How Xi can make Trump's visit a success

An edited version appeared in Asia Times

It has been widely reported that the Whitehouse staff has been busy preparing a comprehensive approach to China for Trump’s widely anticipated trip to China in November. In fact, two different approaches have been formulated based on the idea of confrontation or cooperation.

Most prominent advocate in favor of confrontation has come from the Steve Bannon school of international thinking, wherein Gordon (the Collapse of China) Chang salutes Bannon as the Paul Revere warning America of the coming economic war with China.

A whole generation of China watchers has been waiting for Chang’s prophecy to find some shred of reality but can only conclude that he is a blindfolded seer muttering gibberish in the wilderness. Yet, Bannon’s Breitbart has seen fit to elevate Chang to the position as “renowned expert on Asia.” This mutual admiration speaks volumes on the callow superficiality of these novitiates in international relations.

Any student of Econ 101 knows that the notion of an economic war between the U.S. and China is preposterous. Much of Bannon’s argument, as is those from Commerce Secretary Ross, rests on the charge that China has gained unfair possession of corporate America’s intellectual property.

We owe it to helping ensure the success of Trump’s China trip by examining this question of China’s alleged hijacking American IP in some detail.

It’s true in the 1980’s and 1990’s, China’s economy was tiny compared to the U.S. and its quality of technology far behind. Therefore as a matter of national policy, China insisted that for certain critical industries, foreign companies wishing to invest in China must form joint ventures with foreign ownership not to exceed 50%. Passenger cars belong to one of these critical or so-called pillar industries.

However, it would be inaccurate to accuse China of coercing the foreign company into handing over its know how and trade secrets. To paraphrase Bill Gates when he entered China, “You want to play in the China market, you go by their rules. If you can’t abide by their rules, don’t enter.” (Google elected to withdraw from China but Baidu came up with their version of search technology anyway.)

GM was one of the first car companies to invest in China and had to form a 50/50 JV with Shanghai Auto Industries Corp. No doubt SAIC learned a lot from their JV partner, but look at what GM got.

GM introduced their Buick into China just as China’s market for passenger cars was taking off and Buick became the established “luxury” car for the Chinese consumer. At one point, GM’s take of profits from all the Buicks sold in China, even at 50%, exceeded the total of the paper-thin profits GM earned from all the sales in the US. GM’s profit from China delayed the inevitable bankruptcy of the parent for some years.

Getting into the China market in exchange for sharing their technology was a deliberate business decision, no coercion involved. Few companies that made the decision to get into China regretted doing so, only the politicians back home like to cry foul.

Autodesk in the San Francisco Bay Area faced a different problem. They had a computer aided design program for the PC that was extremely popular in China. Except, practically every copy in China at the time was a bootleg copy; very few if any were paid for. For years, software piracy was a popular bone of contention between the American embassy staff and the Chinese officials.

The country manager of Autodesk saw the problem differently. He saw all the pirated copies as his installed base, already trained and familiar with the basic program. He then introduced a high-rise building design application to run on top of the CAD program, which he then sold like hot cakes. At the time China was undergoing a building boom and the users were far more interested in paying for the package and getting trained to use the building design program than spend the time trying to find a bootleg version.

Today, China’s economy has narrowed the gap with the US and has been developing its own IP that might benefit the US; in other words a reversal of roles is underway.

Take the example of China Railway Rolling Stock Corp (CRRC) in the US. This company has won contracts to supply subway cars for new lines and replace old cars in Boston, Chicago and Los Angeles. The contract for each city was worth well north of $500 million and each car delivered will qualify as “Buy America,” which means with a local content exceeding 60%.

CRRC will accomplish the local content requirement by shipping the outer shells from Changchun to the US and make all the other components of the car in the US. The final assembly would also be done in the US. CRRC’s proprietary design has reduced the weight of the car, thus reducing cost while enhancing rider safety. They will use their manufacturing methodology in America and supervise local (American) labor to make a superior product.

The CRRC bid was at least 20% lower than competing bids from Canada and South Korea. There were no US bidders. In other words, the use of Chinese know how will provide American cities with state of the art rail cars, at affordable prices, made with American labor, and resulting in the infrastructure improvements to make America great again.

The point about IP is that it’s a dynamic, ever changing asset and not static like a piece of gold that could be locked up in the vault. The owner can profit by sharing its know how via joint venture or license. The IP can also leak away, as employees leave the company, for example. Competitors can copy and reverse engineer to achieve the same end. Even carefully written patents are not foolproof but serves as the beginning of disputes giving litigation attorneys countless billable hours.

The issue of intellectual property ownership is simply too complicated for the Bannons or Bannon-lites to use effectively for the purpose of stoking friction between China and the U.S.

There are other companies from China that would like to invest in America, share their expertise in low cost production for the benefit of local employment and economy. GM for example invited Fu Yao to invest in a plant in Ohio to make windshields for the auto industry. The governor of Ohio was ecstatic. So long as xenophobia does not intrude, good things happen.

Judging from the rapport China’s Xi established with Trump in his visit to Mar-a-Lago earlier this year, we could surmise that Xi has figured out how to make Donald Trump feel good about himself. Xi can use the goodwill to point out to Trump that the flow of technology is now bi-directional and sharing can only help both countries achieve greatness.

In a private conversation, Xi might want to explain to Trump that North Korea won’t feel that they have reached mutual threat parity with the US until their intercontinental missiles can reach Trump’s properties on the East Coast and hurt him in the pocketbook. The only way to calm down the situation is to talk.

