This is the first article in a three-part series on staying resilient in the current China business environment. In this first article, we will explore best practices that a localisation strategy needs to incorporate.
A tent is great for a week in the wilderness. But if you are spending the night on an open beach during hurricane season, you might want something a bit stronger. This does not make the tent any less resilient – just less suited to the threat posed by the hurricane. Resilience is relative: it is about how well you equip yourself to handle a specific environment. The camper cannot fundamentally change the hurricane or the wilderness, but they can consider the threat profile and adapt.
The threat environment for foreign companies operating in China has changed dramatically in recent years. Increasing geopolitical tensions, regulatory enforcement and fierce domestic competition has combined with a downturn in China’s economy. Nevertheless, foreign companies are, for the most part, not leaving; rather, they are considering how to adapt and face these new threats. They are looking for ways to reduce their vulnerabilities and become more resilient.
Nowadays, our clients with operations in China are talking about resilience much more than they are talking about growth. Growth in China is still important – and companies will continue to strive for it – but the external threat environment demands a sharp re-focus on resilience. A resilient company will be in a much better position to capture growth opportunities as markets continue to shift.
Our clients are focusing on three areas to reduce vulnerabilities and increase resilience:
1. Localisation – increasing the self-sufficiency of China operations by reducing reliance on external business inputs.
2. Compliance – strengthening corporate culture and mitigating risks through effective implementation of local governance frameworks.
3. Risk assessment and monitoring – proactively identifying major threats to business and monitoring the rapidly changing environment to respond to threats before they escalate.
Let’s take a look at the first area: localisation.
Resilient localisation
More than ever, China C-suite executives are asking their headquarters to focus on the potential for innovation in the China market. China is presented a major alternative to the US and Europe in generating market-shifting technology. More than half the respondents in a survey of 180 executives of multinationals in China (conducted by InterChina and Control Risks) said that the next groundbreaking technology in their industry would come from a domestic company in China.
If you are in a certain subset of industries already shaken by China’s status-quo-busting innovation (automotive, green tech, telecom equipment, etc.), this should come as no surprise. We might see this play out across a broader set of industries – biotech, chemicals, specialised materials, precision machinery and instruments, and those who supply them. These sectors reflect the government’s strategic shift to align capital, industry and science behind “new productive forces”. Putting aside how efficient this capital allocation might be, the Chinese government is looking to promote new success stories to mirror the heights already captured in solar panels, batteries and drone.
But why operate in China if the environment is so heavily weighted towards promoting new domestic champions? The survey responses from the multinational executives makes the flip side of the argument clear: remaining in China is a way of getting ahead of the competition arriving in Europe and North America and of making headway in emerging markets. If you can’t make it here, don’t expect to have an easy time anywhere else. Moreover, the China market is still too big for most multinationals to ignore and, while some US multinationals have been decoupling, many medium-sized European firms are doubling down on their localisation strategies.
If that line of logic rings true for your company, working through a localisation plan is an inescapable reality for your China business. Localisation can mean a confusing array of different things – management, supply chains, capital raising, B brands, customers, and more. The hope is that the process will make operations and revenue in China more resilient. For example, localised supply chains can foreseeably limit the impact of new disruptive sanctions or more stringent “buy local” restrictions being set in place for Chinese state-owned enterprises.
The process of deeper localisation presents its own set of risks and opportunities. From Control Risks’ perspective, getting localisation right means baking in the following considerations.
First, review your IP vulnerabilities in China. Growth in the next 5 years will mean researching and developing more products and solutions indigenously or bringing further important elements of core intellectual property to China. If you cannot hold on to your IP in this phase, it will be hard to get past even the next 2 years. Often, we find plans around IP protection to be well-intended but inadequate in:
- Identifying what is critical IP. Is it a formula, a process, a price, a blueprint, a person, or all the above?
- Understanding and securing how IP is accessed and shared. This applies both physically and digitally – finding vulnerabilities in the system and rectifying the leaks that are waiting to happen.
- Stress testing IP protection.
Second, study local competitors. The staid and frankly biased assumption has been that Chinese competitors will take your designs and copy your branding. By focusing on lower tier copycats, companies miss the bigger threat from competitors who more closely capture consumer needs and who can make sustained steps in incremental innovation. Observing, learning from and defending against local competitors will be critical:
- What strategies are competitors focused on?
- How do you compare to your competitors in capturing the mood of Chinese consumers? Does it reflect positively or negatively on your brand?
Third, keep localisation transparent and accountable. In many of our fraud investigations into conflicts of interest in China, the response from headquarters is often “we can’t believe they created localised finance and HR systems opaque to us”, “they justified these suppliers as providing specialised China services and access”, or “we set up these distributor networks to access local markets, but we didn’t know it was feeding into people’s pockets”. Localisation, without a good compliance framework, got away from them and was abused.
All too often, multinationals are reluctant to:
- Review whether localisation is being used as a cover, and stringently vet third parties and partners that may be critical for the process.
- Engage in an honest conversation with local leaders about whether success in the market means shifting values and taking short-cuts.
On this last point, the long-term success of any localisation strategy will rely on management at both headquarters and in China being able to communicate frankly about the opportunities and risks in the process. Both sides will need to consider the concerns and fears of the other – certainly plenty of voices both outside and within the business will challenge the trust between them.
For multinationals that still rely on China and plan to stay for the long-term, building the bricks and mortar of their resilience and continued success in the country means being conscious of the fierce competition ahead, assiduously protecting the business’ most important assets and being vigilant in shoring up the foundations of a clean, reliable and ethical business.