Insights

You Might Be A Real Chinese Company…

We have recently written that at the top of U.S. firms’ agendas must be bringing some of the skills that are found in the “fast learner” economy of China into their operations.[1] A frequent response has been: “We got that message long ago; we have been in China for years.”

In most cases, we beg to differ.  Our message is not about physical presence or even taking advantage of low labor costs of China; it is about adopting a business model that is very different from the one we are accustomed to in the west.  We have been characterizing it with the saying: “The early bird gets the worm, but the Second Mouse gets the cheese.”[2]

The Second Mouse business model is different.  It is about borrowing the best ideas from others and ignoring the fact of “not invented here.”  It is about fast adaptations of products instead of slow but revolutionary developments.  It is about using the economics of low-cost labor in creative ways, not just to do the same thing at a lower cost.  It is about focusing product development on eliminating unnecessary product features (and their cost), instead of about raising the bar on design, technology, or features.  It is about adapting to the economic situation faced by the vast majority of customers in emerging markets, not attempting to condition the elite premium buyers to behave like customers in the U.S. or western Europe.  It is about determining how to meet the needs of customers in each segment without burdening them with features and costs that aren’t of importance to them.  It is decidedly not about building an operation in emerging markets modeled on one in the U.S.

Second Mouse companies in industry after industry have followed this business model, delivering products that are “almost as good at a great price point” and gaining leadership in the broad middle market of countries like China.[3] Some of these Second Mouse companies have emerged from within China’s borders to become global leaders in their industries.  For many western firms, the choice will be between becoming more like these firms or competing with them in not only the growth markets of emerging countries, but eventually on a global basis.

There are many secrets to China economics,[4] but the underlying factor in these companies’ success is the mindset that existing competitive products in the global marketplace are acceptable to the market, but they must be offered at a significantly lower price to reach most customers.  It is that mindset of focusing efforts on emulation, simplification, streamlining, and cost reduction that allows Chinese companies to reach the price points necessary for success with Chinese middle market customers.  It also relies in a critical way on personal relationships, with those in other companies and organizations, in order to implement.

A laser-like focus on costs, methods that take advantage of a relationship-based business culture, and responding to the needs of less sophisticated and less world wise customers are key elements of this business model.

When we have managed to convince executives in western companies that the China fast follower company is a very different animal from what we are used to, the next question we are asked is “OK, so how can I tell if the operation we acquired or started in China is a Real Chinese Company or not?”  This question becomes especially important for western firms searching for acquisition candidates in China, as many of the case studies we’ve presented of confirmed Second Mouse companies involve Chinese firms that have travelled quite far down the path of Second Mouse evolution, with a number of them such as Huawei or Haier now firmly established as global leaders within their industry.

Since there are many dimensions of business models operating in China and because they cross various topics, we like to answer in the Jeff Foxworthy style of “You might be a real Chinese company if …”[5] The themes are grouped under the two distinct aspects of the business model – the methods of operation included within the business model itself and the implementation of the business model through the use of close relationships outside the company.

After providing examples of behaviors of real Chinese companies in these two groupings, we’ll offer some final thoughts about the importance of the fundamental elements of the Second Mouse business model – and the challenges that face western firms as they contemplate expanded operations in China and acquisition of real Chinese companies into their own corporate structures.

REAL CHINESE COMPANY BUSINESS METHODS

You might be a real Chinese company if the historical display cabinet on the first floor contains decades-old products that have your parent company’s name stamped into the castings, from the time that they were first copied.

Visiting executives from the U.S. who see knock-offs of their own products on display in the lobby of a newly-acquired firm might be appalled.  It would be a challenge for us to convince them they should be thankful that they have managed to buy a real Chinese company.  But we think they should secretly be pleased.  IP infringement is a serious problem and we make light of it only to illustrate the mindset of fast followers.  They believe the market is content with the others’ offerings, they borrow from where they can, they change only what they can improve, and most of all they get to market quickly.  The challenge for a U.S. parent company is to preserve that willingness to build upon good ideas and focus on incremental improvements (especially in cost), while making sure to follow the rules.  In our experience, it is easier to mandate following the rules than it is to teach fast follower skills to those who don’t come by them naturally.

