A Chinese lesson for the world

By Charles Charalambous

Peter Williamson is Professor of International Management at the Judge Business School, University of Cambridge, having previously taught at INSEAD, Cheung Kong Business School (Beijing), Harvard Business School and London Business School. He is a recognised authority on doing business in and with China, having published a number of books on the subject, and was formerly with the Boston Consulting Group in London, and Merrill Lynch Inc. in London, Singapore and New York.

Professor Williamson was interviewed during his recent visit to Nicosia, to address the 2009 Marketing Summit organised by the Cyprus Institute of Marketing (CIM).

CC: What was the theme of your talk to the CIM Marketing Summit?

My argument is about taking a step back from marketing and talking about "value for money" strategies. If value for money is becoming very important for commercial survival in this era, then projecting that might change the way you do the marketing.

When I say "value for money", I make a sharp distinction between that and the lowest possible price, the cheapest possible product. What we should be aiming to do is to maintain quality at a reasonable level that is perfectly adequate for functionality in the mass market, and yet deliver that quality at a very competitive price. People should really feel that the product is not just cheap, it is "value for money", that they are getting quality, choice, a certain amount of customisation, that they are getting new - or at least recent - technology.

I believe that the Chinese in particular have a lot to teach us about "value for money" strategies, because even though China has been showing double-digit growth for a long time, the purchasing power of the mass market in China means that you've got to have a very tight "value for money" offering.

If you don't have that, you can't sell things except to a very small, top-end niche that probably doesn't care about the price-tag and just wants to buy whatever is the brand. So they have developed what I called "cost innovation".

This has three elements:

- The first important aspect is taking new and high technology very quickly to the mass market. Many companies follow the idea that you just release the technology at the top end, and over many years it migrates into the mass market. I don't think you can use the traditional approach to new technology in this kind of crisis environment. The Chinese have actually thought about how to re-engineer new technology and high technology to bring it to the mass market quickly.

- The second element is that a lot of companies basically follow the strategy that says if you want a "bog-standard" product, you can have it at a very competitive price, but if you want to have choice or customisation you have to pay a hefty price or premium for it. Again, the Chinese have worked on ways to provide a variety of customisation at very competitive prices.

- The third element is to take what a lot of Europeans think is a niche product with very small potential markets and high prices, and to say "if we could really change the value-for-money equation of that product, then a lot of people would want to buy it" - in effect, turn it into a mass market product.

A good example is battery technology. A lot of products we buy today have lithium-ion batteries, much better performance than the old nickel-cadmium ones we had. Initially that technology was dominated by the Japanese, and the price of these batteries was very high, around $40 per unit for an industrial model.

So a Chinese company called BYD, which is the world's second largest rechargeable battery company today, spent a lot of time essentially on R&D, working out two things. First, how to substitute cheaper raw materials in these lithium-ion batteries, and secondly, they learned how to make them at ambient temperature and humidity. In the past, to deliver that technology, you either needed very expensive raw materials plus a very expensive plant that could make these batteries in a dry environment at a very controlled temperature.

So they learned to use the cheaper materials and using ambient temperature, so they took a lot of cost out, and they got the cost down from $40 to $12 a unit. So what that did, it took the technology from a kind of upper-end curiosity to a mass market technology.

CC: So how does that fit in with the aspirational aspect of the price and the product? We can say that a certain market segment will only consider buying something if it is very expensive, irrespective of how much it cost to produce."

I think the answer is it doesn't really fit in. That kind of thinking was probably a luxury that people could afford before, but in the environment we're in now - and I don't think we're getting out of it in a hurry - the majority of the market, the real volume, the real growth is going to be in providing value for money. There are a couple of reasons for this: firstly, it's fairly clear that economic growth in the world is going to be in the developing world. Not too many people realise that in 2005, for the first time the developing world market overtook the developed world in size, expressed in purchasing power parity - in other words if you adjust the exchange rate. It's over 50 per cent of the total, and it's growing much faster. The Chinese say they are going to grow at 8 per cent, the World Bank just said 6.5 per cent, but we are talking about minus something per cent in Britain or most of Europe. The second reason is that actually the average person didn't do all that well out of the last boom. Real i
ncome has hardly moved at all, and if anything people have been squeezed on what they could afford, given all the other things they've got to buy.

