Tag Archives: McKinsey

Twelve McKinsey Predictions For China In 2012

Gordon Orr, a director in the Shanghai office of McKinsey, a firm of management consultants, has made 12 predictions for China in 2012:

  1. Government policies will spur consumption and investment.
  2. Dominant models will emerge for reforming rural land ownership.
  3. Real estate will stagnate.
  4. The fundamentals will cause further inflation in food prices.
  5. Chinese investment in green tech will spike upward.
  6. Accounting scandals will continue.
  7. Private-equity and venture capital funds may go ‘walkabout.’
  8. Chinese acquirers will be bolder.
  9. The automobile segment will be slow.
  10. Hospital reform will accelerate.

This Bystander likes (in the sense of agrees with) 6, 7, 8 and 9 and is intrigued by 10. 2 is a bold call. Necessary as land reform is, it will be difficult to push through in a year of political leadership transition. That will also blunt the impact of any efforts towards 1. 5 is this year’s bit-of-a-cheat, given what is outlined in the new five-year plan. 3 and 4 are the least convincing, not because Orr’s logic is wrong, but because the social disharmony they imply won’t likely be tolerated in what is looking to be a bumpy year. What do you think?

By the way, how did Orr do with his six predictions for China in 2011?

  1. Inflation in food prices will take longer than expected to control.
  2. Middle-class bankruptcies will expand dramatically.
  3. Minimum wages will rise, but productivity gains will outstrip labor costs.
  4. China’s economic growth will be lower than expected.
  5. China will step up its “invest out” program in the new five-year plan.
  6. The state will again try to reduce its ownership role in business.

1 and 3 came good. 2 and 4 not so much, though ‘dramatically’ and ‘lower than expected’ give him a lot of wiggle room to claim vindication. 5 was a bit of a cheat in the first place. 6 was wide of the mark, at least in the sense that SEOs increased their dominance in the economy.

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The Next Stage Of Innovation In China

The McKinsey Quarterly has a newly published package of pieces on innovation in China. As the authors of the overview, Gordon Orr, a director of McKinsey’s Shanghai office, and his colleague Erik Roth, note:

Considerable innovation is occurring in China in both the business- to-consumer and business-to-business sectors. Although breakthroughs in either space generally go unrecognized by the broader global public, many multinational B2B competitors are acutely aware of the innovative strides the Chinese are making in sectors such as communications equipment and alternative energy.

Chinese companies’ increasingly outdated global reputation for being imitative not innovative is because much product innovation in China stays there, and so escapes the notice of those not on the ground. That is as true of advances by local companies in domestically oriented consumer electronics as it is in tech media such as instant messaging and online gaming.

Orr and Roth acknowledge the importance of government support, clearly already evident in the development of industries, from high-speed rail to pharmaceuticals to green energy technologies, that Beijing considers strategically important. There will be more of that to come. The current five-year plan calls for a large increase in R&D spending. Up to 10 trillion yuan ($1.5 trillion) is a figure being bandied about. The anointed industries are biotech, post-fossil-fuels energy, energy conservation and environmental protection, clean-energy vehicles, new materials, and next-generation information technology and high-end equipment manufacturing.

But government support for R&D is far from the only reason for China’s increasing innovation. The quantity and quality of the country’s scientific and technical talent is growing. China’s universities graduate more than 10,000 science PhDs each year. That is enabling a potent blend of technology transfers from multinationals and indigenous R&D.

The formula isn’t infallible. Again, as Orr and Roth note:

Some notable examples [of flops] include attempts to develop an indigenous 3G telecommunications protocol called TDS-CDMA and to replace the global Wi-Fi standard with a China-only Internet security protocol, WAPI.

As we noted yesterday about some Harvard Business School research on the management of Chinese companies, the heavy preponderance of state-owned companies acts as a counterweight to developing the internal corporate cultures of risk taking, learning and collaboration that are necessary to nurture innovation. Chinese companies have traditionally preferred what Orr and Roth call “innovation through commercialization”—putting a new product or service into the market quickly, however rough its initial quality might be, but improving its performance rapidly through subsequent generations.

What also needs not to be lost sight of is that this is a different stripe of innovation, not so much yet leading-edge technological innovation, as process innovation; the use of China’s labor quality, including its intellectual capital, supply chain integrity and infrastructure to reduce cost. As S.D. Shibulal, chief operating officer of Infosys Technologies, noted in an INSEAD article on innovation in emerging markets, Chinese companies “are redesigning products to reduce costs; they are redesigning entire business processes to do things better and faster than their rivals.” He dubs this “frugal innovation”.

This lets Chinese companies pick off niches where consumers are prepared to accept a small drop in quality in return for a large cut in price. The real challenge for foreign firms is going to be not so much at the top end of the market in many given industries, but in the middle market. No doubt China will eventually be making breakthrough innovations; Orr and Roth say it will only be a matter of time before China evolves “from a country of incremental innovation based on technology transfers to one where breakthrough innovation is common”. But before that happens, Western multinationals are going to have to learn to compete in the middle market as well as the top-end one, as that is where the next battles for world market share will be fought.

