Where's That Chinese Pot Of Gold?
Although China has always been a difficult place to make money, multinationals have maintained that success requires patience. Yet as China moves into more sophisticated industries, many companies are questioning whether their investments will ever pay off. From power generation to aircraft and telecommunications, veteran investors find that the hurdles for success grow higher. Beijing encourages overcapacity, bureaucratic problems drive up costs, and central planners disrupt the market. The experiences of foreign carmakers and drug companies underscore the problem. In both sectors, China is one of the most important emerging markets. But profits are as elusive as ever.
AUTOS: STUCK IN FIRST GEAR
Huge plants, skimpy sales
Four years ago, Peugeot seemed poised to realize its big ambitions in China. The French auto maker announced it would invest $1 billion by the turn of the century to boost output at its joint-venture plant in Guangzhou from 20,000 units to 150,000. But today, such hopes seem forlorn. With the French beset by problems ranging from an outdated product to a weak partner, the Peugeot plant turned out only 2,674 vehicles in 1996. Rumors are rife that Peugeot is trying to sell its stake.
Peugeot may become the first foreign auto maker to call it quits in the potentially enormous China market. But it is hardly the only one climbing the walls in frustration. Volkswagen, whose Santana joint-venture in Shanghai is China's most successful car project, has lost more than $100 million in a new venture. Peugeot's sister company, Automobiles Citroen, is posting steep losses at its new plant in Wuhan. Among American companies, General Motors Corp. still hasn't concluded a deal to build Buicks that it signed in October, 1995. Chrysler Corp. has no new plans beyond its 14-year-old Jeep venture in Beijing. Says Chrysler Chairman Robert J. Eaton, who is fed up with the bureaucracy: "There is concern whether the Chinese will ever let any company determine its destiny."
Beijing's meddling is a big part of the problem. In the early 1990s, when China regarded cars as a "pillar industry" of the future, policymakers pushed to set up huge, world-class plants. But when the economy overheated, Beijing imposed tight-money policies that suppressed car demand. The result: Last year, passenger-car sales rose by 19%, to 382,000. Capacity, however, reached 700,000 and will continue to grow dramatically.
SMUGGLING. Adding to the competition is car smuggling from Japan and South Korea, which some industry sources estimate reached 100,000 units last year. Meanwhile, the government recently lowered its projections for future car demand from 1.2 million in 2000 to 850,000.
Compounding the problem is that passenger-car prices are fixed by the government at between $15,600 and $26,000. At those levels, few manufacturers can realize profits because of their low production volumes. The situation could "get very serious in a year if the government keeps playing around," warns Denis Duchesne, general manager of Dongfeng Citroen Automobile Co.
The Citroen plant, among China's most modern, has Beijing's blessing to make up to 300,000 cars a year next century. Yet last year, it produced a paltry 13,000 of its ZX Fukangs. That low volume, plus the need to import 40% of its parts, makes it impossible to break even on the ZX Fukang's $17,800 price tag. Citroen is expanding steadily and expects to become profitable in five years, Duchesne says, provided Beijing's policies become more rational.
Peugeot has not even approached a profitable level of production. The company's aging 505 model, which is priced at nearly $26,000, has never been a hit in China. Also, its local partner, the Guangdong provincial government, has been unable to get Beijing's go-ahead for expansion plans. Last year, the venture sold less than 3,000 cars, compared with 6,600 in 1995. Peugeot is entangled in negotiations to sell its 22% stake or shift production to its Citroen affiliate in Wuhan. As of mid-January, says Frederic Saint-Geours, deputy managing director of Automobiles Peugeot, the Guangzhou plant was facing "major difficulties."
GETTING STALE. Even the market's savviest player is running into trouble. While Volkswagen's Shanghai joint venture has been profitable since 1986 and now accounts for 54% of China's passenger-car market, its deal with state-owned First Automobile Works in the northern city of Changchun is another story. This project to produce Jettas has struggled with weak sales, poor plant efficiency, and other glitches. After four years, annual sales are just 25,000 units, half of its target and well shy of its 150,000-unit capacity. "Last year was the first time that cars were not automatically sold" in China, says Volkswagen Asia-Pacific Chairman Martin Posth.
