinese commercial banks, whereas in less-developed areas, foreign bank’s impact may be limited, but they will enlarge their influence and lay foundations for the future. In time, city commercial banks’ profit share will be decreased sharply. Foreign banks will erode the funding resources of the Chinese commercial banks in a short time; Chinese commercial bank’s income of net interest and capacity of operation will be decreased, especially due to the internal weaknesses and their lower quality. Already saddled with huge bad assets, if foreign banks were to expand their scale and absorb more foreign currency and CNY deposits, they will have some serious impact.

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Besides, city commercial banks will lose its clients. At present, the system of city commercial bank leaves much to be desired; the quality of staff is low, and lacking in talent. Foreign banks’ favorable reward system, flexible distribution mechanism, and meritocratic talent mechanism will attract talent away from the city commercial banks.

Positive impact on commercial banks Where there is a challenge, there lies opportunities; thereby fully opening up domestic finance market accords, some positive impacts too; the competition has forced city commercial banks to speed up their efforts at reforms and innovation; it is positive for city commercial banks’ development in the following ways:

Push Chinese commercial bank into accelerating reforms and innovation In order to solve the problems pervading China’s finance reforms, such as low efficiency of city commercial banks, which cannot be solved by internal reforms, it is a good thing to introduce an external strategic investment. In the long run, the structure of China’s finance market will undergo profound changes. The monopolization of the state-owned economy in finance market will be broken up; the trend of finance property pluralism will be more obvious; this kind of structure will enhance the market performance, and has a Pareto improvement effect. In response to the pressure of competition from foreign banks, domestic banks will accelerate its reforms. Meanwhile, most multi-national banks have a long history and abundant experience of management. They know the symmetrical relations between risk and income, the method of controling risks while earning an expenditure income, the strategy of business development, the promotion of finance, localization of talent, and the way of asset management. They have the successful experience and measurement to solve the problems of bad assets. After liberalization policy, Chinese commercial banks should be propelled to learn from the foreign banks and to improve their own management techniques (Table 2).

Push Chinese commercial banks to enhance client resource management Client strategy is very important to the Chinese commercial banks’ core competitive strength. There are two points pertaining to foreign banks’ impacts on the Chinese commercial banks’ client management: one is paying more attention to its client resource. Traditional finance services industry always pay more attention to their assets and productions, but not the clients. In fact, clients are the most important and most efficient assets; the concept of client will be more and more important in information age. In order to survive the new environment, city commercial banks must adjust their strategy. As today’s clients

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Table 2: Details on foreign banks involvement in joint-stock city commercial banks. Institution name

Shanghai bank

Time of joint stock

Joint-stock company

Amount of joint stock

Proportion of joint stock (in %)

September 1999

CICC

0.2 billion CNY

5%

HSBC

62.60 million USD

8%

Hong Kong Shanghai commercial bank

0.195 billion CNY

3%

December 2001

CICC

25 million USD

2%

CICC

53.76 million CNY (Initial pay)

1%a

Xi An commercial bank

September 2002

Nanjing commercial bank

November 2001

CICC

27 million USD

15%

October 2005

Paris bank

0.704 billion CNY

19.2%b

Jinan commercial bank

November 2004

Commonwealth Bank of Australia

17 million USD

11%

March 2005

Internationale Nederlanden Groep N.V

1.78 billion CNY

19.9%

April 2005

CICC

0.447 billion CNY

5%

Hangzhou commercial bank

September 2005

Commonwealth Bank of Australia

0.625 billion CNY

19.9%

Tianjing commercial bank

December 2005

Australia and New Zealand Banking Group Limited, ANZ

0.11 billion USD

19.99%

Beijing bank

Scotia bank

4%

Source: Newspapers Report and China Annual Statistic Report, 2001–2006. a In the future, four years proportion of joint stocks will be increased to 24.9%. CICC and Scotiabank will hold 12.5% and 12.4%, share each. b This time 19.2% is held by Paris bank in Nanjing commercial bank, including 10% from CICC, others 9.2% provided by other shareholders, the transfer price is 3.04 CNY, after transformation, the share of CICC will be decreased to 5%.

are becoming more mature, they require finance products and services that can satisfy their needs and life-style. They want to have different channels to connect to the bank at any time or any place. Only by satisfying the client’s needs, the banks can survive. The second point is the adoption of new, advanced technological methodologies. Customer Relations Management (CRM) can connect client information and management tools with technology very tightly, integrating client needs, product development, extent of reach, and services all-in-one, thus resulting in changing modes of banking services, in line with the profound understanding that a bank’s success depends on the needs of the clients. Only through better understanding of its client, a bank can set the right product at right price, using the right channel at the right time. The extent of finance competition and development of finance information will promote the concept of integration finance at the expense of the concept of specialization.

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China’s city commercial banks will improve their service levels through learning from foreign banks’ client service strategy and gain strength in long-time competition; in sum, this is the positive impact.

Push Chinese commercial banks’ product innovation and developments in technology Due to the intense competition of the foreign banks in China, new finance products such as various finance options, currency exchange, and floating interest loan will be introduced to the market. Foreign banks’ businesses are concentrated in high value-added businesses, cross-border businesses, retail businesses, financial derivative businesses, investment, and cash management businesses. These businesses always need an abundant operation experience, but those are the weaknesses of domestic banks. In corporate banking, a foreign bank starts from the needs of corporate clients, develop some convenient finance products for clients, for example, the products of cash management to improve group enterprise funds-operating efficiency, and the products of receivable buyout to improve the financial structure, and the products of combination derivation products to avoid the exchange risk and to improve funds using efficiency. Besides, foreign banks utilize Internet banking as an avenue to overcome the restriction of networks and regions, and attract better quality clients. Thirteen banks, such as Citibank, HSBC, EAB, DB etc., have already obtained permission to operate web-based banks. All these finance products will surely push the city commercial banks to learn from them and speed up finance innovation.

Push Chinese commercial banks to pay more attention to talent management The fight for talent between foreign banks and Chinese commercial banks will become more intense. As a first step, the foreign bank uses the strategy of talented people localization at the point of set-up and rapid growth. They offer higher salaries, the chance of training abroad, good positions and welfare and good working conditions to attract the middle and high-level managers from Chinese commercial banks. On the contrary, limited by the system and policies, domestic banks cannot match these favorable terms, hence losing talented people; this constitutes another source of pressure on domestic banks. By attracting China’s banking elites and speeding up localization, foreign banks integrate into China’s banking industry immediately. Therefore, Chinese commercial banks should change their traditional thoughts of how to manage people, re-focus on the need to manage talent, pay more attention to training, consolidating salary, position, and the incentives system. Try to retain people, attract people, establish the system of survival of the fittest, and enhance the efficiency of the people. Chinese commercial banks should embark on the flexible policies to win the hearts and minds of their staff.

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Push Chinese commercial banks’ mixed businesses, speed up the development of intermediary services Due to the vast advancement of information technologies, mixed businesses have now become the trend of the finance industry. After the opening up of domestic finance, there will be more foreign banks and finance institutions entering into China; mixed management is one of their strengths. So, Chinese commercial banks must adapt to this new wave of advancement in technology; besides their traditional businesses, they must offer more products that are value-added and of higher information content. Credit businesses must be decreased in favor of such service products, especially the high value-added ones; meanwhile, we must pay more attention to assets structure and income-structure adjustment. It is a useful way to modify Chinese commercial banks’ income structure by speeding up the development of intermediary services. At present, compared to foreign banks, Chinese commercial banks are still lagging behind in the realm of intermediary services. But foreign banks’ intermediary services developed very fast in China, for example, the Shanghai branch of HSBC is permitted to do commission insurance businesses; before that, the Guangzhou branch of EAB has already entered into the area of commission insurance businesses; word has it that SCB and Citibank want to enter the market too. Foreign banks are also eyeing the credit card market, for example, ABN Amro will issue their own bank cards in the China market; by the end of 2006, foreign banks would have obtained permission to issue their own cards, there will be another impact on Chinese commercial bank, therefore, Chinese commercial banks must pay more attention to, and speed up their developments in intermediary services (Hubei city Finance Organization programme team, 2006).

City Commercial Banks: A Strategic Choice As can be seen from the above analysis, financial liberalization presents both challenges and opportunities for China’s city commercial banks. With domestic financial markets being fully open, coupled with trends in financial globalization, the future of the city commercial banks are fraught with uncertainties. Potential risks are ever-increasing. In addition, the city commercial banks lack capital strength, as well as risk hedging abilities as compared with foreign banks. In such circumstances, what strategies ought to be undertaken? City commercial banks will have to increase their core competitiveness and abilities to handle risks. In this light, we believe that the city commercial banks should implement the following development strategies:

Inter-regional development strategy The city commercial banks with superior operating conditions, stronger management capabilities, better corporate governance structure could opt to implement crossregional development strategies. These city commercial banks should at least be of

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a medium-size city commercial banks, hail from the cities with strong economies. Such examples include the Beijing Bank, Shanghai Bank, and the Commercial bank of Nanjing. Since the inception of city commercial banks, their business scope has been limited to a single city. Such a geographical limitation inhibits risk spreading, and is not conducive to the optimal allocation of financial resources in order to create a fair, competitive financial environment, neither is it conducive to business nor to product innovation. On the other hand, China’s regional economic development needs a regional bank to meet the local demand for banking services. Banks operating in a single city will not be able to adapt to the fierce market competition. Therefore, city commercial banks ought to implement cross-regional development strategies. There are three ways to implement regionalization: through the acquisition approach, self-development approach, and joint development approach. Acquisition is the purchase of other city commercial banks. This approach is suitable for banks endowed with considerable resources. Through the acquisition of other banks, duplication of expensive technology spending can be reduced, cost savings can be made, and competitors are eliminated. The self-development approach refers to the city commercial bank’s dependence on their own capital accumulation to set up branches in other areas, expanding the scale of business. Due to their heavy reliance on local governments and local enterprises, this move is not the best choice for the city commercial banks, because on one hand they have to rely on their own and achieve economies of scale, thus making it very difficult to expand, often taking a long time; on the other hand, a scattered structure dilutes human and material resources. An alternative could be the formation of provincial groupings of city commercial banks; and in turn establishing cross-provincial groupings, for instance, the North China, East China, Southern China regions, and so on, or even forming national commercial bank groupings. Recently, Shandong, Jiangsu etc., formed provincial groupings of the city commercial banks. City commercial banks should adhere to the following principles in choosing their own development path: profit maximization, and minimizing costs, the latter should be at least compensated by future revenues. A notable example is that of the Shanghai Bank, which has embarked on a successful regionalization strategy.

Development of inter-regional strategic choice: the district strategic advantage In 2004, the Bank of Shanghai embarked on a set of comprehensive cross-regional business development strategies, namely, cashing in on its strategic locational advantages. The geographical advantage of the so-called strategy is the exploitation of the areas around Shanghai, that of the Yangtze River Delta, and the surrounding areas. Bank of Shanghai attempted to understand better the situation in the region and the market, and provides more suitable services to meet the needs of the financial services market, and gain a

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competitive edge. In its regional distribution, the Bank of Shanghai promoted regional economic integration, utilized the strategy of diversification of services to accelerate the development of the Yangtze river delta region, expanding service networks, at appropriate times, gaining access to the regional Bohai Rim and the Pearl river delta region.

Model of inter-regional development: taking the road of diversified development First of all, the Bank of Shanghai has set up remote branches, expanded its service network, and strengthened its financial service functions. Since 2002, it started to expand toward some cities in the Yangtze river delta through setting up remote offices to achieve feasible inter-regional development. Shanghai shares a strong complementarity and synergy with Ningbo. In Ningbo, it set up branches in promoting inter-regional development and expanded service networks. Secondly, acquiring shares of other city commercial banks improved its overall competitiveness, and enhanced its ability to manage risks. In recent years, Shanghai banks adhered to the market-oriented principles; through cross-shareholding practices, expanded into cities in the Yangtze river delta. It increased its capital base through mergers with other city commercial banks; its successful integration and sharing of resources through such mergers prompted others to study its achievements.

Re-organization strategy The four major state-owned banks relied on their national networks to retain their market share. The joint-stock commercial banks, however, relied on their technologies and institutional strengths to expand nationwide. As for the foreign banks, they relied on providing a wide array of quality products and services to develop their customer bases among the urban high-end clients. Under such circumstances, the city commercial banks embarked on the strategy of regional groupings to enhance the complementarity and the overall competitiveness. The joint restructuring of the city commercial banks should give full consideration to the particularities of the various banks in terms of asset size and quality, profitability and capital adequacy rate, and the reality of unbalanced development, in the light of its own actual conditions, careful analysis of the macro-economic environment, in accordance with pre-established banking development strategy, thereby, selecting the best mode of the joint re-organization to improve their core competitiveness. The two main modes of joint re-organization are: mergers as well as joint business operations. In 28 December 2005, the first regional merger of city commercial banks took place, forming the Commercial Bank of Huizhou, consisting of the following banks: Wuhu in Anhui Province, Ma’anshan, Anqing, Huaibei, five Bengbu city commercial banks and Liuan, Huainan, Tongling, Fuyang technology, Fuyang Xin Ying, Fuyang Galaxy, seven

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urban credit co-operatives from Fuyang. Based on the estimates of their original assets, stocks of the new bank were awarded to the constituent banks. The original name was that of Hefei Commercial Bank, but in order to avoid a “Hefei-centric” impression, it was re-named the Commercial Bank of Huizhou.

Market positioning strategy Commercial banks in the West frequently use the “CAP” model description and analysis of market positioning. That is, banks according to their own characteristics, select the best mix of the customer (client), area of competition (area), as well as the product (product). To the city commercial banks, its market positioning focuses on its core banking businesses or products, as well as the major customers, the area of competition, in order to achieve the most optimal allocation of the financial resources. China’s city commercial banks ought to target the urban residents and the SMEs; their products ought to serve the retail needs; their focus ought to be local in nature, while exploring the regional operations, keeping the following pointers in mind:

Based on the local economies, as well as cross-regional development where conditions are ripe In many cities, the city commercial banks are the most competitive local banks. Many city commercial banks operate only in a single city, but their rate of return on capital, and other business indicators are quite good, take for example, Beijing Bank and the Bank of Shanghai. In Wuhan, Wuhan city commercial bank is the most popular. This is a huge intangible asset for the city commercial banks. Since its formation, the city commercial banks focused on serving the residents, the SMEs and the local economies, though some are still wavering in their market positioning. The key of commercial banks lies accurately in identifying their positioning, so as to grasp the right development strategy, maximizing the capital resources, so as to achieve the fastest development.

Positioning for the SMEs SMEs are prospering under the market economy, their demand for financial services are becoming increasingly diverse. The city commercial banks, due to their localization of employees, have a close relationship with the local customers and are familiar with the customer’s credit and operational conditions, and monitoring the local SMEs, as compared with the large state-owned banks. With lower transaction costs, they are able to avoid problems related to “information asymmetry” arising from adverse selection and moral hazard problems, they can improve the security of loans and the efficiency of services provided. In addition, since the city commercial banks are flexible in their decision-making mechanisms, they can better meet the financing needs of the SMEs; the

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two sides can reduce costs and add value; city commercial banks when positioned for the SMEs have a comparative advantage.

Positioned for local communities Due to the geographical advantages, the city commercial banks are closer to the local communities as compared to the larger banks. The statistics show that 68% of the households use local banks as their main financial services provider. However, owing to the limited resources, the city commercial banks should, based on the market analysis, focus on low risks, high-return clientele, in particular, on local residents with stable incomes as well as the rising middle class.

Positioning for the retail business Changes in the social wealth structure, consumption patterns, and rising incomes meant great opportunities for China’s city commercial banks in providing all-rounded retail services for the individuals and the families. For a long time, the city commercial banks neglected the retail business, leading to an irrational operational structure, high volatility in their finances, as well as higher costs. In the past one or two decades, many in the Western world’s banking business began to shift to the retail business, some are already accounted for 50% of the overall business, or even 70%. Although retail businesses are piecemeal, each of the income may be relatively small, but they are small in risks, yet high in profit margins. Broadly speaking, the retail business includes wealth management as well as retail services. The development of individual retail businesses requires the need to adjust the bank’s structure, so as to meet the rising needs of China’s increasingly affluent population.

Brand Strategy Branding is an overall manifestation of competitiveness. The competitiveness of the products and the competitiveness of enterprises ultimately depend on the performance of the brand competitiveness. Brand is not only about the performance of the individual products but also about how the product is distinguished from other similar products; it is a guarantee on product quality and corporate reputation. Brand strategy in most people’s impression seems to be important only in the industrial and commercial enterprises, in fact, in the financial enterprises (such as commercial banks) it is similarly important. Moreover, the future of the financial sector depends more on the brand strategy, more important than the commercial sector. In an increasingly competitive environment, the financial industry will lose the protection barriers under the conditions of financial enterprises, as survival and development are increasingly dependent on the characteristics of its own operations. Having well-known financial brands, financial institutions can better utilize the financial resources, expand

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market share, and maintain sustained and stable development. Therefore, if the financial enterprises were to have a place in the future, it has to learn from today’s industrial and commercial enterprises in their brand strategies. For the city commercial banks, the brands can overcome market constraints especially in the development of personal financial businesses. It is therefore necessary to promote brands, and market financial products within the framework of regional consumer trust, and promoting the infiltration and business development; at the same time we should closely focus on the brand’s core values in promotion and publicity, to build a positive brand, and promote a clear corporate image.

The introduction of foreign strategic investors In the new round of financial reforms, in order to increase their investment in the development of a number of relatively good or fairly ambitious city commercial banks, the international strategic investors have to play a clear role. Clearly, in the present circumstances, the introduction of the foreign strategic investors is an effective source of capital for the city commercial banks. The introduction of strategic investors in the development of city commercial banks brings forth many benefits:

The introduction of overseas funds increases a bank’s capital The introduction of the foreign strategic investors has opened up a new channel of additional capital to raise the bank’s capital adequacy ratio to a significant degree. It is a first step towards the more strategic co-operation that can accrue benefits such as the import of technology and know-how.

Increase the public credibility of the banks At present, the visibility and the credibility of most of the city commercial banks are not high. The foreign strategic investors are usually relatively well-known outstanding banks; the city commercial banks can thus improve their credibility..

Improve the corporate governance structure After the introduction of the foreign capital, the presence of foreign directors on the board can help to the improve the corporate governance.

Introduction of advanced management experience Foreign banks have rich management experience; this goes some way in strengthening the risk management capabilities of the domestic banks.

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Introduction of new financial products The domestic banks can improve the technological innovation and business innovation. The foreign banks are keen competitors in the long-term environment, and have a strong ability to innovate. The introduction of the foreign strategic investors enriches the domestic banking business by increasing the product varieties and improving the ability to innovate.

More conducive for worker training Co-operation with the foreign banks can improve worker’s training. At present, many domestic commercial banks in the city with overseas strategic investors have agreements to provide training for Chinese staff.

Listing strategies The city commercial banks are facing unprecedented pressures. Stock listing can provide supplementary capital, improve corporate governance structure, and enhance the bank’s ability to withstand risks, and improve their competitiveness. After the impressive performance in the stock markets of 2004, the Securities Commission stated that in 2005, it will accelerate the implementation of the “Nine Point National Plan”; this bodes well for the stock market. The commercial banks that are already listed in the stock market have also performed well. Conditions are, therefore, favorable to the city commercial banks to be listed. Listing can add capital to the banks; establishing a good supplementary capital mechanism is conducive to banks to improve risk management capacities and to facilitate expansion. At present, China’s commercial banks supplementary capital funds rate is generally low, capital complementary mechanisms are also very incomplete. The city commercial banks, increase their investments mostly through retained earnings, dividends to shareholders to inject some additional capital, and other channels. They are limited not only by their own operating conditions restrictions but also by the stringent regulatory authorities. In this way, commercial banks in accordance with their own development can access timely supplementary capital, particularly after more intense competition, since the imposition of WTO entry requirements. Therefore, if the city commercial banks wish to raise their capital adequacy ratio to expand scale and increase their strength, public offering is the most effective way. Faced with these development strategies and reform measures, the city commercial banks should find out what is most suitable for their own development path. These strategic options are not mutually exclusive. First of all, a bank can choose change transformation, and then expansion to other cities, or find strategic partners. The strategic investors can assist through external reforms and external expansion.

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China’s city commercial banks need to adapt to an appropriate pace of development in dealing with their problems. Banking reform and development is an arduous process. The banks need to be cognizant of their business competitiveness, map out developmental strategies, instill a conducive culture, formulate relevant policies and systems, establish a flat management, optimize business processes, focus on staff training, improve their technical infrastructure and applications, and supporting the corporate strategy and business development. In the backdrop of the full-fledged financial liberalization, it is imperative for the city commercial banks to re-align themselves according to their uniqueness and strengths, and choose strategies suitable to their unique situations. In the next few years, with the entry of foreign banks into the local market on a full scale, the city commercial banks will face a rare opportunity to develop beyond their regional operations. Therefore, the city commercial banks ought to seize this decisive opportunity and develop themselves, so that they may survive the ensuing all-out market competition.

References China Banking Industry Report, CBRC, March 2006. China Finance Annual Report, 2003. Hubei city finance organization programme team, research on the impacts to commercial bank of domestic finance market fully opening in 2006, special topic research, http://www.enki.net. Li, Z and DZ Ming (2003). Competitive Strength and Development of Middle and Small Commercial Banks, 1st Ed. China Society Science Press (December 2003). Po, CJ (2005a). Research on the development problem of China’s city commercial bank, Masters thesis. Zhang Zhou University. Po, CJ, (2005b). Research on the development problem of China’s city commercial bank, Masters thesis. Zheng Zhou University. Schedule of China finance industry opening after entry into WTO. Economic observe Journal, Weipu information, http://www.cqvip.com. Shen, YB. What should commercial banks do to confront the environment of finance integration? Changing Business Circles Magazine, www.shangjie.com.cn.

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Session 3

From “Made in China” to “Designed in China”

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Analysis of Trends in China’s Venture Capital Industry ͣZHENGPING FU and BINBIN LI Sun Yat-Sen University

P

rofessor Fu Zhengping is the Associate Dean of School of Business and Professor of Department of Business Administration, Sun Yat-Sen University. He obtained his Bachelor Degree of Engineering, majoring in Industrial Management Engineering, from Tianjin University in 1988. He studied in Nankai University for his Master of Economics (major in World Economics) from 1988 to 1991. Prof. Fu also joined Sino-Canadian MBA program in International Business at Nankai University from 1988 to 1990. He was awarded PhD in Economics by Beijing Normal University in 2002. Professor Fu joined Sun Yat-Sen University as a teaching assistant in the Department of Business Administration in 1991. From 1999 to 2002, Prof. Fu studied in Erasmus University, Rotterdam. He was the Head of Business Administration Department. In 2004, he was appointed the Director of Entrepreneurship Center of Sun Yat-Sen University. Prof. Fu has been a member of the Academy of International Business since 2006. He is also a Vice-Chairman of expert commission, the Association of Entrepreneurs of Guangdong Province since 2004 and also the standing member of the Association of Quality Management of Guangdong Province since 2002. Professor Fu focuses his teaching on International Business Administration Strategic Management, Growth of SME, etc. Professor Fu published various papers, including “The Dynamics of Small and Medium-Sized Enterprise Clusters in China”,“The Upgrading Strategies of Industrial Clusters in China”, “The innovation Capacity and Creativity of Industrial Clusters”, “Enterprise Network and Cluster Competitiveness under Collective and Private Property Right” etc. He also published one textbook named International Business Administration (Renmin University Press). Professor Fu has also led and participated in various research programs such as An Investigation of Co-operative Behavior in Industrial Clusters in China; National Natural Science

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Foundation of China (NSFC) (2005),Factors in Determining Location Choice of R&D Investment by Multinational corporations, Soft Science Foundation (2003),The Creation Conditions of Industrial Clusters in China, Social Science Foundation, Ministry of Education (2002), and The Emergence and Growth Mechanism of Small and Medium-sized Enterprise Clusters in China from NSFC (2000), etc.

M

r. Li Binbin is currently pursuing his Masters degree at Sun Yat-Sen University’s School of Business, majoring in Industry Organization. In 2007, Mr. Li graduated from Zhongnan University of Economics and Law with a Bachelor of Management, as one of the top ten students of his class. He is active in many extracurricular activities and has also won many honors for his leadership skills. Mr. Li is fluent in English, Mandarin and Cantonese, with also basic knowledge of French, having participated in a 650hour program organized by the Embassy of France.

Abstract: China’s venture capital industry is merely 20 years old. Compared to its foreign counterparts, it is still in its infancy. First of all, this article discerns key features of China’s venture capital industry in recent years, including the different types of venture capital firms, venture capital investment scale, industry and regional distribution, the choice of investment project stages, and exit channels. In addition, it undertakes a comparative analysis with foreign joint venture capital companies. Secondly, it describes new developments in the legal and policy environment of China’s venture capital industry. Keywords: China venture capital industry; Trend analysis; Policy environment

Background In China, venture capital (VC) and startup investment refer to similar activities in practice. Although, there is a difference in the Chinese translation, the two words are of the same nature (Liu, 1998). Venture capital is well known as an important incubator and catalyst of high-tech industrialization nowadays. The State Development and Reform Commission (SDRC) and other 10 ministries On 14th November 2005, jointly issued the document — “Interim Measures for the Administration of Startup Investment Enterprises”. Based on article 2, the term “startup investment”, as mentioned in the preceding paragraph, refers to any stock right investments that are injected into a startup enterprise in expectation of capital gains mainly by way of stock right transfer after the invested startup enterprise becomes mature or relatively mature. The development of startup investment reflects the spirit of innovation, technical level, and the level of professional management of a country or a region.

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Over the past 20 years, China’s VC industry is driven by government-led industrialization of science and technology policy, and by the commercial sector, which is undergoing a gradual evolution in a transition phase (White et al.), (2005). The Central Committee of the Communist Party of China (CPC) on 1st January 1985 released the document — “the Decision on the Reform of the Science and Technology Management System”. The document stated the following guiding principle that: “In our rapidly changing, high-tech and high-risk development work, support can be given to the establishment of venture capital.” In 1998, the China National Democratic Construction Association (CNDCA) raised the proposal during the inaugural meeting of the 9th Chinese People’s Political Consultative Conference (CPPCC) National Committee — “Several Opinions on Accelerating the Development of Our country’s Venture Capital Enterprises”, also known as the “first proposal”. The SDRC and other 10 ministries on 14th November 2005, jointly issued the document — “Interim Measures for the Administration of Startup Investment Enterprises”. In early 2007, for the first supporting policies of “Interim Measures for the Administration of Startup Investment Enterprises”, the Ministry of Finance and State Administration of Taxation jointly issued the “Relevant Tax Policies on the Development of Startup Investment Enterprises”. In retrospect, China’s VC industry is in its 22nd year of development and has achieved a lot. In 2006, the total amount of VC ranged from 60 billion to 70 billion. The number of domestic VC organizations was around 400. Data from China Venture Capital Yearbook 2006, showed that local and foreign VC institutions accounted for 76% and respectively 24%.1 The local VC institutions are divided into local government-controlled institutions, government equity participation institutions, and non-governmental institutions. Government background institutions accounted for 54.6% and the context of non-governmental organizations accounted for 45.4%. (See Fig. 1 — 2005 local VC institutions by type of

35.4%

45.4% 19.2%

goverment-controlled goverment equity participation non-governmental

Figure 1: 2005 local VC institutions by type of distribution. 1

Based on the data from China Venture Capital Yearbook 2006, the distinction between local VC institutions and foreign VC institutions depends on whether foreign capital is injected to the institutions. For example, the joint institutions are classified as foreign institutions.

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distribution). By the form of organizations, the limited liability company was the dominant form in the sample, accounting for 79%, followed by 9% for joint-stock company form, and the partnership form constituted only 5%. The proportion of other types is 7%. This paper attempts to analyze the trends of China’s VC industry, including the supply of China’s VC investment, the effective demand, the exit form, and the corresponding laws, regulations and policies system. It then aims to obtain a panoramic description of the overall picture of China’s VC investment environment and policies evolution.

Analysis of the current situation According to incomplete statistics, there are about more than 400 VC organizations, but only around 200 are truly active. Data from “China Venture” shows that, from January 2007 to September, VC market scale reached 1.8 billion US $, or 14 billion RMB. The number basically equals the data of 2006. China’s VC market size is expected to exceed 2.5 billion US $ at the end of 2007, and a year-on-year increase of more than 50%.2

Fundraising situation China’s fundraising market scale is enjoying a rapid and steady growth. The gap between local and foreign organization is diminishing. With “China Venture Capital Yearbook 2003–2007” and related media coverage statistics,3 new fundraising capital scale reached at least 24.085 billion RMB in 2006, which is 6.5 times that of the same period in the survey data of 2003. (See Fig. 2 2003–2006 the total amount of new fundraising capital (Unit: 0.1 billion)). In 2006, the total amount of VC in mainland China reached 58.385 billion RMB, and the amount of new fundraising capital accounted for more than 40%. Meanwhile, from the distribution of the sources of VC, the new fundraising capital coming from foreign background organizations is still dominant, however, the local funding sources increased significantly from 14.05% in 2005 to 31.30% in 2006. (See Fig. 3 2005–2006 total amount distribution of new fundraising capital of local and foreign institutions). But it is worth n-oting that the total amount of VC from local institutions is 27.562 billion RMB in 2006, compared to 27.543 billion RMB in 2005. (See Fig. 4 2005–2006 total amount distribution of local and foreign VC (Unit: 0.1 billion)). The growth capital from 2005 to 2006 was just less than 50 million. In the same period last year, the same capital data from foreign capital institutions increased from 18.907 billion RMB to 30.823 billion RMB, an increase of 63%. This means that the vast majority of new fundraising capital is from the foreign capital institutions. 2

Source: w www.chinaventure.com.cn. Unless particularly specified, data sources in this article originate from “China Venture Capital Yearbook 2002–2007 ”.

3

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300

5.44

5.47 240.85

250 195.71

200

5 4

150

3

100 50

6

2

1.27 37.02

43.3

1 0

0 2003

2004

2005

2006

fundraising amount (Unit: 0.1 billion)

231 Capital amount management per one institution in average (Unit: 0.1 billion)

fundraising amount (Unit: 0.1 billion)

Analysis of Trends in China’s Venture Capital Industry

capital amount management per one institution in average (Unit: 0.1 billion)

Figure 2: 2003–2006 the total amount of new fundraising capital (Unit: 0.1 billion).

100.00% 80.00%

68.70% 85.95%

Percent

60.00% 40.00% 20.00%

31.30% 14.05%

0.00% 2005 local instituion

2006 Year

foreign instituion

Figure 3: 2005–2006 total amount distribution of new funding raising capital of local and foreign institutions.

On one hand, the gap in the total amount of new fundraising capital between local and foreign organization is diminishing; on the other hand, the gap in the total amount of VC in mainland China is increasing. So, this reveals two points: first, foreign VC organizations are optimistic on the current situation of China’s economic development and constantly expand the scale of VC in mainland China. This is good news for the China’s VC industry. Second, on the development trend of VC industry, some local VC organizations did not engage in the related business of VC; some local VC organizations completely withdrew from this field. Faced with a strong competition from foreign VC organizations, China’s VC industry

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Total: 583.85 600

Total: 464.5

500 308.23 400 Total amount of capital (Unit: 0.1 billion)

189.07

300 200 275.43

275.62

100 0 2005 foreign instituion

2006 local instituion

Figure 4: 2005–2006 total amount distribution of local and foreign venture capital (Unit: 0.1 billion).

is going through a “reshuffling” process. Certain local organizations, such as those with inadequate capital strength, lack of specialized capacity, and bad investment judgment, will be cleaned out in this process.

Essential Feature of China’s VC Investment Market Total amount of VC analysis Since 2004, the influx of foreign VC brought about an overall rejuvenation to China’s VC market. The data released by the European Venture Capital Association (EVCA) shows that the growth rate of the deal number of projects is 37% and the growth rate of the amount of capital investment is 58% from 2005 to 2006 (Kuehr, 2007). At the same time, the Yearbook data shows that compared to 2005, the total amount of foreign investment has increased more than 250% in 2006, but the data on local investment shows only a 45% increase. (See Fig. 5 2005–2006 the total amount of local and foreign organizations investment (Unit: 0.1billion)). It can be said that the foreign organizations occupy three quarters of the VC industry market share. Data analysis indicates that is a substantial increase in the number of VC institutions and private equity investment institutions accessing China’s VC market. Therefore, the attendant capital, and the development experience of foreign companies will promote the development of China’s VC industry and improve the quality of the entire market. However, the market share gap between local and foreign institutions has also expanded rapidly. According to China Venture Capital Research Institute analysis, the market share of foreign capital organizations will reach over 80% by the end of 2007. It can be foreseen in the near future that the “market in exchange for technology” argument will yet again become fashionable in the field of VC industry.

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Total: 143.6 160 140 120 100 Amount (Unit:0.1 billion)

109.3 by 76.09%

Total: 54.68

80

31.1 by 56.9%

60 40

34.3 by 23.91%

23.58 by 43.1%

20 0

2005

2006 Year

local institution foreign institution

Figure 5: 2005–2006 the total amount of local and foreign organizations investment (0.1 billion).

The stage of investment analysis The Yearbook data pertaining to investment project stage indicates that medium-term investment projects are still attracting more attention than the other stage projects. Growth and expansion period project together accounted for 61% from 2003 to 64% in 2004, 65% in 2005 and 69% in 2006. In new investment projects of 2006, the growth period project has attracted nearly half the share of the investment market. (See Fig. 6 2003–2006 stage distribution of new investment projects (percentage of the number 49%

50% 50% 42.90%

45% 36%

40% 35% 30% Percent

27%

24%

28% 19.70%

25%

22.50%

20%

20%

20% 15% 10%

11% 7%

9.00% 7%

5%

5%

9%

5.90% 2%

5% 0% 2003

2004

2005

2006

Year Seed period

Growth period

Expansion period

Mature period

Other stage

Figure 6: 2003–2006 stage distribution of new investment projects (percentage of the number of projects).

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of projects)). Foreign capital organizations continue to favor its areas of expertise — growth and expansion period project. Compared to 2005, local VC institutions have favored all stages of projects. (See Figs. 7 and 8 2005–2006 the amount distribution of new investment project between local and foreign institutions (Unit: 0.1 billion)). Liberal policy environment, good macroeconomic situation, and the world economic recovery will contribute to the rebound of the local VC institutions. That is to say, the local organizations will participate in the full recovery of the VC market, while foreign institutions tread cautiously in a big way.

14

12.25

12 10 Amount of project money (Unit: 0.1 8 billion) 6

6.54

4.02

2.74

4

Total: 28.63

1.76

1.32

2

5.48

Total: 11.48

3.36 1.31

0.98

0.32

0

0 2005 Seed period

Growth period

2006

Year

Expansion period

Mature period

listing period

Other stage

Figure 7: 2005–2006 the amount distribution of new investment project in local institutions (Unit: 0.1 billion).

15.76 16 14 10.67

12 10 Amount of project money (Unit: 0.1 billion)

8 6 4 2

4.08 1.93 0.41

2.86 0.94

0.95 Total: 10.22

0.16 Total: 27.54

0

0 2005

Year

2006

Seed period

Growth period

Expansion period

Mature period

listing period

Other stage

Figure 8: 2005–2006 the amount distribution of new investment project in foreign institutions (Unit: 0.1 billion).

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Distribution of the investment area Development of VC market in Beijing, Shanghai, and Shenzhen continues to lead in mainland China. 60% –70% of the total amount of capital is concentrated in Beijing, Shanghai, and Shenzhen. The total amount of capital in Beijing is maintaining its leading position in mainland China; the capital concentrating ratio is increasing year-after-year. The ratio was 15% in 2003, 23% in 2004, 33% in 2005, and 48.14% in 2006. Shanghai stands in second place after Beijing, its capital concentrating ratio accounting for 16.47% in 2006. In mainland China, Beijing and Shanghai account for over 60% of the total amount of investment and total amount of capital.

Distribution of the investment industry Traditional industries displaced the IT industry to become the new focus of VC market. The 2006 survey shows that 16.39% of the VC projects are from traditional industries. The industry absorbed a total VC of 2.057 billion RMB, accounting for 14.32% of the total investment, second only to the IT industry. Venture capital is breaking through.

Exit Strategy Analysis

73.50% 62.07% 78 72

80.00%

The percentage of project amount

70.00%

90 80 70 60 50 40

60.00% 50.00% 40.00% 30.00% 20.00%

31.90% 37 20.80% 22

5.70%6.03% 7 6

10.00% 0.00% IPO (local and foreign)

Equity transferring

30 20 10 0

The number of project

The Yearbook data show that there are total of 116 exit cases in 2006 China’s VC market. Enterprises listing exit method and equity transferring exit method are the main exit channel, accounting for 83.97% of the total number of exit cases. Furthermore, equity transferring exit method reached about 62.07%, and IPO pattern is growing in the trend of upward from 20.8% in 2005 to 31.9% in 2006. (See Fig. 9 2005–2006 project amount

Liquidation

Exit way 2005

2006

2005

2006

Figure 9: 2005–2006 Project amount distribution of new investment projects exit way (Unit: items).

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distribution of new investment projects exit methods (Unit: items)). From the structure data analysis of equity transfer exit method, the aggregate accounting of enterprise purchase and transfer to other investment organization exit method reached 47% in 2005, and 48% in 2006. The original shareholder repurchases and MBO exit method account for 38.02% and 11.27%. Throughout the year 2006, there were 22 exit cases through the IPO pattern, (which raised 11.504 billion RMB), including 17 cases of overseas listing and 5 cases of local listing. In addition, there were 7 business liquidation exit cases, 7 exit cases using double additional issuance, and 2 unknown exit cases. Based on the above analysis, the following conclusions can be drawn: (1) China’s VC has emerged from its doldrums, and is on a recovery path; (2) China’s fundraising market scale is getting a rapid and steady growth, and the gap between local and foreign organization is diminishing; (3) Local investment institutions are undergoing consolidation; (4) The influx of foreign VC brought about an overall rejuvenation to China’s VC market, but foreign organizations occupy three quarters of the VC industry market share; (5) The medium-term investment projects are still more attractive than the other stage, and all stage of projects have been favored from local investment institutions; (6) Development of VC market in Beijing, Shanghai, and Shenzhen is continuing to lead in mainland China; (7) Equity transferring exit method is the main exit channel. The IPO pattern is however in an upward trend and (8) The local IPO exit channel is gradually taking shape, and overseas IPO remains the dominant exit strategy.

The Evolution of VC Policy in China China’s VC industry was established in the 1980s. For more than 20 years, the development of China’s VC industry can be divided into four periods. The first is the incubation period (1985–1996); the second is a period of substantial growth (1997–2001); the third is the consolidation period (2002–2003); and the fourth is the comprehensive recovery period (2004–now).

Incubation period (1985–1996) Formulating the state development policies of VC, the CPC on 1 January 1985, promulgated the document — “Decision on the Reform of the Science and Technology Management System”, pointing out that: “In our rapidly changing, high-tech and high risk development work, support can be given to the establishment of venture capital”. This was the primary guiding principle and formed the basis of policy in the Chinese VC industry. In accordance with this decision, in March 1991, and 1995, the government issued the documents — “Interim Provisions on Certain Policies Concerning National High Technology and New Technology Industry Development Zones” and “Decision of the

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Central Committee of the Communist Party of China and the State Council Concerning the Acceleration of Advancement of Science and Technology”, stating that: “Some departments can raise VC funds in National High Technology and New Technology Industry Development Zones”. And, VC firms can be established in the zones with mature conditions. This was a signal that government was devoting more attention in the development of VC industry, and re-directing its efforts to promote high technology and new technology industries into VC field. In this period, the first true VC shareholding firm — China new technology VC firms was established in September, 1985, which was supported by the State Science and Technology Commission, People’s Bank of China, and the State Council. This was a meaningful practice that provided an important experimental model for the ascendant firms around the nation. After that, some local VC firms were set up, such as Guangzhou Technology Venture Investment Company and Jiangsu Province High-Tech Venture Capital Firm.

