Marketing Infrastructure Investment

For the past two decades China has been the world leader in domestic infrastructure investment and construction. It has now become the global leader in infrastructure investment and construction. With towering Chinese capital reserves, bank and SOE resources, engineering, equipment, construction capability and strategic policies, global infrastructure investment and construction will be China’s next great economic driver to sustain GDP growth.

 Rough estimates from the 2009 OECD Infrastructure Project suggests that annual investment requirements for telecommunications, road, rail, electricity transmission and distribution, and water taken together are likely to total around an average of 2.5% of world GDP. If electricity generation and other energy-related infrastructure investments in oil, gas and coal are included (as the IEA does in its Investment Outlook), the annual share rises to around 3.5%. Clearly, the figure would rise further if we include other infrastructures, e.g. sea ports, airports and storage facilities, telecommunications, etc. Since the 2011 global annual GDP was $65 trillion, this amounts to $2.275 trillion a year (at 3.5%) or $56.8 trillion over a 25 year period. The real physical need is probably closer to 5% of annual global GDP; and this excludes social infrastructure.    

The highly respected 2009 Cohn & Steers Global Infrastructure Report projects a need for $40 trillion over the next 25 years for water, electricity, roads and rail and airports and seaports. Excluding other vital areas of physical infrastructure, the estimate corroborates the OECD forecast. Both of these projections do not account for cost increases or variable global GDP growth rates and revenue streams. Nor do they consider any reserve costs for unanticipated innovative systems that are bound to emerge over a 25 year time period.

To highlight the magnitude of investment need, KPMG estimates that the U.S. has to spend roughly $40 billion a year just to upgrade its roads. President Obama’s 2013 budget proposes $50 billion for all infrastructure expenditure. The estimates of different sources are all over the place, but they are all staggering.

When you consider that the U.S. purports to spend 2.5% of its GDP on physical infrastructure; Europe 5% and China 9%, you notice several things. The U.S. cannot even update its current infrastructure. It is rated as 26th in infrastructure quality by the Society of Civil Engineer’s 2009 Global Report.   Europe at 5% is committed to infrastructure maintenance and marginal growth, but is hardly likely to accomplished this target in view of its long-term fiscal crisis and sovereign recessions. China is racing ahead  at 9% of its GDP.

However essential physical infrastructure is for competitive economic growth for Developed, BRIC and Developing Economies, traditional capital sources cannot meet this need. Typically, capital customers were government budgets and user fees, government debt; commercial and investment banks, public funds, like the World Bank, private investment funds and commercial privatization. In today’s post- fiscal crisis world of intense global competition for infrastructure, these sources have largely dried up. The new frontiers of investment are sovereign funds, specialized private global infrastructure funds, larger scale public/private partnerships and extensive privatization.

As Berthold Brecht in his opera Mahaggony declaims, “There is no Money in this Town”! The gravity of this issue is illustrated by the paltry sum of available global infrastructure private funds. Goldman Sachs is among the largest of such funds. In its current 2011 report, GS Merchant bank announced it has raised $10 billion since 2006 for investments in infrastructure and infrastructure-related assets and companies.

Pension funds are enormous, but it should be noted that the second largest pension fund in Europe spends only 1% of its holding on infrastructure. Pension funds are reluctant to invest because of political instability, regulatory interference, cost overruns, extended periods of cost recovery (often 15-30 years), and disruptive technology that can upset forecasts. Postal service investment has been wrecked by the Internet. Maritime ports are clobbered by trade fluctuations and competitive ports and trade routes. Rail investment is constantly at war with highways development and truck transit alternatives. Fifteen years is a long time for cost recovery and a fair return on investment.

Over the past decades, privatization has mitigated the deficiency of public finance, notably in telecommunications, gas and electric power and roads. Privatization will continue to grow in the years to come. However, it requires a dependable legal and regulatory structure; standards protocols for operataibility, politically reliable user-fee rate-setting regimes, and numerous subsidies to make it viable for listed companies to finance, build, operate and maintain reliable and durable systems. It is an important contributor to infrastructure maintenance and growth in the U.S. and Europe, notably the UK. BRIC countries are getting there with 20%-30% of their infrastructure already in the private sector.  Developing countries lag behind because they lack planning and management capability, as well as the legal, regulatory, administrative and political conditions that can protect long-term foreign investment. There is also a resistance in developing countries to privatization because it withdraws a powerful instrument of political control and public employment from political leaders.

Public/Private Partnerships (PPPs), such as listed utilities, have developed over the past three decades to meet infrastructure needs. These are complex arrangements that meld public budget and debt resources with private domestic and foreign investment partners to build, operate and maintain infrastructure though a variety of business models. One model is equity investment; another is Build, Operate and Transfer (BOT), which gives private companies concessions to build and operate public installations for a term to recoup capital costs and profit targets; and then revert the concession back to public ownership, or whatever successive arrangements of operation and capitalization public authorities may wish to make. 

These are very long-term projects and their performance has been mixed. The Millau Bridge in France was totally financed to the tune of 320 million Euros by the private company Eiffage on a 78 year concession for toll increases not to exceed the rate of inflation. The Confederation Bridge in Canada, linking Prince Edward Island to New Brunswick has a 35 year concession for private tolls. These projects are by and large successful, with exceptions like the bankruptcy of Sydney Australia’s Cross City Tunnel, which overestimated the volume and value of truck freight to the port. 

The newest sources of global infrastructure investment are the sovereign reserve funds of BRIC and Middle East countries, primarily China. These funds have different investment strategies and business models and have taken an aggressive position in turning from sovereign debt purchase to investments and acquisitions of tangible infrastructure and company assets.  

Sovereign funds, Public/Private Partnerships and intensified privatization are the key to future infrastructure in the competitive environment of the wide and deep search for scarce capital.  The old public finance paradigm of selling infrastructure to ample capital sources must be replaced by a new paradigm of competitive marketing to scarce capital sources. Marketers can help countries to shape infrastructure projects that can compete for capital on the basis of what capital customers specifically want, not the wish list of country infrastructure desires.   

China

China has built more infrastructure in the past two decades than any other country. It has more highway miles than the U.S., the largest telecom network in the world, the three Gorges Dam, 14,000 miles of operating high-speed rail and work in progress for a total of 43,000 by 2015, the largest seaports in the world, airports galore and more planned, and the greatest number of electric power plants in the world, along with 36 planned nuclear plants.

China has the engineering and related equipment, construction know-how, technology and human resources to build and manage many sectors of infrastructure anywhere in the world, not to mention its $4.3 trillion sovereign fund and additional trillions held by state banks and state-owned enterprises. China's export of infrastructure financing, equipment and construction is a new major driver of China’s economy.

Addressing European appeals for debt purchase, Lou Jinwei, Chairman of China Investment Corporation, China’s sovereign wealth fund, declared that “it is difficult for long-term investors, including his company, to buy European debt, and investment opportunities are more likely in infrastructure and industrial projects” (China Daily, February 15, 2012). Primer Wen Jiabao has reiterated this same message in numerous meetings with European leaders.

China has supported the West with national debt purchase for a decade and continues to do so to a lessening degree. Now, China wants to make real money by building tangible, revenue producing physical assets that advance their foreign manufacture, trade penetration and geo-strategic interests. Global infrastructure investment, construction and management are the new drivers of Chinese economy. 

China’s infrastructure in Africa grew from less than $1 billion annually to $6 billion in 2007. Its cumulative investment by 2009 reached $24 billion, which was 10% of their total outbound FDI. This amount has grown since then, and it is concentrated in electric power, roads, rail, dams and water systems, airports, sea ports, mining infrastructure, telecommunications and Special Economic Zone (SEZs).

In 2007, China financed 10 hydroelectric power projects in Africa with an investment of $3.3 billion. It financed $4 billion worth of investments in road and railway network in Nigeria, Gabon and Mauritania. In information and communication infrastructure China supplied $3 billion in equipment to national firms in Ethiopia, Sudan and Ghana.

The $3 billion Great Gabon Belinga iron ore mine, which broke ground in 2009, is China’s largest mining operation in Africa. China is building a rail that links the Atlantic coast of Africa in Bengala, Angola with two ports on the Indian Ocean, in Tanzania and Mozambique. This is the first ever East-West rail link between Africa’s two bordering oceans. The most recent investment is a $1.5 billion refinery investment in Uganda. China has  constructed SEZs in Ethiopia, Nigeria, Egypt, Mauritius and Cape Verde to leverage their infrastructure investments.

