Question

Use examples to discuss the different capabilities needed by foreign companies to be successful in China.

Answer 1

Caterpillar the world leader in construction equipment, is having trouble making deeper tracks in China. The U.S.-based manufacturer of tractors, backhoes, road graders, and other devices began selling equipment in China in 1975, a year before the death of Chairman Mao. As the Chinese government invested massively in infrastructure, Caterpillar helped pave the way, literally, for economic growth and modernization in the world’s fastest-growing market for construction equipment.

Like many foreign players in any number of industries, Caterpillar got its start in China by selling goods to the Chinese government—the only possible customer before the era of economic reform—and then began selling high-quality equipment to the private sector as a premium segment of the market emerged. But it never broadened its focus to include other segments, and by the early 2000s, Komatsu, Hitachi, Daewoo, and other competitors from Japan and Korea were in the middle market with tools and equipment that cost less but were still reliable. Meanwhile, a tranche of local manufacturers that had previously been focused only on the low end of the market were burrowing up to battle the established players, designing and releasing their own products targeted squarely at middle-market consumers.

As the experiences of Caterpillar and other multinationals suggest, a critical new battleground is emerging for companies seeking to establish, sustain, or expand their presence in China: It’s the “good-enough” market segment, home of reliable-enough products at low-enough prices to attract the cream of China’s fast-growing cohort of midlevel consumers.

An Evolving Opportunity

Historically, there has been a simple structure to China’s markets: at the top, a small premium segment served by foreign companies realizing solid margins and rapid growth; at the bottom, a large low-end segment served by local companies offering low-quality, undifferentiated products (typically 40% to 90% cheaper than premium ones) that often lose money—when producers do their accounting right. Between the two is the rapidly expanding good-enough segment. (For an example of how one market sector breaks out, see the exhibit. ”The Structure of China’s Market for Televisions).

Consequently, China’s middle market is growing faster than both the premium and low-end segments. In some categories, the good-enough space already accounts for nearly half of all revenues. Eight out of every ten washing machines and televisions now sold in China are good-enough brands. It should come as no surprise, then, that China—and, in particular, its opportunity-rich middle market—is increasingly capturing multinational executives’ resources and attention. As Mark Bernhard, chief financial officer of General Motors’ Shanghai-based GM China Group, recently told the Detroit News: “For GM to remain a global industry leader, we must also be a leader in China.”

Colgate-Palmolive made similar moves in China. It entered into a joint venture in the early 1990s with one of China’s largest toothpaste producers, and it acquired China’s market leader for toothbrushes a decade later, allowing it to scale up and then leverage its production processes to compete in other parts of the world. As a result, Colgate more than doubled its oral hygiene revenues in China between 1998 and 2005, and it now exports its China products to 70 countries.

Local Chinese competitors pose the biggest challenge to multinationals seeking to capitalize on their business ventures in China and beyond. In the auto industry, for instance, domestic carmakers like Geely and Chery have eaten away at Western companies’ market share in China by introducing good-enough cars for local consumption. Several of these automakers have started exhibiting vehicles at car shows in the United States and Europe, buying available Western brands, and exporting vehicles to other emerging markets. True, these players face enormous challenges in meeting safety and emissions standards and in building up the required distribution networks to compete in Europe and North America.

European and North American companies producing major appliances, microwaves, and televisions know this all too well. They abdicated China to low-cost local competitors in the 1990s and now find themselves struggling to compete globally against those same Chinese companies. Haier, which started making refrigerators in 1984, went on to become one of China’s best-known brands and then used its hard-won scale advantages and manufacturing skills to crack, and then dominate, foreign markets. Today, it is one of the largest refrigerator companies in the world, controlling 8.3% of the highly fragmented global market. The company sells products in more than 100 markets, including the United States, Africa, and Pakistan.

Making an Entrance

It’s one thing to recognize the importance of China’s middle market; it’s another thing entirely to turn that awareness into action. The first step in winning the battle for China’s good-enough market is determining when—or when not—to enter the fray. That will depend on the attractiveness of the premium segment: Is it still growing? Are companies still achieving high returns or are returns eroding? Another consideration is your company’s market position: Are you a leader or a niche player?

Foreign companies grappling with the good-enough decision in China will need to consider these factors and perform thorough market and competitor analyses, along with careful customer segmentation and needs analyses—classic strategy tools, of course, but applied in the context of a rapidly changing economy that may lack historical data on market share, prices, and the like. Senior managers will need to establish the factors that are key to success in everything from branding to pricing to distribution. This knowledge will inform important decisions about whether companies should expand organically into the middle market, acquire an existing player in that space, or find a good-enough partner.

Generally speaking, competing in the good-enough space is neither necessary nor wise for multinationals operating in stable premium segments. These companies should instead focus on lowering their costs and innovating to maintain their premium or niche positions and to sustain their margins. We studied one large manufacturer of automation equipment, for example, that wisely decided to stand pat in the premium segment. Market research suggested that its customers were still willing to pay more for reliability, even with a variety of lower-cost choices out there. The company continued to invest in R&D, hoping to further differentiate its products from those of local players; it expanded its distribution and service networks to improve its responsiveness to customers; and it cut costs by taking advantage of local production resources.

Few multinationals find themselves in such a fortunate position, however. If growth in the premium segment is slowing and returns are eroding, multinational corporations will need to enter the good-enough space. Even those companies that because of their strong competitive position initially abstain from entering the middle market should revisit their decision frequently to guard against emerging competitive threats. For their part, Chinese companies will need to move upmarket as the lower-end segment becomes increasingly competitive.