You might be a real Chinese company if you are so famous for your service that customers are happy that your products are not as reliable or long-lived as the competition.

Real Chinese companies are masters at balancing the low labor cost of service with the cost of improvements and testing to bring superior product reliability.  Some of the companies in China with the best reputations in our thousands of customer interviews over the decades are known for putting products in the marketplace that are not “fully tested” because they know how inexpensive it is to fix them later and how much the customers appreciate the fast service that they can afford to provide.  They also recognize local conditions, such as the fact that buildings in emerging markets are not built to last for 30 years, so why should the equipment that goes into those buildings be built to last for 30 years?  That is an avoidable expense, pure and simple, and it is important for a real Chinese company to think of it that way.

You might be a real Chinese company if you are greeted by mayors when you go to visit your suppliers because they are the only employers in their towns and you are their only customer.

Real Chinese companies are always on the lookout for lower-cost, unconventional suppliers, such as rural villages that can learn to specialize in making an important part.  The cost of cultivating relationships with those suppliers is more than compensated for in the reliability that your relationship guarantees and the lower cost that comes from using labor that is literally surplus, since there is no other employer.  One of our clients describes running an Internet auction for a critical component and getting a bid of less than 10% of what they expected.  Rather than dismissing that bid as a product of some scam, this client sent in a SWAT team of engineers and accountants to teach the prospective supplier how to do a quality job and how to develop a profitable long-term business (at a price above what they bid, but one that is sustainable).  At a price that is still a fraction of what they previously paid, our client has one of the world’s most competent and loyal suppliers and a willing pupil for future learning.

You might be a real Chinese company if your selling price for your product is lower than your major global competitor’s cost of materials in China.

Evidence of the real Chinese company’s devotion to saving by scouring the country for lower-cost suppliers is in its cost of materials.  The suppliers might not be “certified by U.S. headquarters” but the materials they supply are good enough to suit the basic requirements and meet the needs of the market.  Suppliers do need to be monitored and the long-term relationship does need to be managed to make sure that the supplier does not follow their instinct to cut corners too far.  Obviously we are not counseling our clients to cut corners in critical areas of safety and performance, but we are suggesting that if your operation in China is sourcing from the “usual suspects” or the list of “approved global suppliers”, it is probably not a real Chinese company.

You might be a real Chinese company if your products are sometimes shipped in the same cartons in which poultry arrives for your cafeteria.

Real Chinese companies scoop up the crumbs – the small opportunities to reuse and conserve.  It is unimaginable that most U.S. companies would send employees searching for a used box when a product is ready for shipment, but a true Chinese company’s employees are watching for chances to save small amounts even at the expense of a little extra time spent.  Employees in these companies literally run to turn off the lights when a room is not being used.  If and when Chinese labor becomes too expensive to allow people to look for simple ways to save, this advice might have to be changed, but so far we have seen few cases in which “penny-wise and pound-foolish” is a problem in China.  Having the company fall into the habit of “Doing things the global company way” is a much greater risk.

You might be a real Chinese company if the SAP team arrives to do implementation and finds the accounting group working on abacuses.

Methods appropriate to the task are the hallmark of a real Chinese company.  Some of our clients marvel at how efficient the newly-acquired company actually is at doing accounting by traditional methods.  They have argued that abacuses are actually faster.  And they report that the Chinese financial department knows much more about the details of transactions and customer relationships than if their reports were spit out of a computer back at headquarters.  Once again, we are not anti-technology, but we are suggesting that the Chinese methods – simple systems to do simple jobs – are in place for a reason and shouldn’t be replaced by high-tech methods without a more compelling reason.  “That it is done that way elsewhere” will never sound like a compelling reason to a real Chinese company.  It almost surely will raise costs and be quite disruptive to send in the IT SWAT team.

You might be a real Chinese company if your annual report describes three factories, but two of them require that a visit by outsiders be arranged in advance so the name on the front of the building can be changed.