The recent Sino-Angolan association is illustrative. When this  petroleum-rich area called for investment and rebuilding, China advanced a $5 billion loan to be repaid in oil. They sent Chinese technicians to reconstruct a large part of the electrical system. In the short term, Angola benefits from Chinese-built roads, hospitals, schools, hotels, football stadiums, shopping centers and telecommunications projects. In turn, Angola mortgaged future oil production. It to be a costly trade for Angola, but their need for infrastructure is immediate and that is precisely what China provided when no one else is willing or able to do so. Angola has become China's leading energy supplier. Chinese corporations, financial institutions, and the government are involved in billions of dollars worth of large dams in Africa.

Turning to Southeast Asia, South and Central Asia, Premier Wen Jibao announced a new $10 billion Asian Infrastructure Investment Fund. China Communications Construction is investing $100 million in constructing Burma’s new capital city airport. China is building railways to Laos, Cambodia and Thailand. It is also building a railway that links Afghanistan, Pakistan and Uzbekistan, which is part of China’s plan to connect to ports in Iran and Pakistan. The railway will be a 700 km long at an estimated cost of $5 billion. China has also agreed to take over operations at Gwadar port in (Baluchistan province) as soon as the terms of agreement with the Singapore Port Authority (SPA) expire.

In Bangladesh, China is negotiating for investment and construction of Sonadia Island deep sea port, new rail lines through Myanmar to Bangladesh and a $200 million loan for 3G telecommunications.

In Sri Lanka a consortium consisting of China Merchants Holdings International Company and local conglomerate Aitken Spence was awarded the tender for the construction and operation of the Colombo South Harbor Expansion Project. This $500 million Chinese investment is the largest foreign direct investment project in the country. Official data shows that China was Sri Lanka’s biggest lender in 2010, with loans amounting to $821.4m. It also offered $7.5m worth of grants. China plans to pump $1.5 billion into Sri Lanka over three years to develop infrastructure including roads,  bridges, water supply schemes, irrigation and power.

The Philippines has presented to Chinese and international contractors a $12 billion transport sector infrastructure development project under the administration’s PPP program. China is likely to take the biggest chunk.

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In Europe, the China Development Bank financed Serbia to acquire a bridge over the Danube. China Overseas Engineering Group won the bid for an A2 highway in Poland at less than half of what the Polish government had budgeted; that project is currently halted because of underestimated costs. China is investing an estimated EUR 10 billion in the Croatian seaport of Rijeka, which will be the largest seaport in the Adriatic.  It is investing and building the new Zagreb airport and financing the rail line connecting Kiev to its airport.

China’s CIC has taken an 8.6% investment stake in UK Thames Water, and announced its interest in pumping money into Britain’s railways, as part of a major plan to invest in the crumbling infrastructures of developed countries. It has expressed interest in financing a proposed highspeed rail line from London to the north of England.

CIC has taken a 40% stake in Portugal’s national grid and a Chinese power company has acquired Portugal’s leading power company for 2.7 billion Euros. Bernhard Hartmann, an expert in the power utility sector at A.T. Kearney sees “a big wave of Western interests trying to find someone in China to bankroll them”. (China Daily, 02-17-12).

China is causing geostrategic sweats in its bid to acquire .03 percent of Iceland for recreational development and a future potential Atlantic seaport. It has purchased Greek debt as a quid pro quo for a 35 year lease on Piraeus harbor and a deal to finance the purchase of Chinese ships.

Turning to Latin America, China is leading the way in foreign infrastructure investment. In July 2010 China signed a $10 billion agreement with Argentina to refurbish the Belgrano Cargas freight rail line and an additional $2 billion agreement to upgrade the Ferrocarril Belgrano Norte y Sur. Two other initial agreements worth $1.5 billion each are related to a potential subway line in Cordoba and train line connecting the Buenos Aires Ezeiza airport.

In 2009, China signed an agreement to take a 40% stake in a Venezuelan rail project worth $7.5 billion. This project will connect oil producing regions to the Capital as part of China’s interest in maintaining a steady energy oil supply from a Venezuela. A consortium of three companies from China, (as well as companies from Japan and South Korea) are bidding on a high speed rail project in Brazil to connect Rio, Sao Paulo and Campinas. Beyond rail, Chinese companies are building three hydroelectric dams in Ecuador. In total, China is financing over half of the energy infrastructure projects in Ecuador right now.

China is today the largest and most willing infrastructure investor in many countries on every continent.  They have a current problem of getting into certain countries, like the U.S., but they want in and it is only a matter of time that they will get in. The U.S. needs Chinese infrastructure support more than China needs U.S. infrastructure demand. CIC has already taken a 15% equity interest in AES, the largest U.S. power company, and is discussing a 35% share in its wind power business.

A great part of the world is seeking infrastructure investment and construction from China. Conversely, China is driving global infrastructure as a new growth industry. There are other global capital customers, but not of China’s scale and scope. China invests more in Africa today than the World Bank. ME Sovereign reserve funds are not investing in foreign infrastructure. They prefer fast returns and have limited long term strategic interests.

The demand for Chinese infrastructure investment exceeds its capital supply or scope of strategic interest. China is steadily adding internal and external capital and industrial partners for more extensive ventures; and is always varying its scope of strategic interest as conditions change. We are not looking at an earlier infrastructure “selling” scenario, where public authorities sold numerous projects to bankers and bond underwriters, who had to place ample capital supply into limited infrastructure demand. We are instead looking at a marketing scenario, where project demand exceeds capital supply and countries have to market their numerous infrastructure project needs to the limited capital suppliers. The paradigm has shifted from “selling” to capital markets to “marketing” to capital customers.

How to Market Infrastructure Investment to China

I suggest ten things to consider:

1.    Customers

With regard to infrastructure, the seller is the public authority seeking investment for its projects. The buyer is the capital customer who wants to invest and construct installations that meet its economic and strategic objectives. The Marketer’s role is to help infrastructure sellers thoroughly understand China’s economic and strategic investment goals and requirements; and help governments develop projects that have a competitive advantage for China’s distinctive needs and wants. Marketers also help Chinese government agencies and companies find investment and construction projects that generate the greatest value for China’s economic and strategic goals. The key thing is customer focus, and that is what Marketing is about.

           

China Investment Corporation is a $400+ billion source of out-bound capital for infrastructure investment, but it is by no means the only source or first port of call for a seller. State-Owned Enterprises in road, rail, seaport, airport, mining are power generation are the initial point of contact. These companies want contracts for engineering, construction and management of developments. Buyers have to identify the prime contractors for projects, build a relationship and make their case. If it fits the goals of the SOE, the SOE will carry the ball through the political process for approval and ultimately to CIC and Peoples Bank of China which hold the currency reserves.

Too many foreign projects waste time by first going through diplomatic and political channels or going directly to CIC to gain interest. The real beneficiary is the prime SOE and its SOE and private sub-contractors. It is their job to maneuver the political and financial process.  

2. Investment objectives and goals

Foreign physical planners, engineers and politicians can draw up all sorts of infrastructure project proposals that do not fit China’s agenda. Government planning departments need marketers to shape plan offerings that fit the China capital market, not their own glorious aspirations. How many politicians, planners and engineers and politicians have the foggiest notion of what China and its SOEs want, let alone who the Marketers are who can help fit projects to these wants? It is the challenge of foreign political leaders to make their planners and agencies aware of the need for Marketers to research, analyze, segment, target and brand their needs to China’s foreign infrastructure investment program.  Infrastructure projects that do not fit what China wants are pie in the sky, in so far as China’s capital is concerned.

3.Market Profile

We are deluged with global engineering and innovation driven estimates of infrastructure need from every level of government... $5 billion here, $20 billion there, even trillions. The figures are so high they paralyze, rather than promote real investment activity. The new rule is to understand what capital customers, like China, want to buy, not what foreign countries want to sell. The Marketer’s job is to understand Chinese objectives for return on investment, security, industrial fit, trade advancement and leverage, indigenous operation and management capability and efficiency, duration of capital recovery, geo-strategic advantage, and regulatory, legal, administrative and political support.