Xi can’t tell Pyongyang what to do, but certainly can try to broker a session at the conference table. The operative words are step-by-step, confidence building conversation that hopefully can lead to serious negotiations. Since Trump does not have the patience for this painstaking process, Xi could hint that someone else should take the lead.

Trump in turn can shower praise on Xi’s vision in creating the Belt and Road Initiative and make the observation that trains already run from China straight to London, an economic lifeline increasingly vital to U.K. as Brexit moves forward. Given that governor Jerry Brown has already declared California to be part of the initiative, Trump may also want to ask Xi how the US can participate in the BRI.

A surprising offer would be for Xi to propose sharing China’s quantum encryption technology with America! The idea would be to initially develop hack proof communication between the governments in Beijing and Washington and gradually expand to cyber communications between two countries and put the network out of the reach of the criminal elements. The implications would be huge and Trump can look exceptionally statesman-like as he emerges from his visit to China.

The key to making Trump’s China visit an unqualified success, in addition to having positive cooperative developments to talk about, is to keep the two leaders’ exposure and engagement with the western medial to a minimum.  Minimize the opportunity for Trump to strut or tweet and for the western media to create real or fake news. Let the discussions and frank exchanges proceed behind closed doors.

Book Review: Can China Lead?

This book is published by Harvard Business Review and my review first appeared in Amazon.

If the authors had posited the rhetorical question from the geopolitical point of view, the short answer would be: "Yes, China can lead though not in the confrontational style favored by the Americans." When applied to doing business in China or by Chinese companies on the global stage as the authors intended, the answer is more nuanced and complex. The authors tried hard and deserve a "B" for their effort but they missed the bullseye. 

This thought provoking book loaded with information and case histories (in the tradition of Harvard Business School) is highly instructional for those wishing to understand today’s China, especially the business environment of China. While the authors provided a balanced discussion of the complexity of a society undergoing breathtaking rate of change, the analysis that accompanied the discussion was often too light and not fully satisfying.

The book began with a historical review demonstrating that much of China’s centrally planned policies had the roots in the early republic days as proposed by Sun Yat-sen, the founding father of modern China. Contrary to Western perception, many of China’s policies were not invented by China’s Communist Party but preceded CCP’s coming to power.

The authors then described the rapid development of China’s economy alongside intensive investment in infrastructure that has been unprecedented in human history. They attributed the success to China’s leaders being trained in engineering, as opposed to emphasis in law as is the case with western political leaders.

The book presented many successful business cases as well as failures. Both categories included state-owned enterprises as well private ones founded by entrepreneurs. Reasons for their success or failure were useful and instructional. The book also talked about China’s rapid expansion of the capacity to train college graduates and China as emerging source of outbound foreign direct investments. 

While the description of China’s impressive economic progress was positive and fair in giving the policymakers their due, there was an undertone of nagging concern that China’s miraculous development won’t last. Because of China being a single party rule, they expect the nation to eventually hit the wall. As I read the book, I kept waiting the other shoe to drop. That is, I waited for an analysis and explanation of why China will ultimately fail but that conclusion while hinted was never articulated.

It is somewhat unfortunate that the book went to press just after the sentence of Bo Xilai. To the authors’ credit, they did not simply dismiss Bo’s downfall as political infighting between his losing faction and Xi Jinping’s winning faction—as some western pundits have suggested. Had they waited a bit to see the full implication of the anti-corruption drive, still on going today, they might have a more hopeful prognosis on China’s future.

I suppose it’s unrealistic for a less than 200 page book to fully cover the many facets of China, some contradictory and conflicting, and some too complex to lend to straightforward analysis. For example, the authors devoted one paragraph on the likelihood of military conflict with the U.S. and their concluding sentence was: To the extent there is a Chinese-American competition, we believe it will be primarily economic, not military, in nature. Wow, there were a lot of whys and why-not’s that they didn’t talk about.

In discussing the rise of China, especially in the early years after Deng Xiaoping return to power, the authors did not discuss the critical (in my view) roles of Hong Kong businesses relocating into Shenzhen and Taiwan manufacturing companies into Dongguan and Kunshan. They were in China well ahead of significant western presence and their factories began the knowledge transfer of good manufacturing practices to the indigenous factories, heretofore indoctrinated by the “iron rice bowl” mentality wherein quality and productivity did not matter.

While the book drew linkages to early republic days just after the fall of the Manch  dynasty, it barely mentioned the early signs of privatized venture led by the so-called township enterprises (乡镇企业) in the early days of economic reform. To my knowledge no one has really gone to the trouble of figuring out why the TVEs had such meteoric rise and why they flamed out.

The book also did not talk about how failing SOEs were “rescued” by some energetic entrepreneurs, usually an insider, taking the small efficient part of the operation with greatly reduced payroll and restart as a stock holding company. In exchange for a minority equity in the new company, the local government was left to deal with closing and laying off the greater part of enterprise beyond economic salvage. Some newly formed company raised capital by agreeing to relocate to the outskirts and giving up the dilapidated facility located in the heart of town to the local government for cash, whereupon the government would raze the old factory and build new shopping mall or office building or high rise apartments. Everybody won.

The round-trip funding of the newly formed privately held company also played a critical role in the early days of economic reform. “Round trip” refers to the secret transfer of funds from inside China to Hong Kong and then remitted back to China as qualified foreign direct investment, sometimes accompanied by addition of fresh funds from Hong Kong. The motivation for the round tripping was that any enterprise with 25% or more equity belonging to the foreign investor qualified as foreign invested enterprise and FIEs were eligible for favorable tax treatment and other concessions.

