The China Vortex

Following on the global credit crisis, many have come to me to ask how these changes will affect China. As I have said earlier, China and the US are two sides to the same coin, and it pays to look at them as one economy, as this Newsweek article does. It goes without saying that this crisis will have a profound effect on China, and I’m not optimistic about the capability of the Chinese central government in Beijing to deal with it as quickly as it should. Michael Pettis, who lives and teaches in Beijing, has been a persistent advocate of stimulating more domestic spending from Chinese consumers, and continues to advocate that position. I agree that this is necessary; I don’t think that this will happen quickly or on an even basis. There is a simple reason for this: stimulating consumer spending depends, to a large extent, on the rollout of a national healthcare system; this is something which Beijing has tried to do since the early 90s, all without success. When it comes to the lack of a national healthcare system, the US and China are in the same boat, and the national governments are equally ineffective.

So what are some investment rules you can use? Let me list seven below:

• Avoid Shanghai and Beijing. Both have excellent universities, and Beijing has central government ministries while Shanghai is the commercial capital of China. In IT, companies have preferred to hire from Tsinghua for smart technology people. But there are major problems with both cities. First of all, staff turnover is too high, and costs are too high. In the past few years, staff have routinely asked for 20-30% raises just to stay in the same company! And with all the western companies constantly going into those cities, there has been a bidding war for staff. We are in tough times now, so do you really want to get involved in bidding wars over your local staff and deal with staff turnover issues? I don’t think so. And when it comes to Internet/IT, I say that the Internet already has become a platform and there is plenty of talent around. Do you really need expensive people from the very best universities in China who may prove a pain to manage? If you don’t, second-tier people who are reliable and don’t ask for huge pay raises are good enough, and maybe even better. When hiring local talent, look for tortoises, not hares. We are heading for much tougher times, and you need a good stable team. Beijing and Shanghai have too many hares. Your most loyal people will be the ones you hired and trained on the job. They will also be the ones who understand local market and conditions and connections.Another major issue about Beijing and Shanghai is that they are geared for exports, especially to the US. Do I need to tell you what happened to that export market?
• Instead of going to Beijing and Shanghai, look at the 20 major city markets in China if you are thinking of selling to Chinese consumers. Now is a good time to get into services for Chinese consumers. Think of cities like Dalian, Hangzhou, Ningbo, Xiamen, Guangzhou, Wuhan, Nanchang, Chongqing, Chengdu, Fuzhou, Kunming, Nanning, Nanjing, etc. If you want to get into China under the radar (in my opinion, always a wise strategy), these are places to look at very seriously. If you need knowledge workers, as in programming or game production or pharmaceuticals, pay special attention to the local universities, and partnering with them to hire their graduating students. If you show the cash and commitment, and can guarantee jobs for their students, you will get multiple offers of good deals.
• Guangdong and Zhejiang are the two largest manufacturing provinces in China. Guangdong’s factories depend on a huge pool of unskilled immigrant laborers, mostly young women, from Sichuan and other provinces. These factories and workers are going to be hit hard because of their dependency on the US market. There is too much overcapacity, too little value-added, and too little profit for most of these factories to move up the value chain. Unemployment in Guangdong and Sichuan will become a major issue. Zhejiang’s factories are mostly family-owned, and it has less reliance on immigrant workers. Because of Zhejiang’s strong private sector and private wealth, they will be able to make the adjustment in market demand from exports to domestic Chinese consumption more quickly.
• If you are a private equity or hedge fund investor, you need to think about investment horizons. In order to make up for the dropoff in exports, Beijing and provincial governments would naturally think of investing more in infrastructure. So far, most of this money has gone into infrastructure, manufacturing and real estate. The problem is that these areas are already built up and have over-capacity. They are really at a loss about what to do. If you can help and offer investments which create jobs and upgrade the skill force, you are in a good position. Be sure to get your money and profit back within 15 years (by 2023). That is because if you are selling to Chinese consumers, you are selling to the current group who are in their 20s - 40s. By 2023, China’s demographics will fall off a cliff because of the one-child policy, and they will be in savings mode instead of spending mode.
• When it comes to modernization, China is crossing a 30-foot chasm with a 20-foot rope, with each foot representing one year. China’s hardware development and infrastructure are very impressive and are the most modern in the world, as the Beijing Olympics showed. The hardest part to modernize is peoples’ mentality as the tainted milk scandal has shown. China’s aging demographics do not give it enough time to cross the chasm, so Chinese will get old before they get modern. When that happens, China will look like a bigger version of Japan, and will have all the problems Japan has today. Just hope that China has a national healthcare system in place by then.
• The wealth gap will become wider over the next 10 years between the cities and the countryside, then stabilize for five years, then shrink as the city worker bees retire in 15 years. Rural infrastructure is less developed, and so far, the Chinese government has made all the wrong moves in rural development by not supporting the development of rural collectives for the farmers. There is an excellent article (in Chinese, h/t to Stan C) about the failure of China’s rural development, and how Chinese rural development will look like the Philippines with large food processing companies employing poor farmers. This organization is partly responsible for the Sanlu tainted milk scandal, and is copied from the US. But the US has a surplus of land and shortage of farmers, while China has a shortage of land and excess of farmers! If you are interested in macroeconomic issues, this is worth more study. Its view converges very well with the view of Yasheng Huang in his new book Capitalism with Chinese Characteristics, which I have also mentioned in my previous article.
• The dumb money has already been made in China. It’s time to rebalance your portfolio to make smart money. It can be done, but it won’t be easy. Think smart, work smart, and invest for 15 years. By that time, you should be able to retire.

