ChinaVortex Interview with Handel Jones, Author of Chinamerica: The Uneasy Relationship That Will Change the World

August 10th, 2010

I recently conducted a phone interview with Handel Jones, the author of Chinamerica: The Uneasy Partnership That Will Change the World which is published by McGrawHill.

You have worked as a consultant for many years in China and the west. What motivated you to write this book?

Many Americans don’t know much about how China works, except for those who are in the business sector. Now that China has become economically powerful, it is important for more people to understand how the Chinese government and people see themselves, and their role in the world.

In your book, you mention that China needs and respects a powerful US, but if the US becomes weaker, then the relationship would become unstable and even dangerous. Why?
China has looked up to the US for a long time as a world leader, and setting the rhetoric aside, continues to have a deep respect for many things which the US has done. For example, in the area of graduate university education, Chinese continue to choose the US as their most popular destination.

In your book, you express some frustrations at recent US government policies. What are they?
Domestically, with the change in administration, we were expecting more support in the business sector. However, for small businesses, there has been more regulation and more taxation. This has hurt the overall competitiveness of US businesses. This is in comparison to the Chinese government’s policies, which have been to support Chinese businesses and exports, especially state-owned enterprises.

What is your feeling about the competitiveness of US businesses?
I believe that US management practices, generally speaking, are the best in the world. It also has the best business managers in the world. This is why the US has world leaders and brands such as HP, Apple, Boeing, just to name a few. However, there is little understanding on the government policy level as to how to leverage these American strengths as most US politicians are too absorbed with domestic issues so that they can win the next election.

How is this different from the Chinese government’s worldview and their policies?
When China’s reforms started thirty years ago, China worked from a very weak base. Just about the only thing it had a was a large pool of unskilled labor and some smart leaders. They leveraged this base to obtain key technologies and become a manufacturer and exporter, while giving away as little as possible. To this day, it is virtually impossible for any non-Chinese company to gain access to the Chinese market without being forced to give access to key technologies, which often find their way to Chinese competitors. This is a source of frustration to virtually all non-Chinese companies.

Many US and western policymakers say that China needs to revalue the yuan upwards. What do you think?
Instead of putting pressure on China to revalue the yuan, it’s more important to put pressure on China to open up its markets to foreign-made goods, so that they are treated the same as goods made domestically in China. Non-Chinese manufacturers should not be pressured to hand over their technology to gain access to the Chinese market.

What does the US need to do to become competitive again?
Over the past few decades, US government policy has become more short-sighted, and Wall St. has reacted by creating debt instruments which were speculative in nature, instead of being investment-oriented. However, the US still has strengths in areas such as medical research, energy technology, and other leading areas. China and the US need to work together in developing these new fields of research and manufacture.

How do you see leverage between China and the US changing over the next decade?
If the US government does not wake up and change its policies to support the US business sector and investment, it will continue to lose leverage to China. This is not good for either country. This is why I wrote the book; I want Americans and the west to wake up to this real challenge, and understand the importance of our changing our own policies so that our relationship with China will become more complementary instead of potentially antagonistic. China is looking to the US for enlightened leadership, and it is time that the US government delivered, not only for its own good, but for world stability.

What hidden threats do you see to China’s leadership?
Chinese state-owned enterprises may become too powerful and greedy, leaving too little for others. This may lead to the abuse of power, which would lead to instability. So far, the Chinese government has done well at keeping these abuses in check.

In conclusion, how would you say China has performed over the past thirty years?
The Chinese government has been very smart in the way it has utilized resources to gain benefit for China. It has shown that it is not a pushover like Japan was in the late 80s. It thinks in big terms, and has a clear strategy for what it wants to do, but it is willing to be flexible in what tactics it uses to achieve those goals. I plan to write more about this in my next book on Chinese strategems.

The New Investment Rules For China

October 5th, 2008

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.

MySpace China Loses Out To Local Competition

September 6th, 2008

The story of western social network sites losing out to local Chinese competitors continues; this time MySpace China joins the list as its CEO Luo Chuan makes it official that he is going to leave to join a local online video startup.

