BEIJING (Reuters) - It was a proper dressing-down for the boss from deepest China who had travelled to the capital to seek government help with overseas expansion.
Vice-Premier Wang Qishan publicly interrogated the head of Sany Heavy Industry Ltd Co, a big engineering firm, about his management capabilities, asking if he was sensitive to cultural differences and the difficulty of dealing with unionized labor in the west.
“If the other side’s engineers resign, are you really going to send people from Changsha overseas, and make the whole company speak Hunanese?” he asked, referring to the dialect spoken in Hunan, a province of nearly 70 million people whose capital is Changsha.
The gulf that so exercised Wang — in a scene played out in public last year during the annual session of parliament — has since been on full display in a cultural and political skirmish between the Chinese government and U.S. internet search engine Google.
That row, over censorship in China, will hardly make western politicians and consumers feel more kindly about China or its corporations as potential suitors. China’s ambitions, and how they might be affected by the Google controversy, are likely to be a hot topic at next week’s annual meeting of the World Economic Forum in Davos and beyond.
How readily such differences in values are bridged could have an important bearing on whether Chinese companies can graduate from being mere low-cost manufacturers to secure a role on the world stage commensurate with the country’s growing economic clout.
China has seemingly effortlessly amassed the world’s biggest stockpile of foreign exchange reserves, it is overtaking Germany as the biggest exporting nation and now has a car market bigger than America’s. Now comes the hard part.
Chinese companies are snapping up natural resources firms across the globe and picking over the carcasses of car marques laid low by the financial crisis. The value of Chinese outbound M&A, at $42.6 billion last year, was below a record $73 billion from 2008, but nonetheless accounted for China's highest share yet of the global total at 7.5 percent, Thomson Reuters data show. here
The international ambitions of Chinese firms, not content with their 1.3 billion-strong domestic market, can only accelerate. With an eye to the added value in expertise, Beijing is especially keen to encourage its companies to forage abroad for high-technology, cleantech know-how and established brands in addition to securing further supplies of oil, gas and commodities to feed the country’s thrumming industries.
But bankers and consultants say the obstacles that Chinese firms must overcome are immense: money cannot buy overnight the managerial expertise and cultural sensitivity needed to build a multinational with operations and brands spanning the globe.
Jim Hildebrandt, managing director in Asia of Bain Capital, a big private equity firm, said relatively few Chinese companies had teams of specialists to hunt for acquisitions. And often, the targets that came into their crosshairs were too big to be easily run by managers with little international experience.
“I do think we are entering a new era of acquisitions by Chinese companies overseas and that this era will be one of offensive acquisitions — so acquiring positions overseas, manufacturing facilities to expand the breadth of scale on which you operate,” he said.
“Many Chinese companies are ready to do this, but the level of merger and acquisition skills is probably the major constraint at this stage.”
He gave an example of a company that ran the rule over a multinational without initially realizing that Chinese nationals are barred from entering 10 of the countries in which its target had operations. “I can tell you that it’s very hard to run a company if you’re not allowed to enter the country.”
Some Chinese firms have already learned the hard way about the importance of adapting to the local environment.
In 2007, President Hu Jintao had to cancel plans to cut the ribbon on a $200 million smelter at a Chinese-owned copper mine in Zambia after miners rioted over harsh working conditions. Chinese contractors also periodically spark anger for relying excessively on Chinese labor and materials when building roads, dams and housing across the continent.
In Algiers, tensions spilled over last August when about 100 local residents and Chinese migrants fought a mass brawl using knives and bludgeons in a clash put down in part to cultural differences.
Chinese suitors looking to buy Hummer from General Motors and Volvo from Ford are certainly overlooking a track record in high-profile manufacturing acquisitions that to date can charitably be described as patchy.
The jury is still out on the purchase by computer maker Lenovo of IBM’s laptop business in 2005. Lenovo initially concentrated on expanding internationally before the global downturn led to deep losses and prompted the company to turn its attention back to the Chinese market.
TCL Corp has two disasters to its name: the electronics manufacturer was hailed as a trailblazer for China when it formed a joint venture with its French rival Thomson SA in 2003.
