Trace the Lights II: China’s 19 City Clusters by 2020

China Clusters Map by 2020

As outlined in China’s 11th five-year plan, the Chinese government has pushed for the development of regional city clusters, aiming to drive economic growth, strengthen transportation, and influence the pattern of migrants. For those less familiar, city clusters are comprised of one or two cities, considered the nucleus, and several neighboring cities with well-connected transportation facilities.  China already has several mature mega clusters such as the Yangtze River Delta centered in Shanghai and the Pearl River Delta anchored by Guangzhou, but new initiatives to continue city cluster development are underway.

Earlier this year, The Central Committee of the Communist Party of China together with the State Council released the New National Urbanization plan, a series of integrated, cooperative government initiatives to establish a more coherent city cluster plan.  According to the document, China will have 19 clusters by 2020 as illustrated in the map above. The government intends to break the constraints of administrative divisions of these city clusters, realize the integration and consolidation of social and economic activities within vast areas, greatly reduce the distance and space between people, and promote human movement and economic activities at regional and national levels.

The formations of these metropolitan areas and urban clusters are changing and will continue to fundamentally change the way we look at China’s cities. In my previous post, I discussed China’s urbanization as a major driver for the future consumption-led economy.  As China continues to urbanize, the inter- and intra-cluster’s connectivity and motilities, driven by the development of public transport infrastructure, city boundaries are increasingly blurring.

FSG has aligned the clusters’ definitions with the government’s plans. Of the 19 clusters, 3 super clusters have been targeted to become world-class economic zones. An additional 8 clusters are called emerging clusters, each composing as much as 3–9% of total GDP in 2013. The government aims to turn these clusters into national zones as key pillars of the Chinese economy. The remaining 8 frontier clusters are included in government’s 2020 cluster master plan but haven’t yet taken shape, each with equal to or less than 2% of total GDP. Apart from the well-known super clusters, 8 emerging clusters have already or will feature prominently in the national urbanization process. Among them, FSG has highlighted the Yangtze Mid-River cluster and the Chengdu-Chongqing cluster because we believe they are poised to be the upcoming super clusters.


This article is part two of a three-part blog series on China Urbanization called Trace the Lights. Check back next week  for part three.

For a full report on evolving consumer base and urbanization in China, FSG clients can visit the client portal.  Not a client? Contact us for more information.

Trace the Lights: 5 Key China Urbanization Stories for MNCs

nasa earth at night
Source: NASA Image

Take a look at this famous NASA image, a satellite photo of the Earth at night. This map shows the geographic pattern of night time electricity consumption, but it also clearly shows the geographic distribution of cities and population. Lights are bright in South Korea, but most places are in dark in North Korea; within the US, the east coast is brighter than the rest. Likewise, the lights are brightest around Paris and London in Europe. While there are still lots of dark places in China, we must ask ourselves, as urbanization continues in the country, what will this map look like for China in 2020, and where will the brightest lights be?

1. Strategic plan for China 2020 should incorporate future urbanization landscape—“go deep” vs. “go wide”

Every Western multinational needs to ensure they look at China’s urbanization as a major driver for the future consumption-led economy. FSG’s analysis is a starting point to assess the clusters in which multinationals already operate, and more importantly, what the best plan for the future should be—“going deep” vs. “going wide.” A clustering approach uncovers synergies, which are necessary given the scale in China and therefore an important input into the game plan for China 2020. My next blog will provide more details on which clusters I’m referring to.

2. Managing profitable growth in China

Concentrating resources on certain clusters brings the opportunity to exploit scale more quickly, because companies can leverage the synergies in sales force, distribution partners, supply chain, and marketing efforts across a wider geographical scope than by managing on a single city basis without sufficient regional scale.

3. Future organizational design is tilting toward decentralization

Multinationals will have to assess the possibility of decentralizing their Chinese sales headquarters by branching out sales centers to other hub cities to get closer to local business—for instance, using Beijing as the northern China headquarters, Guangzhou as the southern China headquarters, and Chongqing as the western China headquarters. MNCs can also consider breaking down functional responsibilities into different clusters by leveraging the clusters’ specializations—for instance, building a logistics center in Wuhan because of its favorable geographic location, establishing an e-commerce hub in Chengdu, and incubating R&D innovation in Suzhou.