If you need more information specific to your fund/company/situation, you can contact me from the About page.

Technorati Tags: Beijing, beijingolympics, chengdu, China, chongqing, credit, crisis, dalian, demographics, export, fuzhou, guangdong, hangzhou, hedgefund, HR, infrastructure, investment, IT, japan, kunming, melamine, michaelpettis, milk, nanchang, nanjing, nanning, ningbo, rural, shanghai, turnover, US, workforce, wuhan, xiamen, Zhejiang

Yesterday I participated in Barcamp Beijing 2007, which was held at the France Telecom Research and Development Building in Haidian district in Beijing. There were more than 100 participants with some 24 sessions held in three different languages.

It is hard to describe the firehose of information from Barcamp, but I will try to offer some of the highlights.

Michael Sikorsky, CEO of Cambrian House, first spoke about how to raise financing for startups. Based in Calgary Canada, Cambrian House offers a business platform for service providers, and Michael has successfully transitioned from being a tech person to a business person. I was immediately impressed by his praise of Paul Graham, founder of the Y Combinator seed-funding group. Paul Graham is the smartest tech guy who has transitioned to business, and Michael showed how Y Combinator has introduced a new VC business model of seeding startups by mentoring them through the startup process.

I have spoken frequently with Frank Yu about the need to bring something similiar to the Y Combinator seed capital model to Beijing. Chinese startups badly need mentoring, especially in their early phases because most of the founders do not know how to build teams. This is something Paul Graham’s Y Combinator organization has been able to address very well, teaching business smarts to founders from tech backgrounds.

The other main takeaway from Michael’s talk was that it was important for new companies to be “investor-centric” as opposed to “founder-centric”. If a company is set up to be friendly to investors up-front, then it is much easier for it to scale.

Andrew Lih, who is now living in Beijing, spoke about the Wikipedia movement. Andrew is a researcher in new media, and is now working on a book on Wikipedia due for publication sometime next year.

In the afternoon sessions, Karl Mattson, president of Medium Cool based in San Francisco, talked about what kinds of people were needed to build a good company. He put special emphasis on need for background diversity. When most Americans hear the word “diversity”, then tend to think in terms of racial, religious and sexual diversity. What Karl was talking about was the need to get people from different parts of the world, social and educational backgrounds so that they can exchange views by looking at a business proposition from different angles. Failure to do so meant that companies would often have “blind spots” and result in “group-think”, where the same group of people have a narrower and narrower vision.

I have noticed this tendency even in very large and successful US companies such as Microsoft and Google, where the definition of a smart person fits very closely with the founders’ definition of smart. This has resulted in a form of inbreeding, where the companies’ blind spots get bigger and bigger, creating opportunities for new challengers and startups.

