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(originally published by Booz & Company)


The New Chinese Economy

The boom years may be in the past, but China still offers big opportunities for multinationals that adapt to its new economic reality.

As China’s once-in-a-decade leadership succession gets under way, another transition has been capturing headlines: the country’s recent lackluster economic performance after years of double-digit growth. The Chinese economy reportedly grew only 7.4 percent in the third quarter of 2012 — its lowest growth rate since 2009 — and if the economy finishes the year as projected, this rate will mark a 13-year low. The decline varies by industry. Hardest hit have been businesses related to heavy industry and to the real estate sector; new home prices in many cities continue to drop because of government policies intended to control inflation. Growth also varies by region; some of China’s interior and western provinces have experienced above-average rates of growth, whereas growth in the traditionally wealthier coastal provinces has cooled.

But other indicators tell a different story. Beijing recently reported that industrial output grew 9.2 percent in September, and retail sales increased 14.2 percent during the same month. Sectors such as healthcare and other services continue to grow strongly. And even as the growth rate comes down, actual GDP continues to expand. Both government officials and executives on the ground say that the Chinese government still has the will and ability to ensure a soft landing through its control over the domestic banking system, foreign exchange rates and capital flows, infrastructure investments, and other macroeconomic policy tools. Although any government stimulus in the coming months will not be as large as the one Beijing launched in 2008, they say, it could effectively mitigate the worst spillover damage from the financial crises in Europe and elsewhere.

Opinions and predictions on China’s outlook may vary with the monthly figures, but one reality is beyond question: The Chinese economy is maturing. China is moving away from a focus on low-cost manufacturing toward sustainable growth and higher-value-added business, and from infrastructure- and export-led growth to domestic consumption. In a few years, China could look very different from how it does today, as regional shifts in wealth, more demanding and discerning customers, and highly motivated Chinese companies change the competitive landscape. The country’s economy is also evolving in fundamental ways as single-digit annual growth becomes a plausible new normal. Multinational corporations (MNCs) that have grown accustomed to the boom years may be nervously eyeing the situation. But they can be confident that China remains a significant source of opportunity for those who adapt their strategies. To do so, companies first need to understand the trends that are shaping these changes.

Short-Term Shifts

Domestic demand is growing in China, but today and in the near future, it will come from regions that have been largely ignored by many multinationals. These substantial shifts in demand reflect the movement of wealth away from the coastal areas and toward some of China’s interior and western provinces, and away from so-called top-tier cities and toward lower-tier cities and, for some categories, rural areas. This trend is affecting certain sectors, such as consumer goods, automotive, and industrials, particularly strongly.

Both Chinese and multinational companies will need to realign their footprint and operating model accordingly, adopting a Fit for GrowthSM approach, with a much stronger focus on both the top and bottom lines. They can expand beyond the Tier One and Tier Two markets with which they established themselves in China by deepening and broadening their channels to enter lower-tier markets, implementing what is called a “go down” (xia chen) strategy. This will often require changes to their traditional go-to-market model, as well as to core elements of their customer value proposition. For example, they will have to link inland and western regions to the rest of the country and build nationwide logistic and marketing networks. Foreign companies can benefit from partnerships with Chinese players to accelerate this strategy and fill gaps, but they also need to develop their own capabilities to execute this shift successfully.

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