4. Western multinationals need to monitor the industry clusters very closely

The government is and will continue building numerous industry clusters across the country that will help build the ecosystem around them. High-skilled and high-tech industry value chains are gradually taking shape. For example, a few biotechnology companies set up their administrative operations and R&D centers in Shanghai, while locating manufacturing in neighboring cities such as Suzhou or economic zones such as Kunshan or Zhanjiang Industrial Park. MNCs can leverage the formation of mature industry clusters to screen out horizontal suppliers and customers, as well as monitor the vertical competitive environment.

5. Multinationals need to keep an eye out for key signposts that will evolve over time; everything may not be rosy

China’s urbanization program will cost approximately US$ 6.8 trillion. From 2015 to 2020, more than US$ 100 billion of new, related professional services and biddable infrastructure contracts are estimated to be available every year. However, local governments are already deeply debt-ridden, given that China’s total local government debt in mid-2013 ballooned to 17.9 trillion RMB. The gap between the urbanization rate and urban “hukou” rate has widened over time. The high levels of local government debt will make it difficult to provide provisions for adequate public services, including healthcare and education, to new migrants.


This article is part one of a three-part blog series on China Urbanization called Trace the Lights. Check back next week for part two.

For a full report on evolving consumer base and urbanization in China, FSG clients can visit the client portal.  Not a client? Contact us for more information.

Rising Competition from ASEAN-based Corporations

As the ASEAN region begins to mature, the power, reach and influence of its indigenous companies have begun to increase dramatically.  We’ve witnessed similar rises of local and regional companies in other parts of the world — East Asian companies in the 1980s-1990s, Multi-Latinas over the last decade and mostly recently we are seeing increasing competition from Chinese firms.

ASEAN’s resilient performance over the past decade has allowed many of its local companies to rapidly expand across the region and beyond, giving birth to numerous ASEAN-based corporations.

Asean Local Competition

Under the Radar

Companies from ASEAN often do not receive much attention from Western analysts who instead focus on China and India. However, ASEAN firms are a force to be reckoned with; keeping pace with the region’s growth, the number of ASEAN companies on Forbes’ list of Global 2000 companies has more than doubled in the past seven years. Moreover, ASEAN has more companies on the Forbes’ Global 2000 list than India, Brazil, or Russia. The region is also home to 227 companies with more than $1 billion in revenues, making it the seventh-largest host for such companies, or 3% of the global total.

ASEAN countries and companies have continued to invest within the region at a steadily growing pace, with 2012 seeing twice the amount of intra-ASEAN FDI, in dollar terms, compared to 2008 (pre-crisis). The strengthening of intra-ASEAN investment can be attributed to a number of factors, including (a) the maturity of a growing number of companies in ASEAN who are venturing abroad, (b) regional integration, which provides future opportunities to scale, (c) improved financial capacities of ASEAN companies, and (d) home-country measures that encourage overseas FDI through institutional and informational support.

Western MNCs Should Monitor the Business Climate

Hailing from a new group of countries and leveraging competitive advantages that Western firms have not seen before, emerging-market multinationals have shaken up many stagnant, mature industries in developed countries. While not mature enough to rock Western markets, the rise of ASEAN corporations is going to lead to an increased fight for resources (both natural and human), heightened competition for several fast-growing segments, and the reduction of prices alongside faster innovation in ASEAN. 

MNCs should explore all potential partnerships with regional firms; ASEAN-based companies understand the market better, tend to have deeper distribution networks, and lower-cost operations. Emerging-market multinationals are born in a new world, one that is highly globalized and integrated, where internationalization will happen much faster than experienced by MNCs, making them much more of a threat to long-established businesses.

For more information on the rising competition of ASEAN-based corporations, FSG clients can access the full report on the client portal.

China’s Rapid Pulse: Thoughts from the Road

I am standing amid the hustle and bustle of the main street of Shanghai, unable to hail a taxi and scrambling to open Google on my phone. I’ve forgotten it’s recently been banned in mainland China and that drivers now prefer passengers who book through WeChat, a mobile app that awards taxis an additional service fee. I’ve lived in this country for most of my life, but I still have trouble keeping up with the pace of China’s evolution.

During the 12 days I spent in Shanghai, I spoke at length with clients, experts, local think tanks, and consulting analysts all focusing on one thing: how businesses can adjust to a developing China. A few of the on-the-ground insights I picked up are highlighted below.

