The Changing Context for Multinational Companies to Re-evaluate their China Strategies amid New Realities

By Edward Tse

October 2020

If you are the CEO of a global company with sizable operations in China, the past couple of years must have caused much anxiety. The US-China relations have undoubtedly deteriorated, in contexts ranging from the trade war, consequences of COVID-19, the threat of “decoupling,” to the feud over Huawei, ZTE and most recently Tik Tok and WeChat. There is also a widening distrust between China and the people in the West. For example, Pew Research Institute has reported that 73 percent of US adults have an unfavorable view of China, up 26 percentage points since 2018.[1]

In the meantime, however, you have witnessed some notable developments in China. First, having rapidly contained the outbreak of the pandemic, the country has successfully reversed the contraction of its economy from -6.8 percent in the first quarter to 3.2 percent in the second quarter and 4.9 percent in the third quarter.[2] China’s foreign trade in the third quarter grew by 7.5% against -6.5% and -0.2% in the first and second quarters of the year.[3]

Second, foreign companies especially American companies are staying in China, and many among them are actually increasing their local investments. Shanghai American Chamber of Commerce (AmCham) revealed lately that 78.6 percent of American companies in China have “no change in their investment allocations,” and 28.6 percent plan to increase their investment in China.[4] Nor are supply chains moving out of China in droves as many speculated due to the pandemic. While some companies have built supply chains outside of China, they did so mostly for risk mitigation purposes, in particular for medical supplies.

Lastly, US President Donald Trump’s threats of a ban on Tik Tok and WeChat have not gone smoothly, since both attempts were blocked by courts in September.

You have been getting lots of inputs on China from various sources. Some positive, some negative. However, your financial reports are telling you a clear story. For some of you, China is one of the best performing markets or the best. For some, while your home market is still larger or the largest, China is delivering the fastest growth. And for some of you, because you are prohibited by the US administration to sell to China, your business is taking a big hit. Though the situation is different for different companies, in almost all cases China’s importance has not declined. In many cases, China has become even more important to you.

So, what are the implications for you? Granted, your next move depends on your view of the future, especially how the world order would evolve going forward. What would be the role of China in your next-generation global strategy, that is, commensurate with your view of the post-pandemic new world order? Where, how and how much should you place your bets?

What are the Facts?

In the sea of information on China, let’s examine some key facts.

Fact 1: The unique development model of China that has evolved from Deng Xiaoping’s experiments in the 1980s has had a major impact on the Chinese economy. On one hand, its “three-layer model” has driven continued economic progress. At the top, the central government sets the stage, outlining directions for the rest of the country to follow. At the grass-roots level, fast-growing, highly dynamic entrepreneurs are driving growth and innovation. In the middle, local governments compete and cooperate, while some have formed regional clusters, becoming a glue between the central government and grass-roots businesses.

On the other hand, in a dual economic structure, state-owned enterprises (SOEs) provide public goods beyond narrow economic considerations, while privately-owned enterprises (POEs) leverage these public goods to create commercial value for stakeholders. Together, the “three-layer duality” has provided significant resilience to the economy, and will continue to evolve and refine.

Fact 2: Citizen support for the Chinese government remains strong. A survey by Harvard Kennedy School’s Ash Center shows that overall satisfaction with the central government reached as high as 93.1 percent in 2016.[5] Other renowned surveys have reported similar results, including Edelman’s Trust Barometer released this May, which says citizen trust in the Chinese government is up five points to 95 percent since January.[6] In the 2020 Ipsos survey of the state of happiness, China was ranked number one with a score of 93%, having grown 11% over the last 12 months, against a global average of 63%.[7]

Fact 3: As the US proclaims an “America First” policy, China has been accelerating its opening to the rest of the world. In 2018, authorities decided to phase out foreign ownership limits on automotive companies. With that, Tesla became the first wholly-owned foreign carmaker to operate in China with its Shanghai “Gigafactory.” Major energy multinationals such as ExxonMobil and BASF are building multi-billion US dollars wholly-owned chemical processing plants in China after the Chinese government relaxed foreign ownership limit in the energy sector. Last year, British telecom operator BT became the first non-Chinese telecom firm to acquire an operating license in China. The massive financial sector too is open, allowing the world’s biggest asset manager BlackRock to set up its wholly-owned mutual fund unit in Shanghai this August.

