Insight

Three Growth Megatrends in China


As fears of a double-dip recession fade, companies are looking once more to invest in potential growth areas. Foreign direct investment into China and emerging markets such as Brazil and India is on the rise again. FDI has climbed for seven straight quarters since August 2009, rising nearly 5% more in January and February than it did in those months during 2009, according to China's Ministry of Commerce. However, executives need to realize that major changes took place in China during the financial crisis. They should rid themselves of commonly held misconceptions about China's economy, then reconsider how the middle kingdom should fit into their business plans.

China is no longer just the world's workshop. Driven by rising incomes, for instance, China bought more from the rest of the world in March than the rest of the world bought from China, with a trading deficit of $7.24 billion. The country has become the largest auto market in the world, with over 13.6 million vehicles sold in 2009, vs. just over 10 million in the U.S. It is also now the second-largest market for luxury products, with Chinese consumers buying nearly $7.5 billion of them annually.

Aside from increasing domestic consumption, there are two further megatrends developing in China over the next five years that senior executives need to keep in mind. One involves Chinese labor: Instead of moving to find work in manufacturing centers in southern China or such first-tier cities as Shanghai and Beijing, more young people are moving to second- and third-tier cities such as Wuhan, Hefei, and Shenyang, where they can find good white-collar jobs closer to home.

Much of China's rapid growth over the last three decades was made possible by hundreds of millions of low-skilled Chinese laborers willing to leave their homes for months at a time to work in factories in southern China, making cheap products for such companies as Nike (NKE) and Apple (AAPL) for low pay. This is changing fast. There is a major labor shortage in Guangdong province right now. Younger Chinese are no longer willing to work in factories far from home with no opportunity for career advancement. With the number of university graduates having increased from 1 million to 6 million per year in the last decade, it is only going to grow more difficult to find young people willing to labor in factories for little pay, far from their families.

multinationals: following the workers

At the same time, prohibitively high housing costs in Beijing and Shanghai are driving younger white-collar workers to second-tier magnet cities such as Hangzhou or Nanjing, where the quality of life is high and entrepreneurship is thriving, especially in the high-tech sector. Too much of the local economies in Shanghai and Beijing is increasingly accounted for by the reemergence of large state-run enterprises, real-estate developers, and multinationals that offer little career potential to young Chinese who wish to make it big.

Many companies are migrating to where the costs of doing business are cheaper and where the workers are, bringing plum, high-skilled jobs with them. Applied Materials (AMAT) in October 2009 opened the world's largest commercial solar research and development center in Xian, for instance, and Intel (INTC) has relocated many China operations away from Shanghai to such cities as Chengdu and Dalian, It is in these regional hubs, as well as in third- and fourth-tier cities in their orbits, that incomes are growing fastest and where new opportunities are opening up for companies looking to expand their market presence. (See my column "Beyond Beijing: Selling Across China.")

A further megatrend unfolding in China is the upgrading of quality and capabilities in Chinese factories. Many factory owners are looking at how to move away from simply being outsourcing manufacturers and toward building their own brands, just as Taiwanese computer vendors such as Acer (2353:TT) and Asustek (2357:TT) have done.

As cheap labor becomes increasingly scarce and as fear of a Chinese yuan appreciation rises, Chinese factories are retooling to become more automated. Companies see that owning their own brands gives them better margins than mere manufacturing does. It also lets them sell to the fast-growing domestic market.

Chinese partners now look to compete

A consumer backlash in the U.S. and Europe (as well as in China itself) against poorly made Chinese products has also driven factories to improve oversight and quality control. Advances have been made to such an extent that even German companies renowned for demanding perfectionism are starting to relocate production of higher-end products to China, which partly explains why China last year replaced Germany as the world's biggest exporter.

The key takeaway: If low-cost labor is a priority, companies need to look to other labor pools such as those in Vietnam and Bangladesh to manufacture low-end products. They also need to realize that old manufacturing partners in China might quickly start competing directly with them on brand image, not just price.

Companies must adjust their vision, if they haven't already, to accommodate the fact that China is now more important as a market than as a cheap export source. High-quality production is now possible there. Those who realize this soonest will be able to seize the advantage over slower movers. China has changed in five years—and it will change a lot more in the next five years.

Shaun_rein
Rein is the founder and managing director of the China Market Research Group, a strategic market intelligence firm focused on China. He is the author of "The End of Cheap China: Economic and Cultural Trends that Will Disrupt the World."

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