Buildings in Shanghai
Older Shanghai-style “Shikumen” architecture is found adjacent to newer modern facilities.

From the business operations standpoint, local competition is happening at the provincial level rather than the national level. Many strong, regional-based Chinese brands are emerging and ramping up their capabilities in order to become “national” brands. Echoing the findings detailed in my past report on Managing Local Competition in China, the biggest challenge multinationals are facing is how to localize their strategy in an increasingly sophisticated China. Opening up a developed-market “toolbox” is not sufficient enough to solve China-specific issues.

The crux of this problem is that, in a sense, China is not really a single country—it is a series of distinct regions. A standardized strategy cannot work well in China because of the cultural diversities, wide range of local dialects, and large wealth gap. Some clients are beginning to reconsider their city tier-based model, questioning whether it is an effective way to segment customer needs. Even within one tier, the divergence will be daunting. However, you cannot create 200 business models for one country because it will not be profitable. In my upcoming report on Evolving Consumer Base and Urbanization, which will be released in a few weeks, I will provide detailed analysis of FSG’s cluster model and its implications for MNCs’ go-to-market strategies.

The idea to develop city clusters is central to the government’s plans to smartly urbanize people and cities in order to better allocate resources and boost small and mid-sized cities by leveraging the agglomeration effect from big cities. In the future, China will have three world-class super clusters that will radiate around 16 regional clusters. Logistical corridors will be built to strengthen the linkages between the northwest Chinese city of Urumqi and Russia, as well as the southwest city of Chengdu and European countries through the Pan Europe-Asia Bridge.

One pitfall that MNCs run into easily is making overambitious investments in backend facilities before the business strategy has been proven successful and the front end starts to generate revenue. Another pitfall is applying a swing strategy between the premier and middle markets. As the middle class booms, successful MNCs will create high-margin products to serve the massive middle market instead of the super premier market, which has very limited scale. (One client used the metaphor, “We don’t want only to skim a slide of fat from a big soup.”)

The O2O (Online-to-offline) model is poised to be the future of e-commerce in China. An e-commerce solution provider I talked to has already seen its O2O revenue contributions to their overall portfolio increase from 0% to 30% within one year. Target clients include lots of big-name retailer/FMCG/luxury products. Many MNC clients will be looking into this option in the coming years.

From the macroeconomic perspective, the recent shift in manufacturing is a result of the Chinese government’s policies. Although the current manufacturing outflow is an irreversible trend for China, the question here is about its timing. On one hand, this change is happening before the economy is fully ready. That’s why this transition is creating some problems. Some enterprises in the coastal region cannot afford the increasing labor/land cost because the government has implemented a land quota, and they will eventually move to ASEAN. On the other hand, the government is encouraging investment in west/central China by increasing the land supply and subsidiaries. However, the infrastructure-driven model makes inland China more prone to debt issues, the “ghost city” phenomenon, and heavy pollution.

Government always follows the path of creating supply first and then waiting for demand to materialize the supply. When the pace of “city-urbanization” outpaces “people-urbanization,” ghost cities are created. When highly polluting manufacturers move to inland cities, polluted water then flows along the Yangtze River from inland to east regions. Two types of manufacturing shifts are taking place. First, higher labor-intensive manufacturing is moving to ASEAN (as we mentioned in our latest ASEAN manufacturing piece), and possibly to Africa in the next 20 years. Second, lower labor-intensive manufacturing is moving to Shanghai’s satellite cities, such as Hefei or inland/west cities, based on the analysis of overall transportation costs and whether the business nature is more export-driven or more domestic market-driven.

Last but not least, China’s growth model dictates that it MUST grow. If growth is under 5%, all of the problems—shadow banking, local debt, and the real estate bubble—will explode. The internationalization of RMB and the financial market will feel consequences overnight and then will impact global markets too. If the country manages to maintain current levels of growth, all of the issues can be resolved by themselves. China’s current challenge is similar to the European debt crisis—one country, one currency. In addition, people cannot move freely because of the “hukou” restriction (the local registration system in China), and governance administrations are managed separately (different provincial governments work differently and lack integration). However, the future of China’s growth is promising. China is different from Japan. The advantage of having a centrally manipulated economy is also having well-planned fiscal/monetary policy from a government that can achieve highly effective results.

