SPECIAL REPORT—The first half of 2013 has been an unusually turbulent period for companies doing business in China. Amidst an apparent economic slowdown, the new leadership has pursued a number of actions. This includes an anti-corruption drive, a government frugality campaign, and a stronger Internet crackdown. But that’s not all. We have seen the trial of Bo Xilai, as well as the purging of China’s most profitable state owned enterprise, PetroChina.

Additionally, we have witnessed pharma executives paraded on national television admitting commercial bribery, the collapse of the high-end restaurant sector, infant formula brands paying considerable fines for alleged price fixing and forced to drop their prices, liquidity in the banking sector dry up for two weeks, and the taming of the “Big V” micro-bloggers on the Internet.

The international press was full of negative reports on China’s growth prospects in July until news reports suddenly turned positive in August. Meanwhile, many sectors and businesses in China have continued to develop strongly. Thus, automotive companies are experiencing one of their best years ever with strong growth and good margins, many consumer industries such as packaged goods, e-retail and food service continue to witness double digit growth, and expansion also remains robust in healthcare, automation and logistics among others.

As a result, it’s not surprising that confusion exists in corporate boardrooms—even among executives in China—regarding the direction in which China’s economy is heading and what this means for companies. Consequently, executives are wise to anticipate a lack of clarity ahead. Thus, uncertainty and volatility will become the name of the game in China.

Much of the turbulence to date has been a consequence of the leadership regime establishing its authority and improving public support. And this turbulence will continue as the regime now proceeds with its policy priorities and economic reforms for the coming decade.

For those ready to engage, new opportunities will present themselves. Thus, growth in consumption will remain robust, advanced offerings will find new markets as the economy upgrades, market access and fair competition will improve, and acquisition options will arise as consolidation accelerates. However, international companies will need to understand the new environment of uncertainty and volatility in order to take advantage of these opportunities.

Economic Reforms: Long-Term Benefits With Short-Term Volatility

Given its current weaknesses and long-term challenges, China has no options other than to restructure and upgrade its economic model. Primary reform goals include the improvement of investment efficiency and productivity, as well as the continuation of growth in consumption and household income.

The range of reforms required to achieve these goals is very broad. This includes (a) strengthening of the role of the market and addressing distortions to improve competition, (b) decelerating and re-directing investment into productive capital stock, (c) improving the quality and efficiency of the urbanization process, (d) continuing to unlock consumption, developing wage-intensive industries and supporting the livelihoods of citizens, and (e) reducing debt levels and introducing more appropriate financing sources.

The leadership is building the political muscle to tackle the interest groups that will resist reforms.

We believe the new government is committed to achieving these goals and will reveal this in November at the Third Plenum of the Communist Party’s 18th National Congress. More importantly, we believe the leadership is building the political muscle to tackle the interest groups that will resist reforms.

Nevertheless, the vast array of specific reforms will take years to cascade through the government bureaucracy, facing many obstacles and complexities. As a result, we should expect a gradual and experimental approach, following Deng Xiaoping’s “crossing the river by feeling the stones.” While the general direction may be clear, specific reforms will be assessed based on their effectiveness, and then either retracted, refined or deepened. Each step may be small, but meaningful in view of the bigger picture.

In addition, the new regime will be treading a fine line. While the economic model is under transition to ensure growth does not collapse or large-scale unemployment does not ensue, China will continue to rely to a large degree on state-led investment despite the problems of poor investment absorption and low investment efficiency. This is just one of many factors that could exacerbate the current disequilibria, including a further slowdown in the economy, the influence of interest groups, and insufficient tools and levers given the economy’s increasing complexity, and miscoordination between the various actors responsible for the implementation of reforms.

This environment of uncertainty and volatility, which will continue until the dust settles and reforms take effect, is bound to remain for a considerable time. Thus, we estimate the period lasting 5 years or longer given the depth and range of reforms required.

What Does this Mean for Business?

The profound change in status quo will start to impact business faster and harder than many may expect. Business in China will become more complicated and risky, but it also will generate new opportunities not currently reflected in most corporate strategic plans. What this means for individual companies in specific sectors is impossible to predict in detail. Nevertheless, there will be a set of common themes.

Growth Will Slow

As a maturing economy, growth will slow compared to previous decades. The size of China’s labour force is contracting, the investment boom has led to declining efficiency of capital, and productivity growth rates have been falling off.

China needs to grow at 7 to 8 percent this decade and 5 to 6 percent next decade to become the world’s largest economy and escape the “middle-income trap.” This trajectory is possible if the new leadership proceeds with productivity boosting reforms. Otherwise, a significant improvement in the global economy would be needed. And while the economy becomes more dependent on domestic consumption, volatility will increase as the spending behavior of fickle consumers is less controllable than the investment patterns of credit-fueled SOEs.

The Economy Will Upgrade

Despite the fast growth of the last decade, Chinese labour productivity still is only similar to that of South Korea in the late 1970s and below that of Japan in the 1960s. International experience shows that labour productivity growth is a prerequisite for sustainable growth. 

We expect China to pursue reforms that will boost productivity. This requires a shift in resources from low-productivity to high-productivity sectors, greater investment in machinery, automation, innovation and new technologies, and more advanced education and training to upgrade workforce skills.

