Download 10. Can Chinese Brands Make it Abroad?

Can Chinese Brands Make it Abroad?
The answer is yes, but it won’t be easy.
by: Paul Gao, Jonathan R. Woetzel, and Yibing Wu
source: The McKinsey Quarterly
published : October 01, 2003
China dominates world manufacturing because of its low-cost labor. So far, though, most Chinese
companies have been content with the role of original-equipment manufacturer (OEM), supplying the
world’s biggest brands and retailers’ private labels with products ranging from toys to televisions. But the
government is now urging some of China’s biggest companies to sell branded products abroad—and
many have reasons of their own for trying to establish brands in developed countries. The home market is
fiendishly competitive and puts constant pressure on prices, branded products can be more profitable
than those of OEMs, and competing in foreign markets forces companies to innovate and improve, thus
helping them to move away from their image as producers of cheap goods.
Some Chinese companies have already established a branded presence in emerging markets, with
products such as domestic appliances, consumer electronics, and motorcycles. The next move is into
developed markets, a process already under way with appliances and consumer electronics. Haier,
China’s biggest appliance maker, is selling small refrigerators under its own name in the United States
and has ambitious plans to win 10 percent of the US market for full-size refrigerators by 2005.1 (To do so,
it must sell 500,000 units a year, 80 percent of them from its manufacturing plant in South Carolina and
the rest from China.) Meanwhile, Legend,2 China’s biggest computer maker, has launched Lenovo as a
global brand to position itself for overseas expansion. In an attempt to build name recognition, Kejian, a
mobile-telephone maker, sponsors Everton, one of England’s top soccer (football) teams. And the
Shanghai-based electronics company SVA sells its branded plasma televisions in US retail chains such
as Costco Wholesale.
Do Chinese appliance and consumer electronics companies have what it takes to sell branded products
profitably in markets such as the United States, Europe, and Japan? We think that these companies have
a long way
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to go. Creating and sustaining brands in developed
markets is complex, expensive, and uncertain. The
biggest obstacle is the Chinese manufacturers’ lack of
vital marketing skills. It took years, and a great deal of
money, before the giant Japanese and South Korean
consumer electronics companies established themselves
abroad (see sidebar "Samsung got there").
This doesn’t mean that China should be counted out. The
country’s consumer electronics companies are rooted in a large and open market where their products
prove themselves daily against the world’s best in features, quality, and price. Low labor costs make
Chinese goods less expensive, and some of the savings can be passed on to Western channel partners
and consumers. In addition, China has a large and growing pool of skilled engineers and the money to
invest in new products.
So the question is less whether Chinese companies can make the grade in product features and quality
and more whether they can develop marketing strategies for branded goods. Some companies will find
openings by offering value for money to distributors and retailers seeking to differentiate themselves;
those that can move quickly will find opportunities in the increasingly popular value channels. In general,
the economic slowdown in the developed world will help, too. Some companies have already begun to
gain a foothold (Exhibit 1), learning the ins and outs of selling in developed markets while moving
cautiously by making deals with distributors that are able to get leading-edge products in front of
consumers without having to invest vast sums on marketing campaigns.
It may still be early in the game, but branded, higher-priced global manufacturers such as Sony and
Samsung Electronics will have to watch their Chinese competitors quite carefully. As for the wholesalers
and retailers, they must balance the opportunity to offer their customers good value against the
countervailing risk of upsetting their existing relationships with other branded manufacturers.
The branding challenge
Chinese companies see a lot of money on the table in the branded-goods market (Exhibit 2). In the US
home refrigeration and laundry sectors, the top five brands hold more than 80 percent of the market. In
Europe, at least 80 percent of the refrigeration products sold are replacement purchases—and
consumers tend to replace with the same brands they had before. Brands represent features and value,
and most consumers in most developed economies prefer those they know.
Higher prices for branded goods translate into huge profits. For household appliances, the US profit pool
is worth more than $2 billion, 9 times the profit pool of China and 100 times that of Brazil. For consumer
electronics, it is worth more than $1 billion, 10 times more than China’s and 20 times Brazil’s. Moreover,
developed countries offer a wider range of sizable segments to target. The US market for projection
televisions (screens of 45 inches—115 centimeters—and up) is actually worth more money than all of the
video products that are currently sold in India, while the $400 million worth of compact refrigerators sold in
the United States in 2000 amounted to no less than twice the total value of all refrigerators sold in either
South Africa or Poland.