Although it is a well-known fact that local management teams need to be empowered to compete successfully in the Chinese market, western tech companies continue to make the same mistakes over and over again. I believe that the reasons for this are:

  • While there is much talk about diversity, there is the firm belief that “brands” must be protected with a unified set of features and look all over the world;
  • Most VPs of marketing are not fluent in other languages and cultures, and try to dictate from headquarters. When they visit the local office, they appear sympathetic, but when they return to HQ, everything learned from visits to local subsidiaries is quickly forgotten;
  • Local Chinese competitors are unrestricted by these considerations; they just do what they need in order to win users. There is very little if any discussion of “brand” and “look and feel”. These are the horses VCs like to bet on;

When you come right down to it, there is little a global brand can bring to the table in China. Most add a burden of a faraway headquarters without empowering the local management team to be more competitive. This is not a problem which is unique to China, it is also happening in the social networking market in Japan.

My conclusion: The problem does not lie with China, but instead lies with the reluctance of western social networking sites to empower their local management to do whatever they need to win users and market share. By trying to force common features, standards and branding too early from their headquarters way before the market is mature, they cripple their local companies’ chances of success, and cede the market to the local competitors.

That is why the successful local competitors get such high valuations; they make ideal acquisition candidates and give their founders a good exit strategy.

Ask Meg Whitman, former CEO of eBay.

Understanding the Chinese Hockey Stick

February 3rd, 2008

baidu.jpeg

One of the things past experience has taught me that while it is possible to guess that some business will take off in China, it is almost impossible to tell when. The most common scenario is that for many years, a western business will devote its people and resources to making its business popular with Chinese, it will not show results. Frustrated, it will depart China with nothing to show for its hard work and investment. (This happened frequently in the eighties and nineties; now it is much more rare.)

This rule does not just apply to business; it even applies to Chinese government policy. For years, the Chinese government actively urged the Chinese people to travel more; it even increased the number of public holidays, creating the Golden Week holiday around the May Day holiday in the late 90s to get Chinese to travel more, and spend some of their savings. For years, the policy yielded no solid results.

But later it worked, and beginning this year, the May Golden Week holiday will be abolished. Put simply, it’s no longer needed. Chinese now travel freely, are willing to spend their savings, and the incentive is now no longer needed.

The same phenomenon occurred in the auto industry. For years, local Chinese automakers were unable to get Chinese to spend money on automobiles; most of their production went to taxis and to Chinese government ministries and officials. These habits changed suddenly with the SARS crisis in 2003. All of a sudden, Chinese were afraid to take public transport and started buying cars. And unlike in the west, they paid for their cars in cash.

This trend, which started in 2003, has continued to this day. Now, if a young man in China’s cities wants to get married, more and more young brides are expecting an apartment and car to go with their husband-to-be. Today, in Beijing, 1,000 new cars are being added daily to the city’s traffic woes.

This creates a phenomenon which I call the “Chinese hockey stick”. In simple terms, this means that “It is likely that a new business/service/product will take off in China, but it is hard to say when.” This can be endlessly frustrating for businesses which need to plan their expenditures on an annual or quarterly basis. When are they going to see some of their investment money come back? Country heads need to tell their head offices when the hockey stick will finally take off, and more often than not, it is very hard, if not impossible, to tell.

Part of my rationale for the Chinese hockey stick is that Chinese consumer spending patterns will track more closely to the spending habits of their Asian neighbors in South Korea, Japan, Hong Kong and Taiwan, than to the west, as Chinese society becomes more prosperous. If you want to understand how Chinese spending habits are likely to develop, take a close look at these places. You will learn a lot. In culture and language, these places are closer to how Chinese think, act and behave than the societies of North American and the EU.

Most frequently, the businesses which are able to time the rise of the hockey stick are local Chinese entrepreneurs. Unlike western companies which try to sell their foreign-designed products in China; these Chinese entrepreneurs stand in the wings, just waiting to swoop in at just the right moment. Unlike western corporations, these companies do not have the big budgets of western companies, but their knowledge of their countrymen’s thinking and spending habits more than compensates for this. This is why many leading Chinese Internet companies such as Tencent, Baidu and Sohu have been able to prosper, while their much larger and richer western competitors have been unable to gain traction.

With the dramatic growth of the Chinese consumer market in the past five years, you would think that western observers would learn to be quiet instead of sticking their necks out and betting against the spending power of Chinese consumers.

Apparently not.

David Wolf’s Silicon Hutong has pointed to an article by Donald dePalma in which he claims that China’s buyers account for only 1.1% of what he calls “online GDP”. Unfortunately, he does not explain his methodology as to how he gathered his numbers.

In the west, the Internet led to the creation of some whole new businesses, with Amazon and Google being the best examples. In China, many Internet companies are front-ends for established brick and mortar businesses. For many Chinese consumers, the Internet is like a shop window; when they buy, they still prefer to buy from a person in a store.