Finally in a taxi on my way to the airport, I noticed something interesting. Old Shanghai-style architecture is being replaced by modern facilities. It’s a result of the rapid pace of China’s urbanization, and the sharp contrast is visible on every corner. Differing styles must coexist as the society transitions, proof that everything moves at an astonishing pace in this market.

Expectations for India’s BJP Government

Infographic India's BJP Government Expectations for Next 5 Years

India has just experienced a landmark general election; the incumbent Congress is going home with its worst ever defeat since the party’s formation post India’s independence in 1947, while the Bharatiya Janata Party (BJP) government holds the strongest majority held by any single party in India since 1984. With such a strong hold on power, the country expects the BJP government to be the first in decades to pass bold reforms that can revive India from its sleepy, sub-par growth and bring it to its true double-digit potential. In this infographic, we lay out FSG’s expectations of the BJP government that MNCs can expect in the short, medium, and long run. These expectations are based on the BJP’s manifesto, market expectations, actions of the previous BJP government, and a statement released by the President of India on June 9.

Frontier Strategy Group clients can read the full analysis on the client portal

How Can MNCs ‘Partner’ with Governments in China?

It only has been one month since my last blog titled, “Why MNCs Need a Better Government Engagement Strategy for China.” However, since then, the dynamics have changed drastically. Foreign multinationals have been publicly investigated for illegal business practices and have been exposed to cyber security risks and intellectual property infringement. The paradox of an uncertain regulatory environment existing alongside a relatively attractive market suggests MNCs must have found an effective way to manage relationships with Chinese governments.

After extensive conversations with our clients, industrial experts, and business associations, I realized that the biggest challenge MNCs face is how to build a strong advocacy message to governments.

Naturally, the rapidly evolving government structure makes it difficult for multinationals to identify the right stakeholders. To make matters worse, the opaque environment hinders companies from having a proactive reaction before a negative policy rollout. The crux of problem is that most foreign companies lack a deep understanding of Chinese government agendas and are unable to deliver their values to governments by facilitating their political objectives.

Below is a snapshot of the most pressing challenges for the Chinese government. To better work with the Chinese government, multinationals should change from being regulation “destructors” to “instructors,” who can demonstrate knowledge about policy and provide valuable industry input—areas in which the central government is most interested. For example, multinationals can match their companies’ capabilities with the Chinese government’s publicly stated objectives to develop cutting-edge technology in strategic industries or promote innovation among China’s youth.

5 most pressing challenges for the Chinese Government

Nowadays, think tanks are playing an increasingly important role, and the policymaking process is no longer a “black box” in China. Companies can work on participating in the decision-making process to lobby think tanks and shape policy, thereby preparing for any policy “surprise” before it is too late to make changes. In some cases, a company’s government affairs team can engage the right opinion leaders and then recommend them for the policy development process. By doing so, they help the government select true experts, who can provide professional suggestions, and also help themselves influence policy making.

Policy Development Process

Manufacturing Attractiveness Index of the ASEAN Countries

Southeast Asia has experienced a strong CAGR of 5.5% in terms of its manufacturing output over the last decade and is now responsible for almost 4% of the global manufacturing output. This growth has been funded both by domestic companies as well as foreign investors; ASEAN surpassed China in terms of the FDI inflow in 2013 and the manufacturing sector received a large chunk of the funds. In fact, more than 30% of all FDI that has flown into ASEAN between 2005 and 2010 has been towards manufacturing, and the sector is likely to continue to be one of the biggest beneficiaries of the growing interest from foreign investors. The major reasons for this drive in investments can be summarized through the ASEAN’s four C’s: Consumption (growth), Cost (low), Commodities (abundant), and Community (single ASEAN trade bloc).