Following his talk, Robert Scales, founder and CEO of Raincity Studios, talked about his company’s experience working with Drupal, the open-source community web framework. Robert talked about how Drupal has matured into an excellent solution for all kinds of businesses, with new modules being added on a regular basis. Previously, companies had been wary of using open-source as a solution because of security cares, but now he found that they had gone past those issues and had come to embrace it as a development platform. The best part for his 12-person team based in Vancouver was that because the software is regularly updated, his company only has to concentrate on basic functionality, design and configuration issues for his clients. And if his company cannot perform the work, design and feature requests can just as easily be addressed by another team which is familiar with Drupal. Now, his company is so busy that he has come to China to look for designers and coders to augment his Vancouver team; he mentioned that he is so busy that he has had to turn away business.

In reply to a question from me, Robert mentioned that the average billing amount and timeframe for a project is 3-6 months and 50-100k (Canadian dollars) per project.

My session was on the topic of “Building Management Teams” for startups. I focused on some of the problems which I found most Chinese startups to have:

• Founders fall in love with their own ideas too much, take criticism personally. This makes companies too slow to ditch old bad ideas.
• Chinese companies tend to be “founder-centric” instead of “investor-centric”, which means it is very difficult for a company to grow past US5B market cap in size (with the exceptions being Chinese state-owned enterprises or SOEs).
• Healthy startups have a technology founder, product founder and a bizdev founder, forming a tripod. Most startups in China do not have this setup; instead relying on one person to drive growth and vision. This model does not scale well, and feeds the founder’s ego too much. This puts a cap on future growth.
• There are too few original ideas; companies tend to copy each other.
• China has a high-competition, low-trust society. This also puts a cap on Chinese companies’ growth. If someone can successfully address the issue of how to build trust in the online/offline world, they will have something very interesting.

Many photos were taken, including many by Kris Krug, president of Bryght, one of the event sponsors. You can find the list of sponsors from my previous pre-event posting. If you would like to see photos from the event, you can find them on Flickr.

Many participants will be going to Shanghai where Barcamp Shanghai 2007 will be held at the offices of Tudou on Sept 8.

Barcamp Beijing 2007 was a very interesting and exciting event for those interested in technology. It provided an excellent opportunity to meet some of the participants and drivers in open-source and Web 2.0, and gave those from outside China a chance to learn about the Chinese market, and a chance for Chinese to mix with outsiders.

All in all, an excellent experience.

Technorati Tags: barcamp, barcampbeijing, barcampshanghai, Beijing, business, China, Chinese, dollar, google, HR, information, investors, language, management, market, microsoft, open-source, research, SOE, software, US

The consulting industry in China is flourishing. After all, it is the largest potential single market in the world, and everyone is flocking to it. New companies need information and advice about how to tackle the unique challenges of this market. For any MBA who is fluent in Chinese, or who has grown up in China, and is familiar with the tools of the trade, such as financial modeling, business negotiations and company valuations, China represents an “iron rice bowl” which will make their careers for years to come.

Or is it? My experience is that there are errors which are repeated over and over again. It gets like being condemned to watch a single Broadway show, over and over again, where the only things which change are the sets and the actors; the lines are the same.

I have covered one of the major fallacies in a previous posting, Getting Past the China Market Hype, which covered their initial reasons for entering China. This posting will cover some of the reasons for failing post-entry.

Since most of my experience has been with technology/media/startups from the US, I am naturally biased towards those companies in my evaluation. There have been many success stories from the financial sectors, engineering and consumer goods. These areas, unlike hi-tech, have had decades, and in some cases even more than a century of experience, building their China presence, and understanding the challenges involved. They have the money, and have built up a knowledge base of experience which they can draw from, and because of the large scale of their businesses, even if they cannot draw from in-house experience, they know how and where to get it when needed.

Some of the US technology companies which have come to China and have failed to succeed in the Chinese market are eBay, which basically had to hand over its operations in China after running into the strong local player, Taobao.com, in the auction field. Yahoo! had to basically pay a China partner, Alibaba.com, US1B to take over its China operations. More recently, Google, the US search advertising firm, has had to fight an uphill battle against the largest Chinese search firm, Baidu.com. Online gaming is a new area which does not exist in nearly as large a form as the US, with Shanda being the granddaddy in China, while newer players such as Perfect World (PWRD) have sprung up with new and different business models, and successfully going public on the Nasdaq. In instant messaging, Tencent’s QQ has been able to rack up 600M registered users, and unlike any US IM clients, become profitable.

