THE BATTLE FOR CHINA'S GOOD

ENOUGH MARKETBy Orit Gadiesh, Philip Leung,

and Till Vestring

ALI NAWAZ SHEIKH

Presented by

Multinationals and local firms for thefirst time are squaring off in China’srapidly growing middle market – a critical staging ground for global expansion and the segment from which world-beatingcompanies will emerge.

CATERPILLAR The world leader in construction

equipment US based In 1975,As the Chinese government

invested massively in infrastructure, Caterpillar helped pave the way, literally, for economic growth and modernization in the world’s fastest-growing market for construction

Caterpillar got its start in China by selling goods To Chinese government High quality equipment to the private

sector as a premium segment of the market emerged.

But it never broadened its focus to include other segments

Aim of Multinational Companies by focusing to china’s market Goldman Sachs estimates that China will account for 36%

of the world’s incremental GDP between 2000 and 2030.

Businesses wanting to succeed globally will need to win in China first.

They are conditioning themselves for worldwide competition tomorrow

They’re building the scale, expertise, and business capabilities they’ll need to export their China offerings to other large emerging markets (India and Brazil, for instance) and, ultimately, to the developed markets

An Evolving Opportunity Historically, there has been a simple

structure to China’s markets: at the top, a small premium segment served by foreign companies realizing solid margins and rapid growth

At the bottom, a large low-end segment served by local companies offering low-quality, undifferentiated products (typically 40% to 90% cheaper than premium ones)

Middle segment of market Growing very fast Creating intense competition By the early 2000s,Komatsu, Hitachi,

Daewoo, and other competitors from Japan and Korea were in the middle market with tools and equipment that cost less but were still reliable.

Local manufacturers that had previously focused low end ,now started to focus on middle market

REASON FOR GROWING GOOD ENOUGH MARKET (MIDDLE) Recent shifts in consumer buying

patterns and preferences.

Shifts are coming in two direction (1) Consumers with rising incomes are trading up from the

low-end products they previously purchased. (2) higher-income consumers are moving away from pricey

foreign brands and accepting less expensive, locally produced alternatives of reasonable quality.

# China’s middle market is growing fasterthan both the premium and low-end segments.

# In some categories, the good-enough space already accounts for nearly half of all revenues.

# Eight out of every ten washing machinesand televisions now sold in China are good-enough brands.

# It should come as no surprise, then, that China – and, in particular, its opportunity-rich middle market – is increasingly capturing multinational executives’ resources and attention.

“For GM to remain a global industry leader, wemust also be a leader in China.

CFO OF GENERAL MOTORS Shanghai-based GM China Group, recently told theDetroit News:

General motors and Colgate-Palmolive

CHINA CHINA

GM had traditionally been an underperformer in the market for small cars.

its acquisition of Korea’s ailing Daewoo Motor in 2002 enabled it to compete and ultimately take a leadership position in China.

Daewoo-designed cars now make up more than 50% of GM’s sales in China, currently its second biggest market

Colgate-Palmolive made similar moves in China.

Entered into a joint venture in the early 1990s with one of China’s largest toothpaste producers, and it acquired China’s market leader for toothbrushes a decade later

Now exports its China products to 70 countries

Response From Local Producers (Automobile) Domestic carmakers like Geely and

Chery have eaten away at Western companies’ market share in China by introducing good-enough cars for local consumption

Started exhibiting vehicles at car shows in the United States and Europe, buying available Western brands, and exporting vehicles to other emerging markets

The important issues in entering the middle market when – or when not – to enter the fray. Attractiveness of the premium segment:

Is it still growing? Are companies still achieving high

returns or are returns eroding? Another consideration is your company’s

market position: Are you a leader or a niche player?

Multinational companies need to perform Market analysis Competitors analysis Customer segmentation Need analysis Application of classic strategy tools Determine key success factors # This will help in taking of decisions like Whether to go partnership or acquisition of local

firms.

The companies should instead focus on lowering their costs and innovating to maintain their premium or niche positions and to sustain their margins

Market research suggested that itscustomers were still willing to pay more for reliability, evenwith a variety of lower-cost choices out there. The companycontinued to invest in R&D, hoping to further differentiateits products from those of local players however.

If growth in the premium segment is slowing and returns are eroding, multinational corporations will need to enter the good-enough space. Even those companies that because of their strong competitive position initiallyabstain from entering the middle market should revisittheir decision frequently to guard against emerging competitive threats.

Chinese companies will need to move up market as the lower-end segment becomes increasinglycompetitive.