CC: Surely one significant element in the Chinese story that we cannot ignore is the seriously low labour costs? Although the cost of materials and technology is important in the price build-up, if you then plug in significantly lower labour costs, doesn't that give you a serious competitive advantage?

No, because basically today any western company can access that labour cost advantage by sourcing or manufacturing in China. What the Chinese discovered is that if they rely purely on low labour costs they can't compete either with their other competitors in China or with the multinationals in China - they have to do something different. This shows that unless we can really change the value-cost equation, we can't actually compete. It's actually an interesting myth - people say the Chinese advantage was due solely to low labour costs. The advantage of western companies doing things in China is about low labour costs, but the advantage of Chinese companies is not about low labour costs, because western companies can access those low labour costs today, too.

But I think the important thing is that it's a way of thinking. A lot of people in the west, and Europe in particular, only define innovation as more features, more functionality, more "value-added", as they would put it. But in this kind of environment, faced with these kinds of problems, these leading Chinese companies have said that actually innovation can be about improving value for money. Part of my argument is that we need to redefine our view of where to put the focus on innovation, it's not just coming up with more and better, it might be coming up with more for less, or better value for money. So even if you don't have access to a low-cost place, it's a way of thinking.

CC: Could that way of thinking be learned in the west? Doesn't it need to be?

I do believe so. Everybody knows how to work within a smaller income by just going to a lower quality or more standard product, but that's not what the consumer wants you to do. The consumer says: "I want you to maintain my living standard, I may not need the bells and whistles or the fancy packaging and distribution, but I want to maintain the basic functionalities and the quality of life with lower spending." I think that's going to be an important thing, and there are companies that have learned that. It's not unique to China, it's just that they've had a lot of experience in that because of the nature of their domestic market.

CC: One issue that seems to be worrying the Chinese Prime Minister is the inflationary effect of pumping newly-printed money into the world's financial system. The fact that China is reducing its long-term position in US Treasury bills and increasing its short-term position is already a clear signal that confidence is falling. How likely do you think it is that China will publicly lose confidence in the US?

Their foreign exchange reserves are around US$2 trillion (i.e. US$2,000 billion) and many of them went into Treasury bonds, so they are extremely concerned about a couple of things. One is devaluation of the US dollar, which will have two effects - to reduce the value of their assets, and to make it harder for them to export - so they don't want a collapse of the US dollar.

At the same time, they don't want inflation to take away the value of their assets. So I think you will see them gradually try to rebalance their portfolio. This is why they are trying to buy a big piece of Rio Tinto and other resources, because they say at these prices, at least we're going to have a hard asset that's not going to lose value. What's happening is that they would like to move their portfolio, not because they've lost faith in the long-term possibilities of the economy, but in the government's ability to manage the imbalances in the economy.

CC: The IMF just cut its growth rate forecast for China to 6.7 per cent, which is still pretty impressive. If China hits that target, neighbouring economies will most likely also be pulled up by two per cent or more. What if China doesn't hit that growth target, what are the ramifications?

There are two worries. The first is that if China doesn't hit that target, the chances of the rest of the world pulling out of this crisis quickly are even less, especially the other Asian economies. Secondly, people worry a lot about social unrest, because the implicit contract is that we might not like the form of government, but as long as it can deliver stability and increasing living standards we'll accept it, because a chaotic form of government is much worse. I actually believe that even a lower growth rate than that will still not create widespread social instability in China, because a lot of people who came to work in the cities have simply gone home in their millions, and that provides a buffer, because these workers can go from an expensive lifestyle in Shanghai to a very cheap lifestyle in Hunan province.

This big buffer exists in China, but we don't have the ability to do that, because most of our expenses are pretty much fixed. The other thing I would say is that I believe China will achieve at least that growth rate and probably better, because again, the direct effect of government spending on infrastructure projects, and subsidising low-income rural people buying consumer durables like washing machines or TVs is having a direct effect. I was with a company a couple of weeks ago that makes turbo chargers for diesel engines, and in the middle of January they suddenly saw their order-book surge.

The reason was that civil governments are starting public construction projects, and for construction projects you need trucks. Part of the problem, as we discussed earlier, is that in most developed countries the government doesn't have very good mechanisms to develop those infrastructure projects quickly, because we have such a convoluted process which doesn't exist in China. If they decide tomorrow to do something, they can more or less start to do it tomorrow. This is why I am much more bullish about China than most commentators.