Growing Domestic Consumption

Chinese economic development for the past two decades has depended on the rapid export growth of consumer goods to developed markets. The current and likely long term decline of export dependent growth has led the Chinese government to espouse and promote increasing domestic consumption in order to absorb manufacturing capacity and employment.

Three courses of fiscal policies have been taken: 1) employment and income support through infrastructure spending; 2) direct incentives to consumers and retailers, such as tax reductions, credits and subsidies; and 3) transfers payments to build a social safety net of healthcare, unemployment benefits and pension security are being put in place to stimulate consumption. But so far domestic consumption growth has been modest. It is assumed that these government policies will have growing force; but this may not be the case. Vast Infrastructure stimulus is time limited. Consumption subsidies in a savings culture reach a point of diminishing returns. A social safety only enhances the value of savings. Germany is a good case in point. It enacted Europe’s earliest safety net in the 19^th century and retains to this day Europe’s highest savings rate.

Fiscal policies cannot alone overcome the historic habit of the Chinese people to save instead of spend. Cultural habits of saving that are rooted in a history of “tough times” can only be broken by the persuasive for of entrepreneurial marketing, in consort with pro-consumption fiscal policies. The willingness and ability of companies to invest in marketing to consumers is the horse that pulls the cart of government fiscal policy; not the other way around.

As an American marketer in China helping producers and retailers over the past ten years, I know the trepidation of Chinese shoppers to part with their cash; and what it takes to get them to do this. They will abide risks of spending for investment to grow their money, whether stocks, real estate or even gambling, but they hesitate to spend money on goods and services that perish with use.

It is natural for human beings to save so they do not have to depend on others to help them live decently when times get bad or when their earning power diminishes. Consumption, beyond necessities and immediate pleasures, is an artificial behavior. It only becomes “natural” once a new habit of consumerism takes its place..

Consumerism is not just buying more goods; it is a cultural disposition to spend money for new goods and services, beyond immediate need or pleasure. It is really spending for the joy and confidence of personal aspirations. The agent of this cultural change is the science and practice of marketing. Government must support it, but also constrain its inherent momentum through regulation to a point of sustainable balance between personal income and debt. The U.S. failed to regulate this measure. But China has the ideology and government means to control this.

The power of marketing to change habits rests upon a complex system of marketing management. This system encompasses sophisticated marketing research of personal and social consumer desires. It methodically segments consumer markets to find the small groups of specialized unmet desires. It makes tremendous investment in research, development, application and commercialization to launch goods and services to meet these desires. Statistical methods contrive to target the right consumer segments to a company’s product or service offering. Competition for target market share only sharpens the quality and features of offerings that make them even more desirable and expensive.

Enormous investment in branding imbed a high perceived value of these offerings into the consciousness of target consumers and make it easy for them to recognize and decide what they want to buy. Repetitive promotion whets the appetite by building consumer awareness, interest, and desire for these offerings. Distribution and retail (store and Internet) makes these offerings accessible to people for purchase. Pricing places an exchange value on these goods so that people feel they are getting fair or even more value than they are paying for. The sales process finalizes purchase transaction and completes the battle of marketing to overwhelm the natural resistance to save for future security against inevitable misfortunes. Companies spend billions of dollars to carry people through this process of spending down their savings and incurring debt to buy goods and services for their pleasure, career advancement, social status and power.

If the Chinese government wants to encourage domestic consumption, it has to support enterprise marketing in many ways. It has to gather household data from the official census and make it available to intermediaries to analyze, organize and sell its consumer relevance to enterprises. Government has to expand the distribution of credit cards and authorize banking and insurance mechanisms to process credit transactions and manage default risk. It has to support a security structure to authenticate purchases. It may, as in the U.S. during the 1960s and 70s, deduct consumer credit interest payments from personal income taxes. There is a vast inventory of Western government instruments that the Central government can draw upon to support enterprise marketing in China. One thing is clear, government fiscal policy alone cannot achieve the consumption growth it requires to offset export decline. It must support an enterprise marketing infrastructure.

I personally lived through the U.S. cultural change from saving to spending, and as a marketer contributed to it. Change began in the 1950s with the introduction of credit cards. In the mid 60s my brother Philip Kotler published his seminal 1^st edition of Marketing Management. Philip turned marketing into a science and consumer companies followed his science with practice - building marketing organizations within the body of their companies and driving marketing campaigns that radiated through the media of the country. Universities business schools followed Philip’s direction and built an academic disciple to advance this science and practice. They turned out marketing managers for every consumer company. These managers and their cohort of advertising agencies, public relations, direct marketing companies and credit card issuers turned a savings culture into a spending culture. Multinational consumer companies spread this system to the four corners of the world.

Marketing produced a big change in U.S. personal savings. If 1975, well after the safety net was in place, savings were 17.6 percent of income. Marketing intensity brought this rate down to1.75% in 1985 and by 2005 down -.4%. By 2006 it fell to -1%. When we couple this with the fact that between 2000 and 2007 U.S. households nearly doubled their outstanding debt to $13.8 trillion—an unprecedented amount in both nominal terms and as a ratio of liabilities to disposable income (138 percent), you can appreciate the force of consumer marketing to change a culture. By 2006, consumption accounted for 70% of U.S. GDP.

If China wants to grow consumption for sustainable internal demand, it will have to cut its personal savings rate in half and turn trillions of Yuan into internal demand growth. It will have to invent its own approach to powerful marketing with enough regulatory control to prevent the evaporation of savings and the kind of debt explosion that precipitated the U.S. financial crash of 2007. China’s socialist economy, unlike the U.S. free market economy can accomplish this. The fact that a trend can become excessive if unchecked does not mean that its regulated moderation should be dismissed.

China’s path to marketing must be also be mindful that foreign companies in China know how to market and have the deep pockets to penetrate Chinese consumer demand. The marketing organizations of Chinese companies today cannot match this experience. If the China wants its own enterprises to profit from consumer growth if will have to encourage and support Chinese companies to build marketing organizations and branding, promotion and distribution capabilities. Chinese universities will have to take marketing seriously and steer good business minds to the marketing disciple, instead of the finance discipline towards which they now headed.