FSG’s Country-Level Manufacturing Attractiveness Index
As costs rise elsewhere and the addressable market becomes larger in ASEAN, companies should explore the viability of moving production to the region using a “total factor performance” analysis. It is important to make sure that the analysis looks beyond the simple math of labor-cost and considers total factor performance (labor, transport, leadership, material, components, energy, and capital)

FSG has created an industry-agnostic, manufacturing attractiveness index of the five major ASEAN countries based on the assessment of 30 key indicators under 6 key major groupings. See bar-graph below for the results of our analysis:

  • Labor conditions: average wages, minimum wages, engineer’s salaries, redundancy costs, literacy rate
  • Transport infrastructure: Quality of roads, quality of ports, quality of railroads, quality of air transport, logistics competence
  • Utilities (Support infrastructure): Quality of electricity supply, electricity production, energy production, broadband penetrations, mobile penetration
  • Regulatory environment: Investment freedom, tax rate, openness to foreign investment, prevalence of trade barriers, intellectual property rights
  • International trade conditions: Efficiency of import-export, number of days to import and to export, cost to import and export
  • Risk Factors: Gini coefficient, corruption, equity risk premium, banking sector risk, natural disaster risk

ASEANs Country Level Manufacturing

For companies conducting a similar analysis, couple of points to note before embarking on the exercise:

  • Make use of Weights: This benchmarking assumes equal weights for all parameters; however, companies should make adjustments according to their business needs to create the most accurate comparison
  • Conducting A Time Series Analysis: The benchmarking exercise should be done annually to measure change in the market’s dynamics

Country Profiles of the Major ASEAN Players and Their Key Provincial Regions of Manufacturing

1.       Malaysia

  1. Established industrial base: MNCs entered Malaysia as early as the 1970s, conducting manufacturing assembly in the country as a cheaper alternative to Singapore. The early entry of Western companies, access to raw materials (oil), and its established supply chains have allowed Malaysia to become one of the most competitive manufacturing locations in the region with top quality infrastructure
  2. High sophistication: Compared to its ASEAN peers, Malaysia has steadily moved up the value chain and is now mostly involved in higher value-added manufacturing and assembling, attempting to closely follow the footsteps of its neighbor, Singapore
  3. Cost barrier: With continuous progress and increasing sophistication, the cost of labor has also risen; engineers and manufacturing labor are the most expensive in the region

2.       Thailand

  1. Detroit of Asia: Accounting for over 12% of the country’s GDP, the automotive sector in Thailand has played a large part in cementing the country’s role as a key manufacturing location in the ASEAN region. Thailand has benefited heavily from sustained Japanese investments and is now the most industrialized nation in the region
  2. Rise of the Northeast: While most MNCs are unlikely to be exploring opportunities in Thailand beyond the central area, local firms are expecting the Northeastern region to perform better in the future, as it has access to a large consumer base, closer proximity to China, more attractive government incentives, a geographical area not prone to flooding, and mostly non-arable land

3.       Indonesia

  1. Manufacturing laggard: Despite obvious advantageous in terms of its location and relative wages, Indonesia has continued to remain a small player in regional production networks. Its labor market rigidities, a history of political uncertainty, and protectionist measures have kept MNCs at bay, but these trends are likely to change soon
  2. Rising interest because of costs and customers: Rising demand from ASEAN’s largest market has led several big-name MNCs to invest in the country; P&G began operations at its diaper production facility in 2013, and Foxconn, the world’s largest contract manufacturer, has committed a US$ 1 billion investment in order to set up its manufacturing facility

4.       Philippines

  1. Long-time semiconductor affair: The Philippines began to witness investments from semiconductor MNCs back in 1970s, when Western companies avoided the better established locations of Hong Kong, Taiwan, and South Korea, which were feared to be affected by the ongoing Cultural Revolution in China. Till date, the industry has a stronghold on the Philippines; almost 50% of the country’s network products (parts and components, and final assembly) exported are semiconductors, with another 27% related to computer manufacturing
  2. Philippine Economic Zone Authority’s (PEZA):  PEZA is an ISO 9001:2008 rated government agency responsible for being the one-stop-shop for investors looking to set up in the Philippines. The agency’s lack of corruption and relative efficiency have allowed for the 286 economic zones it manages, under which there are more than 3,000 companies and over 800,000 skilled and semi-skilled workers. The advantage companies find when dealing with PEZA is that it is a single entity, making stakeholder management simpler while reducing external intervention