Period of substantial growth (1997–2001) After 10 years of development, in line with a general drive to step up legislation, the government gradually implemented legislation that actively promoted VC, recognizing its significance in the technology sector reforms. “The Law of the People’s Republic of China on promoting the Transformation of Scientific and Technological Achievements”, issued by the government in 1996, formalized the VC legal process. Later, in the same year, the government once again stressed the need to develop VC by issuing the document — “Decision of the State Council Concerning the Deepening of the Reform of the Science and Technology Management System”. During the “Ninth Five-year Plan Period”, and some departments embarked on some exploratory and useful activities. However, at that time our country’s economic environment was not stable enough due to the Asian financial crisis. Furthermore, the economic strength of local VC firms was not strong. As a result, there were some problems and mistakes on the actual operational aspects. Conceptual, mechanism-related, and the legal obstacles of VC industry still existed. The first national VC institution — the new technology venture capital firm deviated from its original intentions. Its capital was invested in stocks, real estate, and other speculative areas, which eventually led to bankruptcy and liquidation of its assets. In this situation, in March 1998, the CNDCA presented a proposal — “Several Opinions about Accelerating Developing Our country Venture capital Enterprises”, which was listed as an important motion at the inaugural meeting of the 9th CPPCC National Committee; it was also known as the “No. 1 proposal”. It won the support from the relevant government departments and researchers. In August 1999, the Central Committee CPC made a decision enshrined in the document — “Decision of the CPC Central Committee and State Council on Strengthening Technical Innovation, Development of High-tech and Realization of Its

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Industrialization”. It highlighted the policy spirit of the original intention, which was to integrate high-tech industry development with the promotion of VC. In December 1999, the General office of the State Council transmitted the document — “Some Opinions of Establishing Venture Capital Investment Mechanism in the People’s Republic of China”, which was issued by the Ministry of Science and Technology and seven other Ministries. After its promulgation, VC industry development in China was promoted widely as an innovation in capital raising and investing mechanism. At the same time, the Standing Committee of the National People’s Congress amended the “Company Law of The People’s Republic of China”. After entering into the 21st century, the government promulgated a standard basic trust relationship law — “Trust Law of the People’s Republic of China” (October 2001). During this period, some famous local laws and regulations were issued, including “Regulations of Zhongguancun Science and Technology Garden” in Beijing, and “Regulations of Shenzhen Economic Zone on the New and High Technology Industries Parks” in Shenzhen. In 1997 and 1998, the Yearbook data showed that the local VC organizations growth rate was up to 65.22% and 55.26%, and new capital raised per year amounted to 2–4 billion RMB. By the end of 1998, the total amount of VC capital in mainland China exceeded 10 billion RMB for the first time. There were 36 local VCs organizations by the end of 1996, and 246 by 2001.

Adjustment period (2002–2003) Affected by the slow development of the world economy and inactive international VC, the development of China’s VC industry encountered many difficulties, and entered a difficult period of adjustment. At this time, the government promulgated its first law pertaining to the development of SMEs — “Law of the People’s Republic of China on the Promotion of Small and Medium-sized Enterprises” (June 2002). This is the first law in a real sense to promote SMEs development. In order to attract foreign VC and stimulate local VC industry, “Provisions Concerning the Administration of Foreign-funded Business-starting Investment Enterprises” was issued in 2003, by the Ministry of Foreign Trade and Economic Cooperation, the Ministry of Science & Technology, the State Administration for Industry and Commerce, the State Administration of Taxation, and the State Administration of Foreign Exchange. After the release of this document, two support policies — “Notice of the State Administration of Taxation on the Relevant Issues Concerning the Payment of Enterprise Income Tax by Foreign-funded Businessstarting Investment Enterprises” and “Provisions on the Establishment of Investment Companies by Foreign Investors” were promulgated by the State Administration of Taxation and Ministry of Commerce. All these documents were aimed at the relaxation of foreign capital entering our country and promoting foreign VC development in mainland China.

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Full recovery fourth period (2004 till present) The full recovery period is now underway, and the policy emphasis is on formalizing legislation and the implementation of policies conducive to the VC development. In 2004, various ministries of the State Council successively promulgated a number of VC investment-related laws and regulations, greatly substantiating the law and regulation system of China’s VC industry and improving the mechanism of exit from the legal VC system. These legal documents mainly comprise the following: “Some Opinions of the State Council on Promoting the Reform, Opening and Steady Growth of Capital Markets” (2004), addressing the significance and course of the development of China’s capital market from nine aspects, that it is an important milestone in the history of our capital market, including the development of VC industry. “Regulations about Foreign Capitals Establishing Investment Company promulgated” on 28th February 2004, stipulates every detailed aspects of foreign participation in the area of China’s investment. On 17th May 2004, the long-time controversial SMEs Board was set up in Shenzhen, followed by a series of successive related legal documents including “The Implementation Scheme of SME”. In July 2004, the State Council promulgated another important regulation — “Decision of the State Council in Reforming the Investment System”. This is a landmark document of China’s investment mechanism reform, sparking another round of the reform initiatives. The year 2005 was a thorny year for VC legislation. In January and April 2005, the State Administration of Foreign Exchange issued “The No. 11 Paper” and “The No. 29 Paper” one after the other, designed to contain the outflow of assets, tax evasion, and illegal currency outflow as a result of a “regulatory vacuum”, placing mainland companies listed in Hong Kong and abroad under the supervision of the State Administration of Foreign Exchange. However, foreign institutional VC investors participating in China’s investment field were also inadvertently involved, causing delays in mainland companies listing in Hong Kong and abroad. In order to alleviate the negative impact, the State Administration of Foreign Exchange issued “The No. 75 Paper” on 23rd October and abolished “The No. 11 Paper” and “The No. 29 Paper” at the same time. While recognizing the efficacy of stock market listings, the supervisory divisions sought to step up on regulation through the implementation of standardized management and monitoring. On 25th February 2005, the State Council promulgated — “Several Opinions of the State Council on Encouraging, Supporting and Guiding the Development of Individual and Private Economy and Other Non-Public Sectors of the Economy”, a significant comprehensive policy document promoting the development of non-public economy that lowers the market threshold for private capitals and broadens the realm of investment. In March 2005, Shenzhen Stock Exchange issued “the Conduct of Directors of the SMEs Board”, which was a crucial move of the Shenzhen Stock Exchange to further regulate the practice of the SMEs directors, to upgrade corporate governance, and to promote SME board development. This legal document lays a solid

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foundation to improve the exit mechanism of VC and a smooth transition to the growth board market. On 29th April 2005, the China Securities Regulatory Commission promulgated — “Notice of the China Securities Regulatory Commission on Piloting the Share-trading Reform of Listed Companies”, this officially initiated the reform of split-share structure, further enhancing and developing the capital market. The reform lasted six months and was fully implemented by the Shenzhen SME board on 22nd November 2005. On 27th October 2005, the 18th session of the Standing Committee of the 10th National People’s Congress of the People’s Republic of China adopted the revised “Company Law” and “Securities Law”. These two new laws lowered the threshold requirements for start-up capital and initial public offerings (IPO), facilitated the establishment and listing of SMEs, and thus help encourage VC investment. On 14th November 2005 the National Development and Reform Commission (NDRC) issued — “the Interim Measures for the Administration of Startup Investment Enterprises” — which was about to be implemented from 1st March 2006, specifying the record management of enterprises, improving the system of legal protection for VC and promoting entrepreneurial investment to develop into specialized industries as soon as possible. In addition, on 31th December 2005, five ministries including the Ministry of Commerce promulgated — “the Measures for the Administration of Strategic Investment in Listed Companies by Foreign Investors” — to encourage large-volume and longterm investments of foreign strategic investors. To some extent, it relaxes the entrance restrictions of foreign institutional venture investors into China’s market, and paves the way for future issues of management approaches of foreign institutional venture investors. At the same time, related legal documents such as “the Notice Regarding the Promotion of Technological SME Financing” “issued by China Development Bank and Ministry of Science and Technology” and “the Guiding Opinions on the Small Enterprise Loan Business of Banks” issued by the China Banking Regulatory Commission will effectively alleviate the dilemma of SMEs with financing difficulties. In 2006, based on the independent innovation strategy stipulated according to the outline of the “11th Five-year Plan” (11th FYP) for the Economic and Social Development of the People’s Republic of China, the government published several influential legal and political documents concerning the development of VC industry. “Interim Measures for the Administration of Startup Investment Enterprises” has been implemented since 1st March 2006. On 27th August 2006, after various drafts and amendments, the 23rd session of the Standing Committee of the 10th National People’s Congress of the People’s Republic of China adopted the revised “Law of the Peoples Republic of China on Partnership Enterprises” which makes it clear that corporate partners can participate in partnership, providing the supreme legal basis for the implementation of limited partnership in China. The new law enriches the VC organizational models, efficiently brings in advanced international operation mechanisms, and ultimately reduces the investment risk and the

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future worries of certain investors, which was of incredible significance to the promotion of China’s venture investment. Additionally, on 8th August 2006, the Ministry of Commerce, State Assets Supervision and Administration Commission of the State Council, State Administration of Taxation, State Administration for Industry and Commerce, China Securities Regulatory Commission and the State Administration of Foreign Exchange promulgated — “The Interim Provisions on the Takeover of Domestic Enterprises by Foreign Investors”, enforcing hitherto absent enterprise property rights markets, standardizing the procedures of mergers and acquisitions, and enabling takeovers to take place in an open and transparent property transaction market. The latest legal developments are as follows: In the first half of 2007, according to the spirit and principle of “Accelerate the development of venture capital investments, stipulate supporting regulations of the Interim Measures for the Administration of Startup Investment Enterprises and perfect the legal protection for venture capital investment” pointed out by the State Council directive, “On a number of Supporting Policies concerning the Implementation of the “National Outlines for Medium and Long-term Planning for Scientific and Technological Development (2006–2020)”. On 25th February, the Ministry of Finance and the State Administration of Taxation jointly promulgated — “The Notice on the Relevant Tax Policies on the Development of Startup Investment Enterprises” (“Tax Policies Notice” in short) after a year-long debate and amendments. The Tax Policies Notice exerts a profound influence on the VC industry in the four following aspects: 1. reduce the tax burden of VC enterprises; 2. standardize the duplicate taxation problem; 3. specify that venture capital fund should invest in new and high-tech SMEs and 4. review the record of VC enterprises. In this period, according to the China Venture Capital Yearbook 2007, referring to Fig. 10 (comparisons among 2003–2006 total registered capitals of VC institutions

700

Registered capital(Unit: 0.1 billion)

608.25

600 500 Registered capital amount (Unit: 0.1 billion)

380.58

400 300

214.06

190.61

200 100 0 2003

2004

2005

2006

Year

Figure 10: Comparisons among 2003–2006 total registered capitals of VC institutins (Unit: 0.1 billion).

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(Unit: 0.1 billion)), China’s VC market has been growing rapidly. The overall size of institutional registered capitals has been enjoying a trend of dramatic increase since 2004. The total registered capital of institutional VC in 2006 increased by 59.8% compared to that in 2005, and 99.7% in 2005 compared to that in 2004. China’s VC industry is grasping a historic opportunity of development at the present stage. All in all, the recovery bears a close relation to the emergence of the world economy from the downturn, the strength of China’s macroeconomy, and the promulgations of the venture investment industry-related policies.

Conclusions and Outlook All along, the Chinese government sought to create an external environment conducive to the investment mechanisms of VC. In 2007, the promulgation of “Notice on the Relevant Tax Policies on the Development of Startup Investment Enterprises” implemented the spirit and principles of an earlier policy document — “Interim Measures for the Administration of Startup Investment Enterprises”. Nevertheless, the VC domestic environment still needs to be further improved so that VC institutions, in particular local VC institutions, can be truly run as market-oriented operations. Therefore, the primary tasks at hand are to accelerate the development of the VC industry, improve the system of legal protection, and enhance the business operating environment. Looking ahead, a number of factors influence the development of China's VC industry, which can be broadly divided into two aspects: the good thing is that economic development is in good shape, the promotion of high-tech industries led to the development of the VC industry; at the same time, foreign VC institutions have brought along opportunities and experience. First, the policy environment continues to improve, paving the way for private capital entering the field of VC. The bad thing is short-term behavior by certain institutions; careful attention needs to be paid to ensure the healthy development of VC industry in a long-term stability environment, in conjunction with the development of high-tech industries. Second, the increasing trend of fierce competition chasing international capital on the global capital markets is having an adverse impact on the competitive landscape of China’s VC industry development. In the near future, it is highly likely that the next phase of competition between Chinese enterprises and regions would depend critically on the high-tech development and the injection of VC.

References Cornelius, B and Persson, O (2006). Who’s who in venture capital research. Technovation, 26(2), 142–150. Kuehr, TW (2007). Globalization: challenge or chasm for venture capital industry. Proc. of the Transnational investment and financing forum of the Ninth China Hi-Tech Fair. Shenzhen.

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Liu, J (2007). Comprehending the tax policy for promoting venture investment firms development in China. Macroeconomic Management, 4, 33–36. Liu, M (1998). People Venture Investment: Innovation and Finance. Beijing: People University of China Press. Ping, Qian and W Zhang (2007). Returns on venture investment in China and influence factors. Economic Research, 5, 78–90. The Institute of China Venture Investment (Hong Kong) (2002–2007). China Venture Investment Annuals. Shenzhen: Democracy and Construction Press. White, S, J Gao and W Zhang (2005). Financing new ventures in China: system antecedents and institutionalization. Research Policy, 34(6), 894–913.

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Towards a Network Approach: Trends in China’s Logistics Industry ͣSONG-DONG JU and JIE XU Beijing Jiaotong University

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rofessor Ju Song-dong was born in September 1946. He obtained his Masters degree in Material management speciality from Northern Jiaotong University in 1982. He is currently the Director and Doctoral Director of Logistics Network Institute, Beijing Jiaotong University (BJTU). Prof. Ju has been awarded the Government Allowance by the State Council since 1993. Professor Ju holds several positions, including: VicePresident of China Society of Logistics, member of Institute of Supply Management of United States, standing director of China Society of Quantitative Economics, director of National Association for the Study of Higher Education, independent director of China Railway Modern Logistics Technology Co., Ltd., editor of “the Journal of Quantitative and Technical Economics”, member of the editorial board of “China Logistics Yearbook”, Vice-Director of editorial board of “Railway Materials Management”; commissioner of National Logistics Professional Committee and member of “Overseas Returned Scholars Association”. Professor Ju was formerly a Director of the 2nd National Association for MBA Education, Vice-Dean of Graduate College of BJTU, and Dean of School of Economics and Management of BJTU, Dean of Educational Administration department of BJTU. Professor Ju conducts research and teaching tasks for logistics, has published three monographs, eight teaching materials and translated books, and published about 90 papers in the academic journals and for a number of forums and meetings. Prof. Ju has taken charge of around 30 researches and projects in the field of logistics, of which the projects have received four science and technology awards of provincial or ministerial level. To date, Prof. Ju has guided over 90 doctoral and masters students. Professor Ju’s current research directions are focused on the following areas: Logistics Network Engineering, Logistics and Supply Chain Management, Regional Logistics Development, and Logistics Industry and Policies.

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ssociate Professor Xu Jie was born in 1973. She obtained her Masters degree from Northern Jiaotong University in 1996 with a major in Material Currency Engineering. She was awarded PhD from Beijing Jiaotong University in 2007. She is the vice-dean of Logistics Network Institute, Beijing Jiaotong University. Prof. Ju is also a member of China Society of Logistics and member of Institute of Supply Management of United States. Associate Professor Xu’s research interests are purchasing and supply management and logistics network engineering. Her major academic works include: Distribution Center Planning (2003); Purchasing and Warehousing Management (2004); Purchasing Management (2005); Supply Management Process (2005); Research on the Economy Effect of Logistics Network Organization (2005); Complex Structure of Logistics Organization Network and Study of Its Operation (2006).

Abstract: From an analysis of how the logistics industry has evolved in China, this article puts forth a new concept of “logistics organizational network”. Based on analyses from socio-economic aspects, characteristics of logistics service and demand, and reforms in the regulatory framework for logistics management, this article concludes that future developments in the logistics industry will necessarily adopt a network-based approach. Keywords: Logistics; Logistics network; Logistics organization network; Resource integration

Introduction The networking trend of logistics service has become increasingly important to the Chinese Government and logistics enterprises, as well as the logistics researchers. To achieve a sustainable development of the logistics industry, various solutions are being researched, the forms of logistics organization are undergoing evolution, and the network theory of logistics is being improved as a result of developments in the logistics industry. On 17 April 2006, the ZJS Express Co. Ltd. announced that it was going to open its huge network including transportation, warehousing, and distribution resources to all the logistics enterprises and freight agents, home and abroad. It took the ZJS Express 12 years to establish the immense network, which covered over 2,000 cities and regions in China, and now was shared by the whole industry. “The network is just like a highway.” The ZJS Express Co. Ltd. explained, “Since it brings about so much convenience and expediency, why not invite more cars to join us?” In August 2006, the ZJS Express issued another report showing that part of its delivery business was outsourced to China Railway Express to take advantage of the latter’s network during 2005.

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It can be seen from the above examples of ZJS Express and China Railway Express that resource integration is becoming a key to the future development of logistics enterprises. By building an open and sharing network, logistics resources are effectively integrated, leading to higher quality service for customers. As the logistics organizational network is gradually being formed, networking is becoming a certain trend in terms of the development of the modern logistics industry.

The Connotation and Features of Logistics Organization Network The connotation of logistics organization network The future development of the logistics organization is mainly aiming at co-ordination, which requires breaking the boundaries of the single logistics company, providing customers with best logistics services through conformity. That means each organization node in the network should start to connect and co-operate with each other instead of persisting in a state of benign neglect. Logistics organization network (Jie and Songdong, 2006), defined in this paper, refers to an open multi-lateral network with full sharing of resources and the capability of dynamic reorganization. In such a system, each organization node is an open subject, which is able to obtain information and resources from outside, and is willing to share its resources and information as well. Reviewing the history of development of logistics organizations, we undertake an analysis of the connotation and logistics inside various forms of logistics organization as shown in Table 1. Table 1: A comparison of various forms of logistics organizations.

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Different types of logistics organizations

Connotation

Features

Internal logistics organization

Part of the structure of the internal organization

Devoted to the service of the enterprise as significant resource. Focus on the enterprise’s core business

Semi-socialization logistics organizations

Part of the structure of the internal organization

Supporting both the enterprise’s own business and other enterprises, making part of its profits through social services

Independent logistics organization

Professional logistics services organization with enterprise operation and management

With clear-core business, clear and enterprise management, be propitious to its own development, and providing logistics services for the community

Logistics organization network

An open multi-lateral network with full sharing of resources and the capability of dynamic reorganization

Be able to share resources and risks among organizations and to provide a higher quality service on demand

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Features of the logistics organization network From the definition of the logistics network, we find that logistics organization network has the following features: on-demand assembly, dynamic linking, and resources sharing that are discussed as follows:

Assembly-on-demand Logistics organization network is different from the logistics union, and also different from the virtual logistics enterprises. It is a new logistics organization model engendered in the Internet era. It regards customer service as its chief goal. To this end, logistics organization nodes in the network are assembled randomly and work closely together to provide high-quality logistics services.

Dynamic link Logistics organization network is a dynamic and an open organizational model. A dynamic link is built in a task-oriented manner among the members of the network, which can reduce information costs while achieving great exchange of information, and make full use of the resources through integration.

Resources sharing Logistics organization network is also collaborative and sustains continual innovation. In such a network, resources can be fully shared and therefore lead to a synergistic effect. The whole collaborative, spiral evolutionary process stimulates continual innovation of the organization.

Networking ss the Way Ahead for the Development of the Logistics Industry Logistics organization network discussed in this paper refers to making previously loose segments of the logistics organization connect and co-operate with each other. It relies on the co-ordination between organizations instead of internal integration. Networking is the way ahead for the development of logistics.

Demand drives the networking of logistics services Different from ordinary products, the essence of logistics services is the value of space and time, with a requirement of accuracy, timeliness, low cost, safety, and efficiency. It requires a mesh-value creation system of a close co-operation, and rapid response, with the customer at the core. An important support to this system is the “logistics (or

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distribution) network system.” The target of the logistics service is to direct flexible, highly efficient, low-cost services towards satisfying increasingly strict demand of customers, and ensure a high level of connectivity among logistics-service providers. Only in this way, we can realize the customer-centric goal. Co-ordinated through rational planning and optimization of product flow, modern logistics aims to achieve maximum benefits at a minimal cost. To meet the evolving needs of users, modern logistics services, in terms of simple transportation, warehousing, and other services, is incorporating modern technology, management, and information technology, integrated logistics support services; in terms of the scope of services, it is rapidly expanding overseas. In addition, there are signs that modern logistics is gradually moving towards a network-based integrated services system. In developed countries, there has been a mature network system in terms of scale, automation, information technology, and synthesis. According to the trend abroad and China's actual situation, we can see that the future of logistic services relies heavily on network technology, with the aim of enabling the entire society to fully sharing logistics resources on demand. (Wenliang and Songdong, 2005; Wenliang and Songdong, 2006a).

Logistics resource integration requires networking Logistics services require network operations, and also a certain degree of infrastructure. Therefore, logistics enterprises often require a higher pre-investment, and the capital investment recovery period is also relatively longer. As a result, it is very unrealistic and risky for a single logistics enterprise to continuously expand its own hardware facilities network. Thus, it is inevitable for logistic enterprises and major internal logistics organizations to form a network alliance. During the current “logistics fever,” there is a perennial question for the Government and enterprises: how to avoid duplication of logistics infrastructure investment and wastage of resources? An obvious answer lies in a network approach to logistics organization. At present, China is endowed with a favorable economic environment and market conditions for the development of a modern logistics industry. However, as China’s economic development has been relatively backward for a long time, the logistics industry has the characteristics of small-scale, low industrial concentration, simple service functions, and weakness in competitive and scattered resources. Therefore, integration of logistics resources is crucial to China’s logistics industry as discussed below:

To take full advantage of the logistics resources, and to avoid redundant construction A survey of China’s logistics enterprises showed that enterprises with vehicle utilization above 90% accounted for 39% of the companies surveyed, while those with the utilization rate at 70% –90% covered 26.6%, and those with utilization rate at 50% –70% accounted

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for 22.7%. Logistics enterprises with a storage utilization rate of more than 90%, only accounted for 39.3%. On one hand, the logistics resources are wasted, and on the other hand, redundant construction is still ongoing.

To adapt to market changes and better meet customer’s needs At present, the service level of China’s logistics business is too low to respond quickly to the changes in market demand. The income statements of logistics enterprises reveal that China’s logistics enterprises mainly profit from traditional services, 85% of which come from transportation and warehousing management and other basic services, while those deriving from logistics information services, and packaging and product-return management valueadded services only account for 15%. Through resource integration, while maintaining the advantages of the existing services, China’s logistics business can then extend into new areas. What distinguishes modern logistics from its traditional predecessors? It is the use of modern technology, and management methods that maximize the co-ordination and mobilization of the global community resources to provide logistics services, thus maximizing overall effectiveness. In the era of rapid IT development and the Internet, enterprises often find themselves enmeshed in multiple supply chains and value networks that transcend time and space. To maximize capacity, enterprises must participate in a distributed network-based logistics system, where the integration and management of information facilitates the best use of its own resources and other social resources. Faced with globalization, the management of enterprises is becoming more and more complex, unwieldy, and fluid and technical. It is impossible for a single logistics enterprise to satisfy all its requirements on its own, and it is hardly necessary. Under these conditions, the network approach to logistics organization becomes more relevant, and is fast becoming the new trend.

To optimize logistics distribution From an overall layout point of view, the development of China’s western logistics industry is obviously lagging behind those of the eastern and central regions (Songdong and Yisong, 2003). The logistics circle enjoying rapid development includes the Beijing and Tianjin Bohai logistics laps, the Yangtze river delta logistics laps, and the Pearl river delta logistics circle. From the view of third-party logistics providers, business activity and revenue are largely concentrated in the eastern region. In addition, China’s logistics industry lacks integration, which means logistics in different regions suffer from a lack of connectivity.

To optimize China’s logistics industry structure There are a large number of logistics enterprises in China, however, most of them do not enjoy economy of scale. In 2005, the total revenue of logistics services by 26 logistics listed companies in China was less than US$ 20 billion, whereas that of the UPS from America reached US$ 12.5 billion and SAGAWA from Japan achieved US$ 5.7 billion. According to a measure of centralization of industry standards from Bain, China’s

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logistics market is characterized as having an “atomic structure”, i.e., containing a large number of enterprises with low concentration and irrational industrial structure. It is, therefore, in urgent need of integration.

Innovation of logistics services model promotes networking The key influencing socio-technical factors in the economic environment of logistics organization network include: advances in technology, the Internet economy, and the development of knowledge economy. In the internet economy, social organization is developing from the ply-rating model to the networking model. There is no longer a strict hierarchy within and between the enterprises. Each enterprise and each department is an activity node that communicates with another. The impact of the knowledge economy affects both the study and innovation of the organization. Logistics organization network is not only a knowledge network of mutual learning from enterprises but also a collaborative network with innovation in logistics services models. The vertical and horizontal expansion in the supply chain system imposes greater professional demands and pressure to form alliances within logistics services. The future of logistics services will be based on information technology among the enterprises in collaboration. The support of network technology enables the formulation of a comprehensive logistics service system that has the following features: sharing of resources, rapid response, and an optimal cost. The actual availability of social products will be greatly improved to the end customers. The diversification to pursue “quantity” and “quality” of customer’s demand is driving innovation in logistics service models and promoting a more efficient logistics service.

Successful Cases of Logistics Organization Network Operation The operation of a logistics network requires logistics information network as technical support, through which logistics infrastructure resources can be fully utilized, goods in the logistics network can be tracked in real-time, enquiries of logistics services can be answered to, and information collection, transmission, and operational management can be enabled as well. In this way, it can effectively reduce intermediate costs and greatly improve customer service (Ren and Songdong, 2006). With grid and other new types of network technology, it will truly achieve full integration and sharing of resources among logistics organization nodes ( Wenliang and Songdong, 2006b).

Case 1: The collaboration of network among the logistics district In July 2007, the author participated in the Fifth National Logistics district seminar held in Kunming. Delegates were very interested in such a case study: in the old days, each logistics district was a single logistics node, however, there were a few linkages among

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all the nodes. After China Freight Service Network (www.peihuo.cn) established its service center in Suzhou, once its vehicles got into the logistics district, the information will be posted immediately to collaborative logistics districts. For example, customers in Wanda logistics district may directly call the vehicle, which would immediately rush to the loading point after unloading.

Case 2: Global logistics network “Global Logistics Network” is a non-governmental organization with international logistics companies from more than 40 countries. They have made important contributions to the application of the latest technology, the promotion of new service items and standards of service, and commands a good grasp of development direction of the global logistics industry. “Global Logistics Network” provides a standard services platform, where customers can enjoy a unified service standard, share of e-commerce systems, and an awareness of policies in different regulations to achieve the global transaction facilitation. In choosing any node in the global logistics network, customers can get direct service with global standardization from collaborative nodes in the network (www.8856.com.cn). In these two cases, with the help of the logistics information Network, the organizational node in the logistics district or logistics enterprises managed the collaboration of the network. Thus, customers enjoy more convenient services, and logistics enterprises gain a greater efficiency. The co-operation between logistics information networks and logistics organization networks will lead to a faster networking trend of logistics industry.

Conclusion To suit new economic relations and demands on efficiency, the future development of the logistics industry in China is tending towards greater network integration. Further research in logistics network theory ought to focus on actual conditions, how it could be adapted to suit changes in the domestic logistics management system, and the interactive nature of logistics organization models. Such research would undoubtedly contribute to the development of the Chinese as well as the global logistics industries.

References Bian, Wenliang and Songdong Ju (2005). Grid and logistic networks. Dynamics of Continuous Discrete and Impulsive Systems,Series B: Applications and Algorithms, 7. Bian, Wenliang and Songdong Ju (2006a). Study on MF networks adapting to grid environment. Journal of Beijing Jiaotong University (Social Science edition), 4, 33–38.

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Bian,Wenliang and Songdong Ju (2006b). Logistics networks affected by grid and its effects on the operation of logistics enterprises. China Soft Science, 2. Ju, Songdong and Yisong Li (2003). Logistics in China’s western region and regional economical development. The Journal of Quantitative & Technical Economic, 2. Liu, Ren and Songdong Ju (2006). Approaches of logistics information network dynamic grouping and information sharing based on OGSA. Logistics Technology, 12, 84–87. Xu, Jie and Songdong Ju (2006). Complex structure of logistics organization network and study of its operation [C]. Proc. of the 13th International Conference on Industry Engineering and Engineering Management, Shandong: China (8). www.8856.com.cn.

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Competing in Global Markets: A Case Study on the Wenzhou Shoe-Manufacturing Industry ͣYONGYI SHOU and JIE WANG Zhejiang University

D

r. Shou Yongyi is an Associate Professor at the Department of Management Science & Engineering; School of Management, Zhejiang University, China. His research and teaching interests focus on project management, operations management, and management of innovation. Dr. Shou has published over 20 papers in academic journals and international conferences. Dr. Shou holds a Bachelor of Engineering in mechanics engineering and a Master of Science in management science from Zhejiang University, China. He received a PhD degree in system and engineering management from Nanyang Technological University, Singapore. Dr. Shou also serves as the Director of Education Center of Master of Engineering at the School of Management. The Center provides two master degree programs. One of it being a Master of Project Management, which co-operates with International Project Management Association. And another is Master of Logistics Engineering; which co-operates with the Institute of Logistics and Transport, UK.

M

s. Wang Jie is a post-graduate student of School of Management, Zhejiang University. She entered Tongji University in September 2003, and was awarded a Bachelor degree in engineering. In 2007, she enrolled in Zhejiang University for post-graduate study in the Department of Management Science & Engineering.

Abstract: The manufacturing industry has played an important role in the development of Chinese economy. With China’s gradual integration into the international market, the Chinese manufacturing industry has encountered increasing global competition. For small- and medium-sized enterprises (SMEs), of the Chinese manufacturing industries, decisions as to how to enter the international market become critically important. This paper sums up different entry modes

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chosen by Chinese SMEs, when accessing international markets and analyzes the main considerations underlying entry mode selection through a case study of the Wenzhou shoe-manufacturing industry. Keywords: Globalization; Entry mode; Wenzhou; Shoe-manufacturing industry

Introduction In the new century, the Chinese manufacturing industry is developing at a dramatic speed. In recent years, the Chinese manufacturing industry has been accorded greater exposure in the global media, attesting to the effects of globalization. “Made in China” has become a widespread label in global markets. In some industries, Chinese firms have earned their global competencies after years of heavy investment in technological capabilities and product development. China is being recognized as the world’s factory. According to the United Nations Industrial Development Organization (UNIDO), for the past decade, the annual growth rate of Chinese manufacturing industries has surpassed that of other developing countries, as shown in Fig. 1.

12 10 8

China

6

Developing countries

4 2 0 1993−1998

1998−2003

Figure 1: Annual percent growth of value added of manufacturing industries.

Yet, many Chinese manufacturing firms earn slim margins and stand to lose their market shares to new entrants from other developing countries. Many Chinese enterprises are still looking for their own niches in the wave of globalization. Therefore, Chinese enterprises are facing not only competition from many multi-nationals in the domestic market, but also trying to find the right way to enter the international market in direct competition with global enterprises. This paper attempts to analyze some typical modes for Chinese small and medium-sized enterprises entering the international market through a case study of some flagship enterprises of the Wenzhou shoe-manufacturing industry.

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The Global Market Entry Modes For Chinese enterprises, one of the most important decisions is the selection of an appropriate mode of entry to penetrate the international market barriers more effectively. In the process of exploiting the international market, what is a suitable international market entry mode? A foreign entry mode (FEM) is an institutional arrangement facilitating the entry of a company’s products, technology, human skills, management, or other resources into a foreign market (Root, 1994). There are various methods of market entry. According to Root (1994), it could be divided into three categories: export-entry mode, contractual-entry mode, and investment-entry mode. Each mode of entry has its own merits, the enterprises have to choose the appropriate mode to help them enter the international market. Root (1994) divided the factors which affect the enterprises on overseas operations into two parts: external and internal factors. External factors are those environment variables which are difficult to control or beyond control, including target countries’ market, environmental, production and home countries. Internal factors include enterprise resource factors and production factors. Anderson and Gatignon (1986) provided the economic analysis approach for foreign market entry based on economic analysis of transaction cost, emphasizing costs and benefits comparison among the different market entry modes. They considered “control” as the only important factor in the impact of the overseas market risks and benefits. The key to the selection of entry mode is to ensure a reasonable “degree of control” of multi-national operations. “Degree of control” of multi-national operations has a direct impact on the profits and transaction costs of enterprises overseas operation. The choice of an international market entry mode aims to strike a rational balance between the “degree of control”, “cost”, “risk”, and “return”. Economic approach of global market entry, which belongs to the traditional approach, emphasizes cost comparison of different entry modes regardless of “competitiveness” considerations. Using the strategic behavior approach, from the perspective of industry structure and the entry barriers, the enterprises should choose the entry mode which can enhance their competition position in foreign markets. In our day and age, a fiercely competitive environment requires enterprises to select a suitable entry mode, not only because of the low-cost factor, but also to maximize their competitive position to earn monopoly profit (Lu, 2003).

Wenzhou’s Manufacturing Industries The Chinese manufacturing industry’s spatial distribution presents obvious regional differences. During the process of globalization, the manufacturing industry in the southeast coastal areas developed very well in the past 30 years. Wenzhou is a typical region in this area.

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Since the introduction of China’s market reforms and open-door policy, Wenzhou has become more entrepreneurial. Through 20 years’ development, Wenzhou’s industries have experienced major changes. The dominant economic form of Wenzhou changed quickly from agriculture to manufacturing industry. The interior structure of industries also had a big change. Industrial economy kept dominant in regional economy. Brand consciousness became more and more explicit. Agriculture industrialization went steadily. Service industry stepped up rapidly. Industrial structure was on top among the whole province (Tao, 2006). All these progress in industry structure depended on Wenzhou industrial clusters. With the development of “one village one brand”, “one country one trade”, now Wenzhou has formed five large-scale industry clusters: low-voltage electrical cluster in Liushi with 30% of home market, shoe cluster with 20% of home market, clothes cluster with 10% of home market, glasses cluster with 80% of home market, and lighter cluster with 95% of home market and 70% of international market.

Table 1: Production values of Wenzhou’s main industrial clusters in 2000. Industrial cluster

Annual production value (RMB)

Industry production value (%)

Cluster of shoes

28.3 billion

15.7

Cluster of clothes

22.3 billion

12.3

Cluster of low-voltage electrical

15

Cluster of glasses

billion

8.3

4.5 billion

2.5

Because of the development of Wenzhou industrial clusters, the enterprises in Wenzhou deliver higher production levels, in turn enjoying a low-cost advantage. Higher levels of innovation also contribute to superior technology and quality. Moreover, the cluster enterprises are much better at co-operation. To illustrate, the Wenzhou shoe manufacturing industry is selected as a typical example in this paper.

Wenzhou Shoe Manufacturing Industry The enterprises’ distribution of Wenzhou shoe manufacturing industry takes the form of a demijohn. In 2000, the production value of Wenzhou shoe manufacturing industry was RMB 28.3 billion with the production value of shoe leather at RMB 23.2 billion. 4,000 enterprises, its output totaling 600 million pairs, which is equal to 20% of the nation’s output. Wenzhou became the biggest production base and was awarded as “Chinese Shoe City” by China National Light Industry Council and China Leather Industry Association. “Kangnai”, “Dongyi” and “JED” gained the honors of “Chinese famous brand”. There were 60 enterprises acquiring the mark of “genuine leather”. In the top two honors

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“China’s Top 10 Genuine Leather Shoes” and “China’s Top 5 Famous Shoe Brand” awarded by China Leather Industry Association, Wenzhou enterprises won 3 awards and 2 awards, respectively. At present, there are about 4,500 Wenzhou shoe manufacturers, and over 2,500 associated enterprises of shoe machines, shoe materials, leather, synthetic leather, and leather chemicals production. About 400,000 employees produce 1 billion pairs of shoes every year. The output constitutes a quarter of the national output and one eighth of the world’s total output. In 2003, the annual value of Wenzhou shoemaking stood at up to $5 billion, and export value was at $1,019 million. Since 1990s, many companies have started brand strategies. Hence, many enterprises have their own brand shops in Milan, Paris, and other fashion cities. The enterprises of Wenzhou shoe manufacturing were clustered in Lucheng, Yongjia, and Rui’an. But everyone has its own feature with shoemaking. Wenzhou shoe manufacturing industry started in Lucheng where the output is equal to 40% of Wenzhou’s. The enterprises such as Kangnai, Dongyi, JED, and Aolun have a great influence on Wenzhou shoe manufacturing. Many of them focused on export, and only a few like Kangnai sold products in the domestic market. As the world market changed, many enterprises adapted by selling more products in domestic markets. In recent years, a large number of promising enterprises, such as Aokang, Red Dragonfly, and so on have done successfully in marketing. Now, they have well-recognized brands and huge market shares as well. The group currently has a brand advantage. Thousands of enterprises producing shoe-making machine, shoe decorations, and leathers assemble round these shoe-making enterprises. Professional co-operation and division is the key to the rapid development of the footwear industry. The clustering of enterprises results in a high degree of industry information flow; this is then harnessed by the shoemakers in making rapid responses to market changes. (Wang, 2004). The history of Wenzhou shoe manufacture industry can be reviewed from three dramatic events as follows. (1) The first fire: Burning Wenzhou shoes in Wulinmen Square. On 8th August 1987, in Wulinmen Square, Hangzhou, the staff of Hangzhou Commerce and Industry Bureau lit a fire and destroyed more than 5,000 pairs of low-quality Wenzhou shoes. This fire was so famous that not only media but also many cities began to “notice” Wenzhou shoes. At that time, Wenzhou shoes were infamous for being fake and shoddy. (2) The second fire: Burning counterfeit Wenzhou shoes. At 15:00 on 15th December 1999, in the suburb of Hangzhou, Aokang’s Chairman Zhentao Wang together with the mayor of Wenzhou lit a fire and 2,000 counterfeit shoes and labels were burned to ashes. The “Economic Daily” described the event vividly as follows: “12 years ago, a fire burned Wenzhou inferior shoes; 12 years after, a fire burned counterfeit Wenzhou shoes.” Finally, Wenzhou shoes were recognized as high-quality shoes. (3) The third fire: Burning Wenzhou shoes in Spain. On 17th September 2004, hundreds of unemployed men in local Spanish shoe factories burned Wenzhou shoes

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worth more than 800 million RMB. Wenzhou shoes, of high quality yet at a low price, were the hot-favorites of foreign consumers, but hated by other shoe-making enterprises at the same time. In order to break the barriers to international trade, to change “Made in China” to “World Manufacturing”, a group of Wenzhou shoe manufacturers have set up factories in foreign countries. In addition, the exports were shifted from merely products to combination of products, brands, technology, and capital.

Typical Examples of Wenzhou Shoe Manufacturing This paper focuses on three flagship enterprises in Wenzhou shoe manufacturing industry: Aokang, Dongyi, and Kangnai. This paper attempts to analyze different global market entry and the main factors influencing mode selection.

Aokang Aokang Group, initially named Aolin, a Yongjia shoe factory, was founded in 1988. In 1995, it was approved by the Wenzhou Municipal Government to organize Aokang Group. Aokang Group has three large bases: a headquarter in Wenzhou, an international brand industrial park in Oubei, and a shoe-production base in Chongqing, with more than 30 modern production lines imported from Italy and Taiwan. The actual annual output was 10 million pairs. In 2005, the industrial sales revenue of Aokang Group was more than RMB 20 billion, and the annual tax was more than RMB 30 million. In 2006, its industrial sales revenue reached RMB 30 billion. There were two important events in the development of Aokang’s globalization. First, Aokang led other Chinese enterprises in response to anti-dumping through legal action. Second, Aokang co-operated with the international shoe giant GEOX, from piecemeal co-operation to today’s full co-operation. From 2003, it was the co-operation with GEOX that officially launched the process of Aokang’s internationalization. Aokang not only made shoes for GEOX, but was also involved in Asian product design. Moreover, GEOX explored Chinese market through Aokang’s strong domestic network. In the international markets, GEOX helped to recommend Aokang’s brand and products through its global network. Aokang gained access to sales agents, and more importantly, the top experience of international brand management, technology, and the latest information.

Dongyi The Eastern Technique Shoe Factory was founded in 1986. In 1991, the factory became Dongyi Shoes Co. Ltd. The products were oriented by the market needs, targeted border trade and international trade under the help of overseas Chinese. In the new century, Dongyi began to accelerate its development of shoemaking, with 95% products exported

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to more than 20 countries and regions. Shoe-manufacturing industry is a typical labor-intensive industry, in which the proportion of labor costs is just a little lower than material costs. Compared to developed countries, Chinese labor costs are much lower. Moreover, in China’s western regions, the labor costs are even lower. Therefore, 90% of 2,000 workers in Dongyi come from less developed central and western regions. Products of Dongyi are mainly for export sales, ranking first in Wenzhou shoemanufacturing industry. Most enterprises focused on domestic markets, and went for globalization only due to overproduction. However, Dongyi sought for globalization intentionally. This innovative business model involves three stages. In the first stage, Dongyi chose indirect exports to enter international market, primarily through domestic agents to partake in the Russian border trade. In the second stage, Dongyi obtained the right to export, and hence developed direct exports and opened up other international market outside Eastern Europe. In the third stage, Dongyi actively expanded the United States and other markets and attempted to form a diversified, multi-market “trade” pattern. After the year 2001, Dongyi turned its strategic focus to the United States, relying on the retail outlets of trans-national purchasing groups, in order to reduce marketing costs effectively as well as to promote innovation and internationalization in the internal management of Dongyi.