An effective policy of consumption that will befit Chinese enterprise requires a deep cultural shift in the thinking of Chinese leadership. This is new stage for China. Deng Xiaoping initiated an economic development policy based on export cost advantage. The export policy of the 1980s was a great leap for Chinese leadership from decades of internal planned economy. But it was still production focused and carried forward the industrialization mentality of the planned economy, except directed to external demand rather than internal development.

Consumption of a scale to absorb long terms export decline is “a horse of a different color.” It requires a cultural leap to focus production of what consumers want. There is no heritage of this in China’s modern history. It is a new stage of China’s socialist market economy based on the idea that people should enjoy life today, rather than fear the future. This view challenges the normal disposition of leaders to await global economic recovery for renewed export growth. This normal view is really a gamble that may not succeed.

Consumer Credit: The Key to Domestic Growth

Economic Stimulus[1]

China is committed to a policy of domestic economic growth to offset a declining rate of export growth. Export accounts for one-third of Chinese output. Decreasing exports due to global slowdown (recession + protectionism) will result in factory down scaling, shutdowns and skyrocketing unemployment. This will affect all of China’s export regions.

There are two Western ways to stimulate domestic economic growth: 1) Increase consumer demand for goods by increasing employment through infrastructure investment and reduced interest rates for private investment to meet increased demand (Keynesian economics) ; 2) using incentives for people to produce goods and services, such as adjusting income tax and capital gains tax (Supply side economics.). Both approaches aim to increase the amount of money consumers will spend on goods, but takes different paths. Keynesianism increases government spending to increase demand and employment; supply side economics increases private spending and investment to increase demand and employment.

The problem with these models in China is that there is no assurance that increased employment and money in the pocket will be spent to boost the domestic economy. China has a savings culture (over 40% of earnings) while the U.S. has a spending culture (zero savings). This difference is reflected in the size of the retail sector in both countries. China’s retail sector accounts for only 30% of GDP; while U.S. retail accounts for 70% of GDP. In the U.S. people will spend all of the money in their pocket and move on to their credit cards. In China, people will spend only a small portion of new money. They will save the rest. Hence, western models in China would result in much less economic stimulus than in the U.S.

A further fact must be considered to understand the impact of Western models on consumption. The average Western consumer leverages every new dollar in the pocket with consumer credit. Hence, economic stimulus is compounded. China, on the other hand, is still a cash economy, so there is no leverage on added earnings. In fact the opposite is true. An extra dollar in China results in only $.60 cents of spending. Hence it is far most costly in China than in the U.S. to gain an equal amount of demand for a given amount of stimulus.

Some argue that the key to Chinese domestic growth is to convert savings into spending. But this is an intractable cultural problem. How do you change a 3,000 year habit? And how do you win the political battle with National banks and their state-owned industrial borrowers that want to retain savings deposits? It is more reasonable to leverage the 60% of earnings that are spent on consumption by instituting widespread consumer credit.

Expanding Consumer Credit

Government expansion of consumer credit requires a marketing strategy. All marketing strategies consist of nine steps.

1. Vision. Den Xiaoping said, “It is glorious to be rich.” This early vision of China’s export market economy did in fact build wealth at the top through direct foreign investment to a new class of owners who invested that money in factories and capital equipment for an export economy. They paid taxes and fees, which in turn built public infrastructure.

The new policy of domestic growth requires another vision, “It is glorious to consume.” This mantra affirms the pivotal role of the middle class in supporting Chinese domestic growth. They have the resources for consumer credit. They will not spend enough cash to grow the domestic economy. But they will spend credit and work hard to revolve and extend their credit lines. Many other countries have gone through this process. The Chinese government will regulate consumer credit expansion.

2. Objectives. Credit card use is very new in China. There are 100 million credit cards in circulation. Most credit cards are used for business expenses, not personal or household consumption. Credit lines are also very limited. A typical card will carry a credit limit of RMB 20,000. This is hardly enough to make a make a down payment on a car. It is reported that 85% of car sales are cash transactions.

The government has to set a reasonable objective for the projected size of the consumer credit card market. That size has to be a percentage of retail sales and a percentage of GDP. The benchmarks of different countries are all over the place. In the U.S. consumer credit is $2.6 trillion, or 20% of GDP. The U.S. retail sector is 70% of a $13 trillion GDP, or $9.1 trillion. Nearly 1/3 of current retail is supported by current consumer credit. The U.K. is closely approaching the same ratio of consumer credit to GDP as the U.S.; but Germany, Norway and Sweden are at around 10%, while Hungary, Switzerland and the Czech Republic have a 3% ratio of consumer credit to GDP. Mexico has a low percentage of the credit cards to population – only 34%. China has a much lower percentage. So what is a viable benchmark?

The most reasonable benchmark appears to be Germany. Like China, Germany has a high savings rate and an export ratio of 40% to GDP. So it is not unreasonable to project a 10% ratio of consumer credit to GDP as a long term objective in China. The official exchange rate GDP of China is $3.2 trillion. Using the German benchmark of 10%, consumer credit should be at $320,000,000. China’s current ratio is less than 1%of GDP. Hence, China has a long way to go and requires a policy regime to grow consumer credit to a reasonable level to meet objectives of domestic growth. China needs a 5-year plan for consumer credit growth to reach the lower standard of the Czech Republic at 3%. A second 5-year plan could boost it to the German level of 10%.

3. Target Customer Segments. The only way to achieve rapid growth of consumer credit from a very low starting point is to market cards to segments of the population that already have them and use them to some degree for personal consumption. That means more cards and extended credit lines to current users and their demographic and psychographic cohorts. A qualified cohort profile can be extracted from current data. It would include all people similar to the people who already have and use credit cards. In all likelihood, 80% of that cohort either do not yet have credit cards or do not yet use their credit cards for personal consumption.

