American companies missing the boat when investing in China !
Companies / Analysis & Strategy Dec 26, 2006 - 08:26 PM
The six Chinese office workers in front of me all ordered the same thing — a Chinese specialty called hot pot, a simmering fondue-like pot of aromatic and spicy stock that contains leafy vegetables, mushrooms, dumplings, meat, and/or seafood. It looked absolutely delicious and smelled even better. 'I want one of those,' I said to the cashier who couldn't speak a lick of English.
My host at the Zhang Jiang Hi-Tech Industrial Park cafeteria on the outskirts of Shanghai gently interrupted me. 'I suggest you make a different selection, Mr. Sagami,' he quietly warned. 'That is dog hot pot.'
'Dog? Dog as in woof woof? ' I asked.
Thank goodness my Chinese lunch companion was considerate enough to point out the menu's finer points before I ordered! A typical Chinese menu has a lot of things that I won't touch with a 10-foot pole. They may taste just fine, but dishes like house special pigeon, braised saliva nest, duck tongue with black pepper, or spicy chicken feet just don't appeal to me.
Eating in China Is a Lot Like Investing in China
Someone who doesn't know their way around the block can really get surprised in China. That's especially true for American companies that are trying to crack into the Chinese market. Succeeding there is a lot more complicated than opening an office or hanging up a shingle. As an investor, you can't assume that every company with a strategy for China will succeed.
I've seen it with my own eyes — most American companies fail very badly in China because they don't adapt to a completely different business environment and a completely different culture. Let me give you an example ...
One of America's most respected companies, Best Buy, opened its first Chinese store last week. The electronics retailer's 8,000-square-meter store is in Shanghai's bustling Xujiahui district. Best Buy operates stores in the U.S. and Canada but never before has it set one foot outside of the comfy confines of North America. It's ready to spend millions in China, but it's already making several fatal mistakes:
Mistake #1: Best Buy is entering a business that has one of the smallest profit margins in all of China — margins on electronics are typically between 1% and 3% there. Let me tell you, that is not the type of business that I'd want to jump into. When it comes to retail electronics, the Chinese market is far, far from a trophy lake. Instead of jumping in with both feet, the smartest decision would have been to stay the heck out.
Mistake #2: Best Buy is using its North American business model of giving employees regular paychecks rather than big commission incentives. Now, if you've ever been to Shanghai, you know that its inhabitants are some of the hardest working, eager, ambitious business people in the world. In fact, if you really want to make a Shanghai merchant mad, try to leave his or her store without buying anything! They are always ready to do some business.
That is why most employees that work at appliance and electronic stores in China are heavily compensated by commissions. Best Buy's biggest competitors — Gome Appliance and Suning Appliance — follow this system. Best Buy thinks its strategy will make the sales process friendlier and less biased. Ha! All this strategy is going to do is push the most knowledgeable and best salespeople to other stores that will pay them better.
Mistake #3: Best Buy thinks the playing field is level and fair in China. Maybe ... for Chinese companies. Best Buy originally planned to open its first Chinese store in Beijing in a prime commercial space recently vacated by Ikea. That's until the #1 retailer, Gome, heard about it and snatched the space away from Best Buy!
Get this: Best Buy offered to pay $10 million a year in rent, but the owner of the building accepted a $2.5 million-a-year offer from Gome instead! The owner of the building was more impressed with the credit and financial strength of Gome over Best Buy. Bottom line: It's not easy for foreign companies to do business in China. And Best Buy isn't the first or last to get its lunch eaten overseas ...
Other American Companies Are Making Similar Mistakes In China
For starters, let's talk about Home Depot. The home improvement retailer recently announced the purchase of Home Way, a 12-store home-improvement retailer in northeastern China.
The company thinks it's going to make a bundle in China. Not likely! Here's why:
- Home Depot is targeting Chinese with an income of more than $3,000 a year. But these people are spread over a giant country, and that will drive up distribution costs.
- Go to Shanghai or any large Chinese city and try to find a single-family dwelling. The Chinese live in apartments and condominiums. They're not exactly clamoring to work on home improvement projects.
- Most important of all, because labor is so cheap in China, there is a very small do-it-yourself market.
Hey, I love Home Depot and can spend hours wandering its aisles. But the company is in for a rude awakening in China. And there are even more outrageous examples of American companies screwing up in China.
For example, Nike ran a TV ad that showed NBA superstar LeBron James playing and defeating a computer-generated Kung-Fu master. People were so insulted that the Chinese government banned the ad.
And just last week, eBay announced that it will shut down its Chinese website and replace it by buying a 49% stake in Beijing-based Tom Online, an online portal and wireless operator. The fact that a small Chinese start-up was able to defeat an Internet giant like eBay just proves how tough the Chinese market can be.
Don't think other foreign companies are immune, either. A Toyota ad showed its Land Cruiser towing what appeared to be a Chinese military truck. Another one featured stone lions, a traditional symbol of power in China, bowing down to Toyota's Prado. Millions of Chinese balked at the insult to their armed forces and at the notion of bowing down to anything representing Japan! I'm not telling you all this to scare you away from China. Instead, I'm trying to show you why it's important to be selective when it comes to your investments.
A lot of investors think just owning a few large American companies will give them enough of a stake in China. But what they might not know is that some of these firms are going to ultimately come home with their tails between their legs.
As I've told you many times before, there are great companies operating both here and in China. But don't just select from the menu haphazardly ... you might end up with dogs.
Best wishes,
Tony Sagami
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