The End of Cheap China: Economic and Cultural Trends That Will Disrupt the World (2 page)

Chapter 1

CHINESE BILLIONAIRES OUTNUMBER AMERICAN ONES

I was sitting on a leather couch in an opulent meeting room in Shanghai’s five-star Okura Garden Hotel in the former French Concession in 2010. Above my head dangled a chandelier of such scale that it would fit in at Versailles. I imagined former supreme leader Mao Zedong sitting in the room, as he did decades earlier when the hotel was his stomping ground on visits to Shanghai.

A man who appeared to be in his early forties stood in front of me, doing tai chi. He was thin, had a fully shaven head, and wore a simple white oxford shirt unbuttoned at the collar. There was a serene aura about him that commanded the respect of everyone else in a room that included some of the most successful businessmen in China; he seemed to be the king among kings. He smiled at me, asked me to sit, and gently requested that someone pour me some tea as he continued his routine.

Looking around, most of the others joining us were worth tens if not hundreds of millions of dollars. A few might have crossed the billion-dollar mark. All were entrepreneurs who had built up brands every Chinese person knows. There was Chen He Lin, the slight and gregarious founder of ASD, a kitchenware company known by Chinese housewives for durable and safe but affordable crockery. He had looked at me curiously, perhaps because I was the youngest and the only foreigner in the room, or perhaps because I was the only face he didn’t recognize. After looking me up and down, he too grinned at me and handed me his business card.

Sitting to my right was a tall, bald man chain-smoking furiously. He stuck out because he was dressed in an all-white athletic suit while everyone else was wearing dress clothes. Like the king of the room, he too had a shaved head, although unlike his friend he did not offer me his card. He pretty much ignored me when I asked him a question about his business. He told me his name was Shi Yuzhu. He was famous for losing his entire fortune before building it back up again when he took his online game company, Giant Interactive, public on the New York Stock Exchange. Shi Yuzhu became infamous several months later among Western investors for ultra nationalism when he publicly sided with Alibaba’s founder, Jack Ma, in his public dispute with Yahoo! over the ownership of the online payment service Alipay by calling Ma on his Sina microblog a “patriotic hooligan.”

On Shi Yuzhu’s right side sat Zhou Xin, a towering man with short-cropped hair who reminded me of Yogi Bear. He was the cofounder of E-House, an online and offline real estate brokerage firm that was also publicly traded on the New York Stock Exchange. He beamed at me with a mix of pride and humility when I told him that consumers my firm had interviewed had responded they were very happy with his company’s products and services.

While the rest of us listened, the man doing tai chi started to talk about the business environment and the economic problems facing the country due to the financial crisis in America and Europe. The man’s name was Guo Guangchang, the founder of the Fosun Group.
The Hurun Report
, which tracks the net worth of the Chinese rich, estimates Guo’s wealth at nearly $5 billion.

As I listened to Guo and the others discuss the business climate, I looked around the room at their faces. All seemed to have the intensity of Olympic athletes about to compete. Optimism and confidence, born from being raised with nothing but making it big through their own sweat and grit, seemed to ooze from their pores. They knew they could overcome any challenges with enough hard work and patience.

To my left a number of the executives gathered to talk about joining forces to lobby the government more. They were worried about a credit crunch hitting small and medium enterprises, and they wanted to join together to present their case to the government to remedy the situation. Concerns about underground banks, loan sharks really, calling in loans was starting to become a topic of conversation.

Listening to the discussion, it was clear these were some of the savviest businessmen not just in China but in the world. I have advised chief executives of Fortune 500 firms and trailblazing entrepreneurs whose innovations change the world, but these Chinese entrepreneurs were as impressive as any executive or thinker I had ever met, and perhaps even more so, considering the filthy poverty and chaos they had grown up in just a few decades before.

