Can Chinese brands make it abroad?
The answer is yes, but it won’t be easy.
Paul Gao, Jonathan R. Woetzel, and Yibing Wu
The McKinsey Quarterly, 2003 Special Edition: Global directions
China dominates world manufacturing because of its low-cost labor. So far, though, most Chinese companies have been content with the role of original-equipment manufacturer (OEM), supplying the world's biggest brands and retailers' private labels with products ranging from toys to televisions. But the government is now urging some of China's biggest companies to sell branded products abroad—and
many have reasons of their own for trying to establish brands in developed countries. The home market is fiendishly competitive and puts constant pressure on prices, branded products can be more profitable than those of OEMs, and competing in foreign markets forces companies to innovate and improve, thus helping them to move away from their image as producers of cheap goods.
Some Chinese companies have already established a branded presence in emerging markets, with products such as domestic appliances, consumer electronics, and motorcycles. The next move is into developed markets, a process already under way with appliances and consumer electronics. Haier, China's biggest appliance maker, is selling small refrigerators under its own name in the United States 1and has ambitious plans to win 10 percent of the US market for full-size refrigerators by 2005. (To do so,
it must sell 500,000 units a year, 80 percent of them from its manufacturing plant in South Carolina and 2the rest from China.) Meanwhile, Legend, China's biggest computer maker, has launched Lenovo as a
global brand to position itself for overseas expansion. In an attempt to build name recognition, Kejian, a mobile-telephone maker, sponsors Everton, one of England's top soccer (football) teams. And the Shanghai-based electronics company SVA sells its branded plasma televisions in US retail chains such as Costco Wholesale.
Do Chinese appliance and consumer electronics companies have what it takes to sell branded products profitably in markets such as the United States, Europe, and Japan? We think that these companies have a long way to go. Creating and sustaining brands in developed markets is complex, expensive, and uncertain. The biggest obstacle is the Chinese manufacturers' lack of vital marketing skills. It took years, and a great deal of money, before the giant Japanese and South Korean consumer electronics companies established themselves abroad (see sidebar "Samsung got there").
This doesn't mean that China should be counted out. The country's consumer electronics companies are rooted in a large and open market where their products prove themselves daily against the world's best in features, quality, and price. Low labor costs make Chinese goods less expensive, and some of the savings can be passed on to Western channel partners and consumers. In addition, China has a large and growing pool of skilled engineers and the money to invest in new products.
So the question is less whether Chinese companies can make the grade in product features and quality and more whether they can develop marketing strategies for branded goods. Some companies will find openings by offering value for money to distributors and retailers seeking to differentiate themselves; those that can move quickly will find opportunities in the increasingly popular value channels. In general, the economic slowdown in the developed world will help, too. Some companies have already begun to gain a foothold (Exhibit 1), learning the ins and outs of selling in developed markets while moving cautiously by making deals with distributors that are able to get leading-edge products in front of consumers without having to invest vast sums on marketing campaigns.
It may still be early in the game, but branded, higher-priced global manufacturers such as Sony and Samsung Electronics will have to watch their Chinese competitors carefully. As for wholesalers and retailers, they must balance the opportunity to offer customers good value against the risk of upsetting existing relationships with other branded manufacturers.
The branding challenge
Chinese companies see a lot of money on the table in the branded-goods market (Exhibit 2). In the US home refrigeration and laundry sectors, the top five brands hold more than 80 percent of the market. In Europe, at least 80 percent of the refrigeration products sold are replacement purchases—and consumers
tend to replace with the same brands they had before. Brands represent features and value, and most consumers in most developed economies prefer those they know.