5.       Vietnam

  1. Concentration: Vietnam’s most important industrial zones are concentrated in a remarkably small number of provinces. The majority of Vietnam’s manufacturing is located in the Southeast and the Red River Delta; together, these regions account for almost 75% of the country’s industrial output
  2. Cheap labor and proximity to China are Advantages: Samsung announced plans to invest US$ 4.5 billion in two plants in Bac Ninh and Thai Nguyen as part of its plans to relocate production from China. Both factories are expected to produce 250 million mobile phones per year. Vietnam serves as an excellent source of cheap labor (the cheapest among the ASEAN five) and is relatively close to two other manufacturing economies, China and Taiwan

Highlighted areas account for more than 75% of the manufacturing output in their respective countries

Manufacturing Map

For more information on the topic, you can download the podcast in which we discuss (a) the rise of ASEAN as a manufacturing hub, (b) diagnose the viability of movement of industries into the region, and (c) decipher the impact of the AEC

Why MNCs need a better government engagement strategy for China

Continuing from my last blog post around the workshop I led in Shanghai, I realized that across the board all MNCs need to build/re-think their strategy around Government Engagement. There are three fundamental themes that have changed in China and are leading companies to revisit their GA (government affairs) strategies.

Increasingly Decentralized Landscape Invites New Challenges
Local governments in China are rapidly becoming more important and have greater roles in economic development and commercial investment issues; the governments are becoming economically liberalized and politically centralized. The rise of second-tier cities are encouraging the development of government relationship strategies from the national level to local levels. For example, MOFCOM delegated its approval authority for the establishment of FIEs (foreign-invested entities) within “encouraged” industries to its provincial counterparts.

However, this is not to say that MNCs can shift focus from the national level to the local level. Because the central government still plays a decisive role in important policymaking, MNCs have to engage multiple sets of government authorities.

Change of Barometer: “Guanxi” is Still Necessary But No Longer Sufficient
Guanxi (relationships) are less valuable now than they were in the past. By contrast, creating and maintaining positive relationships with the Chinese government is more about developing a deep understanding of policies and building a reliable public image than purely relationship building with government officials.

Shift of Chinese Government MotivationsWe’ve witnessed that MNCs that use their knowledge to engage with the governments are more likely to succeed more in China

GA Function is Prone to Expectation Conflicts and Functional Disconnection
Increasingly, we see a lot of MNCs considering merging GA and public affairs teams in China. This is due to two issues:

  1. Expectation Conflicts: Misaligned expectations complicate the balancing of business units’ short-term commercial needs with headquarters’ long-term policy studies as well as the application of global government affairs standards to the unique China context.
  2. Functional Disconnection: The Chinese media is censored by the government. Separate GA and external communication functions may cause the misalignment of key messages and delay prompt and proactive reactions from GAs

Expectation Conflicts

Policy Understanding Differs
Through industry associations and local relationships with NGOs, MNCs can play a very active role in ensuring that central policies are interpreted appropriately by the local government (another big issue). Having the right advocacy through independent research, NGOs, etc. will work in a company’s favor. Many MNCs report that local governments are taking much longer to make decisions, because the central government’s view on their long-term role isn’t clear.


Leverage Distributors to Build Local Relationships
MNCs are piggybacking on their distributors’ connections with local officials to build their own relationships with lower level governments. The conversations may be tough, but the outcomes are often profitable, because having a local face on your company is a big part of building an effective strategy

We are finalizing our report on Government Engagement tactics in China in the next couple of weeks, and I would encourage our clients to download the report and review the best practices in detail when it is available.

 

Preparing for China 2020: Effective Distribution Management

I’m writing this blog post with great enthusiasm because the inputs came from more than 40 client meetings I did during my trip to Shanghai in April. In addition to my meetings, I also had the privilege of hosting a workshop for a group of FSG clients, mostly comprised of Heads of Asia-Pacific or GMs of China.

During the workshop, we discussed in detail the implications of the macro environment for MNCs along with break-out sessions on distribution management and government engagement in China.

I have listed some of the key learnings regarding distribution management from my trip below:

1)  Distribution Consolidation—Good or Bad?

MNCs view distributor consolidation as both good and bad. Companies that have been in China for decades want to drive efficiency by consolidating distributors (at times driven by government policies). In some cases, MNCs have more than 350 distributors. A lack of hunger continues to be the biggest inhibitor to convincing distributors to go beyond their respective cities and further expand.

MNCs that have been in China for less than five years aren’t in favor of consolidation, because it would undermine their bargaining power. Some of the late entrants to the market prefer to work with tier 2 distributors, as they are more eager and hungry to grow the business.

