Emerging Markets Insights

Leadership constraint has been constantly identified as a top business challenge multinationals face in China. Rapid growth over the last twenty years has created a huge imbalance in demand and supply of experienced managers and leaders. Shortage of managerial talent has fueled wage inflation in China, and compensation for senior executives has skyrocketed as many companies compete for a small pool of managerial talent (see charts below).

*Source: Frontier Strategy Group Analysis, Mercer China Monitor Report, EIU

To make it worse, multinationals are facing increasing competition from local Chinese companies, which offer attractive financial packages and perceived better career development opportunities to attract seasoned Chinese executives working for multinationals. However, many Chinese executives who have built their careers working for multinationals often found it was difficult to adjust to a local company’s culture and experienced “reverse culture shock.”

*Source: Frontier Strategy Group analysis, 中华英才网 (ChinaHR.com)

Most leadership challenges in China can be attributed to either a capability gap or talent shortage, or sometimes a combination of both. FSG recently created a comprehensive framework to identify key leadership challenges and develop best practices to strengthen the leadership bench through retaining key individuals, leveraging global scales, strengthening the fundamentals, and adjusting to a new reality.

Senior Chinese managers are motivated more by symbolic recognition such as enhanced decision making power, rather than material recognition such as financial compensation. So it is important for multinationals to realize that seasoned Chinese leaders want to achieve “self-actualization” by creating a vision for the business and having an impact on other people.

Local Chinese managers are already commanding an equal if not higher compensation than their peers in developed markets, and yet they are subject to higher attrition risk due to strong demand. One solution is to tap into experienced managers in talent surplus areas, such as Western Europe, who are more willing to relocate to high growth regions like China for an “expat light” package.

Share/Bookmark

This blog entry is the first of a six-part series on China which will cover China’s productivity growth, portfolio management, geographical coverage models, talent management, post-merger integration and sales force effectiveness.

Is China Losing its Competitive Edge?

Many multinational companies are re-assessing China’s competitive advantage as a manufacturing base since labor arbitrage is becoming less compelling. Although China’s productivity gains (as measured by TFP growth) outpaced other major economies in the first decade of the 2000s, this rapid growth was interrupted by the financial crisis in 2008 and has been slowing ever since.  This is largely due to overcapacity and a “crowding out effect” caused by the massive fiscal package that Beijing put in place to offset the effects of the global financial crisis.

We believe that China is gaining momentum in higher value-added industries such as heavy machinery, information technology, and medical devices, but losing competitiveness in low value-added manufacturing to other low-cost Asian countries, even when it comes to serving the domestic market. In a workshop that I have run recently, we discussed the possibility that “Made in Bangladesh” apparel will begin to flood the Chinese market in a few years.

As China continues climbing up the value chain, more and more of its companies are expanding abroad to other emerging markets. This leads to interesting dynamics on talent requirements, intellectual property, and portfolio management.

Share/Bookmark

Here’s a look at a few of this week’s global headlines with added commentary by our research team members:

Market Watch’s Post-Chavez Venezuela: oil’s next Saudi Arabia?:

“As Associate Vice-President for Latin America Clinton Carter is quoted in this article, oil production is unlikely to experience any increase over the short term, as a necessary shift toward investments in PDVSA are likely to continue to be secondary to the need to fuel social spending and support any post-Chavez government.”
- Antonio Martinez, Senior Analyst for Latin America Research

The Financial Times reports new property market cooling measures put doubt on China’s economic recovery:

“China has launched yet another round of of cooling measures, including a 20% capital gain tax on property sold in the secondary market, higher down payment and mortgages, to contain property prices. This is will impact property and construction related industries, which represent a big chunk of the Chinese economy, adding new pressure to the fragile recovery.”
- Shijie Chen, Practice Leader of Asia Pacific Research

Reuters had an article on Brazil’s industrial recovery:

“Any sustainable economic rebound in Brazil will have to be led by the industrial sector, making this heartening news for multinationals concerned about a seemingly interminable slowdown in Latin America’s largest market.”
– Ryan Brier, Practice Leader of Latin America Research

Share/Bookmark

Many of this week’s US headlines primarily focused on the the imminent United States government sequestration.  In addition to following those developments, our research talent kept an eye on headlines pertaining to emerging markets, too.  Below are some headlines with FSG research analyst commentary:

