Multinationals’ Mounting Challenges in China

In the fierce marketplace of China, how do multinational firms come out on top? What are their keys to success? And how do local firms compete head to head with multinationals after emerging from their restructuring processes?

By He Chong, PhD Candidate, Department of Management, CUHK Business School

These are the topics discussed at a recent seminar by Prof. See-Jin Chang, Provost’s Chair in Business Policy at National University of Singapore Business School, who has been doing research on multinational firms for a decade. The seminar, titled “Multinationals’ Strategy, Competition and Performance in China,” was jointly hosted by CUHK Business School’s Department of Management and the Center for International Business Studies.

Prof. Chang began the talk by pointing out what roused his interest in China business – the rapid transformation of China from a state-planned economy in 1978, to a liberalized one in 1998, and finally becoming the world’s second largest economy in 2010. “Twelve years in China equals to 40 years in other countries,” he said.

During the transformation, he said, the nature of competition in China has also changed rapidly from a clearly divided structure in which multinational firms dominated the high-end market while local firms supplied to the low-price mass market, to a mixed structure with localized multinational firms and emerging locals. The dividing line between these players has blurred.

According to Prof. Chang, in operating their foreign businesses, multinationals must face the issue of the type of ownership they choose for their subsidiaries. With the liberalization of foreign business regulations in China, new entrants to the market prefer wholly owned subsidiaries over joint ventures, and many old joint ventures are converting to wholly owned subsidiaries.

Prof. Chang and his colleagues found in their research that converted wholly owned subsidiaries outperform continuing joint ventures in industries characterized by high levels of intangible assets such as technology or brand. He said in the high advertising industry (often those with high consumer visibility, with advertising expenditure-to-sales ratio higher than average), for example, joint ventures converted to wholly owned subsidiaries have improved their performance by 1.6 percent ROA compared with continuing joint ventures. However, such a conversion in ownership structure does not help — nor harm — those joint ventures in the low R&D (those often regarded as the opposite of high-tech ventures, with an R&D expenditure-to-sales ratio lower than average) and low advertising industries (often industries with relatively low consumer visibility, with advertising expenditure-to-sales ratio lower than average).

Chinese local firms are also undergoing rapid changes. Many state-owned enterprises and collectives are replaced by private and incorporated firms. Prof. Chang’s studies show that this has improved their performance: “The effect of privatization could be a one-percent increment in ROA.” He said most new entrants in the market are private firms, and they tend to be more productive.

Multinationals Influence the Locals

According to Prof. Chang, multinationals can be the source of positive spillovers such as resource and knowledge transfers. At the same time, they give competition pressures. In his studies, he found that multinationals’ spillover effects are stronger than their competitive effects in the national market while competitive effects outweigh spillover effects in regional markets. Multinationals seem to compete more fiercely with modernized local firms than with conventional local firms, which do not exit the market despite competitions from foreign firms.

Prof. Chang reveals that while local firms located outside of the regions where multinationals operate could benefit from multinational firms’ presence, multinationals are being crowded out by both their foreign counterparts and local firms in and outside of the regions in which they are located.

The current market competition between multinationals and locals seems to be mixed. In some markets such as telecom terminals, foreign firms are dominant; in other markets, such as telecom equipment, local firms have become the leaders. One may expect that with more advanced technology, foreign firms would be more likely to win in high-tech industries. But Prof. Chang’s research reveals that as we move to industries with a higher R&D level, the market share taken up by foreign firms drops. However, in the high advertising industry, foreign firms can benefit from their intangible assets, he said, adding that they tend to have high market share in this industry.

To look deeper into the market and plan for the future, Prof. Chang has studied the China beer industry. “The industry has grown almost three times in the past 12 years, but the combined market share of the eight largest companies has increased from less than 30 percent to close to 70 percent,” which means that the once-competitive industry has now turned into an oligopoly. Along with the consolidation, the profitability of the industry has improved.

While people often view China as a market made up of several regional markets with different firms dominating different regions, Prof. Chang observed the integration of the beer market: The main producers are now “everywhere.” He also found a similar consolidation trend in other industries.

Prof. Chang summarized his view of the future of the China market: A less fragmented, more integrated national market, with strong local and multinational companies dominating the market.

In closing, Prof. Chang quoted from an LG Electronics executive: “China is a place like an Olympic game. The best players from all over the world are here and fight to win…. If we lose in China, we cannot succeed in the world market.”