Historically, the most profitable multinationals in China have harnessed the duality of China as both an export and domestic market, compared with companies that have pursued the narrower objectives of either taking advantage of the country’s low-cost labor to make inexpensive products or parts for Western markets, or importing products into China for sale in the growing domestic market. Companies that make a play on China’s dual markets are better positioned and have more motivation to implement best practices, because to succeed they must devise factory footprints in China that produce large volumes of products but delay the moment at which those products have to be customized for Chinese and non-Chinese markets. They must do so in globally connected supply chains that are lean and highly responsive.
In this year’s survey, the concept of China as a duality play continued to gain prominence: 57 percent of companies described this approach as their primary motive for establishing and growing their presence in China, versus 47 percent last year. At the same time, the percentage of respondents that identified labor or material cost savings as their primary reason for being in China without also citing local market access as a motive dropped by half, from 22 percent to 11 percent.
This study was among the first to measure the impact of the financial downturn on multinational business operations in China. Uncertain about the global economic outlook and concerned about economic progress in low-cost markets that are usually seen as alternatives to China for manufacturing operations, fewer respondents this year said they have concrete plans to relocate or expand manufacturing capacity out of China in the next five years (10 percent in 2008 versus 17 percent in 2007). Also, more respondents this year (28 percent versus 13 percent) were neutral when asked to comment on whether China was losing its competitive edge to other low-cost countries, likely reflecting the slowdown in new manufacturing investments worldwide as well as the volatility in demand and supply in competing low-cost countries. Even with a worsening downturn, companies grew firmer in their desire to invest in China, with nearly half saying that they intend to “grow” or “grow significantly” their production capacity on the mainland in the next couple of years.
The global economic crisis has changed the assumptions about future business strategies for virtually every manufacturer operating in China. Before the recession, the biggest challenges were higher material and compensation costs as well as the appreciation of the renminbi; now, declining rates of domestic growth, falling demand for Chinese exports, global currency volatility, and tight credit are paramount concerns.
To navigate this increasingly difficult environment, multinationals in China should focus on a few key activities:
- Accelerating domestic market development beyond the premium segment and moving down the price/performance ladder for products and services to take advantage of the continuing growth of the middle class, while reducing dependence on export markets.
- Tailoring their product design to meet domestic demand by fine-tuning current offerings for local market conditions and preferences and developing new business models to support this initiative.
- Linking local Chinese manufacturing and purchasing activities with their global extended supply chains to build and capture economies of scale and scope, harnessing the duality of China in the process.
- Remaining vigilant and in fact seeking to identify potential discontinuities in supply and demand and being ready to act.
Every downturn creates opportunities for the fleet of foot, especially for strong companies with healthy balance sheets and the institutional capacity to act swiftly.
Ronald Haddock is a partner with Booz & Company based in Zurich. He has been with the firm since 1994, including 10 years in the China, India, and Korea offices. During his recent assignment in Shanghai, he led the auto and industrials practice in Greater China.
Brenda Lei Foster has been president of the American Chamber of Commerce in Shanghai since 2005. She has more than 30 years of experience working on Asian and Chinese global concerns, and is a member of the Council on Foreign Relations.