There are two segments that fall into this target market. The first group is the population under 24 – “the little emperors” of a one child policy. They are at the universities in major cities and have enough cash from their parents to pay credit card bills. They are spending their parent’s savings, so they have taken the first step to be true consumers. Consumer credit will leverage their family cash support for minimum payments and enable this segment to buy several-fold the amount of goods they are buying for cash. Their credit lines are limited because they are not employed, or fully employed. But they are a numerous class and can generate a high volume of credit based retail sales.

The second segment is the professional and young entrepreneurial class 25-50 in age. They need to show success and status and are paying cash for these the emblems of achievement. But they psychologically need to buy more than their cash permits. They are employed and have a rosy future. They can support a substantial credit line. The proper targeting strategy for fast domestic growth through consumer credit is to penetrate the cohorts that have cards and use them. There is no need to try to convert endemic savers into spenders.

4. Value proposition. The value of consumer credit to target segments is that credit cards multiply the goods you need to impress those with whom you are connected and those with whom you wish to be connected. This is an economic value proposition. Consumer credit is an investment in your advancement. As the Chinese economy matures, the value proposition will shift to Western modes of emotional rather than economic purchase, like impulse purchase, cult, or identity purchase, experience consumption, shopping sprees and other non-economic motives. But China is not there yet, and hopefully will not reach the excesses of the West. The economic value of status is enough to greatly expand the domestic economy.

5. Brand strategy. The government and card issuers need a brand strategy to manifest the value proposition with powerful messages, symbols and design. This requires the best way to tell the story of personal success through consumption; consumer happiness through brand identity; portraying leaders and celebrities as consumer role models; improved design to enhance the shopping experience; and the social value of credit use to the country.

6. Products. There are many credit card products. Typically in the West there are many levels of branded card offerings that relate appropriately to different demographic and life style classes. Silver, gold and platinum cards denote wealth classes. Affinity cards that are issued by banks, associations and companies reflect life style hobbies to which cardholders are very loyal. Sport teams issue cards, along with airlines, social cause groups, and so on.

7. Promotion. Cards are typically promoted through direct marketing by mail, online advertising and application or direct enrollment at events of card issuers. Credit card issuers spend a lot of money on print, TV and online marketing. The government will have to play an active role in promoting credit cards by its communications and information agencies.

8. Pricing. Annual fees, interest rates and rewards are key elements in the competition between credit card issuers. China has to be careful to regulate these matters and avoid the usurious interest rates prevalent in the West.

9. Distribution. The backward supply chain of credit card distribution is complex. Applicants have to be evaluated for credit qualification. Credit has to be financed by a chain of financial institutions and service organization. Risk has to be widely distributed. The forward supply chain is also complex. Distribution companies like American Express, Visa, Master Card, and Union Pay need information systems to organize and implement issuance, transactions, payments from buyers, payment to sellers, as well as receipts from and payments to financing sources and regulatory agencies.

Benefits of Consumer Credit

Chinese policy and Chinese enterprise have great aspirations for innovation and branding. But it is very important to understand how these aspirations relate to consumer credit. Innovation creates a useful or desirable value-added object. Branding adds a rational and emotion appeal to the innovation. But consumer credit makes it possible for people to buy these products.

So long as Chinese consumption remains on a cash basis, very few people can afford to pay cash for discretionary goods. They save their cash to purchase a home, a car and educate their children. They lay out a lot of cash for these fundamental purchases and take out banks loans for the balance. There is little cash left for goods that can support status and advancement, like gifts, stylish and fashionable apparel, entertainment, home furnishings, consumer electronics, and other appurtenances of personal success and achievement. They need to purchase expensive goods to display their status. Innovation and branding tempt purchase, but consumer credit enables purchase and accelerates domestic economic growth.

[1] This article was published in February, 2009 in the 21st Century Business Herald.

Searching for Markets

The following is a speech given by Milton Kotler at The Wharton School of Finance, University of Pennsylvania on February 21, 2009.

Introduction
•I have only ten minutes to tell you where companies in China are searching for customers in this global recession.
•I will not waste time telling you how bad things are.
•I will limit myself to:
–Where Chinese companies are going to market in China
–Where Chinese companies are going to market internationally
–Where foreign companies are going to market in China.

Chinese Companies in China
•There are three “ Going to Market” roads for Chinese companies in China:
–Follow the “stimulus” program.
–Expand the consumer credit market
–Add value to consumer products
–Penetrate the countryside

Stimulus Market
•Infrastructure
–Dilemma
Only super-size infrastructure is controlled by the Central Government and can be measured for stimulus efficiency.
Big infrastructure will benefit SOEs.
Local infrastructure is decentralized. The Central Government cannot control “pork” allocation and corruption beyond normal means. (Much like giving stimulus money to the States in the U.S.). Hence, little stimulus efficiency.
Private companies will struggle for local development “relationship” deals.
Bank lending will double this year over last year to capitalize both levels of infrastructure.
•Supply side industry subsidies
–Export industries will get cost reduction subsidies to capture more export market share in declining global trade.
–Loans for retail expansion
•Social benefits and welfare
–Health care companies will benefit from health care expansion and upgrade. The government needs new NGO social service groups to serve the poor.

Consumer Credit
•The Central government is encouraging consumer spending with more loans and tax incentives
–Bank loans for auto and household durables purchase, mortgages loans
–Purchase tax incentives
–Trying to contain credit supply within the state owned banking structure. This will not work.
•China will have to extend consumer credit credit supply to private retail channels.
–This is the crux of demand side stimulus
–People will not spend their savings; only spend credit.
–The government banks and private lenders needs data and systems to expand consumer credit.
–Major entrepreneurial opportunity for Chinese companies that can service the growth of this industry..with data, systems and media promotion.
–The government will have to promote a public campaign….It is Glorious to Spend!

