How You Can Win In China

The obstacles are huge but surmountable

It's a frantic, cavernous place, filled with frazzled passengers trying to catch the next train to Shanghai and peasants disembarking from the far corners of China. Yet amid the mayhem around the Beijing West Railway Station is a sparkling IBM service center. The outlet, one of 40 IBM has set up around China in a venture with the Railways Ministry, is part of an aggressive push that has enabled IBM to vault to the top of China's booming personal-computer market after a decade of frustration. It's the kind of success that heartens those who wonder if China will ever pay off for Western investors.

Encouraging, that is, until you talk to somebody such as Jean C. Monty, chief executive of Northern Telecom Ltd. Since agreeing to a $130 million investment plan in 1993, Nortel has built a giant factory making state-of-the-art digital switches, forged a raft of research and development tie-ups with government institutes, and secured a solid foothold in China's fast-growing $13 billion telecom-equipment market. The problem is Nortel is barely breaking even. All of its major rivals, such as Lucent Technologies, Alcatel, Ericsson, NEC, and Siemens, have built similar plants. Instead of the five competitors Monty expected in 1993, there are 12. "We all built capacity and killed the price levels," says Monty. "That's fundamental economics." He doesn't see the situation improving anytime soon.

VICTIMS. Why are some foreign executives so bearish on China while others rave? It's almost as though there are two Chinas--one the mother of all emerging markets, the other a maddening, bottomless money pit. In a way, there are. There is old China, where holdovers of the Communist Party's planning apparatus heap demands on multinationals, especially in politically important sectors such as autos, chemicals, and telecom equipment. Companies are shaken down by local officials, whipsawed by policy swings, railroaded into bad partnerships, and squeezed for technology. McDonnell Douglas, Peugeot, and BellSouth all have been burned on big investments.

These investors' travails also have serious political implications. In the U.S., which posted a $39.5 billion trade deficit with China last year, critics of the Clinton Administration's "constructive engagement" policy--and many executives--increasingly question whether the strategic importance attached to the China market is warranted.

But the critics should realize that a new, market-driven China is emerging fast. Many consumer areas, from fast foods to shampoo, are now wide open. Even in tightly guarded sectors, the barriers to entry are eroding as provincial authorities, rival ministries, and even the military challenge the power of Beijing's technocrats. By tying up with entrepreneurial players, GTE Corp. has secured a foothold in telecom services and Ford Motor Co. a beachhead in autos. More barriers will tumble if China enters the World Trade Organization.

Some clear lessons are emerging on what divides the winners from the losers. The winners have become smarter about picking Chinese partners and are increasingly daring to go it alone. They have learned how to transfer technology without giving their crown jewels away. Western companies have also learned that rather than making grandiose, multibillion-dollar promises, it's better to fly below the radar screen of Beijing's state planners with modest projects. More than ever, success depends on such basics as service and marketing. The winners manage their business for profits, while many money-losers simply have lousy business plans. "If a venture doesn't see a return in a few years, it won't see a profit," says Brian Wilson, director of Greater China at Andersen Consulting.

Whether the level of profitability is acceptable is another question. In a 1995 survey by Andersen, 64% of multinationals said they are making money in China. But half said their margins were lower than in other developing countries. China veterans now accept that the returns are way out of line with the risks. Survivors minimize losses by learning to avoid deadbeats and resisting unreasonable demands by Beijing.

A growing number of companies are getting it right, including some in America's leading-edge industries. Motorola Inc. had $3.4 billion in sales last year in Hong Kong and China, 12% of worldwide revenue. Skyrocketing PC sales in China are a big reason why Asia now accounts for 21% of Intel Corp.'s revenue, compared with 11% just a year ago. "China is emerging as one of the great growth markets," says Intel China President James W. Jarrett.

No industry better illustrates the changing rules of the game than information technology. Chinese planners once limited imports of PCs and software to promote homespun industries. But Chinese buyers preferred smuggled imports to the overpriced, backward PCs of local manufacturers. Beijing eventually loosened the restraints. Now, Microsoft Corp.'s Chinese version of Windows 95 is emerging as the dominant PC operating system. And the PC market, growing at a 40% annual clip, is a stronghold of U.S. brands.

IBM has seized on this new openness and refined its China strategy. In the early 1980s, the giant invested too heavily. Then it cut too far back and stubbornly insisted on flogging its unpopular PS/2 systems. When the PC market took off, rivals zoomed ahead. Then, IBM moved its China headquarters from Hong Kong to Beijing, launched cheaper PCs, and hiked China investments in everything from world-class manufacturing lines to research labs.

