Book review: Winning in China
Can foreign companies succeed in China?
Wharton professor Karl Ulrich’s and Lele Sang’s new book “Winning in China” chronicles the successes and failures of foreign companies trying to succeed in China. Some have done extraordinarily well. Others have failed.
So what are the characteristics of the companies that did well and not?
Amazon.com
Amazon actually had some early successes in China. In 2007 they had a market share of 12% - not far behind market leader Dangdang’s 18%. Their major bet came in 2004 when they acquired Chinese online book-seller Joyo, run by Xiaomi’s current CEO Lei Jun. Amazon tried to integrate Joyo into its existing China team, but Joyo employees felt constrained by Amazon’s bureaucracy. So eventually, Amazon got rid of most Joyo employees and replaced them with Western-educated Chinese professionals. Amazon did try hard to adapt to the local market with a more complex website - which many Chinese prefer. And while most e-commerce platforms required cash-on-delivery, Amazon introduced a point-of-sale system that enabled customers to pay with their credit cards. They also built a highly advanced integrated logistics network.
But from 2007 onwards, JD and Alibaba started catching up. JD was well funded, and its strategy was to pursue market share gains at all costs. Alibaba received major funding from Softbank and Boyu Capital - an investment firm run by the grandson of Jiang Zemin. Alibaba came up with major innovations: an instant messaging platform that enabled shoppers to interact with merchants. They also came up with an online payment solution called AliPay, which held purchase funds in escrow until the buyer accepted merchandise. Alibaba offered its platform for free to merchants. They then tried to sell ads to those merchants that wanted greater visibility on the platform. Amazon, on the other hand, didn’t sell much advertising. They used an algorithm to decide who the best merchant would be for each product. That was a major reason why merchants didn’t like Amazon’s platform. JD built out its own logistics network that achieved even better speeds than that of Amazon. And finally, JD and Alibaba discounted heavily. Amazon refused to engage in price wars. And for that simple reason, price-sensitive shoppers turned to JD and Alibaba instead.
Ulrich & Sang believe that Amazon’s only advantage was in logistics. Well-funded JD.com took away that advantage. They also think Amazon didn’t have enough commitment to the Chinese market - being unwilling to engage in price wars. Amazon’s China unit also lacked the necessary autonomy to respond quickly with new features to help them compete.
My view: E-commerce is a commodity business, and Amazon’s competitors had bigger pockets. JD still doesn’t make any money from its e-commerce business. Alibaba is profitable, but their accounting is somewhat dubious, in my view. Alibaba has indeed had major innovations such as AliPay and the messaging platform that enabled customers to communicate with merchants.
Norwegian Cruise Line
Florida-based cruise operator Norwegian Cruise Line entered the Chinese market in 2015. It set up a China branch headquartered in Shanghai and courted local travel agents to sell its new cruise services. The year after, the company set out to build a new ship called “Joy” specifically designed for the Chinese market. The ship had three casinos, a laser tag course and the first go-kart track at sea. It had 900 square metres of shopping space with 50 international luxury brands such as Rolex, Chanel and Tiffany’s. Since many Chinese families travel with grandparents, they built different cabin configurations for customers that brought their extended families. To appeal to Chinese tastes, they built teahouses, karaoke rooms, gaming rooms with mahjong and Chinese restaurants. Instead of a pool deck, they turned it into a tranquility park with faux grass and trees where staff offered tai chi and yoga classes. Wang Leehom became the face of the Joy cruise ship marketing campaign, which is available on YouTube here. They also let customers use AliPay instead of dual-currency credit cards or cash as on other cruises. Since it was targeted at the premium segment, prices were 10-15% higher than those of other cruise operators.