Higher prices for branded goods translate into huge profits. For household appliances, the US profit pool is worth more than $2 billion, 9 times the profit pool of China and 100 times that of Brazil. For consumer electronics, it is worth more than $1 billion, 10 times more than China's and 20 times Brazil's. Moreover, developed countries offer a wider range of sizable segments to target. The US market for projection televisions (screens of 45 inches—115 centimeters—and up) is worth more than all of the video products
sold in India, while the $400 million worth of compact refrigerators sold in the United States in 2000 amounted to twice the total value of all refrigerators sold in South Africa or Poland. Although the best Chinese OEMs have shown that they can be as profitable as sellers of branded goods—
after all, they don't bear the costs of R&D and marketing—they view selling branded products as one way
to get an even bigger slice of the pie. Makers of branded goods can charge higher prices partly because they promise higher quality, and that is a crucial issue for Chinese companies in developed markets. Much "as the consumers of the past were reluctant to buy goods out of Japan and South Korea for fear of quality issues, products from China are now experiencing similar obstacles," says Robert Rodriguez, vice 3president of marketing for SVA's North American operations. "SVA intends to change the misperception
currently held that all Chinese-brand electronic products in the US are without merit." Many companies in China have shown quite convincingly that they can manufacture competitively priced, high-quality products
In fact, Chinese companies have shown convincingly that they can produce competitively priced, high-quality goods. Galanz, for instance, makes microwave ovens on an OEM basis for almost all of the world's leading consumer electronics companies (see sidebar "Taking the OEM route"). Little Swan supplies
General Electric with dishwashers. And Changhong Electric supplied Wal-Mart Stores with televisions sold under an unrelated brand, Apex Digital, in a giant one-day promotion in 2002.
The Chinese companies most likely to succeed in establishing brands in overseas markets are those that have a track record in low-cost, high-quality manufacturing and show marketing prowess on the local level. In general, Chinese manufacturers have relied on a fully integrated model in the domestic market. They start off using foreign technology and then try to develop their own technology and products. Most of these companies are heavily asset-based and have large manufacturing organizations, and almost all have their own distribution networks and large, cheap sales forces. Replicating this model with traditional products in developed markets would be prohibitively expensive, time-consuming, or beyond the skills of management. Only a few Chinese companies, such as Haier, have built factories in the United States; Haier's leaders believe that the added expense of producing goods there will be outweighed by the ability to respond more quickly to changes in local consumer tastes.
More specifically, the Chinese have no overseas distribution channels or service networks, little promotional or advertising savvy, and limited pricing skills. It is questionable whether these companies could quickly develop a feel for the design and feature preferences of Western customers. Working the channels
We have identified two business models that would help a Chinese consumer products company move its branded goods quickly into developed markets while taking the time to become familiar with them. The primary model is a step-by-step procedure in which products exported from China penetrate overseas markets through independent distributors serving discount channels. This gradual process would permit Chinese companies to gain an understanding of customer behavior and to build brand recognition. In the second model, Chinese companies buy an established brand that has fallen on hard times and then move its production to China to benefit from lower labor costs.
The step-by-step approach
Channel consolidation in advanced markets has long been seen as a barrier to outsiders. Mass-market retailers in the United States, for example, control more than half of the consumer electronics market, and the trend is accelerating. This development means that there are fewer competitors to which manufacturers can pitch their goods and that they have less power over pricing. Exclusivity deals can also block access to consumers. Nonetheless, a big problem in retailing today is sameness. Retailers are looking for distinct brands and products, and if these provide good margins and fair prices for the consumer, so much the better.
A senior purchasing executive at the US retailer Sears, Roebuck, for example, told us that it is always looking for winning products at good prices to draw shoppers to its stores and that if the Chinese offered such products, they would be considered. Retailers might also be interested in deals with Chinese companies to supply products on an exclusive basis. Other US retailers emphasize that shelf space is expensive and competition for it intense. In many cases, they have to offer top brands such as Sony or Panasonic but say that current second-tier brands—even well-known ones—could be expendable in favor
of well-made, attractively priced Chinese products.
