Why China is too important a market for foreign companies to exit, especially as Chinese innovation takes off

Edward Tse says multinational companies are realising that they cannot ignore Chinese innovation and must embrace China-specific strategies
As China’s auto industry opens up, for example, new forms of partnerships among foreign, local, state-owned and private companies are being formed

Edward Tse

Published: 3:00am, 19 Nov 2018

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Chinese President Xi Jinping met a group of entrepreneurs on November 1 and underscored the government’s support for the private sector. Soon after, Guo Shuqing, chairman of the China Banking Regulatory Commission, pledged that at least 50 per cent of new corporate loans by China’s banks would be provided to the private sector.

These moves reaffirmed Xi’s earlier position that both the state-owned and private sector are critical to China. In fact, a “three-layered duality” working model has emerged and is providing resilience for China’s economic development. At the top, the central government sets the overall development priorities. At the grass-roots level, private-sector entrepreneurs have become a major driving force behind the economy. Sandwiched in the middle, local governments, in response to the central government’s direction and strategy, collaborate and compete in regional clusters, often by teaming up with entrepreneurs.

Another major initiative by Xi was highlighted in his speech at the opening ceremony of the China International Import Expo in Shanghai, on November 5. He emphasised China’s commitment to opening up and reform, inviting more foreign participation in the country’s growing market. He further endorsed multilateralism on global trade and finance, forging a win-win platform so countries can together create greater prosperity for the world.

Over its 40 years of reform, China has been gradually opening up, sector by sector, to non-state and in particular, foreign companies. Many sectors are already open to foreign participation, including consumer goods, retail, automotive parts and appliances.

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Beijing recently set a timeline to phase out the ownership cap on the automotive industry. It has also committed to liberalisation in other sectors such as financial services, agriculture, aircraft and ship manufacturing. Clearly, liberalisation of market access will be carried out against a set of constraints defined by the Chinese government. Key industries touching on “national security” – military, defence, mission-critical public utility, data and cybersecurity – will continue to be subject to investment restrictions.

All these moves carry profound meaning, especially in the context of the US-China trade war. Reuters reported in October that, as the cost of production rises, a large percentage of US companies are planning to shift supply chains out of China. However, among this growing list, only 1 per cent said they had any plans to establish manufacturing bases in North America.

For many foreign multinational corporations, including American companies, the China market has become so important that an exit is almost not an option. Take the auto market as an example. Though China recorded the sharpest sales decline in car sales in September since 2011, the country remains the world’s largest market. For most major international carmakers, it is a must-win market. China is also of strategic importance to the likes of Apple, Starbucks, Nike, Adidas, L’Oreal, Johnson & Johnson, and many other global companies.

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While US politicians and lobbyists are pressuring China for “reciprocity” – that is, more market access – they and many foreign companies have missed China’s waves of business innovation, probably the country’s most important development in the past decade. This innovation, often led by Chinese entrepreneurs, is creating new paradigms across the board. Terminologies such as “automobility”, “new retail”, “OMO” (online merged with offline), “smart homes” and “big health” signify how industries are being reshaped.

For example, the auto industry is quickly evolving into an “automobility” industry, driven by three major forces – electrification, autonomous driving and “mobility-as-a-service”. The latter enables people to completely plan trips using digital platforms that integrate booking, planning and ticketing across public and private services. This new paradigm involves both hardware and on-demand personal mobility services, such as ride-hailing services, in contrast to the old one of people owning traditional internal combustion non-digitally-connected cars. Though car sales in China are under pressure, the automobility market size is forecast to expand from around US$30 billion in 2017 to over US$210 billion by 2025.

Global carmakers have found that, to participate in this new paradigm, they need to build competitive advantages specific to China and embrace innovations in China for China.

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Thus paradoxically, as the auto market opens up – and therefore “reciprocity” is in theory achieved – foreign carmakers are not shedding local partners to form wholly owned operations. Instead, new forms of partnerships among foreign, local, state-owned and privately-owned companies are being formed.

An employee uses a laptop next to a car body at an assembly line at a Ford manufacturing plant in Chongqing municipality in April 2012. Photo: Reuters

In September, Ford and Zotye Automobile, a Zhejiang-based privately owned enterprise, formed a joint venture to focus on providing customised smart electric vehicles to fleet operators and drivers in China’s ride-hailing industry. In October, Daimler and Geely, another Zhejiang-headquartered private enterprise, announced they would set up a joint venture to offer premium ride-hailing services.

Today, most have come to realise the power of the innovations by the Chinese players, as well as the growing importance of China’s market

Investments by foreign multinationals in China are not shrinking but expanding. In recognition of the strategic importance of the China market, for instance, Ford has just announced an elevation of its China operations to a separate business unit led by a newly recruited CEO, who is a Chinese national, reporting directly to the company’s global headquarters.

Innovation, not reciprocity, is the real game changer. In the past, foreign multinational companies have either dismissed or ignored Chinese innovations due to a combination of a lack of awareness and disbelief. Today, most have come to realise the power of the innovations by the Chinese players, as well as the growing importance of China’s market despite the trade war with the US.

As new technologies such as artificial intelligence, the internet-of-things, 5G and blockchain emerge, old knowledge from the past and from the West will no longer be enough. Global CEOs need to develop a “new game” strategy to win, or just to survive, under a drastically different set of conditions. Those who get it will be able to reap major benefits and build a strong position not only in China but for the world. Those who don’t will be marginalised over time.

Edward Tse is founder & CEO of Gao Feng Advisory Company, a global strategy and management consulting firm with roots in greater China. He is also author of China’s Disrupters

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