“Above are rules, below are ways around the rules (上有政策，下有对策)” is one saying everybody in China is familiar with. It is very much ingrained in the Chinese business culture and something every western business in China needs to keep in mind. The authors emphasized the importance of western companies understanding and getting along with the national and local governments in China. Very true. The challenge is that nothing in China is black or white but in shades of grey--nothing to do with sexual bondage but everything to do with staying out of FCPA related indictments back home. Knowing where the line is and not stepping over the line is the daily challenge for the expat manager.

While there was an impressive collection of cases presented in this book, there were some gaps I could nit pick. For example in discussing China’s rising trend to consumerism, they talked about the competition of Ford and GM to win the hearts and minds of the Chinese consumer. Actually VW, who was in China years before GM or Ford, has been much more a competitor to GM than Ford.  Breathing down their collective necks are the local privately held entities as well as the big state-owned auto companies that are in bed with the western automakers.

Also as part of the discussion on China’s rising consumerism, the authors studied the use of credit card companies as a “growing appetite for consumer debt.” Missing in the discussion is a much needed, more expansive study of the Chinese consumer (or is it the government) that resisted the use of outside credit cards such as Amex, Visa and MasterCard until the introduction of UnionPay, a Chinese version of a universal credit card. What made UnionPay successful? What was the government’s role?

In fact, an entire new chapter could be devoted on how Chinese companies emulated a successful western business and localize the model in order to succeed in China. Examples would include Baidu over Google and Alibaba over eBay and Amazon. The authors suggested that the government tilt the field in favor of the Chinese companies but I believe there was more to it. The Chinese entrepreneurs understood the local culture and practices and made sure theirs was an approach that took advantage of their understanding. An interesting case to watch for possible inclusion in their next edition of this book will be the rise (and more rise or fall) of Xiaomi in the highly competitive mobile phone market.

The authors devoted only one sentence to the turbine maker: Sinovel was also accused of stealing proprietary wind turbine technology from its American main supplier. This was somewhat misleading because the dispute was over alleged theft of software, and as the authors rightly pointed out, software was not a strength of Chinese companies. Actually the authors missed an opportunity to develop a case study on how to develop a strategic partner and avoid a nightmare. (The damaged American company was located in Massachusetts and should have been easy to interview.) Instead of same bed, different dream, based on the Bloomberg report, I suggested that the American executive missed the opportunity to form a classic win-win relationship, a virtue the Chinese love to extoll.

The authors are using this book for one of their China related courses. It is a worthy first effort but I would expect future revisions and editions, if for no other reason because China is still very much a moving target. As I suggested in this review, to do justice to this subject, the book needs to be much bigger, at least twice the number of pages accompanied by more in-depth analysis.

  

Caterpillar's Latest Stumble in China

Recently Caterpillar announced having to write off $580 million investment in ERA Mining, a Chinese mining equipment company Caterpillar acquired less than a year ago. Reason given for the charge to earnings was the discovery of "deliberate, multi year co-ordinated misconduct" at the Chinese entity--in other words, somebody cooked the books.

This would not be the first time the Peoria multinational has stumbled in China.

Around 17 years ago, Caterpillar proclaimed amidst great fanfare that they have a formed a JV with Shanghai Diesel to make Diesel engines for the China market and for export.

At the time, the Chinese regulations did not allow for foreign entities to own majority controlling interests in ventures in a pillar industry. But Caterpillar insisted and persisted in their negotiations until they came away with controlling interest in a 55/45 JV.

Then Caterpillar informed their US based suppliers that to continue their business relationships with CAT, they would need to supply from China as well.

One of CAT's major supplier, a Wisconsin company, proceeded to retain me to help them find a manufacturing base and a Chinese partner that would become a qualified supplier to the Shanghai JV.

The entire process from identifying potential partners to signing MOU to drafting the letter of intent to completion of the feasibility study and sitting down to serious negotiations took a little over one year.

For a variety of reasons my client found China's way of doing business, especially getting around the then notorious triangular debt dilemma* daunting and was wavering about making the final commitment.

By then the CAT/Shanghai JV was coming apart which in effect took my client off the hook. The need to supply CAT from China became moot and they decided to backed away from investing in China.

While we were visiting China conducting various due diligence work, we invariably stopped in Shanghai to pay our respects to CAT and thus I had an up-close view of how the CAT JV was failing.

As the majority owner, CAT provided most the senior management team. At the time, CAT in the U.S. was on strike and thus CAT had plenty of idle executives to send to Shanghai.

As we toured the new JV plant under construction, we noted the presence of many American executives, each one with a young bi-lingual Chinese assistant in tow. The senior Chinese official accompanying us on the plant tour, confided to me that it was going to be very difficult for the JV to break even with such a costly top heavy structure.

Our host also told me privately that the CAT management insisted on hiring only bi-lingual graduates and engineers, which meant many skilled and competent professionals could not be employed because of their lack of English fluency. Conversely, he said that English proficiency did not equate to proficiency in their technical discipline.

Within a year of our last visit of the JV, CAT renegotiated and reversed the equity split giving the majority control back to their Chinese partner. That reversion was too late to save the venture and CAT eventually shuttered the JV and wrote off the entire investment.