One man’s scam is another man’s real Chinese efficiency.  We have seen many cases ourselves (and heard of many more from our clients and friends in China) in which a local factory is “renamed” with the name of a company that is called upon to show a customer its plant.  What is usually going on is that a local operation is the manufacturing site that is “shared” by a number of closely-connected local companies.  The outright scam would involve trying to sell a company claiming to own a factory that is not owned; we have seen those too.  Any company leader who would attempt that is obviously not to be trusted.  But the real Chinese efficiency comes from being willing to utilize a factory with which there is a very close relationship, as close as ownership would be in the west, without it actually being owned.  This conserves on capital and better manages production loads, while often delivering the same quality with the same responsibility as if the factory were owned.

REAL CHINESE COMPANY RELATIONSHIPS

You might be a real Chinese company if your annual report has a picture of the CEO shaking hands with the top leaders of China, the governor of the province, the mayor of the city, and Bill Clinton (an all-time favorite), all before the report ever mentions what it is your company actually does.

Real Chinese companies put the most important thing first in their annual reports – evidence of who they have relationships with.  Drinking baijiu (white liquor), doing “inspection tours” of local government facilities, and getting pictures taken with officials is the ultimate in torture experienced by foreign executives in China, to hear most tell it.  But these relationships are paramount in getting almost anything done in China.  In a very real sense, the ability of your company’s leaders to meet China’s important officials is more important than the products and services you provide.  Products and services can be adjusted to meet the needs of the market, and if you are a real Chinese company, those can be adjusted with lightning-like China speed.  But without relationships, many initiatives, from plant expansion to doing business with local government enterprises, are literally impossible.  And, by the way, if you think that meeting officials and drinking their baijiu is torture, the Chinese will probably figure that out since their experience in relationship-building vastly outweighs yours, so do yourself a favor and find some other person to be the company’s top representative.

You might be a real Chinese company if there is a room in your office building full of baijiu (liquor) that was taken in trade for spare parts.

Local customers are likely to be connected by government ownership and other relationships with a complex web of other companies.  We know of suppliers who have been asked by the mayor to take local products, from baijiu to autos, in return for equipment or spare parts that are needed when funds are scarce.  Every company, whether or not a real Chinese company, needs to decide how far it is willing to go to accommodate requests for unconventional financing and payment.  Payment problems are one of the thorns in the side of most foreign companies, especially if their local relationships are insufficient to make eventual payment assured.  But working in the real Chinese way of being flexible is what the customers expect and what earns their gratitude and that of local officials.   In return for finding financing for a major infrastructure project, a company we know quite well was once given the exclusive advertising contact for the facility.  Not knowing how to run an advertising company, they would have been far better off to decline this quid-pro-quo, but everyone needs to live and learn.

You might be a real Chinese company if you ask to see the major customers’ contracts and the sales team disappears for a week because they don’t want to admit that they have no idea what you’re talking about.

Relationship replaces contractual formality in most business transactions in China.  Attempting to formalize business relationships might seem tidy and important for global consistency, but think twice.  The customers probably will not understand why you are treating them that way.  They will spend useless energy trying to figure out what they have done to make you distrust them.  And very few in China will hesitate to violate a written agreement, but disappointing someone with whom they have an important relationship is taken seriously indeed.  So, in fact, if you damage your customer relationships in order to formalize your customer relationships, it almost surely will negatively affect your future.  Nonetheless, a foreign company, especially one making an acquisition in China, needs to make sure that the longstanding relationships are intact or you could be left with neither relationship nor formality.

You might be a real Chinese company if the local authorities have never requested payment of property taxes and there is no evidence that you have ever paid any.

Even when it comes to an aspect of business as formal as paying taxes, relationship trumps written rules.[6] Instead of the carefully-crafted and detailed agreements for tax forgiveness we would execute in the U.S. in return for locating manufacturing in a jurisdiction, such things in China are based on people and their relationships.  We have seen several acquisitions fail on exactly this issue.  Local government has been foregoing taxes without any written agreement and they have no intention of ever trying to collect, but no one in a position of authority is willing to document these facts.  While a real Chinese company understands this, a U.S. parent is unlikely to be comfortable without making balance sheet provisions for paying all possible statutory taxes in the entire company’s history.  So, in an accounting sense, the acquisition candidate is literally worth less to the acquirer than on its own.  And, indeed, a change in local government leadership might be all it takes for the “agreement” to be forgotten, so being cautious is sometimes justified, although the price might be the ability to acquire a real Chinese company and its competencies and relationships.