Brand Trend in China
•The Chinese brand trend is different than the Western trend
–The Western trend is down-brand
–The Chinese trend is a mix of up-brand and value brand movement
–Depending on the depth of the Chinese slowdown there may be a convergence.
•Price-only goods dominate the Chinese domestic mass market.
•Rising worker and farmer earnings are moving shoppers to value brands
–Galanz is changing is lowest price strategy to a value brand with added features
•Aims to compete more forcefully with Midea
•The middle class is moving from value brands to standard brands
–Rowe in autos; Hisense in Appliances
•Foreign makers own the premium, performance and luxury brands
–But they are moving down-market with standard and value brands

China Brand Challenge
•Continue competitive advantage in price-only and value brand production for the domestic market and global export.
•Move domestic branding from lowest price to value brands
–Block foreign brands from invading value market.
–Foreign makers are trying to move into this high volume market and capture urban worker and rural purchase.
•Move forcefully to capture the domestic standard brand market.
–This is a new brand level market for China’s middle class.
–The Chinese middle class wants to move from value to a higher notch of quality and status. As the middle class matures, standard brands will take over.
•Don’t try to compete with foreign makers in the performance, premium and luxury brand levels.

Penetrate the Countryside
•The government is putting a lot of its stimulus into the countryside.
–To reabsorb unemployed urban workers who are returning to their towns and villages.
–A lot of the old farm land is gone
–Policy requires rural development: town and village development.
•Small scale local enterprise assistance
•Micro-financing
•Better education and training
–Chinese companies are moving more small scale production and distribution and sales into the countryside.

Chinese Companies Internationally
•Protection is an operating assumption; therefore:
–Focus export on developing countries where China has enough political leverage to prevent doors from shutting.
–Develop production, assembly and distribution in foreign markets.
–Acquire foreign value brands

Diversify Export
•China will increase export to developing countries to offset declining export to developed markets. China will:
–Use its past decades of political relations with developing countries in Africa, Mideast, SE Asia and Latin America to prevent protectionist exclusion and optimize access.
–Leverage its resource and infrastructure investments in these countries for consumer export access.
–Use highly flexible overseas Chinese communities and labor deployment programs.

Export Production
•Prolonged global recession will require more cheap goods
•China is the master of cheap goods production
–State policy models – SEZs (Special Economic Zones)
–Industrial operations, labor resources and risk culture
–Supply chain management
•China will follow the pattern of the U.S. to export production, assembling and distribution to foreign markets.
•Local production in foreign markets adds brand value..meeting local quality and safety standards.
•Protectionism trend will accelerate a multi-national trend for Chinese enterprise. We will see Chinese economic development zones in the U.S.
–Chinese SEZs will support their enterprises to locate abroad to protect and expand their market access and retain tax revenue from these enterprises.
•Shenzhen has an industrial zone in Vietnam.
•TEDA (Tianjin Economic Development Zone) has a SEZ in Egypt
–Chinese production and distribution enterprise will be accommodated (grudgingly) in foreign market for employment and local tax generation.

Acquire Foreign Value Brands
•It the current global recession, good global brands are for sale and are “dirt cheap”
–Lenova paved the way with IBM’s Think Pad.
•The company is struggling for its global foothold and other Chinese enterprises are watching to see if they can make it.
–Sichuan Auto is talking about purchasing Hummer from GM
•We may see Chinese purchase of off-loaded U.S. carmaker brands
•Dying brands in the West, like Buick, seem to succeed in China.
–Esprit died in the U.S. and is now a big hit in China.
–Haier made a play for Maytag
•As China becomes more “global” and more confident in its business management, they will buy foreign brands for brand premium and distribution margins.

Foreign Companies in China
•China will pressure foreign companies in China to prevent protectionism in their home countries.
•As the recession deepens and unemployment grows in the home countries this may not work; therefore:
–Become more Chinese!
•Sell more corporate bonds and equity to Chinese investors and companies.
•Acquire Chinese companies
•Strategic alliances with Chinese companies
–Promote consumer credit in the China market for foreign goods
–Penetrate the major urban markets with value and promotion
•Local politicians will make it hard to penetrate the countryside for foreign goods

Diplomatic Load
•Profit from China operations and sales is the life blood of many foreign companies.
•China will press foreign companies doing business in China to pressure their own home countries to play down currency manipulation allegations and protectionist threats.
•This business diplomacy will struggle to transcend WTO channels and seek bi-lateral agreements. It may not work.

Acquire Chinese Companies
•As Western domestic consumer markets shrink, foreign companies will have to expand their China portfolio.
–It is the only large growth market without high debt and instability downside.
•New inventive financing for these acquisitions
•New forms of China partnership deals
–Help advance China privatization policy
–Application of skilled Western technical and management talent to China
•IBM offers option to lay offs to move to new sites in China and India.
–Changing the global business model of foreign companies
•Wal-Mart is opening more stores in China than in U.S.
•Etc. for Starbucks, YUM, and many other franchises.
•Acquisition strategy will require bi-lateral political negotiation and agreement.

Strategic Alliances
•The key to strategic alliance for foreign companies with Chinese companies for market position is:
–Technology transfer
–China acquisition rights in home countries
–Increased DFI
–Shouldering political burdens for China
–Sharing distribution rights and margins

Consumer Credit
•The smartest thing for Western companies to do in China’s consumer and B2B market is to advance consumer credit.
•Western consumer companies should take the initiative to promote and facilitate consumer credit
–They have the technical and marketing skills to advance these systems
–They have a larger global framework for risk management.
•Cooperate with the China government banks to advance this frontier for domestic growth.

Sustain Position in Urban Markets
•Western products enjoy the confidence of quality and status in China’s urban markets.
–This is the essential competitive advantage of Western products in China.
–Chinese companies and brands are trying to catch up.
–If Western companies soften their quality and prestige by countryside downgrading, their value will decline.
•Don’t make the Mercedes A Class mistake.
–There is still great room for penetration in the sophisticated primary and secondary cities.
–Apply resources to strengthen brands and penetration urban markets, rather than endanger advantage through rural distribution.

