Only fittest state firms will survive
Wednesday, November 7, 2001
JONATHAN WOETZEL
China's state planning has been loosening since 1978, when Deng Xiaoping introduced the "Four Modernisations", de-emphasising ideology and promoting agriculture, industry, science and technology, and defence.
Today state enterprises have less in common with their Chinese predecessors than with companies in the West: they can pursue mergers and acquisitions, raise money in capital markets, and, with the acquiescence of local governments, lay off workers. Adding to the pressure of reform, import tariffs are being steadily reduced as China prepares to join the World Trade Organisation. Foreign firms no longer treat their Chinese counterparts as mere arms of a monolithic bureaucracy.
Beijing views industrial development as a key to economic growth and Western economies as the blueprint. In the West, a few large firms with global scale dominate most industrial sectors, and Beijing sees no reason for China to be different in this respect. The challenge is how to ensure some of those companies are Chinese. By adopting proven Western management practices, some of China's biggest companies are undergoing an unprecedented transformation in the path towards a truly market-driven economy.
Legend has outperformed Dell, Compaq and IBM to become the largest computer-manufacturer in Asia. Haier has stolen household-appliance market share from Whirlpool and GE in China and is starting to expand globally. Some Chinese companies in the telecommunications, insurance and petroleum industries are rapidly closing the performance gap with their global competitors.
Despite these success stories, most Chinese enterprises are ill-prepared to face the challenges that lie ahead. Many are heavily indebted, overstaffed and reliant on products already decades out of date. Even worse, the pervasive bureaucratic culture has driven many of their most talented employees away, while those that are left are ready to retire.
Multinational corporations and, to some extent, private Chinese enterprises have been the leading advocates of the performance-driven approach in China. Many successful foreign investors have sought to control operations tightly, and have invested in building world-class manufacturing capabilities in China.
But operational excellence has been more difficult to introduce to traditional state enterprises. Most still suffer from inefficient and inflexible manufacturing systems that waste capital investment, lengthen production lead times and produce low-quality goods. On top of this, inflexible labour policies prevent them from hiring workers more open to learning new processes or from firing those too attached to the old way of doing things.
Another area where Chinese enterprises are lacking is customer service. In general, providing good customer service has not been a source of competitive advantage in China. Multi-layered distribution channels, weak marketing networks and unsophisticated customers have made this a forgotten strategy. In many industries, most customers have been the traditional state-owned enterprises for whom the economic benefits of excellent service go unrecognised, especially since they usually handle their own transport needs.
Only one-quarter of the companies in a recent McKinsey survey on China's logistics market said they relied on third parties for logistics services. In addition, companies often lack experienced marketers, and market research skills are very rudimentary.
Knowledge of international markets is especially limited by the inadequate English skills of most Chinese employees. Beyond internal problems wrought by inefficient operations and poor customer service, many of China's industries are beset by severe fragmentation. Take car assembly. Although Volkswagen and other foreign vehicle-makers hold as much as 90 per cent of the passenger-car market in China, 130 domestic car-makers are pursuing the remaining 10 per cent share.
China's television-assembly industry, with 20 large brand-name TV-makers and more than 50 manufacturers, is engaged in a price war that is eating rapidly into profit margins. Given the fragmentation of China's industrial economy, one would expect more mergers and acquisitions to accompany the process of reform.
Unfortunately, this has not been the case. And in those industries where deals have been done, capturing value from consolidation has proven difficult because in many cases, little operational integration occurs. And, of course, the potential social costs of restructuring have dampened the will to move forward.
So now that China has been cleared for WTO entry, what lies ahead for state-owned enterprises? As the competitive stakes get higher, management must work to create value for shareholders or risk falling by the wayside of economic reform. Firms can tailor at least three winning strategies to their own needs. These strategies may be familiar elsewhere, but they represent big steps for China, given the culture and capabilities of its enterprises.
First, improving operational performance is a tremendous untapped opportunity for many Chinese enterprises. Cost savings of more than 30 per cent and increases in revenues of 20 per cent or more are possible in an environment where minimal effort has historically been made to implement even the most basic management methods.
Second, companies need to foster a strong focus on the customer. While this may seem like an obvious strategy, in China it is not. Producing enterprises still rely on a web of traders and distributors to reach the market.
Instead real marketing driven by fact-based market research is needed to craft appealing products and maximise the efficiency of sales and distribution channels.
Finally, while operational excellence and good customer service are increasingly prerequisites to success, these may not be enough in industries faced with excessive competition.
China's state enterprises can use mergers and acquisitions to reduce the excessive competition plaguing many industries and improve productivity. But only those that master the process of identifying and capturing integration synergies will have a chance to create significant value.
China's state-owned enterprises have a unique window of opportunity during the next few years to reposition themselves to compete in the new, post-WTO world. Only the fittest and most disciplined will survive to fulfil China's dream of building a strong economy.
Jonathan Woetzel is a senior partner in Mckinsey & Co's Shanghai Office.
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