The Shanghai JV failed because CAT insisted on the American way and made no attempt to localize their practice. The latest failure was apparently due to careless or insufficient due diligence before making the acquisition. One of the principals of ERA Mining was an American living in China and one time president of the American Chamber of Commerce.

Did the patina of American ownership cause CAT to take too much for granted? 

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* In the mid 1990's China underwent a severe credit crunch and cash flow was reduced to a trickle. Companies delayed paying their bills, sometimes with IOUs and other times with all sorts of in-kind payments. The sales force frequently were charged with collection as well as getting sale orders. It was not an environment for the queasy.

Hey China! Stop Stealing Our Stuff

The cover article in latest issue of Bloomberg Businessweek has the above subject as the title. A provocative piece that is likely to be cited in months ahead by congressional spokes persons and law enforcement officers whenever China is in the cross hairs of public discussion about China's bilateral relations with the U.S.

One of the Sino American business relationships described in the article that went off the tracks involved Sinovel, a Chinese maker of wind turbines for wind farms and AMSC, an American maker of electronic systems that control the operation of the turbine. Ostensibly this was a match made in heaven; the Chinese with low labor cost to put the hardware together and the MIT spinoff to supply the sophisticated electronics.

Indeed, Daniel McGahn, the CEO of the American side said, "We always saw it as a symbiotic relationship of having China's low manufacturing cost coupled with Western technology. We would grow as they grew." It didn't hurt that Sinovel was a market leader and dominant supplier in China.

Unfortunately, as was the case with cellular phone, energy saving light bulbs, solar panels, wind turbines or other fashionable products of the day, whenever one company makes a high profile entry, others follow suit and soon China is overloaded with too many manufacturers with too much output and everyone having to resort to price cutting in order to stay in business.

In 2008, the electronics from AMSC accounted for 12% of Sinovel's cost of the turbine system. Three years later, the AMSC package made up 18%. "Everybody was getting squeezed except AMSC," according to an American consultant quoted by Business Week.

In my view, McGahn missed an opportunity to proactively re-balance the AMSC partnership with Sinovel that could have forestalled the ugliness that ensued.

Instead of assuming that his company would continue to enjoy the margin of 2008, he could have empathized with his partner's plight and share some of the pain of eroding margin. Perhaps he could have seized on the opportunity to restructure the business relationship in such a way that Sinovel would own equity in AMSC and vice versa. Perhaps he could have proposed a joint venture to develop export sales of complete turbine systems with hardware from Sinovel and control system from AMSC and thus expand the pie for both parties.

Just the information presented in Business Week is not sufficient to come up with a definitive solution that could have headed off the Chinese side from trying to steal the technology, but the principle is obvious. Namely as with any partnership, one needs to constantly think of ways for both parties to win and make sure that the cost of doing business together is more appealing than going separately.

One particular aspect of doing business in China that is especially difficult for western executives to understand is that the best way of not getting screwed is to develop real friendship with their business counterparts. Chinese value face and yiqi（义气）. The dictionary defines yiqi simply as personal loyalty but it's much more. To behave without yiqi is to dishonor oneself and suffer a great loss of face and self respect.

As AMSC's case showed, keeping the crown jewels, in this case the source code, outside of China did not prevent theft and the attempt to go it alone. If the parties had found a way to remain in the same bed and share the same dream, they might still be living happily ever after.

Is the Chinese Culture Better Equiped to Deal with Change?

"Domains under heaven, those long asundered must reunify, long united must disintegrate." Thus begins The Romance of Three Kingdoms (San Guo Yan Yi).-- arguably the novel read by greatest number of Chinese school boys and not a few school girls as well. The opening sentence was to set the stage for the epic narrative of the chaotic end of the Han dynasty and the subsequent division into three kingdoms more than 1700 years ago. I believe this sentence also aptly summarizes an aspect of Chinese culture not often discussed.-- namely, the Chinese resignation to change. Perhaps from their acceptance comes their ability to deal with change.

In fifteen years, China has transformed from a state-controlled, planned economy to a booming economic power that has been ranked second or third largest in the world, from no where to become world's 10th largest trading nation and now holds fourth largest hard currency reserve, at over $80 billion --though still less than Taiwan.

In about the same 15 year-span, Taiwan has emerged from a low cost, contract manufacturing base to becoming the world's capital for the design and manufacturing of personal computers.

Hongkong, of course, is world famous for spotting a trend and get in and out of the market before anybody even appreciates what has happened --witness plastic flowers, Cabbage Patch dolls, handheld games and the like.

Singapore, which is over 70% ethnic Chinese, became the disc drive capital of the world in a decade and is now 9th in the world in per capita industrial output.

Even though their political system may vastly differ, these Chinese run economies all seem to share one common characteristic: namely the ability to move quickly, the willingness to adopt and not resist change. Perhaps this is the trait that enables many of the Chinese to become such successful entrepreneurs.

The Complexity of the China Market

Those formulating a strategy for entering the China market need to take various complicating factors into consideration, some of which are rather uniquely native to China. I have summarized some of these factors below to serve as check list for the international business development executive.

Geographical diversity.

Assuming that China is one homogenous market would be disastrous. It is not. As can be seen from the chart, most of the foreign investment has been going into the southern provinces, specifically Guangdong and Fujian. The greatest industrial output is coming from the middle coastal provinces around Shanghai while the coastal provinces north of Shanghai and around Beijing is second. Purchasing power, cost of labor, availability of skilled labor, cost and availability of land, energy and raw materials among other things can vary by huge increments across the vast country.