Then there's the issue of Beijing's goals vs. commercial viability. Among the hitches apparently holding up Mercedes' plan to make minivans, announced in mid-1995, is China's demand that production be split between factories in Guangzhou and Hainan Island, hundreds of miles away. Although the German company insists it is committed to the project, it is far from signing a contract. General Motors, which has a 1995 agreement to produce Buicks at a planned $1.2 billion facility in Shanghai, also is growing weary of waiting for Beijing's formal approval. Says Chairman John F. Smith Jr., "This is going to get stale if we don't get going."
Except for Peugeot, however, no auto maker seems close to pulling out. Nobody wants to be left behind in a market with such potential. Although its executives are frustrated at the pace of negotiations, GM still expects to put some $2 billion into a host of deals. GM's Opel unit has expressed interest in taking over Peugeot's Guangzhou venture. And despite its troubled minivan project, Mercedes-Benz in September signed a new agreement to make commercial buses. But as the prospects of profit get ever more distant, the world's auto makers will have to wonder whether staying in the China game is really worth the price.
By Mark Clifford in Hong Kong, with Dexter Roberts in Beijing, Mia Trinephi in Paris, and Kathleen Kerwin in Detroit
DRUGS: PLENTY OF BITTER PILLS
Knockoffs and protectionism
At the Shangdi high-technology park in Beijing, the Danish pharmaceutical company Novo Nordisk is constructing a $10 million research-and-development center. To show how serious they are about China, the Danes have built a "spirit wall" to shield the center's main entrance, a traditional Chinese means of keeping bad luck away.
It may be just a gesture, but Novo Nordisk needs all the help it can get in this market, as do other Western drugmakers. Last year, China registered more than $5 billion in prescription and over-the-counter drug sales, and the industry should grow at close to 20% annually for years. Some established companies, such as Xian-Janssen and SmithKline Beecham, have earned strong profits. But many other ventures are seeing their profits erode. Problems include new moves by the government to protect the local drug industry, fresh restrictions on foreigners' ability to sell drugs, and serious problems with protection of intellectual property.
Many government practices make foreign drugmakers uneasy. When a non-Chinese pharmaceutical company applies for patent protection, for example, it releases the formulas of its drugs to the State Pharmaceutical Administration of China (SPAC). The suspicion is that somehow, local rivals then copy the formulas. "There is definitely some leakage," says the head of one Western drugmaker who has seen his company's drugs rapidly copied. To make things worse, a loophole in Chinese law essentially means that copycats can escape punishment.
Foreign companies also complain about Beijing's tactics in cutting health-care costs. The government keeps lists that show which drugs the state will pay for: If a consumer wants drugs not on the list, he or she must pay out of pocket. Many foreign drugmakers note that the lists contain few foreign products. They claim the lists are a disguised form of protectionism. The Chinese say it's just logical. "Eight hundred million farmers can't afford to buy expensive biotech," argues Chen Zhangliang, president of Beijing-based China PKU Winning Biotech Group. "So China has to develop cheaper pharmaceuticals."
OFF THE LIST. Yet the suspicions remain. "[The Chinese] don't want the multinationals to dominate the whole industry," says Mandy Chui, business-development manager at IMS China, a medical-business and market-information company. Take SmithKline Beecham's experience. Its successful Tianjin factory rolls out thousands of Contac capsules every minute to feed what is already the largest market in the world for its cold medicine. Yet Contac has recently been taken off the government reimbursement list, while Contac's main Chinese competitor, Black & White cold formula, remains on the list.
With all these obstacles, it's no wonder many companies have not met their original targets. Pfizer Inc. which has invested $60 million in a factory in Dalian it opened in 1993, and Glaxo Wellcome PLC, which has been making anti-asthma aspirators in Chongqing since 1991, are two of many companies that have had trouble reaching full production in their China facilities. Sales are not strong enough yet. "Some companies are even talking about subcontracting out part of their factories to other producers" because of slow sales, says Chui.
Still, no foreign player is ready to pull out. Companies such as SmithKline and Pharmacia & Upjohn Inc., for example, still plan sizable additional investments. "It's going to be a major market," says Chris Robbins, general manager of China Bristol-Myers Squibb. "The question is: How far away is the pot of gold?" Pretty far, it seems. But with such huge sales beckoning, drug companies are still betting China is worth the headache.
By Dexter Roberts in Beijing