4. Segmentation

Every government has numerous physical infrastructure needs. Different capital buyers have specialized infrastructure interests, based on their industrial strengths and strategic goals. China, for example, looks for road, rail, power stations, airports and sea ports, bridges and mining infrastructure because of  their mix of strengths in steel production, trade logistics, resource needs and other factors. They do not do as well as the French in nuclear power and water management, or the U.S. in terms of aviation. The Marketer helps country projects target capital resources of different centers of infrastructure excellence.  

The next level of segmentation for foreign sellers is to distinguish big infrastructure projects from small ones. Big projects are more likely to attract Chinese interest where China is a welcomed investor on the basis of past and ongoing projects. For these countries, small projects can be layered into the negotiation for costly dams, rail and ports. For countries that have not previously welcomed Chinese investment, small projects may be of interest “as a foot-in-door” tactic. A large project, like California’s approach to China for investment in high speed, is hardly going to interest China. The political risks of a new departure of cooperation, however heartily hailed, are too great to engage.  If California wants Chinese infrastructure capital, it should starts with toll roads and bridges. 

A further level of segmentation for Chinese investment is what is essential to replace or maintain and what is new and innovative for exceptional growth. Global investors, sovereign or private, prefer lower risk, in-place infrastructure to new infrastructure. China would rather buy a share of the UK Thames water authority, than build a new water system; the same with existing power plants. Revenue, cost and management systems are already in place.

Governments have to make a seed capital stake in Public/Private Partnerships projects.  The less robust the domestic investment, the higher the risk for external investors! Governments have to parse their money very carefully and invest enough to meet external investor risk standards. This means reserving enough money for “conventional” projects that meet the risk standards of capital sellers, like China, not for “exciting” priorities beyond the pale of reasonable foreign investment. This is a tough lesson to learn for foreign buyers of infrastructure capital, because it is counter-intuitive to the domestic political hype of grand schemes.

    

5. Targets

Infrastructure investment Marketers are international in a global economy, not nationalistic. They should try to work for countries that have a track record of attracting Chinese infrastructure capital, like SE Asian, South Asian, and Central Asian republics, African countries and Latin American countries, UK, the Euro periphery and Eastern Europe. These regions welcome Chinese infrastructure investment. The trick is to multiply investments in these countries for synergistic economic value both to the Chinese capital customer. 

Frankly, I think it is a waste of time for Marketers to try to sell U.S. National projects to Chinese capital customers. There is too much Congressional resistance to Chinese tangible investment, despite recent sanguine presidential rhetoric. The best U.S. sellers are certain State governments like Georgia, Texas, Iowa and several other States that have reached out to China. National level infrastructure is political dynamite. Progress is being made in the energy field. For example, Sinopec paid $2.5 billion to Devon Energy of Oklahoma of a 1/3 stake in 1.2 million acres of drilling property. Other investments have been made with Chesapeake and other U.S. energy companies. The key is low profile and not controlling share.

6.Positioning

Positioning is more about offering a superior value proposition to customers than competitive offerings. It is the Marketer’ job to document the unique and superior fit of his client country’s project to China’s capabilities, trade, financial and strategic interests, like the transcontinental African rail and the investment in Portugal’s largest power company which they got for very little money. The positioning question is always why the capital seller should invest in W country project X, rather than Y country project Z. Why is X superior to Z in revenue, political reliability, trade or geo-strategic advantage.

7. Strategy

Chinese capital buyers want synergies in their investments. They prefer to work with countries that have a strategic plan for Chinese investment for multiple infrastructure inputs over a long term period. One infrastructure impacts another set of needs. Roads, rail and ports make mineral resource acquisitions feasible. All of these inputs leverage Chinese trade through SEZs, which bring hundreds of Chinese companies together into infrastructure region.

Some countries, like the UK, are developing strategic plans for Chinese infrastructure investment. Cressida Hogg of 3i Infrastructure in the UK sees an emerging UK strategy for Chinese investment in a new model for investors to take on more of the construction risk instead of seeing infrastructure purely as a safe income yielding asset. The UK needs 200 billion pounds of investment in energy, water, transport and other projects by 2015. For the past two decades it has aggressively privatized infrastructure and, according to Hogg, “there is no political resistance in the UK to Chinese or other investors in major infrastructure assets, unlike the United States.”

 8. Branding

The purpose of branding is to build customer trust in the seller. The UK has done a splendid job of marketing its country brand for privatizing infrastructure, a friend of China and a stable government. France is a friend of China, but has a restrictive privatization. African countries like Kenya, Ghana, and South Africa are relatively stable, compared to other African countries.

Country branding has its limits. Democratic regimes change leadership frequently by election; autocratic regimes have longer leadership cycles, but are prone eventually to rebellion. In both cases the cast of characters changes in the long duration of an infrastructure project. Brand trust requires continuous relationship building that can withstand these changes in political leadership.

Provincial and municipal governments have more entrenched elites than national governments, which can better sustain public/private partnerships for the long duration of a project. They are also more aggressive and innovative because of domestic, regional, and local competition.

9.Promotion

 Countries need well funded and organized campaigns to promote their infrastructure projects to China’s CIC and its SOEs. It is not enough to impress China to have a president or governor’s hailing a new day of bi-lateral cooperation. Infrastructure buyers need road show events, business models and plans, documentation, feasibility studies, financial incentives, public relations and events, favorable public opinion, political support, corporate business involvement, community support, media celebrity, social networking, personal relations and tireless staff work to demonstrate seriousness. China wants to see a big, well-financed promotion campaign to get them on board.

   

10.Marketing Organization

Finally, countries and state and local governments need an aggressive infrastructure marketing organization in place to play the competitive game of capturing scarce global infrastructure capital. Public bureaucrats, by and large, know nothing about Marketing, and are notoriously poor at Selling. Public infrastructure marketing organizations should be public/private consortia, so there is embedded business and political leadership, profit-centered incentives and driving energy to battle the way to China’s infrastructure capital market and win the battle against ever smarter competitive countries. Marketers should propose, design and staff these organizations.

In conclusion, infrastructure replacement and new development is the biggest new industry in the world. It has traditionally been left to public authorities and bankers to handle. This is no longer the case. Marketing must step in with its vital discipline and play a robust role in the value exchange between infrastructure project buyers and new capital, equipment and construction sellers, principally China.

Chinese Industrial Investment in the U.S.: The Time is Right!

Top U.S. manufacturers are shifting their capital, operating and marketing and sales activity from the U.S. to developing markets, where the profit margins are higher. This leaves the U.S. SME industrial purchasers without dependable and affordable supply from large domestic suppliers upon which they previously depended. There is an important market gap in the U.S. industrial sector that large Chinese companies can profitably serve, albeit at a lower profit margin that top U.S makers require for shareholder value. Chinese companies should look at this gap as the basis of their international marketing strategies.

 

 

The Sany Group, China’s largest manufacturer of earth moving and construction vehicles, has just announced that it is planning to open a $60 million assembly plant in Peachtree, GA, USA. The first products will be trucks mounted on concrete-pumping equipment.

AVIC has made two notable U.S. aviation acquisitions this year: 1) Cirrus general aviation in Duluth, Minnesota. Cirrus is a recognized leader in general aviation, best known for incorporating luxury automotive ergonomics, pilot‐friendly avionics and advanced safety features into its high performance airplanes. It has delivered nearly 5,000 new piston airplanes over the last decade and is the best‐selling four‐place airplane in the world. 2) AVIC has also acquired Teledyne Continental Motors, Inc., located in Mobile, Alabama, which is recognized as a global industry leader in the development and supply of aircraft piston engines, parts and components for more than eight decades. Continental Motors provides engines to most of leading piston aircraft manufacturers in the world.

The list of Chinese acquisitions of U.S. manufacturers and new industrial developments can go on and on from industry to industry. While the press emphasizes Chinese global acquisition of strategic mineral and natural resources, it generally overlooks manufacturing acquisitions.

 

 

These purchases and new facilities are not simply a response to cheap assets in a distressed U.S. economy. Chinese companies, either State-Owned or private, do not spend money on faltering or worthless foreign assets. The acquired companies are making money and profits, but their future survival as suppliers to top American industrial purchasers is questionable, because their purchases cannot meet the high profit margins that top U.S. companies are seeking and getting in exports to developing markets. This trend of U.S. top business global strategy is revealed in a current report conducted by Kotler Marketing Group USA, entitled “Marketing through Difficult Times”. The report is available at www.kotlermarketing.com.