Although the best Chinese OEMs have shown that they can be as profitable as sellers of branded
goods—after all, they don’t bear the costs of R&D and marketing—they view selling branded products as
one way to get an even bigger slice of the pie. Makers of
branded goods can charge higher prices partly because
they promise higher quality, and that is a crucial issue for
Chinese companies in developed markets. Much "as the
consumers of the past
were reluctant to buy
goods out of Japan and
South Korea for fear of
quality issues, products
from China are now
experiencing similar
obstacles," says Robert
Rodriguez, vice
president of marketing
for SVA’s North
American operations.3
"SVA intends to change
the misperception
currently held that all
Chinese-brand
electronic products in
the US are without
merit."
In fact, Chinese
companies have shown
convincingly that they
can produce
competitively priced, high-quality goods. Galanz, for instance, makes microwave ovens on an OEM basis
for almost all of the world’s leading consumer electronics companies (see sidebar "Taking the OEM
route"). Little Swan supplies General Electric with dishwashers. And Changhong Electric supplied WalMart Stores with televisions sold under an unrelated brand, Apex Digital, in a giant one-day promotion in
2002.
The Chinese companies most likely to succeed in establishing brands in overseas markets are those that
have a track record in low-cost, high-quality manufacturing and show marketing prowess on the local
level. In general, Chinese manufacturers have relied on a fully integrated model in the domestic market.
They start off using foreign technology and then try to develop their own technology and products. Most of
these companies are heavily asset-based and have large manufacturing organizations, and almost all
have their own distribution networks and large, cheap sales forces. Replicating this model with traditional
products in developed markets would be prohibitively expensive, time-consuming, or beyond the skills of
management. Only a few Chinese companies, such as Haier, have built factories in the United States;
Haier’s leaders believe that the added expense of producing goods there will be outweighed by the ability
to respond more quickly to changes in local consumer tastes.
More specifically, the Chinese have no overseas distribution channels or service networks, little
promotional or advertising savvy, and limited pricing skills. It is questionable whether these companies
could quickly develop a feel for the design and feature preferences of Western customers.
Working the channels
We have identified two business models that would help a Chinese consumer products company move its
branded goods quickly into developed markets while taking the time to become familiar with them. The
primary model is a step-by-step procedure in which products exported from China penetrate overseas
markets through independent distributors serving discount channels. This gradual process would permit
Chinese companies to gain an understanding of customer behavior and to build brand recognition. In the
second model, Chinese companies buy an established brand that has fallen on hard times and then move
its production to China to benefit from lower labor costs.
The step-by-step approach
Channel consolidation in advanced markets has long been seen as a barrier to outsiders. Mass-market
retailers in the United States, for example, control more than half of the consumer electronics market, and
the trend is accelerating. This development means that there are fewer competitors to which
manufacturers can pitch their goods and that they have less power over pricing. Exclusivity deals can
also block access to consumers. Nonetheless, a big problem in retailing today is sameness. Retailers are
looking for distinct brands and products, and if these provide good margins and fair prices for the
consumer, so much the better.
A senior purchasing executive at the US retailer Sears, Roebuck, for example, told us that it is always
looking for winning products at good prices to draw shoppers to its stores and that if the Chinese offered
such products, they would be considered. Retailers might also be interested in deals with Chinese
companies to supply products on an exclusive basis. Other US retailers emphasize that shelf space is
expensive and competition for it intense. In many cases, they have to offer top brands such as Sony or
Panasonic but say that current second-tier brands—even well-known ones—could be expendable in favor
of well-made, attractively priced Chinese products.
SVA has pushed in this direction in the United States for the past two years. In China, the company has
transformed itself from an also-ran maker of conventional color TVs into a leading electronics group
focusing on high-end plasma TVs, TFT-LCD displays (flat-screen monitors), and DLP projection TVs.
SVA has proved itself by mass-producing quality products at low cost and now records annual sales of $4
billion (including revenues from joint ventures with companies such as Siemens and Sony). But outside
China, it is unsure of its marketing skills. As SVA’s strengths and weaknesses are consistent with those of
other Chinese companies, what it has accomplished in the United States might offer lessons for them.
SVA made several important choices upon entering the United States. First, it decided to rely largely on
distributors, such as Ingram Micro and D&H Distributing, that offer promotion and service assistance to
manufacturers. Working with distributors gives the company a chance to learn about the US market and
the requisite breathing space to build its own overseas marketing capabilities. While SVA does sell
directly to some retailers, it came to the realization that the biggest ones, such as Wal-Mart and Best Buy,
would expect standards of logistics, service, and promotion it couldn’t meet. These retail chains offer one
chance only, its executives reasoned, so it would be foolish to risk disappointing them.