SVA has pushed in this direction in the United States for the past two years. In China, the company has transformed itself from an also-ran maker of conventional color TVs into a leading electronics group focusing on high-end plasma TVs, TFT-LCD displays (flat-screen monitors), and DLP projection TVs. SVA has proved itself by mass-producing quality products at low cost and now records annual sales of $4 billion (including revenues from joint ventures with companies such as Siemens and Sony). But outside China, it is unsure of its marketing skills. As SVA's strengths and weaknesses are consistent with those of other Chinese companies, what it has accomplished in the United States might offer lessons for them. Working with distributors provides a Chinese company with a chance to learn more about US markets and build its overseas capabilities
SVA made several important choices upon entering the United States. First, it decided to rely largely on distributors, such as Ingram Micro and D&H Distributing, that offer promotion and service assistance to manufacturers. Working with distributors gives the company a chance to learn about the US market and the requisite breathing space to build its own overseas marketing capabilities. While SVA does sell directly to some retailers, it came to the realization that the biggest ones, such as Wal-Mart and Best Buy, would expect standards of logistics, service, and promotion it couldn't meet. These retail chains offer one chance only, its executives reasoned, so it would be foolish to risk disappointing them. Second, SVA chose to work with distributors on trade-level promotional activities, including attendance at industry conferences, rather than spend millions of dollars to build brand awareness. Distributors find SVA attractive because it enables them to offer customers low-cost products—a factor of particular value
to the small- and midsize electronics retailers that compete with the likes of Wal-Mart. Third, SVA decided to avoid the low-end color-TV market, where it would have been up against intense competition from other Chinese companies selling on an OEM basis. Instead, it put its efforts into upmarket products such as plasma displays and TFT-LCD monitors and televisions. Sales of these products are growing quickly, and they face relatively little rivalry from other Chinese companies. SVA wants to be thought of as offering value for money for products aimed at technology-savvy customers who are not put off by the absence of well-known brand names. The company therefore prices its products well below the levels of its Japanese and South Korean competitors but above those of manufacturers that rely solely on low prices. It sells through Amazon.com, BJ's Wholesale Club, Buy.com,
4Costco, and Office Depot, among others. Feedback from trade shows in 2003 suggested that this value-
for-money positioning has promise given the consumers' worries about the US economy. Finally, though Chinese companies don't always acknowledge the importance of understanding local markets, SVA recognized from the start that it needed a local team to run its US business. Besides recruiting US-based executives, to whom it gave an equity stake in the venture, it hired Japanese ex-Sony production managers to help it control its manufacturing quality and is working with international firms to improve the design of its offerings. Consumer focus groups help the company refine its product lineup for the United States. The result has been some initial sales success, with expected revenue as high as $80 million in 2003.
With a few twists, this conservative entry model could be applied outside the United States. Europeans are more conscious than US consumers of brands and quality, which might make acceptance more difficult, while in Japan the Chinese will have to contend with the traditional ties between domestic manufacturers and leading retail chains. But it is increasingly difficult for retailers in these markets to pass up quality products at attractive prices. Japanese consumers have already begun to vote with their wallets and are looking for bargains.
It will, however, be several years before Chinese companies threaten the big global consumer electronics players—not that the trend should be ignored. Wholesalers and retailers should consider the possibilities that the Chinese present to them, not least the opportunity to bargain hard with their traditional suppliers.
Buying your way in
The alternative to entering a market step-by-step is to buy into it through mergers and acquisitions. Suitable targets would be companies with valuable assets—brands, customer bases, technology, or
channels—as well as products that have become overpriced as a result of management's failure to monitor costs, to move production offshore to low-cost locations (such as China), or to extract the best prices from overseas factories or offshore OEMs.
A buyer could move the bulk of the acquired company's production to China and retain the brand name, distribution channels, and some of the local talent. Over time, it could co-brand the product with its own name to build consumer awareness of its Chinese brand. Once the association and awareness had been firmly established, the buyer could phase out the target brand. The biggest obstacle for a Chinese company would be locating qualified turnaround managers for its typically distressed targets, since it would be unlikely to have postmerger-management and marketing skills in-house.
One Chinese company, D'Long International Strategic Investment, succeeded in building a position in the US market by acquiring, in 2000, Murray, a well-known manufacturer of bicycles and of lawn and garden equipment. During the postmerger-management effort, D'Long integrated its Chinese production facilities with those of Murray, carried out some short-term turnaround maneuvers, and identified lower-cost sources of supply. Murray still controls some operations in the United States. Sales of Chinese-made products are projected to reach $700 million by 2005, with excellent returns on invested capital. The company is currently seeking further acquisitions.
China’s appliance and consumer electronics manufacturers have little choice but to compete on the home turf of global companies
A leading Chinese electronics maker is pursuing a variant of this approach. TCL International Holdings purchased an insolvent German television maker, Schneider Electronics, for $8 million in September 2002 in an attempt to break into the European market. Included in the acquisition price were Schneider's plants; its distribution network of chain stores, hypermarkets, and mail order; and trademark rights to a series of brands, including Schneider and Dual. TCL, hoping to avoid European quotas on the importation of Chinese TV sets, expects to continue production in Europe. A professional management team is helping TCL understand the local market and sales networks, and some Schneider employees have been rehired to oversee production. If the strategy is successful, TCL could one day introduce the TCL brand to the European market; electronics products bearing the name are already exported to Australia, the Middle East, Russia, South Africa, and Southeast Asia. In a twist, TCL is using its Schneider brand to position its mobile telephones in the high-end segment of the Chinese market. More recently, TCL bought GoVideo, of Scottsdale, Arizona, which makes DVD players.