But it failed to tap into growing demand for flat-screen TV sets and the venture was declared insolvent in 2007. TCL’s subsequent purchase of then-Alcatel’s handset business was also a fiasco, largely because the Chinese company did not anticipate the high integration costs and found its phones were not competitive on the global market.
Car maker SAIC Motor Corp lost its shirt investing in Ssanyong: its South Korean partner went bankrupt.
So Chinese companies seeking to trade up the value chain will clearly first need to broaden their skills. The business of digging up iron ore or extracting oil is a world away from manufacturing and selling global retail products, and China has scant experience of managing overseas workforces or marketing to sophisticated consumers.
Yet this is where the profits are to be earned.
Benefiting from cheap labor, Chinese manufacturers have become unbeatable on price. But one study, by the University of California, Irvine, in 2007, estimated that Chinese workers contributed only 1 per cent of the retail price in Western markets of an Apple iPod. No wonder Beijing wants its factories to grab a larger share of the profits from research and development, design, marketing and branding.
“I think Chinese companies will learn by doing, but, just being realistic, they still have a long way to go on that front,” said Philip Partnow, deputy head of investment banking at UBS Securities in Beijing.
“The good news about that is that Chinese companies are aware of the issue and are sensitive to the issue.”
Partnow said some Chinese companies with which UBS has worked hard had realized it made sense to get the managers of foreign firms they had acquired to spearhead further M&A: “So in addition to learning by doing there is a desire to acquire management expertise through the deal. That’s very smart.”
Given all the deterrents, it is not surprising China has a long way to go on outbound investment. According to the United Nations Conference on Trade and Development, China’s foreign direct investment outflows are still puny relative to the size of its economy. China’s total FDI stock at the end of 2008 at $148 billion was 3.4 percent of its GDP that year.
By comparison, the figure was 14 percent for developing economies and 26.9 percent for the global economy. here
Establishing a stronger presence on the global corporate stage will also help spread the risk of the country’s investments. China has the world’s biggest stockpile of official foreign exchange reserves, totaling $2.4 trillion, of which about two thirds is invested in U.S. bonds.
Rising costs at home, as well as a likely further appreciation of the yuan, are among the forces to gradually push Chinese manufacturers offshore. Deutsche Bank, in a January 6 report, said it expected the Chinese currency to gain 50 percent in value over the next 10 years.
There are even broader considerations. Successful expansion overseas would enable China to reduce its dependence on energy-intensive, polluting manufacturing and take production closer to the markets it serves. Aluminum Corp of China Ltd (Chalco) made such a move in 2007, agreeing to co-build a 1-million-tonne-a-year aluminum smelter costing $3 billion in Saudi Arabia.
“When our infrastructure becomes saturated and we don’t need so many reinforced steel bars, where should the installed capacity go to?” asked Xu Lejiang, chairman of Baosteel Group, China’s largest steel maker. “We need to transfer it to emerging markets, including Africa, Latin America, Middle East and other Asian countries,” he told a recent forum. “Chinese steelmakers are targeting projects in those regions.”
Depending on the industry, it makes sense for Chinese firms to start close to home. Just over half Chinese M&A investments overseas are within the Asia Pacific region.
Such acquisitions are easier for managers to handle, not least because the time-zone difference is smaller and they are more likely to be able to recruit ethnic Chinese who can bridge the culture and language gap.
“More frequently the right answer is to consolidate in Asia and start with a smaller acquisition,” said Bain’s Hildebrandt. “Our experience has been that companies that started successfully doing smaller acquisitions are more able and more likely to be successful at the big acquisitions later.”
But to acquire sophisticated technology, China has no choice but to set its sights on the United States, Europe and Japan. And that raises the perennial problem of political opposition to the sale of what are perceived to be treasured national assets.
China is still smarting from the failure by CNOOC, one of its big oil companies, to buy Unocal of California in 2005. Similarly, a bid last year by state-owned metals giant Chinalco to raise its stake in global miner Rio Tinto foundered on hostile public opinion in Australia.
“Political sensitivities will always be there,” said Brian Gu, head of Greater China mergers and acquisitions at JP Morgan. “Chinese players are going to be more sophisticated and capable of approaching these sensitive issues. But I don’t think these noises will go away.”