Bloomberg News reported that Emerging Stocks Erase Weekly Gain on China, Commodities:

“Today’s headlines highlight the US budget sequester’s ripple effect on emerging-market growth. That could incrementally diminish the opportunities for MNCs in some EMs, but it doesn’t change the fundamentals. We are more concerned that US-based MNCs will react to economic mismanagement at home by remaining overly risk-averse abroad, allowing local competitors to capture yet more market share.”
- Joel Whitaker, Senior Vice President and Head of Global Research

The Wall Street Journal’s Deal Journal blog posted Doubts Over Returns Hit Fundraising in China:

“Look beyond headline GDP to gauge China’s economic performance. Look at corporate profits in China and return of PE investment is a good indicator.”
- Shijie Chen, Research Practice Leader for Asia Pacific

From Reuters - Brazil may use imports to curb inflation:

“Offhand comments by Brazil’s finance minister raise the possibility that the country could drop import tariffs in sectors and on goods where local producers have been raising prices aggressively. This would be a 180 turn from years past, when Brazil raised tariffs on imported goods in industries impacted by cheaper imports due to a strong currency.”
- Clinton Carter, Director of Research for Latin America

And lastly, another article from Reuters - Russia says central bank independence not at risk:

As CEE governments struggle to boost growth without increasing fiscal deficits, they are increasingly pushing regional central banks to cut interest rates, even at the expense of undermining the banks’ independence. This is a trend to watch in 2013, especially in Russia where reduced central bank autonomy could significantly undermine investor confidence.”
- Martina Bozadzhieva, Senior Analyst for Central and Eastern Europe

Share/Bookmark

I’m writing en route to Washington DC from Shanghai, where I moderated a fascinating breakfast roundtable of FSG clients, all MNC general managers or heads of strategy for Asia-Pacific and China. We brought together diverse perspectives, representing companies with a mix of consumer, industrial, and government customers, some with products aimed at the mass market and some in a premium position. Everyone had something to teach and something to learn from others.

Here’s what I heard from top executives trying to make the most of today’s China opportunity for their parent multinationals:

• We’ve all seen the headlines projecting the demise of labor arbitrage in China, starting with top managers and technical workers. The executives at our event deal with spiraling wages every time there’s a job opening, but they are much more focused on improving productivity than on containing costs. For example, revenue per sales rep tends to be low given frequent travel to maintain customer relationships, which flags China as red on the corporate dashboard. But overall cost of sales as a percentage of revenue tells a more favorable story. Sometimes the metrics that HQ expects to see are a poor guide for managing operations inside China.
• Companies with relatively mature penetration of China’s markets are seeing pressure from corporate to deliver profits as revenue growth slows. It’s a different type of challenge that that of relatively new entrants who, if their product brings something unique to the Chinese consumer, can still pursue high double-digit growth targets without tight margin constraints. The more mature players are finding some leverage in revisiting their distribution strategy, consolidating channel partners or going direct in tier-two and tier-three cities.
• China gets no shortage of attention and investment from headquarters in the US or Europe. It is, after all, the biggest long-term opportunity regardless of ballyhooed concerns about its aging workforce.  That said, local leaders still struggle with HQ’s tendency to look at China as a monolith. Again and again, people noted that many Chinese provinces are larger than entire nations in Southeast Asia. Despite that recognition, not one of the companies represented directly compares Chinese provinces to similarly sized Asian countries when making investment decisions. Country boundaries still drive corporate strategy.
• Organizational design and leadership talent remain considerable hurdles to executing growth plans. One China GM flatly stated that there is no way for him to understand what’s happening on the ground across the vast country, so he has decentralized authority to five regional CEOs – each of which, he added, run larger operations than many of his country peers around the world. But how to fill such roles with ready leaders? The scarcity of seasoned local talent (especially with MNC experience) was cited, as usual, as no less a limit to growth as any inflection in the economy.
• Time and again, I heard similarities between our Shanghai discussion and my recent meetings in São Paulo. Geographic complexity, an outsized role in the regional portfolio, talent challenges — the parallels are striking. Any company that isn’t “buddying up” its China GM with its Brazil GM is missing an opportunity to cross-pollinate internal best practices and innovations between two big-bet markets.