The KMG study interviewed 190 CEOS and senior marketing and general management executives of top U.S. companies on their major strategies for profit growth in the current weak domestic economy. Corporate profitability during this difficult period rests upon foreign sales driven by five strategies: 1) Emphasis on product profitability; 2) Increased use of digital marketing communication; 3) Increased reliance on Strategic Account Management; 4) Reducing the number of marketing employees; and 5) Expanding the responsibility of the sales force. Each of these factors is rich in strategic implications for large Chinese enterprises that are fashioning international marketing strategies.

Recent product profitability of large U.S. corporations is due to the shift of manufacturing and sales from on-shore to off-shore purchasers. GE saw U.S. revenues in core industrial businesses shrink 3.4% during the second quarter of 2011, while its international revenues soared 23%, accounting for the 59% of the company’s total industrial revenue. GEs China business rose 35% to $1.2 billion and it orders increased 80 percent. Forty six percent of its work force is in the U.S.; but mostly producing for export. For example, every gas turbine manufactured by its 3,000 workers in its Greenville facilithy is exported. GE announced its policy of maintaining only half of its work force in the U.S. This means that its capitalization for new manufacturing facilities will be primarily off-shore. As off-shore facilities advance in technology and capacity, they will absorb current U.S. export sales and further reduce GE operations in the U.S.

Air Products & Chemicals, a major global supplier of argon, oxygen and other industrial gases, will split its capital investment equally between the U.S. and Asia.

Caterpillar reported a 44% rise in 2011 second quarter profits to $1.02 billion, most of this in foreign sales. Ninety per cent of the large mining trucks it makes in the U.S. are exported. More than half of 17,000 new hires this year are off-shore. According to Richard Lavin, President of Caterpillar’s Global Construction Business, “We have got to win in China…if we do not lead in China we’re not going to be the global industry leader”. While Caterpillar excavator sales increased in China this year 52%, Sany grew its excavator sales 97%. Caterpillar is splitting its $3 billion capitalization for new projects in half between the U.S. and foreign markets, principally China.

 

 

This data suggests that large U.S. companies are strategically limiting their capitalization, employment and sales in the U.S. economy, while pursuing higher profit margins off-shore. While this trend is a short term detriment to the U.S. economy, it is good news for the Asian economy, U.S. corporate shareholders, and finally, and most important, for Chinese manufacturing to pick up the slack and serve the U.S. industrial purchasers, as well as export purchasers, that do not meet Caterpillar’s profit margin requirements. This brings us to the third finding of our study.

Executives report an increased reliance on Strategic Account Management. This means that Caterpillar, GE, and its cohort of top global U.S. manufacturers are shedding their small customers at home and abroad and focusing of their large, high profit accounts. Chinese mainland manufacturers are already benefitting from this policy by selling to smaller purchasers in developing markets. However, the major new opportunity is for large scale Chinese manufacturers to come to the U.S. and supply this SME industrial sector, abandoned by the top U.S. manufacturers. U.S. SME competitors that historically competed with the top makers to sell to industrial buyers at a lower price do not have the scale or credit today to get this business. Companies like Sany, AVIC, Huawei, ZTE, Goodpower, BYD, Haier and many other well capitalized industrial manufacturers have an open door foothold to build facilities in the U.S. to sell to small account purchasers at a suitable profit margin, though less than top U.S. makers, and eventually win larger domestic and foreign accounts. Sany’s new facility in Peachtree, GA is going to do this.

 

 

Our further finding on the reduction of U.S. based marketing staff by the large corporations reinforces the focus on strategic accounts. The main point is that there is a growing unmet U.S. market for small and mid-size industrial purchasers to whom the top U.S. manufacturers are paying less marketing attention. China has the capital and international marketing strategy to fill this gap. Further research should be done to size these different neglected industrial market sectors and develop strategies and tactics for capturing this segment that the top U.S. makers are forsaking.

 

 

In coming years we may see the ironic reversal of global development. From 1982 forward, inbound FDI has rapidly advanced the Chinese industrial economy. From 2011 forward, Chinese in-bound FDI to the U.S. may revive the U.S, industrial economy.

Sino-U.S. Technology Marathon ¹

Milton Kotler

President, Kotler Marketing Group

February, 2010

mkotler@kotlermarketing.com

www.kotler.com.cn

www.kotlermarketing.com

¹
I wish to acknowledge the research assistance of Blake Nixon, KMG, in developing this article

The Sino-U.S. Technology Marathon

There is an international competition for public and private R&D investment in new technologies that will produce the next generation of industries and jobs. While many smaller countries in the West invest a larger percentage of their smaller budgets in R&D, the outcome of this race will be dictated by a marathon of two giants – the U.S. and China.

Current academic literature in the West, notably China's Emerging Technological Edge, by Denis Fred Simon and Cong Cao, Cambridge UK, Cambridge University Press, 2009 is skeptical that China can manage the science and technology human capital resources to achieve China's desired economic output. The book concludes, "It should be clear from this study that China's science, technology and managerial base does not constitute a critical source of competitive advantage in economic and technological terms." (p.345).

My experience in China and research has led me to a different conclusion, namely that in many sectors of new technology, China is nearing par, on par, or fast approaching par with the U.S. I am not referring to basic science, but to applied and translational research for commercialization.

Paradoxically, much of my data is the same as that of the skeptics, except that we place different weight on one metric of competition – rate of growth. The skeptics are not mindless of this variable. The skeptics diminish the importance of rapid Chinese R&D growth rate, by assuming a steady and even marginally increasing rate in the U.S.

By the end of 2008, global contract sales of Huawei Technologies, China's largest telecoms gear maker, jumped 46 percent to 23.3 billion USD. Huawei also forecast sales of more than 30 billion USD in 2009.

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The difference between us is that the skeptics, notably Simon and Cao wrote their books before September 2008, the date of the fall of Lehman Brothers and the onslaught of the Western financial crisis. From that moment forward, a major alteration in relative R&D growth rates occurred. The U.S. de-accelerated R&D private investment in favor of financial rescue. China continued to grow technology R&D investment. Their skepticism may have been valid before the financial crisis (BFC), not after the financial crisis (AFC). They wrote before this happened. I am writing after it has happened.

The irony of this prefatory note is that American academic writers and journalists have steadily assumed American financial stability and constitutionally based social stability; while assuming that with continued wealth growth and income disparity the Chinese social order will implode. In fact, in AFC the American and Western financially order imploded, while China has forged ahead financially and has retained its social stability.

The Facts

As of 2010 (YTD) the U.S. is expected to spend $401 billion, or 2.85% of its GDP, on R&D and China is spending $141 billion (USD), or 1.48% of its GDP on R&D. China's growth rate of R&D spending is currently running at 17%, far in excess of what the Battelle Institute expects to be a U.S. R&D growth rate of 3.7% of GDP over 2009. With double digit annual R&D growth for the past decade, China is expected to match the R&D spending by all of Europe combined in 2018, and match U.S. R&D spending in 2022.

For a critical understanding of the competition in R&D investment, we have to factor three elements into the equation. The first is the relative ratios of public and private R&D expenditure. 70% of Chinese R&D is government funded (including State-owned enterprises), against 27% for the U.S. While U.S. private sector spending for R&D represent 73% of the total R&D spend, it is important to note that 55% of U.S. private R&D is spent off-shore in consort with offshore production; very little Chinese R&D is off-shore. Because of this, U.S. R&D has a reduced impact on U.S. domestic economic growth and job creation in new technology sectors.

The second element is the relative proportions of R&D expenditure between basic science and applied science R&D. The U.S. spends 18% of total R&D on basic science, while China spends less than 5%. U.S. Federal government R&D expenditure has been historically devoted to basic science performed by national laboratories and universities, while Chinese R&D, both public and private, is principally dedicated to applied science and translational research for commercialization. This factor has a huge impact on near term economic impact. China gets more economic bang for R&D buck, while the U.S. government subsidizes global applied science.

The third factor is the relative ratios of public U.S and Chinese R&D to defense spending. Historically, between 50 and 60 percent of the U.S. Federal R&D investment is made in defense. Most of this investment (93.6 percent in FY 2010) is made in the Research, Development, Test and Evaluation (RDT&E) account in the Department of Defense (DOD) with smaller amounts coming from Atomic Energy Defense Activities at the Department of Energy and other programs within the DOD. The 2010 U.S. budget shifted more R&D funding to non-defense spending.