Kangnai Established in 1980, Kangnai Group is one of the leading shoe manufacturers. In 1999, it was recognized as “China Well-known Trademark” by China’s National Trademarks Bureau. It is also one of the first Chinese enterprises to establish its own brand in China and also in overseas markets. Kangnai Group’s international strategy began from the downstream of the value chain: sales. Its strategic targets were the international brands and the number of the brand stores. In 2001, Kangnai Group became a member of SATRA, a world-acclaimed professional shoe-maker accreditation board. It then entered a new phase of global competition. In December 2005, Kangnai entered into a co-operative agreement with the French chain store — Advanced Vision — with the aim of Kangnai entering 200 luxury shops in the European Union during the next five years. This went some way in facilitating Kangnai’s entry into both the wholesale system and the retail system at the same time. Kangnai also plans to set up an industrial park in Russia. The industrial park covers an area of 2,280,000 sqm, and costs RMB 2 billion. The annual yield of high- and medium-grade leather shoes is up to RMB 24 billion. Such forms of foreign investment represent another means of overcoming trade barriers.

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Analysis of Wenzhou shoe-manufacturing industry In the above-mentioned cases, the Wenzhou shoe manufacturers have, in the era of globalization, consciously or unconsciously stepped into the international market. Different enterprises vary in their target market, resources, and collaborators, as well as the entry modes selected. Table 2 summarizes different global market entry modes of these enterprises. Table 2: Entry modes of Wenzhou shoe-manufacturing industry. Company

Entry mode

Target market

Resources sought abroad

Partners

Aokang

Contractual

Global

Core technology and channels

GEOX

Dongyi

Export

Russia and America

Marketing channel and retail terminals

Overseas Chinese and retail terminals

Kangnai

Export and investment

EU and Russia

Sales channels and industrial parks

SATRA, Advanced Vision and parks

Analysis and Discussion Chinese enterprises have successfully penetrated international markets. Different factors influence the entry modes of Chinese enterprises. External factors are objective in nature. The enterprises are unable to change them, but they can adapt their own development strategies according to the situation. Internal factors are subjective; they can be changed or exploited. Through the investigation on Wenzhou SMEs, we uncovered the main considerations behind entry mode selection. The top five external factors were the size of the market and sales potential in the host country, the intensity of market competition in the host country, the host country’s political, economic and financial stability, the competitive pressures in home market, and the mother country’s trade and investment policies. The factors of production in the host country accounted for less, in part because of the preference of Wenzhou SMEs towards the export entry mode rather than investment entry mode. The top five internal factors of entry mode selection were the overall goal of exploiting the international market, product adaptability in the host country, technology-intensive services of the products, the degree of product differentiation, and the company’s industry orientation (Sun, 2006). We observe similar factors through the case studies of Wenzhou shoe industry enterprises. In the beginning, Wenzhou shoe manufacturers were not familiar with overseas markets and used the OEM pattern, or offered their own products to overseas partners to achieve risk-free operation. After accumulating a certain amount of capital

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and experience, they would consider direct exports to the larger foreign markets. There were three types of direct exports: (1) Building up malls together with other partners and (2) Co-operating with foreign large-scale chain stores as its suppliers (For example, in December 2005, Kangnai signed a co-operation agreement with the French chain store Advanced Vision.) and (3) Brand output, e.g., Kangnai opened brand stores in foreign markets. In general, the global market entry modes for Wenzhou shoe manufacturing enterprises may be classified into three categories: export entry mode, contractual entry mode, and investment entry mode. With the development of Wenzhou enterprises, more and more companies began to choose the contractual entry mode and investment entry mode. However, the selection of an appropriate mode of market entry remains a key consideration for Chinese enterprises, in the light of world-wide competition and globalization trends.

References Anderson, E and H Gatignon (1986). Mo des of foreign entry: a transaction cost analysis and propositions. Journal of International Business Studies, 17, 1–26. Lu, T (2003). Operations Strategy of Chinese Multinational Corporations. Beijing: Economic Management Press (in Chinese). Root, FR (1994). Entry Strategies for International Markets. Lexington: Lexington Books. Sun, J (2006). Factors of Wenzhou SMEs’ international market entry modes. Enterprise Research, 7, 62–64 (in Chinese). Tao, G (2006). Present status of Wenzhou industrial structure adjustment and its policy orientation. Technical Economy, 5, 8 (in Chinese). Wang, J (2004). Studying Wenzhou footwear industry to understand local collective economy. China Quality and Brand, 11, 14 (in Chinese).

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A Business Model for Knowledge-Based Service Enterprises in China: The Case Study of Kunshan ͣSHYU JOSEPH Z, CHEN JOU-CHEN and YANG CHIA-HAN National Chiao Tung University, Taiwan

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rofessor Joseph Z Shyu received his Bachelor degree in Chemistry from Fu-Jen Catholic University in 1976, an M S in Applied Chemistry from National Tsing-Hua University, Taiwan, in 1978, and his Ph D in Analytical Chemistry from the University of Pittsburgh, Pennsylvania, in 1982. In 1992, he received an MBA from the Illinois Institute of Technology. For over a decade, Professor Shyu worked in several industries including automobile, oil, chemical, and venture capital in the United States. He returned to Taiwan in 1993, holding a position of professor in the Graduate Institute of Technology of Management in National Chiao Tung University. His recent research interests include national innovation systems, high-tech industry analysis, strategic planning, management of high-tech services, and global marketing strategy. His research results had published in some international journals including Technological Forecasting and Social Change, Technovation, R&D Management, and Technology in Society.

M

s. Jou-Chen Chen is currently a Masters student from the Institute of Education, National Chiao Tung University, Taiwan. In 2006, she graduated from the National Hsinchu University of Education, Taiwan with a Bachelor degree in Education, garnering the honour as the top student. In the same year, she enrolled into National Chiao Tung University pursing a Masters degree in Educational Policy and Administration; she also minored in Management of Technology. She had honourably received the Academic Achievement Award during her graduate studies in the Institute of Education, from 2006 to 2007. Most of her research to date has been in the field of University–Industry cooperation,

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Innovation Policy, Macro-Strategic Management, National Competitiveness, Higher Education Policy and the Sociology of Education.

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r. Chia-Han Yang is currently a PhD candidate at the Institute of Management of Technology, National Chiao Tung University. He received his Bachelor degree in Power Mechanic Engineering from National Tsing-Hua University in 1998. In 2000, he obtained his Masters degree in Mechanic Engineering from National Taiwan University, proceeding to pursue a Masters degree in Management of Technology from National Chiao Tung University, in 2006. His master thesis was based on the numerical reliability assessment of structures and strategic analysis of the bioagricultural industry. Mr.Yang also spent two years in the international patent firm as a senior patent engineer from 2003 to 2004. His recent interests include policy and industry analysis, management of high-tech services, and national innovation system.

Abstract: This research aims to offer new business insight into knowledgebased service enterprises in China. In particular, a service approach, namely, the IIS (innovation intensive service) platform, is adopted as an analytical tool to illustrate the development of service platforms. A case study of the industry cluster in Kunshan City is also used to demonstrate the validity of this research. This approach integrates the platform strategy, service package and network externalities to diffuse innovation. Service packages are created and delivered with a high degree of customization including unique, selective, restricted and genetic services. The result shows that not only can a new business model be applied to assist existing manufacturing in value upgrading, it can also provide a niche opportunity for SMS development under highly intensive global competition. Keywords: Knowledge-based enterprise; Service platform; Value activity; Externality; Kunshan Institute for Technology Commercialization

Introduction This paper focuses on offering a new business model of knowledge-based service enterprises in China. In particular, a service approach, namely, the IIS (innovation intensive service) platform, is adopted as an analytical tool to illustrate the development of service platforms. A case study of industry cluster in Kunshan City is also used to demonstrate the validity of this research. With knowledge dynamically evolving and globally proliferating, several factors of industrial development are defined as driving forces of knowledge-based evolution such as diversity of highly segmented markets, systems and platform services, network

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effect derived from internet, business process outsourcing (BPO), and technologyenabled new markets. With this perspective, this research elaborates a new business model of knowledge service enterprises, enabled by the value migration process through the transfer, accumulation, reconfiguration, and value-added of knowledge. This model integrates the platform strategy, service package and network externalities to diffuse innovation. In accordance with this concept, the service enterprises share and externalize their core competence to serve different types of customers through the service process, which require network interaction of externalities. After these integrations, service packages will be created and delivered with a high degree of customization including unique, selective, restricted and genetic services. This study also devises the operational mechanism of service platforms by supplier affiliation, customer affiliation, and the development of infrastructure and syndicated navigation. The case of Kunshan Institute for Technology Commercialization is used as an empirical study to demonstrate the validity of this business model. The result shows that not only can a new business model be applied to assist existing manufacturing in the process of value migration; it also provides a niche opportunity for SME development under highly intensive global competition in China.

Knowledge-intensive Business Service The rapid growth rate of business services and a number of varying definitions have emerged to describe the scope of business services in the knowledge-based economy for decades. With knowledge dynamically evolving and globally proliferating, several factors of industrial development are defined as driving forces of knowledge-based evolution such as diversity of highly segmented markets, systems and platform services, network effect derived from internet, and technology-enabled new markets.

Definition of KIBS In the last several decades there has been a tremendous wave of interest in the research of knowledge-intensive business services (KIBS) due to the rapid growth rate of business services, and a number of varying definitions have emerged to describe the scope of business services in the knowledge-based economy. Firstly, OECD (1996) defines KIBS to include transportation, communication, financing and insurance services. Other studies addressed two types of KIBS firms, including traditional professional services and new technology-based KIBS (T-KIBS). In addition, KIBS industries are also known as private companies or organizations relying heavily on professional knowledge, and described as firms performing highly intellectual value-added services, mainly for other firms (Czarnitzki and Spielkamp, 2000; Hipp and Grupp, 2005; Miozzo and Grimshaw, 2005).

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KIBS

Peripheral and supporting

Technology Brokerage Transaction IPR

Innovation intensive services (IIS)

R & D, IP, & Technological

Production Services

Professional services

Financial Consulting Risk Management Organizational Structural

Figure 1: Categorization of KIBS.

Fig. 1 summarized the related discussion in the last few decades to construct a categorization of KIBS, including peripheral and supporting, innovation-intensive services (IIS), and professional services. This research adopts the definition of IIS among this categorization to focus on analyzing the critical linkages between specialization strategies of manufacturing and service industries. Moreover, in recent years considerable concern has arisen over the concept of platform strategy based on the development of network effect under the assumption of the knowledge-based economy. Three sets of resources encompassing core capabilities, complementary assets, and the capacity to learn are used to explain the ability of network to accumulate and diffuse the knowledge among this network system. The network concept is adopted in this research. It proposes seven externality elements — complementary asset suppliers, R&D, design, production, servicing, market, and users — based on trust and shared norms to develop and diffuse core capability in the network system. Another explanation of network system is “outsourcing”, in which a company or a government agency turns over an entire activity to an independent firm that specializes in that kind of work. During the outsourcing process, all resources, complementary assets, and information are separated in the value chain; the network then integrates them into a systematic platform. That is the reason why platform strategy is the strategic approach in the network and knowledge-based economy (Muller and Zenker, 2001; Hipp and Grupp, 2005). The operation of platform strategy has been widely investigated since the definition of platform was introduced to explain the new business model of services. Ohmae (2005)

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offered a definition of platform as a means of allowing companies or individuals to communicate with each other to get things done more quickly or more efficiently. Among the network, this mechanism could aid communication, enhance delivery, and establish the common standards that come to be the accepted norm (Ohmae, 1990). In addition, Meyer and Dalal (2002) argued that the platform structure is the mechanism to aggregate user requirements into target market segments towards the end of producing value products and systems. It was also discussed that the platform is used to provide models of a similar basic size and layout for more separate brands held within one group. In the operational structure of KIBS, compared with the traditional broker institution, KIBS could be a bridge between supply and demand sides in the form of internet exchange platform, exchange intermediary, retailer, and business consulting and transportation platform, to achieve platform objectives such as infrastructure development, information sharing, search assistance, and opportunities for technology exchange, shown as Fig. 2. To be elaborate, several characteristics could also be listed to describe the industrial situation favorable to be operated by the KIBS model, such as customer-centric and clarity of focus, knowledge-intensive competition and platformbased operations, competition-driven network effects, externalities and cross-company collaboration.

Development of BPO The concept of business process outsourcing (BPO) is also the critical operational mode of KIBS in the global competitive market. Present companies, particularly in high-tech industries, outsource their business process to other enterprises for the reason of cost,

Traditional interface & broker search, sort, inventory, delivery Supply

Demand Type of KIBS Internet exchange intermediary platform intermediary retailer intermediary Transportation Business consulting

Develop platform infrastructure Share product and sales information Provide exchange opportunities Search assistance Provide technology platform

Figure 2: Comparison of traditional broker and KIBS intermediary.

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risk sharing, demand of customers, and new market creation. This trend provides a new opportunity for KIBS enterprises to formulate a specialized BPO platform (Gillespie, et al., 2007). The original concept of BPO could be traced to transactional cost theory in the field of economic analysis (Coase, 1937; Williamson, 1991; Gulati, 1998), which argues that corporations properly pour their resource into activities with high value-added and transfer other activities to external enterprises, thereby achieving the objectives of minimum cost and maximum profit. In addition, researches of the resource-based view (Wernerfelt, 1984; Barney, 1991; Grant, 1991) and core competence (Prahalad and Hamel, 1990; Quinn and Hilmer, 1994) in typical management studies also emphasize the importance of resource bases and the core capabilities of enterprises. The aforementioned literature provides the theoretical basis of BPO development. Meanwhile, the emergence of enterprise outsourcing is also related to the division of labor in the economic research. Stigler (1951) presented that the division of labor may occur along with the extension of market scale, resulting in the development of enterprise specialization. Finally, this trend would contribute to the network system of industrial structure that accumulates and diffuses knowledge, thereby formulating a variety of outsourcing models (Economides, 1996; Tabscott, 1999; Shapiro and Varian, 1999; Kash and Rycoft, 2000). A number of studies have demonstrated differences in the development of the outsourcing model. Most of the outsourcing activities today are focused on the process of new product development (Wind and Mahajan, 1997; Zhao and Calantone, 2003). Next, Corbett (2004) introduced two dimensions, that of net ability and net cost, to classify outsourcing strategies into strategic, product, value, and location outsourcing. In Ohmae’s definition (2005), he revealed that BPO activity is the business process operating from high cost environment to similar quality but low labor cost environment. Meanwhile, some novel literatures adopt the concept of internet economics such as Web 2.0 and blog marketing (Wright, 2006; Holtz and Demopolous, 2006), to explain the operational mechanism of the BPO platform for information survey.

Concept of institute for technology commercialization This research adopts the concept of KIBS and BPO, to devise an empirical business model for technology commercialization according to the application of WiKi interface (Tapscott and Williams, 2006), for enhancing the diffusion of industrial technology and the diversity of market development in the selected region. Fig. 3 illustrates the designed structure of the business model to integrate regional externalities for maximizing the core capabilities itself and creating new technology applications and market segment. Fig. 4 explains the operational concept of this institute for technology commercialization. The institute would bridge the interface between the global research center and local academic or private institute, to use the R&D capabilities created by

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New Industrial development Upgraded Market Applications

Technology Capability & Applications

IIS Platforms wiki interface

Technology Capability & Applications Technology Capability & Applications

Upgraded Market Applications

Upgraded Market Applications Upgraded Market Applications

New Technology & Applications

Existing Industrial Technology

Technology Capability & Applications

Figure 3: Framework structure of institute for technology commercialization.

resource sharing and interaction between the two sides. This structure would connect the interface among the value or industrial chain by the role of this institute in the middle, thereby maximizing the synergy of platform economy.

Global research center

Global enterprise research center

Institute for technology commercialization Firm

Private enterprise research center

Firm

Universities

Public research institute

Regional R&D institute & innovation system

Figure 4: Operational concept of institute for technology commercialization.

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Customer Types Parties with Promising Technology Parties demanding marketing assistance parties demanding commercial applications Project Review Committee

Promotion

General Administration Office

CTG Platform

Technology Transfer R&D Support Business Development Marketing & TC Investment Legal Evaluation

Apply Evaluate Feasibiltiy Assessment Investment % R&D IP Ownership,% Total Investment & Proportion

Figure 5: Operational Procedure of institute for technology commercialization.

To elaborate, the operational procedure of the institute for technology commercialization is illustrated in Fig. 5, according to the aforementioned concepts. Firstly, the investment division should be established for investment promotion depending on the types of customers. Next, the technology consulting committee would accept and evaluate customers’ application cases in accordance with the feasibility studies. Further, the R&D and investment ratio, ownership of IPR, and service model of platform would be decided, to offer further support in human resource, legal service, business consulting, capital and incubation.

Development of KIBS in China Economic evolution in China A substantial body of literature provides a review of China’s economic development process which started in 1978 and has continued to the early 21st century. This process has involved many elementary transformations of the institutions that make up the economic system (Pyle, 1997; Hou and Hou, 2002). China’s industrialization over the past 30 years, from revolution to reform, has been marveled by the rest

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of the world, due to the amazing growth of its gross domestic product (GDP) at an average rate of about 10% (11.4% in 2007). As this review has demonstrated, the initial reforms in the late 1970s and early 1980s consisted of liberalizing trade with the outside world, instituting the household responsibility system in agriculture, through which farmers could sell their surplus on the open market. The challenge in this stage was to solve the problems of motivating labor to produce a larger surplus and to avoid economic imbalances that were common in developing economies. The reforms of the late 1980s and early 1990s focused on creating a pricing regulation and decreasing the role of the state in resource allocations (Dutta, 2005). Next, the reforms of the late 1990s focused on closing unprofitable sectors and dealing with bankruptcy in the financial or banking system. After the start of the 21st century, increased focus has been placed on several contemporary challenges such as energy, wage, labor relation, regional inequality, and ownership in industrial sectors after WTO accession in China (Appleton et al., 2005, Wei and Yu, 2006). Meanwhile, the increased focus of the new Communist Party leadership has been placed on narrowing the gap between city and village, rich and poor, industry and agriculture, or economic growth and environmental protection. Among the policy instruments, the Chinese government announced that the nation’s future economic policy is likely to be firmdriven in lieu of traditional government-driven growth. Secondly, consumption-based economic development will take greater priority over investment-oriented growth. In other words, the Chinese government intends to transform itself from a planner and dictator to a facilitator in a market-driven economy, to adjust the economic structure by increasing the sector shares in service sectors, such as the role of KIBS in hightech ICT industries (the growth trend of services as a proportion of GDP for the past ten years is as shown in Fig. 6).   Service



RI*'3

    Industry

    

Agriculture



















Source: National Bureau of Statistics of China (2006).

Figure 6: Trend of sector shares in China.

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Current status of KIBS in China For the discussion of services or KIBS in China, the development of this industrial concept in China started much later than western countries. Until the late 1990s, KIBS began to develop rapidly in China and played an important role in producing, distributing and using knowledge within the regional industrial chain. With the limitation by the stage of development, the legal system and related human resource, the service industry still has a relatively backward level compared to western companies. Manufacturing has been in the dominant position for a long time in China whilst service industry is subordinate to it. As the essential technology to KIBS, the development of information technology is therefore closely related to the development of KIBS. Information infrastructure is of special importance here. Telephone and computer coverage rates in China are much lower than the rest of the world. However, in recent years, the information infrastructure has greatly improved, including both the communication technology and infrastructure. Until the end of 2006, the number of internet users in China has exceeded 137 million (Peng et al., 2007). Furthermore, R&D activity in this field has been continuously improved for pushing the development of KIBS in China. However, concerns still exist because most KIBS companies need online communication and operation, such as E-Commerce, E-Government, or E-Banking, but the overall security of network environment is still a concern to companies. Therefore, a well-founded system and safer network environment is necessary to be established by relevant government ministries whilst intellectual property protection and standardization are also required. To elaborate, the operational model of KIBS in China could be classified into seven types, including R&D strategic alliance of large corporations, intermediaries for agriculture technology, adaptive foreign technology provider, incubators for academic research, R&D outsourcing services, technology exchange platform, and financing consulting services. In recent investigations (Qian et al., 2004, Peng et al., 2007) samples were attained from Beijing, Shanghai, and the Guangzhou Province. It showed that the income of those employed in services industries, especially KIBS, surpasses those in industry and agriculture 10%. Meanwhile, KIBS industries occupy the top 15 highest income industries as in shown Table 1. As the income of the state-controlled KIBS industry occupies an obviously advantageous position in these 15 industries, we could demonstrate that the role of government policy played an essential role in the service development in China.

Industrial Development in Kunshan City This section would introduce the industrial development situation of Kunshan City, before we further devise the Kunshan Institute for Technology Commercialization proposal in the following section. Situated in the Yangtze River Delta, Kunshan City lies between

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Table 1: Top 15 industries with highest income (RMB Yuan) (data in 2004). No

Industry

Average income

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Computer application service Air transportation industry Commercial economy and facto rage Pipeline transportation Tobacco processing industry Post and telecommunication industry Information and consultancy industry Engineering design Ocean environment Higher education in general Insurance Social science research service Petroleum and gas exploitation Other scientific research Scientific research service

38,810 30,641 28,776 27,338 23,923 23,582 23,056 21,861 21,316 21,241 21,121 20,963 20,796 20,570 20,065

Source: Peng et al., (2007).

the metropolitan Shanghai and the renowned historical and cultural city of Suzhou. Thus, it is just like a glittering pearl between Shanghai and Suzhou, and also an open city with a highly internationalized economy. Investors from 55 countries have invested in over 3500 investment projects. Total investment exceeds US$ 20 billion until 2007. Kunshan has become one of the regions with biggest inflow of international capital, yielding substantial profits for foreign direct investment (FDI) in China. The industry sharing proportion among agriculture, manufacturing, and service is 2.3%, 67.6%, and 30.1%. Until now, more than 10 of the world top 500 globally leading companies such as Alcartel, TotalFina, Tetra Pak, Novartis, Kone Elevators, Neste, DSM, Danisco, Hoechst, Avery, SCI, Texico, Texaco, Catpillar, Mitsubishi, Toyota, Maruaka, Makita, NSK and Itochu have invested in the industrial high-tech zone in Kunshan City, constituting the four leading industries in this area: electronic information, precision machinery, fine chemistry industry and consumer goods industry. For the electronic information sector, the region specializes in developing products related to computer and its peripheral products like laptops digital products, communication equipments, semiconductors and software. More than 800 manufacturing factories form the overall IT industry chains in Kunshan and six of the world’s ten biggest laptop manufacturing factories have established footholds in this area. In the precision machinery industry, it is also encouraged to develop automobile spare parts and special vehicles in this region by tax incentives. The emphasis is on developing equipment and plant industry, large moulds and mould frames and their extended products. There are more than 270 auto parts manufacturing plants forming the special vehicle industry with Toyota Forklift, San Ichi Heavy Industry, Kato Engineering Machineries.

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In addition, the focus of fine chemistry industry is directed at biotechnology, biopharmacy, and bio-farm chemicals sectors. Most of the investment is focused on R&D activities now. Food, costumes, and textiles are also emphasized in the sector of consumer goods development. Meanwhile, Kunshan City also invest in some service trade industry like modern logistic, banking and insurance, tourism and leisure recreation, consultation services and human resources training, to link the development of service and high-tech manufacturing. Modern agriculture emphasizing the cultivation and processing of farm products and by-products also attract some FDI capital to this area.

Kunshan Institute for Technology Commercialization As mentioned in earlier treatments of the IIS platform, BPO, theory of institute for technology commercialization and empirical cases, the Kunshan Institute for Technology Commercialization (KITC) could integrate the platform strategy, service package and network externalities to diffuse innovation. Service packages can be created and delivered with a high degree of customization including unique, selective, restricted and genetic services. Moreover, KITC can be applied to assist existing manufacturing in the process of value migration; it also provides a niche opportunity for SME development under highly intensive global competition in China.

Operation of KITC The operation of KITC is constructed by the IIS platform model, as illustrated in Fig.7. The core activities of KITC encompass R&D and commercialization, technology brokerage, new applications development, marketing research and intelligence, integration of foreign technology. KITC uses its core competence and value activities and combine external resources such as legal and investment consulting, business consulting, industrial research institute, financial and venture capital. KITC can help enterprises to develop new business, new products and technology. KITC not only develops platform infrastructure, provides exchange opportunities, facilitates mutual assistance, and shares product and sales information, but plays an integrating role to enhance the diffusion of industrial technology and the diversity of market development in Kunshan City.

Management of KITC The leading industries in Kunshan City concentrate on electronic information, precision machinery, fine chemistry industry and consumer goods industry. All of these are specialization-driven industries, so the management of KITC will focus on specialization. Fig. 8 illustrates the management of KICT.

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Business I

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Industrial Research Institute

IIS Platform

Non-technology

Business Consulting

R&D and commercialization Technology Brokerage New Applications Development; Marketing research and intelligence Integration of foreign technology

Business III

Business II

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Figure 7: KITC platform strategy.

The most indispensable element of KITC is specialization, of which enterprises could replenish and enrich resources in Kunshan and control trafficking. Moreover, it specializes in network and market-oriented operations; it is market and technology-driven; this in turn serves to result in a more market-driven management of KITC, enhance the Specialization

Specialized Network

Develop into IIS Operations

Develop Core Competence & Strategic Network

Replenishing & Enrichment Market-Oriented Operations

1. Develop into Professional and Specialized IIS Services Firms 2. Establish Organization and fundraising

Organizational Development

Trafficking control

Market & Technology Driven

1. Promote Experience Marketing 2. Investment 3. Develop Marketing Networks 4. Market Development

Develop Brand and Investment

Figure 8: Operating strategy of KICT.

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interaction between KITC and industries, integrate industry chain, and promote the industries in Kunshan City. In addition, in order to develop into IIS operations, KITC can not only develop into professional and specialized IIS services firms, but also establish organization and fundraising. In addition, KITC promotes experience marketing, offer investment consulting, develop marketing networks, and develop market. With developing core competence and strategic network, enterprises can gain information, improve organizational development and develop brands and investment.

Construction of KITC We will argue over the construction of KITC with the following section. In the beginning, the Chinese government, FDI will invest in KITC and entrust BOD to manage KITC with independent finance and business process outsourcing. Utilizing the hardware laboratories and software innovative intensive service as operating foundations, and wiki blog as an interactive interface, it targets both local and overseas clients. During the process, government plays an investor and consultative role in its participation in the BOD, while not interfering in the operation of KITC. Second, to avoid KITC becoming an academic research center, the operation of KITC should emphasize on specialized network, market-oriented operations, and market and technology driven. KITC recruits managers who are experts in industrial science and technology, business, management of technology from Taiwan or other countries. Third, to achieve the goal of self-sufficiency, KITC should accord priority to promote, expand business, build up a specialized network continually. The consumers of KITC consist of the following: individuals and firms of ICT industry in Kunshan City and Yangtze River Delta, firms in other religions which need technology and funding support, recipient of technology transfer and incubator, and foreign companies that need technology, legal and business consulting. Finally, the organization of KITC is as illustrated in Fig. 9. First of all, in the set up phase, the BOD leads the management of KITC, such as market intelligence and public relation. Following that, the committee hires professional managers in legal and business consulting, technology consulting, financial and venture capital. Furthermore, after field investigations, the project review committee provides various forms of support to develop new businesses.

Implementation of KITC The implementation of KITC is founded on the environmental dimension; the key elements are those of openness of environment and markets, collaboration with externalities, high-quality education, and environment for nurturing technology and innovation (Ohmae, 2005). In the implementation of KITC, four factors are of crucial importance, including covering effective communication, capital investment, corporations, and consumers. KITC is constructed in four phases. In Phase 1, KITC

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Project Review Committee

BOD

Business I

Business I

Business I

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Legal and Business consulting

Market Intelligence & PR

General Administration Office KITC

Figure 9: Organization of KITC.

has to provide infrastructure development and control information which is to secure information flow and market developments. Phase 2 then identifies niche market to excel and supplier affiliation and also includes external partner engagement for technology commercialization, sales channel development, and fundraising. Phase 3 is to syndicate the supply and demand and facilitate information flow. Finally, KITC can perform customer affiliation to provide specialist services, as illustrated in Fig. 10.

Openness

Externalities

Education

Phase 1

Infrastructure Development

Phase 2

Identify niche market to excel in Supplier Affiliation

Phase 3

Syndicate navigation Develop branding strategy

Phase 4

Customer affiliation Specialist Services

Technology & Innovation

Collection of internal/external resources & integration Innovation; Process flow; Business model; Software Operational organization; 4C strategy implementation Communication

Capital

Corporations

Consumers

Figure 10: Implementation of KITC.

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The implementation of KITC not only helps firms in Kunshan to gain and integrate resources, but also to develop innovation, specialization, management and professional knowledge. Therefore, KITC could be the IIS platform and fulfill the 4C strategy to achieve the goal of industrial chain integration and specialization.

Conclusion This research offers a new business model of knowledge-based service enterprises, focusing on the importance of intermediaries. Industry intermediaries can integrate platform strategies, service packages and network externalities, thereby facilitating innovation. Service enterprises share and externalize their core competence to serve different types of customers through the service process, which requires network interaction of externalities. Highly customized service packages can then be created, delivering unique, selective, restricted and genetic services. This study also details the operational procedure of service platforms by supplier affiliation, customer affiliation, and development of infrastructure and syndicated navigation. The case of Kunshan Institute for Technology Commercialization is used to illustrate the empirical operation of such an intermediary platform in resource syndication of a regional industrial chain such as Kunshan City. These research results are not without academic and practical significance. Not only does it provide a new business model to aid existing manufacturing vis-à-vis the process of value migration, it may prove highly critical to SME development in China amid intensive global competition.

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R&D Collaboration and Innovation in China’s Emerging Market ͣWUBIAO ZHOU Nanyang Technological University

Z

hou Wubiao is an Assistant Professor in the Division of Sociology at NanyangTechnological University. He obtained his Bachelor of Law from Peking University and his PhD from Cornell University in 2006. He is trained in economic sociology, organizations, and quantitative methods.Currently, he is working on several projects in four areas: entrepreneurship, technological innovation, corporate governance, and organizational diffusion. Recently he has a paper accepted by World Development and has several other papers under journal review.

Abstract: Why have firms been increasingly engaging in R&D collaborations? What are the implications of such collaborations on R&D performance? Previous research suggests that R&D collaborations are a response to either increasing foreign competition or the need for organizational learning. However, less is known about the relationships between the two rationales and different strategies of R&D collaborations. Moreover, there exists theoretical indeterminacy, as well as rare empirical test, on the impact of collaborations on R&D performance. Using recent large sample firm-level survey data from China, this study has the following findings. First, Chinese firms participate in R&D collaborations in order to both manage uncertainty from increasing foreign competition and facilitate organizational learning. Increasing foreign competition, however, may account more for R&D collaborations with other firms; and organizational learning more for R&D collaborations with universities and research institutes. Second, R&D collaborations have a positive, independent effect on R&D performance, net of the inhouse R&D intensity of the firm and other firm-specific characteristics. Keywords: R&D collaborations; Foreign competition; Organizational learning; Chinese firms

Introduction In recent decades, the role of collaborative alliances in the innovation process has become increasingly important. Collaborative alliances in the innovative process here mean contractual or long-term R&D collaborations and can take different forms or strategies. Broadly speaking, there are two strategies. One is R&D collaborations among firms; the

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other between firms and various research institutions, which include universities and public or private research institutes (Arora and Gambardellas 1994; Doz et al., 2000; Owen-Smith et al., 2002; Powell et al., 1996). Previous research suggests that the increasing R&D collaborations are a response to either increasing foreign competition (e.g., Link and Bauer, 1989) or the need for organizational learning resulting from recent technological changes (e.g., Arora and Gambardellas, 1990, 1994; Powell et al., 1996). Yet, we still do not have much knowledge about the relationship between the rationales and different forms or strategies of R&D collaborations. Do both rationales play a role in all forms of R&D collaborations? Is one rationale more important for understanding one of the strategies? On the other hand, although we have learned the increasing significance of R&D collaborations, we are still not certain about the impact of such collaborations on R&D performance. Do R&D collaborations facilitate innovation in the firm? Or, as one may argue from the transaction cost perspective, they might be not cost-effective? This paper aims to answer these questions by investigating the rationales behind the rapid growing interorganizational R&D collaborations and their impact on firm competitiveness in China. Using recent large sample firm-level survey data from China, this paper finds that Chinese firms participate in R&D collaborations in order to both manage uncertainty from increasing foreign competition and facilitate organizational learning. Increasing foreign competition, however, may account more for R&D collaborations with other firms; and organizational learning more for R&D collaborations with universities and research institutes. This paper also finds that R&D collaborations have a positive, independent effect on R&D performance, net of the in-house R&D intensity of the firm and other firm-specific characteristics. This study can be viewed as a part of a broader research program dealing with the changing nature of the organizational structures of the firms under increasing world competition and rapid technological development. Since 1980s, scholars have argued that the locus of innovation has shifted from large firms to a network of interorganizational relationships (Arora and Gambardellas 1990, 1994; DiMaggio, 2001; Hagedoorn, 1995; Link and Bauer, 1989; Powell et al., 1996). While this claim has been tested against only a few high-tech industries, especially biotechnology, this study suggests that the emergence of interorganizational R&D collaborations may be a general phenomenon because it occurs in many less high-tech industries in China as well. Moreover, this paper offers direct empirical tests of the relationship between increasing world competition and rapid technological development on one hand and different forms of R&D collaboration on the other. This study may contribute to our understanding of how indigenous firms, especially those in the less-developed economies, can enhance their competitiveness under global competition. Taking Chinese firms for example, one line of research suggests that domestic firms can keep competitiveness by mimicking the organizational practices and arrangements of Western firms (e.g., Guthrie, 1999). Another line of research, on the other hand, stresses the importance of technological innovation for domestic firms to survive and develop. In this line of research, increasing investment in in-house R&D

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is considered a plausible way to compete with foreign invested or multi-national firms (Hallward-Driemeier et al., 2002; Jefferson et al., 2001). This study adds to the second line of research by arguing that R&D collaborations also have positive effects on technological innovation for domestic firms, thus helping them gain a niche in the more and more globalized market. This paper is organized as follows. The second section briefly reviews the recent literature on the rationales and impact of R&D collaborations. The third section analyzes why firms engage in R&D collaborations and how R&D collaborations affect firm competitiveness in China. The fourth section discusses the data and methods used to test the hypotheses. The fifth section reports and discusses the statistical results. The sixth section is the conclusion.

Literature on Rationales and Impact of R&D Collaborations Rationales of R&D collaborations According to the literature, organizations create interorganizational collaborations including R&D alliances in order to manage environmental uncertainty, satisfy their resource needs, and facilitate organizational learning (Gulati, 1998; Gulati and Gargiulo, 1999; Kogut, 1989; Pfeffer and Salancik, 1978; Powell et al., 1996; Uzzi, 1996). Roughly speaking, two rationales for interorganizational collaborations can be identified. One rationale considers interorganizational collaborations as a strategic response of firms to manage environmental uncertainty: firms form alliances with research institutions or other firms to enhance their competitive positioning or market power. Another rationale focuses on the learning benefits of interorganizational collaborations: alliances can enhance the capability of the firms by facilitating knowledge sharing between the partners. To account for R&D collaborations, these two rationales may complement with each other. Environmental uncertainty, from the demand side, answers why firms participate in R&D alliances. And organizational learning, from the supply side, helps understand why and how firms benefit from R&D alliances. Exogenous environmental changes often pose a threat to the competitiveness of the incumbent firms, thus facilitating alliances among the incumbents to reduce uncertainty and share risk. New entrants into an existing market are a frequently described change in environmental conditions thought to produce interdependence and the need for collaborations among the incumbents (Doz, Yves L, 1996; Doz et al., 2000; Van de Ven, 1992). Changes in common market opportunities — such as the emergence of the European Economic Community — is another frequently described change in environmental conditions creating interdependence that leads to collaboration (Urban and Vendemini, 1992; see also Doz et al., 2000). This logic of environmental uncertainty has been extended to the study of R&D alliances as well. Link and Bauer (1989), for instance, identified the increase of foreign competition in an industry as the most important predictor of growing co-operative research in the United States, as well as in many other industrial nations. Under increasing

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foreign competition, there is an increasing need to combine complementary assets among domestic firms, universities, and research institutes in order to speed products to markets, develop new technologies, and reduce lead times (Freeman, 1991). Organizational learning becomes important for R&D collaborations as a result of the rapid development in the division of innovative labor. Up to 1970s, most technological innovations introduced by many firms resulted primarily from systematic in-house R&D investment. In recent decades, however, technological development has exhibited some new features in a number of industries, so that most firms were unable to internalize all the resources necessary to produce and commercialize new technologies (Arora and Gambardellas, 1990). First, many new discoveries require a large investment and considerable time and thus cannot be well developed within one firm. Second and more importantly, scientific knowledge for many new technologies are not concentrated within one firm any more but are diversely distributed; and the pathway of technological development becomes uncharted. As a result, “sources of innovation do not reside exclusively inside firms; instead, they are commonly found in the interstices between firms, universities, research laboratories, suppliers, and customers” (Powell et al., 1996). Consequently, the degree to which firms learn about new technological opportunities is a function of their participation in R&D collaborations (Levinthal and March, 1994). An important implication of the organizational learning perspective is that to gain more learning benefits from R&D collaborations requires a firm to be active in the research process (Arora and Gambardellas, 1994; Freeman, 1991; Hagedoorn, 1995). It is because “[p]assive recipients of new knowledge are less likely to appreciate its value or to be able to respond rapidly” (Powell et al., 1996, p.119). To become an active learner, a firm must be an expert at both in-house research and co-operative research with external partners, so that it has the ability to evaluate and utilize research done outside and can get access to news and resources that cannot be generated internally (Arora and Gambardellas, 1994; Nelson, 1990). In summary, the existing literature suggests that firms form R&D collaborations mainly for two reasons. First, from the demand side, R&D collaborations are formed by firms to maintain competitiveness under environmental uncertainty, especially, under increasing foreign competition. Second, from the supply side, R&D collaborations can facilitate organizational learning. And collaborative research is not a substitute for inhouse research. On the contrary, firms can learn more from collaborations by engaging more in in-house research. From the existing literature, however, it seems not very clear yet about the relationship between the two rationales and different forms/strategies of R&D collaborations. Previous research has suggested that firms set up a number of strategies of external R&D linkages in order to satisfy different objectives of the firm. As stated above, two different strategies of R&D collaborations are identified in the existing literature. One is R&D linkages with other firms, and another is R&D linkages with universities and research institutes. Many studies, however, have focused on one strategy only, which in most cases is R&D

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collaborations among firms. There are studies that have explicitly differentiated these different strategies and tried to account for them (e.g., Arora and Gambardellas, 1990, 1994; Link and Bauer, 1989). However, such research usually focuses on a single rationale. Link and Bauer (1989), for example, focused on the increasing foreign competition. Arora and Gambardellas (1990, 1994), on the other hand, emphasized learning benefits of R&D collaborations. Thus, we do not know much about the relationship between the two rationales and different R&D collaboration strategies yet.

Impact of R&D collaborations According to the resource dependence theory, an organization’s competitiveness is contingent on its ability to obtain resources from its environment (Pfeffer and Salancik, 1978). R&D collaborations help firms better absorb new knowledge from the environment and may thus improve firm performance. This has two reasons. First, unlike in-house research, co-operative research brings new information about technological knowledge in a swift way. As put by Powell et al., (1996, p.120), R&D collaboration is “both an admission ticket to an information network and a vehicle for the rapid communication of news about opportunities and obstacles.” Second, co-operative research helps a firm absorb tacit (meaning in-depth and highly inter-connected) as well as dense (meaning tightly packed and full of relationships) knowledge, which cannot be transferred via arms length market relationship (Liebeskind et al., 1996). On the other hand, scholars have long argued that there are serious problems associated with collaborative research (Arrow, 1962; Nelson, 1959; Arora and Gambardellas, 1990). According to the transaction cost perspective, the co-operative parties may lack trust; the joint project may be too complex; relinquishing control may be difficult; each party’s ability to learn new skills may be differential; and so on. All these could result in co-ordination problems and appropriation concerns, thus creating barriers for effective collaboration (Gulati and Singh, 1998; Powell et al., 1996; Williamson, 1991). Thus, whether a firm can benefit from R&D collaborations is not certain and is largely contingent on the scale of the transaction costs. Besides the theoretical indeterminacy on the impact of R&D collaborations on firm performance, there also exists rare empirical research testing the relationship between R&D collaborations and firm competitiveness. The indirect evidences suggest that R&D collaborations might improve firm performance. Andersson et al., (2002), for example, found that a high degree of firms’ technical embeddedness — information exchange among firms regarding R&D — is positively related to their market performance. Using 225 independently owned companies from the biotechnology industry, Powell et al., (1996) also found empirical support for a positive relationship between degree of centrality in a R&D network and employment growth rate. Nevertheless, little research has been done which directly estimates the effect of R&D collaborations on the competitiveness of a firm.