Despite intellectual property problems, uneven government regulation, corruption, poorly trained labor forces, and difficulty raising capital, these battle-hardened executives had all taken risks and built up groundbreaking organizations in the last 10 years. It was also clear that these entrepreneurs were building up strong Chinese brands. None of them was simply copying Western business models or stealing intellectual property as many Westerners think all Chinese do—they were creating new ones.

Not only were these businessmen building brands in China, but many of them were also growing abroad organically and competing on foreign turf. Some had even begun buying up iconic foreign brands. Guo’s Fosun Group had started scooping up stakes in foreign firms. He had acquired 7.1 percent of Club Med, the French resort company known for opening all-inclusive resorts in exotic locales, to cater to more of the 50 million Chinese tourists who travel abroad every year. Guo had also bought the rights to
Forbes
magazine in China, and had signed several major deals with foreign investment firms. His company had set up a $600 million joint investment fund with Prudential Financial to invest in foreign and Chinese firms that have significant growth potential in China. He had also launched a cobranded fund in renminbi (China’s currency) with the politically well-connected Carlyle Group, the private equity firm that once had former President George H. W. Bush and British Prime Minister John Major on its payroll, for investment in China.

Looking at these executives, it became clear that too many Western observers of China foolishly discount the management and branding abilities of Chinese companies, much as many American companies discounted Japanese firms like Toyota and Sony in the late 1970s. Aggressive, confident, and capital-rich Japanese firms quickly took advantage of bloated American firms like General Motors and painfully forced American companies to reassess their business models. Japanese firms went from making cheap, tacky products to defining quality in some industries. Chinese firms might similarly disrupt entire industries if American companies are not forward thinking enough to react to evolving Chinese companies and stay ahead in innovation before the business threat materializes.

When you walk along the aisles of your local Walmart or Best Buy, most products are marked with a “Made in China” label. Trying to keep costs down, many multinational companies established direct-owned manufacturing operations in China or began sourcing from Chinese-owned factories through intermediary firms like Li & Fung. Even in your own home, you would be hard pressed not to find at least some products in each room touting this sticker.

You would also probably be hard pressed to name any Chinese brands, despite China being the factory of the world for the last two decades and having the world’s second-largest economy. Unless you had observed the rise of Chinese brands in the last decade, the absence of these brands in Walmart might lead you to agree with the many Western analysts who think that Chinese companies simply do not have the ability to build brands.

Atlantic Monthly
journalist James Fallows is one of those observers. He calls the 44 percent of Americans who think China is the world’s leading economic power, according to a 2009 Pew Center poll, “crazy” because he does not think Americans can “name even 10 [brands] from China.” Fallows continues, disparaging the research ability of Chinese scientists: “Name the most recent winner of a Nobel prize in science from a Chinese university or research institution.” That was a trick question, because there have not been any winners.

Fallows believes Chinese companies cannot brand, and that its leading minds in the sciences do not have the innovation and creativity to win a Nobel Prize in the sciences. He seems to agree with the conventional wisdom of Western analysts that Chinese are better at copying what worked in America, building a clone of it, or simply ripping off intellectual property to make money. After all, many of China’s publicly traded companies, such as search engine Baidu or e-commerce auction site Taobao, seem like rip-offs of Google and eBay. Are analysts like Fallows right, or are there deeper explanations why Americans cannot name many Chinese brands?

At first glance, Fallows is right. Few Americans would be able to name more than 10 Chinese brands. The ones Americans might know, like information and communications technology provider Huawei, tend to be more focused on selling products and services that are good enough but cheap to businesses. They tend to focus more on business-to-business clients, rather than on more fickle and brand-conscious end consumers. Or Americans might know brands like Huawei not because of their quality, but because of fears they are fronts for the Chinese military and pose security risks, which makes them a frequent target in the Western media and of members of Congress on the campaign trail. However, everyday Americans’ lack of knowledge about Chinese brands does not really mean that Chinese companies cannot brand and build global champions. A deeper glance, and a basic understanding of recent Chinese history, will show that underestimating Chinese businesspeople as Fallows does would be foolish.