©Milton Kotler, Kotler Marketing Group

Doing Business in China

Doing Business in China:
Establishing Small- and Medium-sized American Enterprises
By
Milton Kotler *
© Copyright, May 2008

Most of the American commentary on doing business in China has focused on large multinational companies. But more and more people with small and medium-sized enterprises (SME) are seeking to establish a foothold in that country and are searching for principles and policies that will help them avoid the pitfalls inherent in setting up a business in a foreign culture with new and evolving rules of business conduct. They need two kinds of information: 1) detailed information about regulations, business intelligence, demand and supply, and the marketing practices of their industry in China. This kind of information is readily available from business journalism, technical reports and industry reports. And 2) a general sense of how to conduct their search for Chinese and American counterparts with whom they can work—partners, experts, strategic allies, customers, managers, staff and support services. That is the human side of business and it is a minefield for the newcomer. This article outlines basic policies for avoiding these pitfalls, based on nine years of serving the interests of Chinese and SME American businesses. This article is excerpted from Why China? An American Business Adventure.”**

Policies for Establishing a Business in China

The American business man or woman needs to know how to acquire an effective introduction to China, how to facilitate his or her way into the country and once there, how to find partners: how to build, manage and lead the business; and how to serve clients and customers. (Americans will also need to become familiar with the Chinese language and business culture and, if they plan long stays in the country, how to find the friends who will make their lives there pleasant. These are dealt with in the author’s book.)

Before You Go. Important sources of information in the U.S. consist of colleagues, experts and friends who are already involved in China. In addition, journalists’ coverage--particularly the business press—and technical reports are helpful. But for the most useful background Americans should turn to U.S. academic institutions, the Chinese embassy and consulates in the U.S., the trade and professional associations in their fields and local Chinese-American and Western meet-up groups.

University business schools often have executive seminars on doing business in China. While the cost of attending may sometimes be high, it is seldom prohibitive and these are important busness investments, not only for their educational value but also the benefit of introducing you to peers with whom t0 share information. Every Chinese consulate throughout the U.S. has a commercial officer who is there to talk with American entrepreneurs and can supply official and personal knowledge. There are Chinese business groups in almost every American city at which Chinese-Americans merchants and professional meet regularly. They willingly reach out to the broader community and will welcome you to a meeting where your business interests may fit opportunities some of them are seeking.

Several national associations have Chinese programs. The U.S. Chamber of Commerce conducts a Chinese business program in several cities. The U.S.-China Business Council in Washington, D.C. holds workshops in the U.S. and publishes reports on various business topics. And the National Committee of U.S. China Relations has a very active program of public affairs education concerning China in many cities. Their membership is prominently involved in business, government and academic institutions in China.

Many trade and professional associations are increasing their Chinese programs to meet the business needs of their members. There are also informal “meet-up” (see http://www.meetup.com/) groups of Chinese and Western social and business networks in every major city. These offer a good way to make Chinese acquaintances who can introduce Americans to friends in China. (Be careful to check out any grandiose claims a new Chinese “friend” may make.)

Once You’re There. In China you will meet people who can connect you to potential partners and help you make practical decisions about your business mission. The American with a modest budget who hopes to establish an SME must find a good Chinese partner early in the game. While Chinese commercial policy requires joint-ventures in designated industries, you’ll also have a practical need for a Chinese partner for a wholly owned foreign enterprise. You will also need a professional advisor or consulting firm--either American or Chinese (the American advisory, or consulting firms are far more expensive)--for strategic assistance. Most of the Chinese consulting companies have Western-trained, English-speaking staff and know the Chinese industries, companies, and leaders better than the American firms. Check their client list and ask for references. There are also independent consultants who will offer you their help. The American should be careful in dealing with this group and should not waste time with anyone who offers to help on a commission or success basis.

Still a third group of people who will facilitate your entry into China’s business world consists of Chinese companies who will contact you. Communications among the Chinese is very fast and word will spread quickly that you are looking for a partner. Companies in your field of business will soon know that you are looking for a partner and will--after some screening to be sure you’re legitimate--ask you for a meeting to discuss a possible relationship.

Partners. A Sino-American partnership involves many more than two parties. On the Chinese side, private enterprises may involve family, friends, investors, and other businesses with which the enterprise is associated. There are also support partners in the areas of supply, distribution, governmental relations, business development, finance, customer relations and operations. All of them participate in the value of the enterprise and most of them have to be consulted by the Chinese partner for consensual agreement before entering a Sino-American partnership. The American “partner” may also, of course, consist of more than one participant, but seldom to the same degree. Americans may be confused by the fragmentation of the Chinese enterprise they are dealing with but in reality, the American side, which is more vertically organized, may in fact take a longer time for communication and decision than the Chinese side takes to move horizontally. American vertical decision patterns are just as confusing to the Chinese as theirs are to us. It is well to keep that in mind when negotiating with Chinese partners.

Goals. Americans tend to look for short-term, transactional deals since they have a world of industrial trade and investment opportunities to choose from and can find a lower-cost provider or a better market. The Chinese, who are new to the global marketplace and therefore less sure-footed, tend to look for on-going relationships. The American has to decide at the outset of a partnership discussion if he is in for the long haul and he must communicate that very clearly. If he only wants a transactional deal, then he must be prepared for the fact the Chinese side may short-change him in exact proportion to the weakness of the intended business relationship.

Age. American partners are usually older than Chinese partners. It is not unusual to meet a 35-year-old CEO of a multi-million dollar company. Even State-owned companies have largely replaced an older generation of managers and executives with younger, well educated people. But this age disparity is good for Sino-American partnerships because Chinese culture in general reveres age and young Chinese managers respect older businessmen from American and Europe whose experiences has been in free markets rather than planned economies. It’s good policy, therefore, for an American SME to send its most experienced, and probably oldest, executives to China to make deals the company is looking for.

