The China Vortex

Over the past year, the tone of coverage of many China-related topics in the US has improved. For the most part, writers covering China have tried to look past the generally-accepted stereotypes, and have tried to get a deeper understanding of what is going on in China.

But occasionally something finds its way through the cracks.

This article is really exemplary; it seems like the writer has taken all the stereotypes about Apple and China, and thrown them all together in one basket. Judging from the tone of the article, and what he professes to be truth, it seems like he has never set foot in China. Otherwise, how could be believe some of the things he writes?

Let’s take a look at some of the choice statements:

Apple has less than 8 percent market share in China for media players, and far less than 1 percent of either PC or cell phone market share.

Yes, so? I wonder if the writer has walked into any cafe in Shanghai, Beijing and Shenzhen, and looked around? Or has he taken any of the subways in any of those three cities and looked around for the signature white earbuds? The question should not be the percentage market share. It should be the trend, and whether it is tracking up or down.

Apple’s second biggest hit in China, the iPhone, isn’t authorized. One Chinese analyst estimates that some 1 million Apple iPhones are currently operating on just one Chinese carrier — China Mobile — with a smaller number on other carriers. Most Apple “Authorized Resellers” in China sell black-market iPhones, and many even offer illegal cracking services — a process that reportedly takes less time than activating an iPhone 3G in California.

Apple makes money off of every iPhone sold, whether it is through authorized or unauthorized channels. Sure, Apple would like to have a carrier agreement in China, but having a group of fans, even though it is relatively small percentage-wise, which is very enthusiastic about Apple products, is a good thing. Besides, there are a lot of people in China who pay even more for more expensive feature-packed mobile phones in China. In fact, the iPhone is not the most expensive phone in the market. Ask Nokia.

Apple succeeds because customers love the products and the brand. But in China, brands mean little to most potential customers, and hardware even less. Chinese consumers prize value above all.

This quote is a true gem and qualifies as one of the most ignorant sweeping statements about China for 2008, even though we are only halfway through the year. Obviously the writer has not been to China and walked in the downtown of any major city. Here is an article about the runup to the recent opening of the Sanlitun store in Beijing and another story about Chinese youth camping out in front of the Beijing Apple store, where they were behaving just like American Apple fans.
I guess that’s why there are no Mercedes Benzes, BMWs, and Chinese women don’t care about the labels they wear? Maybe he thinks that they still wear Mao suits?

The rest of the world’s love of the Apple brand has enabled Apple to get favorable terms with carriers around the world. But this hasn’t helped much in China. Apple initially demanded a big two-digit percentage of carriers’ wireless revenue as a condition for granting its coveted exclusivity deal, according to reports (one company says Apple demanded 30%). The Chinese carriers were apparently unimpressed by the value of Apple’s brand compared with the value to Apple of access to Chinese consumers. They appear to have forced Apple to drop its demand for any share of wireless revenues.

The reason Apple has not been able to get an agreement with China Mobile is because they are both big companies with very big egos who want to control everything. I would say that Apple and the carriers have trouble reaching an agreement because they are so much alike, and don’t believe in compromise.

One-party rule in China actually affects product quality. One example is that Apple will probably be required to disable the iPhone’s Wi-Fi feature in order to comply with the Communist Party’s strict Internet control and censorship rules.

The relationship between one-party rule and product quality is an arguable point. But if it is that simple, then why are ALL of Apple’s products made in China? As for the disabling of Wi-Fi on phones sold in China, that is a China Mobile requirement, not a State Council requirement. (If you think that the rulers of China don’t have better things to worry about than whether mobile phones in China have Wi-Fi functionality, you don’t know anything about the country and how it’s ruled.) Besides, with the recent re-arrangement of the Chinese telcos, it’s not as if China Mobile is able to control Wi-Fi as much as it would like.

China is number one in intellectual property theft

Apple’s whole business model is based on creating value through exquisite design, superior branding and the sale of creative intellectual property (IP) — then defending its rights against the IP thieves, pirates and counterfeiters.

How will this formula succeed if China doesn’t enforce intellectual property laws?