Not having a Nobel Prize winner in science does not mean Chinese scientists cannot conduct leading research. Such awards are usually conferred for work done decades earlier. Japanese scientists Ei-ichi Negishi and Akira Suzuki won the 2010 chemistry Nobel Prize for research conducted in the 1960s and 1970s—the same period when the Cultural Revolution was ravaging China, as we will explore in Chapter 3.

If Chinese scientists have not won a Nobel by 2050, one could then argue Chinese researchers in a Chinese institution cannot do groundbreaking research—but I bet one will. After all, when I was a graduate student at Harvard’s Graduate School of Arts and Sciences at the turn of the millennium, more mainland Chinese were enrolled there than from any other country except America, and many of my classmates have been lured by government initiatives to recruit mainland scholars to return to Chinese universities rather than stay in America.

Fallows is also correct that few Americans know Chinese brands, but once again he is wrong about the reasons. He would be correct if it were still the 1990s, when Chinese management teams were weak and focused on the short term, but surprisingly, Fallows seems to have missed China’s business evolution in the last decade.

Today’s Chinese brands are quickly moving up the value chain to compete on branding and innovation rather than just on price. They have had to figure out earlier than foreign competitors how to deal with the End of Cheap China. Rising labor and real estate costs and demanding consumers are forcing them to think more long term about building sustainable brands and changing manufacturing operations, in order to command the fatter margins they need to stay alive.

Those entrepreneurs sitting with me at the Okura Garden Hotel are all developing strong brands—in fact, it is directly because of branding efforts that they have been able to beat local competitors over the past decade to emerge as domestic powers. They defeated state-owned enterprises, with their easy access to credit and political patronage, because they offered the market what it demanded and stayed ahead of trends. None had made their riches by being the stereotypical cheap Chinese original equipment manufacturer, squeezing razor-thin profits. They had created brands that had earned Chinese consumers’ trust, and had become rich in the process.

A decade ago, most Chinese brands competed on price, but not because Chinese inherently lack creativity or the government stifles creativity and innovation. There are several reasons why executives’ focus on planning was more short term.

First, incomes were still low. The dramatic, sustained rise in incomes and purchasing power that China has seen was only beginning, so it did not make sense to compete on anything but price. In the 1990s, China was steeped in real poverty. The average per capita gross domestic product (GDP) was less than $1,000 a year, and the majority of the country earned less than $300 a year, below the World Bank’s definition of extreme poverty. Meat was often a luxury, and eating at a restaurant like McDonald’s or KFC was reserved for special occasions. Hot showers were rare—most people still stood outside in full view of neighbors and passersby, using buckets to wash themselves, or went to company shower facilities on weekends. The lack of running water explains why even today getting your hair washed at a salon is an essential part of the hair-cutting process; in those days, visits to salons for a warm hair wash was a real treat.

Competing on anything other than price in that climate would have been foolish. Global brands took this strategy, launching global brands in China and investing for the long term. One Kodak executive told me in the 1990s they were investing not for short-term profits but to “make a lot of money twenty years from now.” Fewer than 10 percent of Western brands selling into the Chinese market in the 1990s actually made money there, in part because no one could afford their products. Another reason was that Western brand positioning often did not fit the aspirations and needs of everyday Chinese people. It is hard to relate to Ralph Lauren, with its preppy lifestyle image of summering in the Hamptons, when you dream of indoor plumbing and eating meat for dinner.

The lack of profits and price sensitivity on consumers’ part changed in less than a decade. In its 2010–2011 report, the U.S. Chamber of Commerce in Shanghai found that 79 percent of American companies now make money in China, and 87 percent reported revenue growth in 2010, up from 47 percent in 2009. A thriving middle class, with the desire and the money to sustain brands that focus on more than just price, is fueling these profits.