Second, SVA chose to work with distributors on trade-level promotional activities, including attendance at
industry conferences, rather than spend millions of dollars to build brand awareness. Distributors find
SVA attractive because it enables them to offer customers low-cost products—a factor of particular value
to the small- and midsize electronics retailers that compete with the likes of Wal-Mart.
Third, SVA decided to avoid the low-end color-TV market, where it would have been up against intense
competition from other Chinese companies selling on an OEM basis. Instead, it put its efforts into
upmarket products such as plasma displays and TFT-LCD monitors and televisions. Sales of these
products are growing quickly, and they face relatively little rivalry from other Chinese companies. SVA
wants to be thought of as offering value for money for products aimed at technology-savvy customers
who are not put off by the absence of well-known brand names. The company therefore prices its
products well below the levels of its Japanese and South Korean competitors but above those of
manufacturers that rely solely on low prices. It sells through Amazon.com, BJ’s Wholesale Club, Buy.com,
Costco, and Office Depot, among others.4 Feedback from trade shows in 2003 suggested that this valuefor-money positioning has promise given the consumers’ worries about the US economy.
Finally, though Chinese companies don’t always acknowledge the importance of understanding local
markets, SVA recognized from the start that it needed a local team to run its US business. Besides
recruiting US-based executives, to whom it gave an equity stake in the venture, it hired Japanese ex–
Sony production managers to help it control its manufacturing quality and is working with international
firms to improve the design of its offerings. Consumer focus groups help the company refine its product
lineup for the United States. The result has been some initial sales success, with expected revenue as
high as $80 million in 2003.
With a few twists, this conservative entry model could be applied outside the United States. Europeans
are more conscious than US consumers of brands and quality, which might make acceptance more
difficult, while in Japan the Chinese will have to contend with the traditional ties between domestic
manufacturers and leading retail chains. But it is increasingly difficult for retailers in these markets to pass
up quality products at attractive prices. Japanese consumers have already begun to vote with their
wallets and are looking for bargains.
It will, however, be several years before Chinese companies threaten the big global consumer electronics
players—not that the trend should be ignored. Wholesalers and retailers should consider the possibilities
that the Chinese present to them, not least the opportunity to bargain hard with their traditional suppliers.
Buying your way in
The alternative to entering a market step-by-step is to buy into it through mergers and acquisitions.
Suitable targets would be companies with valuable assets—brands, customer bases, technology, or
channels—as well as products that have become overpriced as a result of management’s failure to
monitor costs, to move production offshore to low-cost locations (such as China), or to extract the best
prices from overseas factories or offshore OEMs.
A buyer could move the bulk of the acquired company’s production to China and retain the brand name,
distribution channels, and some of the local talent. Over time, it could co-brand the product with its own
name to build consumer awareness of its Chinese brand. Once the association and awareness had been
firmly established, the buyer could phase out the target brand. The biggest obstacle for a Chinese
company would be locating qualified turnaround managers for its typically distressed targets, since it
would be unlikely to have postmerger-management and marketing skills in-house.
One Chinese company, D’Long International Strategic Investment, succeeded in building a position in the
US market by acquiring, in 2000, Murray, a well-known manufacturer of bicycles and of lawn and garden
equipment. During the postmerger-management effort, D’Long integrated its Chinese production facilities
with those of Murray, carried out some short-term turnaround maneuvers, and identified lower-cost
sources of supply. Murray still controls some operations in the United States. Sales of Chinese-made
products are projected to reach $700 million by 2005, with excellent returns on invested capital. The
company is currently seeking further acquisitions.
A leading Chinese electronics maker is pursuing a variant of this approach. TCL International Holdings
purchased an insolvent German television maker, Schneider Electronics, for $8 million in September
2002 in an attempt to break into the European market. Included in the acquisition price were Schneider’s
plants; its distribution network of chain stores, hypermarkets, and mail order; and trademark rights to a
series of brands, including Schneider and Dual. TCL, hoping to avoid European quotas on the importation
of Chinese TV sets, expects to continue production in Europe. A professional management team is
helping TCL understand the local market and sales networks, and some Schneider employees have been
rehired to oversee production. If the strategy is successful, TCL could one day introduce the TCL brand to
the European market; electronics products bearing the name are already exported to Australia, the Middle
East, Russia, South Africa, and Southeast Asia. In a twist, TCL is using its Schneider brand to position its
mobile telephones in the high-end segment of the Chinese market. More recently, TCL bought GoVideo,
of Scottsdale, Arizona, which makes DVD players.