The Joy cruise ship didn’t perform as well as anticipated. It turned out that most of Joy’s customers were middle-class people with families. They didn’t gamble in the casinos, they didn’t buy luxury bags, and they didn’t go to the ship’s luxury restaurants. Most customers only dined on the complimentary fare. They didn’t go drink in bars as most Western tourists would. Instead, Joy’s customers used the electric kettle in the cabins to boil water and drink. And it was difficult for Norwegian Cruise Line to adapt. The company procured food and beverages internationally, and that made it difficult to lower prices. Cruise ships make most of their profits from onboard services, but Joy’s onboard service revenue was one of the worst among NCL’s markets. Another issue was that customers didn’t book off-ship excursions with NCL but directly with their travel agents, who made money from commissions from stores for bringing in shoppers. Eventually, NCL admitted defeat. They rerouted the Joy cruise ship to Alaska, where it has done much better financially.
Ulrich & Sang think that NCL didn’t really understand their customers. Their Chinese customers expected an exotic Western-style experience. They also overestimated their spending power. They noted that competition within the cruise industry is fierce. Royal Caribbean has a strong brand name by having been in the Chinese market for decades. Customers didn’t know NCL but instead simply asked to go on the ship “where Wang Leehom was the captain”.
My view: My take-away is that competition within the cruise industry is simply fierce. NCL tried very hard. I know that other cruise operators have found the Chinese market difficult as well. What NCL could have done was to start small and iterate until they found a value proposition that worked in the Chinese market.
Hyundai
Korean car manufacturer Hyundai was initially very successful in China. It increased its yearly sales to 1 million vehicles in just a decade, achieving a 10% market share. Customers valued Hyundai’s low prices and their modern designs. In the mid-2000s, Hyundai won the contract to provide 70% of the taxicabs for Beijing and soon received taxicab orders from many other cities in China.
In 2017 after South Korea installed a THAAD missile defence system, China retaliated through anti-Korea publicity campaigns. Several Korean companies were hit hard, including Hyundai, Kia, Lotte, Samsung and AmorePacific. Hyundai’s market share fell to the low single digits, and it has had to close one of its factories in Beijing. Also, Hyundai had a dispute with its Chinese joint venture partner Beijing Automotive Industry Holding (BAIC). Hyundai brought in its Korean suppliers and refused to rely on BAIC’s own fully-owned auto component subsidiaries. Roughly 80% of Hyundai’s components came from its own Korean suppliers, who they claimed were better. That created a conflict between BAIC and Hyundai. Hyundai didn’t want to conduct R&D within China. Competition from Geely and Great Wall Motor has also been fierce as they have moved up the value chain.
Ulrich & Sang think it was a mistake for Hyundai to replicate its Korean supply chain in China since that move made it difficult to lower costs. They also think that Hyundai lagged behind Chinese consumers’ demand for more and better SUVs. They think that the THAAD crisis was bad luck for Hyundai.
My view: I really think they got Hyundai wrong. I am nothing but impressed with Hyundai’s execution in China. While Hyundai lacked lower-priced SUVs for a few years, they eventually caught up. Today, their product portfolio is better than ever. If I were Hyundai, I would have done the same and also relied on Korean suppliers. The more R&D you do on the mainland, the more likely it is to be stolen. You can call the THAAD crisis bad luck, but I see it as more of a general risk of doing business in China. It is not a coincidence that all Korean companies have suffered over the past four years, just as it’s not a coincidence that all Japanese companies suffered after the Senkaku Islands dispute in 2012.
LinkedIn
LinkedIn initially did well in China. They had already accumulated a few million Chinese followers when it officially arrived in 2014. They partnered with venture capital firm Sequoia China and China Broadband Capital, a politically connected venture capital firm. LinkedIn quickly obtained an Internet content provider license through their connections - a prerequisite for operating in China. They struck a deal with WeChat, linking WeChat accounts with LinkedIn accounts. LinkedIn also offered data to Alibaba that helped Sesame Credit assess credit scores.
One problem with LinkedIn is that it relies on e-mails. Chinese often opt for direct phone calls or WeChat as their means of communication. And searching on Baidu is unlikely to return a LinkedIn profile, as many parts of the Chinese Internet is divided into walled gardens belonging to Baidu, Alibaba, Tencent, etc. LinkedIn also had difficulties adapting quickly since all initiatives had to go through the California headquarters. LinkedIn tried to launch a local product Chitu, but it was essentially just a LinkedIn copy but without the global network that LinkedIn itself enjoyed.
