Shenzhen Ten Years Later

When I first visited Shenzhen, about ten years ago, the city had only a handful of skyscrapers, and probably no more than 100,000 inhabitants (four years earlier, less than 20,000 farmers had lived there). The old outdoor market, still active, was about to be razed and, except for the occasional government limo, there were few private cars. Just as well, for only some roads had been built, and the city seemed to float on a cloud of dirt.

Although I had since passed Shenzhen on the elevated highway that leads from Hong-Kong to Guangzhou (Canton), a recent visit was my first one since that first, brief foray into China. Shenzhen is now a bustling city of seven million people, full of skyscrapers and neon signs. A multitude of private cars, buses, taxis and delivery trucks compete to get through the traffic jams. Although many areas have been preserved for parks and green spaces, the downtown areas remain fairly oppressive -- as in most world metropolises. But here there are several such areas, and my host repeatedly pointed to districts that “used to be downtown a few years ago but not anymore” as a result of the city’s growth.

The first striking observation about Shenzhen is that there are no old people. A city can only grow from one hundred thousand to seven million people in a single decade through massive immigration, and only young people leave their home towns to seek opportunity elsewhere. The average age of the city’s inhabitants is 27.5 years. There are more women than men, because light industries and services, which preponderate, employ a majority of women. So the city works and bustles, but has an eerie feeling about it.

The other feature that makes Shenzhen different from other large Chinese cities is that there is no ethnic unity. I reported last year on the shock of visiting the western province of Xinjian, near the borders of Kazakhstan and Afghanistan, where the inhabitants look like Turks and speak mostly Uygur and… Russian. With immigrants coming from all over China, everyone in Shenzhen looks mostly Asian but distinctly different and, in the absence of strangers, speaks a multitude of local dialects. Shenzhen is a microcosm of China’s diversity – at odds with our preconception, as westerners, of a huge mass of uniform Chinese.

I was fortunate to have as a guide Zhen Qin-An, originally from Xian – a provincial capital between eastern and western China. Qin-An moved to Shenzhen more than fifteen years ago and, as such, qualifies as one of the city’s longest inhabitants. At a young-looking 47, he also is one of the oldest. After a stint in the military, he worked for the local administration and was later instrumental in organizing the Shenzhen stock exchange, now the largest in China. Today, Qin-An is a management consultant to both domestic, entrepreneurial firms and foreign companies entering China. In spite of a thoroughly Chinese education, he speaks fluent English and has traveled to several countries outside China.

Qin-An is an almost perfect bridge between East and West. He has been successful in bringing an American style of management to his Chinese corporate clients, forcing them to plan and focus on long-term objectives while identifying and concentrating on their main competitive advantages. At the same time, he has been able to prevent many costly mistakes for foreign clients, by guiding them through the maze of complex and sometimes unwritten rules of Chinese bureaucracy. He also selects for them accountants, lawyers and other specialists that provide western reliability while skillfully navigating through the many cultural and regulatory obstacles that often trip even the most experienced foreign experts.

This visit confirmed my earlier impression of the vast divide between China’s new, entrepreneurial firms and older companies slowly and laboriously emerging from their state-owned heritage.

The Great Divide

Chinese entrepreneurs are fairly typical of entrepreneurs everywhere: same boundless enthusiasm; same sense of empowerment and total confidence in their abilities; but also the corollary that they feel capable of pursuing opportunities wherever they arise. This is amplified by the fact that privately-owned businesses, except for small mom-and-pop shops, are very young. Most are barely older than six or seven years, and there are few time-tested models to follow: almost none in China and most of the proven ones in the United States. (Europe, in spite of some cultural similarities in the business environment is less-well known by entrepreneurs).

As a result, there is little strategic thinking, and decisions tend to be very opportunistic. This is facilitated by the ease of hiring and firing and the fact that entrepreneurial firms operate in an exceptionally regulation-free environment: the government’s presence is only felt once a business becomes very visible. Sometimes, this combination of factors results in poorly focused businesses that may combine retail chains together with golf club manufacturing etc. This is where Qin-An’s business thrives: by bringing strategy and focus to the entrepreneurs’ innate eclectic tendencies.

Former state-owned enterprises, on the other hand, struggle with heavy legacies. First, there are the plethoric payrolls, heavy bureaucracy and ill-defined or poorly assigned jobs that traditionally have characterized Chinese organizations. This is further aggravated by the pervasive role of the Party inside large, traditional firms, with agendas or attitudes that often complicate the task of management. In addition, the transition from semi-monopolistic positions in regional markets to an open national (and increasingly international) marketplace represents a greater challenge than starting a business from scratch.