Unlike a developed country such as the United States, the infrastructure in China is still in the frantically building and modernization stage. A modern infrastructure smooths out the bumps and any uneven distribution of resources. A backward infrastructure is a major cause for regional disparaties.

Uncertainties asssociated with transition.

In its drive to becoming a market driven economy, the country's economic performance tends to be 3 steps forward and 1to 2 steps back. State planning has not been dispensed with, just not as obvious. As the late Chen Yun, China's former erstwhile economic planner, was known to have said: "A free economy can fly away like a bird." Part of the planning function is to put a cage around the economy. Sometimes the cage is loose and other times tight. So far no one has found a reliable way to forecast financial performance for a business in a pulsating birdcage economy.

Marketing & distribution related headaches.

In the old days of planned economy, the factory manager only worried about meeting and exceeding production quota. The manager didn't have to sell. The State allocated the disposition of goods. The customer came to the supplier once or twice each year to place orders. Since the economy was not booming, the channels were not overloaded and the State can handle the logistics of getting the goods from supplier to customer. Material for marketing communication? Didn't know what that was and didn't need them. Advertising? Decadent bourgeois practice.

Now, a foreign company entering China will have to deal with finding the customer, how to reach the customer, how to get the goods to the customer, how to provide service, what kind of message to send, etc. As one experienced China trader lamented over his brew at one of many karaoke bars in Beijing, "Life was so simple then. All you have to do was to visit Erligou (where most of the foreign trade corporations held court) and try to get your orders. You didn't have to worry about any of this stuff!" Yes, but, you didn't have any karaoke bars to go to then.

Opportunities for alliances.

Western companies, in particular, have found that forming alliances with local entities is one way to cut through the complexities, especially since much of the complexities are due to bureaucracy. (Whatever we may think about Washington or Sacramento, they are novices compared to the Chinese who invented bureacracy.) China Hewlett-Packard is a successful joint venture since 1985. Even 3M which in 1984 had one of the first wholly owned foreign ventures in China decided that less equity was more market share and took in a local partner about ten years later.

This is a good time for the western company to find and pick a local partner in China. One of the consequences of the transformation to a market economy is that the State is removing the safety net from the state owned enterprises. The enterprises now have to justify their existence based on laws of economics--that means they have to make money. This is a revolutionary concept that most Chinese were quick to grasp. They are now eager to make deals.

It is not just the western technology, know-how, management practice, capital and access to international market that appeal to the Chinese enterprises. Those are nice, but in addition any enterprise with 25% or more foreign ownership can shuck off the heavy social burden (such as onerous pension obligations, free health care and heavily subsdized housing) and reorganize into leaner and meaner companies. A new company can replace the iron rice bowl with incentives based on merit and the threat of dismissal for the slackers. (This is the real revolution that western media rarely talked about.)

The dilemma of western company going to China will not be not finding potential local partners. Just the opposite, the company will be challenged to find the winner among a haystack of propositions and alternatives.

Nancy and McDonald, peaceful co-existence

On one of the busiest sections of Shanghai's Huaihai Road, there is a fast food restaurant doing brisk business called Nancy's Fast Food. The logo is the slightly exaggerated letter "N" in one and one half golden arches on an orange red background that McDonald's made famous. A sub-title underneath the restaurant sign reads: Chinese Foreign Joint Venture. If Nancy's had opened in the U.S., the owner would have heard from McDonald's lawyers in no time flat. But this is China and Nancy's owner is said to have powerful relatives. Besides, Nancy's had been in business for almost two years before McDonald's entered Shanghai. McDonald's approach was to open its first restaurant just a few store fronts from Nancy's. In effect, Nancy has introduced the concept of fast food to Shanghai consumers and McDonald's is taking advantage of the built-in stream of customers. Nancy's offers all sorts of fast food but no hamburgers; the last time I looked, both places were busy with lots of customers.

Lesson: In Asia, symbiosis works better than confrontation.

China's first McDonald's

Do you remember the international brouhaha that was raised late last year because McDonald's 20 year lease on the corner of Changan Avenue and Wanfujing Street, arguably the most coveted address in Beijing, was suddenly in jeopardy? Most China wise folks would know that Changan is the main east-west thoroughfare that runs by the famed Tiananmen Square. The intersecting Wanfujing extends northward and has historically been known as the premier street of commerce in Beijing.

Many a homesick visitors in Beijing for an extended stay have probably eaten at the 700 seat restaurant, said to be the world's largest McDonald. After a gala opening in 1991, it was to vacate prematurely in favor of a big time development financed by Hongkong money. Going by recently, I see that the restaurant was still standing, though rather forlornly because everything around it has turned to rubble.

As the locals tell it, Li Kaishing, one of Hongkong's richest billionaires, made the deal with the Beijing municipal government, which normally would have been sufficient. The envisioned project was going to be so huge, that it was going to dwarf the 17-story Beijing Hotel across the street, dominate the nearby Tiananmen Square and cast a shadow over the grandeur of Forbidden City, the finest imperial palace in China,--movie goers will remember it as the back drop for Bertolucci's Last Emperor.

In January, cooler heads from the central government reconsidered the matter and ordered the project put on hold, but not before all the buildings on that long block from the corner of Wangfujing eastward along Changan had been razed. Maybe the fuss over McDonald contributed to stopping this project, but it was too late to save the street. From the most desirable location, the restaurant is now next to one of the biggest eye sores in Beijing. With reduced foot traffic, McDonald did not exactly win.