You might be a real Chinese company if the employees show up looking for their annual bonuses which have always before been paid in cash, with no record of where the money came from or where it went.

Real Chinese companies have many agreements that are simply understood – from employee bonuses to sources of income outside of the core business.  In some cases we know, the bonuses were paid out of some relatively innocent sources of funds that accrued near the end of the year.  So, some reasons for the lack of documentation are not red flags, but others are efforts to avoid taxes or worse.  We include this example to point out that there are many things that real Chinese companies do that are at best hard to accept and at worst illegal for a publicly-traded western company to engage in.  To the extent that hiding profits saves on taxes or other obligations, the western-owned real Chinese company is at a disadvantage to the local competitors.  But such is unavoidable.

You might be a real Chinese company if your answer to a customer inquiry about the human body parts found in the latest product shipment is that you didn’t charge extra for that.

For the life of us we can’t figure out a positive lesson that comes out of this story, but we have heard virtually the same story twice from different customers.  Their China factories made shipments with such an unexpected “surprise” inside.  The story is too good and too illustrative of how challenging it is to run a real Chinese company, so we couldn’t resist including it even though we can’t see how being this cavalier about both employee safety and product delivery is a good thing, regardless of one’s focus on cost.

REAL CHINESE COMPANY LESSONS

We have taken a lighthearted look at what we think is a very serious topic:  how to operate according to the fast-follower business model that we believe is critical in addressing the critical middle market in developing countries – and potentially in enabling your firm to evolve to sustain a position of leadership in the middle market segments of the developed country markets of the west.  Many of the companies that will have attributes important to your firm’s future success will also have characteristics such as we’ve described in the examples above.  We doubt that you will encounter a firm that shares all of the attributes we’ve cited, even in China, but our own experience in identifying interesting acquisition candidates includes far more cases in which many of these attributes were present than ones in which they were all absent.

Some of the behaviors we describe are well worth fostering, while others cannot be tolerated.  In an article arguing that western firms must implement a different approach to acquisition and integration as they look to their China (and global) strategy for the future, we suggested a new focus for integration, namely that the mantra of the integration process must be to change what must be changed without destroying what must be assimilated into the acquiring company.[7] Shifting in that direction will be a challenge for most firms, as our examples here suggest, but the critical reason for making an acquisition of a real Chinese company is to bring what it does best into your own organization.

Finally, for those that feel the challenge is too great to contemplate, we argue that understanding the business model of these real Chinese companies will become increasingly important – as such firms are likely to become your most formidable competitors of the future, in the growth markets of China and other emerging countries and most likely in your own home country markets in the west.  Being able to compete with companies that work this way will be a challenge, but insight is probably better than ignorance.

Authors: George F. Brown, Jr. and David G. Hartman


[1] See David G. Hartman and George F. Brown, Jr., Change Before You Have To, Business Excellence, August 2011.

[2] See George F. Brown, Jr. and David G. Hartman, The Second Mouse Gets the Cheese, Sales and Service Excellence, June 2011.

[3] See George F. Brown, Jr. and David G. Hartman, Second Mouse Tales from China, Blue Canyon Partners, Inc., September 2011.

[4] See David G. Hartman, China Economics: Unraveling the Mystery of China’s Low Costs, Blue Canyon Partners, Inc., © 2007.

[5] These anecdotes provided in the following sections are all ones that we’ve either observed or heard from clients and friends over the years.  All are either know to be true or reported to be true.  In many instances, we’ve seen many versions of each of the behaviors that we’ve reported.  We’d appreciate additions to our roster from readers of this paper who have similar experiences to share.  You can email George Brown at gfb@bluecanyonpartners.com and David Hartman at dgh@bluecanyonpartners.com.

[6] See George F. Brown, Jr., David G. Hartman, and Atlee Valentine Pope, The Unwritten Rules of China, Blue Canyon Partners, Inc., © 2005.

[7] See George F. Brown, Jr. and David G. Hartman, Change Before You Have To, Business Excellence, August 2011.

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