IBM study: Multinational companies must develop new strategies to tap China's mass markets

ARMONK, NY — IBM announced today the findings of a new study which concludes that, in order for multinational companies to succeed in China, they will need to develop strategies that focus more on China's mass markets, and increasingly less on top-tier cities where the competition is fierce and the market potential is maturing. The study defines "mass markets" as a combination of smaller, emerging cities with fast growth, such as Fuzhou and Hefei, that represent nearly 40 percent of China's urban population (234 million), and the rapidly growing consumer segment with household incomes between U.S. $3,000-$6,000 annually.

According to the study, these "emerging" cities contribute up to 43 percent of China's Gross Domestic Product, and more than 80 percent of them have household income levels falling within the U.S. $3,000-$6,000 mass market range, compared to only 50 percent of larger top-tier cities. Furthermore, the Gross Domestic Product of these emerging cities is growing significantly. For example, the top 10 emerging cities are growing at 28 percent per year compared to only 18 percent for the top 10 prosperous cities.

IBM's Institute for Business Value, in conjunction with the Economist Intelligence Unit, surveyed senior-level executives at more than 180 multinational companies in China in four industries (electronics, automotive, consumer packaged goods and retail) for the study. Additionally, IBM interviewed 50 international and Chinese executives with front-line China operations experience, and segmented more than 650 cities in China into six tiers based on a number of key demographic and economic variables including population, average annual salary and per capita Gross Domestic Product. The study, titled "Winning in China's Mass Markets: New Business Models, New Operations for Profitable Growth," underscores the need for multinational companies to transform their business models and operations to tap China's mass market opportunities and effectively compete with domestic firms which typically excel in this segment.

The study also found that the need to re-examine business models is not directly related to the length of time a company has been doing business in China. For instance, the study found that companies with more than five years of experience in China enjoyed 47 percent higher profitability compared to newcomers, but surprisingly, companies with over a decade of experience in China were actually slightly less profitable than those with five to ten years.

"The rapid increase of consumer spending power combined with the current rate of deregulation in China is cause for all companies — both newcomers coming up the learning curve and early entrants struggling to adapt their legacy operations — to revisit how they go after the mass-market consumers," said George Pohle, Global Leader, Institute for Business Value, IBM Global Business Services.

Sales and Distribution Challenges

The study shows that multinational companies trying to expand into emerging cities must transform their legacy sales and distribution channels to succeed in China. According to the study, up to 42 percent of foreign companies' sales are still going through three or more layers of distributors and only 10 percent have point-of-sale visibility, leading to high cost structures and limited understanding of customers.

Survey respondents acknowledged that while special relationships will remain an important part of doing business in China, as deregulation lowers barriers and companies target mass consumers, customer insight and sales capabilities will become increasingly critical priorities. Distribution roles are also changing — market-leading multinationals are gradually outsourcing physical distribution to logistics specialists while grooming distributors to focus on sales development and penetration into smaller cities.

R&D and Procurement Challenges

According to the study, winning in mass markets requires creating quality products that satisfy the need for more simple and functional offerings at lower prices, which typically requires using more local suppliers. Thirty-four percent of respondents indicate their number one challenge is finding local Chinese suppliers. Nonetheless, the survey states that multinational companies are currently sourcing 9 percent of their global revenues from China and plan to significantly increase this to 14 percent within three years — a 57 percent increase. Multinational companies are transforming their procurement strategies not only for savings but to create strategic advantage, such as local market insight and control over critical resources.

The study emphasizes that multinational companies must execute in four key areas of R&D and procurement to develop products at the right price points to tap China's mass markets. These include: establishing local R&D and product specifications to meet local market needs; improving identification and qualification of local suppliers; protecting intellectual property while increasing collaboration with local suppliers; and increasing procurement organization capabilities.

Human Resources Challenges

The study also revealed that multinationals face a severe and growing talent shortage in China. This is a bottleneck to growth that will only worsen as they compete with each other and domestic companies for employees with critical skill sets needed for the mass market. Candidates lacking English language skills and "soft" skills, such as communications and managerial capabilities, were the top two reasons cited by multinational recruiters for the current talent shortage for multinational positions.

In order for multinational companies to grow, survey respondents indicated they will need to build their internal talent pipelines. This includes, for example, developing deeper partnerships with universities and vocational colleges to build and gain preferential access to a pool of talent that can be groomed with the skill sets needed to pursue mass markets.

Despite some marketplace perceptions of a "glass ceiling" limiting Chinese professionals from rising to management positions, multinational companies are reporting high levels of management staff localization, particularly in operational roles such as sales, logistics and manufacturing. This trend will increase as companies seek to scale up operations cost-effectively and gain the local market insight needed to pursue mass markets.

Study Methodology

The IBM Institute for Business Value, in conjunction with the Economist Intelligence Unit, surveyed more than 180 multinational companies in China during the months of June - September 2006. IBM further interviewed 50 international and Chinese executives with front-line China operations experience in the areas of sales channels, distribution, R&D and procurement and human resources. The industries covered in the survey include electronics, automotive, consumer packaged goods and retail. These four industries represent 85 percent of the total 2004 revenues of the largest 250 multinational companies in China.

About the IBM Institute for Business Value

The IBM Institute for Business Value provides strategic insights and recommendations that address critical business challenges to help clients capitalize on new opportunities. The Institute is comprised of consultants around the world who conduct research and analysis in 17 industries and across five functional disciplines, including human capital management, financial management, corporate strategy, supply chain management and customer relationship management. For more information about this study, which was conducted by the IBM Institute for Business Value in Beijing, China, visit www-900.ibm.com/cn/services/bcs/mnc.