Originally published in Forbes
How many Chinese brands can you name? Probably fewer than the fingers on your hands, reckons the Atlantic Monthly journalist James Fallows. He's probably right. The typical American buys products made in China, like Nike (NKE) shoes or Apple (AAPL) iPhones, but probably can't name many Chinese brands at all.
Still, we shouldn't make the mistake of thinking that Chinese companies are incapable of branding. That's what Fallows suggests, and his logic would be right if this were still 2005. Five years ago most Chinese companies did indeed compete mostly on price and distribution. Their management teams didn't have the savvy and patience to build brands, and their consumers were extremely price sensitive. Moreover it had taken decades for Japanese and Korean firms like Sony and Samsung to become household names in the West.
But in 2010 it would be foolish for executives to underestimate the competitiveness of Chinese brands. Take Li Ning (OTCPK:LNNGF), the sports apparel maker. It just announced that it had surpassed Adidas (OTCQX:ADDYY) in sales in China even though Adidas had spent tens of millions of dollars as the official sponsor of the Beijing Olympics two years ago. Li Ning is no longer competing just on price. It has hired Americans to work as shoe designers near Nike's Beaverton, Ore., headquarters, opened retail stores in the U.S. and Singapore and hired high-profile celebrity endorsers including Shaquille O'Neal. Its wide range of products appeals to Chinese consumers, while Adidas has been too slow to introduce new products and has been hit hard by a glut of inventory.
Kevin Garnett, the Boston Celtics great, opted out of his contract with Adidas to be the celebrity endorser for Anta, another up-and-coming Chinese sports apparel maker. Executives at Puma, New Balance and other sports gear makers should be concerned. They are facing aggressive, marketing-savvy domestic competition in a retail market that is growing 16% to 18% a year.
Unlike other developing markets, like Nigeria or Columbia, China confronts multinationals with well-capitalized, ambitious local competitors that often get preferential support from the state. My firm, the China Market Research Group, recently interviewed dozens of senior executives at multinationals in 10 sectors to find out what they felt were their biggest challenges operating in China. They are concerned about rising Chinese players that are no longer positioning themselves as simply cheap but are actually moving up the value chain. This is happening in industries from health care to clean technology to consumer products.
Look at Google (GOOG). Our research suggests that Google failed in China in large part because consumers believed that Baidu (BIDU) had far better Chinese-language search capabilities, not just because of an unfair playing field. In head-to-head search comparisons we conducted, Baidu's results weren't necessarily much better than Google's, but its branding as the site that knows Chinese better than Google and that has technology as good has helped it dominate. Unused to serious local competition, Google was slow to roll out local services and marketing campaigns that would resonate with Chinese consumers. Similarly, Ctrip (CTRP), an online travel site, is beating up Expedia (EXPE), and Taobao, the online auction site, remains far ahead of eBay (EBAY). They are better branded, and they fit the needs of local consumers better.
Multinationals need to develop strategies that include acquiring local firms, launching secondary brands and/or rebranding their current product lines so they can deal with local competition and evolving consumers. If they don't, their market share may drop like Adidas' has--even if they spend tens of millions of dollars on advertising.
Chinese companies increasingly knowing how to brand is one of three big trends multinationals need to stay on top of now. The second is rising labor costs. Many people are surprised that Chinese workers in factories from Toyota (TM) to Honda (HMC) have begun demanding higher salaries and better working conditions. They shouldn't be.
Rising labor costs are not a short-term trend. They are an ongoing phenomenon, and they are why apparel makers have been relocating production to Indonesia, Vietnam and other lower-priced markets for years. Pricing pressures will continue.
Why the shift? First, there is a demographic change taking place. Because of the one-child policy that China implemented in the late 1970s, there are fewer younger workers in the labor pool. Second, young Chinese are optimistic about their futures. They have seen their country emerge as an economic superpower, and they feel they deserve a piece of the pie. They want to buy Estée Lauder (EL) cosmetics, Zara clothes, Nokia (NOK) phones and their own homes too. They need high salaries to lead the lives they want and are less willing to work at low-wage or blue-collar jobs. A decade ago there were only 1 million Chinese graduating from universities each year. This year, there were more than 6 million, and they all see their path to prosperity in white-collar jobs.
To combat rising wages and real estate costs, companies have to either relocate manufacturing capabilities to lower-cost countries, automate their production facilities and move up the value chain or relocate factories to China's western and central regions, where wages remain relatively low. Foxconn (OTCPK:FXCNY), which makes products for Apple, Dell (DELL) and Hewlett-Packard (HPQ) and which received heavy criticism this year for its poor working conditions, has shut many of its facilities in southern China and is relocating 300,000 workers further inland to central China, closer to the homes of many of them.
Manufacturing will remain a significant part of China's economy for years. The infrastructure and government policies are far better for it than in most markets, making producing still worth it for multinationals. However, the kinds of manufacturing will necessarily change. Instead of turning out cheap products, less-polluting factories will increasingly be pushing out high-quality electronics and auto supply parts and the like.
The third trend that multinationals need to closely follow is domestic consumption by consumers in second- and third-tier cities like Chengdu. It is becoming a major driver of China's economy. Although most economists argue that Chinese consumers account for only 30% of the economy, because of their high savings rates, my firm estimates that they already account for 40% of the economy, and will fuel 50% in the next five years.
With rising wages and a vastly underestimated underground economy, consumers have the money and the desire to spend. Executives at multinationals need to understand which consumers are spending, where they are and what they're buying. Far too many multinationals focus excessively on selling in Shanghai and Beijing, when the real growth markets are cities like Chongqing and Zhengzhou.
That's why Ralph Lauren (RL) and Ermenegildo Zegna have had opposite experiences. Ralph Lauren recently opened up a new flagship store in Shanghai's Bund area and has plans to open up 15 or so more stores mostly in Shanghai and Beijing. The problem? The company should be opening stores in other cities and in better locations. Most Shanghai residents buy luxury products on trips abroad to Europe or Hong Kong, where the prices are lower and the cachet greater. Those who do buy at home don't go to the Bund; they consider it a shopping destination more for foreigners than for locals. Ralph Lauren has completely misunderstood who its target market is and where they shop.
Zegna, on the other hand, is enjoying soaring sales in China, because it has 75 sales points, mostly in second- and third-tier cities. It even celebrated its centennial in Shanghai rather than in Milan, because China is where it sees the future.
The China market presents huge opportunities for foreign companies, which is why more and more businesses like General Motors are looking there to drive their global growth. But this isn't 2005. Competition is heating up, costs are rising, and to truly harness China's growth companies need to be smart about where they'll sell and how they'll position themselves against local firms.