Share/Bookmark

In this podcast, FSG practice leader Adam Jarcyzk shares his insights into China’s booming ecommerce market. By 2014, the Chinese ecommerce market will be larger than that of the US, but the traditional strategies companies have used in the West are unlikely to succeed in China. Adam shares three recommendations for adapting your approach.

To listen to or download the podcast, click on this link to access the iTunes store.

Share/Bookmark

I recently shared some insights into effectively structuring distributor contracts in China that were gleaned from the recent executive discussion hosted by FSG in Shanghai. The eight executives that FSG brought together, representing heads of China or heads of Asia for a range of technology, industrial, and healthcare companies, also spent quite a bit of time discussing two sides of the same coin: building relationships with distributors, with a long-term partnership in mind, and transitioning or ending relationships with distributors.

But, it is hard for us to discuss these two issues without coming back to contracts! The key takeaway on contracts that was discussed in my previous post was the necessity of conducting an annual review and negotiation of the contract. In addition to the benefits outlined in that post, an additional benefit of an annual discussion is the opportunity to sit down across the table from your distributor and level-set on where the relationship stands, what is going well, and what needs improvement. This guidance and feedback, shared in the context of achieving mutual benefit, is the anchor of a strong relationship. It is also the best tactic at your disposal for ensuring that distributors are not caught off guard if you decide to make a change to the relationship (either by ending it, or scaling it back).

Nobody likes surprises. But, even in the best case scenario, when bad news is being delivered to your distributors, there is a risk in the Chinese market of “losing face.” Several executives mentioned instances of terminated partnerships where the local distributor felt that he had “lost face,” and as a result, felt a personal vendetta against the vendor. This could be manifested in the disgruntled former distributor establishing a relationship with a competitor (and taking key accounts along), sharing trade secrets, or poisoning your company’s reputation in the market.

One way to minimize the damage of a perceived loss of face is to ensure that when territories are transitioned, it is from a small distributor to a larger distributor (and not vice versa). A large distributor will have greater power in the marketplace to minimize the damage that could be caused by a disgruntled former small distributor. But, if you switch from a large distributor to a small distributor, the disgruntled former large distributor has an increased ability to harm your business and impair the operations of your new, smaller distributor.

As the discussion turned to the challenge of transitioning from indirect to direct in China, the key takeaway was to expect the unexpected. Your distributors may well be telling the truth when seemingly making excuses for underperformance, so do not be too hasty to make such a transition, or in his words, “wait until the pain is unbearable.”
Finally, it is important to bear in mind that investing in developing the capabilities of distributors does not and should not be conflated with retaining distributors. Taking a “tough love” approach has proven to be a trend among the highest growth companies. Investing in distributors to develop the capabilities you require should not prevent you from terminating relationships with distributors that are not meeting expectations, and a track record of doing so instills current and future partners with a higher expectation of accountability.

A structured, annual contract negotiation process builds a natural inflection point into the vendor/distributor relationship, which offers an opportunity to proactively evolve the relationship over time, or to bring the relationship to its conclusion with minimal loss of face.

Share/Bookmark

The slowdown impacting China could get worse before it gets better for business-to-business companies.  Demand from the US and Europe for Chinese exports will remain depressed until issues such as the eurozone crisis and US fiscal cliff are resolved.  Investment is constrained by the heavy debt burden of local and provincial governments in China, and existing overcapacity.  China’s forthcoming leadership transition only adds an extra layer of uncertainty for Western companies attempting to grow their foothold in the Chinese market.

It was against this backdrop that FSG brought together eight senior-most China executives from leading technology, healthcare, and industrial companies to discuss best practices for managing the channel and driving growth despite the headwinds.  Our discussion over breakfast in Shanghai yielded insights into three aspects of the vendor/distributor relationship: 1) structuring effective contracts, 2) building long-term relationships, and 3) minimizing the pain of transitioning away from an under-performing distributor.

For this post, I’ll touch on contracts.  I’ll address the other two points in a future post.

