This article originally appeared in Forbes.
Last week the Chinese government rejected Coca-Cola's (NYSE: KO) planned $2.3 billion acquisition of the Chinese company Huiyuan Juice, despite Coke's announcement a week earlier that it would commit $2 billion on top of that to expansion in China over the next three years. When the government declared the deal dead, a chill blanketed boardrooms around the world. Is the climate for foreign firms in China cooling? Is protectionism rearing its ugly head?
Retail sales in China are still growing at a double-digit rate despite the global financial turmoil. The country can no longer be considered an emerging market for many brands. It became the largest market in the world for automobiles earlier this year; car sales rose 25% in February after the government started issuing tax rebates for small engines. Companies are getting more and more of their revenues from China; Yum! Brands (NYSE: YUM) generates about a third of its revenue from its KFC and Pizza Hut sales in China. If the country turned inward, the effect on the bottom-line of businesses from Unilever to General Motors would be huge.
However, China's government went to great lengths to indicate that the rejection of the deal was about monopoly, not protectionism. My own observations suggest that local officials throughout the country are green-lighting more investment projects faster now than at any time in the last three years, as fears about overheating and inflation give way to worries that more jobs will be lost on top of the 20 million already gone.
While what some see as socialism creeps into American economic policy, China is going all out to jump-start its economy by becoming more capitalistic. Local officials in Beijing have even awarded a $300,000 automobile to a CEO for hiring a record number of people.
As companies look for ways to grow in a stalled economy, emerging markets, and China in particular, seem to be their best bets. Coke's failed bid for Huiyuan offers several lessons about how to take advantage of China's continued economic strength.
800 Million Emerging Consumers
Huiyuan would have given Coke much-needed market penetration in third- and fourth-tier cities. Most companies go into China looking to target Shanghai and Beijing. They ignore less-developed areas because they think the consumers there are too poor to buy high-priced foreign goods. But Coke was smart to seek a way to reach those less-developed markets. They are where the real consumer growth will come in the next decade.
Those areas are home to roughly 800 million Chinese consumers. They may not have as much disposable income as their counterparts in the megacities, but they do spend. They have been relatively shielded from the financial panic, and the government is trying to boost their consumption with a 13% rebate on many home appliances, such as air conditioners, refrigerators and televisions.
It's also trying to improve their health care coverage. My firm, the China Market Research Group, conducted interviews in 10 cities in the last two months and found that second- and third-tier consumers had the highest levels of optimism. More than 70% of them predicted that they would spend more in 2009 than in 2008.
China Mobile (NYSE: CHL) gets that message. It's the world's largest telecom company, with more than 600 million users, and it derives more than half its new subscribers from China's smaller cities and towns. China Mobile has wisely priced value-added mobile services like downloadable ringtones and text messaging low enough to cater to those consumers. Its average monthly fee per consumer is a low $12, but multiply that by hundreds of millions and and you start to see the dream of getting rich by selling one widget to every person in China.
To cater to those emerging consumers, companies may need to scale down their products, because many people can't afford to buy large but still want to buy the best. Homes are so tiny that people want packaging they can store in nooks and crannies. Coke made the right play in trying to gain access to those markets inside China. They will be the next great battleground for business.
The Health-Conscious Chinese Consumer
Coke was also smart to try to buy Huiyuan, with its healthy image. Its fruit juices are popular among younger Chinese consumers between the ages of 22 and 32, who are willing to pay more for healthful and safe products. Coke has been losing market share in beverages to companies like Wang Lao Ji, an herbal tea producer, because Chinese consumers prefer juice and teas to colas. In fact, they buy more Sprite, a Coca-Cola brand, than Coke itself. They think of Sprite, with its lemony taste and clear color, as healthier than cola.
In a country where tainted food scares and pollution problems plague daily life, younger consumers willingly shell out for products they think are good for them. We found that younger consumers are willing to pay 20% to 30% more for premium construction materials for their unfinished homes.
DuPont (NYSE: DD) has capitalized on that trend by providing Chinese homeowners with home construction and decoration products and services that emphasize health and safety. The company charges more than its native competitors, but it is driving major growth in China by catering to younger consumers who demand healthy and safe products.
Honor the Ruling Party!
The ultimate lesson of Coke's failed attempt to acquire Huiyuan is that companies must always look long and hard at China's laws. Foreigners complain that those laws are often opaque and whimsically interpreted by local officials, but in fact the laws governing major purchases are fairly straightforward. As ChinaLawBlog.com summed them up,
Foreigners are permitted to purchase non-majority interests in strong, successful Chinese companies, but only if there is some added benefit, such as transfer of technology, advanced management or access to foreign markets.
Coca-Cola thought the government wouldn't mind the sale of a nonstrategic asset, but a simple reading of the relevant Chinese laws would have shown that the government doesn't want foreign firms to buy controlling stakes in large national players that don't need financial or management help.
Nonetheless, China is moving toward greater competition. It is wary of monopolies and is trying to build more national corporate champions like the appliance-maker Haier and the sports apparel firm Li Ning. The official justification of the deal's rejection was that it would reduce competition. Huiyuan controls 8.5% of the country's fruit and vegetable juice market and 40% of its pure juice market; Coke already commands more than half of China's soft drink market and 12% of its fruit and vegetable juice market.
In many cases, acquisition is the right approach. You just have to be sure to consider the laws before embarking on an expensive and time-consuming acquisition strategy, even if you've been as good a friend to China as Coca-Cola has been.
In short, the lessons from Coke's failed bid for Huiyuan are that you should definitely look beyond Beijing and Shanghai to under-served markets, you should understand that younger consumers often spend more than older consumers--and you must honor the ruling party and its laws.