Many of China's appliance and consumer electronics manufacturers have little choice but to go global. Born into an industry that is essentially open to worldwide competition, they must gain scale in the only
place they can—the home turf of the world's multinationals. Just getting into the branding game, though, will require a combination of attractively priced products, good service, and first-rate technology. To stay there, the Chinese will have to build or buy a wide range of new skills. But if standards of quality and service remain high, a number of Chinese companies will earn shelf space for their branded goods in developed markets and, one day, might even capture the price premiums that some of their Japanese and South Korean competitors enjoy.
Samsung got there
The experience of South Korea's Samsung Electronics shows how hard it can be to build brands. Today, with more than $33 billion in annual sales, it is a global leader in consumer electronics: half of those sales are mainly to Europe and North America. But Samsung spent much time and money on its globalization campaign. Starting with domestic operations, the company acquired basic product-development skills through joint ventures and more than 50 technology-licensing agreements. Branded exports began in the early 1980s, with US prices set at a discount to those of Japanese and US competitors as a way of appealing to price-sensitive customers. Samsung also acted as a private-label supplier to retailers and brands.
It slowly learned the requirements of its markets by conducting extensive consumer research and building up its overseas sales and manufacturing operations in the United States, Germany, the United Kingdom, and Australia. The company increased its R&D budgets, and by the early 1990s its aspirations had led it to invest in products and technologies (for example, flat-screen monitors and televisions, digital high-definition televisions, and digital mobile phones) that would raise its brand profile. Finally, in the late 1990s Samsung launched its global brand with more than $1 billion in advertising, including sponsorship of the Olympic Games. It formed alliances with high-tech partners such as the US telephone company Sprint and introduced a wave of cutting-edge products, spending more than $7 billion, or 5 percent of sales, on R&D from 1996 to 2000 and upward of $400 million on brand advertising in 2001 alone. In the meantime, the company positioned itself as a premium brand by shifting its channel focus from mass merchants to category killers. In a 2003 survey of global brands, Interbrand, a brand strategy and design consultancy, ranked Samsung as number 25, with a brand worth $10.8 billion—a 31 percent increase from the previous year.
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Taking the OEM route
Most Chinese companies seeking to expand abroad have pursued an OEM strategy (exhibit), enabling them to build scale quickly without the need for corresponding investments in marketing. Information technology has made it feasible to construct global networks that seamlessly link production in China to
marketing and design operations in developed markets. Conversely, manufacturers in developed markets can outsource what would otherwise be high-cost production, in turn creating greater price flexibility. Cost and quality leadership and the ability to support a number of global customers and to acquire the needed technology and capabilities are the key success factors in this model. Low costs, which are necessary to secure the initial contracts, must be accompanied by excellent skills in supply chain management and sourcing. A number of customers are required to minimize dependence on any one of them and to gain scale. But while this strategy demands the lowest level of additional skills from Chinese companies, it also offers the lowest upside from the market. Returns can come only through expanding scale to achieve a position of global dominance in components and assembly.
Galanz is an example of globalization through an OEM strategy. Founded in 1978 as a textile company with 200 employees, in 1992 it started making microwave ovens, which it soon began manufacturing for OEM customers, targeting those keen to lower their manufacturing costs but not yet ready to set up operations in China. The company is now the world's largest producer of microwave ovens, with almost 30 percent of the global and 70 percent of the Chinese market.
Galanz maintained cost leadership while integrating itself into its customers' networks and lowering prices to gain market share and scale; industry average pricing dropped by 18 percent a year in the late 1990s. Since then Galanz has signed more than 80 contracts with OEMs. The strategy has paid off. By 2003, sales to OEMs represented over 60 percent of the company's revenue, and annual production had reached 15 million-plus units. Total sales had risen to more than 5 billion renminbi (over $600 million) and net profits to more than 450 million renminbi. Galanz is now introducing branded products for markets in South America and rolling out an OEM approach for other home appliances. Return to reference
About the Authors
Paul Gao is a principal and Jonathan Woetzel is a director in McKinsey's Shanghai office; Yibing Wu
is a principal in the Beijing office. This article is adapted from Jonathan Woetzel's book, Capitalist China:
Strategies for a Revolutionized Economy, New York: Wiley, 2003.
The authors wish to thank Perchow Joseph Chang, Chris Shu, and David Yu for their contributions to this article.