China's Power Brands
How do you get rich in China these days? Build a brand. That's what 35-year-old Huang Guangyu has done. The Guangdong native started out at 18, renting a market stall in Beijing and hawking cheap plastic appliances. Today, his GOME Electrical Appliances is China's top consumer-electronics chain, with well over 100 stores, $2 billion in sales, and the kind of high-plateau brand recognition that Circuit City (CC ) and Best Buy (BBY ) enjoy in the U.S.
And thanks to a backdoor stock listing in Hong Kong this summer, Huang's net worth is at least $830 million. Just one hitch, though. China's domestic retail players, including GOME, are already worried about the impact of foreign competition next year, when Beijing will open the entire country to retailers from abroad.
This little tale neatly sums up the story of China's emerging brands today. Tremendous excitement about the brands, but a good dose of fear about their staying power. Global business executives are certainly agog at the prospect that the next stage of China's superfast development will be the establishment of power brands in everything from retailing to white goods to autos and more -- brands strong enough both to dominate at home and thrive overseas. "They are definitely going global," says Glen Murphy, the Shanghai-based managing director of ACNielsen in China. "With their resources and production base, they are large enough to reach out to the world."
There are plenty of well-known local names besides GOME. Haier Group, of course, is the granddaddy, a $10 billion maker of refrigerators, washing machines, and more, with global ambitions nurtured by its well-known boss, Zhang Ruimin. Hangzhou Wahaha Group Co., with $1.2 billion in sales, is the top vendor of bottled water. TCL Corp., with $3.4 billion in revenue, is so powerful in TVs and other electronics that it reached a deal to merge its television business with that of France's Thomson (TMS ) last year and took control of Alcatel's (ALA ) cell-phone business this year. Lenovo Group Ltd. (LGHLY ), formerly known as Legend, with $3 billion in revenue, is No. 1 in China's PC market. Li-Ning Co. Ltd., founded by a Chinese athlete, is the top seller of athletic footwear and apparel: It went public this year, too. The roster goes on and on.
But China brand watchers wonder, is this impressive enough? They see the capacity overhang in Chinese industry, the tendency to skimp on innovation, the ever-growing presence of multinationals on the mainland, and the continuing popularity of foreign brands on the mainland. Share prices for many of China's consumer brand companies are way off this year. Brand awareness of Chinese companies among U.S. and European consumers is, by and large, low. And for every China brands enthusiast, there's a skeptic. "Export their brands successfully?" asks Tom Doctoroff, CEO for Greater China at U.S. ad agency J. Walter Thompson (WPPGY ). "Chinese companies are light years away from it."
Then again, so were the Koreans when they set out 20 years ago to join the stable of world-class brand companies -- and no one could have predicted that Samsung, LG, and Hyundai would be the up-and-coming global brands they are now. Like the Koreans, the Chinese are certainly going to stumble many times as they build their brands. But with all the furious activity going on in the marketplace, some of these brands will emerge as real winners, both at home and abroad. Unlike the nationalist Japanese, some will hook up with foreign companies to get a boost -- and some will even use the brand name of their foreign partner when they market abroad, as TCL will with RCA, Thomson's big brand in the U.S., and the Thomson brand itself, in Europe. China's huge domestic economy gives these contenders the chance to cut their teeth in the most competitive market on earth, and to build up a war chest of revenues for efforts abroad. "Market shares will go up and down. Some Chinese companies will lose. It's a learning process," says Paul Gao, a principal in the Shanghai office of McKinsey & Co. "But there is no doubt that world-class Chinese brands will emerge." The learning process will involve both making better products and selling them more effectively. Ogilvy & Mather Chairman and CEO Shelly Lazarus recently led a conference of more than a dozen Chinese companies at the former estate of agency founder David Ogilvy. Lazarus was impressed both by their lack of knowledge and their hunger. "Most Chinese companies don't yet understand even what we mean by 'positioning' a brand," Lazarus told BusinessWeek. "But they are anxious to know. They can't suck it in fast enough. They are going to figure this out. You can see it in their eyes."
THE COMPETITIVE CRUSH
Who will those winners be? China brand watchers pick TCL, Haier, and SVA, a top TV maker. But at this stage in China's tumultuous economy, it's hard to say for sure. Overcapacity has reached 30% in many industries, including televisions, washing machines, and refrigerators, putting tremendous pressure on margins. "Home electronics appliance prices are decreasing 10% to 15% annually," says Chen Kaixun, vice-president of Hisense Electric Co. Ltd., an appliance maker and rival to Haier. "For the price war, the only thing we can do is decrease our costs." Hisense managed 2% profit growth in the first half. The price war has also hit Haier hard; its Shanghai-listed arm pulled off only 6% profit growth for the first half, despite sharply rising sales. And it's not just white goods. Auto prices have fallen 7% in each of the past two years and are expected to drop at least 10% this year. The television glut is especially severe -- and an aggressive export drive has triggered anti-dumping suits from the U.S. and Europe.
