After twenty years of market creation in China, profound changes have taken place that affect how international companies need to operate there. Part two of our three part series examines the growth of national markets.
In the first part of this article, we observed that three profound changes have taken place in China since Deng Xiaoping announced the replacement of a planned, centrally-dictated economy by a market economy just twenty years ago. A quite different China has emerged, one in which business-to-business markets have been created, markets have begun to transition from local to national, and sales and distribution have become important business functions. Below, we will focus on the implications of the second of these major changes.
Geographic isolation of markets has also seen tremendous change. Most consumer markets have moved with reasonable speed toward the brands in each major city being familiar to visitors. In personal and home care markets, P&G has become a China market leader by understanding how to advertise and create recognition across the nation, joining some well-known Chinese brands like White Cat, Liby and Jakwa.
Even as recently as last year, however, we cited the inherently local nature of China’s markets.[1] In defining opportunities for business-to-business suppliers, our work in China remains heavily oriented around geography, even today. But, while markets are still different, the knowledge gap is narrowing quickly across regions, pointing to continuing change. Whether we will always find a large number of local Chinese competitors with a very restricted geographic reach, or see a transition to truly national market participants is a critical question for western business looking at China, either as suppliers or as competitors. And, for Chinese companies, the key question they must ask is do they in fact face the choice of either growing towards national stature or being overcome by competitors that do so?
A decade ago, we were working for a company making advanced construction materials looking for China market opportunities. In our first customer interview, we were told that the product on which we were focusing was illegal in China and would therefore not be found anywhere. With visions of the shortest strategy consulting project in history, but also knowing how complex and confusing China can be, we proceeded to a different part of the country where we found competitors’ products for sale everywhere. We were told that the local market in that region was large and growing rapidly. That was one of our most important lessons about the written and unwritten rules in China.[2]
Today there are fewer places in China where a superior technology is unknown or unaccepted, due to the much better access to information. Those selling solutions have spread their messages across the country. The emergence of national suppliers is in no way restricted to global firms. World-class competitors like Sany, Zoomlion, and Liugong in heavy construction equipment, for example, are emerging in China with broad reach across the country and beyond. We have seen Chinese companies achieve national reach in industries ranging from medical equipment to cooling towers to renewable energy.
In agriculture, with perhaps the most difficult geography of any market, we earlier found that different types of equipment were being used in different provinces, despite much the same climate and topography. The short explanation was that the leaders of agricultural extension stations, which are a vital information source for farmers as well as a link to government funds and policies, simply had different levels of knowledge of and opinions about products in the market. We have seen the knowledge gap close over the past ten years because of training and outreach, by both government and suppliers of equipment. Once again, those suppliers include western and Chinese firms.
Both market forces and the government have helped local markets become more national. But, even in the face of the changes taking place, thinking about “the China market” is usually a bad assumption for a company to make. Knowing exactly how far markets have gone in becoming national is an important step to understanding opportunity in China. Markets involving smaller equipment in agriculture and construction are still more local than national, with different practices and products and suppliers of those products dominating on a local basis. Many suppliers of such types of equipment are completely unknown outside their home region.
On one recent project, we met a business-to-business supplier of specialized manufacturing equipment. This company is of significant size and well-respected by its customers, but we had never heard its name in many interviews in other parts of China. We soon learned why. Their factory has a set of loyal customers nearby who come to them when they need equipment and actually pick it up themselves from the factory. So, in essence this company has no marketing, sales, or logistics capability, no brand name, and no means or ambition to sell to anyone not in close proximity to their factory door. While extreme, this company is not unusual in being a respected business-to-business supplier in a very narrow geography within China.
Understanding the landscape of potential customers or potential acquisition targets is quite an undertaking, since industries which would have two or three major participants in North America could have many hundreds of firms in China, each with its own geographic footprint.[3]
Even the relatively advanced auto industry, selling to consumers informed by advertising and many enthusiast magazines, recently had over 100 manufacturers, which the government is attempting to combine into a few large companies able to compete on the global stage. And even the best-known brands, with a truly national sales network, still have a strong geographic focus to their sales. Volkswagen and GM dominate in Shanghai, Audi and Hyundai in Beijing, etc. But they and their reputations now have a much wider reach.
The fact that many brands are present across regions and their suppliers are trying to penetrate a wider market speaks to a gradual maturation. Consumer market firms will likely lead the way in terms of China-wide reach. Business-to-business suppliers, without national advertising channels to reach customers, are even more likely than consumer goods producers to divide up the country according to home territories. This will inevitably evolve in many cases, as winners emerge from among the Chinese firms that have growth aspirations or as roll-up strategies create advantages of scale.[4]
In short, the structure of most industries is still fragmented across geographies but the knowledge of competitive products is far greater than twenty years ago. Why, then, have we not seen some markets move faster toward the emergence of national brands that displace most of the local products? One factor is China’s geography, with an immature transportation system, a variety of languages, dialects, and ethnicities, which is challenging in itself, probably a more extreme version of the challenge that faced European suppliers that sought to reach additional country markets.
And, once again, we have to emphasize the heavy influence of the government in markets. When local governments have influence, as business-to-business customers or just as heavy-handed influencers, they tend to favor local products. Even the best manufacturers are often challenged to achieve success outside of their home areas. “We have no relationships anywhere else” is the most common reason that companies have given us for their limited sales reach. When we look ahead at whether China is headed toward being a national market, the role of government is the major reason to believe that China will stop considerably short in any near-term time frame.
The champions among the Chinese Second Mouse companies that we mentioned earlier – those high flyers that look likely to take on global competition in mid-markets around the world – are succeeding in those market segments where success accrues to the firm that is faster, more adaptable, more focused on meeting mid-tier customer needs, and highly price competitive. Finding examples of companies like that a decade ago was akin to finding a needle in a Chinese-sized haystack. That multiple examples are obvious today is a clear sign of evolution. The trend will continue, but the transition from local markets to national markets will continue for many years to come.
The immature regional market structure that exists today means that entering China through acquisition involves great challenges and tremendous opportunity for those above to overcome the challenges. We often find that the potential acquisition candidates know far less about “the China market” in which they participate than we do. Their total knowledge is often limited to their own province, sometimes only to a radius of a few miles. The opportunity is to extend their business into virgin territory, a task which even ambitious Chinese firms see as formidable. Combining together a set of local companies that can have wider reach, more relationships, and greater scale offers opportunity for an outsider that sees the big picture, as long as he is aware of what factors drive market decisions in each geographic segment.
Succeeding as a supplier in such a marketplace is also not easy. The markets are difficult to characterize and selling into fragmentation is expensive. Sometimes there will be strong local competitors and sometimes the playing field is wide open. Where markets have become national, sales and distribution systems have grown to handle the geographic reach that is required. We turn to that dynamic, the third major change that has taken place since Deng’s speech of two decades ago, in the next section of this article.
[1]George F. Brown, Jr. and David G. Hartman, Fifty Ways to Win in China, Business Excellence, June 2011.
[2]George F. Brown, Jr., David G. Hartman, and Atlee Valentine Pope, The Unwritten Rules of China, Blue Canyon Partners, Inc., © 2005
[3]See David G. Hartman, Three Strategic Challenges in China Acquisitions, Blue Canyon Partners, Inc., © 2009
[4]See George F. Brown, Jr. and David G. Hartman, There Is Money to Be Made in Mice, iP Frontline, May 2012.
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