Transparency. Americans expect a transparency of information from potential Chinese partners, but that is rarely possible. Many Chinese business relationships are not formally documented; accounting standards differ; relationships with government are based gaunxi (personal relationships); and so on. Chinese company governance is different from that of American companies. They do not have to report to the government or to their shareholders the same amount of information that American companies are required to report and a great deal of activity that is off the books is very hard to uncover. You need to engage a competent professional to conduct due diligence. There’s not much you can do about all of this, except to press your Chinese counterpart for more information and then adjust your risks factors to accommodate for gaps in information.

Cultural Rituals. All the Chinese you deal with in your search for business relationships will want to spend a good deal of time with you in order to assess your character and learn about American business practices. This involves a ritual of lunch and dinner meetings which may seem unnecessary to the American who wants to make a deal and head home. But for the Chinese, personal dignity is tied up in every deal and if something goes wrong, your Chinese partner loses face in the eyes of his peers. No lawyer can repair this, so there has to be time to build genuine trust and confidence in the American party. There is always an uneasy mix of Chinese sociability and American impatience.

Managing Your Business in China. No American SME can succeed in China with a competent, industrious and responsible general manager (GM). In the beginning your GM will have to handle the development of the business and your staff. Your company is bringing a new value to the Chinese economy and it is up to the GM to introduce you to Chinese CEOs who are interesting in doing business or partnering with you. Unless you speak fluent Chinese, your GM will have to be your voice and your ears in all transactions, so it is essential that he or she has a good command of English and can interpret effectively.

Actually, you, as the leader of your company, will play only a small role in negotiations with the Chinese. Your job is to make your requirements very clear to your GM, present a gracious attitude and character at meetings and be available as needed. Your GM builds and sustains the relationship with the Chinese counterparts. However, the American SME must maintain a presence in China and that will require frequent trips.

Staff. You will need a good senior staff and this starts with bringing a top member of your U.S. company to China. He or she will work with your GM to set the standards of professional performance for the rest of your staff. This person must be willing to stay in China long enough to build a competent staff, for he or she serves as your alter ego for the quality of the work your company will do in China just as your GM serves as your alter ego for business development and management. Knowledge of Chinese is not a requirement for the job, since your GM will serve as translator and interpreter in dealings with the staff. But the person you choose should have the background and disposition of a teacher so that he or she can be effective in training new staff members. It is important to remember that members of your staff are working for you both for wages and for career development. They are serious to learn American modern business methods to advance within your company or to leverage their experience into another company at a higher position and salary.

You must learn to adhere to Chinese rules of company organization, which are much more rigid than American rules. If you say something to a subordinate that you have not cleared with his or her immediate superior, you upset the chain of command and create difficult management problems. Remember not to encourage personal staff initiatives without checking first with your GM.

Reward good performance with an extra bonus, in addition to the annual New Year bonus everyone expects. If you can’t match the salary increases they can get in another company, give them good references and don’t stand in their way. When a staff member falls short of doing the job you expect, work with your GM to explain his or her failure and spell out what you want him or her to do. It is you job to build the company culture. If the staff person continues to do a poor job, he or she must be dismissed with a careful explanation, without malice, of the reasons for the dismissal.

Support Services. All American companies in China need the support of lawyers, accountants, research companies, and other outsource firms. Given the evolving nature of Chinese commercial law and complex tax and regulatory issues, it is important to have a Chinese accounting firm to handle the bottom line of budget and control, receivables and payables, tax and social welfare payments, balance sheet, annual audit, regulatory compliance and foreign payments. Chinese policy changes frequently in the growing market economy. There are several large Chinese law and accounting firms that are very trustworthy for on-going service. They are much less expensive than American firms. For the start-up, however, though they are more expensive, it is probably easer to deal with an American firm in China and move toward a Chinese firm later.

Dealing with Clients, Customers and Experts. Once you have set up your business and are dealing with Chinese clients and customers, you will find that they expect you to do a great deal more for them than would be the case with American counterparts. Details abut service deliverables, product quality, logistics and payment schedule must be pinned down with as much precision as possible or the customer will always ask for more. There will always be latitudes of interpretation in any contract, so it is necessary to budget with full awareness that you’re going to be asked to do more that you’ve agreed to do. In addition, market circumstances and government policy can change over night and the SME must be constantly aware of these changes and continuously adapt project management and deliverables throughout the course of a project.

An American SME may have to outsource a number of elements of a project. Either Western or Chinese expertise may be necessary. The Western expert will undoubtedly to be more expensive and will usually require tutoring by the SME to prepare them for the Chinese situation, additional demands by the client or for changes in government policy. If the expert is not flexible enough to deal with this situation, the project is in danger of foundering. Chinese experts, on the other hand, my be less expensive at the outset but may be carrying an overload of other assignments at a lower cost in order to attract more business. The danger here is that either they cannot deliver on schedule or they subcontract the assignment without your knowledge and deliver poor quality. It is prudent to investigate their true workload and to develop very specific and deliverables, personal responsibilities and schedules so you can terminate the relationship without legal headaches if there is a performance failure.

Your Chinese clients will expect you to attract investment funds for his or her project as well as design the project. Every private Chinese company is looking unceasingly for capital. Chinese banks favor State-owned companies, so there are limited capital vehicles for private businesses. Unlike American marketing consulting companies that separate strategic marketing from investment attraction, most Chinese companies will not pay for marketing studies without an identification of prospective investors. There is a danger in integrating investment attraction services with every project. Investment services target a particular niche of investor interest. The momentum of this targeting can force its way into the strategic direction of your company and drive it to focus on that niche to the detriment of a broader service offering.

Americans in China. American and other Westerners are not bringing a market economy to China; the market economy, although only 25 years old and still growing, is already there. And Westerners have to find their way to enter it by bringing something new and valuable into a dynamic pattern of growth. The Chinese business culture does not exist from 9:00 am to 5:00 pm. Chinese owners and managers work hard and take little time off for recreation and family affairs that Westerners find so necessary.