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R&D Collaborations in China: Rationales and Impact Increasing foreign competition The market-oriented economic reform, together with the open-door policy, has greatly intensified competition from domestic and especially foreign companies for Chinese firms since 1978. First, the economic reform lifted ideological and regulatory restrictions on the entry of new firms, such as township and village enterprises and private enterprises, which are not owned by the state. The new entry firms not only competed with each other for market power, but also created severe pressure on the existent state-owned enterprises, many of which began to produce for the market since the mid-1980s (Naughton, 1995). Second, the open-door policy removed much of the barriers for the entry of foreign products and foreign capital. Since the early 1980s, therefore, foreign products had increasingly entered the Chinese markets; and foreign capital could virtually invest in the majority of the industrial sectors in China as a result of generous permission from local governments. A large amount of foreign-invested companies1 had thus emerged in China in order to take advantage of the potentially giant Chinese market (Chow, 2002; Huang, 2003). With more adequate capital, better management, and especially much more advanced technological capacity, foreign-invested companies, as well as foreign companies which had not yet invested directly in China but had already sold their products in the Chinese market, consisted of formidable competitors to domestic Chinese firms. In a wide range of industries ranging from low-tech industrial sectors such as the apparel sector to relatively high-tech sectors such as the electronic equipment sector, foreign-invested companies had dominated the domestic market and the foreign export, accounting for at least 40% of the national industrial output by the late 1990s. As a whole, they also accounted for 19.45% of patents applied for and 18.97% of patents actually granted in 2000 in China. In many industries, foreign-invested companies had held even much higher proportions in patents application and approval. In the stationary and officesupplies sector, for example, foreign-invested companies accounted for 82.54% of all patents actually granted in China in 2000 (Wang and Chen, 2005). Under severe competition from foreign companies and foreign-invested companies, many domestic firms, some of which once had most famous brand names in China, were either forced out of the market or taken over by their foreign competitors. In 1998, Kodak — a major multi-national corporation — acquired almost all domestic firms in the photosensitive-materials sector except Luckyfilm, which has since been the only remaining major domestic firm, and obtained 50% of the Chinese market. Coco Cola and Pepsi also acquired seven major domestic firms producing carbonated beverages, 1

Foreign-invested companies here refer to all three types of firms that are located in China and related to foreign capital: jointly funded enterprises, co-operative ventures, and entirely foreignowned enterprises (Chow, 2002).

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forcing these once famous Chinese brands to be out of the market (Wang and Chen, 2005). As a result, domestic firms had to think of ways in order to stay competitive if they did not want to lose to their foreign competitors. And technological upgrading may be the most commonly used strategy for Chinese firms to compete with their foreign competitors. Previous research has studied how Chinese firms acquire new technologies through increasing investment in in-house R&D or purchasing via the market (HallwardDriemeier et al., 2002; Jefferson et al., 2001; MOST, 2001), both of which, however, are not necessarily effective for firms to upgrade their technological level. As stated above, in-house research may not bring new information about technological knowledge in a swift way; and purchasing via the market cannot help a firm absorb tacit as well as dense knowledge. Thus, as in many industrial countries, Chinese firms have also increasingly participated in R&D collaborations (MOST, 2001). Similar to what have been found in the United States (Arora and Gambardellas, 1990), Chinese firms formed roughly four types of external R&D linkages (MOST, 2001). The first type is research agreements with universities; the second one with governmentowned research institutes; the third one with other firms; and the fourth one with private research institutes.2 Evidence not reported here shows that these different types of R&D collaborations complement each other, thus enabling the firm to gain access to a specific set of tangible and/or intangible resources necessary for technological innovation. As in many developed countries, the increasing R&D collaborations in China may also be a response to the increasing foreign competition, because there is an increasing need to combine complementary assets among domestic firms and research institutions under increasing foreign competition (Freeman, 1991; Link and Bauer, 1989). Zhejiang Shangfeng Company — one of the firms that I visited during my field research in 2004 — provides a good example here. Established in the early 1970s as a village-owned enterprise, Shangfeng Company has since been the largest domestic manufacturer for cooling equipments in China. Since the early 1990s, however, international companies such as BAC, Carrier, York, Trane from United States, TUV and Howden from Germany, GEA from France, and Hitachi from Japan have all entered the Chinese cooling equipments market; many of them even have established subsidiaries in China. Such foreign competition created severe pressure for domestic Chinese manufacturers like Shangfeng Company. To cope with this pressure, Shangfeng proposed a five-year (2000–2004) plan in 1999. According to this plan, the company would increase its R&D expenditures each year from 3.5% of the yearly sales income in 1999 to 6.0% in 2004; moreover, it would strengthen R&D collaborations with some well-known

2

Private research institutes are still rare in China. Most of them were government-owned research institutes before the R&D reform but became private after the reform. Some of them, however, were established by scientists who were still employed by universities or government-owned research institutes (MOST, 1999).

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technological universities in China to learn new developments in cooling equipments technologies; in addition, it would negotiate with several domestic and even foreign firms to form inter-firm R&D collaborations (Zhejiang Daily, September 28th, 2002). Based on the above reasoning, I hypothesize that: Hypothesis 1: The higher the foreign competition that a domestic Chinese firm faces, the higher the probability that it would engage in R&D collaborations.

Division of innovative labor and organizational learning Increasing foreign competition accounts for the increasing R&D collaborations in China from the demand side. I suspect, however, that the supply side factor — organizational learning — may also play a role in the increasing R&D collaborations in China. Being more and more integrated into the World economy since China adopted the open-door policy, Chinese firms cannot escape the new reality of the division of innovative labor. As discussed above, the scientific knowledge required for technological innovation in recent decades has become more complex and more diversely distributed among universities, government or private research institutes, and firms (Arora and Gambardellas, 1990, 1994; Powell et al., 1996). Moreover, the new national R&D system has also strengthened the division of innovative labor in China, as I will discuss below. The increasing division of innovative labor will result in the need for organizational learning, which may then facilitate R&D collaborations. The new national R&D system is a result of the market-oriented economic reform. Under the planned economy (1949–1978), R&D activities in China were administered at the national level. Except for a few R&D activities, which were conducted in elite universities or large state-owned industrial enterprises, most of the R&D activities were assigned to government-owned research institutes under the Chinese Academy of Sciences (MOST, 2001). This research infrastructure enabled the concentration of all national R&D capacities in the hands of the central government, which then deployed all the capacities to explore key technologies that were crucial for national security (e.g., nuclear technologies) or national economy (e.g., technologies for oil exploration and discovery). As the market reform started, however, the Chinese government realized that the old R&D infrastructure was not suitable for stimulating economic growth and thus must be reformed. The reform of the R&D infrastructure abolished the old highly centralized R&D system and introduced a new one, which emphasizes the division of innovative labor between government-owned research institutes and universities on one hand and firms on the other (MOST, 2001). After the reform, government-owned research institutes and elite universities are required to focus on: (1) basic theoretical and experimental research and (2) those R&D activities that have high social returns but low economic returns or that are crucial for national security. Firms, on the other hand, are responsible for most of the goal-oriented R&D activities that could reap rewards quickly. In accordance

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with the new national R&D system, the funding source of R&D activities has also been diversified. After the R&D reform, government funding supports primarily basic research and those R&D activities that benefit the whole nation, and firms become the major source for goal-oriented research (see Fig. 1). The new R&D system, which strengthens the division of innovative labor in China, necessitates organizational learning among various agents involved in R&D, thus facilitating R&D collaborations. Under the new division of innovative labor, many Chinese firms engaging in R&D activities could not conduct all of the R&D activities alone for developing new products because a significant part of the knowledge required for new products is divided between research institutes and universities on one hand and firms on the other. Indeed, most of the research and experimental scientists in China are still in universities, government-owned research institutes, and the newly emerged private research institutes; while most of the firms usually only have R&D experts who are less educated and less experienced than research and experimental scientists. Moreover, Chinese firms have difficulties in obtaining technologies via the market because the market for technologies has not well developed yet in reform era China (MOST, 1999). Thus, Chinese firms often find it necessary to collaborate with universities and research institutes for technological innovation. Universities and research institutes, on the other hand, often consider it lucrative to engage in collaborative research with firms, as firm financing has become an important source for their R&D activities (see Fig. 1). The example of Zhejiang Shangfeng Company can illustrate why organizational learning could facilitate Chinese firms to engage in R&D collaborations. Although the company had probably the most sophisticated within-firm research center in cooling equipments in China, it knew that its own research staff was not capable enough because it had no ability to conduct high-level experimental research in heat physics, technical physics, fluid dynamics, computer science, etc, which is necessary for developing more advanced 100

Percentage

80 60 40 20 0 Whole nation

Government funding

Research institutes Firm financing

Firms

Universities

Foreign and other funding

Figure 1: Funding sources of R&D in the whole nation and three major agencies in 2000. Source: Ministry of Science and Technology, 2001.

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cooling equipments. Thus, ever since the early years, the company has gradually built long-term co-operative research relationships with three universities: Shanghai Jiaotong University, which is strong in heat physics and technical physics; Beijing University of Aeronautics & Astronautics, which is ranked the best in fluid dynamics in the nation; and Zhejiang University, which is strong in computer science and engineering. Our objective is to test whether organizational learning is responsible for the increasing R&D collaborations in China. However, this hypothesis cannot be tested directly since there are no available measures for the need for organizational learning. Thus, we are constrained to testing an important implication of the organizational learning perspective. The existing literature, as reviewed above, has shown that if the need for organizational learning increases the likelihood for R&D collaborations, then to gain more learning benefits from R&D collaborations requires a firm to be active in the research process (Arora and Gambardellas, 1994; Freeman, 1991; Hagedoorn, 1995; Powell et al., 1996). In other words, in-house R&D intensity should be positively correlated with outside R&D collaborations, given that a firm is inclined to learn effectively from its R&D partners. Therefore, I hypothesize that: Hypothesis 2: The greater the in-house R&D intensity, the higher the probability that a Chinese domestic firm would engage in R&D collaborations.

Relationship between rationales and strategies As stated above, the literature has differentiated multiple types of R&D collaborations into two different strategies, namely, R&D linkages with other firms and R&D linkages with universities and other research institutes (Arora and Gambardellas, 1990, 1994; Link and Bauer, 1989). I have also shown above that these two broad categories can also be employed to describe R&D collaborations in China. As mentioned in the previous section, however, it is still not very clear from the existing literature regarding the relationship between the two rationales and the two different strategies. Can both rationales explain partly each strategy? Is one rationale more relevant in explaining one of the strategies? I believe that both rationales play a role in explaining each of the strategies. In other words, hypotheses 1 and 2 hold for both strategies of R&D collaborations. On one hand, under increasing foreign competition, it has been suggested that there is a need to combine all available complementary assets among firms, universities, and research institutes; and using multiple strategies can help a firm achieve this more easily (Link and Bauer, 1989). On the other hand, to learn more effectively and more efficiently from the environment, firms also need to adopt different strategies in order to gain access to specific sets of tangible and/or intangible resources necessary for technological innovation, which may be located neither within themselves nor in one specific type of other organizations alone, but in multiple locations (Arora and Gambardellas, 1990, 1994; Gulati, 1998). Thus, it can be argued that the two strategies are both demand-driven and supply-driven.

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Nevertheless, I contend that the explanatory power of each rationale varies for different strategies. On one hand, increasing foreign competition may better explain R&D collaborations with other firms. According to a strategic interdependence perspective, when foreign competitors enter a new market, they can create a common threat to the incumbent domestic firms; as a result, the incumbents may respond to their interdependence by collaborating with each other (Doz et al., 2000; Gulati, 1998; Link and Bauer, 1989; Van de Ven, 1992). Such interdependence, however, seldom exists between domestic firms on one hand and universities and research institutes on the other because the latter is not affected much by the entry of foreign firms. Therefore, although increasing foreign competition could facilitate R&D linkages between domestic firms and universities and research institutes as well, it may play a more important role in facilitating R&D collaborations among firms. On the other hand, organizational learning may better explain R&D collaborations between firms on one hand and universities and research institutes on the other. Firms usually hardly have the ability to conduct more basic research alone. As a result, they often find it necessary to collaborate with universities and research institutes and their R&D agreements with the latter tend to focus on more basic research objectives (Arora and Gambardellas, 1990), as illustrated in the example of Zhejiang Shangfeng Company above. If transaction costs for a specific co-operative project increase, the firm may change its partner but cannot entirely internalize the R&D activities. In order to benefit from such R&D agreements, firms must also have the ability to evaluate and utilize the knowledge obtained through the agreements (Arora and Gambardellas, 1994; Nelson, 1990; Powell et al., 1996). Firms, however, may be less motivated to collaborate with other firms for the learning benefits. The purpose of R&D collaborations among firms often aims to combine complementary assets (Doz et al., 2000; Gulati, 1998). Such collaborations usually focus on more applied-research objectives or rather downstream activities of the innovative cycle (Arora and Gambardellas, 1990), which the firm may have the ability to conduct alone but may not be cost-effective to do so. As such, firms want to learn from each other, but usually in the areas that they do not have comparative advantages. However, because firms usually have the ability to do such research by itself, they may internalize the R&D activities if transaction costs for a specific co-operative project increase. To benefit more from such collaborations, firms still need to have some internal ability to evaluate and utilize research done outside. But the link between internal ability and such collaborations may not be as strong as that for collaborations with universities and research institutes because it would be easier to evaluate and utilize research done by other firms. Based on the reasoning above, I hypothesize that: Hypothesis 3: Increasing foreign competition may play a more important role in facilitating R&D collaborations among firms; and organizational learning more in facilitating R&D collaborations between firms on one hand and universities and research institutes on the other.

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The Impact of R&D collaborations on the firm The existing literature suggests that R&D collaborations may help firms better absorb new knowledge from the environment and may thus improve firm competitiveness; nevertheless, there are also transaction costs associated with R&D collaborations and thus whether a firm can indeed benefit from collaborations is contingent on the scale of the transaction costs. I argue, however, that many firms would self-select into the ways in which the transaction costs can be mitigated or controlled. In practice, most R&D collaborations typically reflect more than just a formal contractual exchange; beneath most formal contracts lies a sea of informal relations, which could help solve part of the high transaction costs problem (Powell et al., 1996). In a country like China where contractual rights are neither well respected nor effectively protected, firms often choose their R&D partners with which they have good previous relations, be an interpersonal relationship between staff or a previous collaborative relationship on other matters. In addition, most R&D collaborations in China are intermediated by either local governments or socially reputable figures (MOST, 2001; Zhejiang Daily, 28 September 2002). Though not without costs, the mediation of local governments or socially reputable figures is often cost effective because it increases trust and even facilitates social obligations between the partners (Gulati, 1995). Besides using informal relations, firms also mitigate transaction costs through forming long-term relational contracts with their R&D partners. Long-term relational contracts could mitigate opportunistic behaviors and facilitate goodwill between partners and are thus observed widely in many contractual relationships (Dore, 1983; Williamson, 1991). In the United States, for example, long-term collaborations consist of a substantial proportion of R&D collaborations (Arora and Gambardellas, 1994; Powell et al., 1996). And as a matter of fact, research suggests that many initial contractual relationships also tend to change into long-term collaborations in the long run (Uzzi, 1996). Based on the above reasoning, I argue that the benefits of R&D collaborations would outweigh the costs. Therefore, we would observe substantial net positive effects of R&D collaborations on firm competitiveness, as hypothesized below: Hypothesis 4: Domestic firms in China that engage in R&D collaborations would have higher performance in technological innovation.

Data and Methods Data The data used here is obtained from the survey on competitiveness, technology, and firm linkages (CTFL) during 1998–2000 in China. This survey was undertaken by the World Bank in collaboration with the Enterprise Survey Organization of China’s National Bureau of Statistics in 2001. The survey team selected 300 firms from each of

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the five largest cities — Beijing, Shanghai, Tianjin, Guangzhou, and Chengdu. In each city, the sample firms were drawn within 10 industrial sectors, which reflected China’s current or potential competitive strengths. The 10 sectors include five manufacturing sectors — apparel and leather goods, consumer goods, electronic components, electronic equipments, and vehicles and vehicle parts, and five service sectors — information technology, communication, business logistics, advertising, and marketing. Among all the sample firms, 998 are from the manufacturing sectors and 502 are from the service sectors. Like those in the manufacturing sectors, firms in the service sectors also engaged substantially in both in-house and collaborative R&D activities. So, both manufacturing and service firms are used for hypothesis testing. The survey is based on a two-part questionnaire. The first part, which was completed by firm accountants, is about a firm’s basic profile such as ownership, revenues, costs, labor force, etc. The second part, which is based on face-to-face interviews with managers, is about information on competition, R&D activities, external relationships with research institutions and governments, etc. Most accounting data cover the 3-year period (1998–2000), while most interview data are only for one year i.e., the year 2000. The survey includes both domestic firms and foreign-invested companies, which are identified by having foreign partner(s). For the purpose of this paper, I drop all the 382 foreign-invested companies because we want to understand R&D collaborations of domestic firms only. This procedure results in the working sample of 1,118 firms wholly owned by domestic agents. Further analyses show that even if we use the whole sample, all results reported below still hold robustly.

Dependent variables R&D collaboration with universities or research institutes in 2000 and R&D collaboration with other firms in 2000 These are the two dependent variables for testing hypotheses 1–3. The original question for these variables is whether a firm had a formal contractual or long-standing relationship with any of the following four types of institutions — universities, government-owned research institutes, private research institutes, and private companies in 2000. In consistent with Arora and Gambardellas (1994), I grouped universities, governmentowned research institutes, and private research institutes as universities or research institutes. Both variables are binary variables.

Number of new products introduced since 1998 This is one measure for R&D performance — the dependent variable in hypothesis 4. The original question is how many new products the firm had introduced since the beginning of 1998 within the main business line. According to Schumpeter (1934), the more the new products introduced into the firm, the more innovative the firm is. As this variable consists of non-negative integers only, it is a count variable.

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Number of patents actually granted since 1998 This is another measure for R&D performance commonly used in the literature. Here, patents actually granted include both those granted in the home country (China) and in foreign countries (mainly the United States). It is also a count variable. Theoretically, a Chinese firm can get patent protection for the same invention in both China and other countries. So, there might be over-counting of patents for the firms that obtained patents in multiple countries. The survey, unfortunately, does not enable us to learn whether a firm got either a foreign patent or a Chinese patent or both for the same invention or not. However, the data show that there were only four out of the total 1,118 firms that had obtained patents in foreign countries. And for the four firms, the number of foreign patents granted ranges from two to six only. Therefore, over-counting may not be a big problem here. To be cautious, I also conducted analyses using number of patents actually granted in China only during 1998–2000 as the dependent variable. The results virtually do not change.

Independent variables Foreign competition As discussed above, foreign competition comes from two sources: foreign companies that had not yet invested in China and foreign-invested companies that had invested in China. The survey took note of how many competitors the firm had with its main business line in 2000 and of those competitors how many are (1) wholly owned foreign firms; (2) domestic firms that have foreign ownership and (3) domestic firms that have no foreign ownership. Therefore, I measure foreign competition as the percentage of competitors that are either wholly owned foreign firms or domestic firms that have foreign ownership. As the distribution of this measure spreads widely, its logarithmic form is used in the analysis. The data also provided a less satisfied measure for foreign competition: the percentage of total sales supplied by imports in the domestic market in 2000. This measure takes into account competition from foreign companies only but not foreigninvested companies. Nevertheless, this measure is used for robust check. The zero order correlation coefficient between the two measures is 0.31.

In-house R&D intensity I have two measures for this variable. One measure is the average percentages of total R&D personnel (total R&D personnel as a percentage of the total number of employees) from 1998 to 2000. Another measure is the average ratios of R&D expenditures, which include labor compensation and capital expenditure within the firm, to the total sales income from 1998 to 2000 — a standard measure used in the literature (see, e.g., Arora and Gambardellas, 1994). For both measures, taking three-year averages help smooth out the yearly fluctuations in in-house R&D intensity. For both measures, logarithmic

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form is used in the analysis. The zero order correlation coefficient between these two variables is 0.69.

R&D collaboration with universities or research institutes since 1998 and R&D collaboration with other firms since 1998 These are the two independent variables for testing hypothesis 4. These two variables equal 1 if a firm had a formal contractual or long-standing R&D collaborative relationship in either 1998 or 1999 or 2000, 0 otherwise. These variables may pick up both the direct effect of current R&D collaborations and the lagged effect of previous R&D collaborations. For robust check, I also used R&D collaboration with universities or research institutes in 1998 and R&D collaboration with other firms in 1998, assuming that the effect of R&D collaborations may lag for a couple of years.

Control variables A number of firm-specific variables are controlled because previous research suggests that many firm-specific attributes can also affect interorganizational R&D collaborations (e.g., Arora and Gambardellas, 1994; Nelson, 1990). Firm age is the difference between 2001 and the year when the firm was established. Younger firms face liability of newness and may thus be more inclined to alliances (Hannan and Freeman, 1989; Stinchcombe, 1965). Firm size is the average sales income during 1998–2000. Greater size indicates a more extensive hierarchy and is seen as an alternative to alliances in the transaction cost literature (Powell et al., 1996). Firm scope is the total number of products that a firm produced in 2000. Some organizational ecologists argued that firms with a large scope may operate under a set of routines that repeatedly propel them to launch new organizational models such as collaborations and to introduce new products (Sorensen et al., 2006). Larger scope may also bring scope economies and help adjust more easily to the demands of shifting environmental conditions, thereby improving firm performance (Teece, 1986). The logarithmic form of the above three control variables is used in the analysis for their skewed distribution. Government ownership is the percentage of shares owned by all levels of governments in 2000. Government-owned enterprises may be less concerned about firm efficiency and R&D activities because firm managers have less incentive to do so (Chow, 2002; Naughton, 1995). Market share is the percentage of the total sales supplied by the firm in the domestic market of the firm’s main business line in 2000. This variable is also taken for its logarithm to adjust for its dispersed distribution. I contend that market share has a quadratic relationship with the propensity to R&D collaborations. That is, higher market share may encourage R&D collaborations in order to get even higher market share before market share reaches a threshold, but may discourage R&D collaborations beyond the threshold as the firm obtains a monopoly status.

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The characteristics of the CEO (General Manager) may also affect both R&D collaborations and R&D performance of the firm. Education of the CEO is a binary variable, which equals 1 if the CEO has a college degree or above, 0 otherwise. Those CEOs who have a college degree or above may have closer relationships with universities or other research institutions and may also be more capable. Job tenure of the CEO is the number of the years for which the CEO had held the current position. Longer job tenure may suggest more knowledge about the firm, thus helping the CEO make less mistakes in decision-making. Many contractual R&D collaborations may last for several years. Some many even turn into long-term alliances. Therefore, when testing hypotheses 1–3, I also control for two lagged variables — R&D collaborations in 1999 or in 1998, respectively. Including the lagged variables also help control for the unobserved heterogeneities, such as interpersonal relationships between the key staff of the partners, which may have correlations with both the dependent and independent variables. Finally, previous research suggests that R&D collaborations may vary among different sectors (e.g., Arora and Gambardellas, 1990) and among different geographic locations (e.g., Freeman, 1991; Saxenian, 1996). Thus, the dummies for the 10 sectors and the five cities are also controlled.

Model specification The probit model is used for testing hypotheses 1–3. Additional tests using the logit model yield virtually the same results. In the probit model, the conditional probability of y = 1 given x is defined in the following equation: Pr( yi = 1 | xi ) = F ( xi β) =

∫

xi β −∞

⎛ t2 ⎞ exp ⎜ − ⎟ dt ⎝ 2⎠ 2π

1

(1)

where yi is R&D collaboration in 2000 for each firm, which takes on the value of 0 or 1 only; xi is a vector of the firm-specific covariates; β is a vector of the effects of the covariates on the dependent variable; F is the link function, which is assumed the standard normal cumulative distributive function as in the right-hand side of Eq. 1. Our dependent variables in hypothesis 4 are count variables. Since count variable is often assumed to have a Poisson distribution, Poisson regression model (PRM) is often used. However, when there is an overdispersion in the dependent variable, which is clearly the case in our data (see descriptive analysis below), the estimates from the PRM are inefficient, although consistent; and the standard errors from the PRM will be biased down (Long, 1997). To solve this overdispersion problem, the negative binomial regression model (NBRM) is often used. Both NBRM and PRM, however, assume that all zero counts, as well as positive counts, are generated by the same process — either negative binomial or Poisson. This assumption is unrealistic because some zero counts might not be governed by the same negative binomial or Poisson process but may be a function of the characteristics of the firms. If so, failure to differentiate the processes

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Table 1: Description of the variables. CTFL Survey, 2001. Mean

SD

R&D collaboration with universities/institutes in 2000 (0/1)

0.133

0.340

1109

R&D collaboration with other firms in 2000 (0/1)

0.054

0.226

1109

R&D collaboration with universities/institutes in 1998 (0/1)

0.087

0.282

1105

R&D collaboration with universities/institutes in 1999 (0/1)

0.101

0.302

1108

R&D collaboration with other firms in 1998 (0/1)

0.024

0.154

1105

R&D collaboration with other firms in 1999 (0/1)

0.037

0.189

1108

R&D collaboration with universities/institutes since 1998 (0/1)

0.161

0.368

1106

R&D collaboration with other firms since 1998 (0/1)

0.060

0.237

1105

New products introduced since 1998

2.702

13.079

0

257

1114

Patents granted since 1998

0.674

3.673

0

60

1118

26.703

30.754

0

100

978

Percentage of sales supplied by imports in 2000

6.628

15.194

0

100

948

R&D expenditures ratio during 1998–2000

0.034

0.116

0

1

1047

Percentage of R&D personnel during 1998–2000

6.273

15.760

0

100

1066

Percentage of foreign competitors in 2000

Firm age in 2000 Average sales income during 1998–2000 (Yuan)

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Minimum

Maximum

No. of observations

14.956

16.388

1

101

1117

9.98 × 104

5.93 × 105

2

1.10 × 107

1111

Firm scope in 2000

27.307

135.223

1

2652

1114

Government ownership (%)

25.272

42.153

0

100

1116

Market share in 2000 (%)

12.361

22.564

0

100

1025

CEO has a college degree or above (0/1)

0.822

0.383

CEO’s job tenure

5.318

4.395

1113 0

50

1116

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generating the zero counts will result in biased and inconsistent estimates of the β’s. This problem is especially severe when there are excess zeros in the dependent variable, which is also clearly the case in our data (see descriptive analysis below). To solve both problems, Greene (2000; see also Long, 1997) suggested the zero inflated negative binomial model (ZINB) be used as shown below: ⎛ vi ⎞ Pr( yi = 0 | xi ) = ψ i + (1 − ψ i ) exp ⎜ ⎝ vi + μ i ⎟⎠ vi

Pr( yi | xi ) = (1 − ψ i )

Γ ( yi + vi ) ⎛ vi ⎞ ⎛ ui ⎞ yi !Γ (vi ) ⎜⎝ vi + μ i ⎟⎠ ⎜⎝ vi + μ i ⎠⎟

vi

(2)

yi

for y i > 0

(3)

where yi is the count variable; xi is a vector of the firm-specific covariates; μi = xi β is the conditional mean of y given x; ψ i , which is estimated using the logit model, is the probability of the zero counts that arise not from a negative binomial process but are determined by the characteristics of the firm; vi is the parameter in the gamma yi vi Γ ( yi + vi ) ⎛ vi ⎞ ⎛ ui ⎞ function Γ(vi ); and is the negative binomial probability yi !Γ (vi ) ⎜⎝ vi + ui ⎟⎠ ⎜⎝ vi + ui ⎟⎠ distribution. Equations 2 and 3 suggest that the zero counts in the dependent variable are assumed a function of both a negative binomial process and firm-specific attributes; and the non-zero counts are assumed to be generated by the negative binomial process only. When estimating ψ i in Eq. 2 and 3, I tried multiple model specifications using different sets of firm-specific variables. Different model specifications, however, do not change the results much. In Table 5 below, I report the results by using three firm-specific variables for estimating ψ i — firm age, firm size, and government ownership. When estimating all the equations given above, the heteroskedasticity-robust estimates of the variance are used (White, 1980).

Statistical Results Descriptive Statistics The descriptive statistics of all the variables discussed above are presented in Table 1. The pairwise correlations between the variables used are shown in Table 2. It is seen from Table 1 that R&D collaborative behaviors increased during 1998–2000. The percentage of R&D collaboration with universities and institutes increased from 8.7 in 1998 to 10.1 in 1999 to 13.3 in 2000. The percentage of R&D collaboration with other firms increased from 2.4 in 1998 to 3.7 in 1999 to 5.4 in 2000. Note also that Table 1 shows that the two count variables have a very wide range. Results not shown here suggest that both count variables also have excess zeros. For new products introduced, 69% of the firms reported zero; for patents granted, the zero counts amount to 87%. Thus, the ZINB model is justified for testing hypothesis 4.

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Rationales for R&D Collaborations Tables 3 and 4 present the results from the probit model for testing hypotheses 1–3. The dependent variable is R&D collaboration with universities and institutes in Table 3, and is R&D collaboration with other firms in Table 4. The covariates in these two tables are the same. Model 1’s in both tables include all control variables but no independent variables, thus serving as the baseline model. Model 2’s introduce into the baseline model one measure for foreign competition: percentage of foreign competitors (logged). Model 3’s add into the baseline model one measure for in-house R&D intensity: R&D expenditures ratio (logged). Model 4’s introduce into the baseline model both percentage of foreign competitors (logged) and R&D expenditures ratio (logged). Overall, models 2–4 in these two tables provide support to hypotheses 1–3. First, it is seen that, in consistent with hypotheses 1 and 2, the coefficients for both percentage of foreign competitors and R&D expenditures ratio are all positive and significant. Second, the coefficients of percentage of foreign competitors are larger for predicting R&D collaboration with other firms, and those of R&D expenditures ratio are larger for predicting R&D collaboration with universities and institutes. By examining the pseudo R2’s in both tables, it is also seen that the percentage of foreign competitors can explain more variation in collaboration with other firms, and R&D expenditures ratio more variation in collaboration with universities and institutes. Thus, hypothesis 3 is also supported by the data. To interpret the coefficients, I use model 4’s — the full specified models — in both the tables. The coefficient of percentage of foreign competitors (logged) is 0.048 in Table 3, while it is 0.072 in Table 4. Translated into partial changes in the predicted probability of y given x, these coefficients suggest that for a unit increase in log percentage of foreign competitors at the mean, the predicted probability of R&D collaboration with universities and institutes increases by 10%; and the predicted probability of R&D collaboration with other firms increases by 21.4%. The coefficient of R&D expenditures ratio (logged) is 0.109 in Table 3, while it is 0.044 in Table 4. These coefficients suggest that for a unit increase in log R&D expenditures ratio at the mean, the predicted probability of R&D collaboration with universities and institutes increases by 22.2%; and the predicted probability of R&D collaboration with other firms increases by 12.9%. Therefore, it is clear that foreign competition can explain R&D collaboration with other firms more; and in-house R&D intensity accounts more for R&D collaboration with universities and institutes. The effects of the control variables are as follows. Younger firms are more likely to engage in both types of R&D collaboration. This result is consistent with the liability of newness argument. Firm size is positively related with R&D collaboration with universities and institutes but negatively related with collaboration with other firms. The negative effect of firm size on collaboration with other firms supports the transaction cost perspective. The positive effect of size on collaboration with universities and institutes

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Table 2: Correlation matrix of the variables used 1

2

3

4

5

6

7

8

9

1. R&D collaboration with universities/institutes in 2000

1

2. R&D collaboration with other firms in 2000

0.1757 1

3. R&D collaboration with universities/institutes in 1998

0.5888 0.1813 1

4. R&D collaboration with universities/institutes in 1999

0.7250 0.1711 0.7268 1

5. R&D collaboration with other firms in 1998

0.1969 0.6346 0.2425 0.2576 1

6. R&D collaboration with other firms in 1999

0.2052 0.6925 0.2454 0.2515 0.7752 1

7. R&D collaboration with universities/institutes since 1998

0.8975 0.1775 0.7063 0.7690 0.1866 0.2145 1

8. R&D collaboration with other firms since 1998

0.1936 0.9507 0.1799 0.1937 0.6279 0.7789 0.2023 1

9. New products introduced since 1998

0.1893 0.0979 0.2058 0.1998 0.1612 0.1237 0.1762 0.0905 1

10. Patents granted since 1998

0.2075 0.0457 0.1909 0.1996 0.1054 0.0892 0.2190 0.0615 0.2368

11. Percentage of foreign competitors in 2000 (log)

0.1182 0.0937 0.0714 0.0941 0.0770 0.0630 0.1268 0.0827 0.0351

12. R&D expenditures ratio during 1998–2000 (log)

0.3862 0.1490 0.2793 0.3007 0.0936 0.1170 0.4065 0.1642 0.1733

13. Firm age in 2000 (log)

0.0209 –0.0790 0.1107 0.0794 –0.0018 0.0176 0.0493 –0.0677 0.0255

14. Average sales income during 1998–2000 (Yuan) (log)

0.2669 0.0118 0.2620 0.2787 0.1151 0.0494 0.2867 –0.0041 0.1532

15. Firm scope in 2000 (log)

0.2289 0.0986 0.2167 0.2258 0.1271 0.0963 0.2337 0.0993 0.3275

16. Government ownership (%)

0.0419 –0.0535 0.0679 0.0575 –0.0281 –0.0059 0.0603 –0.0475 –0.0111

17. Market share in 2000 (%) (log)

0.2207 0.0400 0.2047 0.2039 0.0558 0.0576 0.2387 0.0372 0.1276

18. CEO has a college degree or above

0.1271 0.0486 0.1019 0.0935 0.0585 0.0663 0.1334 0.0576 0.0255

19. CEO’s job tenure

–0.0236 –0.0272 0.0132 –0.0093 –0.0177 0.0242 –0.0231 –0.0057 –0.0017

0 0 0

0 0 0

0 0 0

0 0

0 0 0

0

0

0 0 0

0

0.0011 0 0.1287 0

0 0 0

0 0 0

0 0

0 0

0

0 0

0 0

0.0004 0.0030 0

0.0027 0.0411 0

0.0002 0.0035 0.0264 0.0033 0.0166 0.0498 0.0001 0.0101 0.2730 0

0

0

0

0.0026 0.0002 0

0

0

0.4874 0.0085 0.0002 0.0082 0.9520 0.5575 0.1016 0.0244 0.3947 0

0

0.6963 0

0.0010 0

0

0

0.0001 0.1015 0

0

0.0014 0

0.8930 0

0.0010 0

0.1632 0.0751 0.0242 0.0561 0.3516 0.8434 0.0450 0.1149 0.7107 0 0

0.2026 0

0

0.0755 0.0663 0

0.1062 0.0007 0.0019 0.0524 0.0278 0

0.2364 0 0.0561 0.3957

0.4319 0.3668 0.6610 0.7571 0.5581 0.4223 0.4433 0.8489 0.9559

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Table 2. (Continued) 10

11

12

13

14

15

16

17

18

10. Patents granted since 1998

1

11. Percentage of foreign competitors in 2000 (log)

0.0193 1

12. R&D expenditures ratio during 1998–2000 (log)

0.1347 0.1774 1

13. Firm age in 2000 (log)

0.0033 0.0322 0.0208 1

14. Average sales income during 1998–2000 (Yuan) (log)

0.1690 0.1450 0.2260 0.2114 1

15. Firm scope in 2000 (log)

0.1371 0.1427 0.2378 0.1555 0.2917 1

16. Government ownership (%)

–0.0447 –0.0079 –0.0062 0.4015 0.1109 0.0359 1

17. Market share in 2000 (%) (log)

0.1650 0.1525 0.3166 0.0472 0.2755 0.2495 –0.0507 1

18. CEO has a college degree or above

0.0420 0.0685 0.1653 –0.0792 0.2276 0.0884 0.0069 0.0843 1

19. CEO’s job tenure

0.0691 0.0150 –0.0201 0.3071 –0.0028 0.0840 0.0388 0.0650 –0.1417

0.5467 0

0

0.9121 0.3144 0.5019 0

0

0

0

0

0

0

0

0.1355 0.8057 0.8422 0 0

0

0

0.1613 0.0325 0

0 0.0002 0.2311

0.1308 0 0.0082 0

0.0209 0.6399 0.5167 0

0

0.1051

0.0032 0.8171 0.0070

0.9271 0.0051 0.1954 0.0374 0

Note: Below the pair-wise correlation coefficients are standard errors

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Table 3: Results from the probit model predicting R&D collaboration with universities and institutes in 2000a. Model Constant

(1)

(2)

(3)

–2.564**

–2.483**

–1.782*

–1.779*

(0.535)

(0.549)

(0.703)

(0.723)

+

Log percentage of foreign competitors

0.048+ (0.026)

0.042 (0.024)

Log R&D expenditures ratio

(4)

0.111** (0.022)

0.109** (0.022)

Log firm age

–0.188* (0.076)

–0.207** (0.077)

–0.198* (0.085)

–0.230** (0.087)

Log sales income

0.079* (0.039)

0.079* (0.040)

0.103* (0.046)

0.102* (0.046)

Log firm scope

0.072+ (0.043)

0.062 (0.043)

0.066 (0.049)

0.058 (0.049)

Government ownership

0.002 (0.002)

0.002 (0.002)

0.001 (0.002)

0.001 (0.002)

Log market share

0.261* (0.116)

0.231+ (0.120)

0.219+ (0.121)

0.193 (0.124)

Log market share squared

–0.054+ (0.029)

–0.049 (0.031)

–0.054+ (0.032)

–0.050 (0.033)

R&D collaboration with universities/institutes in 1998

0.748** (0.247)

0.802** (0.254)

0.716** (0.251)

0.804** (0.261)

R&D collaboration with universities/institutes in 1999

2.018** (0.215)

1.972** (0.219)

2.010** (0.229)

1.961** (0.234)

CEO has a college degree or above

0.255 (0.275)

0.195 (0.283)

0.332 (0.346)

0.313 (0.360)

CEO’s job tenure

0.004 (0.017)

0.006 (0.017)

0.009 (0.024)

0.014 (0.025)

4 city dummies

added

added

added

added

9 sector dummies

added

added

added

added

Pseudo R2

0.5055

0.5038

0.5591

0.5603

Observations

999

907

949

867

a

Notes: Enclosed in the parentheses are robust standard errors. “Bejing” is the comparison group for geographic locations; “apparel” for industrial sectors. * p < 0.05. ** p < 0.01. + p < 0.10.

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Table 4: Results from the probit model predicting R&D collaboration with other firms in 2000a. Model Constant

(1)

(2)

(3)

(4)

–1.689** (0.639)

–1.451* (0.598)

–1.176 (0.790)

–1.020 (0.776)

Log percentage of foreign competitors

0.084* (0.037)

Log R&D expenditures ratio

0.072* (0.036) 0.053* (0.025)

0.044+ (0.025)

Log firm age

–0.414** (0.112)

–0.466** (0.134)

–0.431** (0.121)

–0.483** (0.142)

Log sales income

–0.125* (0.050)

–0.161** (0.049)

–0.122* (0.051)

–0.157** (0.050)

Log firm scope

0.151* (0.059)

0.127* (0.060)

0.129* (0.056)

0.111* (0.055)

Government ownership

–0.003 (0.003)

–0.003 (0.003)

–0.003 (0.003)

–0.003 (0.003)

Log market share

0.007 (0.146)

–0.041 (0.160)

–0.020 (0.154)

–0.045 (0.165)

Log market share squared

0.015 (0.039)

0.031 (0.044)

0.017 (0.039)

0.027 (0.044)

R&D collaboration with universities/institutes in 1998

1.332+ (0.686)

1.398* (0.685)

1.385+ (0.711)

1.437* (0.706)

R&D collaboration with universities/institutes in 1999

2.592** (0.439)

2.643** (0.474)

2.467** (0.453)

2.511** (0.486)

CEO has a college degree or above

0.019 (0.269)

–0.021 (0.305)

–0.019 (0.274)

–0.044 (0.307)

CEO’s job tenure

–0.008 (0.025)

–0.012 (0.025)

0.003 (0.036)

–0.000 (0.039)

4 city dummies 9 sector dummies

added added

added added

added added

added added

Pseudo R2 Observations

0.5214 999

0.5423 907

0.5246 949

0.5425 867

Notes: a Enclosed in the parentheses are robust standard errors. “Bejing” is the comparison group for geographic locations; “apparel” for industrial sectors. * p < 0.05. ** p < 0.01. + p < 0.10.

