Works Cited
Grant, Andrew. "What executives are asking about China: From entry to execution." McKinsey Quarterly (Special Edition 2006): 24-31. Business Source Premier. EBSCO. [Library name], [City], [State abbreviation]. 5 Apr. 2008 <http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=22060428&loginpage=Login.asp&site What executives are asking about China: From entry to execution Multinational executives no longer quip that Marco Polo was the last foreigner to make a profit in China. As the list of Chinese success stories grows,[1] we find that senior managers are focusing more on execution and less on the broader concerns of entering a new market. Yesterday's explorers have become today's insiders. This shift is reflected in the questions that executives in China are asking. Two years ago topics such as the stability of the banking system and China's adherence to trade commitments were at the forefront.[2] But today's China hand seeks guidance on problems such as how to find the talent needed to expand operations and ways of serving consumers in the country's vast interior. The following questions and answers — based on McKinsey's experience in China and on discussions with executives, government officials, and analysts — address some of the current concerns of executives working in the country. Where will companies find the managers they need to run their businesses? First, don't forget about the managers already on staff. The white-hot market for talent is forcing wages up and making it difficult for companies to retain managers. From 30 to 40 percent of senior managers at multinationals switch jobs every year, and their average salary increased by 14 percent annually from 2000 to 2004. Such pressure will likely continue. Chinese companies are also thirsty for talent, further exacerbating the challenge for multinationals. We expect domestic companies to need about 75,000 leaders who could work effectively in global environments within 10 to 15 years, compared with the 1,000 to 5,000 on hand today.[3] In this environment companies must aggressively strive to retain their employees and design the right combination of financial and nonfinancial incentives. Besides competitive pay, companies should provide a positive and comfortable work environment, training and career-development opportunities, and a collegial community of coworkers. If handled well, these intangibles will prove difficult for competitors to emulate. By contrast, a company that relies solely on bidding wars to poach experienced managers will quickly find that they can be lured away by offers of even higher-paying jobs. In addition, multinationals must keep their best managers enthused and remove any perception of a glass ceiling by offering entrepreneurial projects and career options that go beyond those in China. An executive's financial compensation must be competitive, of course, but companies should also innovate when they design pay packages. We find, for example, that competition is most intense for managers with three to five years' experience. Yet companies tend to overlook this fact and offer linear pay increases based on tenure. Instead, they should consider adopting a compensation structure that resembles an S-curve pay raises should he smaller during the first years, with the promise of more rapid increases around the third, fourth, or fifth year — an approach that would reflect a manager's true market value. Companies should also consider using deferred compensation and long-term incentives (such as stock options) to retain experienced managers. To expand the ranks of managers, companies must recruit graduates in China and take a long-term view of their potential. While graduates of top European or US universities can be productive immediately, their counterparts from Chinese schools enter the job market with only about 60 percent of what's required to be successful in a global company. To bolster the skills of these domestic graduates, companies must create formal development programs and offer on-the-job training. How can companies reach consumers in smaller cities? Leading companies make good money in China, but their profits come largely from the first-tier cities — such as Beijing, Guangzhou, and Shanghai — where demand is strongest and the infrastructure most modern. Looking ahead over the next two decades, most of the growth will come
from second-and third-tier cities and even much smaller cities and towns.[4] Although some consumer goods companies and retailers are already exploring markets outside the large metropolitan areas, most multinationals haven't figured out how to serve widely dispersed lower-income consumers profitably. Such companies face three main challenges. First, distribution and logistics networks outside the biggest cities are underdeveloped and will likely remain so for several years. This problem is partly a consequence of China's size. In the early phases of development, massive infrastructure investments focused on the industrialized eastern seaboard, so it will take time to meet the whole country's transportation needs. In addition, the logistics sector remains fragmented, with local and regional distributors retaining considerable influence because of their experience serving far-flung customers. Multinational companies hoping to broaden their geographic reach must deal with these local realities by creating a patchwork of the best available domestic partners and by focusing on efforts to assure adequate execution, such as guaranteed delivery times. At the same time, the multinationals must remain flexible enough to revise their distribution model quickly as the infrastructure and service offerings improve. Second, consumers outside the largest cities are a diverse bunch. Income