For the third year, Heidrick & Struggles surveyed over 100 multinational executives with responsibility over China operations to learn how the evolving market is performing, and how it impacts business
By Seth Peterson
In the early 1980s, Professor Kalok Chan was a bright-eyed undergraduate studying economics at the Chinese University of Hong Kong (CUHK), looking forward to making his mark in the world. Fast forward 28 years later and he has returned to the mountainous campus in Shatin as the Wei Lun Professor of Finance and the new Dean of CUHK Business School.
While countless international companies have looked to their China operations to lead the way in growth opportunities, the business environment in the world’s second largest economy has become increasingly challenging across different sectors. Following nearly two decades of double-digit growth, the high growth days are over and the Chinese government has set a lower target of seven percent.
The “New Normal”
This is the “New Normal” spelled out by China’s President Xi Jinping, designed to strike a balance among social, environmental and economic objectives. The combination of slower economic growth, anti-corruption government policy and various other reforms create both opportunities and threats to the operating environment for foreign companies in China. Meanwhile, the People’s Bank of China (PBOC) surprised the market in August by cutting the daily renminbi (RMB) reference rate. A weaker currency could help boost exports, but the absolute impact on Chinese trade balance and growth is likely to be inconsequential over the long-term.
China has entered a period in which more consolidation and restructuring is likely, where companies must expand beyond the traditional tier one and two cities for growth, and invest in development of products specifically for the local market. At the same time, Chinese companies are increasing their overseas investment into technologies and market access. Another emphasis of the “New Normal” is that the economy is to be driven by innovation instead of input and investment.
As the business community adjusts to the new environment, the Chinese economy faces a number of challenges including the continuing weakness in global demand for its exports, falling business investment as a result of the rebalancing strategies, sectors with excess capacity and a softening of the real estate market. In addition, a significant change in consumer behavior patterns is taking place brought about by the rapid development and disruption caused by the digital technology.
As part of an ongoing effort to better understand China’s business environment, Heidrick & Struggles surveyed more than 110 multinational executives responsible for China operations, with 60 percent of them having a workforce between 1,000 to 5,000 employees. Feedback suggests that most companies remain optimistic and expect to see good profitability, but also anticipate the rate of business growth will continue to slow down. Key takeaways include the following:
- Companies are mostly in China for the China market.
- There is no other China option in Asia, though manufacturers continue to evaluate and in many cases invest in additional manufacturing in countries such as Thailand, Vietnam and the Philippines.
- Chinese companies have become more formidable and are going global, partly through government-supported campaigns such as the One Belt, One Road initiative, a massive effort to expand linkages from China across Asia to Europe to promote development in inland China, and perhaps partly aimed at absorbing excess Chinese manufacturing capacity.
- The Free Trade-zone areas such as Beijing-Tianjin-Hebei, Jiangsu-Zhejiang-Shanghai, and Guangdong represent “hub” growth opportunities.
- Foreign companies indicate they will continue to invest and increase their capacity, albeit at a slightly slower pace than last year. In terms of headcount, companies overall indicate they are going to stay on track with their recruitment objectives, although at a slightly lower pace compared to 2014.
- A concern for 90 percent of respondents is “fierce” competition, with 92 percent reporting that market conditions have become “increasingly challenging”.
- Leaders provide different points of view as they interpret the impact of the New Normal on their business activities: 82 percent of respondents believe that the “New Normal” situation creates fresh opportunities. Principally, opportunities are anticipated through expected growth in consumer and service markets, increased emphasis on innovation, greater urbanization and a more leveled playing field strengthened by the government’s ongoing anti-corruption drive.
Though perhaps at a slower pace, generally sales growth continues: 83 percent of respondents confirmed they had recorded an increase in sales during 2014, and 75 percent expect their sales to continue increasing (Chart 1). So far this year, 50 percent said their profitability had grown, while 60 percent are expecting to increase their manufacturing and operating capacity. Compared to last year when organizations were asked the same question, 83 percent of respondents said they expected an increase in manufacturing and operating capacity. (Chart 2) Furthermore, organizations with a well-established presence in China report seeing their long-term strategies paying off. This is despite higher salaries and a more competitive sales environment, factors which are being mitigated by higher efficiency and more productivity.