The key takeaway I took from the discussion on contracts was seemingly counter-intuitive.  Every executive around the table acknowledged that there is little chance of any Chinese partner strictly adhering to the letter of contracts, but despite the apparent futility of these documents, all of the executives agreed that the best practice is to more heavily invest in the negotiation, preparation, and enforcement of contracts.  Local Chinese partners are more likely to view a contract as a roadmap than a strict and binary agreement.  And, every executive in the  room could share his own horror stories of partners violating contracts (or setting up new legal entities to skirt inconvenient agreements).  Although it may seem counter-intuitive to over-invest in contracts when there is little guarantee that partners will strictly adhere to them, a strong argument was made that investing the time and energy to structure a detailed contract can pay dividends, and furthermore, these contracts should be negotiated annually.

Companies should take a modular approach to structuring contracts, that links specific distributor activities to points of margin.  This accomplishes two things.  First, it sets clear expectations for the distributor of what capabilities they are expected to bring to bear with a direct link to their incentives.  Secondly, it allows the vendor to “take back” activities in the future, either because the distributor is underperforming, or because the vendor has built some of its own internal direct capabilities but does not wish to sever distributor relationships entirely.

We spent quite a bit of time discussing the ins and outs of building and eventually transitioning distributor relationships in China; I’ll share some highlights of this discussion in my next post.

Share/Bookmark

In the latest installment of China’s 5-year plan, the government laid out a series of initiatives that will make China one of the largest pharmaceutical markets in the world.  China’s pharmaceutical market is expected to grow from $46 billion in 2009 to $178 billion in 2019, and this massive growth is largely being driven by the ongoing healthcare reforms.

These government initiatives are creating massive opportunities for companies with their fingers on the pulse of these programs.  Here are three key government objectives and the impacts they are having on our clients:

1) Key Objective – To Provide Universal Healthcare Insurance

Under the healthcare reform, the government introduced two new basic healthcare insurance schemes, NRCMS and BMIUR, to expand coverage among the rural and the poor urban population, respectively.  In addition to a much larger population with access to health insurance, reimbursement rates have also increased; which is likely the cause of higher per capita spending on medical examination and treatment in hospitals countrywide.

2) Key Objective – To Improve Healthcare Services at Grassroots Level

As of February 2012, around 2,200 county hospitals and 33,000 primary healthcare institutions have been renovated as part of the healthcare reform, with approximately 70% of township hospitals and 85% of community health centers having been upgraded.  In 2010, 627 new hospitals were set up in China, and because of improved spending on healthcare facilities, about 70% of counties have at least one hospital at the secondary level-A.  With all of this new construction, there has been a sharp uptick in utilization and demand for diagnostics and examinations.

3) Key Objective – Public Hospital Reform

Introduction of reforms in the public hospital system has been the toughest challenge for the Chinese government; the government’s reform plan includes separation of ownership and management and a gradual elimination of drug margins.  This has led to the government announcing policies that promote private sector investment in hospitals.  Specifically, the tendering process is now much more in the hands of individual hospitals and lower-tier clinical facilities, which could be a boon for healthcare companies that are able to leverage their geographic reach and local knowledge into a competitive edge during this process.

Share/Bookmark

Frontier Strategy Group Expert Adviser, David Wolf recently wrote the following on his Silicon Hutong blog:

While the Fourth BRICS (Brazil, Russia, India, China, and South Africa) summit was nearly three months ago, the meta-message that is emerging from the aftermath is that these countries do not yet form anything resembling a bloc of interests.

Ruchita Beri’s short piece (linked above) is guardedly optimistic about the grouping, but if you read between the lines you can almost feel the divergence of interests that is pulling this grouping apart. Beri, a senior researcher at India’s Institute for Defence Studies and Analyses, gently suggests that China is part of the problem.

“While the BRICS grouping does provide an opportunity for each member to play an important role on the global stage, one of the challenges that it faces is cohesiveness. Take the issue of the BRICS development bank. While it is indeed a laudable initiative, the challenge lies in aligning the differing interests of the member countries. Moreover, other members of the grouping are wary of China’s domination over the bank given that China holds very large foreign exchange reserves ($ 3 trillion).”

All of this serves to underscore the real elephant in the room, which is the fact that while some of the BRICS might trust each other, most are having a hard time trusting China. As it considers its soft power challenges, China also needs to see that being a trustworthy player in the global system would do a lot toward making it influential (rather than disruptive) in such international groupings, and in turn toward making those groupings influential.

To view the original post, click here.

Share/Bookmark