Because most US startups come from technology backgrounds, they tend to believe that their business is scalable. The word “scalability” is in itself, an engineering term, which means that an architecture can go from 1 user to one billion (or infinite) users, or across national borders and into different languages and markets, without any major architectural hiccups. For this reason, they tend to play down distribution and cultural differences in their most initial stages. Most of the time, they have people on staff or in management who know something about the local market; more often than not, they are not in senior decision-making roles.

Then, when they get to China, they try to do what they did in the US, and quickly discover that the rules in China are very different. Whereas labor is very expensive in the US, with each hire drawing the attention of different company committees, in China it is one of the single cheapest expenses. (Except for senior and executive management, where highly qualified individuals cost just as much, if not more, than in the US.)

The most common failing comes in the area of product management, when the US insists on controlling the product development and launch schedule, with local product launches coming only after the US is ready. In smaller markets, that’s fine, but in fast-moving large markets, especially one as large as China’s, it’s a killer. (Even in fast-moving small markets it’s a dubious strategy; in South Korea, Google has been consistently beaten by Naver, a highly successful Korean company.)

This puts the China office in a continuous battle with the US headquarters for resources; the Chinese local competitor has no such restrictions on what it can do, and the Chinese company surges ahead in capturing market share, and eventually, revenue. The American company then organizes what can best be called a “strategic withdrawal”, as did eBay.

In more mature industries where there is some kind of brand equity, product lines are already fairly mature, and headquarters makes resources available to country managers as needed. Because of the fast-changing nature and relative immaturity of hi-tech, this has not yet happened.

When the American companies fail, the blame is usually assigned to some form of Chinese government protectionism, and favoritism to the local companies. Of course, this explanation is more palatable to Congress members seeking re-election and US TV talk-show hosts, but more often than not, it is a vast over-simplification of a complicated issue.

Technorati Tags: advertising, baidu, business, China, Chinese, google, HR, information, language, management, market, qq, resources, Shanda, trade, US, yahoo

Until very recently, Chinese language qualifications were not considered a deal-breaker for senior positions in China. For the most part, US and European employers assumed that a person of Chinese extraction had some degree of fluency in Chinese, and could communicate with other Chinese in China.

This all changed when Goldman Sach’s proposed appointment for China co-head, Richard Ong, was disqualified from his proposed position because he failed to pass the language requirements for the position which were passed by the China Banking Regulatory Commission. Ong was a Malaysian Chinese who had been mostly educated in English in the west.

The test which Ong failed to pass was the HSK or Hanyu Shuiping Kaoshi. The test is given in three levels: basic, intermediate and advanced. The most basic level of Chinese language fluency is level 1; the most advanced is level 11. Those who reach level 11 Chinese language fluency are deemed to be able to work in a Chinese-language work environment. The HSK is the only government-sanctioned test given to non-Chinese whose results are recognized by the Chinese government.

Previously, the HSK was considered important only for those who were interested in the Chinese language for research and academic purposes; now, it is quickly evolving into an important job requirement qualification for those who want to work in China.

The test information and registration website includes full information about the process and tests, with test dates and places. Registration for the tests can be done online, as well as payment. All the candidate then needs to do is print out his form and photo, and present himself on the date of the test.

Test preparation books and materials are widely available in foreign-language bookstores in China, as well as in online stores.

As China becomes more important and influential on the international business scene, the need for senior executives who are fluent in written, spoken and in reading Chinese will become more important. Now, because of CBRC regulations, the sectors most affected are the sensitive financial sector; it is likely that as western companies become educated about the difference between being ethnically Chinese and fluent in Mandarin, they will ask for HSK test scores to get a handle on the Chinese language fluency of their staff and management, and prospective candidates. It is likely that it will soon evolve into a requirement for those in marketing in China, and in operations. Already, among executive search firms, there is a serious shortage of senior-level staff and management positions where candidates with Chinese-language fluency and overseas work experience are sought. For those who are serious about working in China, it would be wise to take the HSK and have their scores ready for their meeting with the human resources department.

Among China consultants, the HSK has already become a hot topic for discussion.

For those who are interested in learning more from others, and in sharing their knowledge, there is a discussion group for the HSK on Facebook.

Technorati Tags: business, career, China, Chinese, fluency, goldman, HR, human, information, interest, job, language, management, market, marketing, ong, online, preparation, qualifications, requirement, research, resources, richard, sachs, US