The music piracy rate in China is between 90 and 99 percent, depending on whom you ask. China is the global epicenter of intellectual property theft in general, and of Apple IP theft in particular — especially iPhones and iPods.

Fake iPhones, and phones that steal Apple branding; illegal iPhone unlocking services; trade in illegal movie and music files; all appear to be tolerated and even government-protected activities in China.

Oh yes, how can we talk about China without IP violations? Seriously though, this is an issue. The best way to fight IP though, is for a country to get more prosperous. As people become wealthier, they are more willing to spend money on software, music, etc. In China, it is also very important to explain the importance of IP to various government ministries, and even be flexible about how much you charge Chinese consumers. Many Chinese think that they should not have to pay as much for music as US consumers because they have a lower income and standard of living. Does that fit into any American companies’ equations? Up until four years ago, Microsoft had a very high level of illegally installed Windows licenses in China, and constantly lobbied with the US Congress to “punish” China. When Microsoft China changed tactics and chose to engage Chinese ministries, educate them, and lower the license fees (as China’s standard of living increased), first the ministries, then the schools, then the people started buying original software from Microsoft. Now Microsoft gets more revenue from China, and the relationship with the government is much less confrontational. Piracy of Microsoft software still exists, but again it’s about the trend, which is improving.

Steve Jobs is an exemplary business and marketing genius. But when it comes to learning about other markets, he is lazy. He would like nothing better than to set prices for all media products sold through iTunes himself, and he would like it to be the same all over the world. China is a major kink in his vision.

How many times has Bill Gates been to China? How many times has Steve Jobs been to China?

I rest my case.

There is a whole brave new world for social marketing which is unfolding and which, so far, has caught many businesses off-guard.

A good part of the reason for this is because many corporate marketing departments are managed by people who cut their teeth when TV, radio and print were the main ways to reach audiences.

Sam Flemming, who is the founder of Shanghai-based CIC, a market research and consulting firm which covers brand buzz in China, has posted an article on how online trends will affect how agencies will think and work.

Based on my experience working in traditional media and then online in China, I think that online users are about 2-3 years ahead of online users in the US. This is because the Internet developed without the help of advertising income in its early stages, unlike in the US where advertising was a very established model. For this reason, it is much easier for Chinese consumers and advertisers to adapt. In China, there is much stronger tie-in between offline events and online promotions, instead of just relying on online advertising as in the US.

US corporations and advertisers have to “unlearn” much of what they have thought would work in the new online space.

One of the big questions is that agency account people will have to learn to become advocates for their brands and products both offline and online. Where does the agency and customer advocate line end and begin? It’s easy to see that in the very near future the best agency account people will be those who are the most passionate and eloquent advocates for a product, and can exercise good judgment quickly. Those who succeed will be the ones who can go from strategy to tactics very quickly, while keeping the client clear about overall goals and weaving through the intricacies of the online conversation.

One book which is going on my “to read” list is Jump Point, which talks about how marketing to the interconnected online crowd is going to work.

Over the past few years, one subject has dominated Chinese thinking on the government and enterprise levels: how to take Chinese brands global. During the runup to the Beijing Olympics in 2008, and then the Shanghai Expo in 2010, this subject will become even more popular, as China’s economic power grows and the US’s economic dominance gradually recedes.

So far, the thinking is that Chinese companies, with some degree of Chinese government assistance, should buy leading US brands and manage them. This was the thinking, for example, behind Lenovo’s purchase of IBM’s money-losing PC division and the Thinkpad brand in 2004. It was also the thinking behind the aborted CNOOC purchase of Unocal, an offer which had to be withdrawn because of heavy US congressional pressure over security.

Outright purchases of foreign companies, in the form of hostile takeovers and mergers rarely go well, even when the cultures of the two companies are close. When they are as far apart as Chinese and western companies, the odds are overwhelmingly stacked against success.