As of April, the government has asked Li Kaishing to proceed at a reduce height comparable to the neighboring Beijing Hotel. Whether the Hongkong investors would still find the project economically attractive is not known at the time of this report.

In any case, students of Chinese tradition would not find the refusal to allow the development to proceed as surprising as the initial approval. For dynasties, no building around the palace is permitted to look down into the palace grounds. After all the site of the imperial grounds was carefully chosen to ensure long and stable reign. This and other traditions involving the palace and its powerful fengsui are observed by the current regime with the tall Beijing Hotel being only a slight stretch. Fengsui is the Chinese term for their science of geomancy that basically says location is everything. (Maybe the first Chinese geomancer was a real estate broker.)

If you don't think the current regime is a keen observer of traditional fengsui, next time in Beijing look at the prime real estate on the avenues that radiate directly north and south away from Forbidden City. You will find no tall buildings. Why? Because, as it was explained to me, the central nervous system of the imperial dragon lie underneath the north-south axis, and nothing heavy should be allowed to press on it.

People that do not understand China, which include many in Washington, tend to think of China as a tightly controlled state in which everybody moves in sync. This kind of go/no-go happenings, which occur with regularity, should persuade otherwise.

Other explanation for the go and stop and maybe go again of the Wangfujing project attributes the cause to political in-fighting between the central and the municipal government. Whatever the case, it does reaffirm the maxim about China, namely "nothing stays the same and nothing is as it seems."

Getting on the Fast Boat to China

Depending on who you believe, China now has the second largest economy in the world, after the U.S. according to the UN, or the third largest after Japan according to the International Monetary Fund. Either way, it is pretty startling for a country with a per capita gross domestic product of less than $400. (Both the U.S. and Japan's per capita GDP are more than fifty times greater.) That China's economy has been under stated and under rated does not surprise those of us who have been doing business in China for years.

To others who are just getting the message about the exciting opportunities in China and are ready to join the next stampede into China, a word of caution is in order. As many business executives who joined the first wave into China in the late '70's found out: some of that glitter is pyrite. The outcome will depend on the executive's advance preparation, assumptions, motivation, Asia-related experience, and whether the objectives are long term or short. (If you're the investment banker looking for the quick hit, get there early. Don't wait until all are labled persona non grata.)

China's appeal

Specifically, why is China so attractive? China has been enjoying close to double digit economic growth for nearly 15 years. To fuel this growth, China has been a voracious buyer of capital equipment and technology. They buy from the U.S. when politics and export control don't get in the way, from others when they do. This is why Silicon Valley IC equipment companies, among others, are rushing into China.

After such sustained economic growth, the domestic consumer market is becoming one worth drooling over. Goods bearing the Pierre Cardin and Yve St. Laurent labels are prominently displayed in Guangzhou, Shanghai and Beijing and sold at world level prices. The shift from a centrally planned economy to a market economy means people are no longer evenly poor. While it's still a tiny percentage of the population that are making a lot of money, a very small percentage multiplied by a very large population base nonetheless amounts to a significant number of customers for expensive goods. Coca Cola has been in China for a long time and knows first hand about the growth in consumption. More recent entrants doing well there include MacDonalds and Campbell Soup.

Furthermore, China still possesses a large pool of motivated and reasonably well trained workers who can make goods at a competitive cost. The first ones to go to China because of this comparative advantage were the Hong Kong toy makers and the Taiwanese personal computer manufacturers. Motorola is one the first American high tech companies to establish manufacturing bases in China, not just to take advantage of the low cost labor but also to participate more effectively in the local market.

Pitfalls of Doing Business in China

So where are the potholes on this modern silk road to Cathay? First, virtually nothing stays the same about China. The economy, for example, according to most pundits and crystal ball gazers is likely to come to a screeching halt sometime this year or early next. (If Americans can't fine tune a market-based economy, what can be expected of the Chinese who are new at this game?) In the past, the Chinese economy lurched forward for 2-3 years and then hit a wall. Like a stunned drunk, China will pause and collect itself then lurch forward again.... In the meantime, if you have a contract that depended on the Chinese buyer getting easy credit from the Peoples Bank, you had better check into the situation soon.

Many people will tell you that whether your deal is in jeopardy depends on how well your Chinese counterpart is connected. Alas, that's true. However even 24 carat connections today could turn into brass tomorrow. Companies contemplating wholly owned operations in China need to be even more mindful of this issue--namely, how to track which way the political wind is blowing.

Having the right local partner to take care of the formidable amount of red tape can ease the pain of entry, and the local partner can guard your ongoing interest. Furthermore, China still has that 3rd world sensitivity about being exploited. Even though they now permit 100% owned foreign operations in China, the thought of the foreign entity taking all the profits still smacks of exploitation to them, and the approval process is bound to be long and arduous. If you leave a, say 20%, minority stake on the table for the local partner, you will find life easier now and in the future. 3M is a case in point. They had the very first wholly foreign owned venture in China, grudgingly approved in late 1984. Recently 3M took on a local partner to accelerate their business expansion of that venture in China.

Smaller American companies need not be fazed by the prospects of doing business in China if they have long term objectives and can gird themselves for the Chinese decision-making process that is almost never quick. Establishing a carefully thought out base now should pay dividends over the long haul as China's economy continues to grow.