For Chinese defense R&D spending, we turn to the OECD which estimates that China's current military budget generally "ranges from roughly US$40 billion to US$90 billion a year. Trends in Chinese spending on R&D are even more difficult to ascertain. However, a reasonable estimate of current Chinese spending on military R&D might be US$2-5 billion." If we take Chinese total 2010 R&D spend at $141 billion, and assume that Chinese defense R%D is contained in its total R&D spending, we have a 2%-4% defense related portion of total R&D spending. This divergence in defense related R&D has a crucial impact on economic output. The greatest portion by far of Chinese R&D is directed toward commercial output. The greatest portion of U.S. R&D goes for basic science and defense related purposes.

A fourth factor of importance in the rate of technology growth is the number of scientists and engineers each country is graduating annually. As of 2006 the U.S. was graduating 70,000 engineers a year (many Chinese and Indians), while China was graduating 600,000. A Duke University study subtracted the number of Chinese sub-baccalaureate transactional, or technician, engineers which it estimated at 290,000, leaving an annual number of Chinese dynamic engineers (U.S. standard) at 310,000, or four times the U.S. annual number. The Chinese number has grown since 2006, while the U.S. number has remained stable.

A fifth element is the marathon is scientific research output represented by peer reviewed articles in scientific journals. Here the U.S. enjoys a big lead, but Chinese scientists and researchers have quadrupled the number of published papers in the past decade, second only to the USA, and are on course to overtake the US by 2020.

A sixth element of new technology growth is patent protection. As of 2007 nearly 50 million patent documents, covering 18 countries, are gathered in the Chinese Patent Office. A small percentage of these have international patent protection and domestic IP is relatively weak. By contrast, the U.S. Patent office issued 7 million patents by 2006, with a large percentage that are internationally protected. The U.S. patent is still the gold standard of international IP. The global value of new discoveries and inventions requires U.S. patent protection, since the U.S. is still a major global market for investment and commercialization of new technologies.

Despite China's strides, researchers in China accounted for only about 1% of the roughly 150,000 U.S. patents granted in 2008, whereas U.S.-based inventors accounted for 49% of U.S. patents granted. The relatively weak IP regime in China enables Chinese enterprises to copy international designs and bring them to play in the domestic market more quickly and at lower cost than internationally protected offerings. This perverse effect of weak IP has been a major stimulant to technology advancement in China for the past decades. But with the growth of indigenous discovery and invention, China will have to harden its IP and forsake this advantage.

A seventh element of R&D impact is that Chinese companies in 2008 had the highest number of IPOs in the world, completing 183 deals, while the U.S. completed 54 IPOs in 2008 and Europe completed 62 IPOs. This reflects the greater Chinese R&D emphasis on translational development of research for commercialization, as well as greater liquidity in Asian markets than in Western markets. But it also reflects easier regulatory and underwriting standards.

From this evidence we can that China is developing indigenous technologies and adopting technologies from all over the world to build a 21^st century new technology economy. Barring unforeseen circumstances, China may in the near term equal and even exceed U.S. publicly supported R&D and the U.S. will lag behind China in the economic impact of new technologies. The graph on the following page is illustrative of this trend.

Georgia Tech's recent HTI indicator report predicts that China will pass the US in translational research and new product development by 2018. The four "HTI" indicators are:

National Orientation to Compete

Socio-Economic Infrastructure

Technological Infrastructure

Productive Capacity

Development: The systematic use of the knowledge gained from research directed toward the production of useful materials, devices, systems, or methods.

The East Asia Marathon

Before moving on to the Sino-U.S. technology race, it is important to clarify China's relation to Asian technology. Commentary in the West generally refers to the shifting trends of high tech R&D from the West to Asia. We have to clarify that reference to Asia in this context principally means China.

China's traditional role in the Asian region, vis-a-vis the Asian Tigers, was low cost technology assembly, packaging and export of consumer and business products. This is rapidly changing to China's high tech, capital intensive, value added production for a number of reasons: 1) Incoming FDI is increasingly for high tech production; 2) China is advancing its skilled human capital base of scientists and engineers, while retaining low cost intellectual capital; 3) China provides much greater IP security by supporting company measures for "black boxing" technology; 4) The Chinese government had instituted attractive incentives for high tech domestic and foreign innovation; 5) There has been a greater willingness by Hong Kong and Taiwan in both policy and FDI to transfer technology to China; 6) Large numbers of foreign educated and employed scientists and engineers are returning to China; and 7) At current levels of spending, China alone will outspend Japan in R&D by mid-2010.

New Technology Sectors in China and the U.S.

We will explore the Sino-U.S. marathon in eleven sectors of new technology: 1)Telecommunications; 2) New Energy, including solar, wind power, nuclear power, and clean coal, carbon capture & storage; 3) Electric Vehicles and Advanced Batteries; 4) Biomedical, Translational and Clinical Research; 5) Nanotechnology; 6) IC/Electronic Industry; 7) Advanced equipment production (industrial robotics, sensors, signals, etc); 8) High tech research and production parks; and 9) High speed rail.

Telecommunications

AT&T and its famed Bell Laboratory was for decades a world leader in telecommunications. When AT&T was parceled into independent regional companies by re-regulation in the 1980s, the Bell Lab was re-structured as an independent equipment maker, named Lucent. In 2006 Lucent merged with French owned Alcatel to better contend for dominance in the global industry. By 2009 Alcatel Lucent revenues of $21 billion USD were topped by a Chinese private Company – Huawei. The story of Chinese leadership in the telecommunication equipment can be seen in the dramatic growth of Huawei revenues of $30 billion in 2009.

Huawei is the largest networking and telecommunications equipment supplier in China and headquartered in Shenzhen. It was established in 1988 as a private high-tech enterprise specializing in R&D, production and marketing of communications equipments, and providing customized network services for telecom carriers. By the end of 2008, global contract sales of Huawei Technologies, China's largest telecoms gear maker, jumped 46 percent to $23.3 billion USD. Huawei forecasted sales of more than $30 billion in 2009.

Huawei serves 35 of the top 50 telecom operators and puts 10 per cent of revenue into R&D each year. In addition to the R&D centers in China it has R&D centers in Stockholm, Dallas, Silicon Valley, , Bangalore, Ireland, Moscow Jakarta and the Netherlands. It is a global Company and has within a short period of time has risen to become the world No. 2 company in the mobile equipment industry behind Ericsson, replacing Nokia Siemens for the #2 spot.

In December, 2009, Huawei beat Ericsson to win deals to build next-generation networks for major mobile carriers in Norway and Sweden. Huawei was the largest applicant for patents in 2009 and in that year overtook Alcatel-Lucent in 2009 to become #1 in global optical networking equipment. Huawei is planning an IPO. Huawei is a potential buyer of Motorola's network division, which is planned for sale.

The New Energy Race:

The U.S. has been struggling for over a decade to lead the worldwide energy race. Every step for forward, propelled by increasing oil prices, has led to a step backwards, as oil prices fell. Congress has failed to pass an energy bill, over disputes on global warming, cap & trade, nuclear energy and a sidebar of special interests barriers. Despite rhetoric, President Obama is not making any headway on this front. As a result, the private sector is reluctant to invest in translational research and development. Meanwhile, China races forward.

Deutsche Bank asserts that China is a low risk environment for new energy investment. It has generous and well-targeted clean energy incentives, as well as high levels of private investment and a comprehensive and integrated government plan. By contrast, it describes the U.S. as a "moderate-risk" country with volatile incentives, a lack of enabling infrastructure and an inversion to government-led investment

According to the New York Times article, China Leading Global Race to Make Clean Energy, "… the West may someday trade its dependence on oil from the Mideast for a reliance on solar panels, wind turbines and other gear manufactured in China." China is subsidizing greater public investment in applied R&D than U.S. public investment in alternative energies that are not yet cost effective for the market place. Chinese policy mandates for clean technology are stronger than the US. China has a first-mover advantage, and will capture more substantial domestic and international investment to clean energy industries than the United States. In the next 5 year plan, China will call for more Chinese domestic consumption. Conversely, the US will import from China clean tech equipment, which will further increase the trade deficit. The U.S. will become a clean tech user, not a clean tech producer. This means service jobs, not manufacturing jobs.