The concept of “saving face” is all-important to the Chinese, whereas Americans are more concerned with creative deal making and legal formulation than with personal honor. The American business person can inadvertently humiliate his Chinese counterpart and in order to avoid it has to recognize that a Sino-American partnership is a trusted collaboration with all of the collateral elements of business--partners, investors, operators, customers, suppliers, connections, friends and family.

Despite the pitfalls which confront the American leaders of SME businesses in China, the chances for establishing a successful business there are growing exponentially. Chinese industry is now beginning to develop strong domestic markets to match the strength of the country’s global activities and American SMEs can take an active role in contributing to that development while working with their Chinese partners.


*Milton Kotler is President of Kotler Marketing Group (KMG), headquartered in Washington, DC with offices in Beijing, Shenzhen and Shanghai, China. KMG China has three divisions: strategic marketing; urban and industrial land development and marketing and marketing and sales training. KMG China has been operating since 1999. mkotler@kotlermarketing.com; http://www.kotler.com.cn/. My thanks to Carla Sykes for editing this article.
**Kotler, Milton, Why China? An American Business Adventure, (forthcoming)

Crisis and Opportunity*

The Financial Crisis

The private Western financial system is structurally broken. The extraordinary leveraging of capital, into hundreds of trillions of debt, created a bubble that had to burst. Capital assets have been decimated.

Flaws

The excessive leveraging if credit was due to the failure to regulate the debt origination, structure and transaction of mortgage-backed securities, hedge funds, credit-default swaps, derivatives and other innovative capital instruments. Alan Greenspan has admitted his error. This admission is ominous because what he could not have imagined has no intrinsic limits. We have only seen the tip of the iceberg. After the housing bubble, we will see the collapse of consumer credit and auto loans. Defaults on credit cards have reached 7% and auto loans are beginning to unwind.

Government bail-outs throughout the world will not work because there are not enough reserve capital assets to absorb an astronomical scale of debt.
Financial institutions are being nationalized and the financial sector is reduced.

Prospects

Remaining private capital will continue to seek protection in the safe haven of government bonds, which have virtually no yield, when factored for inflation, and the downward speculative arbitrage of currencies. Government financial intervention is a powder keg of inflation. There is no end in sight.

Economic Crisis

The West is in technical recession. Collapse of the financial service economy has caused massive layoffs. The next distressed sector will be retail, which is 70% of U.S. GDP. Retail growth is negative and will be devastated by credit suppression. Commercial real estate and brand equities will decline.

China, India and emerging economies will continue to grow at a lower rate, which distresses their need for higher growth to urbanize large rural populations. Seven percent growth for China looks good in the West, but it is not enough for China. Yet the East will be better able to manage reduced growth than the West, which wrestles with negative growth. The growth imbalance is between the East and West is likely to last for a long time

Flaws

The West became a consumer, financial and technology society while the East has became an industrial economy. The greatest mistake of the U.S. was its refusal to sell advanced technology and weapons to every buyer (its only growth sector in the real economy) to balance its trade deficits. American foreign policy butt heads with real economy, and forced China to build its own advanced technology. The West produced and sold credit, while the East produces things and moves which move forward to added value.

Debt is only manageable as long as there is credit to recycle debt. Once Western credit became paralyzed, its debt had to be devalued. Industrial manufacture in the East can be managed by reducing variable costs. It is more flexible in tough times than finance.

Prospects

There are no new economic growth drivers in the West. The hope of an alternative energy will be vitiated by falling oil prices. Equities will fall to the level of the real economy and it is very difficult to measure what the real economy is. U.S. agriculture is only three percent and manufacturing nine percent of the economy. Europe, traditionally with a higher manufacturing percentage of GDP, is rapidly declining, without a retail expansion offset. We will see soaring Western unemployment, political confusion, protectionism and social unrest. Wealth is shifting from West to East.

Marketing Crisis

Marketing created a consumer society based on consumer credit.
So long as finance was regulated, the leveraging of this credit was limited. Deregulation took the cap off of leverage. Information and media technology vastly enriched the perceived value of brands. The dynamic interplay of brand enhancement, consumer credit and low cost offshore production created vast profits in brand equities. In recessions, brands, which are, after all, only perceived values, lose their perceived value as savings become a stronger value. Consumers turn to value and price only goods. While brand value declines in the West, it is gaining strength in the East. The manifest wealth of brand ownership masks real debt.

Flaws

Marketing became vastly empowered by information technology, product innovation and management sophistication. On the B2C side, product marketing went too far in hyping demand with too many new and varying product models, distribution channels, aspiration and promotions. Financial credit marketing to consumers hyped demand with too many consumer credit instruments (redundant credit cards, interest only credit programs, excessive credit lines, sub-prime mortgages) and leveraged debt to users, who lacked the resources to handle this debt.

On the B2B side, financial marketing technology and management innovation, without regulatory restraint, created sophisticated and impenetrable financial instruments (Mortgage backed securities, credit defaults swaps, repos, and other instruments) and sold them to financial institutions, which were incentivized by bonuses to buy this stuff, rather than scrutinize it. This has been an explosive combination of B2C and B2B marketing to consumers and to financial institutions.

Prospects

It is not enough to regulate financial institutions at a macro-level. Micro consumer credit has to be regulated as well, along with product marketing. Even with a tightening of credit, clever and ruthless lenders will devise and sell new products to desperate consumers to get them out of their mess. They will find ways to sell this paper to traders desperate to grow client accounts. These practices will make matters worse.

Governments will have to empower their retail trade authorities to monitor and restrain both demand and supply products and their advertising claims. Marketing has to be regulated. In desperate situations, criminal penalty is the only restraint on fraudulent invention. Voluntary restraint flies out the window. Branding will have to be compelled to become responsible. In a deep recession we will see a tremendous shift from brand to value marketing…a movement from perceived value to demonstrated value.
We will return to the basics.

