Relationship between China and multinational firms is set to become a lot more complex

China continues to attract the world's top multinational companies seeking to establish a presence or expand their presence in the world's second-largest economy. Such companies will continue to play an important role, but Chinese home-grown businesses have also evolved fast. It is increasingly important for CEOs to be prepared to adapt in this market. It is a competitive environment, and domestic companies are now raising the stakes, with global aspirations for their own brands. China is benefiting from its western development policies and the increasing migration of manufacturing to second and third-tier cities, with improving infrastructure.

E-commerce offers huge opportunities as China now has more than 500 million Internet users. With the expanding middle class we are seeing growing demand for domestic delivery with the rapid development of the e-commerce-logistics sector. There are clear reasons why multinational companies are still attracted to China.

First, the inland economy naturally ranks high on any multinational's wish list, due to its high growth potential and a belief that whether China can successfully develop its inland economy will be one of the biggest drivers of global growth over the coming decades.

Second, even if China's economic growth was to slow in the coming years, to about 7 or 8 percent, the country would still account for about 30 percent of the world's growth through to 2017, based on the latest global forecasts from the International Monetary Fund. That is a hard reality for any multinational to ignore. We also see a new generation of savvy entrepreneurial business executives in China, and as the country's manufacturing moves up the value chain there will be a greater focus on those sectors including auto and high-tech.

The result is that the relationship between China and the world's multinationals is set not only to grow, but to grow in complexity. In this, the relationship reflects the change in the global economy. That makes predicting where we will be in the next 10 years harder than during the past 20 years. China is going to be much more than a factory for the world. In terms of challenges, every multinational we spoke with highlighted recruiting and retaining staff as their biggest problem. For multinational companies, staff turnover rates usually range from 15-30 percent, meaning that human resources departments often spend more time trying to replace staff, rather than recruiting new staff to support company growth. This is not a problem only for multinationals, but also for mainland companies.

Indeed, mainland companies are increasingly demanding grade A office space in the larger cities, partly as a means of competing with multinationals for the most talented staff, recognizing that employees want to work in nice offices near a subway. What can multinational companies do to retain staff? Pay is clearly important. But the multinationals we spoke with emphasized career development as a critical means of retaining staff. Employees must feel that they have a stake in the company and the company they work for must offer opportunities for promotion. To this end, ensuring that all middle-level employees have senior-level mentors is a common strategy.

Another major issue is rising costs. It is a widely held view among multinationals that China is no longer a cheap destination to make goods and outsource services, at least relative to other emerging economies. We may therefore see a major change in the world's production chain, as factories relocate to either cheaper countries, such as Vietnam or Bangladesh, or to China's inland regions. However, there is optimism that Chinese manufacturers are responding to the challenges by investing in capital equipment or learning new production techniques (such as lean manufacturing) to save costs.

Some multinationals even expect that within two to three years Chinese manufacturers can hold prices steady, or even start cutting them again. If so, China will hold on to much of its manufacturing capacity. And as China's economy grows, especially in the inland provinces, multinationals are starting to think about the country as more than a single market. And the differences between cities and provinces can be indeed significant. It used to be that boardrooms spoke of a single China strategy. That approach no longer works, and it is common for the world's largest multinationals to operate multiple strategies, distinguishing between the coastal and inland regions; the first, second, and third-tier cities; and the large regional clusters in the southern Pearl River Delta, the central Yangtze River Delta, and the northern Bohai Rim. That makes sense given that China's economy is similar in size to that of the eurozone, on a US dollar purchasing power parity basis, but with four times the population. Distinguishing between markets in Guangdong and Henan will grow as common as comparing France and Germany or California and Texas.

There is little doubt that China will remain a large and growing source of revenue for the multinationals. However, the shift from "cheap China" to "consuming China" means firms will be looking to produce less in the country's factories, and instead sell more to its consumers, ultimately a more challenging business model, but one that offers significant rewards. And multinationals are now "in China for China" and not simply to manufacture for those overseas markets.

One big change to look out for is a return to joint ventures. Such arrangements were popular in the 1990s, largely because legal alternatives were limited. But that approach changed soon after China's entry to the World Trade Organization in 2001, and many foreign firms took advantage of the more liberal investment laws to set up wholly owned enterprises, believing that such structures gave firms a greater control over their own destiny and allowed for organic growth.

But the popularity of joint ventures is rising again, especially as a result of greater local competition and a push into the more challenging third and fourth-tier cities. It has accordingly made more sense for multinationals to team up with local partners as a way of expanding their markets, rather than through acquisitions or organic growth. Local firms are also increasingly maturing, valuing joint ventures not just as a source of income, but as a source of strategic strength and an opportunity to market to the outside world too.

Another change will be the extent to which multinationals invest more in the services sector, as opposed to the manufacturing sector, a development that would be consistent with China's own move up the value chain. So far such investments have been largely limited to the logistics and financial sectors. But were China to open up a wider range of service industries to foreign participation, multinationals would be sure to respond. However, the key will be ensuring that both China and the world's multinationals continue to jointly lobby for further growth in global trade and investment flows amid a period of global difficulties and uncertainties. Both parties have benefited so far, and should expect to continue so.

The author is regional senior partner, Southern China, KPMG. The views do not necessarily reflect those of China Daily.

(China Daily 10/05/2012 page11)