China plans to generate 20% of its electricity from renewable sources by 2020, while the US is projected to reach 10% by that date. Chinese local governments are offering firms free land and R&D money. State-owned banks are offering loans to clean tech firms at 2%, much lower than financing in the U.S. The U.S. energy sector invests less than one quarter of one percent
of annual revenues in R&D activities. This is one-tenth the US industry average of 2.6%. According to China's Medium to Long Term Plan for the Development of Science and Technology, 2006 to 2020, the criterion for qualifying an enterprise as high tech requires a range of 3% - 6% of sales revenue invested in R&D, the highest degree for smaller firms. Under this standard, the U.S. new energy industry, by average enterprise, would not qualify as high tech by Chinese standards.

As a portion of annual revenues, U.S. energy sector R&D investments are two orders of magnitude lower than leading innovation-intensive sectors such as Biomedical technology R&D at 10-20% of annual revenues; Semiconductor R&D at 16% of annual sales; and Information technology at 10&-15% of annual sales.

It may be a forlorn misnomer to even call U.S new energy industry a high tech sector. Let's examine this industry by sectors.

Solar

China currently exports 98% of its PV output, and is the leading solar exporter in the world. It also has the largest solar manufacturing capacity in the world. It has one-third of global solar manufacturing capacity and supplies 30% of the global PV market. The U.S. supplies only 5%. China's 2008 PV production volume was 1.8 GW, from 820 MW in 2007. US PV production was 375 MW in 2008. Applied Materials is the world's #1 supplier of PV manufacturing equipment, offering systems for both thin film and crystalline silicon solar products.

Applied Materials, the world's biggest supplier of solar-manufacturing equipment has opened a research center in China and its chief technology officer will relocate to that country next month. Applied Materials was founded in 1967 as a semiconductor company, has manufactured in China for 25 years, but is expanding its presence to be closer to its customers and develop products suited to the country's urban population.

"We're doing R&D in China because they're becoming a big market whose needs are different from those in the U.S.," says Mark Pinto, Applied Materials' CTO. Going forward, he says, "energy will become the biggest business for the company," and China, not the U.S., "will be the biggest solar market in the world." The move by Applied Materials is just the latest sign that China is rapidly moving to the forefront in developing renewable energy technologies.

We are seeing a replay in the new energy industry of the earlier off shore movement of U.S. consumer goods manufacture and their import back to the American market. U.S. solar power manufacturers are moving to China for production and research and exporting equipment back for U.S. Once again, we are transfiguring a manufacture industry into a service industry.

China is the largest producer of photovoltaic cells. Suntech (of China) is the second largest PV supplier in the world, with American company First Solar ranked #1. Of the 1.2 GW of cell production capacity operating or announced by First Solar, less than 20 percent exists in the United States.

Solar Production Capacity

Wind Power

China is the largest manufacturer of wind turbines. Only one of the top ten wind turbine manufacturers is American. China's top three companies' manufacturing capacity is each over 4 GW/year. Domestic wind turbine manufacturers supply a majority of the domestic market in China.

Wind energy deployment in US is reliant on a Wind Production Tax Credit (PTC), which has lapsed on three occasions. The U.S. fiscal stimulus bill extends the PTC through the end of 2012. U.S. imports of wind-powered generating sets have increased from $365 million in 2003 to $2.5 billion in 2008, while U.S. wind turbine exports have never exceeded $84 million. It is unlikely that the U.S. will ever dominate this equipment production market.

The U.S. has the world's largest wind market with a current installed wind power base of ~35 GW. China's total installed wind power is ~25 GW. By 2020, Chinese policy aims for a wind power capacity of over 100 GW, or 3% of the country's overall energy consumption.

Nuclear

China currently has 11 nuclear power plants with a total installed capacity of 9.08 GW. Seventeen new plants are under construction in China and are projected to produce 86 GW of new nuclear capacity by 2020. This will equal today's U.S. nuclear capacity of 96.245 GW. 104 U.S. nuclear power plants produce 20 percent of the electric power grid and use American nuclear technology. The US has not built a nuclear reactor since the 1970's.

President Obama is offering loan guarantee for new plants, but only two are being planned for completion by 2017. The private sector does not view nuclear energy as an efficient investment. It is not unlikely, considering the old age of existing U.S. plant, that the U.S. will out-perform China in nuclear-based electric power.

China is increasingly sourcing its nuclear power plants with domestically produced parts. Heavy forging capacity is critical for nuclear reactor construction.

There are few suppliers capable of delivering the ultra-heavy forgings that weigh >400,000 pounds. The US has no such suppliers. Two Chinese companies currently have the largest forging presses in the world, at 15,000 tons of capacity. China Guangdong Nuclear Power Holding Co. (CGNPC) will be the first Chinese company to build a nuclear plant outside the borders, in Belarus. It is positioning itself as a major global player in nuclear electric power construction.

Clean Coal, Carbon Capture and Storage (CCS)

GE, itself a CCS leader, stated that China is currently more advanced in developing CCS technology than the United States and European countries.

GE and Shell both signed agreements with China's largest coal company Shenhua Group (Beijing) to develop clean coal technology. A CCS technology developed by China's Thermal Power Research Institute is being licensed for use in the FutureGen project - a 275 MW CCS demonstration plant in the United States and the first commercial scale plant to use the technology.

The same technology is also being used in China's first CCS power plant, GreenGen, which is expected to be operational by 2011. Almost all of the components for that plant are being manufactured domestically.

Electric Vehicles & Advanced Batteries

China's first electric carmaker BYD displayed its e6 and F3DM electric vehicles at Detroit's North America International Auto Show (NAIAS) in December 2009. BYD's ferrous battery e6 has an expected range per charge cycle of 330 km in cruising mode, an estimated acceleration time from 0-100 km/h in less than 14 seconds and with a projected top speed of 140 km/h.

These characteristics make the e6 ideal for daily commutes, in-town driving and even long distance travel. The new version F3DM electric vehicle also features BYD's FE battery together with a BYD 371QA 1.0-liter gasoline engine. It will be equipped with the solar panel sunroof, which can be used to channel power to the Fe battery.

The F3DM has a range of about 400 km on one tank of fuel, with a maximum speed of 160 km/h. It can also run for 100 km powered by the FE battery pack alone. These cars will be launched in Los Angeles in 2010 to the happy anticipation of Warren Buffett, who owns a 10% share of BYD. BYD sold more than 430,000 cars last year, about a 50% increase from 2008, and exported its products to the Middle East, Africa and East Europe.

All of China's major state-owned and joint-venture automotive companies have announced plans to launch electric vehicle models. SAIC Motor Corp will release a fully-electric car in 2012. China automaker Chery has introduced the S18 EV, an all-battery electric vehicle that it developed in-house. The S18 electric vehicle has a range of 120 to 150 km (75 to 93 miles) when fully charged, with a top speed of 120 km/h (75 mph).

As Chinese domestic automakers find innovative ways to produce cheap electric cars to fulfill the demand of China's domestic market, they will be able to use this technology to expand internationally. A new generation of Chinese electric cars may help drive down the production cost of electric cars globally. In doing so, electric cars may become the car of choice not only in China, the fastest growing car market in the world, but also in the United States.

Turning to the U.S. in this EV arena, the news is grim. There are only two small and unlisted EV makers in the U.S.: Tesla and Fisker. Neither company has gone public for production and marketing capital. Ford is planning to introduce four electric vehicle models in 2012, following earlier Chinese launches. As for GM, its early deliberate destruction of its all electric EV1 is not likely to put GM in the EV race. It is launching a hybrid-electric vehicle, Volt, in 2012. Chinese and Asian vehicle makers will dominate the U.S. EV auto market.

Biomedical, Translational and Clinical Research

The U.S. has a clear lead over the China in the field of biotechnology and biomedicine. The U.S. is home to the majority of biotech industry's revenues, profits, and jobs. It has more than 300 publicly listed biotech companies, and leads the world in biotech and biomedicine basic research. But the picture changed in 2008. By the 2^nd quarter of 2008, following the financial crisis, the number of biotechnology venture backings fell by nearly 50%, and the dollar amount invested fell by more than 40% from the first quarter.

China is moving very rapidly in this field. It has had double-digit growth in its biotechnology industry and has gone from being one of the slowest to one of the fastest nations in the adoption of new biotechnologies. China has more than 2,800 biotech firms and looks to capture clinical and translational research and commercialization. China will focus on regenerative medicine, genomics and stem cell research.

The sector has been vigorously supported by public funding in translational research. China has had double-digit growth in its biotechnology industry and has gone from being one of the slowest to one of the fastest nations in the adoption of new biotechnologies. The government is intent on pushing applied research, driving Chinese firms to develop new therapies in pioneering fields such as gene therapy and stem cells U.S. venture capital in biotechnology, more structured for longer term economic results.

