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 / Summer 2012 / Issue 67(originally published by Booz & Company)


China’s Mid-Market Innovators

Thousands of new mid-market customers emerge every year in newly developed cities such as those in the Chinese interior or those formed on the edge of existing metropolitan regions. They tend to begin as domestic players, selling to Chinese industrial customers who are looking for goods and services that offer a fair level of functionality and quality at a relatively low price compared with most imports. As Ming Zeng and Peter J. Williamson point out in their book Dragons at Your Door: How Chinese Cost Innovation Is Disrupting Global Competition (Harvard Business School Press, 2007), the mid-market innovators are like many other Chinese companies, competing on price skillfully and relentlessly. But they also compete on innovation, by continually improving their products, processes, and business models, and closing the gap in reliability and performance between themselves and their established global competitors, sometimes with remarkable speed. At the same time, their products remain far lower in cost, and, just as importantly, are attuned to Chinese needs. For example, these companies do not target all parts of the country at once; instead, they recognize that different regions are developing at different rates, and they concentrate on the regions that are ready for their particular level of low-cost product.

Some Chinese customers who buy from mid-market innovators today will eventually reach a point at which they can afford more reliable equipment with more features. Global companies will be eager to sell it to them. But by then the mid-market innovators will have built long-standing relationships with those Chinese customers — and their counterparts in India, Latin America, Indonesia, Africa, the Middle East, and other countries and regions around the world. Moreover, the financial crisis and resulting pressures on government spending have led to increased demand for low-priced, high-quality tools, devices, construction equipment, and machines of all kinds — making Chinese industrial products competitive even in established markets like Germany and the United States. With their seasoned knowledge of the middle market’s priorities, the Chinese innovators can build scale, add capabilities, and start to encroach on turf that global multinationals have long regarded as their own.

A good example of the dynamic — and the threat — is the construction equipment sector. China’s rapid expansion of buildings and infrastructure has involved widespread subcontracting, with work on all sizable projects shared among a chain of hundreds or even thousands of small businesses. Most of these Chinese construction subcontractors think in the short term. They want equipment that is good enough to do the immediate job, and that will then be written off after five years or less. They are not interested in expensive, feature-rich products with a long life span supported by service contracts.

This type of segment is hard to penetrate for non-Chinese heavy equipment manufacturers, such as Caterpillar (U.S.), Liebherr (Germany), and Komatsu (Japan). These manufacturers follow well-established business models with buyers who, supported by long-term financing, think on a 10- to 15-year time span. Equipment must both last a long time and have the service needed to keep it operating with as few interruptions as possible.

Meanwhile, upstart construction equipment manufacturers have emerged to serve China’s fragmented construction industry. They sell low-cost machines that typically do not get expensive servicing, but are replaced when they wear out. The manufacturers focus on only a small range of related products, and keep their prices ultracompetitive by restricting investment only to functions and features that are strictly needed. Their versions of multinational products might not pass muster in Canada or Denmark, but they are considered superior in China.

Already, some of these mid-market construction equipment companies are becoming global powerhouses. For example, Sany Heavy Industry Company — founded in 1994 in Changsha, the capital city of Hunan province — became the world’s largest concrete pump manufacturer in 2009; its total revenues in 2010 approached $8 billion. In 2012, Sany announced that it would acquire the second-largest producer, the German company Putzmeister, and it has built plants in the U.S., Brazil, India, and Germany, as well as a major R&D center near Cologne. Other construction equipment manufacturers expanding outside China include ZoomLion (also based in Changsha), XCMG (a state-owned company headquartered in Xuzhou), and Shandong Heavy Industry Group. They all got their start by selling to China’s fragmented construction industry.

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