Moving on to the next China

Not a day seems to go by without a headline detailing the challenges facing the Chinese economy. For many executives, the mood is becoming increasingly sombre as they grapple with the country’s lagging economic performance.

Data showing shrinking exports, declining real estate transactions and rising youth unemployment is difficult for many to get used to, in light of the extraordinary growth China has enjoyed over the past two decades. Between 1990 and 2019, China’s real gross domestic product grew at an average of almost 10 per cent per year, contributing more than a quarter of global GDP growth.

Such growth has a peculiar ability to conceal challenges, mistakes and inefficiencies. For companies operating in China, the mantras during this period were “think big”, “copy and paste” and “winner takes all”. They were straightforward.

First, the sheer size of China’s market meant that businesses that set the biggest and boldest goals were often the ones that reaped the biggest rewards. The market, as well as investors, rewarded these trailblazers. There are many examples of companies who by the sheer might of capital and investment (and risk-taking) made it to the top of their industry.

Second, China’s ability to facilitate rapid scaling, owing to its vast number of cities and a relatively homogenous consumer base (with some regional differences, of course), encouraged businesses to replicate successful models across the nation. In fact, for some local companies, the ability to scale quickly across second- and third-tier cities was their most important weapon against more sophisticated foreign competition.

Third, especially in the past decade, with the rise of the digital economy, the winner-takes-all model seemed to work. Business sustainability and profits took a back seat to the goal of becoming the dominant player in the industry. Massive price wars followed. Many companies scaled until they became dominant players, expecting regulations and policies to become favourable to them.

The rise of the digital economy in China favours a winner-takes-all model, allowing companies to expand quickly to dominate the industry.

However, like all good things, this era has come to an end. The old playbook no longer works. We need to move forward. Gone are the days when size and growth immunised companies against failure.

It’s not just domestic companies that are feeling the heat. So are multinational corporations. In fact, multinationals’ share of all revenues earned in China declined from 16 per cent to 10 per cent from 2006 to 2020. (Although it is important to note that the size of the market grew significantly during this period.) Local brands of goods from portable electronics to groceries have gained 20 to 40 percentage points of market share over the past decade.

Multinationals have started reappraising their relationship with China. A recent survey indicated that the share of multinationals from the United States perceiving China as one of their top three investment priorities dropped from 77 per cent in 2010 to 45 per cent in 2022. Although many multinationals continue to invest in China, some are curtailing their operations there or rebalancing their investments towards other countries, and a minority are pulling out of China altogether.

While a reassessment of the risks is sensible, China still offers multinationals a unique market. To begin with, China’s sheer size ensures multinationals’ attention. Its GDP is now 18 per cent of the global total, a share greater than the European Union’s and second only to that of the United States (with 25 per cent).

China’s real GDP may grow between 2 and 5 per cent per year over the coming decade, depending on which of various scenarios proves accurate. Even if it grows at just 2 per cent, the additional GDP over the 2021–30 period alone will be larger than India’s total GDP in 2021. At 5 per cent growth, the additional GDP will be as large as the 2021 GDP of India, Indonesia and Japan combined.

Even if China does land at the lower end of projected growth rates this year, China may still account for nearly 30 per cent of global growth. There simply is no replacement for the Chinese market.

In some industries, such as cars, luxury goods and industrial equipment, the China market already represents 25 to 40 per cent of global revenues, and multinationals in those industries will have no choice but to compete there.

What’s the new winning formula in this next era? Domestic companies as well as multinationals will need a much more nuanced understanding of Chinese demand and how to address the needs of different segments.

Size matters, but distinctiveness will matter more. Organisational agility and front-line capabilities will be much more critical in the next era. Success will no longer hinge on having a brilliant founder or a top-selling product, but instead will be about continuous innovation.

The quality and health of businesses will also take centre stage. In re-evaluating the composition of their businesses, many companies will likely find a significant portion are low-quality and money-losing. They will need to make the adjustments necessary to transition to a healthier portfolio mix.

This may sound painful, but it may not be all bad news. More rational and sustainable corporate behaviour will ensure higher-quality companies and bigger shareholder returns. This transition period will create new winners in the Chinese economy – among both domestic and multinational companies – which will be stronger, more resilient and more agile.

It’s evident that the narrative surrounding China’s economy is shifting. It’s crucial to adapt and prepare for the “Next China”. The opportunities are vast, but only for those willing to evolve.

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To read the complete report upon which this analysis was based, please read the report I co-authored with the McKinsey Global Institute, “The China imperative for multinational companies.”

This article was originally published in the South China Morning Post.

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