Apple China Forum

Godd afternoon, ladies and gentleman. It is a pleasure to participate at this Apple China Forum and a honor indeed to be part of this distinguished body. Parenthetically, I should admit that I am glad that the 49'ers played yesterday.

As recently as 15 months ago, when I chaired a conference in Silicon Valley sponsored by the Asian American Manufacturers Association on fastest growing economies of Asia, it was still necessary to declare that China has become the world's hottest and fastest growing market for just about anything. Now that has become common knowledge. Those of us that have been active in China has seen the list of items that every household hungers for changed from the bicycle and sewing machine to color TV and refrigerator; now its VCR, camcorder, CD player and home karaoke sets. The family car and the personal computer are likely to be next on the desired list.

As you can see from this chart, courtesy of Dataquest, sale of personal computer, since 1992, is already beginning to take off in China. I believe, however, that so far virtually all of the sales are outside of the home market. But there is a lot of market left. One way of looking at China's market potential of China is to compare to that of the U.S. Even if we consider only the urban population which is roughly 25% of the total population, the per capita concentration of PCs in China is about 1/40th of the U.S.

So if you decide to enter this market, what do you need to know about China? Where are the potholes on this silk road to Cathay? In addition to the usual parameters in entering any new market, there are some that are peculiar to China. My fellow panelists will no doubt add others.

A big reason for the complexities of the China market is because China is still in transition from a state-controlled allocation system to a distribution that is unevenly determined by market forces. Some organizations can import directly; others still have go through state authorized trading corporations. Some dealers have powerful backers; others operate in briefcases that were here yesterday but gone today. Some specialize in soft currency transactions to organizations loaded with Rmbs but no dollars.

Take our money but keep your stock

A Silicon Valley company owned proprietary technology that would allow a multinational Japanese company to catch up to the leader, another Japanese company, in the consumer electronics business. Every discussion and meeting went smoothly and mutual agreement on the basis of cooperation and contribution from each side was reached reasonably promptly. The only sticking point came up when the American company wanted the Japanese company to invest in the American company. This issue took some time to resolve. Eventually, the Japanese company injected the cash demanded and needed by the American company but as fee for a license agreement. In effect, the Japanese company said to the American entrepreneurs: "Here is the money, but you keep the stock." In a casual setting outside the meeting room, the Japanese executive explained to me that a license agreement can be committed at the division level while equity investments required board level approval. While the American company looks at the equity investment as a potential upside kicker in a strategic alliance, the Japanese company looks at equity investment as a potential source of embarrassment when and if the invested company goes down the drain.

Lesson for privately held companies looking to partner with Japanese companies: Do not assume that stock in your company is useful as negotiating chips.

P and G Rejoice in Prell

Proctor & Gamble's "Prell" shampoo is arguably one of the most talked about entries of western consumer products into China. There were at least three ingredients in its formula of success. P&G found a local partner to manufacture the product inside China and change the brand name to "Rejoice," a real word instead of "Prell," a made-up word that might confuse customers with limited English vocabulary. Most importantly, the company introduced the product in single-use, foil packs instead of just packaging them in large containers. Chinese women can afford the "luxury" of washing their hair with the P&G shampoo every so often but a bottle or tube would have been too expensive. Of course they will become loyal customers for larger containers when their income rises. In the meantime, it seems every stall and street vendor carry the little packets of shampoo and P&G is making a nice profit while watching the business grow.

Lesson: Adjust your product according to the local standard of living.

Basics of collaboration for Chinese companies in America

Increasing number of delegations from China are visiting the U.S. for the purpose of finding investors or cooperating partners. From my observation, I would guess that most of these delegations have not received very satisfying results so far. To enjoy greater success in future visits to the U.S., Chinese delegations need to keep certain rules in mind: (1) They need to meet the right kind of organizations. (2) When they do meet prospective investors/partners, they need to have the kind of information that would stimulate Americans' interest. (3) In order for this to happen, they need proper preparation. I would like to briefly discuss each of these rules with the hope that my explanation will be useful to groups planning to come to the U.S. in the future.

Meeting relevant organizations.

I have seen visiting delegations announce they intentions to meet prospective American partners by advertising in local Chinese language newspapers! This is a severely limiting approach. Americans of Chinese ancestry make up about 2% of the U.S. population and only a fraction of these regularly read any of the Chinese language newspapers. Many of those that do read Chinese language newspapers are retired and are unlikely to be interested in the delegation.

In order to meet prospects that would have genuine interest in meeting delegations from China, it is necessary to know who these prospects are and contact them well in advance. Since in most cases, it is not possible to identify the prospects in advanced of coming to the U.S., the delegation need to depend on organizations in the U.S. that could make the introduction, arrange the meeting and take care of other local details. Such intermediary organizations could be national organizations, such as U.S.-China Business Council, local organizations such as Asian American Manufacturers Association based in Silicon Valley, or for-profit organizations and individuals that participates in U.S.-China trade such as my organization.

How to Stimulate Interest

It is, of course, not enough just to be able to contact an American organization willing to host a delegation from China. If the American host do not understand the intent of the visiting delegation, they would be reluctant to accept the responsibility of being a host. Even if they are host, they would not know who to invite to meet the incoming delegation and the results will still be disappointing. It is therefore important for the delegation to be able to state their intentions, and that means the delegation must first know themselves as to the purpose of their trip to the U.S.