2) Breaking the Myths on E-commerce 

It is becoming increasingly difficult for MNCs to strike the right balance between brick-and-mortar and e-commerce operations. Pricing conflicts are on the rise, because country/provincial policies at times tax goods sold via traditional channels but not via e-commerce.

Conflicts with distributors are also increasing, as some smart distributors are opening their own e-commerce platforms at the local level (and selling low-end products).

E-commerce is 2–3 times more costly than traditional channels, because it’s very expensive to drive demand online. Educating consumers on the products is both costly and time-consuming.

3) Distributors as a Threat

It seems to be increasingly important in China for MNCs to reach out to end users directly and own their customer relationships. In the medical devices space, for example, distributors are copying the devices from MNCs and then selling them to clients as a cheaper option.

In many cases, it is the distributor who has developed a close relationship with the buyer (e.g., a hospital or doctor). Because of this relationship, they will be invited into the operating room to help operate the device. As a result, the original manufacturer loses control over its sales and marketing process as well as its brand image.

4) Go beyond “Volume” to “Value-Based” KPIs for Distributors

MNCs are experimenting with new ways of incentivizing distributors; many of these methods utilize KPIs based more on value than on volume. Companies see quarterly reviews with their China leadership as critical to success.

During the workshop, I asked our clients on how their 2014 targets comparison with 2013. Their responses were quite interesting:

China 2020 Polling Graph

■     Extreme views are emerging on China’s 2014 MNC business outlook; 37% of respondents expect growth in 2014 to be less than 5% higher than 2013 or slower than growth in 2013

■     On the other hand, 55% of the respondents expect their business to grow by more than 10% this year, and a staggering 26% expect their business to grow by more than 21%

In FSG’s recent report on distribution management in China, we a) explore in-depth issues around distributor consolidation and how government policies are impacting the business landscape, (b) provide a robust and pressure tested framework for MNCs to consider as they evolve in their game plan to go direct or indirect from tier 1-5 cities in China; and c) provide tactics around what other multinationals have done in China (with inspiration at times taken from local companies in China).

FSG clients may click here to access to report.

Myanmar: To Invest or Not to Invest, That is the Question

When we talk to executives who are thinking about expanding into Myanmar, many of their concerns seem to come down to the same thing: politics.  There is a round of elections coming up in late 2015 that has the potential to radically shift the country’s power structures, and the prospect of dramatic change in Myanmar’s leadership is giving companies pause because it adds to the uncertainty already inherent in the market. Many executives are waiting to invest until they see how things shake out.

The problem with this approach is that companies looking for political certainty in Myanmar will have to wait quite a while to get it.  After the new president, cabinet, and legislature take office at the beginning of 2016, it will take at least another 2–3 quarters for businesses to really assess the new government’s priorities and capabilities.  In other words, companies will not have significantly more political certainty in Myanmar until Q4 of 2016 at the earliest.  That’s a long time to wait, particularly if your competitors are already in the market.

This is not to say that all companies should be investing now; it is simply to say that companies should recognize that political uncertainty in Myanmar isn’t going away anytime soon.  And that’s not just true of the overarching governmental structures.  It’s also true of the operating environment.

To give an example, I met with one executive during a recent trip to Yangon who shared a story about his experience with Myanmar’s Internal Revenue Department (IRD).  Apparently, the government had lowered taxes for his company the year before, but he was still made to pay taxes at the original rate. It turns out that there was a communication breakdown within the government, and the IRD simply hadn’t inputted his company’s new rates into their system. (The authorities returned the money once the problem was identified several months later.)

The bottom line is that any company with a presence in Myanmar will have to navigate gray areas for the foreseeable future.  After decades of isolation and stagnation, the country’s institutions are immature and its legal frameworks are weak.  Myanmar’s officials are still learning the basics of government administration, and its legislators are rushing to fill gaps in its regulatory infrastructure.  They are moving quickly, but they have a lot of ground to cover.

With this in mind, executives who are thinking about expanding into Myanmar should not delay their decision on the hope that the situation will clear up sometime next year.  Instead, they should consider whether they would rather invest now with less political certainty or invest two-and-a-half years from now with more political certainty.  Comparing those two scenarios will give executives who are weighing their options a much better idea of the tradeoffs they face.