As a result, even capable executives at formerly or partly state-owned firms seem to have more tentative (less voluntary) strategies and evidence a sense of powerlessness in implementing them. The most dynamic ones long for providential, outside help in the form of foreign investors, an outcome that, itself, faces many obstacles. The reason is that most of these firms have prospered thanks to an artificially uncompetitive environment: they lack truly strong brands, own relatively obsolete production facilities and have distribution networks without clear competitive superiority. Add the sometimes-unrealistic prices demanded by existing (government) shareholders and most potential foreign investors might elect to penetrate the Chinese market on their own. For some, this will be achieved by piggybacking on the fast development of new distribution network such as those being built by large hypermarket chains (Carrefour, Wal-Mart, etc,). This would further erode the value of state-controlled enterprises, especially manufacturers of consumer staples.

More generally, China’s business environment has not, to date, been propitious to long-term strategic planning. This became obvious to me last summer in an unlikely context.

A young French entrepreneur in China and his Chinese wife, were visiting with us in Fire Island. In the conversation, the wife reminisced that “in her first job” she had had to leave home at 5am each morning, ride a heavy bicycle to work for one-and-a-half hour and repeat the exercise at night. “When was that?” I asked. “Five years ago”. This young woman now speaks fluent English and French and runs a business of her own. She has traveled to several countries and stayed in the most luxurious palaces. I could not help wonder how one adapts to such rapid and radical change, and it occurred to me that the same consideration applies to businesses. How does a manager adapt to, even less plan for, the kind of breakneck and exponential pace of change China has experienced in the last decade? Strategic planning implies the ability to rely on a reasonably predictable economic and business environment for the forecasting period. This has not been the case in China:

·           The pace of economic growth has exploded, boosted by accelerating foreign direct (industrial) investment in the country.

·           Many regulatory barriers have been eliminated, though often in a haphazard, tentative way that made the “trend” difficult to apprehend or to rely on;

·           New businesses and competitors have been born at a record pace, while many others have closed.

All of this has happened on the backdrop of a tug-of-war between China’s central government and sometimes-insubordinate provincial and local entities, which has made the “official” rules an unreliable guide to doing business.

A Shanghai friend with twelve years of experience in and around China, who currently is regional manager for a large multinational company, once explained to me the art of negotiating with the Chinese. As they enter a negotiation, their cultural history gives them confidence that they have all the time in the world (“a thousand years”). On the other hand, China also is a nation of natural traders, who cannot resist the attraction of an immediate-cash deal. One’s ability to play on this apparent contradiction is the key to success in negotiating with the Chinese, my friend said. The same contradiction applies in assessing the maturing of Chinese enterprises into organizations with true strategic thinking that may eventually become world leaders in their field.

The markets in which Chinese companies operate and the place they occupy in these markets are changing so fast that they need to be hyper-reactive to developments they do not control. This is why Chinese management styles sometimes seem erratic or to lacking in focus. For example, TCL, one of our portfolio companies, stuck with its TV-set business throughout the fierce price wars of recent years. It improved product quality, built a strong brand name and reaped the benefits this year when prices stabilized. On the other hand, it closed its white goods business almost overnight to become China’s No.1 mobile phone manufacturer, partly through acquisition.

In China, a competitive advantage due to lower price or better quality can evaporate very quickly. The more agile local competitors are prompt to catch up with new products or better production techniques and to strengthen their distribution networks. Management must therefore constantly look for new niches where they can establish a competitive advantage temporarily, before their lead over local competitors is eroded.

Over the next few years, the universe of Chinese companies from which to select world-class investments is set to increase significantly. First, a large number of Chinese entrepreneurial companies are approaching the size and maturity at which they will consider a public listing. Second, with the proposed opening of the “A” share markets in Shenzhen and Shanghai to foreign investors, many state-controlled enterprises will be submitted to either the discipline of the markets or the effective control of strategic foreign partners. While we are skeptical that a majority of latter will successfully manage their transitions, some will.

It is essential to become more familiar with Chinese-style corporate strategies and to closely monitor the progress of these companies to be able to select the ones that will survive and prosper.

François Sicart

^© Tocqueville Asset Management L.P.