How foreign companies can compete in China

How foreign companies can compete in China's

high-tech market

The emergence of strong local high-tech companies is creating a

formidable challenge for multinationals seeking to grab a share of the

Chinese market.

Ingo Beyer von Morgenstern

Web exclusive, January 2006

Lenovo, TCL, and Huawei are well-known examples of Chinese

high-tech companies that have established a global footprint. Beyond

these headline-making brands, however, scores of high-tech

companies—largely unknown outside China—are rapidly assuming

market leadership within the mainland while quietly building the

capabilities to go global.

China's high-tech sector is growing at an impressive pace. Over the

past three years, revenues of its 100 largest high-tech companies

grew by 26 percent annually, more than twice the overall market

growth rate of 12 percent and nearly four times the annual global rate

of 7 percent. Of these, nearly 20 midsize and large companies have

grown at 50 percent or more a year—a remarkable pace for

businesses of that size.

The rise of Chinese companies comes at a challenging time for the

high-tech sector in the rest of the world. Slowing core markets and

pressure from investors to increase earnings are forcing companies to

turn toward China. Depending on the product category, 30 to 75

percent of future growth in the global high-tech industry will come

from emerging markets, with China expected to generate a significant

portion.

Foreign high-tech companies in China find themselves up against a

host of challenges: limited demand growth in high-end product

segments, where they tend to compete and in which they are

increasingly under attack from Chinese players; severe pricing

pressure; a tendency to overinvest, leading to excess capacity; high

turnover of qualified local management talent; and difficulty

managing joint venture partners. Many foreign CEOs seem convinced they are doing the right thing. In

addition to utilizing expatriate managers, they have local managers

on the ground, source and manufacture components in China, and

visit the country three or four times a year to check on the business.

These actions, though necessary, will not be enough to win in China.

By applying their tried-and-true product and business models, foreign

high-tech companies are unlikely to earn the level of profits—not only

from hardware, but also from after-sales parts, services, and

software—in China that they do elsewhere. In mature markets, for

example, printer makers earn as much from the sales of cartridges,

ink, paper, and services as they do from the printer itself. In China,

this model does not work as well, since consumers would rather refill

an old cartridge or purchase a new, low-cost copycat one. Many local

companies are available to provide maintenance services at a fraction

of the price that a foreign group would charge.

A different set of dynamics is at work in China, requiring foreign

high-tech companies to rethink how they compete. First, they will

need to reduce costs severely—by 30 to 50 percent—to bring

themselves in line with Chinese competitors. Many foreign players

believe they are getting a good deal on components sourced in China,

yet they often pay 10 to 20 percent more than local companies.

Foreign companies in China often rely on a single, more expensive

overseas supplier for a particular component because Chinese

suppliers cannot meet the design specifications. To reduce costs,

foreign companies will need to design products that local Chinese

suppliers can manufacture.

But cutting costs is only part of the equation. Since many foreign

high-tech corporations may never be able to reach cost parity with

their Chinese rivals, they will have to think of other ways to create

value. One way is to rethink their distribution system in China. In

Europe and the United States, consumer electronics goods are

distributed mostly through large retail chains. But these channels do

not have the same scale or reach in China. To get around this problem,

Sony distributes its notebook PCs through hundreds of stand-alone

shops and sales counters in consumer electronics malls. Setting up its

own distribution network has helped Sony boost its share of the

Chinese notebook PC market from just 1 percent in 2002 to more than

8 percent today.

Foreign companies should also leverage their global brands and

marketing muscle in China, especially given how brand conscious

Chinese consumers appear to be. In a recent McKinsey survey of