levels are lower than those of the biggest cities, and there is a wide range of ethnicities and consumer behavior; for instance, Yunnan Province, in southwest China, is home to about 25 ethnic groups. Our research shows that the smallest cities and towns include at least three major customer segments, each with a quite different approach to shopping. Companies shouldn't treat these markets as a homogeneous block, as though they resembled a smaller and more dispersed Shanghai. Rather, they should try to understand the nuances that drive buying behavior in each key segment. Third, and most often overlooked, is the difficulty of finding and keeping good managers outside first-tier cities. When companies move their operations beyond the biggest urban centers, they must find thousands, rather than hundreds, of new managers and salespeople each year. Furthermore, China's smaller, more remote cities are less desirable places for most top managers to live. Relocation and retention become more problematic, and human-resource models that work in the biggest cities must be revamped to account for these differences. Mengniu Dairy, for instance, addressed this issue in the northern city of Hohhot by building its own expatriate infrastructure with amenities such as Western-style housing and modern health facilities. Other companies in China give expatriate managers extra time for home leave â&#x20AC;&#x201D; up to a month in some cases â&#x20AC;&#x201D; to encourage them to relocate to smaller cities. Will Chinese companies become innovators? As China's economy blossomed over the past two decades, domestic companies were better known for absorbing new ideas from their foreign partners than for pushing their own thinking forward. But today the country seems on the brink of a resurgence in innovation. The transition is not assured and much work remains, but there are signals from the government and domestic enterprises that multinationals should heed and prepare for. Beijing has put commercial innovation high on the country's agenda. The central government aims to increase expenditures on research and development from the current 1.2. percent of GDP to 1.5 percent by 2020 and to reduce the country's dependence on foreign technology[5] to 30 percent, from 50 percent, during the same period. As the government works toward these goals, it will establish clear priorities with immediate impact by creating tax incentives for companies engaged in research, deciding whether public agencies buy homegrown or imported technology, and adopting technical standards that could reward successful innovators, among other measures. One test will he whether more capital begins flowing toward small and midsize businesses. China still channels a disproportionate share of the country's savings toward state-owned enterprises. While many of the larger SOEs are profitable, in general they are much less innovative than private companies are, especially small and midsize ones. China's banks now recognize the importance of this sector and are beginning to develop the risk-management skills needed to serve these businesses. A true shift in capital allocation would be a strong boost for the country's innovation agenda in the longer term (see "How financial-system reform could benefit China," in the current issue). The success of a few Chinese companies indicates that attitudes toward innovation are changing. The telecom-equipment maker Huawei Technologies, for example, has an aggressive research program, with nearly half of its 30,000 employees focused on R&D. Although the company faced a copyright dispute with Cisco Systems just three years ago, today Huawei is seen as a model for
Chinese innovation. By 2005 it held more domestic patents, about 1,800, than any other company. Last year Huawei filed 149 international patent applications,[6] ranking 37th on the World Intellectual Property Organization's (WIPO) list of the top 50 companies — the only Chinese business to be included. But the WIPO's data also show how far China has to go. Although Chinese inventors and companies filed 1,451 international patent applications last year — a 44 percent increase from 1004 (putting the country in tenth place globally) — China was still well behind South Korea (sixth place, with 4,747 applications), Japan (second, with 25,145), and the United States (first, with 45,111). The Dutch electronics company Philips, the heaviest corporate filer, with 1,492 applications, had slightly more applications than all Chinese parties combined. And there are risks linked to the pressure to innovate. Earlier this year, in a case that echoed South Korea's cloning-research scandal, a prominent Chinese professor was stripped of his position amid charges that he faked research results and stole technology in developing a computer chip that was initially heralded as a major breakthrough in Chinese innovation. China's new emphasis on innovation represents an opportunity multinationals should embrace rather than fear. By understanding the government's agenda and working with officials, global companies can help shape this potential surge in innovation. Many foreign companies have already established R&D centers in China, staffed by thousands of local workers. In addition, multinationals working alone, with local companies, or as part of an industry group can lobby the government to adopt the technical standards they deem most beneficial. They can also help define tax benefits linked to innovation in order to ensure that their areas of research are included. And finally, by buying small stakes in promising local innovators or even acquiring them, a multinational can use its experience and skills to nurture ideas and launch the resulting products globally. Are personal