One corporate adviser went further, saying Chinese companies had all-but given up on buying U.S. businesses because of the depth of protectionist sentiment.
Other obstacles are home-grown. To fully reap the benefits of an acquisition, as Japanese car manufacturers for example have discovered, a good local manager often has to be left in charge. This is not something Chinese companies are always comfortable doing.
“I think that is a challenge,” said Gordon Orr, chairman of Asia at consultants McKinsey and Co. “The trust-based culture that you see in top leadership teams is very deeply set, and the bias toward sending someone out who has been on the team for 20 years — because they trust him, not because he’s ever lived in Germany or the UK before — is very deep.”
The China head of one Wall Street bank put it more bluntly: most state-owned Chinese companies were petrified at being pushed to go beyond their comfort zone and venture abroad.
Investment bankers, consultants and lawyers are, of course, only too willing to smooth the path for Chinese companies looking overseas. The problem is that those same Chinese companies are not used to paying top-dollar for professional services, and so are reluctant to seek outside advice.
Xiang Bing, dean of the Cheung Kong Graduate School of Business, told a forum in Beijing: “In China, we don’t have as much global management talent as in other countries. Take India, for example. You can find many Indian senior vice presidents in multinational companies, but not many Chinese.”
In financial services, Jerry Lou, Morgan Stanley’s China strategist, said Chinese institutions, especially investment banks, were still too weak to take control of their counterparts in developed economies.
“It is not like buying a building, a mine or a port,” Lou said. “You’re just wasting money on an empty company if you can’t manage the people.”
He expects it will take at least another decade before Chinese banks are truly ready for overseas deals. “Remember, China did not have a stock market until 1992,” he pointed out, to show how China is still a novice in high finance.
That’s one reason why the relatively simple business of extracting commodities is likely to keep grabbing the Chinese M&A headlines for some years yet.
“Our demand for energy and resources will grow,” Zhang Xiaoqiang, a vice-chairman of the National Development and Reform Commission, the country’s powerful central planner, said in Beijing recently. “We must take part in global resource allocation in a more active manner.”
As for manufacturing, managing a global supply chain with its attendant complications of tax regimes, import-export requirements and just-in-time logistics requires much broader expertise than the ability to marshal cheap labor to produce goods to a foreign company’s specifications. Not to mention dealing with local government and unions, and the intricacies of managing on foreign soil.
“A key factor in the success of this type of overseas acquisition is to have a management that is bicultural,” said Christine Lambert-Goue, managing director in the Beijing office of Invest Securities China.
Some Chinese companies have learned this. China International Marine Containers has bought several foreign companies, licensed advanced German technology and hired foreign executives to run its European operations. The resulting leap in productivity cut the time it takes to make a container to about five minutes from 20, according to Winter Nie and Abraham Lu of the IMD business school in Lausanne.
Still, the obstacles to successful M&A are so daunting that organic expansion might be a better solution for Chinese companies with a good product range, especially in emerging markets where distribution channels are not deeply entrenched and local competition is not insuperable, said McKinsey’s Orr.
“Organic often becomes the best way to go,” he said. “You have an ability to ramp up quickly, like some of the Chinese white goods manufacturers are doing in India these days. You don’t have to buy your way in. You can buy build your way in.”
Haier, for example, is doing well at the low end of the Indian market, in much the same way that its keenly priced mini-refrigerators are a big hit in U.S. student dormitories. The telecommunications equipment manufacturers Huawei and ZTE Corp have also shown powerful growth without significant acquisition.
Organic growth has certainly been the major driver for Japan, which was once synonymous with cheap shoddy goods, and South Korea, whose cars were a laughing stock 20 years ago: both are now at the global cutting-edge of autos and consumer products.
There is no reason why China, either through M&A or alone, cannot follow in their footsteps. The country is rich in engineering and manufacturing skills, has benefited from significant technology transfer from foreign companies, and has overseas corporate expansion in its political sights.
A success of such mooted acquisitions as Volvo and Hummer could prove a catalyst, giving other companies the confidence to take the plunge.
“It’s going to happen and it’s going to happen more quickly than all of us would probably predict,” said Gu of JP Morgan.
Additional reporting by Zhou Xin and Aileen Wang; Editing by Sara Ledwith and Jim Impoco