I believe tightly focussed delegations will have more success than broadly focussed groups. What I mean by this is that groups that know exactly what they want from the visit are more likely to meet relevant parties, engage in more substantive conversations, and leading to constructive future dialog. Delegations generally interested in everything will likely ended up not meeting anyone worthy of future contact and conversation.

For example, if a delegation wants to visit the U.S. to discuss cooperative ventures in automotive components. There are directories and associations serving the automotive industry that the host can use to make up the invitation list. If the group is even more specific, say, having an interest in under-the-hood electrical components, the host can quickly contact the handful of companies in that business and establish an itinerary. On the other hand, if the delegation is interested in "latest advances in high technology," the potential host can only wonder as to where to start in order to organize a meaningful program and itinerary.

Advanced Preparation is Essential

In order to organize a mission with a specific objective, ample preparation in advance of the trip is required. It is not enough for the delegation to go to the U.S. and say "we want to do business with you." The delegation need to describe the business opportunity for which they are seeking an U.S. partner, the advantages the Chinese side is offering and the kind of participation they need from the other side, and the anticipated benefits and future for both partners.

When dealing with Americans the first meeting is the most important. American business executives respond to opportunities and information. They respond poorly to general concepts and they become impatient in the absence of hard data. If at the first meeting, the Chinese side can present a detailed plan that take market, technology, competition, resources and other parameters of a business into careful consideration, the American side will be impressed. If on the other hand, the Chinese side present the impression that they do not know what to do, the American side will be disappointed and the likelihood of a second meeting is considerably diminished.

A lot time and resources are expended to organize a trip to meet prospective business partners. It would be a pity to waste such opportunities because of a lack of preparation. Just what constitutes complete preparation is an important subject reserved for another discussion.

AAMA Annual conference, 1993

Opening remarks as Chairman of the 1993 annual conference, the fourth in succession of annual conferences that I chaired going back to 1990.

Since this conference is located in the now world famous Silicon Valley, I thought we would kick off the conference with the help of some state-of-the-art high tech presentation gadget. This device is called Media Pro and is on loan from nView of Newport News, Va. The technical brochure is available in the literature handout area for those interested in knowing more. My colleague Jon Goldman is the creator of ths presentation.

Over the past three years or so, the world has been engrossed by the rapidly changing Easern Europe and may have wondered about the business opportunities in that part of the world.

Frequently overlooked has been one part of the world which has been growing steadily and some would say spectacularly for the last two decades. We are referring to Asia of course, and paticularly East Asia.

Since one of the mission of AAMA is to act as the bridge enhancing greater understanding and cooperation between the East and West, we have accordingly decided to concentrate on "Keys to Asia's New Economies" as the topic for the conference for the next two days. To paraphrase a local TV channel, you have questions, we try to provide answers. As you will see, we have invited speakers who understand and have been successful in that part of the world and others from that part of the world to tell you what changes are taking place, what opportunities these changes protend, and how to participate there.

We had originally hope to invite an official from the World Bank to present an overview of that region. Unfortunately, they have other travel commitments, but they were most gracious in sending us the latest compilation of economic data so that we can pretend to be an economist for next five minutes.

The reason for throwing up this slide on Japan's export history is to show that since 1991, Asia has taken over from the U.S. as its largest trading partner. And as you can see, while the export to the U.S. is static, the trend with Asia is steadily climbing. In fact, in 1992 China alone has become Japan's second largest trading partner, second only to the United States. To give you another indication of the growing importance of Asia and China in particular to Japan, last year Japanese companies initiated 1800 new investments in China, equal to the sum total for the preceding 13 years. What is it that the Japanese know that we in the U.S. still don't know or at least fully appreciate? One of the business books Japanese were reading this summer was "China: Japan's only escape route from America's impending bankruptcy."

If you consider what rate of growth for the gross domestic product or gross national product (to us non-economists GDP and GNP are practically the same) has been for the Asian countries compared to the developed economies like the U.S. and Japan, then Japan's interest in Asia becomes easy to understand. As you can see from this slide, the GDP for Asia outside of Japan has been growing at 5-10% per year and is expected to continue. While for the U.S. and Japan, the growth rate when it is not negative, has been in the 1-2% per year. The forecast for the U.S. here may be by a particularly optimistic economist.

If you compare the per capita GDP of the established economies to the Asian countries by the traditional yardsticks, the difference seemed to be vast (for instance the annual per capita GDP of China is only $370 which is considered barely above poverty level) and one would wonder what markets and business opportunities could possibly exist in these countries. Trouble is traditional yardsticks are not comparing apples with apples and has been misleading.

Recently the United Nations and International Monetary Fund has been adjusting the local GDPs by the purchasing power parity. PPP is economist talk and we do not need to go into it here. Suffice it to say that the same dollar can buy a lot more or less from country to country and the buying power needs to be taken into account. When that's done, all the previously mentioned Asian countries have significant GDPs and indeed the consumer habits and existence of markets more closely reflect the adjusted GDPs that the traditional ones.

In fact according to the UN, when looked upon in that manner, China and India are among the 5 largest economies in the world ahead of all of the developed Western European countries. In light of these findings, Asia should no longer be considered as just a place for low cost labor. Asia represents the most vibrant part of the world.

We have invited some of the most qualified speakers to address the theme of this conference. I am guessing that their recommendations will have certain things in common: The market is global. You need to be there. To be there you need to have an open mind, willing to listen and learn, and ready to be flexible to find ways that will enable you to succeed in each and every local market.
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Note by blogger: These remarks were made almost 15 years ago and still resonates in 2008.