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may be because larger firms had more resources to support high-end collaborative research, which aims at basic research objectives. In consistent with the organizational ecology argument, firm scope has positive effects on both types of collaboration, but the effect is stronger for collaboration with other firms. Market share seems to have a quadratic effect on collaboration with universities and institutes, but has no effect on collaboration with other firms. Previous collaborations have positive effects on current collaboration, with the more recent one having stronger effects.

The Impact of R&D Collaboration on R&D Performance The results from the ZINB model for testing hypothesis 4 are presented in Table 5. I also tried the PRM and the NBM. Overall, the results from both the PRM and NBM are similar to those from ZINB reported here. The coefficients for the independent variables from PRM and NBM are still statistically significant, but the magnitude of the coefficients is smaller. Models 1 and 2 in Table 5 regress new products introduced and patented actually granted on R&D collaboration with universities and institutes, respectively, with all control variables being included. With the same specification, models 3 and 4 regress the two measures of R&D performance on R&D collaboration with other firms. In all the four models, the two independent measures are found to have significantly positive effects on the measures of R&D performance. After I include both types of R&D collaboration in the same model as shown in models 5 and 6, the coefficients for collaboration with universities and institutes do not change much; however, the coefficients for collaboration with other firms diminish substantially and are not significant any more. Thus, it seems that only domestic firms that engage in R&D collaboration with universities and institutes would improve R&D performance; the other strategy may not. To interpret, models 5 and 6 suggest that collaboration with universities and institutes increases the expected number of new products introduced by a factor of 1.57 (= exp[0.452]), and the expected number of patents granted by a factor of 7.30 (= exp[1.988]). That R&D collaboration with other firms has no significantly independent effects on R&D performance is not completely unexpected. Previous research suggests that such collaboration involves much higher transaction costs than collaboration with universities and institutes (Arora and Gambardellas, 1990). The effects of the control variables in Table 5 are as follows. As expected, R&D expenditures ratio has positive effects on the two dependent variables in every model. Also as expected, market share seems to have a quadratic effect in every model. Both firm scope and percentage of foreign competitors have positive effects on new products. The positive effect of firm scope is consistent with the organizational ecology argument that firms with larger scope may operate under a set of routines that repeatedly propel them to introduce new products. The positive effect of foreign competition suggests that the economic reform

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Table 5: Results from the ZINB model predicting R&D performancea (1)

(2)

(3)

(4)

(5)

(6)

New products

Patents

New products

Patents

New products

Patents

Constant

–0.511 (0.919)

–3.168** (0.890)

R&D collaboration with universities/institutes since 1998

0.533* (0.213)

2.033** (0.248)

R&D collaboration with other firms since 1998

–0.586 (0.884)

–4.156** (0.960)

–0.491 (0.912)

–3.264** (0.903)

0.452* (0.212)

1.988** (0.260)

0.572+ (0.326)

0.833* (0.424)

0.393 (0.314)

0.207 (0.463)

Log R&D expenditures ratio

0.105** (0.028)

0.077* (0.034)

0.114** (0.026)

0.098** (0.033)

0.104** (0.028)

0.076* (0.033)

Log firm age

0.035 (0.170)

0.082 (0.154)

0.013 (0.159)

0.197 (0.166)

0.067 (0.168)

0.103 (0.156)

Log sales income

0.008 (0.073)

0.075 (0.064)

0.035 (0.069)

0.214** (0.065)

0.000 (0.069)

0.081 (0.065)

Log firm scope

0.552** (0.062)

0.030 (0.077)

0.544** (0.063)

0.096 (0.088)

0.545** (0.061)

0.020 (0.082)

Government ownership

0.001 (0.004)

–0.014** (0.004)

0.003 (0.004)

–0.009* (0.004)

0.001 (0.004)

–0.014** (0.004)

Log percentage of foreign competitors

0.052+ (0.029)

–0.061 (0.039)

0.062* (0.029)

–0.030 (0.036)

0.051+ (0.028)

–0.065+ (0.038)

Log market share

0.232+ (0.124)

0.713** (0.195)

0.253* (0.119)

0.726** (0.185)

0.222+ (0.124)

0.709** (0.189)

Log market share squared

–0.036 (0.036)

–0.088* (0.043)

–0.039 (0.035)

–0.090* (0.043)

–0.032 (0.036)

–0.087* (0.043)

CEO has college degree or above

–0.125 (0.283)

0.460 (0.396)

–0.146 (0.274)

0.320 (0.405)

–0.138 (0.282)

0.457 (0.397)

CEO’s job tenure

–0.006 (0.022)

0.075** (0.029)

–0.008 (0.021)

0.071* (0.031)

–0.008 (0.021)

0.074* (0.029)

4 city dummies

added

added

added

added

added

added

9 sector dummies

added

added

added

added

added

added

Log pseudolikelihood

–1214.513

–565.5885

–1210.393

–581.4342

–1208.247

–560.8781

Observation

867

868

866

867

866

867

Notes: a Enclosed in the parentheses are robust standard errors. “Bejing” is the comparison group for geographic locations; “apparel” for industrial sectors. * p < 0.05. ** p < 0.01. + p < 0.10.

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is successful in bringing Chinese firms under market discipline. Government ownership and job tenure of the CEO are found to have significant effects on patents granted. The negative effect of government ownership supports the property rights school, which argues that government ownership cannot provide sufficient incentives for managers as well as other stakeholders in the firm to innovate. The positive effect of the CEO’s job tenure suggests that the experience of the CEO is indeed important for the firm to innovate. It is interesting to see that firm size does not have an independent effect on R&D performance, as shown in models 5 and 6, suggesting that the locus of innovation may indeed have shifted from large firms to a network of interorganizational relationships.

Robust Check I used alternative measures for the independent variables to see whether the results reported in Tables 3–5 are robust to different measures. First, I replaced log percentage of foreign competitors with log percentage of sales supplied by imports for measuring foreign competition in Tables 3 and 4. Second, I replaced log R&D expenditures ratio with log percentage of R&D personnel for measuring in-house R&D intensity in Tables 3 and 4. Third, in Table 5, I replaced the two types of R&D collaboration since 1998 with R&D collaborations in 1998, so as to assume that R&D collaboration can only have lagged effects on firm performance. Overall, the results still support the hypotheses significantly. Thus, the hypotheses hold regardless of which measures for the independent variables one uses.

Discussion and conclusion This paper tries to provide further understanding on the rationales for and the impact of R&D collaborations in the Chinese context. Previous research suggests that R&D collaborations are a response to either increasing foreign competition or the need for organizational learning. We still, however, do not have much knowledge about the relationships between the two rationales and different strategies of R&D collaborations. On the other hand, there is a theoretical indeterminacy, as well as a rare empirical test, on the impact of collaborations on R&D performance. Our results provide support to the argument that the locus of innovation has shifted from large firms to a network of interorganizational relationships (Arora and Gambardellas, 1990, 1994; DiMaggio, 2001; Hagedoorn, 1995; Link and Bauer, 1989; Powell et al., 1996). Moreover, this shift in the organizational structures of the firms may be a global phenomenon, not constrained in the developed countries alone, because it occurs in less high-tech industries in China as well. In addition, as suggested by the evidences from this paper, this shift has both economic and technological roots, i.e., the increasing global competition and the rapid technological development, which have happened simultaneously in the past several decades. Nevertheless, the economic root,

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from the demand side, plays a more important role in facilitating inter-firm alliances; and the technological root, from the supply side, accounts more for the firm–university/ institutes linkages. Our results on the positive impact of R&D collaborations with universities and institutes are consistent with previous research on the effect of R&D networks (e.g., Andersson et al., 2002; Powell et al., 1996). Thus, there seems to be a liability of unconnectedness at work (Baum and Oliver, 1992; Powell et al., 1996). The results, however, do not mean that the net effects of R&D collaborations are always positive. They only suggest that the positive effects of R&D collaborations can be more than compensate for the transaction costs in some scenarios, and this may be because the firms self-select into the ways in which the transaction costs can be mitigated or controlled. In other scenarios, the transaction costs may be too high to be compensated for. The nonsignificant effects of R&D collaborations with other firms in models 5 and 6 in Table 5 may be an example for this. If transaction costs are indeed crucial to understand the impact of R&D collaborations on a firm’s technological performance, several questions need to be studied further. Why are there differences in transaction costs between different R&D collaboration strategies? What are the mechanisms that help mitigate or control transaction costs, besides informal relationships and long-term relational contracts that have been briefly mentioned above? How do these mechanisms help mitigate or control transaction costs? Under what conditions are these mechanisms not successful any more? Answering these questions may not only provide a better understanding of the impact of R&D collaborations on firm competitiveness but also have practical implications for firms engaging in R&D collaborations. Previous research has suggested that because of less transaction costs and higher learning benefits, there exists a trend for firms, especially those in high-tech industries, to rely extensively on university-based scientific community (including both universities and public research institutes), and such university–industry relations has helped spark economic growth (Arora and Gambardellas, 1990; Owen-Smith et al., 2002). Findings from this study suggest that this may also be taking place in China. During 1998–2000, the percentage of R&D collaboration with universities and institutes in our sample firms increased from 8.7 to 13.3. And this collaboration strategy has significantly facilitated technological innovation in Chinese firms. However, we still have little knowledge on how university–industry relations work in industrial sectors in China. Are Chinese firms mirroring established policies and arrangements in the United States or Europe, such as those discussed in Owen-Smith et al. (2002)? Or, are they creating new models? If so, what are the Chinese models? What are the sources of the new models? Further research on such questions may shed light on how Chinese firms are catching up with those in the developed countries and whether there exists Chinese models of industrial capitalism. The data used here were collected within 10 sectors from five largest cities in China only. Therefore, I do not intend to extrapolate our findings to all the Chinese

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firms. Nevertheless, this study might shed some light on how the emerging capitalism in China may evolve. It is often noted that many East-Asian capitalist economies appear to have a hard time establishing specialized technology-intensive firms; and given their low technology level, these economies often lack globally scaled and integrated international firms. Japan and Korea, however, are considered as exceptions to this general perception. The development of large technology-intensive corporations in Japan and Korea is often attributed to the visible hand of the state in allocating resources preferentially to a number of key corporations in the sectors carefully selected to enjoy government support (Amsden, 1989; Johnson, 1982). China seems to be taking a different path for technological development. With both diminishing support from the government and increasing domestic and especially foreign competition, many firms in China have been striving hard to upgrade their technology level by not only investing in in-house R&D but also participating in R&D collaborations with outside research institutions. Given the synergistic effects of interorganizational R&D collaborations on technological development and economic growth found in many places (e.g., Mariotti, 1996; Powell et al., 1996; Saxenian, 1996), it may be argued that R&D collaborations would accelerate and many large technology-intensive firms may thus emerge in China.

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Greene, WH (2000). Econometric Analysis. 4th Ed. London: Prentice Hall International, Inc. Gulati, R (1995). Does familiarity breed trust? Academy of Management Journal, 38, 85–112. Gulati, R (1998). Alliances and networks. Strategic Management Journal, 19, 293–317. Gulati, R and M Gargiulo (1999). Where do interorganizational networks come from? American Journal of Sociology, 104, 1439–1493. Gulati, R and H Singh (1998). The architecture of cooperation: managing coordination costs and appropriation concerns in strategic alliances. Administrative Science Quarterly, 43, 781–814. Guthrie, D (1999). Dragon in a Three-piece Suit. Princeton, NJ: Princeton University Press. Hagedoorn, J (1995). Strategic technology partnering during the 1980s: Trends, networks, and corporate patterns in non-core technologies. Research Policy, 24, 207–231. Hallward-Driemeier, M, S Wallsten and LC Xu (2002). The investment climate and the firm: Firm-level evidence from China. http://www.econ.worldbank.org/files/24954_wps3003.pdf. [Date of Access: Aug 1, 2006.] Hannan, M and J Freeman (1989). Organizational Ecology. Cambridge: Harvard University Press. Huang, Y (2003). Selling China: Foreign Investment during the Reform Era. New York: Cambridge University Press. Jefferson, G, H Bai, X Guan and X Yu (2001). R and D performance in China’s large and mediumsize enterprise sector. http://www.nber.org/~confer/2001/si2001/jefferson.pdf. [Date of Access: Aug 1, 2006.] Johnson, C (1982). MITI and the Japanese Miracle: The Growth of Industrial Policy, 1925–1975. Stanford, CA: Stanford University Press. Kogut, B (1989). The stability of joint ventures. Journal of Industrial Economics, 38, 1–16. Long, JS (1997). Regression Models for Categorical and Limited Dependent Variables. Thousand Oaks: Sage Publications. Levinthal, D and J March (1994). The myopia of learning. Strategic Management Journal, 14, 95–112. Liebeskind, J, O Oliver, L Zucker and M Brewer (1996). Social networks, learning, and flexibility: Sourcing scientific knowledge in new biotechnology firms. Organization Science, 4, 428–443. Link, A and L Bauer (1989). Cooperative Research in Manufacturing. Lexington, MA: Lexington Books. Mariotti, J (1996). The Power of Partnerships: The Next Step beyond TQM, Reengineering, and Lean Production. Cambridge: Blackwell Business. Ministry of Science and Technology of China (1999). 1998 nian quanguo keji jingfei touru tongji baogao. (Statistical report of national R&D expenditures in 1998) http://www.sts.org.cn/ report_3/subject3.htm. [Date of Access: Aug 1, 2006.] Ministry of Science and Technology of China (2001). Dangqian woguo R&D huodong de zhuyao tezheng. (Sketches of R&D activities in contemporary China) http://www.sts.org.cn/report_3/ subject3.htm. [Date of Access: Aug 1, 2006.] Naughton, B (1995). Growing out of the Plan: Chinese Economic Reform, 1978–1993. Cambridge: Cambridge University Press. Nelson, R (1959). The simple economics of basic research. Journal of Political Economy, 3, 297–305. Nelson, R (1990). Capitalism as an engine of progress. Research Policy, 19, 193–214.

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Owen-Smith, J, M Riccaboni, F Pammolli and W Powell (2002). A comparison of U.S. and European university-industry relations in the life sciences. Management Science, 48, 24–43. Pfeffer, J and G Salancik (1978). The External Control of Organizations: A Resource Dependence Perspective. New York: Harper & Row. Powell, W, K Koput and L Smith-Doerr (1996). Interorganizational collaboration and the locus of innovation: network of learning in biotechnology. Administrative Science Quarterly, 41, 116–145. Saxenian, A (1996). Regional Advantage: Culture and Competition in Silicon Valley and Route 128. Cambridge, MA: Harvard University Press. Schumpeter, J (1934). The Theory of Economic Development. Cambridge, MA: Harvard University Press. Shangyu: xiaojuren shifang danengliang. (Big contributions of medial firms in Shangyu county) (28 September 2002). Zhejiang Daily. Sorenson, O, S McEvily, C Ren and R Roy (1996). Niche width revisited: Organizational scope, behavior and performance. Strategic Management Journal, 27, 915–936. Stinchcombe, AL (1965). Social structure and organizations. In Handbook of Organizations, James March (ed.), pp 142–193, Chicago: Rand McNally. Teece, D (1986). Profiting from technological innovation. Research Policy, 15, 785–805. Urban, S and S Vendemini (1992). European Strategic Alliances: Co-operative Corporate Strategies in the New Europe. Oxford: Blackwell Publishers. Uzzi, B (1996). The sources and consequences of embeddedness for the economic performance of organizations: the network effect. American Sociological Review, 61, 674–698. Van de Ven, H (1992). Suggestions for studying strategy process. Strategic Management Journal, 15, 169–188. Wang, B and H Chen (2005). Kuaguo longduan zai zhongguo. (Monopoly of multinational corporations in China) http://www.usc.cuhk.edu.hk/wk_wzdetails.asp?id=5167. [Date of Access: Aug 1, 2006.] White, H (1980). A heteroskedasticity-consistent covariance matrix estimator and a direct test for heteroskedasticity. Econometrica, 48, 817–838. Williamson, O (1991). Comparative economic organization: the analysis of discrete structural alternatives. Administrative Science Quarterly, 36, 269–296.

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Innovation Dilemmas of Science-Park Based Chinese University Spin-Outs (USO): A Pilot Case Study ͣJOSEPH YUAN ZHOU Cambridge University

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r. Zhou Yuan (Joseph) is currently pursuing his PhD at the Centre for Technology Management, University of Cambridge, UK. Prior to his study at Cambridge, he was the Manager of Cascadia Capital, based in Beijing, China, in the technology commercialization and transfer practice. He was also the Program Manager of Qidi Venture Capital Ltd., funded by Tsinghua Science Park, and has been working closely with Tsinghua University for the transfer of early-stage technologies. Mr. Zhou was also a Manager in the Nanyang Technopreneurship Centre, Nanyang Technological University, under the business entrepreneurship development and technology-oriented startup. He also has an in-depth understanding in electronics and mechanical research & development, having served as a Project Officer in the joint initiative between NTU and Singapore Technologies. Mr. Zhou holds a B.Engg., and M.Sc., in mechanical engineering and robotics from Nanyang Technological University, Singapore. He is also a graduate for a joint post-graduate diploma in Technology Entrepreneurship and Innovation Program from the University of Washington and Nanyang Technological University.

Abstract: This research aims to develop a firm-level model to study the science-park based university spin-outs (hereafter referred to as USOs) in China. This model will help to holistically understand and analyze the dynamic relationship between USOs’ entrepreneurial innovative capabilities and their performance towards sustained growth. The research will use the dilemma theory to investigate and explicate the building of the innovative capabilities of USOs. In addition, this study also attempts to explore how USOs build their entrepreneurial innovative capabilities to acquire, configure, and re-configure the key assets through reconciling dilemmas, during the various firm-growth processes.

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There is a limited research that recognizes the diversity of resources of USOs in China. Studies concerned with entrepreneurial innovative capabilities of USOs at different growth phases also remain sparse. Addressing this research gap will be of great interest to researchers, policy-makers, entrepreneurs, and international investors. Keywords: Dilemma theory; Resource-based view; Innovative capability; Entrepreneurial innovation; University spin-out (USO)

Introduction USO-related research receives a growing attention, as it is acknowledged as an important source of innovation that brings positive impetus to the local economy. However, most of the existing researches are concerned with their enabling environment, infrastructure support, and public policies that encourage the emergence of USOs from the knowledgeintensive base (such as the universities and research institutes) from an industrial-structure perspective (Hugo and Garnsey, 2002). The studies that consider the heterogeneity of USOs from a resource-based perspective still remain sparse. This reflects that this research topic is still in its infancy. In addition, many existing literatures have studied the associations between the successful attributes and the distinctive performance of USOs (Clarysse et al., 2005), yet a limited number of researchers attempt to conduct in-depth analysis on the critical innovation capabilities at different growth processes of USOs, which might be the answers to achieve a sustained growth. Furthermore, in the absence of the measurement1 of the capabilities in resource-based paradigm, the dilemma theory can provide an analytical model to analyze the innovation capabilities of USOs, by identifying the process-specific dynamic capabilities (Eisenhardt and Martin, 2000; Teece and Pisano, 2004) through dilemmas reconciliation. So, this study can enrich the empirical groundings for both the dilemma theory and resource-based theory. And, the sector-specific study on USO still remains scarce. It is important to conduct research on particular sectors to develop a model to analyze the USOs, because the processes of firm growth are unique across disparate sectors, e.g., micro-electronics and telecommunication sectors, according to an existing research (Garnsey, 1998). Addressing this potential research gap will be of great interest to researchers, policy makers, entrepreneurs, and international investors. This paper provides an overview of a three-year research project, and emphasizes the first and exploratory step of this project. It begins with an objective of this study, 1

There are current criticisms against resource-based view due to the vagueness and tautology by simply attributes superior performance to whatever unique processes that firms possess. It is argued that the lack of framework to establish “functional relationship to resource manipulation” has been recognized, which might be difficult to enable empirical falsification to advance the theory (Eisenhardt and Martin, 2000, p.1108).

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followed by a theoretical background depicting how background theories will be applied to construct this model. A brief review of literature will be discussed in the following section upon which this study is based on. A preliminary framework is then developed for a pilot case study, followed by a research design for further study of this overall project. Finally, this paper concludes with a short summary.

Objective of this Study This study attempts to address the research question: how do science-park based USOs in China build their innovation capabilities, in order to achieve sustainable growth? This research aims to develop a firm-level model2 (Shehabuddeen et al., 2000) to study the science-park based USOs in China. This holistic model will help to understand and analyze the dynamic relationship3 between USOs’ innovation capabilities4 and their in-depth analysis on the critical innovation capabilities at different growth processes of USOs, which might be the answers to achieve sustained growth. Furthermore, in the absence of the measurement of the capabilities in resource-based paradigm, the dilemma theory5 can provide an analytical model to analyze the innovation capabilities of USOs, identifying the process-specific dynamic capabilities (Eisenhardt and Martin, 2000; Teece and Pisano, 2004) through dilemmas reconciliation. So, this study can enrich the empirical groundings for both the dilemma theory and resource-based theory. And, the sector-specific 2

According to Shehabuddeen, a model “supports the understanding of the dynamic interactions between the elements of a system”. (Shehabuddeen et al, 2000, p. 4). 3

According to Markus and Robey, 1988, the dynamic relationship reflects the inter-connected underlying causal relationship between the elements within a system, rather than their static associations. The former one can be identified using an induction method given rich contextual information, from a process-based perspective. On the other hand, the static associations can be investigated using a deductive method, from a variant-based view. (Markus and Robey, 1988, p. 590). 4

Innovative capability characterizes the ability to innovate from a resource-based perspective on the firm-level. In resource-based view, there are different definitions for resource, capability, and dynamic capability by various prior researchers. In this study, the term resource is defined as “those (tangible and intangible) assets which are tied semi-permanently to the firm” by Wernerfelt (Wernerfelt, 1984, p. 172), which is sometimes also referred to as assets in the literatures. And capability is quoted as “a firm’s assets and its ability to use these assets to perform these activities to create and deliver products and services to its customers”, using Afuah’s view (Afuah, 2003, p. 52). In addition, Teece gives the precise definition of dynamic capability as “the firm’s ability to integrate, build, and re-configure internal and external competence to address rapidly changing environments” (Teece et al., 1997, p. 516). The dynamic capability explains the a firm’s ability to acquire and mobilize resource, to build managerial and organizational routines, and to make strategic decision at critical timing, which might bound firm’s future growth, in response to fast-changing environment (including technological change). Further discussion is available in Section 3.3. 5

Dilemma theory is the intellectual invention by Charles Hampden-Turner. For further information, refer to his publications.

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study on USO still remains scarce. It is important to conduct research on particular sectors to develop a model to analyze the USOs, because the processes of firm growth are unique across the disparate sectors, e.g., micro-electronics and telecommunication sectors, according to an existing research (Garnsey, 1998). Addressing this potential research gap will be of great interest to researchers, policy-makers, entrepreneurs, and international investors. This paper provides an overview of a three-year research project, and emphasizes the first and an exploratory step of this project. It begins with an objective of this study, followed by a theoretical background depicting how the background theories will be applied to construct this model. A brief review of literature will be discussed in the following section upon which this study is based on. A preliminary framework is then developed for a pilot case study, followed by research design for further study of this overall project. Finally, this paper concludes with a short summary.

Theoretical Background This study attempts to apply the dilemma theory and resource-based approach to develop a dynamic model. Dilemma theory will be used to explain and analyze the innovation capabilities of science-park based USOs, while the resource-based view will provide a theoretical background for the identification of critical resources and innovation capabilities for USOs, at different firm growth processes. From a resource-based perspective, a USO’s innovation capabilities (the ability to innovate) lies not only in its resources (Wernerfelt, 1984), but also in their capability to construct new codes of knowledge and to replicate these capabilities (Afuah, 2003) to acquire, mobilize, and re-configure the technology assets, complimentary assets, financial assets, and network assets in an innovative way, as well as the ability to make critical strategic decision at a specific time to shape the firm’s future direction for pathdependency growth. According to the literature from the resource-based perspective, resource and capabilities are the sources of firms’ sustainable competitive advantage (Peteraf and Barney, 2003), including internal resources such as professional background of founders/ entrepreneurial team, skills of workforce, and internal efforts to improve technology, and external resources such as intensity of networking, proximity advantages related to networking, and receipt of institutional support. In addition, Teece argues that to achieve sustainable competitive advantage, the dynamic capability is critical, which could acquire, mobilize, and re-configure the resources in response to the rapid changing environment. Then, what are the critical resources and capabilities that enhance USOs’ ability to innovate, to achieve their firms’ sustained growth? There are some prior cross-sectional researches examining the influencing factors to USO’s firm growth in terms of rates, or trends in performance on an aggregate level. For example, (i) Resource: the nature

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of “the founding technology chosen by the entrepreneurs of high-technology industries will have a profound determining influence” on their subsequent strategic formulations (Oakey, 1995). (ii) Capability: the technology management capabilities6 of the USOs reflects the ability to convert the technology into rent-generating product, which can be broken down into research management, opportunity recognition, entrepreneurial commitment, re-organization, and re-orientation, etc. (Vohora et al., 2004a). This study will focus on USOs’ technology assets, complementary assets (intangible) and financial assets, and their capabilities around the above-mentioned critical assets. However, many of them failed to inquiry into the influence of time and sequence on causal process. (Garnsey et al., 2006). This means that the resources and capabilities have variation in their significance for the different firm growth processes. In addition, resources and capabilities are sector-specific. The strong variations in the characteristics of high-tech sectors within a general high-technology industry definition might render the use of such an all embracing categorization a hindrance rather than an aid to the development of theory regarding such firms (Oakey, 1995). Using the dilemma theory, the innovation capabilities of USOs will be explained and their patterns understood by identifying the critical dilemmas and the reconciliations along their growth path. The set of dilemmas will be developed through five procedures, using the existing theoretical framework7 (Hampden-Turner and Trompenaars, 2000).

Brief Literature Review The previous discussion suggested, at least implicitly, that it is complex to understand and analyze the innovation capabilities of a firm. The objective of this section is to review the relevant key literature that examines innovation, dilemma theory, resourcebased view, and some specific relevant fields including the theory of the growth of the firm, entrepreneurip, and USOs. The review first starts with the overview of an innovation research, investigating the definitions of innovation and important innovation models. In addition, the firmspecific resources and dynamic capabilities as a form of innovation capabilities that give a competitive advantage to new ventures is then explored in the context of the resource-based 6

The technology management capability can be referred by ISEAP framework: Technology Identification, Selection, Exploitation, Aquisition, Protection capability (refer to Remito’s unpublished work), which can be explained and analyzed using the dilemma theory. 7 The dilemma theory framework was developed by Charles Hampden-Turner, which was documented in his book Building Cross-Cultural Competence: How to Create Wealth from Conflicting Values. Initially, the framework was used to develop dilemmas concerned with cultural dimensions. But in recent years, Hampden-Turner has used the framework to develop dilemmas pertaining to R&D management, in his book The Titans of Saturn: Leadership and Performance Lessons from the Cassini-Huygens Mission. Hampden-Turner and his students are also working on the development of dilemmas on innovation management, across different themes such as entrepreneurship, innovation policy, and innovation in general.

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view of business strategy within the sub-field of USOs’ studies. This chapter also suggests that there is a need to move from variant studies to processes studies (Markus and Robey, 1988) to take into account the complexity of the firm growth process, in which Penrose’s contributions to both firm growth theory and resource-based view are explained. In addition, this section also explores the recent studies on entrepreneurship, although it is argued that entrepreneurship as an academic field is still relatively new or “adolescent” and this is evident in the controversy surrounding the definition of entrepreneurship and entrepreneurs. Last but not the least, the dilemma theory is explained and it is shown to be an appropriate investigative approach for the study of innovation capabilities. Dilemma reconciliation, which forms a crucial part of the dilemma theory, is put forward as a dynamic competency that how firms build their dynamic capabilities. This section concludes with a discussion on dilemma theory as a meta-theory in the innovation study field.

Innovation Innovation is generally used to denote an idea, product, process, system, or a device that is perceived as new to an individual, group of people, organization, industrial sector, or a society as a whole. Innovation is generally referred to as an outcome or as a total process from the invention of the product and process, towards the delivery of the marketplace. (Freeman, 1974; Freeman, 1982; Kelly and Kranzberg, 1975; Rogers, 1962). In this section, the definition of “innovation” will be investigated within the existing literatures, across different perspectives, and research groups. The distinctions among these concepts will be analyzed and addressed. In addition, the recent important innovation models within the technology management studies will also be discussed, which play significant roles in strategic decision-making for managers, in response to the dynamic environment with rapid technological and market changes. There are many definitions of innovation by various authors in the plethora of literature, and literature can easily be found as far back as the early 20th century (Padmore and Gibson, 1998). There is an arising controversy upon the definition of “innovation”, as innovation receives more and more attention in the research of business, technology, and sociology. Current innovation study has been extended to a broad view, comprising various topics as research and development, product development, entrepreneurship, and technological innovation. Researchers from various groups (schools) view “innovation” differently, defining the disparate types, focusing on a variety of study units, and investigating it at different stages and levels. From the review of the definitions of innovation, we may conclude that: (i) Innovation is a multi-functional process comprising generation of ideas, development, and implementations (Porter, 1991). (ii) Innovation can be classified into different levels of study, including an individual, group of people, organization, industrial sector, or a society as a whole (Freeman, 1974; Freeman, 1982). (iii) Innovations consists of different types, e.g., product and process (Schumpeter, 1928; Schumpeter, 1947; Schumpeter, 1950), technical and administrative

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(Afuah, 2003), radical and incremental (Abernathy and Utterback, 1978; Utterback, 1996; Utterback and Abernathy, 1975), and closed or open innovation (Chesbrough, 2003). To answer the central question “who is the most likely to innovate?” and “how is innovation important to a firm?”, various technological innovation models have been developed by different scholars. According to Afuah (Afuah, 2003), the innovation models have been classified into two major categories: (i) static model, and (ii) dynamic model. In his view, static innovation models analyze innovation functions on a crosssectional basis, exploring the importance of technological capabilities, market capabilities, organizational management capabilities, and strategic decisions to a firm’s abilities to innovate as influential factors, e.g., Schumpeterian models, Abernathy–Clark model, Christensen’s disruptive innovation model, Porter’s innovation value–chain model, and Moore’s ecosystem innovation model, etc. By contrast, dynamic innovation models study the innovation processes of an industry or innovation at a firm-level, from a longitudinal perspective. In his view, dynamic innovation models investigate the industrial innovation evolution based on innovation life cycles to predict the impact of new technologies to an existing product development, e.g., Utterback–Abernathy model, Tushman–Rosenkopf model, as well as the widely adopted Foster’s S-curve model (Afuah, 2003).

Resource-based view Resource-based view is acknowledged as an effective and an efficient approach to understand the growth of USOs, because: (i) USOs studies are concerned about highly entrepreneurial, and resources-centric process and (ii) resource-based approach is viewed as an efficiency-driven framework, recognizing heterogeneity of resources at the firmlevel (Peteraf and Barney, 2003). Resource-based view argues that firms consist of bundles or portfolios of fixed assets and competencies. Competitive advantage flows from whatever unique ability firms have to shape, re-shape, configure, and re-configure those assets to serve the customer needs (Teece and Pisano, 2004). According to Peteraf, resource-based view is a “resource-level and enterprise-level analytical tool. Resource-based view is not a substitute for industry-level analytic tools, such as five-forces analysis and game theory. It is for analysis of the macroenvironment. Rather, it is a complement to these tools” (Peteraf and Barney, 2003, p. 312). Resource-based view can be traced back to Penrose’s significant think piece The Theory of the Growth of the Firm (1959) (Penrose, 1959). And the theory has been later advanced by Nelson and Winter (Winter, 2003), Teece (Teece, 2006; Teece et al., 1997), Rumelt (Rumelt, 1984), Barney (Barney, 1986; Barney, 1991) Peteraf (Peteraf, 1993; Peteraf and Barney, 2003) and many other scholars during the last 25 years. In general, resource-based view recognizes the heterogeneity and immobility of the resources across different firms. It also recognizes that sustainable competitive advantage of a firm stem from resources that are valuable, rare, and difficult-to-imitate within an organization framework (Barney, 1991). In addition, capabilities are viewed as a critical source of sustainable competitive

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advantage for firms, as the ability to acquire, mobilize, configure, and re-configure firmspecific resources. Furthermore, dynamic capabilities framework was developed, in order to explain the firm’s dynamic approach in response to the dynamic external environment in rapid technological and market change (Teece et al., 1997). Dynamic capabilities are known as the “particular (non-imitability) capacity firms have to shape, re-shape, configure, and re-configure those assets, so as to respond to the changing technological markets” (Teece, 2003, p. 1). Dynamic capabilities approach was built upon the theoretical foundations such as Schumpeter, Williamson, Rumelt, Nelson, and Winter, and it has been significantly advanced by Teece (Augier and David, 2007; Teece, 2003; Teece and Pisano, 2004; Teece et al., 1997). According to Teece, dynamic capabilities relate to the firm’s ability to proactively adapt in order to generate and exploit internal and external firm-specific competences, and to address the firm’s change environment. Collis and Winter also emphasized that one significant element of dynamic capabilities is that they govern the rate of change of ordinary capabilities (Winter, 2003). According to Teece, the major objectives of the dynamic capabilities approach includes: (i) Dynamic capabilities approach seeks to provide a coherent (and evolutionary) framework for “how firms develop competitive advantage, and maintain it over time” (Augier and David, 2007, p. 3) (ii) Identifying the foundations underpinning long-term firm growth and prosperity (iii) It is consistent with essential elements of Penrose’s framework. Because “if one can explain the foundations of long-run profitability” (Augier and David, 2007, p. 3), one is quite compatible with the theory of the growth of the enterprise down the road. (iv) Dynamic capabilities approach also identifies the importance of pro-active entrepreneurial behavior shaping the firm’s footprint. (v) The development of intangible assets and intellectual capital is now central to sustained enterprise competitiveness; it requires new conceptual frameworks for business and economic analysis. Dynamic capabilities theory is a well-designed framework for this study. According to Barney (1991), resource-based view provides a significant framework to understand how a firm could obtain sustainable competitive advantage and profitability. Teece also argues that dynamic capabilities approach rooted in: (i) asset selection, (ii) managerial investment choices, and (iii) creative and differentiated entrepreneur acts (Teece, 2003). Therefore, in order to understand how a USO could achieve superior returns in a long term along its growth path8, dynamic capabilities theory is a framework that is well-equipped to meet the challenges. Many researches have been done to address the specific critical capabilities for a firm to achieve sustainable competitive advantages. Nelson and Winter recognized organizational 8

According to Teece, if a firm possesses resources/competences but lacks the dynamic capabilities, it has a chance to make a competitive return for a short period, but superior returns cannot be sustained. They (without dynamic capabilities) can earn Ricardian (quasi) rents (max. productivity or the least remunerative occupation), rather than the Shumpeterian rents (through continual innovation). Nor is it likely to be able to earn monopoly (Porterian) rents, since these require market power coupled with exclusive behavior or strategic manipulation.

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capabilities as an important source as functional routines (Nelson and Winter, 1982). Oakey argues that capabilities to exploit technology as well as to secure fundings are essential for nascent firms to grow to the next phase (Oakey, 1995). Grant emphasized that knowledge is identified as the key firm resource and defined broadly as to include both explicit and tacit knowledge (Grant, 1996). Teece classified capabilities as processes, positions, and paths, integrating and re-configure both internal and external resources (Teece et al., 1997). Wilson asserted that critical capabilities should include knowledge of integration, networking for opportunities, innovation through alliance formation, and managing creativity (Wilson, 2004). These critical capabilities for new firms might be also significant to USOs. Therefore, this study will focus on specific significant capabilities to USOs’ growth towards the commercial success. These capabilities would include technological capabilities, complementary capabilities, financial capabilities, and alliance capabilities, which might be critical competences for USOs to obtain sustainable competitive advantage, reflected by managers’ (entrepreneurs’) strategic thinking and skills to acquire or select assets, thereby making investment choices on technology development, as well as inspired by entrepreneurial behaviors (Teece, 2003). In this study, the innovative-capability framework is developed based on the previous discussions, as illustrated in Fig. 1. In this framework, the innovative capabilities of USOs consist of two levels: (i) functional capabilities and (ii) integrative capabilities. In this research, functional capabilities consist of: (i) technological capabilities; (ii) market capabilities. In addition, integrative capabilities comprise: (i) financial capabilities; (ii) alliance capabilities and (iii) complementary capabilities.

The theory of the growth of the firm The firm-growth theory stemmed from Penrose’s significant think piece The Theory of the Growth of the Firm (1959), although “until two decades ago when strategy researchers picked up this work, Penrose’s emphasis on fungible resources had not received much attention in either the economics or the strategic management literature” (Augier and David, 2007, p. 3). This section will discuss Penrose’s major arguments, and relevant advancement by Garnsey (Garnsey et al., 2006), upon which the firm analysis model will be based. Penrose’s view9: the firm as a “pool of resources, the utilization of which is organized in an administrative framework”. Her major concepts include the following: 9

Penrose has various important contributions to business studies, especially to the field of business strategic management research. She made several explorative investigations about the growth of the firm, in her well-known, The Theory of the Growth of the Firm in 1959. Along the way, she also has a few insightful observations pertaining to the theory of the firm and business strategy, which is of great interest among peer researchers. The most astute notion that the firm can be viewed as a bundle of resources, received most attention in recent 10 years. Based on this concept, many further works have been done by a range of other researchers to constitute a major stream of strategic management named resource-based view (Augier and David, 2007).

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Financial capabilities

Technological capabilities

Functional capabilities

Marketing capabilities

Intergrative capabilities

Complementary capabilities

Alliance capabilities

Figure 1: Innovative-capabilities framework.

(i) Penrose defined the internal resources of the firm as “the productive services available to a firm from its own resources, particularly the productive services available from the management with experience within the firm”; (ii) The firm’s growth is primarily driven by unused capacities of management, “many of the productive services created through an increase in knowledge that occurs as a result of experience gained in the operation of the firm as time passes will remain unused, if the firm fails to expand” (Penrose, 1959, p. 54). And “the capacities of the existing managerial personnel of the firm necessarily set a limit to the expansion of that firm in any given period of time” (Penrose, 1959, p. 45); (iii) Penrose argued that the human resources required for firm growth and the management of change are firm-specific. At any time, these resources are constrained by their internal availability. So, managerial capacity cannot be expanded indefinitely and at will. Rather, expansion requires the recruitment and development of additional high-level human resources; (iv) Diversification: the unused capacities of management, coupled with the tangibility of certain resources, enabled the diversification in the Penrosian firm (Augier and David, 2007); (v) The most astute notion that the firm can be viewed as a bundle of resources, which is of great interest to management researchers in recent years. She argues that “a firm is more than an administrative unit; it is a collection of productive resources, the disposal of which is determined by an administrative decision between uses — and over time the physical resources of the firm consist of tangible things — there are also human resources available in a firm — strictly speaking, it is never resources themselves that are the ‘inputs’ in the productive process, but only the services that they render” (Penrose, 1959, p. 24);

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(vi) “Penrose effect”: while she recognized how the fungible nature of a firm’s resources (so, resources will not be a constraint for firm growth, but capabilities might be) could create the foundation for lateral enterprise expansion; she emphasized on the administrative and managerial constraints on growth; and (vii) Her most astute notion is that the firm can be viewed as “a bundle of (quasifungible) resources”. Garnsey advanced Penrose’s theory by developing a new framework for understanding the firm growth of a new firm (Garnsey, 1998). She identified the new firm’s growth patterns from a resource-based perspective, and summarized seven growth phases as follows: (i) access resources, (ii) mobilize resources, (iii) generate resources, (iv) growth reinforcement, (v) growth reversal, (vi) accumulation, and (vii) maturity. However, Garnsey realized that the term “growth stages” might not be precise to describe the growth of a firm, as the growth phases might come in parallel, if not in sequential all the time. Therefore, she developed a few measurable features of new firms’ growth paths in her later work: (i) patterns of survival, (ii) continuousness of growth, (iii) turning points, and (iv) reversals and cumulative growth. Garnsey’s approach to study the firm growth gave a theoretical framework to study the different growth phases of USOs. Understanding the patterns of grow phases will be used to construct a model in this study, and to provide a dimension to investigate the USOs’ innovation capabilities at different growth phases, as well as how they build them along their growth paths. Based on Garnsey’s framework, Stam used indicators to identify the growth phases of a firm. In this study, I would keep aligned with Stam’s definition, at least in the incipient stage of the research. However, I have modified some of the indicators based on the preliminary study, depicted in Table 1.