Situation in the U.S.

The U.S. is in a recession and it will be prolonged. With the nationalization of financial institutions we are not dealing with a cyclic phenomenon but with structural change. Structural change takes a long time to regain stability and gain trust. In the meantime the bankruptcy of companies and households will lead to austerity instead of “life style”.

Unemployment in the U.S. has reached 7% and will probably jump to 9% by the time the October storm is reported. It will climb higher next year as companies adjust to a weak and almost invisible Christmas buying season. Christmas sales typically account for 30% of annual retail sales. Without a Christmas behind or ahead, companies will retrench in the domestic market. With retail at 70% of the U.S. the magnitude of this domestic retrenchment of employment will be enormous. We will likely see a Japanese style of stagnation for a decade. It happened there. It can happen in the U.S.

U.S. companies will continue to shift marketing investment to the East, where economies will continue to grow, albeit at a slower rate. The economy of large populations growing at a slower rate is much more attractive than smaller populations with no economic growth. U.S. dollar strength, backed by military power, will reduce export and political passions will insure protectionism is a futile attempt to recover domestic manufacture. The trend toward personal and household savings will not fuel a domestic renaissance of manufacture.

Prospects

With falling exports, the U.S. will be compelled to do what it has resisted for years – sell advanced technology and weapons to everyone as the only basis of trade balance or surplus. This will require a strategic alliance with China – a repeat of 1972 Nixon/Kissinger secret diplomacy, but in a new context and a new deal. The deal will probably sacrifice Japan, as 1972 sacrificed Taiwan.

The U.S. population will grow through immigration, legal and illegal, to lower labor costs for the arduous effort to revive the manufacture of low cost goods and expand domestic consumer demand. Protectionism will assist this attempted renewal. Conservative capital will continue to seek the wealth safe haven of U.S. military-based security. Investment capital will fly to growth markets in the East, along with domestic management talent. Foreign currency reserves will finance the Eastern acquisition of Western assets. It is hard to say how the society will manage social unrest.

Situation in Europe

Europe is in a deeper pickle than the U.S. They will have a prolonged recession, political fragmentation, protectionism and a tortured lowering of their fabled life style. The Euro may reach parity with the dollar, or go lower. Indeed, it may disintegrate as a currency.

Prospects

The failure to pass an EU constitution was fatal. If it could not pass in a prosperous time, it certainly cannot pass in a desperate time, when every nation will look out for its own survival and not trust any common accord to insure survival. There is too much disparity of national conditions in Europe for unity of action. Stronger countries cannot carry weaker countries on their back when they can hardly walk themselves.
There is too much embedded welfare in Europe to support capital formation. A serious unwinding of welfare in a continent of high unemployment will cause social unrest. The economy will be paralyzed, which is a step worse than stagnation. Stagnant societies can act; paralyzed societies cannot. Europe’s failure to create an independent military was always the Damoclean Sword of the Euro.

Situation in China

China will be affected by the global economic crisis. Growth is falling to 8% growth and will likely descend to 7%. But China still has $2 trillion of currency reserves, a stable budget and manageable debt. Remarkably, retail is up 30% and exports grew 28% in the last quarter. China’s established model for production of cheap goods is serving her well in these bad times when the whole world needs cheap goods.

Prospects

China will manage a balance between its continuing export economy and the growth of its domestic economy. Chinese policy is smart enough and authoritative enough to induce or force savings into consumption for domestic expansion. Its trade policy and acumen is smart enough to find new niches for the export of cheap goods as well as new niches for value added export. This balance will be a wonder to behold in a messed up world.

Chinese currency reserves will support its enterprises to acquire bargain production, brand and distribution assets abroad for higher profit margins. High distribution margins through ownership can offset higher production costs. In-country production and distribution will off-set protectionism. The economy will have sufficient growth to manage internal harmony. China will augment its world power when technology investment produces competitive value added products and advanced technology. When China has a competitive technology based in its production system it will make the Rmb convertible. It will become a global reserve currency and, unlike Europe, will fortify this currency will increase military strength.

Chinese Opportunity

Prolonged global recession will require more cheap goods, i.e. that is price-only and value goods vs. premium brands. China is the master of cheap goods production through its State policy models of low cost labor, industrial operations, entrepreneurial culture and supply chain management.

The major threat of global protectionism must be pre-empted by the export of its production systems, not just products. China must have internal production and market access in foreign consumer markets so it can flood these recessionary markets with cheap goods. When factoring in high distribution margins, it can offset higher labor costs with distribution profits for a lower total cost than domestic competitors. Chinese production and distribution in foreign markets will be accommodated (grudgingly) for employment and local tax generation.

China can transplant the Shenzhen SEZ (Special Economic Zone) model to foreign markets. SEZ is an integration of public capital support, incentive policies, subsidies and private investment in development, production, logistics and marketing. China’s can develop Sino-U.S. and Sino-EU economic zones in the U.S. and Europe. China and its municipal and provincial governments can retain tax revenues by supporting its enterprises abroad. U.S. state governments, like Kentucky, and certain European countries will welcome this entry to alleviate unemployment and local tax stress. These zones will be partnerships with domestic companies, but Chinese enterprise will have joint control of production, brand, logistics and distribution.

Land costs are cheaper in many State of the U.S. than in Guangdong.
Chinese enterprise will use local management talent desperate for work.
These new zones will be very large and require intelligent planning, artful political negotiations and foreign legislative protection. Unlike current ad hoc Chinese enterprise acquisition in the U.S. and Europe that are scattered and fragmented, these SEZ zones will provide political protection for Chinese local assets. They will represent a new stage of Chinese globalization. Instead of the West penetrating the East during the period of good times, China will penetrate the West during the period of bad times.

Milton Kotler
President, Kotler Marketing Group
October 2008

*This speech was presented to the Asian Economic Forum, Hong Kong. September, 2008. It was published in the China Business Review in December, 2008