China’s top leadership underscores the commitment to openness. In a letter to the Global CEO Council this July, President Xi Jinping promised foreign companies to “provide a better business environment,” and emphasized the “concept of win-win and joint development” to facilitate communications between foreign and Chinese firms.[8]

Fact 4: Despite the worsening US-China tensions, American brands continue to be well-liked by Chinese consumers. Tesla, as well as General Motors through its Chinese venture partner SAIC, dominate the electric vehicles market in China. Starbucks, Nike, KFC, the NBA and the Disney theme park, among others, are just as popular among Chinese consumers.

Fact 5: As Washington’s technology “blacklist” goes on, China is hard pressed to develop competency in areas like semiconductor chips. Companies from large to small, private to state-owned, are engaging in R&D and commercialization of these technologies. Many of such attempts may end up in failures, but a small number of them would ultimately succeed. According to official records, China spent nearly US$324 billion in R&D last year alone, which is roughly 2.23 percent of the country’s GDP.[9] Besides, the concept of what constitutes innovation is getting refined, as now people focus on “real performance,” instead of “paperwork” (i.e. number of publications, degrees and awards).

Fact 6: China’s middle class continues to expand in terms of absolute size as well as its buying power. According to the Economist Intelligence Unit, China’s middle class – defined as having US$10,000 annual disposable income – will account for 35 percent of the population by 2030, compared to today’s 10 percent.[10]

As the middle class expands, consumers can be found not only in coastal metropolitans but also increasingly in “lower-tier” cities. Technologies are reshaping consumer behavior. Many now have appetite for a wide range of products and services whether of Chinese or foreign origin, and newer micro-segmentations are emerging alongside.

Fact 7: China’s evolution in its digital economy continues to evolve and accelerate. Having embraced the wireless internet for over a decade, China is at the cusp of a new digital era, marked by disruptive technologies such as artificial intelligence (AI), Internet-of-Things (IoT), 5G and blockchain technology. More technology-enabled innovations will emerge from China, not only in “2C” (“To Consumers”) but also in “2B” (“To Businesses”) and “2G” (“To Governments”) businesses; and, not only in consumer segments but also in manufacturing, supply chains, business software as well as smart cities and infrastructure. 

Scenarios of the Future

Clearly, the world order post-COVID will be very different, and the US-China relationship will inevitably define that order. Given the above analysis and the common belief that China will continue to play an important, or even more important, role in the world going forward, what would you do? How would you see the future developing? How would the US-China relationship evolve? 

In our view, we believe there will be three potential scenarios related to outcomes of geopolitics, macroeconomics as well as US businesses whose fate will be tied to the outcomes (see Exhibit 1):

Exhibit 1

Scenarios of the Future US-China Relationship

Source: Gao Feng analysis, Automobility analysis

The first scenario is regionalized isolation. As isolationism is on the rise, Chinese companies will be forced out of the US market, with the Chinese government virtually blocking all US investments in retaliation. Decoupling beyond the tech sector will continue to expand. For Chinese consumers, their attitude towards US brands will become increasingly hostile, consequently shifting to local products. 

The second scenario is that of “one world, two systems.” The US and China will remain geopolitical rivals with occasional flare-ups on specific issues, but mostly reconciliation for common interests. Intense competition between the two countries in high-tech areas will continue, though stakeholders will learn to solve disputes with dialogues. Nonetheless, due to export controls and other policy measures, as well as difference in level and sophistication of digital infrastructure, China and the US will evolve in to two tech systems driving differences in product, service and business model design. On the economy end, China shall extend its market access to foreign firms, but with stringent data and security policies, and thus companies will have to work with the government in order to monetize user data. As intelligence and connectivity become increasingly embedded in Chinese society, consumers will gravitate towards brands, regardless of whether Chinese or the US, that can give them desired digital experiences tailored to local tastes.

The third scenario is one of “co-opetition.” The US and China remain rivals while collaborating in certain areas of global governance. In high tech areas, the US and China may continue to both compete and collaborate. Meanwhile, as China’s economy grows with globalization and as its role in the global supply chain upgrades, the country will increase market access for foreign players, and exercise data sovereignty based on recognized principles as global data governance is worked out. Companies' products, services and business models will have a better chance of transcending over national borders, with perhaps the exception of the core technology concerns. Similarly, companies will need to work with regulators in order to monetize data and leverage connectivity, and Chinese consumers will also gravitate towards brands that can give them desired digital experiences tailored to local tastes.

Obviously, your view on which scenario(s) might manifest will depend on your own judgement based on the inputs that you have been receiving. And, of course, that would also depend on how circumstances would emerge. At this stage, our view is that the first scenario of “regionalized isolation”, while not impossible, is the least likely while the second scenario of “one world, two systems” is probably the most likely in the short-term, especially where technology is involved. However, we don’t believe a complete decoupling is likely or even possible. The third scenario of “co-opetition” would probably be more likely over the medium term, perhaps with more competition initially while moving into more collaboration over time. 