Moving up the supply chain
Despite the slowing rate of growth in China, most business leaders view it as a long-term growth market that will continue to play an important role in their overall global strategies. Upgrading manufacturing facilities to produce higher margin products and opening innovation centers to focus on R&D activities are another trend. While in the face of slowing growth and rising labor costs, some companies have had ‘freezes’ on additional headcount, more than half – 55 percent of respondents – expect to increase their headcount during 2015. This figure compares to 79 percent of respondents indicating they had planned to increase their headcount in 2014 (Chart 3).
To move up the supply chain, 48 percent of respondents have established R&D centers in China. For those enterprises without R&D centers, 25 percent report they will soon establish an R&D facility or will consider setting up an R&D facility in the future. It is not only foreign firms that are investing in R&D facilities.
To promote manufacturing and national competitiveness, in early March, the Chinese government unveiled a “Made in China 2025” strategy intended to drive innovation, digital technologies and manufacturing up the value chain.
Operating in a competitive environment
While China remains a key priority for the business leaders surveyed, the vast majority, 93 percent of respondents (91 percent in 2014) still find that business operating conditions are more challenging than in previous years, with 88 percent (slightly less than 2014’s 92 percent) (Chart 5) singling out rising competition as the main challenge. Other contributing factors include the increase in labor costs and in spite of the recent surprise devaluation of the Renminbi, the increase in indirect and direct impact on the cost of sourcing.
Further pressure is being generated by domestic Chinese companies that have raised the quality of their manufacturing and started to operate in domestic and global market sectors with competitive pricing. Domestic companies are also seemingly able to benefit from the immature capital market where they are able to establish practices without government intervention or benefit from government support.
Adding pressure are regulations that favor domestic businesses ahead of multinational companies. A prime example is Alibaba, which has been instructed to focus on working with Chinese companies instead of foreign enterprises. At a time when the Chinese government is focusing on providing incentives to promote domestic consumption and building a more holistic economy, over 50 percent of respondents still see MNCs as their major competitors, while 33 percent view Chinese privately operated enterprises (POEs) as a source of competition for top talent.
With the growing pool of high caliber local talent, the localization of expatriates holds a high position on the agenda of leaders interviewed in the survey.
However, over 50 percent of respondents, slightly less than 2014’s 55 percent, indicated they had no immediate plans to change the number of expatriates they currently have on payroll. (Chart 6) The main reason cited for maintaining expatriate headcount is to further strengthen their Chinese business activities. For instance, expatriates are needed to continue grooming local talent to move up into more senior level roles.
Meanwhile, expatriates also play an important role in the APAC headquarters leadership team role with 15 percent of respondents (17 percent in 2014) expressing they intend to increase their expatriate headcount. Mainly these involve enterprises that intend to expand R&D activities or build on their international customer base. To achieve their objectives they need a good balance of international and domestic employees.
There is consensus among multinationals that now more than ever they need leaders that can manage in more challenging circumstances. Part of the New Normal means companies and their leaders will need to get used to heightened competition, greater complexity and uncertainty, requiring them to think and act more quickly.
While business leaders surveyed expect the “New Normal” environment will lead to increased competition for talent with Chinese domestic enterprises, they also believe that measures designed to steady economic growth could reduce the level of job-hopping, especially among key talent. This, they say, would lead to a healthier landscape to develop talent pipelines.
China still core
Taking the overall business opportunities into account, the majority of business leaders are in agreement that China will continue to be core to their APAC regional strategies, and Chinese operations will continue to play a pivotal role in companies’ overall global strategies.
In many companies this means China reports globally independently from the rest of Asia with APAC headquarters no longer located within Mainland China, but rather in cities such as Hong Kong or Singapore.
Seth Peterson is a Partner in the Industrial Practice in Heidrick & Struggles’ Hong Kong office, serving manufacturing businesses in the region across the C-Suite and main functions. He earned an MBA from Washington University’s Olin School of Business in St. Louis and a Bachelor’s degree in Chinese Studies and International Relations from Grinnell College, Iowa. He studied Chinese in Taiwan as well. He serves on the board of the American Chamber of Commerce in Hong Kong and co-chairs the board of the non-profit AFS Intercultural Exchanges in Hong Kong.