Ulrich & Sang think that LinkedIn’s brand wasn’t strong enough. They think LinkedIn wasn’t able to leverage their global network into gaining users. “A China unit must be granted the agility to compete in China. But if it doesn’t leverage its parent’s assets, it has no particular advantage relative to aggressive local rivals”.
My view: Their interpretation of LinkedIn’s lack of success seems accurate. The entire business is based on network effects, so it will be hard to compete against incumbents who are bigger and more nimble than you (for example, Tencent’s WeChat platform).
Sequoia Capital
Silicon Valley-based venture capital firm Sequoia has taken the Chinese market seriously and made major investments in Chinese tech companies from early on. In 2004, they set out to find a local partner and decided on Neil Shen, the founder of Ctrip and Home Inn. He had also been an early investor in Focus Media. Sequoia China focused on finding operators - partners with actual operating experience, rather than some technology wiz straight out of college. Sequoia also eschewed financial engineering, putting a greater focus on building companies instead. One of their major early bets was on e-commerce. Sequoia’s business model in China was to decentralise the organisation, letting the Chinese partners make their own investment decisions. Sequoia China’s investment and operational decision-making happen in China, whereas IT, finance and organisational coordination are centralised in the United States.
Since the start in 2004, Sequoia has invested in Meituan, Pinduoduo, JDI, Bytedance and many other successful companies. They have also made a few unusual investments, such as wealth management company Noah, which now is the largest independent wealth management company in China.
Ulrich & Sang believe that Sequoia Capital’s success factor was its brand, which creates a halo for any start-up looking to hire or seek further funding. They think it was a correct decision for Sequoia to pick the right China head and let him and his team do their work with little interference from the headquarters.
My view: Their assessment makes sense, though I’m not convinced that Sequoia Capital has necessarily been successful in China. We are in the midst of a venture capital boom, and many Chinese tech companies seem overvalued to me. I’m also not convinced that Sequoia Capital will be able to repatriate the capital they have been accumulating on the mainland.
InMobi
Indian ad-tech company InMobi entered the Chinese market in 2011 after a major investment from Japan’s Softbank. Run by Indian entrepreneur Naveen Tewari, InMobi had an early mover advantage in mobile advertising (matching advertisers and publishing platforms, i.e. websites). Their ad targeting platform was already highly successful in the Indian market, which it dominated. When they entered China, they hired Jessie Yang from McKinsey and let her run the organisation without much intervention from Bangalore. So much that many customers actually believed that InMobi was a Chinese company. The compensation structure for the sales reps was variable, reflecting their contributions to the company. That made InMobi nimble and aggressive. When Yang asked for products adapted to the local market, the Bangalore headquarters obliged and set up a new product and design team in Beijing.
Since InMobi entered the market in 2011, they grew to become the biggest independent ad network in China, partnering with 30,000 apps and covering 80% of iOS users and 40% of Android users.
Ulrich & Sang think that InMobi had a first-mover advantage and made full use of it by letting the Chinese subsidiary operate independently. It was wise to hire Jessie Yang, whose previous start-up failure had taught her valuable lessons that she had taken to heart.
My view: Tewari seems to be unusually open-minded and sensitive to the opinions of his customers. He wants to know them and what they want from the company. The way the Chinese subsidiary was organised - with an unusual amount of autonomy - might also have helped catapult InMobi to success.
Intel
Intel opened its first China office in Beijing in 1985. It didn’t make much progress at first as computers were still expensive and the country was poor. But as computer prices fell and Microsoft Windows improved the user experience, Intel became more and more successful throughout the 1990s. There was competition from AMD, but AMD were run out of Hong Kong and not fully committed to the market.