Two new investment factors are entering the picture. On the Chinese side, the National Development and Reform Commission (NDRC) announced in October 2009 that it was creating 20 venture-capital funds that would be worth 9 billion RMB (US$1.3 billion). A fair portion of this will go to biotechnology. In addition, American venture capital in 2009 invested $3.7 billion in Chinese start-up enterprises, an increase from 2007's $3.6 billion, but a decrease from 2008's $5 billion, but only a small portion of this external investment is going into Chinese biotechnology. The interest of potential international investors in Chinese biotechnology is typically muted by concerns about quality control and IP protection. Chinese domestic venture capital has been reluctant to invest in this sector, when they can achieve earlier gains in other technology sector.

The biotech sector is seen in China and internationally as a core area of national scientific and economic development. Backed by government intent to promote innovation and fuelled by the "brain gain" of talented Chinese scientists and entrepreneurs returning from abroad, China's biotech industry only needs a more favorable domestic investment climate and stronger IPR protection to emerge as a global force in the production of new therapies and medicines.

The first commercialized gene therapy product approved anywhere in the world was Gendicine, an injection used in the treatment of head and neck cancers developed by Shenzhen SiBiono GeneTech Co., Ltd. More than 5,000 patients have been treated with Gendicine, about 400 of them from overseas. The drug is currently undergoing further clinical trials in China for several new indications, including liver, abdominal and pancreatic cancer.

Several Chinese companies are working in the field of human and animal stem cells. One of them, Beike Biotechnologies, has organized a network of satellite hospitals, clinicians and research laboratories to commercialize its stem cells therapies, which involve harvesting stem cells from the umbilical cord or amniotic membrane, in vitro expansion, and administration to patients either intravenously or by injecting directly into the spinal cord. Beike has treated more than 1,000 patients, including 60 foreigners, for a variety of conditions including Alzheimer's disease, autism, brain trauma, cerebral palsy, diabetic diabetic foot arteriosclerosis and spinal cord injury.

Despite its daring medical science innovation and stunning breakthroughs, including the world's first commercialized gene therapy product and the sole cholera vaccine tablet, Chinese firms face an uphill battle in attracting high-risk venture capital needed to sustain innovative, research-driven projects.

In the view of Peter A. Singer, MD, of the McLaughlin-Rotman Centre for Global Health (University Health Network and University of Toronto), "The Chinese biotechnology industry is like a baby dragon, which will grow quickly and soon become hard to ignore. It's no longer the case that the industrialized world has hegemony over biotechnology innovation."

The U.S. situation in this industry has a peculiar gap between relatively stable public investment in basic biotech research and declining private sector investment onshore translation and commercialization of discoveries. Pharmaceutical companies are moving translational research and clinical trials to China and India, where they are much less expensive and where the FDA is increasingly certifying foreign sourced institutions and facilities. With this trend, venture capital will eventually follow suit. It remains to be seen, whether an economic recovery of liquidity will sustain the U.S. lead or whether the trend of investment is toward Asia, principally China and India.

Nanotechnology

Nanotechnology deals with structures of the size 100 nanometers or smaller in at least one dimension, and involves developing materials or devices within that size. Nanotechnology is very diverse, ranging from extensions of conventional device physics to completely new approaches based upon molecular self-assembly, from developing new materials with dimensions on the nano scale to investigating whether we can directly control matter on the atomic scale.

There has been much debate on the future implications of nanotechnology. Nanotechnology has the potential to create many new materials and devices with a vast range of applications, such as in medicine, electronics and energy production. Nanotechnology is estimated to be a $2 billion industry by 2012 and is projected to represent 11% of world's manufacturing jobs by 2014.

China's nanotechnology capability is world class. According Dr. Richard Applebaum and Rachel parker of the University of California at Berkeley's Center for Nanotechnology, China is planning to use existing nanotechnology studies as a starting point and then "leapfrog" the West by further developing the current research.

As of 2007, China was second to the United States in government spending on nanotechnology by investing $250 million (Holman et al 2006: 25) against a U.S. Government investment of $1.5 billion. The U.S. National Nanotech Initiative projects FY 2010 projects an expenditure of $1.64 billion. We have no comparative for Chinese 2010 investment. But is it generally felt among professionals China's governmental spending on nanotechnology may not be far off when adjusted for purchasing power parity, by taking into account labor and infrastructure. Its investment has already surpassed that of any other country after the US. Applebaum & Parker conclude that Chinese nanotechnology output will likely exceed US output in terms of quality as well as quantity within a decade or less. China has more than 5,000 persons engaged in nanotechnology research and development at leading universities, research institutes and enterprises.

By 2005 China had equaled or possibly surpassed the U.S. in terms of total output for academic/peer-reviewed publications on nanotechnology, with a substantial increase in publication rate from around 2003. By 2009, China produced more scientific papers on nanotech than any other nation.

Nanotech plants have sprung up in cities from Beijing in the north to Shenzhen in the south, working on products including exhaust-absorbing tarmac and carbon nanotube-coated clothes that can monitor health. Companies are working on nano-touchscreens for mobile phones. Teams are working on a material to replace the indium tin oxide (ITO) used in the kind of touch panels found on BlackBerrys and iPhones.

Last month, researchers from Nanjing University and colleagues from New York University unveiled a two-armed nano-robot that can alter the genetic code. It enables the creation of new DNA structures, and could be turned into a factory for assembling the building blocks of new materials.

Looking at the 2009 numbers, the U.S. has slipped from being undisputed world champion in 2001 to racing neck & neck with China for a bronze medal in 2009, while Russia and the EU are racing ahead. "The overall trends are irrefutable," says Dr James Wilsdon, director of the Science Policy Centre at the Royal Society, "China is snapping at the heels of the most developed nations, in terms of research and investment, in terms of active scientists in the field, in terms of publications and in terms of patents."

Estimates of the size of the nanotech market are wildly fluctuating. Tim Harper, founder of the nanotech consultancy CMP Cientifica, sees a global nanotechnology market that could top US$2 trillion by 2012. Harper predicts that by 2010, areas of nanotechnology and biology will have merged, setting in motion the production of a wealth of new drugs and clinical equipment (such as the vials of nano-materials for use in health products, clothes and cosmetics). His research sees nanotech pharmaceutical and healthcare products worth an estimated $3.2 trillion by 2012, with military-use nanotech products taking 14% of the total market and worth $40 billion.

Harper goes onto say that "the Chinese are further along in their thinking than even the US on using these technologies for the good of the environment." The US may still lead the nano surge overall, but Harper believes China will be on a par with the EU and US by 2012.

IC/Electronic Industry

U.S. companies are world's leaders in "fabless" (design only) semiconductor companies, such as Qualcomm, AMD, Broadcom, and Marvell. These US companies outsource fabrication to foundries in Asia. Taiwan Semiconductor Manufacturing Company (TSMC) is currently the world's leading "pure play" foundry. As cross-strait investment eases, Taiwan's IC industry is increasingly moving production to China for lower cost. This movement of production to China has an impact on process R&D, which tends to be associated with place of production. Of the new R&D sites planned for construction in the next three years by the 177 leading semiconductor companies, 77% will be built in China or India, often using US corporate financing.

The production value of China's IC design, manufacturing and backend industries is projected at US$17.6 billion in 2010, growing 15.4% from 2009.

Beijing Semiconductor Manufacturing International (SMIC) is China's leading semiconductor producer. SMIC has joined the ARM® Foundry Program, an innovative business model that enables fabless semiconductor companies in emerging markets to gain access to ARM processor technology for use in the design and manufacture of advanced system-on-chip (SoC) solutions. ARM is headquartered in Cambridge, UK and is the world's leading semiconductor intellectual property (IP) supplier and as such is at the heart of the development of digital electronic products.

SMIC offer fabless semiconductor companies and design houses access to ARM foundry technology in a cost-effective and flexible manner. "ARM's relationship to significantly strengthens support for customers in China who now have access to SMIC's world-class manufacturing expertise for their ARM core-based designs…. We continue to see a great deal of innovation within the Chinese semiconductor market," said Jun Tan, president, ARM China. "In today's competitive market, many customers are looking for faster time-to-market and greater flexibility for the design and manufacture of their products," said James Sung, vice president of marketing & sales, SMIC.