Time to Reflect

Your decision on your China strategy is largely dependent on your view on which of these scenarios would pan out. And, of course, your response will also differ depending on who you are – by national origin, industry, role in value chain, etc.

The China strategy and China’s role in the post-COVID world are on the CEO agenda for many multinational companies. The overall context is changing in the midst of new realities in the world. China’s importance to global companies’ finances and competitive positioning will become more critical going forward, despite an uncertain US-China relationship. However, we believe that the most likely scenario is one where China will not be totally decoupled from the west, instead it would stand by globalization and multilateralism even more firmly. And, through the manifestation of its unique (but evolving) “three-part duality” development model, China will be able to continue to make major progress especially in critical areas such as innovation, technology, infrastructure, environment and people’s general living conditions.

Making the right bets now on how the world’s future might look like, and what to do in China and for China will, for many companies, define their longer-term competitive positioning in the world or even the fundamental notion of survival.

References:

1.     Devlin, K., Huang, C., & Silver, L. (2019, August 13). U.S. Views of China Turn Sharply Negative Amid Trade Tensions. Pew Research Center. https://www.pewresearch.org/global/2019/08/13/u-s-views-of-china-turn-sharply-negative-amid-trade-tensions/

2.     He, L. (2020, October 19). China's economy grew 4.9% in the third quarter of 2020. CNN. https://edition.cnn.com/2020/10/18/economy/china-q3-gdp-intl-hnk/index.html

3.     Xinhua. (2020, October 13). China foreign trade up 7.5 pct in Q3. Xinhua Net. https://www.xinhuanet.com/english/2020-10/13/c_139436826.htm

4.     AmCham Shanghai. (2020, September 9). AmCham Shanghai Releases 2020 China Business Report. AmCham Shanghai. https://www.amcham-shanghai.org/en/article/amcham-shanghai-releases-2020-china-business-report

5.     Harvard. (2020, July 9). Ash Center Researchers Release Landmark Chinese Public Opinion Study. Harvard. https://ash.harvard.edu/news/ash-center-researchers-release-landmark-chinese-public-opinion-study

6.     Kehoe, S. (2020, May 6). Record trust gains in Asia are undermined by Japan. Edelman. https://www.edelman.com/research/record-trust-gains-in-asia-are-undermined-by-japan

7.     Ipsos. (2020, October 7). The State of Happiness in a COVID World. Ipsos. https://www.ipsos.com/en/global-happiness-study-2020

8.     Xin, Z. (2020, July 16). China President Xi Jinping promises foreign firms reform, opening up amid heightened US tensions. SCMP. https://www.scmp.com/economy/china-economy/article/3093407/china-president-xi-jinping-promises-foreign-firms-reform

9.     Feng, C., & Zhang, J. (2020, October 5). China spent a record 2.2 trillion yuan on R&D in 2019 but needs to do more to escape US tech strangulation. SCMP. https://www.scmp.com/tech/big-tech/article/3104154/china-spent-record-22-trillion-yuan-rd-2019-needs-do-more-escape-us

10.  Zuo, M. (2016, November 3). China’s middle class to rise to more than third of population by 2030, research firm says. SCMP. https://www.scmp.com/news/china/money-wealth/article/2042441/chinas-middle-class-rise-more-third-population-2030-research

Acknowledgement

The author would like to thank Bill Russo of Automobility Limited, partner with Gao Feng Advisory Company, for his inputs and contributions on the “Scenarios of the Future.” 

Dr. Edward Tse is founder and CEO, Gao Feng Advisory Company, a founding Governor of Hong Kong Institution for International Finance and Adjunct Professor, School of Business Administration, Chinese University of Hong Kong. One of the pioneers in China’s management consulting profession, he built and ran the Greater China operations of two leading international management consulting firms (BCG and Booz) for a period of 20 years. Australia’s In The Black magazine calls him, “the Father of Business Consulting in China.” He has consulted to hundreds of companies, investors, start-ups, and public-sector organizations (both headquartered in and outside of China) on all critical aspects of business in China and China for the world. He also consulted to a number of Chinese local governments on strategies, state-owned enterprise reform and Chinese companies going overseas, as well as to the World Bank and the Asian Development Bank. He is the author of several hundred articles and five books including both award-winning The China Strategy (2010) and China’s Disruptors (2015), as well as 《竞争新边界》 (The New Frontier of Competition), which was co-authored with Yu Huang (2020).

You may visit Dr. Tse's blog to explore more of his intellectual capital: www.edwardtseblog.com