Another menace is the profusion of copycat products that spring up as soon as a brand gains popularity. Products from Tsingtao beer to Li-Ning shoes all compete with knockoffs. Often the only way for the big Chinese and foreign brands to drive the counterfeiters out of business is to slash prices even further -- a strategy that runs counter to developing brand equity.
In this punishing environment, the until-now mediocre record of Chinese companies in innovation is a liability. It's rare for Chinese companies to meet the international norm of spending 5% or more of revenues on research and development. This spending gap can give multinationals the edge.
That's what has happened in cell phones. Between 2000 and 2003, local handset brands like Bird, Amoi, Panda, and TCL beat Nokia (NOK ), Motorola (MOT ), and other global brands on price and flashy features like TCL's gem-studded phone, a big success with the nouveaux-riches. The locals went from a zero share in handsets a few years ago to almost 50%. "We take our Chinese competitors seriously," says Maurice Tan, marketing manager for Nokia China. "They are like a wolf pack."
Yet the wolf pack has been retreating of late. In the past year or so, Motorola, Nokia, and Sony Ericsson have rolled out a raft of phones with fancy new functions, pushed aggressively into new markets, and slashed prices. Nokia, for example, has added Chinese handwriting functions, and expanded its relationships with the thousands of small retailers that sell mobile phones across China. Because of the counterattack, TCL has seen its branded handset market share slip from 8% to 6.1% in the last year and a half: Sales of its mobile phones at its Shenzhen-listed arm dropped almost by a third in the first half, while Bird's sales dropped almost 20%. Overall, domestic vendors have seen their handset sales slip from 42% of the market last year to 37% in the first half of 2004. Says Patrick Kung, general manager of Motorola's handset business in North Asia: "The locals did very well in the past three years. But starting this year, their growth rate has stalled big time." And there are still 37 local handset makers slugging it out.
Foreign manufacturers such as Hitachi and Samsung have also won back share in high-end plasma and flat-screen TVs, while Panasonic and LG have recovered some of the sales they lost in microwaves to local brand Galanz. In autos, the Koreans and Japanese are expected to introduce more affordable models in China. "The next several years will be difficult for local carmakers," predicts Yale Zhang, director of emerging-markets vehicle forecasts at CSM Asia Corp. in Shanghai. General Motors (GM ), Ford (F ), and Volkswagen already offer budget models for less than $10,000. That could spell trouble for Geely Auto, a six-year-old brand that has quickly captured 4% of the market with cars that sell for as little as $3,500. Geely can't match the foreign brands for quality.
The increasing competition in retail will also hurt, at least in the short run. Today, Chinese companies have an edge in developing relationships with the thousands of small stores and kiosks where most Chinese shop. But with the World Trade Organization-mandated opening of all China to foreign retailers coming at the end of the year, multinationals such as Wal-Mart Stores Inc. (WMT ) and Carrefour will further expand their franchises, making those ties less important. "As the distribution model changes, it is becoming less and less suited to domestic brands, making it easier for foreign companies to penetrate China," says Qu Honglin, general manager of Local Strategy, a Shanghai brands consultancy.
A final issue that Chinese companies have to struggle with is the depth of management. Many of China's best brands were conceived by heroic entrepreneurs like GOME's Huang or 59-year-old Zong Qinghou. Zong, who spent years laboring in the rice paddies during the Cultural Revolution, is founder of Wahaha, a beverage group that had profits of $196 million last year. (French company Groupe Danone (DA ) owns 30%.) A hands-on leader, Zong will lead his managers on a tour of street vendors to see how beverages get sold in China's sprawling sidewalk markets. But he scorns market research, and it's not clear how Wahaha would fare without its charismatic founder. That's also true of other Chinese companies, says Local Strategy's Qu.
DON'T SKIMP ON R&D
These are all formidable problems. Yet for every setback, the Chinese find a way to move forward. Indeed, losing a few rounds in the most competitive market on earth is excellent training. Look at Lenovo. Several years ago the computer maker hatched big plans to branch out into PDAs, mobile phones, and other areas beyond its expertise in laptops, PCs, and servers. The company pushed its global expansion as well. Bad idea. The loss of focus started costing Lenovo -- as Dell Inc. (DELL ) stepped up the pressure in China. Lenovo had to lay off 5% of its workforce last spring. But to its credit, the company has refocused its priorities in the China market, and profits rebounded 24% in the first quarter of its fiscal year. Investors need to keep a watch, though. Lenovo is now going into investment banking -- not exactly a core competence.
Other companies are realizing they can't skimp on research. Over the next few years, TCL will ramp up R&D from 3% of sales to 5%. Television maker SVA Group spends 6%. "We must invest and develop new products," says Chen Hong, SVA's vice-president in charge of overseas markets. "If we focus on price alone, we don't have a future." SVA sells only flat-screen and plasma televisions in the U.S. and has hired McKinsey to do consumer research to tailor its branded products.
