FYI | Sep 10 2010
The following assessment by Winter Nie, Professor of Operations and Service Management at IMD, leading global business school based in Switzerland, puts a different perspective on market developments for high-end global manufacturers. This is why FNArena has decided to publish it in full.
By Winter Nie
Leading multinationals around the globe are anxious to exploit China’s potential as the world’s largest and most exciting market. However, a number of leading Chinese corporations are now positioning themselves to compete with the multinationals on their own terrain. Competition on a global scale has created unexpected pitfalls. Not the least of these is the fact that business can often be trumped by political sensitivities and xenophobia that are as endemic in the west as they are in China. China’s advantage in this high-stress, fast-paced environment is the extraordinary flexibility and creativity of its entrepreneurs, whose instincts have been honed by the cut-throat competition of the free market resulting from the reforms that began with Deng Xiaoping.
No one questions that China now handles the lion’s share of the world’s low-end manufacturing. According to various sources, at least 86% of the bicycles sold in the US are made in China, as are more than 70% of the world’s toys and Christmas tree ornaments. Roughly 60% of the world’s watches, clocks and shoes are made in China, along with 55% of the world’s cement and half of the world’s cameras and microwave ovens.
Until recently, however, the premium top end of the market has largely belonged to the multinational giants. That situation is already changing dramatically. Competition is driving the multinational giants, which had previously focused on high-end, top quality goods at premium prices, to begin moving down the market in China to exploit the segment characterized by no-frill goods that are less expensive and for which basic, but dependable quality is considered “good enough.” Competition from the top western firms in this previously Chinese-dominated market sector is combining with market saturation to force China’s homegrown industries to reach out to international markets formerly considered the preserve of the multinationals.
Huawei’s successes on the global stage
The change that is taking place in China is exemplified by the electronics giant Huawei, which was launched with a complement of 14 employees in 1988. Huawei’s founder is Ren Zhengfei, a former army colonel, who had previously been director of the People’s Liberation Army’s Information Engineering Academy, and had retired from government service four years earlier. Despite its name (Huawei translates as “China is great”), the company began with fairly modest ambitions.
It initially imported telephone switching equipment and PBXs to China from Hong Kong. When other distributors began to compete, Huawei was forced to begin manufacturing its own equipment and Ren sought a competitive advantage in developing new technology.
His master-stroke was to produce a new telephone exchange system capable of handling 10,000 switchboards—five times as many as his competitors. The new switching system gave Ren a competitive edge, but instead of immediately competing head-on with multinationals, Ren focused on provincial markets that were being ignored by foreign companies.
When Ericsson sent only three or four salesmen to sell switching equipment in Heilongjinag Province, Ren sent 200.[1][1] By 2005, Ren had captured 30% of China’s domestic market, and Huawei had 30,000 employees worldwide.
In 2002, telecom companies were bottoming out after the dotcom bust of 2,000, and Huawei marked its first downturn in the company’s history. Domestic sales were $2.2 billion, but Huawei’s market in China was shrinking by 21% a year. International sales were only half a billion, just 18% of total sales.[2][2] It was obvious that China’s internal market was becoming saturated and Huawei had to expand internationally if it was going to survive.
By 2004, international business accounted for 40% of Huawei’s revenues – the company was providing telecom and internet switching equipment to more than 30 of the world’s top 50 telecommunications companies.
Huawei’s sales still only added up to 17% of Cisco, the market leader, but Cisco had clearly begun to see Huawei as a threat. Huawei’s engineers were paid a fifth as much as the salaries of their US counterparts, and the equipment they were turning out was of equal if not better quality. Jean-Charles Doineau of Ovum consulting observed: “Huawei’s reputation as a low cost vendor is only the visible part of the iceberg. Below the waterline, the company has high technical standards.”[3][3]
François Paulus, who headed the network division at Neuf Telecom, a Huawei client in France, noted: “When we first saw Huawei, we couldn’t believe that a Chinese company could match an occidental one—we were wrong. Their technology was better and they were 30% cheaper.”[4][4] And Huawei was getting stronger. The company regularly invested 10% of its revenues in R&D, and it was submitting up to three new patent applications a day. It had set up 12 R&D centers around the world.
Only 3% of Huawei’s sales were in the US, but Cisco recognized the company as an emerging threat in its other world markets. In 2003, Ren, anxious to secure an internationally recognized brand, attempted to engineer a merger with 3Com, a Cisco competitor that had fallen on hard times. The deal almost fell through when Cisco tried to sue Huawei for alleged intellectual property violations. The suit was settled out of court and finally dropped, but it signaled the fact that Huawei had caught Cisco’s attention, and that it was henceforth considered a force to be reckoned with.
The story of Huawei illustrates the necessity for multinational companies to adjust their outlook. Multinationals often view their fellow multinationals as their top competition. While large corporates by and large think and act alike, it is the Huaweis of the world, with their aspiration, determination, and flexibility, operating in a new business model and setting the new rules of the game, which pose a significant threat to MNCs.
This trend will only be exacerbated in China as some Chinese companies continue to utilize its low cost manufacturing base, leverage its huge domestic market while focusing on investing in technology. In this game, the size does matter. It is the abundance of low-cost knowledge professionals or skilled workers that will determine the future competition.
The National Science Foundation reports that the US awards diplomas to just over 30,000 undergraduates in engineering a year,[5][5] while China graduates 500,000 a year.[6][6] The companies like Huawei challenge the fundamental assumption on which MNCs build their business models. The MNCs need to think differently. It is no longer business as usual.
Winter Nie is Professor of Operations and Service Management at IMD, the leading global business school based in Switzerland. She teaches on the Program for Executive Development, among other programs. This article is based on her forthcoming book, “Going global: China competes with the multinationals”, written in collaboration with Abraham Lu and William Dowell. The book explores in detail the strengths and weaknesses of China’s most successful companies as they begin to compete, head-to-head, with the world’s leading multinationals, albeit with varying degrees of success.
All views expressed in this story are the author's, not FNArena's (see our disclaimer).
Notes
1 Dr. Liu Shengjun, Case study on Huawei Technologies Co., Ltd. CC-305-021, China Europe International Business School, June 2006.
2 Harper, Sarah and White, Steven in cooperation with Eugene Yang and the Management Case Center at Peking University. Huawei and 3Com (A): Ren Zhengfei, INSEAD case study 06/2004-5218
3 “See Huawei Run,” The Economist, March 5, 2005.
4 “The struggle of the champions,” The Economist, January 6, 2005.
5 National Science Foundation/Division of Science Resources Statistics, National Survey of Recent College Graduates, 2006.
6 Rising Above the Gathering Strom, National Academies Press, 2007