Table 1: Indicators of growth phases. Growth Phases

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Indicators

Initial business idea

1. Forming business idea; 2. Incorporation of the USO

Building resource base

1. Securing external investment; 2. Building productive site; 3. Launching prototype

Value creation and commercial base building

1. Launching first product; 2. Building of sales channels

Value capturing (expand resource base)

1. Break-even; 2. Obtain significant profit

New business idea (re-orientation)

1. New product portfolio; 2. Diversification; 3. Re-structuring; 4. New business strategy

Growth reinforcement or reversal

1. Turning point (employment or sales) to indicate continuous or delayed growth, plateau, or setback.

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USOs USO-related studies are receiving a growing attention in both academic and industrial domains, because “universities are seen as a source of technology development that is useful to entrepreneurial activities. As a result, policy-makers often consider mechanisms to stimulate technology commercialization at research universities as a way to encourage entrepreneurial activity in a region (Shane, 2004, p. 35). Although some researchers argue that licensing is acknowledged as the dominant measure for technology transfer in a traditional view (Siegel et al., 1999), USOs are viewed as the significant entrepreneurial alternative to licensing by scientists and technology-transfer officers (Lambert, 2003).

The definitions and typologies of USOs The traditional university start-ups are defined as “a wide range of companies that originate from universities”(Lockett and Wright, 2005), with a variety of possible associations between companies and universities in terms of people, technology, equity, and management consultancy. There are many different categories of university start-ups by various research types, e.g., (i) research-oriented or non-research-oriented (most consultancy companies provide research-oriented service (Druilhe and Garnsey, 2004)), (ii) upon the assignment of university’s invention or technology, or based on the external technology for initiation (Brett et al., 1991), (iii) initiated by academic inventors (incumbents), academic inventors who leave universities, or other external surrogate entrepreneurs/organizations (Lockett et al., 2003), and (iv) non-external equity supported (a university or an institute) or an external equity backed (Lockett and Wright, 2005), which provides an important indicator of performance, which can be viewed as successfully passed scrutinization by professional investors for significant future returns (Lockett et al., 2002). The recent studies show that USOs attract more attention than the traditional university start-ups. The definition of USOs varies from different perspectives10: (i) USO was defined as “the unit of analysis in this study as a venture, founded by employees of a university around a core technological innovation, which had initially been developed at the university” (Birley, 2002), (ii) USO was defined as “businesses that are dependent upon licensing or an assignment of the institution’s technology for initiation”. (Lockett and Wright, 2005), and (iii) USO was also defined as new firms created to exploit commercially some knowledge, technology, or research results developed within a university (Pirnay et al., 2003). The typologies of USOs are also very critical to study the innovation capabilities and their performances. According to Minshall and Wicksteed, USOs are one kind of the university start-ups (Wicksteed et al., 2006). It includes three sub-types (Minshall and Wicksteed, 2005): (i) high-growth potential USOs, (ii) profitable yet limited potential, and 10

A summary of the definitions of USO (prior to 2003) are included in Pirnay’s work, as part of literature review.

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(iii) acting as legal vehicles for commercial development of a tech. (for future licensing or sale of IP: Intellectual property). Pirnay proposed that typology could be based on two key discriminatory factors, namely: (i) the status of individuals involved in the new business venturing process (researchers or students), and (ii) the nature of knowledge transferred from a university to the new venture (codified or tacit), inducing the nature of the USO activities (product- or service-oriented) (Pirnay et al., 2003). Hugo and Garnsey also studied USOs, defining them as “usually thought of as new firms commercializing a proprietary leadingedge technology from a university department, and backed by venture capital11” (Druilhe and Garnsey, 2004). They named five broad categories of USOs depicted as follows, by the two dimensions: resource requirement and entrepreneur’s relevant knowledge and experience: (i) technical consultancy, sales (distribution), and research services, (ii) license Intellectual Property, (iii) software, (iv) product, and (v) create infrastructure. In this study, USOs should be defined as: (i) startups originating with university equity stake (ii) start-ups with a university technology initially been developed at the university. In addition, this research will focus on the product-oriented or IP-based USOs (including software companies), especially in micro-electronics sector, as well as telecommunication sector.

Theoretical development of USO-related studies Many existing studies view USOs as a black-box, considering an economic output and intellectual properties outcome as a function of environmental, political, market, and financial input. All these frameworks have common pitfalls like: (i) it assumes that resources are fungible and homogeneous across different USOs and (ii) outputs like innovation capabilities of USOs are determined mainly by inputs and their positioning in the market. Some representative studies include: (i) production-function type approach12, which is a study that considers the outputs (e.g., the number of USOs created, or USOs’ performance) as a function of basic resource inputs, in the sense of research expenditure or invention disclosures, human resources — staffing of technology transfer office (hereafter referred to as TTO), expenditure on IP protection, with some determinants of efficiency, such as whether or not the university has a medical school (Siegel et al., 2003) (ii) Di Gregorio and Shane study why some universities can generate more USOs, and the USOs have a better ability to create wealth. Their study focused on university level factors, including (Di Gregorio and Shane, 2003): (a) internal factors: a university’s propensity to undertake industry-sponsored research; their intellectual eminence (reputation and excellence of research); the host universities’ favorable policy 11

It is arguable that USOs are generally backed by venture capitals. Due to the lacking of “proof of technology” and “proof of eventual market potential” in the very early stages, USOs usually do NOT fall into VCs’ preferable catalog. In most cases, angel investors and seed funding are involved in the early phases of the development of USOs, followed by VCs’ participation in a later stage.

12

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This approach was referred as “inefficient model” by Lockett.

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towards IP commercialization; the number of TTOs and the amount of sponsored research expenditure and the number of inventions (b) external factors: the availability of venture capital (external equity investment) in a region, and (c) interactions: internal industrial expertise, and network available to USOs (Lockett et al., 2003). By contrast, there are some studies being conducted on process-view, concerning about the heterogeneous resources or dynamic capabilities across different USOs, compared to the above mentioned cross-sectional study on an aggregate level. Hugo and Garnsey recognized the heterogeneity of resources for USOs, as they developed a framework to categorize USOs from a resource-based and capabilities perspective, by the two dimensions: (i) resource requirement, and (ii) entrepreneur’s relevant knowledge and experience (Druilhe and Garnsey, 2004). In addition, Lockett investigated three distinct models of managing the spin-out processes from a capabilities perspective: (i) by academic inventors, (ii) by TTOs, and (iii) by surrogate entrepreneurs or organizations (Lockett et al., 2003). For these studies, resource-based view was employed, in order to model and analyze the resources inputs and skills of USOs as the sources of competitive advantages. There are some existing literatures focusing on how resources/capabilities could encourage the emergence of USOs. Vohora argued that financial resources are critical to USOs, and the role of joint venture as well as venture capitals are very important. In addition, he identified four critical junctures as important capabilities among the growth phases: (i) opportunity recognition; (ii) entrepreneurial commitment; (iii) threshold of credibility; (iv) threshold of sustainability (Vohora et al., 2004a,b). In addition, Clarysse alleged that the different incubation models for USOs have different resource implications, especially relating to finance, organization, human resources, technology, network, and infrastructure (Clarysse et al., 2005). Furthermore, Lockett asserted that the number of spin-out companies created and the number of spin-out companies created with equity investment were significantly positively associated with expenditure on IP protection, the business development capabilities of TTOs, and the royalty regime of the university (Lockett and Wright, 2005). However, the research to study the USOs’ growth from a resource-based view still remains sparse. In addition, for USO-related studies, resource-based view can be adopted with a dynamic approach. Traditionally, resource-based view perceives a resource as a stock, and a capability or a routine as a flow or an activity, using the equilibrium conceptualization of resource-based view by Barney or Peteraf (Barney, 1991; Peteraf, 1993; Peteraf and Bergen, 2003). However, the development of dynamic capabilities brought a new concept to resources/capabilities, in the sense of an ability to orchestrate resources and build capabilities in response to the internal and external changes (David J. Teece, 1997; Teece and Pisano, 2004; Winter, 2003). Furthermore, the dynamic capabilities for USOs can be viewed as that in early-phase entrepreneurial processes (Boccardelli and Magnusson, 2006), which might include: (i) flexible use of resources in searching for a suitable match between resources and market opportunities (the mode of learning and adaptation), which can be interpreted as the capacity to re-interpret and re-combine the

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already existing resources and thereby improve their fit with the demands of the market environment and (ii) the results suggest that an earlier proposed dynamic capabilities frameworks need to be modified, by taking into account the single entrepreneur as a source of dynamic capabilities, and by introducing the concept of resource flexibility.

Entrepreneurship Entrepreneurship definitely plays a critical role in innovation capabilities building for USOs. First, entrepreneurship is viewed as “an essential characteristic of (technology-based) organizations/firms is that they embody knowledge, which cannot be easily bought and sold. Sometimes, the only way to capitalize on knowledge is to start a firm and build the necessary complementary assets. Through entrepreneurial processes, profit flows from innovation, buttressed by the development of complementary technologies, and the astute deployment of complementary assets” (Teece, 2006, p. 4). Second, entrepreneurship elements in organizational design are important. According to Augier, entrepreneurship should not be confined to a new enterprise startup activities only, but to a broader meaning as entrepreneurship functions by “understanding opportunities, getting things started, and finding new and better ways of putting things together” (Augier and David, 2007, p. 6), “especially in the case of new or expanding firms, the entrepreneur does not face an abstract capital market. He or she exerts much effort to induce the potential investors to share the company’s views (often optimistic) about its prospects. This executive is much closer to Schumpeter’s entrepreneur (or Penrosian manager) than to the entrepreneur of the current neoclassical theory. Whether the firm expands or contracts is determined not just by how its customers respond to it, but by how insightful, sanguine, and energetic its owners and managers are about its opportunities — by how much they possess of the ‘animal spirits’ that Keynes was obliged to introduce into his account of the trade cycle.” (Nelson, 1991, p. 35). Therefore, this study will focus on the entrepreneurial processes along USOs’ growth paths. In addition, the entrepreneurial elements to facilitate USOs to build innovation capabilities will also be investigated, using the dilemma theory approach.

Dilemma Theory This section describes the concept of dilemma in management theory and argues that a theory of “paradoxical logic is an appropriate one to analyze management phenomenon, especially the phenomenon of innovation for an entrepreneurial process” (Seet, 2005, p. 96), such as spinning-out process. It is argued that the dilemma theory by treating values as differences, rather than as tangible things, can be used as a framework to interpret other means of resources and capability uniqueness for USOs; for example, an effective

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co-ordination in terms of good networking or technology capabilities. It is suggested below that the dilemma theory can contribute to the development of a model by reconciling opportunity recognition with co-ordinating knowledge via the process of opportunity framing. It is also suggested below that dilemma reconciliation is a dynamic competence that allows academic entrepreneurs to understand the patterns to build innovation capabilities and when used appropriately, can facilitate innovation and growth of new USOs. Dilemma theory gives a comprehensive framework to explicate entrepreneurial process during the USOs’ growth. It suggests that the process of resolution has a certain level of deliberateness, as it involves processes of eliciting, mapping, processing, framing, timing, waving, and synergizing (Trompenaars and Hampden-Turner, 1997). It has been applied in various fields ranging from strategy, leadership, culture, human-resource management, marketing, and change management. Dynamic processes are central to a rich understanding of entrepreneurship: “If we want to understand entrepreneurship, our research methodology must be able to handle non-linear, unstable discontinuities.” (Bygrave and Hofer, 1991, p. 28). In line with this, analysis methods and tools that can capture and analyze these dynamics have increasingly become important cornerstones for advancing entrepreneurship research (Aldrich, 2001). Researchers are also being encouraged to utilize techniques that can capture the subtleties of dynamic processes and events (McKelvey, 2004). Dilemma theory can also be used to understand innovation. It likewise attempts to interpret Shumpeterian “creative destruction” in a way that is useful at both the macro and micro level i.e., that is useful to both policy-makers and entrepreneurs in spinning-out process. Innovation occurs between the contrasting values and innovation is a way of reconciling remoteness with new associations and being diverse with supplying something useful and so unifying that diversity. This is also applicable in the reconciliation of resources. According to Westenholz, there are six types of paradoxical logic13 (Westenholz, 1999). Dilemma theory is the 6th type, which attempts to reconcile the dilemmas by a “through–through” thinking. Summarized from our earlier discussions, dilemma theory is viewed as a framework (in this study) with the following four characteristics: 1. Dilemma theory deals with values, norms, and information. It constitutes “news of differences”, for example, the red and green colors of traffic lights, low-cost competitive advantage vs., premium product competitive advantage in business strategy, complexity vs. user-friendliness in computers, and the autonomy given to the driver of an auto 13

Westenholz summarized six major types of paradoxes that can be applied to study business problems (Westenholz, 1999): (i) “discipline dominating”: one value is suppressed to reinforce another; (ii) “loose coupling”, an individual ignores opposing values (oppositions are expected, and they do nothing about each other); (iii) “compensating”: an individual keeps on changing between opposing values (in order to compensate for any value predominance); (iv) “flighting/jumping”: an individual escapes the opposing values by diverting attentions to elsewhere; (v) “conflicting”: a person supporting opposing values battle with each other, aiming to eliminate or dominate the other, leading to either “discipline dominating” or “continuous destruction”; (vi) “synergizing”: opposing values strengthen each other to form a “virtuous circle”, and it is named “reconciliation” by Hampden-Turner.

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snatched back when he gets into trouble so that anti-lock, and anti-skid devices snap on automatically, as do the seat belts, air-bags, side-impact prevention, and automatic distress calls. Doors also unlock so that rescuers can get to you. The vehicle needs to be versatile. Where these differences are combined or resolved, the product becomes more valuable through this combination of values and is said to be more innovative. The entrepreneur “stands between” these values and makes the connections, which generate surplus value that is not present before. Where the combination is nothing more than the sum-of-theparts, the innovation is likely to fail since those same parts are available to competitors; 2. There is a five-step process in reconciling dilemmas that can be mapped upon a notional 10 × 10 dilemma grid (Fig. 2). This explains what most innovators do intuitively. (10 × 10 is schematic. It could be 100 × 100 if the combination is far more valuable than its constituents) (Hampden-Turner and Trompenaars, 2000); 3. Many different scholars have tried to explain innovative processes. Dilemma theory examined 16 pairs of attributes whose combination is said to constitute creativity (Hampden-Turner, 2007); and 4. In each case, one value in each pair is achieved through the agency of another, in a process called “through–through” thinking or a cybernetic “virtuous circle”. For example, through the low-cost, standardized, mass-produced components ordered by Dell from its suppliers, a premium, customized, and a particular system can be created to suit each client. The total offering is mass-produced and customized. low-cost and premium, and standardized and unique, but note these attributes are at different levels

Reconciled position 10 Value A

H E

G

F

0

Value Z

10

Figure 2: The helix and reconciling dilemmas.

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of abstraction. The components are of low-cost, and standardized, while the total system has premium value and is unique. You create the second through the first. In this research, dilemma theory will provide a capability-level analytic framework, using a “through-through” paradoxical logic to explicate innovative capabilities. It facilitates the understanding of the innovative capabilities of USOs in a complementary way (from a paradoxical logic perspective), rather than other very limited qualitative measures of capabilities. In a word, I would argue that if we drill into innovative capabilities of USOs, there are paradoxes behind; thus, dilemma theory provides a lens to explicate the underpinning paradoxes to understand the capabilities.

Summary of this section: developing a preliminary framework Research gap Summarized in the last chapter, I indicate the research gap in theoretical context as follows. My claim is that addressing this potential research gap will be of great interest to the researchers, policy-makers, entrepreneurs, and international investors. (a) The studies that consider the heterogeneity of USOs from a resource-based perspective also remain sparse. (b) Limited number of researchers attempt to conduct an in-depth analysis on the critical innovative capabilities at different growth processes of USOs, which might be the answers to achieve a sustained growth. (c) Furthermore, resource-based view might be validated through dilemmas in the USO-related research, and dilemma theory can also be strengthened under the broad perspective of resource-based view. (d) A holistic model of innovation management within USOs should be developed. (e) There is a limited research dealing with the growth of USOs in China, in the context of science parks.

Developing a preliminary framework According to Stam, problems and problem solving are critical for evolving firms along the growth paths. In Hampden-Turner’s view, paradoxical problems are dilemmas (Trompenaars and Hampden-Turner, 1997); some of them can be reconciled based on innovative ideas and capabilities, although some others would fail to be resolved due to the limited capacities. In literature review, I have summarized an innovative-capability framework, and proposed the working definition of the growth phases of USOs. Based on the earlier discussions, 11 capabilities-related dilemmas21 related to the firm-growth have been elicited from an existing literature, using the dilemma theory approach. These dillemmas constitute a preliminary framework, depicted in Table 2.

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A Pilot Case Study This chapter consists of three parts: (i) the description of the pilot case; (ii) a brief analysis of this case; (iii) summarized reflections.

The case: V2 Technology Inc V2 Technology Inc. (hereafter referred to as V2) is a video-conferencing solution (software) provider in China, based on the patented voice encoding/decoding algorithms on H.323 IP-based communication protocol14. It spun-off from Tsinghua University in 2000, founded by the excelling team in the university-wide business plan competition. In 2006, V2 achieved the rapid growth at a rate of 56% in revenue, with the revenue and EBIDA of USD 2.61 million and USD 1.83 million. It was ranked No. 1 among the video-conferencing solution providers (web-based software) in multimedia communication industry in China by a survey on Yesky.com (a leading IT portal in China), in terms of market share (focusing on enterprise users). It had also successfully built a considerable customer base, ranging from Sinopec, China Telecom, China Mobile, and various government agencies. As a USO, V2 is one of the few “survival” cases six years after its establishment. It has established several innovative capabilities, which might contribute to its growth, in the sense of technology capabilities, complementary capabilities, financial capabilities, as well as alliance capabilities. However, it still suffered from some paradoxical problem -solving at different growth phases, in terms of configuration and re-configuration of resources, which might be the possible hindrances for their further growth. For better understanding, the growth path of this USO are described in Table 3, including their opportunities and challenges, responses, and major events from 1999 to 2006. 14 Background of the industry: the first video-conferencing system can be traced back to the 1960s, when Bell Lab launched their first prototype in 1964. However, limited by the networks and other technology, video-conferencing system was brought into market only in 1980s, with the development of codec (coder/decoder) protocol. In 1990, ITU-T (CCITT) approved H.320 framework standard. Therefore, the first commercial and practical video-conferencing system was launched based on this standard. H.320 adopted H.261 CIF/QCIF video format and G.711/G722/ G7288 audio format, supporting ISDN network. However, it has apparently limitations, such as high demand of the network bandwidth, poor audio quality, etc. In 1997, ITU-T launched H.323 multimedia communication protocol, which is IP-based (Internet-protocol). Based on this protocol, the hardware-free video-conferencing system became more and more popular for its robustness and low cost. Video conferencing becomes more and more important as a communication media in companies, household, and individuals’ life. In addition, the global catastrophic incidents contribute positively to the burst of the demand, such as 911, SARS, tsunami, etc. People realize the significance of remote communication. With the trend of convergence of Telecommunication Network (Tri-play), video-conferencing system will have much larger market, and it will take a part to change people’s behavior in lives.

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Problems

Dilemmas

Capabilities

Initial business idea

1. Opportunity identification

1. Brilliant scientific idea vs. workable idea is proven 2. Designed vs emergent in strategy mapping

Functional (technical and market capabilities)

Building resource base

1. Limited resource in prototyping 2. Need to attract external investment 3. R&D: do it in-house vs. outsource

1. Scientific improvement vs. workable prototype (prototyping vs perfection) 2. Scientific potential (public grant?) vs. capacity to attract investors (proximity to market) 3. HIH (have it in-house) vs. adaptation (from external sources)

Functional (technical) Integrative (financial, alliance)

Value creation and commercial-base building

1. Link with technology research base 2. Product need to be delivered to market 3. Founding team has limited commercial experience

1. Technology development vs. product provider 2. Scientific knowledge base vs. market-oriented knowledge base 3. Surrogate entrepreneurs vs. sole proprietary

Functional (technical market) Integrative (complementary, alliance)

Value capturing (expand resource base)

1. Product generates revenue, but how to use the revenue

1. Technical costs money (to improve products) vs. reserve the cash (risking or securing a reward)

Integrative (financial, complementary)

New business idea (re-orientation)

1. Diversification (product portfolio): what product to produce?

1. Managerial investment on R&D project (lateral distributed vs. vertical drill in)

Functional (technical)

Growth reinforcement or reversal

1. IPO or further external investment 1.

1. Novel products (with market potential) vs. exploitation of an existing product (to achieve an impressive balance sheet)

Functional (technical) Integrative (financial)

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Table 2. Preliminary framework for case analysis (Dilemma-theory based).

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Table 3: Opportunities and challenges

Action

Major event

1999

A highpotential technology (data transmission algorithm) was shelved in a R&D lab in Tsinghua University

1. A team (formed by students) was founded for the business plan competition in Tsinghua University. 2. They won the “excellence award”, and successfully attracted investors’ attention.

V2 Tech was founded

2000

External investors showed an interest in the new firm

1. The founding team secured the external investment from three corporate investors

V2 secured an external investment

2001

A few interested investors were reluctant to invest, because V2 was not an international company (difficult to exit in the Chinese stock market at that time)

1. Management decided to form a new corporate structure — a BVI offshore company, with a subsidiary (wholly-owned foreign enterprise) in China, in order to establish a legal vehicle for oversea floatation in the future (a legal entity in BVI)

V2 was re-institutionalized, becoming V2 Tech (China) Corp. (a wholly-owned foreign enterprise) under V2 Tech (BVI) Limited

2002

Two years after establishment, there was still no commercial product launched

1. The board decided to recruit professional managers, to replace inexperienced founders 2. Both ex-CEO and ex-CTO (founders) left V2, after the re-structuring

Surrogate entrepreneurs24 came in, and founders left

2002

Cash was draining. V2 needed more resources

1. New CEO re-structured the product-development process, in order to expedite the product launching 2. New CEO established commercial network

The company was re-oriented, from a technology developer (stream media technology) to a productprovider (software-product provider)

2002

V2 finally launched their first product

1. First product was launched, and received good market response

The company broke even in 2002 (Continued)

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Opportunities and challenges

Action

Major event

2003

V2 achieved their first burst in growth performance

1. Financial resources: positive cash flow and an impressive balance sheet 2. R&D team: 20+ engineers were recruited 3. licensed external technology, and integrated into V2’s product: the voice encoder package from Global IP Song, an encoder licenser for Skype

The company achieved a major revenue increase

2004 to 2005

V2 realized that their product portfolio was too limited (only one product)

1. V2 started to invest more resources in R&D, in order to develop more products

The business was ascending, but at a stable rate

2005

V2 was considering getting floated oversea, for further fund raising

1. V2 approached to the Singapore Stock Exchange

Failed to get floated in the Singapore Stock Exchange

2005

V2 still had only one major product, and the market competition became fierce

1. A larger customer-base was built, comprising MNCs, government agencies, etc. 2. More products were developed: (i) V2 tone video chatting software (p2p); (ii) a p2p service platform

Based on its core product, V2 attempted to diversify its business by developing more products

2006

V2’s growth reached stagnancy; the board was expecting better growth performance

1. A new company board was formed, consisting of five board directors, three corporate investors, and two surrogate entrepreneurs 2.V2 achieved a significant revenue growth, benefit from the economic burst in China (greater demand)

V2 was re-grouped

2006

V2 needed more fund to support its R&D innovation, in order to provide novel products in the market

1. V2 devoted a significant portion of managerial and financial resources into the seeking for floatation opportunity on AIM

V2 was still seeking for floatation opportunity on AIM

24

Surrogate entrepreneur is defined as the entrepreneur who joins in the executive team of a startup in a later time, compared to founders (Lockett and Wright, 2005).

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Table 3. (Continued)

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Brief analysis of this case The summarized result is depicted as follows (Table 4). Table 4: Case analysis. Growth phases

Capabilities

Dilemmas

Initial business idea

Functional (technical and market capabilities) Functional (technical) Integrative (financial, alliance)

A. Brilliant scientific idea vs. workable idea is proven B. Designed vs. emergent in strategy mapping C. Scientific improvement vs. workable prototype (prototyping vs. perfection) D. Scientific potential (public grant?) vs. capacity to attract investors (proximity to market) E. HIH (have it in-house) vs. adaptation (from external sources) F. Technology development vs. product provider G. Scientific knowledge base vs. market-oriented knowledge base H. Surrogate entrepreneurs vs. sole proprietary I. Technical costs money (to improve products) vs. reserve the cash (risking or securing a reward) J. Managerial investment on R&D project (lateral distributed vs. vertical drill-in)

A. Reconciled

K. Novel products (with market potential) vs. exploitation of the existing product (to achieve an impressive balance sheet)

K. Not reconciled

Building resource base

Value creation and commercial-based building

Functional (technical, market) Integrative (complementary, alliance)

Value capturing (expand resource base) New business idea (re-orientation)

Integrative (financial, complementary) Functional (technical)

Growth reinforcement or reversal

Functional (technical) Integrative (financial)

Reconciliation

B. Reconciled C. Reconciled

D. Reconciled

E. Not reconciled F. Reconciled G. Reconciled H. Not reconciled I. Reconciled

J. Not reconciled

Reflections on this case From this case, I argue that functional capabilities are more important in the earlier growth phases, while integrative capabilities become dominant in the later ones. The variation of significance of key innovative capabilities of V2 can be observed, along the growth path. I believe that further pilot case studies will help to better understand the specific important capabilities at different growth phases of USOs, related to their growth performance. In addition, in this case, dilemmas E, H, J, and K were NOT reconciled. According to the discussion above, we can see the dilemma E is technological capabilities, dilemma H is complementary capabilities, and dilemmas J, and K are financial capabilities. There are two questions emerging: (i) how important are these capabilities to V2’s growth performance?; (ii) and how are the reconciliation failures bring impacts (or impediments) to the further growth? Further investigations are called for to study these issues.

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However, some other factors are not reflected in this analysis. For example, sciencepark effects are not identified in this case. It might be because of the insufficient data collected, or science-park effects are less significant to this type of USOs. Therefore, further study is demanded.

Research Design for This 3-Year Research Project This research project will adopt a combined qualitative and quantitative research design, to build a model to improve the empirical grounding of the dilemma theory for explaining USOs’ innovation capability, and to identify and validate the relationship between their competencies to reconcile dilemmas and firms’ ability to create wealth in a sustainable way (Fig. 3). This study consists of the following three procedures: (i) An inductive approach will be used to identify the critical innovation capabilities in the way of critical dilemmas through existing literatures or pilot case studies. (ii) Quantitative methodology (survey) will be used to establish the parameters of the capability using dilemma theory, and to establish statistical associations between USO’s ability to reconcile dilemmas and firm’s ability to create wealth. (iii) Multiple-case studies are used to further investigate the inter-connected causal relationship between the ability to reconcile dilemmas to USO’s commercial success, at different growth processes15 (Garnsey, 2007; Hugo and Garnsey, 2002 has included). This research three major procedures in the following manner. First, the critical dilemmas to explain the innovation capabilities of USOs will be elicit from existing literatures and pilot case studies, given the lack of prior theoretical model and empirical studies of the dilemma theory on science-park based USO’s growth on the firm-level. For pilot case studies, it will include a range of interviews with founders of USOs, university TTO, and angel investors. The interviews are expected to facilitate the elicitation of critical dilemmas along USOs’ growth path. And we expect that the interviews would help us to specify one or two industry sectors of particular interest. Second, the survey will be used to identify and validate the associations between the firm’s ability to innovate (through dilemmas reconciliation) and firm’s performance to sustain growth. This step is to map the competence to reconcile the dilemmas as critical factors to a firm’s growth and ability to generate profit. Third, the dynamic model will be developed to address the elicited critical dilemmas at different processes for USO’s growth, which are sectorspecific in semi-conductor, telecom, or medical-device industries. So the multiple-case methodology will be adopted here, to create, validate, and replicate the model by detailed 15

Garnsey argues that an optimist’s way has strength in being predictive and precise. By contrast, interpretists are strong in understanding and gaining insight. She maintains that a quantitative method can be used to “establish parameters of the issue at an aggregate level (e.g., failure rates or growth rates of new firms) to establish quantitative associations”. And the qualitative method can be adopted when “drilling down to more detailed level to conduct qualitative inquiry into causes”. Therefore, this combined research design tends to integrate the strength of both epistemological stands, to find out the quantitative association first, and then drill down to understand the underlying causal relationship between the elements (Garnsey, 2007).

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Research questions and objectives

Further research

Literature review

Conclusion and reflections

Dilemma theory Theoretical background Resource based view

Multipe-case study data analysis Data analysis Questionnaire data analysis

Unit of analysis University spin-outs at the firm-level

Identify critical innovation capabilities to USO's growth through existing literature or pilot case study. The capabilitles will be explained by dilemma theory

Quantitative methodology (survey) will be used to establish the parameters of the capability using dilemma theory, and to establish statistical associations between USO's ability to reconcile dilemmas and firm's ability to create wealth Combined quantitative and qualitative data collection Multiple-case studies are used to further investigate the interconnected causal relationship between the ability to reconcile dilemmas to USO's commercial success, at different growth phases

Figure 3: A Combined research design for this 3-year research project.

case studies with rich contextual information. Six to eight cases will be studied until the patterns start to repeat themselves16 (Glaser and Strauss, 1968). The primary data sources will be collected through survey and semi-structured interview. In addition, archival data and other materials are also included as secondary sources. On one hand, the survey will be conducted by distributing questionnaires to science-park based USOs at major universities in China, such as Tsinghua University and Zhejiang University. The follow-up calls or personal visits will maximize the response rate to questionnaires. On the other hand, for case studies, the collection of interview data will primarily consider the perspectives of USOs’ founders. To ensure and validate, the investors’ points of view (at an early stage) will also be taken into account, in identifying 16

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It was referred as “theory saturation” by Glaser and Strauss (1968).

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the relationship between the ability to reconcile dilemmas and the performance of USOs. In addition, the interview protocol will be developed before interviews, which would ensure the reliability of the case studies. This model will be validated with structured data analysis method such as pattern-matching to enhance an internal validity.

Conclusion To sum up, this study will focus on the firm-level analysis of USOs in China, examining the critical capabilities of science-park based USOs in China at different growth processes using the dilemma theory. In addition, it is concerned with the way for USOs to build capabilities through dilemma reconciliation, and to investigate the dynamic relationship between USOs’ capabilities and its ability for growth and wealth creation. This study will fill the research gap by conducting a systematic study of innovation capabilities of USOs, and contribute in building a holistic dynamic model to help our audiences (researchers, policy-makers, entrepreneurs, and investors) to have an in-depth understanding and the ability to analyze the science-park based USOs in China.

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Bridging Universities and Enterprises: A Study on Chinese University Technology Transfer Modes ͣSHICHAO LI Tsinghua University

M

r. Li Shichao is a PhD candidate in Public Management in Tsinghua University, School of Public Policy & Management since 2006. His study field is public policy and management; science and technology policy. He also obtained his Master degree in Public Aministration from Tsinghua University in 2006. Mr. Li participated in various researches, such as An analysis framework for indigenous innovation policies: the perspective of policy tools, (National Natural Science Foundation of China) (2007–2009), International S&T institutional arrangement: theory framework and empirical analysis on several studying fields, (National Natural Science Foundation of China) (2007–2009), Analysis of public S&T policies in China: the perspective of global governance, (National Planning Office of Philosophy and Social Science) (2003– 2005), Empirical studies of S&T policy in China focusing on software industry. It analyzes the gaps in the existent S&T policy framework, and develops the process to facilitate the growth of software-oriented high-tech companies in China, (Ministry of Education, China), (2007–2008), and A network between academia, industrialists and policymakers in order to understand, leverage, and capture value from the fast growing research and design (R&D) capabilities of Chinese universities, (Ministry of Science and Technology, China) (2003–2005). Mr. Li’s recent publications include: • Li Shi-chao, (2005), “Technology Complexity and Social Frailty Conducted by It”, Science of Science and Management of S&T (Chinese), 2005 (11) and • Li Shi-chao, Su Jun, (2007), “The reformation trend of university: From research university to entrepreneurial university”, Studies in Science of Science (Chinese), 2006 (4).

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Abstract: How to improve the university technology transfer efficiency and realize the integration of Sci-Tech and economy as an eristic topic in the Chinese academic society. The divergence is rooted in how to identify the bottle-neck in the transfer process. This article discusses the root causes resulted in the structural disequilibrium among the technical chain, industrial chain and technical innovation chain, and leading to the insufficient technical transfer efficiency from the angle of resource allocation, and therefore, further discusses the principal modes for bridging universities and enterprises. On the basis of the previous analysis, three main modes of university technology transfer are proposed taking into account of China’s national conditions: they are technology transfer mode, co-operation and participation mode, and derived enterprise mode. Finally, the features of these three main modes are analyzed, the article, employing the corporate life-cycle theory, goes further to probe into how these modes match with the enterprises at different development stages. This attempt is in the hope of examining the adaptability of the transfer modes from the perspectives of both universities and enterprises. Keywords: University technology transfer; Path analysis; Transfer modes

Talk from “The Darwinian Sea” The former chairman of President’s Information Technology Advisory Committee (PITAC), Professor of Harvard University, Lewis M Branscomb, describes, “The Darwinian Sea between Research & Invention and Innovation & New Business as three Faults” among the inventor, the investor, and the management: the fault in study motivation, the fault in technical experts and the commercial management, and the fault in funds (the discussion of “information gap” is therefore initiated). Chinese scholars Su Jun, Lin Miao and some other people also contributed their deep study on this issue (Jun and Miao, 2001). After analysis, they pointed out that the structural disequilibrium existing among the technical chain, industrial chain, and the technical innovation chain is the deep reason resulted in insufficient university technology transfer. Here we can introduce four functions1, F = f(x1, x2,…, x11), F1 = f1 (x1, x2, x3, x4, x5), F2 = f2 (x9, x10, x11) and F12 = f12(x6, x7, x8). The function F represents the resources distribution situation from selecting a research subject to industrialization of a scientific pay-off; the function F1 represents the university resources supply on technical innovation chain; the function F2 represents the enterprise resources supply on technical innovation chain, and the function F12 represents the transfer function between F1 and F2. The curves of the four functions are all continuous between the intervals on the technical innovation chain (Fig. 1). 1

x1 (strategic orientation), x2 (human resources), x3 (physical resources), x4 (financial resource), x5 (integration capability), x6 (technology infrastructure), x7 (exploratory development), x8 (advanced development), x9 (market entry), x10 (operational know-how), x11 (batch production capacity).

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Comprehensive Resource

345

C

A

B

a

b

Technical chain

Technology transfer

c

Industrial chain

Technical innovation chain

Figure 1: The resource supply-demand relation in the technology transfer process.

In Fig. 1, curve B represents the resource supply status by a college in technical innovation chain F1 = f1(x1, x2, x3, x4, x5) and curve C represents resource supply status by an enterprise in technical innovation chain F2 = f2(x9, x10, x11). By studying the four function curves, this article analyzes the supply-demand relation in the technology transfer process, points out that there is a natural fault existing between the technical chain and the industrial chain, explains that the technical chain and the industrial chain is not geometrically corresponding and mapping, that means not every scientific pay-off can be industrialized. The fact that whether it can be realized depends on the supply function F1 on the technical chain and the supply function F2 on the industrial function, and the transfer function F12 between F1 and F2. Ignoring F12 would not only mislead social resources into a project which though passed research result acceptance test or appraisement, but is not ripe for industrialization and will destroy resource allocation effectiveness, but also result in the co-existence of technical effective demand deficiency and effective supply deficiency. Asymmetrical information in technology transfer would result in “negative incentive”, which definitely causes business to decrease. In the mean time, irrational decision made by incorrect information will decrease co-operation or make co-operation form simple and obstruct the progress of technology industrialization. From the above analysis, we can see that it cannot be explained in one word concerning capital, mechanism, and social culture factors to illustrate the phenomena from

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structural disequilibrium to structural adaptation, instead we need to design and create the paths from the source to improve the university technology transfer efficiency.

Theoretic Revelation and Path Analysis If we can properly understand the inherent mechanism and the basic logic of the structural disequilibrium in the supply and demand on technical chain, industrial chain, and technical innovation chain, it is not hard to find the pickup points for improving the technical transfer efficiency. There are basically three paths to solve the problem of structural disequilibrium: • Path 1, extend F1 curve to F2 curve, that is, point b moves to point c; • Path 2, extend F2 curve to F1curve, that is, point c moves to point b and • Path 3, by organizing and innovating to connect F1 curve and F2 curve. The significance of path 1 policy is to facilitate the potential university commercial value to be converted into realistic productive force and realize the universities’ social function as “science and technology radiation source” by means of technical licensing, technical permission, technical advice and technical service, and some other forms. This analysis is based on mode 1 (technical transfer mode). The significance of path 2 policy is and facilitate the joint participation of universities and enterprises in scientific research. Normally, the enterprises have not obtained technological achievements in universities; they participate in the universities, choice and study of technology only with certain technologies and technological capability, while the universities act as the part of “virtual research institute for the enterprises”. This analysis is based on mode 2 (co-operation-participation mode). The significance of path 3 policy is to facilitate and establish some new enterprises capable of incubating technological achievements or technological capacity. The technology transfer is completely led by the universities, talents and technology is the foundation of the universities; they undertake and participate in the consequent work of the technology transfer and realize their social function as “the incubator of enterprises”. This analysis is based on mode 3 (derived enterprise mode).

Selection of three modes of Chinese university technology transfer Technology transfer mode Technology transfer is an important way for university technology transfer, and one of the popular modes of technical co-operation between university and enterprise. In this mode, university already has relatively ripe core technology. Technology transfer in itself is a characteristic of “technology push”. Technology commercializing is carried out by technology itself, instead of market demand.

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Basically speaking, technology transfer in China is developed in three directions; one is incubating technology market, doing technology transaction in the form of technology co-operation, the other is facilitating co-operation between enterprise and university and scientific institute, still the other is making technology transfer by establishing scientific enterprises by university. The latter two ways correspond with the latter two modes. First, this article discusses the first mode. By “the Law of the People’s Republic of China on Technology Contracts”, technology contract falls into four categories: technology development contract, technology transfer contract, technology consultation contract, and technology service contract. So, transaction mode in Chinese technology market can be divided into technology development, technology transfer, technology service, and technology consultation. Table 1 shows university patent and technology transfer situation in China. Table 1: Universities patent and technology transfer situation from 1996 to 2004. Technology transfer contract amount (thousand Yuan)

Technology transfer actual return of the year (thousand Yuan)

Technology transfer actual return rate (in %)

Year

Patent authorization (piece)

Patent sold (piece)

Patent conversion rate (in %)

1996

1002

367

36.6

618,190

333,335

53.9

1997

1022

362

35.4

652,294

386,398

59.2

1998

1063

371

34.9

867,523

535,556

61.7

1999

1273

298

23.4

1,202,159

694,871

57.8

2000

1952

299

15.3

3,499,148

1,185,374

33.9

2001

1850

410

22.2

4,057,935

1,339,596

33.0

2002

2251

532

23.6

3,796,579

1,098,166

28.9

2003

3954

611

15.5

2,373,817

1,579,611

66.5

2004

6399

731

11.4

2,292,323

1,355,338

59.1

Source: 1996–2004 “Science statistics collection of universities”.

From Table 1, we can see: firstly, number of Chinese patents, patents sold, contract amount and technology transfer contract is rising for 10 years; secondly, although the university patent number is rising, but absolute number is still low, university technology transfer by patent selling or authorizing is much lower, the last one, comparing university patent selling contract and technology transfer contract number, we learn that in Chinese university technology transfer contract, university patent selling contract number accounts for very low proportion. This is different from that in the United States. In the United States, OTL mode has become a standard one for university technology transfer, so in the United States, university transfer is a patent protection and authorization mode.

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As per the above discussion, technology transfer is the business activity transferring research result at certain pricing or through technical contribution to those who need the technology after completing R&D by technology supplier. The basic university technology transfer mode in industrialized countries is that the university transfers its scientific payoffs to enterprises by means of patent application and licensing or patent authorization. While it is different in China, the university acts a bigger part in the technology transfer. In the meantime, transferring the laboratory achievements into enterprises by means of technological licensing and authorization, the university also needs to provide the enterprise with continuous technological support and technical service and they are further involved in the process of commercialization and industrialization of the technological achievements. Chinese university technology transfer mode is an expanded mode based on the technological licensing and authorization modes of the industrialized countries. Technology transfer is always followed by co-operation with the aim of passing on technical know-how. It is a preferred selection based on our basic national situation as lacking innovation ability by enterprise.

