A whole new world

Updated: 2013-02-01 09:13

By Ted Chan and Whitney Haring-Smith (China Daily)

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A whole new world

Chinese state-owned companies must adapt to succeed in international arena

To maintain their success after the current period of easy growth, Chinese state-owned enterprises should consider the option of expanding overseas. Although well equipped financially for the days ahead, SOEs must engage their competitors on fresh terrain, going beyond cost advantage. New skills for innovation, quality, branding, talent management, post-merger integration, stakeholder management and corporate governance will be required.

Traditionally, Chinese SOEs have enjoyed government support in a large domestic market and, when exporting, kept a substantial cost advantage over competitors abroad through low labor costs and economies of scale. However, China's input costs, including labor, are expected to rise 10 percent annually over the next few years, five times as fast as in many developed nations. The period of easy growth - and Chinese domestic cost advantage - is coming to an end.

Despite slightly slower growth in the Chinese economy last year, SOEs have strong balance sheets backed by commitments from state-owned banks to help finance major deals abroad. In the next five years, Chinese companies will likely attempt many multibillion-dollar overseas acquisitions.

Yet, even as Chinese companies look to go overseas, they may be ill prepared for the challenges ahead. Many Chinese SOEs now have the cash and the commitment to make overseas acquisitions, as well as government support to go abroad, but the capabilities and processes necessary for executing these kinds of transactions have not yet been developed.

In venturing overseas, Chinese SOEs have found themselves beaten to the largest deals by faster or more agile challengers from the Chinese private sector or from emerging markets. For example, one of China's leading construction-equipment makers, Sany Heavy Industry - together with CITIC PE Advisors, purchased 100 percent of prominent German concrete-machinery maker Putzmeister for $474 million (351 million euros) last year. In the deal, potential rival Zoomlion, a Chinese SOE, waited for government approval and was unable to move fast enough to capture Putzmeister.

Similarly, in 2008 Tata Motors acquired Land Rover for $2.3 billion when SAIC Motor, the Chinese auto SOE, declined to compete. SAIC Motor was experiencing issues resulting from its 2004 majority acquisition of the Korean company SsangYong Motor, whose bankruptcy in 2009 led SAIC to reduce its shareholding to less than 5 percent. Private Indian conglomerate Mahindra & Mahindra acquired SsangYong in 2011. As Chinese SOEs face more fierce competition, they will need to improve their deal execution - or miss out on some of the biggest opportunities.

The gap in execution skills is not surprising. Leading Western firms have spent more than 30 years honing their global-acquisition processes and procedures, yet they still often get poor results. As new players, Chinese SOEs lack institutional knowledge in these practice areas, face a higher barrier to entry (in the form of government regulation), and have emerged from a climate less conducive to the development of the expertise needed for these kinds of transactions.

Examples of Chinese private companies that have successfully developed these proficiencies include Lenovo, which has built a quality brand, and Huawei, which has established a strong talent pool and invested in innovation. There are fewer such examples of Chinese SOEs. One example is the China National Materials Company, which has gained a strong reputation for quality in the arena of cement plant construction. The company holds the largest share of the global market, built the biggest cement plant in Africa, and experienced rapid growth over the past several years even as domestic Chinese demand slowed.

In short, Chinese SOEs struggle to be competitive worldwide partly because they have not been forced to be competitive locally. The advantages that Chinese companies, particularly SOEs, have enjoyed locally are not present abroad. Government support is less available and sometimes even replaced by opposition. Local labor costs are often higher, sometimes compounded by the complications of working with unions.

On top of this, acquired foreign companies can take years to align cultures. Even successful mergers, such as Lenovo's acquisition of IBM's ThinkPad business, can begin with serious cultural clashes that are encountered less often when a company operates at home.

For Chinese SOEs to make productive, successful acquisitions abroad, they must improve in terms of deal execution as well as post-merger integration.

In the deal execution stage, Chinese SOEs must accelerate their deal-making process and develop strategies for overcoming non-financial roadblocks such as cultural differences and government approvals. China National Offshore Oil Corporation's development since 2005 offers a strong case study to those looking for signs of success in SOE expansion overseas.

In 2005, CNOOC attempted to acquire the US oil producer Unocal through an unsolicited cash offer of $18.5 billion but faced insurmountable political opposition in the United States. In December 2012, CNOOC won backing from the Canadian government for a $15.1 billion acquisition of Nexen, the Calgary-based oil-and-gas producer, even though the Canadian government had recently rejected major resource acquisitions in potash, aerospace, and oil. In the Nexen acquisition, CNOOC managed its overseas stakeholders - commercial as well as political - effectively.

According to the New York Times, "CNOOC hired an army of advisers, including lobbyists and public relations specialists", recognizing that getting a deal done required more than just banker-driven know-how about deals. The company also matched intent with action. For instance, CNOOC committed to listing shares on the Toronto Stock Exchange, establishing Calgary as a head office for North America, and maintaining employment levels.

Post-merger integration offers a much greater challenge for Chinese SOEs than even the art of acquisition. Western firms have taken decades to learn the more difficult science of combining two companies to make a sum greater than its parts. For example, in 1968, the New York Central Railroad Company and Pennsylvania Railroad merged to form the sixth-largest US corporation of its day. Two years later, the resulting entity, the Penn Central Transportation Company, announced the largest corporate bankruptcy in US history at the time. Even the most recent decade is replete with examples of unsuccessful mergers in the West.

Chinese SOEs are learning fast, but it will be several years before their managers are comfortable with overseas integrations and accept the risks inherent to the process.

In post-merger integration, Chinese companies are finding that "leave and learn" can be a successful approach to gaining skills, technology, and best practices from acquired companies. After China Minmetals Corporation, a state-controlled mining company, acquired OZ Minerals of Australia for $1.4 billion in 2009, it headquartered the merged company in Australia, allowed the local Australian sales force to set prices, and left the OZ Minerals management team at the helm. When China Minmetals invested in the El Galeno copper mine in Peru, it called on the OZ Minerals Australian management to support the project.

In recent years Chinese companies have shown signs of progress, particularly in stakeholder management and global corporate citizenship. Chinese companies either acquiring new entities overseas or managing their existing foreign subsidiaries are learning that a degree of autonomy can be productive.

Just as Chinese SOEs succeeded in part due to competition "with Chinese characteristics" so too do subsidiaries succeed when left to compete "with local characteristics". For some companies, maintaining local competitiveness for foreign subsidiaries may involve keeping local management in place; defining a significant scope of local autonomy, including pricing; and managing toward end goals rather than internal processes.

More broadly, Chinese companies are improving their image abroad by making more effort to be transparent. In 2006, only 32 Chinese companies issued corporate global-citizenship reports. By 2011, more than 800 Chinese companies had released similar information.

Making overseas acquisitions is not easy. The complexities of deal execution and the surgery of post-merger integration are challenges for any company. Once operating overseas, new competitive fronts arise around innovation, quality, brand management, talent, and corporate governance. The learning curve for overseas success is difficult and steep; Western companies still struggle with it. Chinese SOEs can scale the learning curve successfully, but they must be competitive at home to become competitive abroad.

Ted Chan is a partner and managing director of the Boston Consulting Group; and Whitney Haring-Smith is a project leader of the same company. The views do not necessarily reflect those of China Daily.

(China Daily 02/01/2013 page9)