The Approaches of companies to move into good enough space Leading multinationals in the premium

segment attack from above.

Chinese challengers in the low-end segment tend to burrow up from below

Finally, multinationals that can’t reduce their costs fast enough, and domestic players looking for more skills, technology, and talent, buy their way in.

Challenges Attack from above Multinational companies dominate China’s small

but high-margin premium segment. Move toward the middle certainly holds a fair

amount of risk for those already thriving in the premium space.

selling to consumers in less-than-premium segments could negatively affect sales of high-end products.

Companies also run the risk of fueling gray markets for their wares.

Tackling the problems Multinational managers need to conduct careful

market analysis to understand the differences between China’s premium and good-enough segments

Multinational executives also need to think about the degree to which the premium and good-enough segments will converge over time

Managers can use traditional forecasting methods (scenario planning, war gaming, consultations with leading-edge customers, and so on

strategy GE Healthcare

continue

Need to consider their possible opportunities in the good-enough space:

Can they take advantage of their lower purchasing costs, greater manufacturing scale, and distribution synergies?

which capabilities they may need to develop

How adept is their organization at designing products, services, brands, and sales approaches that will attract customers in the middle market without diminishing their company’s position in the premium space?

Burrowing Up from Below Multinationals for years underestimated the ability and desire of

local players in the low end of the market to move up and compete Recent developments have strengthened local competition in China

and facilitated Chinese companies' moves up market and beyond. Local companies that were operating not well, they started to make

consolidations. Red Star, Wuhan Xi Dao, and 16 other money-losing concerns

shifted and resifted throughout the 1990s to form appliance maker Haier.

Several of these emerging domestic champions have become direct challengers to global companies in a variety of industries

Customers now no more willing to pay high prices The Italian dairy giant Parmalat discovered exactly that when it tried

selling fruit-flavored yogurt for the equivalent of 24 cents a cup. Instead, consumers went with local brands at half the price.

continue It seemed that brand, innovation, and quality – the

hallmarks of multinationals in China – were no longer critical points of differentiation in customers’ minds.

This price sensitivity is opening up new ground for ambitious Chinese companies traditionally focused on the low end

The journey from low end to good-enough to global usually takes a decade and then some – but more and more Chinese companies are embarking on it

Challenges for local companies Lack of appropriate leadership Lack of managerial talent Inability to compete with global players

through innovation or by establishing a strong brand

Lack of marketing skills Poor research and development situation Ningbo Bird failure Huawei

Buying Your Way In Mergers and acquisitions.

China’s entry into the World Trade Organization in 2001 fueled a surge in M&A activity

Resistant from government

Xugong Group Construction Machinery, China’s largest construction machinery manufacturer and distributor, the U.S. private equity firm Carlyle Group met with unexpected resistance from the government and ended up twice reducing its stake, ultimately to 45%

Officials in Beijing insisted the nation’s construction equipment industry should be controlled by “domestic hands.”

Gillette’s 2003 acquisitionof Nanfu, (China’s leading battery manufacturer)

Gillette’s Duracell division throughout the 1990s was losing market share in China to lower-priced competitors

By 2002, Duracell’s share of the Chinese domestic battery market was 6.5%.

By contrast, Nanfu controlled more than half the market.

Gillette decided to buy into the good-enough market, acquiring a majority stake in Nanfu.

Gillette was extremely careful to protect both Duracell’s and Nanfu’s brands in their respective segments.

Gillette continues to sell premium batteries in China under the Duracell brand and has maintained Nanfu as the leading national brand for the mass market.

Local Companies Chinese companies are also wrapping their arms around

acquisition strategies

Attempting to establish their presence in the middle market by purchasing brands, talent, and other resources from target companies in Europe and North America.

They’ve met with mixed results

Lenovo’s acquisition of IBM’s PC division

Acquisition experiences of TCL, a major Chinese consumer electronics manufacturer, TCL acquired French firm Thomson

Ending Remarks In the 1960s and 1970s, the mantra for many organizations was “Capture U.S. market share, capture the world.” Today, China – and its middle

market in particular – has become the object of multinationals’ ardent pursuit.

The enormous market potential of the country’s population, the formidable growth of the economy, and China’s established position in low-cost sourcing and manufacturing are providing competitive advantages for many companies

Local Chinese companies know their futures depend on entering the good-enough space and attacking global leaders (and their premium positioning) by offering low-cost products of reasonable quality that they can eventually take to the world

Multinationals are beginning to recognize that ceding the middle space to Chinese firms may breed competitors that will ultimately challenge them on a global scale.