connections — guanxi — still important? Businesses around the world try to influence government decisions on everything from pending legislation and applications for licenses to regulatory changes. But in the early days of China's market reforms, personal relationships with the right local-, regional-, or central-government officials took on overwhelming significance and were often the key to success. Guanxi remains a factor for companies doing business in China but now requires a more systematic approach. Nurturing the right ministerial relationships no longer confers the same advantage. As the Chinese economy and regulatory infrastructure mature, fewer decisions affecting businesses are being made for the first time, and precedents can be difficult to break no matter whose ear a senior executive can bend. Moreover, players on both sides of the table are much more professional than they were a decade ago. Still, given China's high degree of political and economic decentralization, the smartest companies recognize that good relationships on all levels of government are important. Top multinationals therefore make senior executives, not junior managers, responsible for government relations in China, just as they are for any other important corporate function, including human resources or accounting. Such companies explicitly recognize the long-term importance of their government relationships, routinely meet with officials at all levels of government (especially the highest), and constantly look for areas where the government's agenda and their own interests overlap. How can companies address corruption? The amount of corruption a business might face varies enormously from one sector to the next. Industries (such as retailing and the manufacture of medical devices) that are especially dependent on individual buyers or suppliers struggle with this problem more than most. In such industries, ethical companies have found practical ways of dealing with the issue — for instance, by rotating purchasers every year or two, by closely monitoring trends in purchase prices, and by establishing well-designed formal programs for reporting corruption. Some companies even have merchandisers sit together in open-plan offices to reduce temptation. China's government has adopted policies to combat the problem. For example, it has cracked down on local officials who don't enforce safety regulations for private mines, either because they own a share of the mine or have been bribed to look the other way.[7] In March of this year the government began a high-profile campaign, featuring President Hu Jintao, to raise awareness about corruption, urging everyone to "be honest."[8] But official efforts are constrained by a lack of resources and the difficulty of changing the behavior of large numbers of people across China's vast
landscape. To accelerate the effort, the country must go beyond public messages and deploy a cadre of judges, court officials, and enforcement officers trained in anticorruption practices. But change will be slow, and companies will likely be facing this problem for years to come. To move beyond low-cost manufacturing. China must do a better job of training its university students. Currently only about one in ten graduates leave school prepared to work for a global company. See "China's looming talent shortage" (www.mckinseyquarterly.com/links/22139). A lot has been said about China and much of the conventional wisdom is just wrong. Global executives in China must separate myth from reality if they hope to succeed See "A guide to doing business in Chins" (www.mckinseyquaterly.com/links/22137) Article at a glance Multinational companies are shifting gears in China, turning away from entry strategies and focusing instead on execution. The head of McKinsey's offices in China takes a look at some of the concerns arising in this new environment. Innovative approaches to recruiting and retaining managers are needed to counter expected staff shortages. Along with distribution and marketing, recruitment will also pose a challenge for global companies as they reach beyond China's large cities. China has targeted innovation as a national priority, and there are early signs that some domestic companies are becoming more creative. Foreign companies should encourage this trend and find ways to benefit from it As the importance of personal contacts begins to fade, a systematic approach to government relations is becoming a necessity. Many companies still face local corruption, although the situation is improving. E-mail this article to a colleague www.mckinseyquartely.com/links/22062 1. A recent survey by the American Chamber of Commerce in Beijing, for example, found that 42 percent of US companies operating in China report that their Chinese profit margins exceed their worldwide average margin. 2. Gordon R. Orr, "What executives are asking about China," The McKinsey Quarterly, 1004 special edition: China today, pp. 16-23 (www.mckinseyquarterly.com/links/22038). 3. Diana Farrell and Andrew J. Grant, "China's looming talent shortage," The McKinsey Quarterly, 2005 Number 4, pp. 70-9 (www.mckinseyquarterly.com/links/22139). 4. China's cities are generally classified into tiers based on population, per capita income, and other factors. First-tier cities are the largest and must affluent. 5. Technology dependence is calculated as spending on imported technology divided by total spending on imported technology and domestic R&D. 6. The 1005 patent application statistics are provisional. 7. Edward Cody, "China cracks down on corruption," Washington Post, February 15, 2006. 8. Edward Cody, "Eight-step program for what ails China," Washington Post, March 13, 2006. Copyright Š2.006 McKinsey & Company. ~~~~~~~~ By Andrew Grant