IBM also got serious about reaching customers. Besides securing sites for a national network of service centers, the tie-up with the Railway Ministry also enables Big Blue to ship parts around the country within 24 hours. IBM's sales have risen 50% annually for the past three years, to more than $500 million.

Other companies are learning to adapt to local conditions. GE Capital had big plans for leasing everything from huge subway drills to bulldozers and cranes. Then executives studied the carnage of earlier leasing ventures by rivals, who lost millions because the weak legal system made it difficult to repossess equipment when companies defaulted.

TESTING. So GE Capital scaled back. In its joint venture in leasing construction equipment in Shanghai, employees drive cranes to building sites and return them each evening to a depot. Instead of launching a credit card, GE Capital is providing consumer financing for purchases of appliances. Now it has just landed a license to set up China's first 100% foreign-owned finance company. Says Daniel H. Mudd, president of GE Capital Asia Pacific Ltd.: "The flood is coming, and we want to be ready for it."

Other investors are starting to test the limits of China's murky regulatory systems. In telecommunications, where foreign operators aren't allowed to hold equity, GTE is investing $82 million to build China's first nationwide paging network. How? By forming a venture with Guangzhou Guangtong Resources Co., a business unit of the People's Liberation Army. GTE supplies the equipment and technological support. The PLA brings a radio spectrum and political protection. What's more, Guangzhou Guangtong employees can sell GTE's pagers out of military vans that drive or park even in the most crowded areas because they are immune from traffic laws. By 1999, GTE expects to have 250,000 customers.

Clever, but still risky. GTE doesn't even have the right to audit the books of its partner. Also, outside Guangzhou, it has had a hard time getting licenses and access to the phone network.

The experience of BellSouth Corp. highlights the perils of bad partnerships. In 1994, the Atlanta-based company tied up with Unicom Corp., a new, state-owned telecom operator. After signing an agreement to build cellular-telephone systems, BellSouth spent $50 million working up numerous studies, training Unicom employees, hosting U.S. visits by Unicom executives, and staffing its Beijing office, which at one point had 20 Americans. Then, a top Unicom official demanded a $10 million cash advance if negotiations were to proceed. BellSouth pulled the plug and hasn't recouped its money. "They got taken to the cleaners," says a Western diplomat. BellSouth declined comment.

The hazards of partnerships are driving some more experienced foreign players to push for more control. Procter & Gamble Co. used joint-venture partners to get started and establish its leadership in shampoo and laundry detergent. But the massive new shampoo factory it is building in Tianjin will be wholly owned. Companies such as Nestle and Avery-Dennison Corp. are either going it alone in new ventures or buying out local partners.

In some sectors, though, eluding Beijing's heavy hand remains tough. Investors in autos, telecoms, chemicals, and other "pillar" industries will likely remain plagued by poor partners and meddlesome bureaucrats until government policies change. "If anything, companies in these areas are feeling new pressure," says Greg Mastel, a Washington-based China consultant with the Economic Strategy Institute.

Take Volkswagen, one of the most successful foreign investors in China. Its joint venture with Shanghai Automotive Industry Corp. has been making money on its Santana sedans since 1987. But things have gone wrong at VW's second joint-venture plant. Authorities dictated that VW team up with First Auto Works, in the northeastern Rust Belt city of Changchun, and build a factory with a 150,000-unit capacity to roll out the Jetta. Now, production is less than one-third of capacity. The two sides have quarreled over everything from distribution rights to accounting. VW says the venture has lost at least $100 million.

Despite such complaints, few deep-pocketed multinationals are cutting back. To telecom equipment suppliers like Nortel, Lucent Technologies, and Alcatel, the alternative--ceding the world's biggest future telecom market--is worse than pushing on. Even if they only break even now on phone lines, they still hope to make big returns by landing follow-on orders and selling upgraded software. Thus, investment continues to pour into China.

NEW CHANCES. The best chance for these and other companies to make money is China's commitment to the reforms needed to turn around the state sector and enter the World Trade Organization. Officials are weighing moves that range from privatization to deregulation of service industries that could open huge new opportunities for foreign investors.

Companies that need high returns fast probably should opt out of the China game. But as the old China gives way to the new, successes will multiply. Instead of trying endlessly to figure out what Beijing expects from them, the winners will be those with more smarts, creativity, and endurance.

    Before it's here, it's on the Bloomberg Terminal.