Now there is renewed interest in buying western companies for yet another reason: the Chinese government is sitting on US$1.3 trillion in foreign exchange reserves, and with the dollar falling against the euro and other major currencies, there is strong pressure to invest this money in something else besides US dollars, which will continue to depreciate. In order to slow down this depreciation, the Chinese government has announced that it will establish a Chinese sovereign wealth fund to invest about US$200-300B in higher-yield investments. Within the past year, sovereign wealth funds have proliferated as foreign governments seek to diversify their foreign-exchange reserves out of US dollars, especially as the US subprime mortgage lending crisis has spread overseas.

For the Chinese government, which likes to do great projects which it can then use in PR to the Chinese people, there is a fundamental bottleneck: there are not enough Chinese who have international experience managing global companies. And those who do have the skills usually decide to spend their time and effort in the private sector where their skills are more needed. In one article some time ago, Business Week claimed that China needed about 75,000 international executives while there are only 5,000 available.

There is another problem with creating global brands: in most sectors, it takes an awful long time to create them. If you look at Toyota in the automobile sector, it has taken the company mostly since the period from 1945 to become established as a leading quality maker. When it comes to manufacturing, global brands are not made, they are earned on the basis of quality products.

The place where brands have sprouted relatively quickly are in the computing and hi-tech sectors. Apple has been around since the 70s and has undergone a dramatic rebirth under the tutelage of its founder, Steve Jobs, who returned in 1997 after Apple’s acquisition of NeXT. Since his return, he has launched the iMac, iPod and now iPhone lines, all of which have won critical acclaim from users worldwide. Steve Jobs has shown that he is that rare type of executive, someone who learns from his mistakes and is passionate about creating excellent products. Now, even for dedicated Windows computer users, Apple’s products are something worth thinking seriously about. When it comes to evoking pure passion among users, there is no company like Apple. The way Apple has launched the iPhone globally has shown that it fully understands how to use the power of the Internet and the media to create global attraction for its new products at very little cost. On October 26, the company will launch its latest version of the OS X operating system, Leopard.

The company’s success has been rewarded on Wall Street; the company now has a market cap of more than 148.2B and its shares are trading at $172.

Another company which has succeeded in creating a global brand in a relatively short time is Google, which was founded on September 27, 1998. Google started as a technology company, and has morphed into a company which understands, and is now revolutionizing the media business. Coming from a very strong technology core base, they like to constantly talk about their technology, even though that is relatively unimportant backend stuff to most people. Very early on, Google figured out that as computing, and now mobile computing grew, more and more data would be accessed from online. The question was: “What was the economic/business models which would support it?” The answer is first search, and then other formats of online advertising. Google strived to make advertising more relevant and less disruptive, and strived to do this all with its Adwords solution.

It has also been a success on Wall Street. Even though expectations were high, it blew past the estimates with its recent earnings announcement , growing the company at twice the growth rate of the growing online ad market.

While Google has continued to have a hard time succeeding in China because of strong competition from Baidu, it is performing exceptionally well in other markets. Compared to their smaller local competitors, US companies continue to have a hard time succeeding in China. Nevertheless, Google continues to make inroads in China.

When talking about large investment amounts, it is easy to forget that the most important part of the equation in brand-building is always people, not marketing dollars or yuan. Buying into Apple and Google would get an inside view into how these leading companies are run.

So what is the best, the smartest way to buy into these companies?

My guess is that the smartest way is to buy Apple and Google shares on the open market and gradually build up enough to get a board seat, where the sovereign wealth fund’s proxies could quietly learn how these companies perform, and find out who are the people who really make contributions to the company. Steve Jobs likes to create the persona that he is Apple and Apple is Steve Jobs, but the truth is not that simple.

Be a smart passive investor, not a dumb active investor. Learn to walk before you run. While it may seem a longer, slower process in the beginning, this is actually the faster, smarter and more economical way to go. Can you think of another way where you earn money while you learn instead spending big chunks?

So to sum up, the benefits of buying into Apple and Google are:

• Great place to park those extra depreciating dollars and get some appreciation
• Great way to learn how digital online products and brands are made
• Great way to find out who the smart movers and shakers are
• Great way to learn how to become a smart passive investor

If the sovereign wealth fund is doing what they were set up to do, they are already buying Apple and Google shares.

Now that would be real smart…