If foreign connections will help, so be it. SVA has a new joint venture with NEC to manufacture LCD panels. TCL, by acquiring Thomson-RCA's TV line and Alcatel's cell-phone business, has acquired Western brand names, distribution networks in Europe, and a bundle of Western technology. Strong sales in televisions in China and abroad helped push up TCL'S first half earnings by 44%, despite its serious setback in cell phones at home.
One brand that has seen its global future and acted on it is telecom equipment maker Huawei Technologies Co. It already spends more than 10% of its revenues on research -- and is not only competing successfully against outfits like Cisco in telecommunications gear but could emerge as a consumer brand as well. It now makes handsets and set-top boxes for TVs. Its formidable research machine could give it a winning hand.
Other companies are building up better knowledge of foreign markets. Haier has been criticized for not grasping what it takes to succeed globally. "One of the steps that many of the Asian companies have missed is the huge investment that's required to build brand equity," says David L. Swift, executive vice-president of Whirlpool Corp.'s (WHR ) North American region, which competes with Haier. In the U.S., Haier's greatest success is with budget items such as compact refrigerators.
Yet Haier already spends 4% of revenues on research and is creating local product-development teams in Tokyo and the U.S. to differentiate its line and move upmarket. In Japan, for instance, Haier offers washers that use less water, are quieter, and are narrow enough to fit cramped Japanese homes. "In the past, we tried to design our products in Qingdao and sell them to the U.S. and Japan," says 55-year-old CEO Zhang. "They didn't meet overseas consumers' needs and didn't sell well." Today, Haier has 22 factories overseas, including a refrigerator plant in Camden, South Carolina. Revenues from Haier's overseas operations are up 53% to $1.3 billion in the first eight months of 2004.
Back home, many parts of the Chinese market are still up for grabs, thanks to the vastness of the country. Wahaha, for example, has built up its market by avoiding head-on confrontations with PepsiCo Inc. (PEP ) and Coca-Cola Co. (KO ) and focusing on less-developed markets. It is now a big force in provincial capitals like Kunming, Yunnan. "We have a huge advantage in second-tier markets," boasts Wahaha's Zong, whose brand leads Coke and Pepsi in most of rural China. "In rural China, Wahaha has a majority position," confirms Zhu Huican, an analyst at Beijing market researcher Gung Ho Group.
Other companies are customizing products for the hinterland. Guangdong Kelon Electrical Holdings Co. has developed the budget Combine brand of refrigerators and air conditioners for less affluent consumers. "We are targeting poor families and farmers," says Kelon Chairman Gu Chujun, a 45-year-old former scientist who patented his own cooling system for his fridges. Kelon's sales are up 49% this year, while profits are up 11%.
Chinese companies are also learning how to raid the competition. Li-Ning has hired Wu Xianyong, a former Procter & Gamble (PG ) manager, to run its marketing and branding. Wu made sure that many of the Chinese athletes at the Athens Olympics wore Li-Ning shoes and other equipment. Such product placement gave Li-Ning an Olympic boost in sales in China, where the company has more than 2,000 outlets and the top spot in athletic shoes, with 12.39% market share, according to Sinomonitor International, a Beijing market monitoring firm. "All of us [Chinese consumer goods] companies must thank P&G for our development," says Li-Ning's general manager Zhang Zhiyong. Geely's Nan Yang, a senior vice-president for overseas production, was formerly general manager of Shanghai Volkswagen Automotive Co., the joint venture between Volkswagen and Shanghai Automotive Industry Corp. Nan has overseen Geely's push into parts of the Arab world. The head of Wahaha's Future Cola unit once was the Beijing bottler for Pepsi.
Like Westerners, the Chinese are learning how to advertise on a grand scale. Ad spending last year was $24 billion in China, making it the third-biggest ad market in the world. A big chunk of that spending will be by Chinese companies, and lines such as Li-Ning's "Anything is possible" are known by millions. The ad spending will only increase as the 2008 date of the Beijing Olympics approaches. Lenovo already became the first-ever Chinese company to be an official "top" sponsor of an Olympics -- up there with Coca Cola and Panasonic -- when it signed on to back the 2008 games. It's part of "a longtime dream to become an international brand," says marketing boss Alice Li. Sports marketing is a fast-rising category even without the coming Olympics. To keep its brand front-of-mind in China, SVA in 2001 bought Shanghai's soccer team. Meanwhile, the world beckons. SVA has established its foothold in the U.S. Meanwhile, TCL, with the Alcatel deal it just signed, has big plans for Europe. Geely has borrowed from the Koreans' early marketing strategy and entered other developing countries as a first step to overseas expansion, starting with the Middle East. On Oct. 10, Haier announced it is opening an R&D center and factory in fast-growing India.
Some efforts will fail. But with every ad campaign, every marketing battle, every product launch, the Chinese learn more. Does another Chinese juggernaut, like the one that has taken over much of global manufacturing lie ahead? Not now. But give them time, and the best of these brands will prove themselves.
By Dexter Roberts
With Frederik Balfour in Shanghai, Bruce Einhorn in Hong Kong, Michael Arndt in Chicago, and Michael Shari and David Kiley in New York