These fundamental differences in consumer spending habits make me question the value of even measuring something like “online GDP”. And as David Wolf alludes to, the eGDP is a static number; it does not capture or reflect trends. It is like trying to understand a movie storyline from a still photo.

That’s why I’ll stick with my analogy for the Chinese hockey stick, at least for the time being.

Risk Is In The Eyes of the Beholder Part IV

January 29th, 2008

watercube.jpeg

Yesterday, the new national aquatics center was unveiled in Beijing. This will become the venue for the leading water events of the Beijing Olympics. After the Olympics are over, it will be converted to a shopping mall for Beijing’s masses.

Beijing is now the site for some of the most exciting architecture in the world. For many Chinese though, there is an underlying uneasiness. Is all this dramatic futuristic architecture the beginning of a new and exciting future of wealth and prosperity which Chinese have never experienced in their long history?

Or is this instead a blip of prosperity, and will the future be much less bright, and will their children and grandchildren look back and see the Beijing Olympics as the apogee of what has since become a downward trajectory? And will this architectural marvel become dirty and dusty and seedy?

China has seen prosperity before, only to have its dreams shattered. Westerners today see China as a rich, prosperous and growing power, but it has run into the wall before, and on many different points in history. The first Chinese industrial revolution, when Chinese factories started making goods for the Chinese market started at the end of the nineteenth century, with textile mills and flour processing factories spouting up in the Yangzi river delta, mostly started and financed by entrepreneurs from Shanghai and Wuxi. Then China went into political chaos in the period following the revolution which overthrew the Qing dynasty in 1911.

Another period of short-lived period of prosperity came in the early 30s, this was cut short by the Japanese invasion of China in 1937.

Then, in the period following the end of WWII, China fell into civil war between the two leading political parties, with the Nationalists losing and retreating to Taiwan. Following the establishment of the PRC, China was very poor, and then made even poorer by the Cultural Revolution. In 1978, the Chinese government essentially decided that they were tired of being poor and moved ideology off the national agenda. From now on, it would be about making money.

Even today though, with all their savings and comfort, Chinese feel that it can all change and all go away. That is why they save and sit on their cash.

Americans are the opposite. Until very recently, most Americans believed that the future would always be brighter, that although there were things that they did not understand, America was the strongest and most prosperous country in the world, and that there would always be a way. This is why theyspent their savings, and when their savings were gone, they would take loans on easy credit terms, promising to repay the loans and credit when they had income again. It led to a bigger and bigger mountain of debt. And now, Americans are much less sure about their ability to repay the loans.

This is a way of thinking which is completely foreign to Chinese, and makes no sense at all to them. For Chinese, the only real money is cash. And when money goes bad in times of high inflation, they don’t even believe in cash.

They believe in land, and if the politics becomes unstable, they go to gold.

Runaway inflation is something the Germans experienced in th 1920s, then again in the postwar period. Japan experienced it too in the postwar period. China also experienced it in the postwar period when the Nationalists had to change national currencies three times in the period up to 1949. With the runaway inflation in the cities, people had to carry their money in paper sacks to do their shopping. They would go to the markets carrying bags of money to buy their groceries, then they would use the same bags to carry their groceries back home.

When the Nationalists lost control of inflation, they lost the Chinese cities and the support of the business community. This paved the way for the establishment of the PRC in 1949. The first task for the government was then to stabilize the currency.

While China was very poor in the fifties, sixties and seventies, there was virtually no inflation.

Today in China, we are seeing the early signs of inflation again in food prices and property prices. For any Chinese government, and this government is no exception, inflation is the greatest single and most frightening enemy it faces. It may creep up slowly, but it unleashes forces which can easily spin out of control.

If a government cannot maintain the value of its currency, it cannot protect its citizens, and the people end up in the poor house. It’s that simple.

This is why the Chinese government will not easily revalue the yuan upwards, and why the government keeps such a tight control on credit.

One of the upsides for Chinese businesses investing in Africa is that although the people are poor, at least they pay cash. When times turn hard, you want to be paid in cash.

For most Chinese, you aren’t rich unless you own cash.

Credit is just a derivative and in tough times, no one wants derivatives.

How Chinese Use Their Mobile Phones

September 4th, 2007

Last night (Sept. 3) I attended the Mobile Users Panel held by Mobile Monday in Beijing. This event was held at the Radisson Hotel. This event was the evening part of the Wireless Developer Forum sponsored by Sony Ericsson and Nokia.