Today, Intel derives roughly 25% of its revenues from China. It has been trying to navigate government policies. In 2000, Intel took a cue from the Chinese government’s “go west” policy, encouraging companies to invest in hinterland hubs such as Chengdu, Chongqing and Xi’an. Intel figured out that the Chinese government valued growth more than anything and tried to help them meet those objectives. In 2004, the government announced a homegrown standard for wireless technology that required Intel to share all intellectual property with Chinese partners. Intel resisted. Lately, Intel has invested US$1.5 billion in Tsinghua Unigroup to roll up the Chinese semiconductor industry. They also helped Tsinghua Unigroup build NAND fabs and thus share their own technology.
Ulrich & Sand think that Intel succeeded thanks to their unique technology and partnership with Microsoft. They also think it was wise to partner with the Chinese government, aligning its business with China’s national priorities.
My view: I'm afraid I have to disagree with the author’s assessment of Intel. Intel has been forced to give up significant intellectual property and capital to maintain their access to the Chinese market, which they most likely would have captured anyway, given Intel’s strength in x86 processors.
Zegna
Zegna entered China in 1991 and initially endured five years of operating losses. Particular focus was put on customer service, with bonuses linked to key customer service KPI. They offered 30-day free returns and free door-to-door tailoring services. By 2008, Zegna owned all of its China stores, thus better managing products, brand, and customer service. Today, about one-fifth of Zegna’s products in China are tailored specifically for Asian customers.
Zegna now operates 70 stores in China across many different provinces. They managed to establish a brand that has now become synonymous with success for many middle-aged nouveau riches. Their standing-collar jacket has been a massive success after Xi Jinping started wearing it since becoming Chairman in 2012. On the other hand, the brand suffered from Xi Jinping’s anti-corruption campaign from 2014 onwards as much of Zegna’s revenues came from gifts. Young people think that Zegna represents an older person’s clothes and think Gucci, Prada and Louis Vuitton suit them better. That presents a challenge to the brand.
Ulrich & Sang think that Zegna brought unique assets to China, notably a brand with an Italian heritage. But that their focus on customer engagement also helped explain their success. Their early commitment to the market also helped build a brand, even when it didn’t make short-term financial gains from doing so.
My view: I agree with their assessment.
The book’s conclusions
Ulrich & Sang point to a few success factors for any company trying to enter the Chinese market:
Market access and political goodwill provided by the government
A product-market fit that helps customers solve a specific job
A unique competitive advantage, some resource or asset that helps the company provide a product or service better than its rivals (brand, technology, network effects, etc.)
Organisational agility to be able to compete in a fast-changing business environment, specifically by not being restrained by a company’s corporate headquarters overseas
Entrepreneurial leadership, as corporate politicians are seldom resourceful pioneers
Personal reflections
The many mistakes and misinterpretations put me off. Ulrich & Sang called Korean conglomerates “keiretsu” (the Korean term is “chaebol”). They referred to Xi Jinping as China’s President while he is, in fact, Chairman and General Secretary of the Chinese Communist Party. The interpretation of Hyundai’s failure in China is off-the-mark, in my view.
So can foreign companies succeed in China? I am more cynical than Ulrich & Sang. As Matt Pottinger pointed out in a recent testimony, the Chinese government conducts wholesale theft of intellectual property to wean off its dependence on foreign technology. Meanwhile, it wants to use foreign companies’ dependence on China as leverage to achieve national objectives. Intel might have achieved a large China business. But it has also been forced to share intellectual property in a way that could be detrimental to its long-term success. Hyundai invested a significant amount of capital in its China business but was used as a pawn when Beijing tried to get South Korea to scrap its THAAD missile system. As Robert Spalding noted in his book Stealth War, some companies have reported difficulties of repatriating capital from China. Even though a company gains significant market share, revenues or cash flows from a business in China, that does not necessarily equate to long-term financial success.
I believe that the companies that are most likely to succeed are those that have assets that local peers cannot copy. Zegna stands out as the true success story. No Chinese competitor will ever be able to copy its brand since it is so connected to its Italian heritage.
So foreign companies can do well in China. They just need to be prepared to share intellectual property, be subject to the vagaries of national politics and perhaps also be willing reinvest the capital in other RMB-denominated assets.