Co-operation and participation mode The main purpose of the co-operation and participation mode is that the university and the enterprise jointly undertake technological selection and R&D innovation activities. The enterprises are usually dominant in this process. The university and the enterprises together share the risks and profits from technological innovation. This mode is actually a joint operation of the university and the enterprises. The enterprises’ “early entry” into the fundamental research, fundamental application research and applied research enables the ladder step-up liner mode in R&D activities to evolve as continuous mode of the cooperation between the university and the enterprises. Meanwhile, the university continually provides the enterprises with knowledge support and technological services. The co-operation between Chinese university and enterprise has experienced a series process from advocating to develop project co-operation at the end of 1970s, promoting establishing combined unit of teaching, scientific, and research and production in the early and middle of 1980s, forming regional united organizations at the end of 1980s, and to implementing “united development project by industry, university and research institute” in the early 1990s. From the end of 1970s to the end of 1980s, scientific system reform centered in science and technology appropriation system had research institutes exposed to the market gradually and formed relatively strong technology supply ability. “Science and technology development program” in 1982, “National key industrial trial program” in 1984, “Torch program” in 1988 covered some production, teaching and research integrated projects. In the 1990s, the co-operation among production, teaching, and research in China saw some new progress. In April 27, 1992, the State Commission of Education issued a “notification of organizing and implementing united development project of production, teaching, and research” with the State Economic and Trade Commission and China Academy of Science.

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In August of the same year, the first working conference of united development project on production, teaching and research was held in Beijing. Since then, the project was initiated through out the country. Take Tsinghua University as an example, it established co-operative commission between Tsinghua and enterprises in 1995; in 1996, overseas department was founded and operated on the basis of membership. By the end of 2005, there are 134 domestic enterprises like Bao Steel, Shougan group, Haier, etc. and 33 foreign companies like IBM, GM, Samsung, and Toshiba etc., participating with the department. With a view to expanding long-term stable co-operation, there are over 80 enterprises who established united research organizations with Tsinghua University which offers new products, new technology, and the latest information. The participating modes by Chinese universities are mainly demonstrated by the following two real forms: co-operative development mode including consigned development and establishing unit jointly. Co-operative development mode is relatively loose and flexible, easy to make use of the advantages of the parties involved, and conforms the principle of optimized distribution of resources. But in the process, university research is apt to be restricted by enterprise which plays a strong guiding role. In addition, there exists some instability in co-operative time, depth, selecting co-operative partner, interest sharing, result property, and risk sharing etc. The mode of establishing joint unit includes setting up high and new technology enterprises, research institute, college, project research center, key lab, and high and new technology industrial park etc. Through new joint unit, the co-operation between university and enterprise develops into a stable long co-operation from loose structure, realizing resource sharing and promoting technology transfer.

Derived enterprise mode As extension of university science and research, university spin-off is an important media for technology transfer. Based in university, the spin-off is founded making use of human resource, product resource, technology resource, and brand of university. In general, university spin-off is established in school or around school. Some technology inventors participate in founding and development of enterprises directly or indirectly whose core technology is originated from the available science and research results in university, or making use of various science and research conditions, and environment to develop the research result successfully. Generally, the universities in industrialized countries do not directly establish and control the enterprise entity, but play more functions of “radiation source” and “incubator”. The difference from foreign situation is, the enterprises derived from Chinese university have their own features and the development mainly along two elementary paths: the first is the mode of university Sci-Tech enterprises, it is developed from the university enterprise mode primarily founded in 1980s, it is the resultant of the practical need for self-development and the difficulties in converting scientific pay-offs of the universities, and a special mode around the world.

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Enterprises run by the Chinese university have undergone such phases as founding, growing, development, and expanding. After entering into 1990s, with a continuous expansion of education and economy system reforms, lots of excellent school-run enterprises were constantly emerging. University-run industry has become an important part of the national economy. By the end of 2005, there are 4,311 companies run by 569 general universities, among them, 2,429 are science and technology enterprises, accounting for 56.34% of the total number. In 2005, the companies run by the national general universities realized a total revenue of 107.134 billion Yuan with a profit of 5.562 billion Yuan (centre for Science and Technology Development). Notice should be given that for the last 10 years, the university-run enterprises grew rapidly, some economic indices are rising for years. But at the same time, the enterprise number has gone down. It is due to the re-organization on Chinese universityrun enterprises initiated in 2002. As university science and technology industry develops and expands, there are some existing problems exposing themselves. It is profoundly manifested as follows: unclear positioning, property order not straightened out, irrational systems, relatively small volume, lacking capital, inadaptable to market system, lacking risk consciousness, no invest and retrieving system etc. The other mode is the derived enterprises incubated by the university Sci-Tech Park. Currently this is more popular internationally. Normally, the university Sci-Tech Parks have Sci-Tech enterprise incubator to provide primary configuration services for establishing the enterprises and assist the new enterprises to grow up healthily. Since 1980s, China has attempted to establish a university Science Park. By 2002, based on 104 universities and research institutes, there are 43 national university science parks which passed examination or initiated its construction. There are 2,270,000 square meters incubating area being put into use, over 5,500 companies set their base there, and 2,276 companies are in the process of incubating. The companie’s incubation has added up to 923 of which 29 have been listed. The incubating enterprises in the parks have transfer provincial level science and research results 1,860, got patents approved up to 1,923, and new products developed added up to 4,116. There are over 1,200 research institutes founded in the parks (Science and Techonolgy Daily, 2003). But from overall development, this mode is still in the preliminary stage in China.

Analysis on Enterprise Adaptability of Three Modes in Practical Level Selecting technology transfer mode not only depends on the wish of technology supplier and receiver, but also depends more on the characteristic of technology transfer mode itself. From the point of enterprise, what the technology level enterprises can digest and introduce is different due to different technology innovation, digest and absorbing ability of enterprises with different scale and condition. So, the technology transfer mode suitable is different. Selecting different university technology transfer mode has much to do with enterprise scale and condition.

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In terms of technology transfer mode, in general, there is relatively matured core technology already in position. It requires a sound research and economic strength in the field for enterprise which would receive the technology and can be deemed as relatively matured enterprise. Regarding spin-off, the technology result is not fully matured and needs further development before coming into the market. Some large companies do not like to purchase such immature technology; while risk investment is unwilling to invest preliminary research without a clear high return. When technology results are not recognized by investors because of low maturity, unclear market prosperity, or technology transfer mode can not play a role due to other factors. So, it calls for a new enterprise which is more suitable for transforming immature and avant-garde high and new technology. In terms of co-operative participating mode, it realizes resource sharing and mutual complementary through co-operation in the progress of technology innovation, then promote university technology transfer. Enterprises likely to adopt this mode generally are in the development period at least in certain area. Fig. 2 shows how university technology transfer modes are easily accepted by enterprises in different periods of the life cycle.

Technology transfer

Derived enterprise

Cooperation and participation

Incubation period

Development period

Matured period

The life cycle of enterprise Week Adaptability

Middle Adaptability

Strong Adaptablity

Figure 2: Selections of university technology transfer modes based on the life cycle of enterprise.

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Concluding Remarks Under certain system environment, university technology transfer is technology carrier change between university and enterprise. It happens either in university internal systems, or only in enterprise internal system, but a sophisticated interactive evolution process in systems of enterprise and university. There is no optimum condition or mode for university technology transfer. But we try to seek a relatively optimum condition and mode. That is, to continuously seek possible effective dynamic match among technology, environment, enterprise, and university. From the point of enterprise, what the technology level enterprises can digest and introduce is different due to different technology innovation, digest and absorbing ability of enterprises with different scale and condition. So the technology transfer mode suitable is different.

References Bozeman, B (2000). Technology transfer and public policy: a review of research and theory. Research Policy, 29. Etzkowitz, H and L Leydesdorff (2000). The dynamics of innovation: from national systems and ‘Mode 2’ to a triple helix of university-industry-government relations, Research Policy, 29. Fan C and Y Chen (2000). The springing-up of university S&T parks in China, Science Research Management, 6. Fan D and Z Shi (2000). The system innovation and the development of high-tech enterprises in China’s universities, Journal of Tsinghua University (Philosophy and Social Sciences), 6. Hong L and Y Jiang (2001). Technology transfer from higher education institutions to industry in China: nature and implications, Technovation, 21. Hua D and W Tao (2006). University-industry interaction mechanism in Chinese higher education institutions, Research On Education, Tsinghua University, S1. Lee, YS (1996). Technology transfer and the research university: a search for the boundaries of university-industry collaboration, Research policy, 25. Lei C and Y Huang (2003). Comparison of university technology transfer at home and abroad, R&D Management, 5. Lin Miao and Su Jun (2001), Technology chain, industry chain and technology innovation chain: theoretical framework and policy implications, Studies in Science of Science, Vol 4. Miao L and S Jun (2001). Technology chain, industry chain and technology innovation chain: theoretical framework and policy implications. Studies in Science of Science, Vol 4. Science and Technology Daily, 7.1.2003. University run enterprises statistics in 1996–2005, website of Centre for Science and Technology Development Minister of Education. Yuan C and Y Peng (2003). New research evolution on the transfer of S&T achichments in China’s high institution, R&D Management, 6.

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Session 4

Internationalization and Brand Strategy

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On the Internationalization of Chinese Brand: The Case of the Shaanxi Blower Group ͣYONGXIU BAI and HONGFANG ZHANG Northwest University, China

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rofessor Yongxiu Bai is the Dean of the School of Economics and Management, Northwest University. Professor Bai is the supervisor of doctoral students and also a senior consultant. At the same time, he is one of the leading teachers in Political Economy course, which has been honored as one of the top quality courses. He also works for the Research Center of Chinese Economy and Policy, the University of Central Communist Party, and as visiting professor of several universities. Professor Bai is also the executive member of the council of the Chinese Institute of Business Management, the vice chairman of Chinese Industrial Economy Research and Development Association and also the chairman of Shannxi Regional Economy Research Association. His research focuses on issues such as marketing economic system and modern enterprise system, the reforms of state-owned enterprises, regional economy and the development in the western regions. He has also published over 600 papers in People’s Daily, Guangming Daily, Management World and other academic journals. Professor Bai is also the author of Research on Modern Market Economy in China,Theories and Practices of Modern Enterprises, Research on Deng Xiaoping’s Economic Theory and other over 30 other academic works. He is also in charge of 14 projects granted by the National Science Fund Project, State Social Science Fund, Soft Science Projects of Ministry of Science and Technology, Humanities and Social Sciences Major Projects under the Ministry of Education, China. As a teacher, he has given lectures on Political Economics, Theory of China’s Market Economy, Industrial Economics and Industrial Enterprises Management, etc. for undergraduates and Market Economy, Modern Enterprise System and Reforms of State-Owned Enterprises, Assets Reorganization, Enterprises Innovation, etc. for postgraduates.

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ssociate Professor Hongfang Zhang graduated from Northwest University, Graduate of PhD of Economics, School of Economics & Management in 2001. She is currently the Associate Professor of Northwestern University School of Economics and Management, a master’s program instructor and the deputy director of MBA education center. Associate Professor Zhang was the lecturer of School of Economics & Management, Northwest University, from 2001 to 2004. She was also involved in four academic research projects, including a Post–doc research project “A Study of the Development of Science & Technology and Education of Shaanxi Province”, funded by Program of Shaanxi Province Government. Abstract: The paper offers a research framework which can be used to analyze the ways in which Chinese brands are being internationalized. It suggests the following five methods: exporting products, direct investment in overseas factories, merging with foreign enterprises, providing manufacturing products for international enterprises and broadening market channels. Subsequently it presents a theoretical framework illustrating the internationalization of brands. The framework involves four factors as follows: (1) the characteristics of technological innovation, (2) the characteristics of industry structure, (3) situating enterprise brand culture, (4) foundation and support of human resource. These factors are important variables in selecting ways of internationalization. The paper then presents the case study of the Shaanxi Blower (Group) Co Ltd in its efforts at brand internationalization, which according to our analytical framework, is leading in its field in this respect. Through analyzing the four variables, the paper offers a comprehensive treatment of Shaangu’s method in brand internationalization which combines investing factory directly abroad and technical cooperation. Keywords: Brand internationalization; Overseas factories; Technical cooperation.

The Overview of the Research on the Globalization of Brands “International Branding” is also referred to as “Globalization Management of Brands”. It is a brand management strategy in which enterprises extend the same brands into different nations and regions by using the same name, packing and advertisement plan, for the purpose of economies of scale and low-cost operation resulting from the unification and standardization of brands. In the process of the internationalization of brands, the differences in brand output or ways of internationalization of the brands directly reflect the degree of internationalization. Currently, the study on the choices of internationalization is reflected in the following two aspects: Some scholars study on the ways of internationalization by combining standardization and localization operations of the brands. From the angle of the different processing ways

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with standardization and localization, Meng Lei (2002) summed up four different ways of internationalization. The first one is standard international branding, which is characterized by unified and standardized elements in all the marketing mix elements, in addition to the necessary tactical adjustments. The second one is simulated international branding. The features of this model are that of brand image, brand positioning and other major marketing elements that are globally unified, and other factors such as products, packaging and advertising strategies, adjusted to enhance the adaptability of the market brand, according to the specific circumstances of the local market. From the industry perspective, the typical one is the automotive industry. The third one is standard local branding. This is international branding strategy of the lowest degree of internationalization. Its key characteristic is that in implementing the international strategy, the introduction of all marketing mix elements should fully take into account the culture and the language habit of the host country, and adjust properly according to the conditions of the local market. The fourth one is the system-decided international branding. The so-called institutional decision means that due to the special nature of certain products, their marketing is not entirely determined by the enterprise itself, but it is influenced enormously by trade issues of the target markets and the distribution system. In other words, the enterprises can only passively factor into the framework certain institutional constraints pertaining to unification or localization of decision-making. With regard to the choice of the above four models, Fei Mingsheng (2005) raises two factors: enterprise comprehensive competitiveness and the difficulty in the operation of the host country market. Some researchers, from the factors of standardization and localization of international branding, consider the pressures of standardization and the pressures of localization in international branding and establish the matrix model of international model choices. The pressures of standardization in this model mainly include: similarity of market demands; technology reunification; customer preferences; a high degree of similarity of requirements; requirements of brand scale. The pressures of localization mainly include: differences in political and economic systems in target markets; market access barriers; cultural differences; consumer preferences and so on. Another type of analysis focuses on generalizing the mode of entering into the target markets into two kinds: exporting products and investing factory directly abroad. This study is mainly from the aspect of costs, risks and potential benefits of the two modes. The American scholar Franklin R. Root studies the factors affecting the mode of opening up the international market in many ways, such as sales potential, the market structure, the marketing facilities, the cost of production, imports and opening up, investment restrictions, cultural differences, political risks and so on. According to the globalization of Chinese brands, a number of other scholars divide international branding into the Haier model, the Galanz model, the TCL model, and so on. The focus was mainly concerned with the differences between the Haier model and the Galanz model, that is, the differences both in the ways of production extension and the region of produce, such as domestic production or overseas production, and the main difference between the two lies in cost differences.

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We believe that in the process of the globalization of Chinese brands, model selections and enterprises development stages are highly relevant. In other words, in different stages of development, there are different access patterns. Therefore, in this paper, we choose the second type of perspectives, which studies the globalization of Chinese Brands from the perspective of synergies between the stages of the development of international branding and the ways of brands entering the target markets. Subsequently it delves into the factors behind selecting ways of internationalization; this framework is then applied to our case study of the Shaanxi Blower (Group) Co. Ltd, a Chinese turbine enterprise.

Selecting Ways of the Globalization of Chinese Brands Five Modes of the Internationalization of Chinese brands are discussed as below.

Exporting products From the specific mode of entry, this mode includes two models, relying on the channel of foreign sales and setting up market abroad independently. This is the model of relying on the channel of foreign sales. The enterprise creates and expands the influence of the brands by commodity exports and the channel of foreign sales in the initial stages of international branding. This model has always been a basic way adopted by many businesses. When opening up the United States market, Qingdao Beer chose Monake which is the largest beer distributor. This company not only has a vast sales network composing of wholesalers, retailers and component salesman throughout the 50 states of the United States, but it has also done a lot of good work in the advertising and packaging of products, meanwhile it has laid a good foundation in boosting sales of Qingdao beer and the expanding of brands. The advantages of this model are as follows: First, it can help the enterprise to enter into the international market rapidly by using fully the long-term sales network and credibility established by the foreign firm. Second, it requires less investment and low start-up capital. Third, it helps the enterprise to lay a foundation for exploring the international market. But there are also many risks: First, the enterprises have not established independent sale channels, and were often controlled by others in pricing, promotion, advertising and other marketing strategies and brand promotion strategies. Second, the integration of foreign enterprises’ activities into our enterprises’ international brand strategy poses a management coordination problem. Third, once all kinds of conflicts of interest lead to the rupture of cooperation, they will cause great impact to the enterprise. Establish foreign marketing channel. Given strong finances, enterprise can invest abroad and establish overseas marketing offices or establish branches after obtaining certain international marketing experience. It helps the enterprise to establish a sales network with strong controlability by directly contacting local retailers or customers,

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and is closer to the consumers. The enterprise can promote brand and product directly. The advantages of this model are as follows: First, it can provide different products and services more flexibly according to the needs of clients and enhance the value of the brand. Second, it is better for the enterprise to obtain strong controllable sales channels with fewer funds. Third, the obstacles encountered in cross-cultural management will be less. However, we should avoid going into the errors due to reliance on low-pricing, and instead deliver brand value to consumers and increase brand awareness and reputation by using advertising, personnel sales promotion, public relations and different products and services. But such models are vulnerable to all kinds of tariff and non-tariff barriers as well as various factors of instability in the world.

Providing manufacturing for international enterprises This model is a way that the enterprise which wants to realize international branding promotes its own brand products in the production and sale with the help of the recognition of international brands. For instance, Galanz wants to be a global manufacturing center of brand appliances and locate this center in China. Compared with developed countries, the main advantage of China is cheaper labor. Compared with some developing countries, there are three advantages in China, which involves in the stable political situation, better industrial base, and manufacturing industry cluster in Shunde. Galanz promotes its own international branding by providing production for international enterprises. The advantages of this model are as follows: First, it helps the enterprise take over the original market share of foreign enterprises in the form of contracts between enterprises and save a lot of marketing costs. Second, relations with industry competition translate into upstream and downstream relations. Third, it helps the enterprise obtain production lines in the form of goods supply contracts and production returns. Fourth, using the differences in legal systems, the enterprise gains the advantages of low-cost. Fifth, with production line introduced in Shunde, the enterprise makes full use of local human capital in lower cost and industrial cluster advantages. This model is better for enterprises to enhance the visibility of their own brands with the help of the visibility of cooperation brands. It can create new demand, save cost of brand promotion and shorten the time for a license and generate premium income. But it may also encounter many problems, such as the agreement of the costs incurred by the union parties, the conflict of interests, the handling of mutual relations, brand harmony and so on. There should be appropriate preventive measures and disposal measures.

Direct investment in overseas factories Enterprises can establish their own production bases by investing in factories directly abroad. Using the “trinity” method of localization, i.e., local designs, local manufactures and local sales, enterprises may introduce their own brand into the target market. This becomes one

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kind of more independent brand internationalization pattern. For instance, Haier, in its internationalization process, set up factories in Indonesia, Philippines, Malaysia in 1996, and in the United States in 1999. In this model, enterprises can create a new production base according to their needs, and produce products according to local needs, and bypass the tariff and non-tariff barriers. It is better for the enterprise to establish a close partnership with local dealers. But it might be a costly affair and sacrifice low-cost advantages if factories were built in the United States and other developed countries instead. It also takes some time to generate profit. Three issues need to be considered when deciding on this model: First, whether the enterprise is in a strong financial position. Second, whether the enterprise has the ability to cope with the complexity and sustain the high degree of risk involved with overseas production. Third, whether the enterprise has the ability to operate and manage in the cross-cultural environment.

Merging with foreign enterprise This model is a way in which enterprises can access strategic resources, such as patents, advanced equipment, brand, sales network, customer loyalty and market knowledge through the control of the foreign enterprises. Many companies use this model to open up the international market. At present, many Chinese enterprises try to enter the international market using this method. For example, Lenovo acquired IBM’s personal computer business. Using the latter personal computer brand, technology and channels, and other resources, it managed to penetrate the international market effectively. In this way Lenovo’s internationalization process was accelerated. TCL purchased Schneider and Covedio, merged with Thomson which is the global electronic industry tycoon, and established TCLThomson. Different brands operated in different market, TCL in Asian market, Schneider and Thomson in the European market, Covedio in American market. This can reduce the time of consumer awareness and acceptance and the difficulty of market entry through this model. It also can develop and strengthen their own brands, shorten the distance between the international brands. Therefore, it is a more favorable international brand model for the enterprise which has enough funds and capacity of transnational operation. The risk of this model is the information asymmetry during M&A, the difficulty of technology and management after M&A and the handicap of cultural integration.

Broadening market channel Chain management which successfully created a large number of world-class brands is a more sophisticated brand business model. Some Chinese businesses choose this model to expand the international market. For example, ERDOS favored by foreign consumers has established dozens of its own brand stores in the United States and more than 30 countries and regions. In this way, they can a promote localization marketing strategy. Tong Ren Tang, a traditional Chinese medicine outfit with a long history, established a joint venture company

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and opened outlets in Malaysia, Thailand, the United Kingdom, Canada, Australia, Hong Kong and Macao. Using its own medicinal formulation and production process, it became a famous international brand in the organic medicine market. When technology, production process and brand recognition of products have a certain specialty or monopoly, and the products cannot be substituted easily by other brands when entering the international market, it can then broaden its market channel. The characteristics of this model are that it uses the unified technical standard, the unification production process, the unification goods supply channel, unification brand marking, the unification management pattern to realize brand internationalization. Enterprises with strong brand products and services in our country may seriously consider this mode of operation to carry out overseas expansion. Summarizing the five kinds of patterns, we may discern three characteristics: First, each kind of pattern is dynamic and mutually transmutable. With the different development period of enterprise and the strength of enterprise enhanced, the five kinds of patterns mutually transmute. The most common transformation is from exporting product to investing factory directly abroad, from providing manufacturing for international enterprise to investing factory directly abroad, from investing factory directly abroad to merging foreign enterprise. Such as Wan Xiang Group, it expanded into the export market through intermediate agents since 1980, set up branches in America, Japan, Europe, Africa, and West Asia since 1990. They carried on with the overseas management by establishing their own production bases abroad. The product become more and more important in the international market since Wan Xiang merged with Ashele and UAI. Second, each model is from the low level to high level. In the ways of internationalization of brands, exporting products, investing factory directly abroad, merging foreign enterprise belong to the modes in the lower level, whereas providing manufacturing for international enterprise and broadening market channel, which are the results of international brands and the form of international operations in the higher level. The tendency of developing from the lower level to the higher level reflects the process from product internationalization to production internationalization and then to resources internationalization. Third, the five models complement each other; coexist instead of being mutually exclusive in practice. The enterprise often uses each kind of pattern when entering the different goal international market. For example, TCL may take the way of merging foreign enterprise when entering the developing countries such as Thailand, but when entering European and American market it may take the way of providing manufacturing for international enterprise.

Underlying Factors Affecting on the Choice of Brand Internationalization Mode Mode selection will be influenced by various factors during the process of brand internationalization of one company. Generally speaking, factors of relevance are capability, strategic location, stage of internationalization and so on. The company will

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choose the proper mode and route to advance internationalization based on its own capabilities, strategic location, stage, operational cost, risk, benefit analysis. But these are superficial factors, what are more important are the underlying factors which are listed in Table1.

Table 1: Underlying factors affecting the choice of brand internationalization mode The competence and monopoly of technology (1) The feature of technology innovation and maturity level

The extent of integration of technology innovation globally The differences among countries and areas as to technology development The phases of life cycle Core value location of brand

(2) Enterprise brand-culture location

Brand culture-location and core competence location National culture in brand location and specific value connotation Value added of company brand The mature level of human resources

(3) The base of human resources and its supporting function

The support of human resources to internationalization strategy The possibility of human resources internationalization The extent of localization of human resources The feature of industry’s market structure

(4) The feature of target international market

The competence extent of target international market Political barrier in target international market The possibility of localization in the target international market

The feature of technology innovation and maturity level The competence or monopoly of technology is an important variable affecting the choice of internationalization mode. It is easier to enter a new market successfully through technology innovation if the technology of industry tends to be competitive or of a lower technological barrier. Choosing the mode of investing to build plants overseas or R&D institutions is feasible in the process of brand internationalization. On the contrary, choosing the mode of direct investment overseas is not feasible if the technology industry tends to be a monopoly; in other words, the leading company has formed some market entry barrier through monopoly so other companies intending to enter the international market through technology innovation require costly research capital, have high risk and difficulties. It is feasible to choose to introduce the technology of leading company or conduct partly technology cooperation, through joint ventures in processing and assembly. The integration of technology innovation globally is another influencing factor. The modern industrial company enjoys economy of scale, huge capital and strong technology

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research capability, but it is hard to be leading in every aspect, so many companies choose the mode of cooperative development of key projects. The United States, Japan, and Western Europe commonly use several R&D mode, such as R&D with universities (domestic and overseas) or institutions, complementary cooperation with other big enterprises, upper and downstream integration with customers and relevant industries, which has achieved better results. The higher the extent of global integration on technology innovation, the higher the possibilities of realizing brand globalization, such as technology cooperation and crossshareholding to build production or R&D institution between international companies. The enterprise which is in a specific field and on the front-edge of technology is more adept to this mode. For instance, Huawei has already cooperated in the R&D and market aspect with 3C, Siemens, NEC, Panasonic, TI, Intel, Motorola, Lucent, Sun, IBM, as well as setting up the Matsushita-dream company with NEC, Panasonic, and establish TDSCDMA joint venture with Siemens, so as to gradually promote brand globalization. Potential difference in technology development of different countries and regions is also an important factor. Despite the extent of global integration on technology innovation being on the rise, but there still exist potential technological differences among different countries and regions; this potential difference will weigh on the technology level of enterprises in different countries and regions. The company which is of a lower technology can adopt the mode of buying patents so as to create its own brand; of course they also can help the company of higher technology with processing and assembly so as to improve production process continually, promote technology and create their own brands.

The cultural content of company brands Culture difference is a crucial factor affecting the success of brand globalization. The process of brand globalization is the process of changing the consuming habit of consumers to other brands; the process of brand globalization is the process of making foreign consumers recognize, know about new brands, abandon original brands and accept new brands; the process of brand globalization is the process of cultivating consumers and customer loyalty. It is not only a kind of economic behavior, but also cultural behavior, and to some extent national behavior. To be successful, brand globalization cannot do without specific (brand) product features. All in all, the cultural positioning of brand greatly affects the choice of the brand globalization mode. Brand globalization must encounter cultural differences between the brand culture positioning and the target market. There are two dimensions as to cultural differences: one is language difference; the other is the difference of culture origin. The process of globalization is bound to run into stronger cultural conflict if differences in language and cultural origin arise. Comparing the two of them, the culture origin difference is bigger and deeper. Unsuitable brand name or logo, improper promotion and advertisement tagline can result in cultural taboos. For example, peacock and elephant logo are inappropriate brands in different Euro-American countries. If the brand positioning of

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some kind of product is not closely related to the national culture of company’s host country, entering international target market would encounter culture conflict but deeprooted culture differences may not exist, in that case the extent of globalization will be higher, which is suitable for the mode of mature investment overseas and so on, such as Huawei, Haier. On the contrary, the difficulties will be greater if the brand positioning of product is closely related to the national culture of the country; in this case entering target market will change the consumption culture of consuming group in this market; so the choice of globalization mode is suitable for export and other lower end products, such as liquor and the clothes industry. Besides that, value recognition of a company’s core competence is a kind of demonstration of culture positioning and can affect the choice of brand globalization. For instance, Glanz identifies low cost global manufacturing as its core competence; Glanz chooses the mode of OEM for international companies in order to realize the advantages of low cost. Haier identifies the comprehensive power of technology and product as its core competence, although entering European and American market are of great difficulties and high risks. Haier still chooses to invest and establish plants in the America to realize integration from manufacturing to sales.

Human resource base and the impact of support functions Against the background of international brands, activities of enterprise human resource management are different from its domestic operations in the following ways: in the face of a dynamic, varied management environment, international human resources management function increases the difficulties and complications, and encounters greater external restrictions. The low efficiency of international human resources management can result in adverse effects. International human resources management faces the business environment which is complex, of higher operational risks and uncertainties due to cultural diversity and the existence of geographical differences. Enterprises must be more sensitive to local governments, workers and public opinion, adjust management thinking and practice in line with the local environment, and provide different human resources management. Through effective international human resources management, enterprises will have the opportunity to gain interests and form the basis of long-term growth. Such opportunities include the following: Firstly, because of a variety of different perspectives and cultural coexistence, the inner spirit of creativity and innovation may be strengthened; secondly, it is more sensitive to foreign consumers, and with more understanding of the special requirements of customers; thirdly, the best staff can be attracted on a global scale; fourthly, enterprises can find the best business opportunities in the world; fifthly, create “super organizational culture”, contain the most essential part of every culture, and form a unified, superior culture on this basis; sixthly, form greater flexibility in the enterprise and be suitable to different business environments and make the necessary changes in time. It can be said that the enterprise’s strategic human

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resources management policies and standards will ultimately determine its ability to achieve real operating breakthroughs and reach the objective of international operation. Enterprise human resources management supports international brands, which is a concrete manifestation of four variables, such as the maturity level of human resources, the support of human resources to the internationalization strategy, the possibility of human resources internationalization and the extent of localization of human resources. Given different levels of maturity in human resources management, the choice of the mode of brand globalization by companies is also different. The more mature the level of human resources management, the higher the extent of support to globalization, human resource globalization and level of target market localization, it is then more suitable for companies to choose the high-end mode of investing overseas, M&A and overseas chain. On the contrary, the lower the level of human resources management, the more suitable for companies to choose the low-end mode of export trade or processing and assembly.

Impact of key features of the international target market Features of the international target market also can affect the alternatives of brand globalization mode. We use four dimensions to measure the features of the international target market. They are market barriers, the extent of competitiveness, political barriers, possibility of localization in international target market. The world market can presently be divided into three categories: the first being the developed market represented by Europe, United States and Japan; the second being the moderately developed market represented by east-Europe, South Africa and Indonesia; the third being the undeveloped market represented by India and Vietnam. The three categories of different countries and regions have different market features as shown in Table 2:

Table 2: Market features of different countries and legions Developed countries

Moderately developed countries

Undeveloped countries

Market barrier

High

Medium

Low

The extent of competitiveness

High

Medium

Low

Political barrier

Low

Medium

High

Possibility of localization

High

Medium

Low

Market entry barrier of developed countries is the highest. The reasons are as follows: Firstly, developed countries possess many international brands and global brands with great strength and are of a stable position; secondly, the demand of customers and customer psychology of developed countries is more mature. Most of them have their

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preferred brands and demand is mostly saturated; thirdly, both customers and regulatory authorities have the highest production standard requirements. The market of moderately developed countries and areas basically do not have their local multi-national corporations and international brands. Multi-national brands are mostly of foreign brands. Thus the loyalty of market customers is lower than that of developed countries; secondly, customers and governments in medium-developed countries have lower product requirements than in developed countries, and the customers are more concerned about the ratio of price to capability of the brand product. But as far as the current situation of these countries concerned, there exist some social, economic or political problems as well. The entry barrier of developing countries is the lowest; as to the globalization of Chinese brands, but there still exist some problems. The features of this market are as follows: firstly, the purchasing ability and demand levels of customers are similar to our country so technically speaking, conditions are favorable; the product quality can fully meet their requirements; secondly, international companies have already entered potential markets. This point is similar to moderately developed countries. The third point is that the competitiveness of local brands and protectionist policies favoring national industries has an adverse impact on the entrance of Chinese brands. The fourth is that developing countries have underlying causes of under-development, such as culture, religions, political and so on, which bring about problems to the adoption of Chinese brands. Superficially, it is most difficult to enter the market of developed countries and easiest to enter the developing countries with lowest cost. But in fact the potential risk is lower to enter developed countries than developing countries. So the company with mature domestic development should adopt the higher mode of brand globalization while entering developed countries, such as the mode of M&A or direct investment patterns. Entering the markets of developing countries entails higher long-term risks, hence the option of the export trade approach is preferred; if one were to choose the mode of foreign direct investment and setting up factories overseas, the joint-venture route reduces risks overall.

The Case of the Shaangu Group: A Model Brand Internationalization Shaangu was founded in 1968, and commissioned in 1975. It engages in five types of core production: axial compressor, energy recovery turbine unit, centrifugal compressor, centrifugal blower and fan. Its key products — the axial compressor and energy recovery turbine unit, are both efficient, energy-saving and environmentally friendly, and is in a relatively monopolistic position. From 2002 to 2006, the output value has grown drastically from ¥ 340 million to ¥ 4.6 billion, an increase of 12.5 times. With the integrated strength rapidly growing, its ranking has been rapidly increased in the industry. Since 2002, Shaangu has been at the top of domestic industry by all economic indicators; in July 18, 2005,

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the State Statistical Bureau stated in its China Industrial Journal in a feature on China’s leading industries, that Shaangu ranked first in the fan industry in 2005.

The achievements and characteristics of Shaangu brand building After several years of brand building, Shaangu has made remarkable achievements. Firstly, it shows that the overall strength is strong and the status in the industry is high. Shaangu, as a large system integration service provider for engineering equipment in turbo-machinery, has an advantage in the same industry, including the ability of product development, technology level, product quality, operating mechanism, etc. In addition, it is also the vanguard of China’s industry enterprise in 2005. Secondly, in the fierce competition, it still has broader market resources, and the market share of leading products is more than 90%. The products are mainly used in the metallurgical, petrochemical, power station, urban construction, environmental protection, fermentation, research & development and many other pillars of the national economy, and the major customers number as many as 500. The brand building of Shaangu achieved such great success, due to the following four aspects. First, brand building and culture building interacted with each other benignly, and therefore promoted the intangible assets and connotation of culture. To some extent, brand building was the building of corporate culture, especially the building of enterprise values, business concept and corporate reputation. In essence, Shaangu brand building was also the transformation of its values and business concept. For one hand, to the business concept, Shaangu stressed the transformation from production management to brand management. This transformation was an important corner-stone of brand positioning. From a strategic point of view, Shaangu clearly identified the transformation from production management to brand management, and transformation from a manufacturer of a single product to a provider of solutions and service. In addition, Shaangu implemented service process reengineering, integrated the service department and made all-around efforts to develop a service brand of providing the system solutions and integration service for clients. Shaangu proposed a business concept that is not merely product-based but stressed the function that the enterprise provided for clients. This concept included two ideas, one that emphasized the function, but not the product; the other emphasized system integration service, but not the single product. On the another hand, it stressed the importance of market innovation, technology innovation which can improve the value-added, Shaangu proposed the values that wisdom is more important than hard work, and the concept of integrity that being loyal to employees, clients, suppliers. In addition, Shaangu established staff integrity files to promote the construction of an integrity system. The concept that wisdom is more important than hard work and the concept of integrity are important cultural bases for brand building.

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Second, brand building and the product interacted with each other benignly, and thereby raising the success rate, and promoted product innovation to brand building. Product innovation and brand building were not separated from each other, for the former success would feed into the latter inevitably. Shaangu has the advantage of core technology, system technology and related technology. Through an established national technology center and post-doctoral research station, Shaangu absorbed many technical personnel and experts, and established experts files, cooperated closely with various experts. In addition, Shaangu placed great emphasis on the R&D of mainframe technology, so formed irreplaceable core products, in addition, applied high level R&D to system technology and related technology, integrated the resources of upstream and downstream, and controlled industrial chains. Shaangu has received nine patents through constant technology R&D. All the technology is vital to improve the competitiveness of leading products. Relied on the successful innovation of technology and product, Shaangu has already nurtured and created a strong brand in the domestic turbine industries — “Shaangu” brand. It also means that product innovation is the starting point, brand cultivating is the result. Meanwhile, successful brand nurturing has brought continuous expansion and extension of the new markets; the need to expand into new areas is an internal driving force to promote technology R&D. Third, brand building and industry interacted with each other benignly; it not only promoted manufacturing innovation, but also pushed for the expansion of product connotation. With transformation from a manufacturer of single product to a provider of solutions and service, Shaangu has gradually transformed from a single fan manufacturing to a new one with R&D, production, system integrated and system service. Therefore, it complied with the development of manufacturing and extended the manufacturing process, and introduced technology support and technology service into the manufacturing area; it improved the service production in the proportion of fan industry, and product connotation has changed in essence; therefore, it’s the major growth of profit point in industry development. It means that Shaangu has changed the industry connotation, for the innovation of technology and product position, and made it the leader of industry, thereby firmly consolidating the domination of its brand. The fourth, top brand building and famous enterprise construction interacted with each other benignly. On the one hand, through top brand building, two leading products (axial compressor and energy recovery turbine unit) have received “China Top Brand” in 2004 and 2005. On the other hand, Shaangu achieved remarkable success, and become a famous enterprise. Firstly, in 2000, the total output value was only ¥ 340.59 million, profits and taxes was only ¥ 43.88 million. In 2005, however, annual output added up to ¥ 2.51441 billion (7.38 times that in 2000), profits and taxes added up to ¥ 520.44 million (24.15 times that in 2000), and also was the firm with fastest growth of each economic indicator in the same industry and the same period. Secondly, Shaangu ranked first in the industry, and was also the vanguard in national industries. Furthermore, Shaangu has received three certifications, including international quality, environment and safety management system, and is making preparations for a social responsibility system.

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The selection and implementation of its strategic model of brand internationalization With the establishment of a monopoly status of the Shaangu brand in the domestic market, Shaangu has gradually entered the international market, the products have been exported to the United States, Spain, Brazil, India, Iran and North Korea, etc. But these measures are only piecemeal without strategic market and brand planning. Therefore, how ought Shaangu enter the international market and what measures can be taken to fulfill its brand internationalization? As to fan technology, since Shaangu introduced the axial compressor technology from SULZER (Switzerland), after several years of adoption and innovation, Shaangu developed independent intellectual property rights. At present, the technology has a certain monopoly status in the domestic and international market. Meanwhile, R&D of the major fan applied technology will be fulfilled by co-operation between many companies and technology institutes. With regard to the current international market, the developed countries are past their phase of highly intensive construction development, hence the demand for large industrial fans is poor; however many developing countries are still in a phase of rapid development, due to greater investment in fixed assets; therefore, they are the main target markets of the fan industry. But in terms of brand culture positioning, fans fall under the category of industrial products, and do not directly involve ordinary consumers. In other words, they do not result in differences in consumption culture, hence the probability of cultural conflict is lower. As to the level of HRM (Human Resource Management), after so many years of rapid development, Shaangu has accumulated plenty of mature HRM experience; as to HR internationalization, however, there still is some room for improvement. Having considered all these four factors, the selection of brand internationalization model of Shaangu can then be divided into two phases as follows. The first stage, Shaangu ought to contact and co-operate with well-known international enterprises in a positive manner, through joint ventures or technical cooperation. In this stage, it can nurture various conditions of brand internationalization. Firstly, it familiarizes Shaangu with the operation norms of international businesses, and learns the concept of international management, thereby improving the management level and enable Shaangu to gradually meet the international standards of business management. Secondly, it can constantly improve the level of R&D and technical process, through technology co-operation with world-class fan enterprises, enable Shaangu’s technical level to meet the international first-class standards gradually. What’s more, through contact with international business, it can gradually introduce internationalization concepts and trans-culture management ideas, and cultivate employees who are familiar with operation norms of international market, and improve the internationalization level of HR. The second stage, with the level of HR being more mature, the brand internationalization model of Shaangu can choose to engage countries with large markets; the developed

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countries being the main targets, and through conscious merchandise exports to expand brand awareness. Although Shaangu has its own products to the international target market, these exports are not systematic nor conscious and do not have strategic planning significance; they are piecemeal, occasional and passive. It has no profound significance to the brand internationalization of Shaangu. Therefore, Shaangu should consciously make plans for its international target market and international marketing channels, based on previous accumulated experience, and accredit branch or sub-branch sales in the countries with large markets, thereby increasing international market share. The meaning of this phase is not only the expansion of international market, what’s more, through the initial practice of brand internationalization, gradually understand international market and be familiar with target market culture and characteristics; in addition, to nurture and improve the internationalization level of HRM in practice. In the third stage, once conditions are ripe, it is then able to apply the direct production operation model with its own brand in developing and developed countries, particularly those within which a sizeable market share already exists. Two conditions need to be satisfied: on the on hand, the level of maturity of HRM internationalization needs to be adequate. On the other hand, the level of maturity of management and the production in international markets ought to suffice. With the implementation of initial two-stage preparations, Shaangu will then be able to invest and build factories in the appropriate international target markets, thereby fulfilling the goals of integration and localization of design, production, marketing and after-sale services.