I always like to listen to how users use new technology products and services. There are a lot of very smart technology and business people who, at the beginning of a project, have all kinds of ideas of what they are going to build into the next killer app. Then, when they test the product on a focus group, they are always humbled by the experience. I call this phenomena “the revenge of the user”.

Mobile Monday assembled a four-person panel: one 25 year-old research student (technology) from Chongqing and who had lived in Beijing for the past seven years; one 18-year old high-school student who called himself Rico, and appeared anxious to test his fairly good English on the audience; one 25 year-old female math teacher in high school and one 30+ tech startup guy. Because the 25 year-old researcher and the startup founder knew more about technology, I tended to discount their views, and was much more interested in how the 18 year-old high school student (Rico) and the 25 year-old female math teacher used their mobile phones.

Benjamin Joffe, CEO and founder of Plus8star, presented the questions, and a female co-host did the English-Chinese translation work.

The 25 year-old researcher spent about 150 yuan on service charges per month, and was a subscriber to China Mobile’s M-Zone service package, which is targeted at youth. He made about 10 calls daily, and received 20-30 SMS messages daily.

Rico also subscribed to the M-Zone package, which offered 800 SMS messages monthly. He would send about 40 SMS messages daily, which would suggest that even 800 SMS messages a month is not enough for him. He used a Samsung phone; previously he had used Nokia phones. Although he was only 18, this was already his 10th phone, which seemed to cause a gasp in the audience, and Benjamin Joffe did a double-take when he heard this.

The 25 year-old female teacher also used the China Mobile M-Zone service, but also used PHS service at home because of the low monthly charges. Her use was much lighter than Rico.

When it came to services used, Rico said that he had once used China Unicom, but the monthly charges had gone up to 300 yuan a month, and he had cancelled. The rate he seemed most comfortable was in the region of 150 yuan monthly.

Aside from the 25 year-old researcher, all had more than one phone and one SIM card.

Benjamin Joffe asked all of them if they knew about 3G. Rico said that he didn’t know the details, but that he thought that it meant there would be higher quality services at lower prices. All said that they occasionally played casual mobile games and never expected to pay for them. This would suggest that entertainment on the mobile platform is headed for an advertising model.

It became most interesting when Benjamin asked what single feature they would like their next phones to have. The answer from both the female teacher and Rico were maps. Rico suggested that he would also like GPS so that he could find his way around. The female teacher recounted how she got lost meeting her class one day on a day trip, and how helpful it would have been to her to have a mapping service; she said that it would have prevented her from being some 10 minutes late to meet her class.

Maps and mapping are still sensitive government-regulated issues in China, and it will be interesting to see how the different regulatory ministries will reach consensus on how to offer these services.

My conclusions are:

  • It will be very difficult to monetize mobile content in the next 2-3 years because of government regulatory hurdles and a generally challenging environment.
  • While China is a very big market in the mobile and Internet space, users are still very price-sensitive. Most teenage urban users would cap their monthly subscriptions at 150 yuan, and 300 yuan would be a ceiling for most salaried people. (Rico was spending his parent’s money; and I assumed that working people would be willing to spend up to 300 yuan of their own income on monthly mobile services.)
  • Just because someone likes a service a lot does not mean that they are willing to pay for it, so please remove those rose-tinted glasses and stop fantasizing about the “China market” is my advice to those entering the Chinese market.
  • Mapping and GPS on mobile phones are the killer app, but are currently regulated by different Chinese government ministries. Currently, there are still no standard published APIs for accessing an online mapping service. A lot of horse trading will happen before everything gets sorted out on the government level. When that is done, advertisers will have to figure out how to monetize maps and GPS services, which involves yet another round of horse trading.
  • The times when telcos and their partners were fantasizing about people spending kajillions of dollars, yuan and yen on mobile services will be hit hard by the expanding credit crisis. I expect users worldwide to put fairly solid ceilings on their discretionary spending, at least in the US. In China, the government may further slow down credit expansion since they have already seen what fast credit expansion has done in the markets of Japan, South Korea and Taiwan, where there are swathes of the local populations which have become victims of their monthly credit card payments.
  • The ultimate measure of how much users spend on mobile services is ARPU (average revenue per user). While China is much larger than Japan in population and market size, the amount of revenue generated by the telcos in the two countries are about the same. It’s going to be a long long time before the average Chinese user spends nearly the same amount on mobile services as the current Japanese user does.