Consolidation Will Accelerate

One of the most severe problems facing Chinese authorities is over-capacity caused by the excessively fast growth in investment. And one of the major consequences of the shift in the growth model will be accelerated consolidation.

Inefficient and uncompetitive companies increasingly starved of cheap financing will be pressured to sell out or slowly die. This already is evident in sectors with less government interference—such as consumer goods or automotive components—where we are seeing a marked increase in M&A activity. The direction is more difficult to predict in sectors with strong government involvement, as will depend on the degree to which private capital is allowed to participate in restructuring.

Since the government will not be able to rely on SOEs alone to achieve its new growth model, we are moderately optimistic that private capital, including foreign capital, will have a role to play.

Consumers Will Pose New Challenges

Despite common wisdom that Chinese citizens consume too little and save too much, consumption has been growing at a healthy rate of 9 percent per annum for the past two decades. In addition, the consumption rate as a share of GDP likely is underestimated, and is, in reality, comparable with the East Asian tiger economies at a similar stage of development.

Over the next few years, consumption-driven industries will out-pace GDP growth, and investment-driven industries and infrastructure will grow more slowly.

Over the next few years, we do expect consumption-driven industries to out-pace GDP growth, and investment-driven industries and infrastructure to grow more slowly. Plus, with the consuming class expanding by several hundred million over the coming decade, consumer-facing companies will need to meet a more heterogeneous and discerning set of needs, with demand dispersed across hundreds of cities and towns.

Outbound Investment Will Grow Slowly, But Steadily

We anticipate a shift away from politically-mandated investments by large SOEs to a more natural outbound flow of investments by smaller SOEs and private companies. These acquisitions may be smaller and less eye-catching, but more sustainable given business interests over political ones. In turn, international companies will experience a more rational basis to enter into partnerships with Chinese companies at a global level.

How Businesses Should Prepare

The new status quo does not mean traditional success factors for China have expired. Thus, a commitment to establish a headquarters in China, a capable local team, local decision-making autonomy, a business model and offerings adapted to local needs, and an alignment with government priorities still are very necessary. These factors continue to remain critical to success in China and perhaps even more so under the changing conditions noted above.

However, given the uncertain and volatility ahead, international companies need to consider a further set of initiatives.

Manage the Headquarter Perspective

Chinese headquartered executives typically react poorly to Chinese-specific issues reported in the foreign press and often do so without a sound understanding of the significance in the broader context. Given the volatility ahead, a gradual mounting of concern and weakening of confidence is likely.

As a result, it will be important to manage the expectations of the headquartered staff. Thus, China country management will need to inform their headquartered colleagues about anticipated volatility, provide an accurate explanation of events as they occur, and continually support and reinforce the overall strategy, and how it accommodates the changing business environment.

Optimize Sales and Distribution

The potential for greater consumption in China poses a challenge: getting the sales and distribution economies to work. Companies will need to accurately pace the expansion of their sales and distribution platforms, select the most efficient geographies and models, and share best practices between regions while allowing sufficient autonomy to meet local needs.

Companies also should consider new route-to-market approaches, fully embracing e-retail as it starts to account for 10, 20 or 30 percent of category sales. Additionally, consider partnerships between those with strong product portfolios and others with mature sales and distribution platforms.


Given the pending consolidation in many sectors, inorganic growth will become obligatory for either establishing a significant presence or staying competitive, both for Chinese and international companies alike. Few global companies are prepared for this new reality.

International companies also will need a reliable view of the consolidation dynamics of their sector, both at the macro (i.e. sector structure) and micro (i.e. available targets) levels. The preferred targets may not currently be available and, as a result, companies will need to establish and cultivate relationships well in advance of acquisition discussions. In addition, they will need to implement strategies to defend against intensifying competition and larger competitors. This will not be easy and will require strong leadership and execution capabilities.

Realign with Government Interests

International companies should monitor the governing Party’s Third Plenum in November and the subsequent policy announcements and implementation plans. They also should look for changes relevant to their businesses, identify new ways to align with government interests, and help the government satisfy its policy goals and reform agendas.

This will be an ongoing process. And, as in the past, the most tangible opportunities will occur at the local level with local governments.

New Challenges and New Opportunities

While China has always been considered a complex and dynamic market, the restructuring and upgrading of its economic model will lead to greater uncertainty and volatility over the next 5 years. And in the build-up to the Party’s Third Plenum in November, there will be much speculation over policy priorities and reform initiatives.

Sweeping reforms are unlikely. As a result, many commentators will express disappointment. Nevertheless, we expect the general direction to be a positive and lasting one, with meaningful steps to quickly follow.

With a greater emphasis on consumption, efficiency and productivity, there will be new opportunities for international companies. And while the choppy waters will be navigable, international companies will need to make sure they are ready. What worked in the past will no longer be enough. There will be a shake-out in many sectors, and only the better prepared companies will flourish.

Eduardo Morcillo, Managing Partner, James A.C. Sinclair, Managing Partner, Simon Zhang, Strategy Practice Managing Director, and Jan Borgonjon, Partner and President of InterChina Consulting contributed to this article.

InterChina Consulting
About The Author InterChina Consulting
InterChina Consulting’s team of 60 professionals has conducted over 500 strategy projects and closed over 160 transactions. With offices throughout China, the U.S. and Europe, InterChina Consulting has continued to deliver the highest quality services to clients for 20 years.


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