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China’s Changing Consumers

McKinsey, the international management consultancy, says three findings stand out from its latest annual survey of China’s consumers:

  • Even in the face of rising inflation, Chinese consumers are more confident this year than in 2010 about their financial prospects. Note, though, that the survey field work was done between February and April when inflation was not seen as being as persistent as it has turned out to be and confidence in the global economy not affecting China’s growth greatly was still strong.
  • Among urban consumers, the number of first-time buyers—a group that has been a major driver of category growth in China—is declining. Note, though, that in less mature niche categories and with several big-ticket items, first-time buyers remain important.
  • Brand awareness is rising, but there is little sign that brand loyalty is following suit. More and more consumers choose among a growing number of favorite brands, typically three to five in any category. Note, thus, that faith in brands does not necessarily translate to brand loyalty.

The good news for retailers is that consumers embrace thousands of new products, services and brands with ease. The less good news is that this ready acceptance can leave retailers breathless trying to keep up.

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When Beijing Betters London And Shanghai LA

A McKinsey Global Institute ranking of the world's top 50 cities by GDP in 2005

By 2025, Shanghai and Beijing will have higher GDPs than Los Angeles and London, a further sign of the world’s eastwards economic shift. The prediction comes from the McKinsey Global Institute, the economic research arm of McKinsey & Co., the international consultancy firm, which has been working on mapping the changing economic power of the world’s metropolitan areas, and is recirculating some work on this it first released in March. Shanghai is already among the world’s top 50 cities ranked by GDP, but as well a Beijing, Chengdu, Chongqing, Foshan, Guangzhou, Hangzhou, Nanjing, Shenyang, Shenzhen, Tianjin, Wuhan and Xian will all join it by 2025, McKinsey predicts. European cities will be most numerous among the dropouts, but another will be Taipei.

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A McKinsey Take On The Implications of China’s New Five-Year Plan

McKinsey, the international management consultancy, has taken a detailed look at the impact of the new five-year plan on 33 industries, in particular its likely effect on the competition and profitability prospects. There is nothing to sum up overall as its value lies in the industry specificity, which is niftily displayed in an interactive chart. Well worth a look.

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The Cold War’s Role In Triggering China’s Economic Reforms

Deng Xiaoping took smart advantage of the Cold War between the U.S. and the Soviet Union encouraging the normalization of Beijing’s relations with Washington to open up U.S. technologies and trade to China’s emerging manufacturers. With America acting as handmaiden to China’s integration into the world economy and China having cheap labour, sitting at a crossroads of global trade, adapting the best of foreign development models to its own circumstances and maintaining a solid political commitment to economic reform, a unique combination of political and economic events converged that allowed China to develop as it has done over the past 30 years.

That, in summary, is the view of Andrey Denisov, Russia’s first deputy foreign affairs minster and the China hand among his country’s senior diplomats, given in an interview to Vestnik McKinsey, a Russian-language publication of the international management consultancy. (A shortened English version has been published in the McKinsey Quarterly.)

It is a conventional analysis with the exception of the Cold War point that Denisov says tends to be “overlooked” but for which he makes a compelling case that it was a critical catalyst. Denisov also provides the American or European reader with a necessarily different perspective on China’s development, and there are some telling if unstated comparisons with Russia’s own economic reforms after the collapse of the Soviet Union. (The Russian version is titled, The Chinese Path: Lessons for Russia.)

Denisov is similarly succinct about the challenges China faces in replacing imitation with innovation and in dealing with the environmental, farming, water and corruption problems that economic reform has brought. He also talks about Russia’s development of its own Far East and its future relations with Asia. Well worth the read.

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Have Investors Got Chinese Companies’ Capital Efficiency Wrong?

Shares in publicly listed Chinese companies used to sell at a discount to their peers in developed markets. Now they sell at a premium. David Cogman and Emma Wang of McKinsey & Co., the international management consultancy, writing in the McKinsey Quarterly, ask whether this is because the companies have changed or just investors’ perceptions of them.

Their answer leans towards the latter, but largely, they say, because investors have expectations of faster growth in emerging economies than in developed ones. Cogman and Wang think investors may be taking a too rosy a view about how that will flow back to corporate profits growth and share prices. “Given the relationship between growth and P/E multiples, Chinese companies would need significant operating improvements to justify the current valuation level,” they say.

If investors’ expectations are to be met, then there will have to be a narrowing of the underlying cause of the valuation disparity, return on capital (on average, the authors find for 2006-10, six percentage points lower than that of comparable U.S. companies). This is a straw best grasped by long-term investors, though the authors point out that more efficient use of capital is back on the agenda with the new five-year plan. This includes administrative measures to get the giant state-owned enterprises to use the capital they get through the banking system more effectively, for example, though divestitures and other M&A to restructure (the authors are from McKinsey’s corporate finance practice, after all), and the expansion of equity and bond markets to use market forces to encourage a more efficient allocation of capital and, by extension, to impose greater discipline on companies.

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