Conclusion In discussing brand internationalization models of Chinese enterprises, the paper summarized the above into five types, namely, the merchandise exports pattern, the OEM method, overseas production and operation of independent brands, the model of brand merger and acquisition, and the overseas chain business model. In addition, the paper proposed a theoretical framework to analyze the various models as follows: the key aspects and level of maturity of technology innovation, brand culture, HR support functions, characteristics of the international target market, etc. These factors constitute the selection criteria of an appropriate internationalization model. Using the above analytical framework, the paper explored the case study of the Shaanxi Blower (Group) Co., Ltd, a leading firm in China’s blower industry. Through an explication of the four aforementioned variables, the paper explained how the brand internationalization of the Shaangu Group was successfully completed in three phases. In the first stage, through domestic joint ventures or technical collaboration with international blower enterprises, it was able to improve the internationalization capabilities of its HRM. In the second stage, it adopted the export model to access foreign markets. Finally, in the third stage, it engages in direct production and operation in developing or developed countries deemed to be less risky in nature.

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References ˊ)UDQNOLQ 5 5RRW㨫ˈᴼҟЁ䆥 lj೑䰙㸠䫔ㅵ⧚ᄺNJˈ˄ৄ˅Ꮌ⌾ߎ⠜⼒ˈ ᑈ ˊᴢ♰ˈĀᇍЁ೑ӕϮⱘક⠠೑䰙࣪䯂乬ⱘᗱ㗗āˈljᏖഎ਼ߞⷨお⠜NJ ᑈ᳜ ˊ⢘⨇࿰ˈĀ⌙䆂Ё೑ӕϮⱘક⠠೑䰙࣪䗨ᕘāˈlj叵㽓໻ᄺᄺ᡹NJᑈ᳜ ˊ਼㧆ˈĀЁ೑ӕϮⱘક⠠೑䰙࣪῵ᓣঞਃ⼎āˈljᇍ໪㒣䌌ᅲࡵNJᑈ᳜ ˊ䚥ќဩˈĀЁ೑ӕϮક⠠೑䰙࣪߱᥶āˈljᅵ䅵Ϣ㒣⌢ⷨおNJˈᑈ᳜ ˊٙ↧㓈ˈ䚥ՇˈĀЁ೑ӕϮક⠠೑䰙࣪ⱘ᥶䅼āˈlj⫳ѻ࡯ⷨおNJᑈ ᳜ ˊḖ⨇ˈԳҕ䆮ˈĀЁ೑ӕϮક⠠೑䰙࣪䯂乬ߚᵤϢᗱ㗗āˈlj⾥ⷨㅵ⧚NJ ᑈ᳜ ˊ䛁Խ‫ˈݯ‬㢣࢛ˈĀЁ೑ӕϮક⠠೑䰙࣪៬⬹ⷨおāˈljᏖഎ㧹䫔ᇐߞNJ ᑈ᳜ ˊ㣗ᑚढˈĀ⍋ֵþゟֵÿफ䴲āljЁ໪ㅵ⧚NJᑈ㄀ᳳ ˊқᯢˈĀþ䍄ߎএÿ៬⬹ⷨお˖೑䰙ଚࡵ⧚䆎ᮍ⊩ⱘ䯤䗄āljϪ⬠㒣⌢NJ ᑈ㄀ᳳ ˊᄳ䳋ˈĀક⠠೑䰙࣪ⱘ῵ᓣ䗝ᢽāˈljଚϮⷨおNJᑈᳳ ˊ䌍ᯢ㚰ˈĀ䎼೑㒣㧹ક⠠៬⬹῵ᓣⱘ䗝ᢽāˈlj∳㢣ଚ䆎NJᑈ㄀ᳳ ˊ䰩哧䲚ಶˈlj䰩哧ὖ‫މ‬੠ક⠠ᓎ䆒ᚙ‫މ‬NJˈᑈ᳜ ˊ䰩哧䲚ಶǃ㽓࣫໻ᄺ㒣⌢ㅵ⧚ᄺ䰶ˈlj䰩哧ક⠠ᓎ䆒䆎യᴤ᭭∛㓪NJˈ ᑈ᳜

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Strategies on Brand Internationalization: A Study Based on Business Capability ͣHUIPING DING and XIAODONG QIU Beijing Jiaotong University

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r. Ding Huiping is currently Professor and PhD Supervisor of Business Economics and Financial management at School of Economics and Management, Beijing Jiaotong University. He also holds position as the Director of China Business Competitiveness Research Center at Beijing Jiaotong University. After receiving a BA in Engineering from Northeast University in 1982, Dr. Ding worked as an engineer and as an administrative staff at the provincial Committee of Science and Technology, respectively, until 1987. From 1987 to 1993, he pursued advanced studies at Linkoping University in Sweden and obtained the Degree of Licentiate in Industry Engineering (1991) and a PhD in Business Economics (1992), he continued to embark on postdoctoral research in 1993. In 1994 Dr. Huiping Ding joined the faculty of School of Economics and Management in Beijing Jiaotong University. During his visit to Pittsburgh in 1996, he was awarded as honored professor of Duquesne University’s Business School, United States. Professor Ding’s major research fields include Business economicsandcorporatefinance,Businessinnovativemanagement, Investment & Finance, business strategy, Operations management and Business process reengineering, etc. He has published over 50 articles in English and Chinese academic journals. Besides academic research and teaching he is also involved in consulting activities and training programs for several companies.

D

r. Qiu Xiaodong is currently a member of the China’s strategic development research program, senior member of the China Technical Economic Institute. He was also the chairman of the National Natural Science Foundation Project, the Chinese post-doctoral fund projects and the Ministry of science and technology development projects. Dr Qiu has also published more than 30 articles for international academic conferences and journals.

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Abstract: This paper deals with how business organizations develop successful brand internationalization strategies to increase their brand value. Based on the view that capability comes from resources and through the analysis of inter-relations between business capability elements and business resource compensability, the feasibility of implementing business brand internationalization strategy is demonstrated under constrained-resource conditions, and the concept of business resource surplus is then put forward. Based on this concept the inter-logic relations and developing strategies of business brand internationalization under resources constraints are investigated, and the relationship between the allocation of resource elements supporting business capability and the business brand internationalization strategies is also addressed. Keywords: Business capability; Business resources; Brand internationalization; Brand strategy

Due to improved business capability, Chinese enterprises have begun to step up their international businesses through merger & acquisition, business branch establishment or alliance; these are important ways of advancing their business capability level and achieving their international business strategic goals. When a Chinese company exports its products and services through different international channels, one of the common difficulties is how to develop its brand internationalization strategy in an effective way. In other words, how can a Chinese company increase its brand value effectively through its brand expanding with the business internationalization. The development of a proper strategy will have a direct impact on the company’s business performance and capability level of the business internationalization as well. Such an impact comes from the product brand as an intangible resource; the business effect of the product brand reflects and also affects the level of product internationalization and in turn, the effectiveness of the company’s business internationalization. From the point of view of business capability, Chinese enterprises are still lacking in resources to support their internationalization in terms of the structure of business capability. The business resources of a company that are the important bases of strategic activities may not be properly allocated within the company’s organization, the shortage in business resources is more often than not present in the processes of brand internationalization. This is a particular issue faced by Chinese enterprises that have already established their brand name in the domestic market and are implementing their international strategy, i.e., how can they be strategically successful in expanding their business brands in the process of the internationalization? As a matter of fact, since the measure of brand resource for business internationalization is to some extent uncertain and uncontrollable, the internationalization of Chinese enterprises has been constrained. Facing with incompatibility of the resources structuring the business capability, how can Chinese enterprises obtain and allocate business resources effectively in order to facilitate and establish their development strategies of brand internationalization is the central issue of this paper. Although researches relevant to business strategies

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with the resource-based view are not uncommon, however, the investigations of brand development strategy based on business capability are still rare in the literature. Our research focuses on Chinese enterprises’ brand internationalization from the point of view of building up business capabilities via developing proper strategies, grasping market opportunities, exploring resource synergy, actualizing business size expansion, and at the same time controlling business risks.

Literature Review Researches on business capability have been done by several scholars during past decades represented by, e.g., the business resource-based-view (Wernerfelt, 1984; Barney, 2001) and corporation core competence (Prahalad and Hamel,1990). Analysis of business advantage by the core competence theory is comparatively lacking in more sound descriptions in circumstances; meaningful researches on business strategies have closely connected with the resource-based theory and have the intention of more comprehensively characterizing and explaining sources of business competitiveness (David and Montgomery, 2005). It can be recognized that formation of business capability comes from available business resources in terms of both quantitative and qualitative levels. Company’s business resources can generally be classified as active type resource and inactive type resource (Ding and He, 2007). The former refers to human resource of the business including entrepreneurs, managers, researchers, workers, and teams made of those individuals; the latter refers to all the resources, except for human resources, including tangible and intangible resources. Human resource is the prime mover of business capability, they operate and coordinate the inactive type resources, cope with changes in business environments, and dominate the processes of accumulating, obtaining, updating and innovating other resources. According to the above classification of business resources, business capability derives from processes in which active type resources act on inactive type resources. The strength of business capability depends not only on the quantity of inactive type resources available, but also more importantly on the effectiveness of applying the business knowledge by human resources to the processes of operating, accumulating, updating and innovating inactive type resources. Based on the view of resources being the source of capability, the business capability presents the effectiveness and efficiency of utilizing the resources by a company in the processes of its business activities, and is the root cause of competitive advantage resulted from the key business resources; business advantage is the outside token of the business capability strength (Ding and He, 2007). Thus, it can be seen that business capability relies on business resources on the one hand, and on the other hand changes in the business environment stimulate enterprises to continually accumulate, obtain and update their business resources; the speed and effectiveness of this process depend on the present business capability of the enterprises. The business resources available are allocated and utilized effectively during the value

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creating activities, which helps an enterprise improve its business capability continually and leap toward a new level, and in turn, become a new basis to further improve its business capability. For a company to realize its business capability leaping toward a higher level it needs to adapt to market changes, increase customer value creation ability with the competitive advantage built up. Based on the consideration of business resources being the source of business capability, investigating the brand internalization from the view of business capability should be involved with analyzing the key business resource elements that constitute business capability and evaluating the preconditions of brand internalization development in terms of the effectiveness of business resource utilization. Several researchers classified business resources from different dimensions, such as the views of the property-based resource and the knowledge-based resource (Miller and Shamsie, 1996), the former includes financial resource, tangible resource and human resource; the latter includes intangible resources and skills. Whatever business resources are defined the resource elements can basically be classified into three types — capital, technology and human power. Thus, the investigation and analysis of Chinese brand internationalization strategies based on the business capability will proceed with these three types of business resources.

Logical Relations Between Business Capabilities and Brand Internalization Brand internalization development strategies depend on business capability, and more exactly on the business resources controlled by the enterprises. When dealing with business internationalization Chinese enterprises are often limited in key business resources, which constrain their business decision making and advancement of their brand internationalization. Business capability theory considers that business capability develops in a dynamic pattern along with changes of business environments; enterprises can take their business activities through market opportunities, and can have the necessary resources available for implementing their business strategies via some other channels even if they are short of enough resources. Thus, to some extent, the feasibility for a company to implement its business strategy of the brand internalization depends on its business capability and business environment as well. In order to properly analyze and evaluate business capability we need to have a systematic analysis of resource elements of business capability, which is the groundwork for the decision making of brand internationalization development. Brand and capital exports through trading or direct brand export have experienced a gradual development during the process of internationalization. With different business capabilities, enterprises will take different strategies in the process of their brand internationalization. As Chinese enterprises increase their capital strength they can realize new developments of brand internationalization strategies, for instance, merger & acquisition, new establishment and alliance have become common models

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for them to implement their international strategies. Analyzing and evaluating business resources structure will help to advance brand internationalization of Chinese enterprises by properly determining their business development strategies.

Allocating Resource Elements of Business Capability for Supporting Brand Internationalization Capability resource elements such as capital, technology and human power are highly crucial, any shortage of those resource elements may have a negative impact on business brand internationalization. The issue of insufficient resources may be resolved by means of a resource complement-effect concept, i.e., whether the resources in terms of the different elements available are sufficient to support brand internationalization, do follow “the long board of resources” instead of the management principle of “the short board of barrel”, which means that even if a resource element is lacking it can be complemented by other resource elements that are sufficient. This judgment coincides with the capability theory of utilizing the resources, the logic contained here will help us to cognize the shortage of the resource elements in the process of brand internationalization and at the same time actively grasp market opportunities by applying the resource complementeffect concept based on available resource elements.

Business Capability Requirements for Brand Internationalization Since international markets are more complex and uncertain, the internationalization of business brand incurs higher risks. Without adequate preparation Chinese enterprises may run into unexpected difficulties while their capabilities are constrained. Successful establishment of a business brand in the international markets needs to be well supported by the business capabilities and resources. Business capability is comparatively difficult to measure due to its unclear boundary but it can still be estimated in terms of resource elements. This may be done by comparing the resource requirements of capital, technology and human power for brand internationalization with the resources available. By doing this we can obtain a result of the comparison which can then be used as the base for evaluating whether or not a business organization is provided with the proper capability to boost its brand internationalization. What kind of capabilities then, does a business organization need to have to be able to support its brand internationalization? The key issue is that we need to find out the sources of business resources necessary for supporting the brand internationalization. From the view of resource elements it can be seen that, by analyzing the business risks of brand internationalization involved with the internal factors, business failure of brand internationalization often results from a lack of resources to support the business capabilities that are necessary for the brand internationalization. It follows that there are needs for enough business resources in terms of both quantity and quality that are required

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for supporting the brand internationalization. Estimated from the resource elements as seen in Fig. 1, the capability required in terms of quantity for brand internationalization needs to be more than that is necessary for current business operations, which we refer to as business resource surplus. It is this spillage portion of the resources that supports the need for brand internationalization so that there will not be any shortage in the necessary resources for the business operations. As shown in Fig. 1 a company must compare its business resource surplus with the resources required for implementing the brand internationalization to ensure that it has enough resources available for supporting its capability. The results obtained can be useful for the company to figure out the scope of its brand internationalization development.

Capital

Technology

Human power

Capital

Technology

Human power

Resource requirement for brand internationalization

Business resource surplus

Resource requirement for current business operations Quantity of structured resources required for brand internationalization

Structured business resource surplus

Figure 1: Resource requirement compared with business resource surplus.

Resources Allocation for Supporting Brand Internationalization Through further analysis it can be seen that business resources possessed by a company do not often match each other in many cases. When implementing brand internationalization the problem of “the short board of barrel” will often emerge immediately if the company is short of one or more required resources. This may restrain the advancement of the brand internationalization and lose the market opportunity of lending itself to expanding further. Therefore, the company needs to be on top of such an issue and think over how to effectively reallocate the resource elements to support its business capability for the purpose of boosting brand internationalization development.

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In fact, the feasibility of optimizing business resources allocation makes it possible to implement brand internationalization even if a short board of the resources exists. The complement effect between business resources is common in practice. Capital, technology and human power can complement each other. For instance, when there is a shortage of funds the company can translate its advantage of technology into capital resource by means of cooperation or finance by taking advantage of its human resource; a situation of lacking in new technology can also be resolved with R&D by taking advantage of human and capital resource; capital and technology advantages are the source of attracting talented people. As can be seen in Fig. 2, comparing business resource surplus with the required resources for brand internationalization shows that technology comes from the constrained resources. Resources may complement each other; the shortage of the technology resource can be made up by the surplus resources from either capital or human power or both. It means that when a shortage of resource elements is present the total resources surplus needs to be more than that required for implementing the brand internationalization. Otherwise, the company should not implement the brand internationalization to avoid the risks of failing owing to the shortage of necessary business resources.

Business resource surplus

Capital

Quantity of structured resources required for brand internationalization

Resource complement

Technology

Resource resquirement for current business operations

Human power

Capital

Technology

Human power

Resource requirement for brand internationalization

Gap between technology resource needed and available

Short board of business resource surplus

Structured business resource surplus

Figure 2: Resource allocation supporting brand internationalization.

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It needs to be emphasized that there are two things one should be aware when allocating business resources to the brand internationalization: that a company must ensure that there are enough resources available for its current business operations to avoid the unforeseen, the other is that the reallocated business resource surplus in total needs to be no less than what is required with the consideration of complement efficiency between different resource elements. This is so as to control business risks more effectively in the face of complex international markets with many uncertainties and to prevent shortages of business resources during the process of brand internationalization. Besides, we should also cognize the periodic characteristic of brand internationalization, identify the sensitivity of market demand to product brands by taking product life cycles into account, and make use of the resource complement-effect to allocate resource elements for promoting brand internationalization with effective developing strategies.

Strategy Development of Brand Internationalization Business resource surplus will increase continually as the business goes well. The capability of implementing brand internationalization is established when the resource surplus is enough to provide with the required resource elements. Brand internationalization strategies can be developed in different ways, how then should a company proceed with its business strategy? Since the allocation efficiency of different resource elements may differ due to their dissimilar scarcities the company may have different business capabilities with different structure of the business resources, which means that brand internationalization is likely to be implemented in different ways. From the practices of brand internationalization there are mainly three ways of developing the strategies, i.e., new establishment, merger & acquisition and cooperation. New establishment refers to a company setting up its new business overseas and developing its product brand in the international markets by relying on its own capability and running the business on its own. New establishment strategy redounds to company knowledge about the markets and enhances market response; it however exposes the company to new environments, new markets and new requirements for meeting the demand with more uncertainties. Fostering a brand to be well established in a new market will experience periods of unexpected risks, and sufficient resources structuring business capability are necessary to support this strategy. Apparently, as far as the efficiency of allocating resources is concerned, new establishment strategy tends to be a better way to implement brand internationalization when the company has enough business resources available. Haier is one of the earliest Chinese enterprises who made the investment overseas, and its success in North American has established a good base for developing its product brands further in the international markets. Many experiences and successes of well-known international brands have shown that owning a business brand through merger & acquisition is one of the most effective ways to develop the brand in the international markets. Through brand acquisition

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coupled with marketing its own product brands a company can expand it business fast in the international market and increase its brand value and reputation as well. Normally, however, there are often more risks involved with merger & acquisition activities. Taking a view of the business capability structure it can be noticed that, besides capital resources, the process of merger & acquisition more often relies on human resources especially during the process of integration. The purchase of IBM PC by the Chinese enterprise Lenovo in 2004 is one of the well-known cases of brand acquisition. Business cooperation through alliance or joint venture with foreign (international) companies is also one of the major ways of developing a brand internationalization strategy. Establishing a brand alliance is propitious to fostering business brand reputation worldwide, and the benefit from the business cooperation is materialized based on resources mutual complementarities from both parties. At present, Chinese enterprises aim to benefit from complementary resources by cooperating with international companies. For instance, with the shortage of technology resources, it can be an active way for Chinese enterprises to cooperate with international companies in order to support their brand development strategies in the international markets. As mentioned above, for the development of the brand internationalization strategy based on business capability Chinese enterprises should structure the available resource elements; explore the suitable strategy by allocating resource elements in line with their performance traits to release the coupling effectiveness among them.

Conclusions In implementing its brand internationalization strategy, a business organization requires certain supporting capabilities. Business resource elements can be used as a proxy measurement when there are difficulties in quantifying business capability. By analyzing the resource elements in a systematic way we can estimate the capabilities of enterprises in implementing their brand internationalization. Our research findings show that using business resource surplus to quantify the business capability ensures risk management and control in the process of the brand internationalization. By so doing enterprises may seek and grasp market opportunities in a better way with business risks under control. By measuring business capability based on business resource dimensions the evaluation of business capability can be quantified, and in this way a more reliable measure is provided for estimating the capability of implementing brand internationalization. This will help enterprises to grasp potential opportunities at the opportune time through comparing business resource surplus with resource elements required for the brand internationalization, and to make progress in developing a better strategy. In other words, whenever there is a shortage of the necessary resources for brand internationalization, enterprises must take advantage of the existing resources together with considering the characteristics of the resource elements required and make full use of the complement-effect of business resources to enhance their business capabilities in order to implementing its brand internationalization strategy.

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References Barney, JB (2001). Resource-based theories of competitive advantage: A ten year retrospective on the resource-based view. Journal of Management, 27, 643–650. David, JC and CA Montgomery (2005). Corporate Strategy: A Resource-Based Approach. 2nd Ed. Boston: The McGraw-Hill Companies, pp. 5–20. Ding, HP and L He (2007). Business capability formation and evolution mechanism based on value creation: An analysis of logistics enterprise. Proc. of The 6th International Conference on August 3–5, Wuhan, China. pp. 1290–1295. Miller, D and J Shamsie (1996). The resource-based view of the firm in two environments: The Hollywood film studios from 1936 to 1965. Academy of Management Journal, 39, 519–543. Prahalad, CK and G Hamel (1990). The Core competence of the corporation. Harvard Business Review, May–June, 79–91. Wernerfelt, B (1984). A Resource-based view of the firm. Strategic Management Journal, 5, 171–180.

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Enterprise Brand Internationalization in China: Challenges and Strategies ͣWEI ZHANG Chinese Academy of International Trade and Economic Co-operation

M

s. Zhang Wei graduated with a Bachelor Degree in Economics from the University of International Business and Economics in 1994, and obtained her Masters Degree in Arts in 1998. Ms. Zhang is involved in the economic study across countries, regions, and industrial fields, since she began her work in 1997. Her major research interests are the study of multi-lateral co-operation of economy and trade, regional economic co-operation of east Asia, export of high-tech products, and the development of manufacturing trade. She took part in the editing of the White book of Chinese Foreign Economy and Trade, Situation and Hotspots (was then re-named as Blue Book of Chinese Foreign Economy and Trade), and Trade Report of Different Countries. Ms. Zhang also took part in the research of more than 10 ministerial and institute-level projects, as an editor for some of the projects. Ms. Zhang has published more than 30 academic papers in various magazines. Ms. Zhang has received many awards, including the prospect analysis of building of 10 plus 3 free trade area; she won the First-Grade Award in the Sixth National Excellent Research Progress in Foreign Trade and Economy; the prospect analysis of building of China, Japan, and South Korea free trade area: she won the Second–Grade Award in the Sixth National Excellent Research Progress in Foreign Trade and Economy; New Economy and International Trade; she won the Second-Grade Award in the Sixth National Excellent Research Progress in Foreign Trade; and Economy and the study of policies to promote the local supply chain and R&D of manufacturing trade; she also won the ThirdGrade Award in the Sixth National Excellent Research Progress in Foreign Trade and Economy.

Abstract: In recent years, brand internationalization is becoming the carrier of global economic integration and the core of competition among different countries. Nowadays, monopoly of brand internationalization has formed and the threshold of development has been raised. The means of brand internationalization are

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increasingly updated and the outer environment of brand internationalization for Chinese enterprises is more and more severe. In addition, Chinese enterprises are also confronted with the confusion of route selection and the restriction of their own ability of innovation, marketing, and management. Therefore, we need the government to enhance cultivation, service, and safeguard to promote the healthy development of enterprise’s brand internationalization. Keywords: Brand internationalization; Monopoly; Chinese enterprise

In recent years, the world economy has entered the era of brand competition. Brand has become the new commercial battleground among various countries; it is a key source of competitive advantage for businesses, and a more strategic means of exporting capital. Brand internationalization is increasingly a carrier of economic globalization and an important symbol of a country’s competitiveness. Compared with the past, brands have a much greater influence on the development of the world economy. Therefore, in the era of brand competition, it is imperative for China to enhance its brand competitiveness and advance its brand internationalization in order to maintain a healthy pace of economic development.

An Increasingly Arduous External Environment for Brand Internationalization Recently, brands have become increasingly monopolized; thus, it is more difficult and expensive for late-comers to access the international market. In addition, the mode of brand internationalization is ever changing. As a result, the external environment for brand internationalization has become increasingly grim for China.

The pattern of brand international monopolization is well-formed Currently, the main international markets have been captured by a small number of well-known brands. Statistic shows that well-known brands accounting for less than 3% of the total brands have captured 40% of the main market and over 50% of the total sales, and in particular, even more than 90% of the sales in some industries. Among the world’s most valuable brands listed in the “Business Week ” in 2006, the total value of the top 20 brands reached US $ 587.028 billion, more than the GDP of many countries. As shown in Table 1, a strong trading position can only be attained when a nation has great brands and brand competition that occupies the center-stage of value competition. In addition, brand internationalization has functioned as an important carrier of global and regional economic integration.

Rising entry barriers for brand internationalization According to the international experience, brand internationalization can be divided into two modes: product-export and capital-export.

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Table 1: Trade status of countries with branding power (Unit: billion dollars; %). Trade rankings

1 2 3 4 5 6

Country

Total amount of goods: sum of imports and exports

% of the total world trade

Number of top 500 international brands in 2006

United States Germany China Japan France United Kingdom

26,370 17,448 14,221 11,119 9,550 8,791

12.5 8.3 6.7 5.3 4.5 4.2

245 27 6 44 46 38

% of top 500 international brands 49 5.4 1.2 8.8 9.2 7.6

Source: Website of the central government of the People’s Republic of China; http://www.gov.cn. World Brand Laboratory; http://www.brand.icxo.com.

As a result of the long-term export of commodities and capital, developed countries have already attained the world’s brand hegemonic positions. Among the world’s top 500 brands, the United States holds 49% of them, and the remaining percentages for France, Japan, and the United Kingdom are 9.2, 8.8, and 7.6 respectively. Altogether, these five classic developed countries possess 80% of the world’s top 500 brands. Besides out-sourcing low value-added processing and manufacturing sectors in the industrial chain, the multi-national corporations of the developed countries have firmly grasped the high value-added R&D and sales sectors in “the smile curve” to seek high profit. Through brand internationalization, these multi-national corporations have reinforced their control over the manufacturing industry and further strengthened their monopoly status of the well-known world brands. In this instance, world market share for the growth of new brands are getting smaller and smaller, while access costs are gradually increasing, thus leading to new brands hovering in the sub-mainstream market and nonmainstream market.

Changing modes of brand internationalization Over the past decade, multi-national corporations-led international capital-export has gained a new connotation: “the integrated output”, a comprehensive export of philosophy, standard, technology, system, operating mechanism, management, and human resource. “Integrated output” has become the main form of international capitalexport. Its essence is brand-export, which is a more strategic type of capital-export and a combination of internationalization, diversification, and localization. In the new round of industrial shifts, the multi-national corporations have sped up the process of their brand internationalization and consolidated their world brand competitive status by these new competitive measures. Their main actions are to advance their brand power by associating with other strong enterprises and to eliminate other up-coming brands by Mergers and Acquisitions (M&A) in the manufacturing sector. Although, multi-national M&A has become an important way to realize the brand internationalization through

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enhancing the monopoly status of these brand companies, there are more difficulties and fewer chances for late-comers to break-through via brand M&A.

Mounting difficulties faced by China’s brand internationalization China has had a late start in the market economy and brand building; the relationship between booming trade volumes and brands has decoupled somewhat. Although, its trade status has improved remarkably, China’s share in the world top 500 brands is merely 1.2%, amounting less than 10% of its total export. China’s competitive advantages mainly lie in its manufacturing and processing capacity. A large number of products export involve Original Equipment Manufacturer (OEM) and its brand share is low. OEM serves to strengthen the competitiveness of other brands via China’s inexpensive labor force which, to a certain degree, has affected the initiatives of China’s businesses to develop their own brands, thus objectively causing more difficulties for China’s brand internationalization in future. Besides, as a result of the strategic integration of the multinational corporation, it is often seen that China’s brands have been squeezed in the international and domestic markets. Therefore, China’s new brands require more time and face higher barrier costs to enter into the international market.

Table 2: International comparison of brand value. Rank

Top 10 of the global best 100 brands as listed in the “Business Week” in 2006 Company name

Value of the brand (in billion dollars)

Country

Top 10 of “500 most valuable brands in China” as listed by the World Brand Laboratory in 2006 Brand name

Value of the brand (in billion yuan)

1

Coca-Cola

670

United States

Hai’er

639.89

2

Microsoft

569.26

United States

Lenovo

630.12

3

IBM

562.01

United States

China Mobile

623.40

4

General Electric

489.07

United States

CCTV

622.90

5

Intel

323.19

United States

Baosteel

597.38

6

Nokia

301.31

Finland

Sinochem

577.93

7

Toyota

279.41

Japan

China Railway Engineering

518.76

8

Disney

278.48

United States

China Life Insurance

486.67

9

McDonald

275.01

United States

Hongtashan

484.56

10

Mercedes

217.95

Germany

Changhong

437.55

Source: website of Business Week; http://www.businessweekly.com. World Brand Laboratory; http://www.brand.icxo.com.

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Running down blind alleys in brand internationalization In 1990s, Hai’er’s international brand strategy, that is “difficult to easy” (i.e., first occupy the markets of developed countries, and then gradually expand the markets of developing countries), has begun to take form. But, by the end of 2006, Zhang Ruimin, the CEO of Hai’er, admitted that “Hai’er has entered a plateau phase”, its international strategy has not met Hai’er’s desired objectives. In the United States, Hai’er ranks among the best in the small refrigerator market share, but has yet to enter the American mainstream refrigerator market of 500 liters to 700 liters. Till September 2006, the TCL Group has lost over 2 billion HK dollars in Europe. In order to prevent the mounting losses, TCL and Thomson Group reached an agreement of understanding to adopt the OEM model instead of selling and marketing television in the European market. The development of the two enterprises both shows that business internationalization and the brand internationalization have faced together the problem of strategically selecting the direction and path. From the view of traditional economics, due to the lack of monopoly superiority, the only internationalization path for China’s enterprises is to transfer its output to lower level developing countries in the international division of labor. But those transfers will further widen the developing gap between China and the developed countries, consequently making it harder to enter into the mainstream world consumer markets. China’s enterprises have yet to formalize the explicit direction and path for their brand internationalization, as there are a few mature development models to serve as a guide during the initial and exploration stage of their internationalization. The internationalization process is also affected by huge cultural differences between the East and West as well as restrictions and obstacles placed on the Chinese M&A activities.

The constraints of brand internationalization capacity The brand competitive strength represents an enterprise’s comprehensive advantage of resource, technology and management, and marketing, and human resource. It is the external expression of the core competitiveness of enterprises, an integration of technical capacity, management capability, and marketing capacity, and is an important driving force of sustainable development. Compared with world-renowned brand enterprises, China’s enterprises still faces great gaps, manifesting mainly in the following areas:

Innovation ability Research data showed that, whether it is the world’s top 500 brands, or “the world’s most valuable brands” in the “Financial World” and the “World Famous Brand” in the interbrand, top brands have a high technological content. Technology contributed over

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65% of the total value for any of the world’s top 500 enterprises, while their average technology content of the “most valuable brand list” in the “Financial World”, is more than 70% of the brand value. However, the technology content in China’s enterprises and brands is low, the overall level of which is less than 35%. Since 1995, the total number of brands in “China’s most valuable brand list” has exceeded 100. Among these brands, it is calculated that the average technology content of the top 20 brands is only 47%, which is 30% lesser than the world average.

Marketing ability The applications of market principles and the market activities undertaken by the Chinese enterprises cannot meet the requirements of international competition. After entering the international market, they failed to overcome differences between brand culture and local culture. In addition, although some products have well-known brands, the enterprises still pursue a strategy of price competition, thus, lacking a high-premium capacity as compared to other brand enterprises. (Other products of a similar quality are generally priced at over 15% higher.) This demonstrates the weakness of China’s enterprises in marketing their products effectively.

Management capability Presently, brand building and management remain relatively backward in the majority of the Chinese enterprises; brand awareness needs to be raised. Most enterprises do not have a comprehensive branding strategy and lack a professional management team for such purposes. How can an enterprise translate its branding edge formed in domestic market to international markets? How can an enterprise price the right value for its brand? In tackling these issues, it is necessary for enterprises to enhance strategic decision-making capabilities and cross-culture brand management capability.

Growth ability Brand internationalization requires an adequate funding. Compared with their counterparts in the developed countries, China’s enterprises do not attract sufficient investment in the initial phase; this impedes the development of their brands in the longrun. From the view of brand acquisitions, the enterprises of the developed countries have the ability to merge leading brands and competitive brands in China, while it is difficult for China to merge similar brands in developed countries. It is not necessarily disadvantageous to merge liabilities rather than assets, e.g., Lenovo’s acquisition of IBM, merger between BenQ and Siemens, and TCL’s acquisition of Thomson, all of which are examples of merging with loss-making enterprises. Many cases of multi-national brand M&A showed that it does not lead to failure when merging vulnerable brands (e.g., P&G acquisition of SK-II, L’Oreal acquisition of Maybelline etc.)

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Trans-national merger and acquisitions allow companies to gain instant access to technology, such as key channels of resources, to enhance the comparative advantages and to promote its process of internationalization. Therefore, trans-national M&A is an important way to improve the growth ability of brand internationalization. But, it is still a question as to how much China’s enterprises can bear the losses of brand internationalization in the initial period.

The Role of Government in Brand Internationalization There is no doubt that a brand constitutes an important aspect of international enterprises. Enterprises have the rights and obligations of independent decision-making, and bear the risks and responsibilities for profits or losses. However, the practice of Western countries shows that the government has played a non-trivial role in guiding, supporting, and regulating brand development. Brand competition is often related to a country’s overall image and the quality of products and services; the national brand image bears a great influence on the brand development of enterprises. At present, the Chinese brand is still not in a good position in the international market. To a certain extent, products made in China are regarded as “labor-intensive”, “low-level” and “low-cost”, which is difficult to change merely relying on certain corporations or products. Therefore, in order to build a corporate brand, the national brand image must be strengthened at the same time, which will in turn promote enterprise brands. The Chinese government should actively promote the brand internationalization using a two-pronged strategy. On one hand, the government should focus on the domestic market to strengthen its brand development, promotion, and protection, and to accelerate the formation of a number of their own international competitive brands, nurturing the “seeds” of potential international brands. On the other hand, the government should focus on the international arena, offering macro-guidance and providing multi-tier, and multi-angle services to more mature enterprises that are poised to conduct brand internationalization, thus promoting their healthy development.

The Chinese government should focus on talent development China’s brand enterprises are generally smaller, weaker, and younger than similar brand enterprises in the developed countries. They require all-round support from all the aspects in China to improve brand competitiveness. Therefore, the Chinese government should speed up the establishment and improvement of the support system, and enhance the development of brands, making full use of financial taxation, monetary policy tools to promote a number of independent brands to open up the international market, to register overseas trademark, to obtain the international certification, and to establish marketing channels. In addition, the government can use public services to cultivate expertise and talent in brand internationalization to solve the “talent bottleneck” and help enterprises

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improve brand building and brand management capabilities, and advance its process of brand internationalization.

The Chinese government should provide more services On the one hand, the government should create a favorable market environment for brand development. At present, there is a gap between China’s overall level of income of residents and those in developed countries. This weakens the domestic market support of international brands. Therefore, the government should enhance the tracking analysis and research of brand development and guide consumption to support leading brand products and brand enterprises. On the other hand, the government ought to gradually establish and improve an intermediary service system to provide market information, assets evaluation, brand positioning, and other service capabilities to help enterprises increase their success rates of brand development.

The Chinese government must strengthen protection The government must further strengthen protection against rights infringement, and to gradually improve relevant legal systems, management systems, and market supervision systems, accelerating the issuance of guiding documents on brand development and brand protection. It should also emphasize mergers and acquisitions of domestic enterprises and the management and regulation of overseas brands, and brand acquisition, thereby establishing a fair and orderly competitive environment for brands.

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Chief Editor’s Bio

A

nthony Teo received his MBA from Harvard University. Presently, he is Secretary to Nanyang Technological University (NTU), Council Member of the Lien Ying Chow Legacy Fellowship and member of the Middle East Institute’s Management Board at the National University of Singapore. Based in Hong Kong for a decade, he was the Vice Chairman of the Singapore Chamber of Commerce in HK & Editor-in-Chief of SCC News from 1996 till 2007.As Chairman of its SCC China Network he launched its proprietary virtual database system to connect the overseas Singapore and Chinarelated business interests in doing business in China. He was Editor of the Closer Economic Partnership Agreement (CEPA) Supplement featuring new and early access between mainland China and HKSAR. This publication was designed to assist Singapore and overseas business interests enter the mainland market through a strategic presence in Hong Kong to tap into the rapid developments of the Greater Pearl River, fast becoming the largest global supply chain. Whilst in Hong Kong he was also publisher of Asian Business, a pan-Asian journal with a circulation of 105,000. An Emeritus Board Member of the global Harvard Business School Alumni Board of Governors, he was the Chairman for Appointing Speakers for the HBS Global Leadership Forum Shanghai 2004 and Hong Kong in 1997 attended by over 1,500 CEOs and spouses. He lectures at NTU’s Technopreneurship & Innovation Program (TIP) Diploma & MSc programmes and the annual Air Liquide Global Executive Development Programme. He served on the Singapore Government’s Public Sector Divestment Committee and as deputy Chairman of SONHK (Singapore Overseas Network) presented a report on innovation & entrepreneurship to the Singapore Government’s Economic Review Committee. Recently, he was appointed as an Independent Director to the Board of Directors of Innovalues Precision Limited, listed on the Main Board of SGX. The company has operations in China,Thailand and Malaysia. He was publishing editor of the Harvard Commemorative book and managed the thematic essays amongst the 20 writers including Captain Dr. Jia Fu Wei, President & CEO of COSCO Group, who wrote 联系中美的纽带 : Fostering China-US Ties (pages 115–125); and the writings of the late Lien Shih Sheng published as 长天集 : The Eternal Sky.

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Publications: The Harvard Experience: Crimson Essays, Co-Editors: with BH Koh, KW Lee & Anthony SC Teo, pp.212, Marshall Cavendish, Singapore, July 2005. The Eternal Sky, Lien Shih Sheng, pp.212, 2007, Lingzi Publishers (Published under the auspices of the Harvard Singapore Foundation). The Singapore Business Supplement on the Closer Economic Partnership Arrangement (CEPA) with China, Editor, SCC News, January 2004; with an Op-Ed on the two challenges for HKSAR and the supply chain of the Greater Pearl River Delta.

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Chief Editor’s Bio

T

an Teng-Kee, Nanyang Technological University, before joining academia in 1999, Dr Tan was an entrepreneur and the founder of several consumer product companies involved in research and product development, engineering, manufacturing and export to international markets. His companies hold several international engineering patents. Dr Tan spent eight years with Electrolux AB, beginning in 1977 as Division Manager of its SE Asian headquarters in Singapore, and later, as Corporate Vice President-Marketing in Canada. He left Electrolux in 1980 to join Sunbeam Corporation, where he spent nine years as Director of Business Development in its Canadian division. He was subsequently promoted and joined Sunbeam’s corporate office in Chicago, USA. Dr Tan rose to the position of Vice President and member of the Executive Committee at Sunbeam’s most profitable division, Northern Electric, Inc. He supervised and was responsible for the strategic planning for Sunbeam’s consumer product subsidiaries in Europe, Asia, Canada, United States and Mexico. Dr Tan received the “Progressive Marketer Award” from Sunbeam and, in 1986, was named among the “People of the Year” in the industry in the United States. Dr Tan attended the Kellogg Graduate School of Management, Northwestern University, where he obtained his MBA. He received his doctoral degree (PhD) from the Judge Institute of Management, University of Cambridge. He pursued his research in Dilemma Theory and New Product Development & Innovation. At the Nanyang Business School, Nanyang Technological University (NTU), DrTan teaches strategic marketing, strategy, and technology entrepreneurship & innovation at the MBA level. He was voted “The Best Marketing Professor of the Year 2001”. His innovative teaching pedagogy has been featured in The Asian Wall Street Journal (October 2001). He is also the founding Director of NTU’s Nanyang Technopreneurship Center, funded by the Economic Development Board of Singapore to promote and nurture technology entrepreneurs. Dr Tan developed the first Technopreneurship and Innovation Graduate Program (TIP) in the world, a collaboration with the University of Washington, Seattle (UW). He clinched the “Outstanding Teaching Award” in the NTU-UW joint TIP program in 2004 and 2005.

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In 2003, Dr Tan received the “Best Paper Award” in Marketing Strategy from the American Marketing Association. He concluded his tenure as Director of the Nanyang Fellows EMBA Program, a top-rated Nanyang Business School alliance with the Sloan School of Management, MIT. In 2002, as part of the “Remaking of Singapore”, he chaired the products and markets diversification committee at the Economic Restructuring Forum of the Institute of Policy Studies, a Singapore government think-tank. Dr Tan specializes in helping international companies transform from being manufacturing or product/salesoriented to being customer-focused and marketing-oriented. He has extensive experience in new product development & innovation, international market development, international product sourcing, OEM business-to-business marketing, consumer product marketing, product management, brand marketing and marketing audit. His interests are in the areas of international business management and strategy, strategic marketing, entrepreneurship, and strategic planning in a global environment. He has extensive knowledge of business management in China and also teaches the Mandarin EMBA program at Shanghai Jiao Tong University.

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