The U.S. has long lost on shore IC production. It lost design to Taiwan a decade ago. Now it is losing design and R&D to foreign invested companies in China and to big Chinese producers like SMIC. While American IC companies may thrive in global sales, it will not generate jobs in the U.S. and will see a declining job contribution to the global design and R&D sectors of the industry.

Advanced equipment production

According to Rick Schneider, President and CEO of FANUC Robotics America, Inc., "Within 15 years, a labor gap will develop when 70 million baby boomers retire and only 40 million new workers enter the workforce. To fill this gap, it is important to invest in product-enhancing tools such as automation and robotics, enabling manufacturers to increase efficiency, reduce cost, maintain control over their operations and produce the highest quality products. Innovation and automation that produce bottom-line results will make the difference between life and death for manufacturers in the near future,"

Schneider says, "Automation is absolutely critical for North American manufacturers to be competitive in the world market because it helps reduce costs, increase quality and improve control of manufacturing operations." As an example, Schneider cited a case in which welding equipment manufacturer Lincoln Electric (Cleveland) prevented a customer from shipping welding operations to China by creating an automated system that cut weld times by over 25 percent. Added benefits to the new automated process included significantly higher quality and improved process control.

But the fact remains that China is the 3^rd largest industrial robot manufacturer behind US and Japan, through domestic companies like Shenyang SIASUN Robot & Automation Co., Ltd; and foreign invested global robotics producers like ABB Engineering (Shanghai) Ltd.

The paradox for Schneider is that while robotics can fill the gap of U.S. workforce needs as the population ages, it is not clear that the robotic equipment and devices will be manufactured in the long run in the U.S., where manufacturing and R&D costs are high. Indeed the U.S. will be a consumer of robotics, but will it withstand the pace of China to out manufacture robotics? The technology marathon is not a race for consumption, but for the development, commercialization, production and sale of advanced technologies.

High Tech and Research Parks

An American university research park is an area with a collection of buildings dedicated to scientific research on a business footing and is associated with a university or consortium of universities. They may be managed by universities or independently incorporated and managed, with some form of university affiliation. Typically businesses and organizations in the parks focus on product advancement and innovation, as opposed to industrial parks which focus on manufacturing and business parks that focus on business services.

For the past decade, U.S. industrial R&D has migrated increasingly from corporate facilities and staff to American universities, where universities and government grants picks up a good piece of the cost. American universities and American university research parks (URPs) are a major source of U.S public and private sector R&D. The U.S. currently has 170 university research parks in North America. The median URP employs 750 people, has a <$1 million operating budget, 6 buildings, limited or no profitability, 114 acres, and 30,000 square feet of incubator space. 75% of the parks have either no retained earnings or less than 10% of retained earnings.

This profile does not do justice to the larger URPs like Research Triangle Park, MIT, Purdue Research Park, and others. Research Triangle Park is one of the oldest and largest science parks in North America. It is a 7,000 acre development that is home to more than 170 companies employing over 42,000 full-time knowledge workers and an estimated 10,000 contract employees. It is located at the core of the Raleigh-Durham-Cary combined statistical area. RTP is a globally prominent high-technology research and development center that serves as an economic driver for the region. Purdue Research Park in West Lafayette, IN is today home to over 140 companies on the main campus alone.

China has a different model for R&D development. Chinese universities have on-campus R&D programs. University R&D, Government research institutes, and private enterprise R&D are located in centrally approved High Tech Parks. There are 54 national high-tech parks in China, employing 6.5 million people in their production companies, research institutes, and incubators. Zhongguancun, referred to as "China's Silicon Valley," is a 7-park zone in Beijing, home to over 20,000 high tech enterprises. In 2009, Zhongguancun grew 20% and generated US$170 billion in revenues and US$20 billion in exports. Twenty of Z-Park's Chinese high-tech companies are listed on the NASDAQ, including Sina, Sohu and Baidu.

According to Craig Spohn of Louisiana Tech Cyber Innovation Center,

"China just announced their intention to build 30 research parks
by 2010, and 60 percent of their economy will be based on the technology industry and the developments produced from those research parks…We will have to compete with that."

High Speed Rail

The Harmony Express from Wuhan to Guangzhou is the world's fastest train, accelerating within one minute to 193km/h and doing a steady 350km/h by the time it hit its first bend. Wholly Chinese-built using technology from Siemens and Kawasaki, the Harmony Express is faster than Japan's Shinkansen bullet trains and France's TGVs. It covers the 1000 kilometers between Wuhan and Guangzhou in three hours. The trip previously took almost 11 hours.

By 2020, China will have 13,000 km of high speed rail (HSR). Travel time from Beijing to Shanghai will be four hours. HSR in China will enable industry to move from north to south and east to west, and create a mobile high skilled professional work force. Intellectual capital moving throughout the country comfortably and efficiently will have great economic impact. New cities and industrial zones are being built along these lines, and urban terminal districts are being redeveloped for high tech commerce. One-third of the current China fiscal stimulus is devoted to the construction of this HSR system.

The U.S. currently has no HSR system. Plans for regional HSR are just being developed by individual State governments. Funding is uncertain and the U.S. has no HSR production capability. Nor is any planned.

Conclusions

• China's technological capability is moving faster than the 20^th century Asian tigers.
  

  
  

• China's government investment is consistent (based on 5 year plans), whereas U.S. public budgets are volatile, subject to elections and the shifting forces of special interests.
  

  
  

• China-based enterprises have government support for translational research, whereas U.S.R&D focuses on basic science to universities and government laboratories.
  

  
  

• There is no significant US government support for translational research. 50% of U.S. Federal government R&D is defense related, with limited GDP impact.
  

  
  

• Chinese R&D stays onshore, while U.S. companies are moving substantial R&D offshore to Asia, principally to China in many sectors, and to India in some sectors.
  

  
  

• US business has moved from translational R&D and commercialization to acquisition.
  

  
  

• China is winning the race in new energy production.
  

  
  

• China will produce and export electric cars to the US market within a short period of time.
  

  
  

• The race for biotechnology basic science dominance is the USA's to lose.
  

  
  

• China will lead the world in nanotech.
  

  
  

• Chinese high tech parks are far beyond the scope and scale of even the largest US research parks.
  

  
  

• China is a breeding ground for high tech startups.
  

  
  

• China will lead the world in HSR transit.
  

Challenges for the U.S.

If the U.S. objective is to create new drivers of the economy and new high skill and high wage jobs, than the U.S. R&D budget is misallocated in many respects. In the first instance, U.S. basic science R&D is subsidizing the translational research and commercialization in China and other parts of the world. It saves developing countries the cost of discovery and invention.

In the second instance, the budgetary focus of a deeply indebted society on social improvement is misaimed. For example, federal support for improved health care assistance does not create new capital intensive industries and market-based jobs.

The U.S. needs an industrial policy that supports translational R&D for commercialization in new technologies that produce new job drivers for the economy. It needs a technology investment bank to finance start-ups that ar above the VC risk investment levels.

There has to be a culture change in American scientific faculties from allegiance to basic science to a new dedication to applied science and engineering. The U.S. can no longer afford to subsidized knowledge for its own sake. This was only possible when American industry invested in onshore applied R&D. That period has gone.

The Federal Government cannot rely on universities to translate and commercialize discoveries and inventions. It needs more national laboratories for technology translation and commercialization, as well as fiscal policies for private business affiliates to incentivize them to produce onshore. Otherwise, R&D and high tech investment will continue to migrate abroad to lower cost countries like China that have great science and engineering talent pools and vast new markets to access. U.S. venture capital will migrate along with human capital assets. There are more IPOs in China than in the U.S.

The US must open its door wide to all foreign scientific and engineering talent that wants to come, in order to maintain a university and National laboratory pool which is already over 50% foreign. Easier policies must b adopted for permanent residence.

For a debtor nation, the Government has to allow the sale to all interested buyers of advanced technologies that are now restricted for export. The U.S. must rectify its trade deficit and gain revenues for reinvestment in technology. Without sales and re-investment, technology leadership, where it still prevails, will vanish.

These are harsh steps, but the facts command attention. The technology marathon is already half over and the U.S. is behind. The only energy for a final leg of the race is a culture change to force feed our children in science and engineering; a social change to commercialize our scientists; a political change to let talent in the door and induce them to remain; and a national security change to sell advanced technology for the financial nutrition to get to the finish line.

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.