Many of China’s appliance and consumer electronics manufacturers have little choice but to go global.
Born into an industry that is essentially open to worldwide competition, they must gain scale in the only
place they can—the home turf of the world’s multinationals. Just getting into the branding game, though,
will require a combination of attractively priced products, good service, and first-rate technology. To stay
there, the Chinese will have to build or buy a wide range of new skills. But if standards of quality and
service remain high, a number of Chinese companies will earn shelf space for their branded goods in
developed markets and, one day, might even capture the price premiums that some of their Japanese
and South Korean competitors enjoy.
Samsung got there
The experience of South Korea’s Samsung Electronics shows how hard it can
be to build brands. Today, with more than $33 billion in annual sales, it is a
global leader in consumer electronics: half of those sales are mainly to
Europe and North America. But Samsung spent much time and money on its
globalization campaign. Starting with domestic operations, the company
acquired basic product-development skills through joint ventures and more
than 50 technology-licensing agreements. Branded exports began in the early
1980s, with US prices set at a discount to those of Japanese and US
competitors as a way of appealing to price-sensitive customers. Samsung
also acted as a private-label supplier to retailers and brands.
It slowly learned the requirements of its markets by conducting extensive
consumer research and building up its overseas sales and manufacturing
operations in the United States, Germany, the United Kingdom, and Australia.
The company increased its R&D budgets, and by the early 1990s its
aspirations had led it to invest in products and technologies (for example, flatscreen monitors and televisions, digital high-definition televisions, and digital
mobile phones) that would raise its brand profile.
Finally, in the late 1990s Samsung launched its global brand with more than
$1 billion in advertising, including sponsorship of the Olympic Games. It
formed alliances with high-tech partners such as the US telephone company
Sprint and introduced a wave of cutting-edge products, spending more than
$7 billion, or 5 percent of sales, on R&D from 1996 to 2000 and upward of
$400 million on brand advertising in 2001 alone. In the meantime, the
company positioned itself as a premium brand by shifting its channel focus
from mass merchants to category killers. In a 2003 survey of global brands,
Interbrand, a brand strategy and design consultancy, ranked Samsung as
number 25, with a brand worth $10.8 billion—a 31 percent increase from the
previous year.
Taking the OEM route
Most Chinese companies seeking
to expand abroad have pursued
an OEM strategy (exhibit),
enabling them to build scale
quickly without the need for
corresponding investments in
marketing. Information technology
has made it feasible to construct
global networks that seamlessly
link production in China to
marketing and design operations
in developed markets.
Conversely, manufacturers in
developed markets can outsource
what would otherwise be highcost production, in turn creating
greater price flexibility.
Cost and quality leadership and the ability to support a number of global
customers and to acquire the needed technology and capabilities are the key
success factors in this model. Low costs, which are necessary to secure the
initial contracts, must be accompanied by excellent skills in supply chain
management and sourcing. A number of customers are required to minimize
dependence on any one of them and to gain scale. But while this strategy
demands the lowest level of additional skills from Chinese companies, it also
offers the lowest upside from the market. Returns can come only through
expanding scale to achieve a position of global dominance in components and
assembly.
Galanz is an example of globalization through an OEM strategy. Founded in
1978 as a textile company with 200 employees, in 1992 it started making
microwave ovens, which it soon began manufacturing for OEM customers,
targeting those keen to lower their manufacturing costs but not yet ready to
set up operations in China. The company is now the world’s largest producer
of microwave ovens, with almost 30 percent of the global and 70 percent of
the Chinese market.
Galanz maintained cost leadership while integrating itself into its customers’
networks and lowering prices to gain market share and scale; industry
average pricing dropped by 18 percent a year in the late 1990s. Since then
Galanz has signed more than 80 contracts with OEMs. The strategy has paid
off. By 2003, sales to OEMs represented over 60 percent of the company’s
revenue, and annual production had reached 15 million–plus units. Total sales
had risen to more than 5 billion renminbi (over $600 million) and net profits to
more than 450 million renminbi. Galanz is now introducing branded products
for markets in South America and rolling out an OEM approach for other
home appliances.