Innovatize China FMCG Blog

Long time since my last blog post, so here’s a short one to warm up:

Not sure where you stand on slogans…but here is some funny news from China (courtesy of the Brit boys over at Access Asia). Nike Addidas, a strong market player, and Li Ning, the leading local player, appear to have similar yet different thoughts for slogans:

Nike’s Addidas’s slogan is “Impossible is Nothing”

Li Ning’s slogan is “Anything is Possible”

By the communicative law of mathematics (and marketing slogans), I hereby claim ownership of these two:

“Impossible is not Possible”

“Anything is not Nothing”

Now I will just sit back and wait for the royalty checks to come flooding in…

By the way, it is OK for me to poke fun at Li Ning since I already killed my chances for consulting work for them. A few months back, one of their senior business strategy people was interviewing me for a potential consulting project, and I was foolish enough to blurt out: “Why would you ever waste a ton of money hiring Shaq to be your spokesperson when your only chance of success is to position yourself as a quintessentially Chinese brand?!?” Result: no call back from the strategy guy. Probably he was the one who had come up with the Shaq idea in the first place.

Recently it has been rumored that Walmart is currently in acquisition discussions with Beijing Hua Lian Supermarkets. Whether it is true or not, remains to be seen, but here is my take on this:

Walmart only recently completed an acquisition deal with Trustmart in China (see my previous post). At the time, I mentioned that it was a good move in terms of scale, but I had doubts whether Walmart could manage this intergration process. Would Walmart walmartize Trustmart? That would be bad, since Trustmart is much more successful and on-target than Walmart is in China. Or would Walmart allow Trustmart to trustmartize Walmart, even just a little bit? That would be good news for Walmart. It’s not clear yet how this is proceding, so I will have to get back to that later.

But, consider now that Walmart might also simultaneously add on another large acquisition (Beijing Hua Lian). In this case, I think they are talking to a company with much less to offer in terms of successful strategy. Beijing Hua Lian’s key strengths in my view are lots of prime real estate locations and lots of mysterious money (secret support from the government which is trying to help locals “fight” against western retailers). Aside from that, they are not a very well run, efficient, or a modern-style organization. How will that fit with Walmart? I suppose the best result would be for Walmart to walmartize Beijing Hua Lian….So Trustmart should trustmartize Walmart, and Walmart should walmartize Beijing Hua Lian…Is this getting confusing to you? Yeah, me too. Imagine what a mess this will be for Walmart especially considering that their existing business in China is not very successful. Getting better, yes, but still a long way behind several other competitors.

Recommendation to Walmart China: Tell the people back in the US headquarters to stop putting too much pressure on you for fast expansion in China. Fix your current business model. Run it. Prove it is successful and scalable (your need more professional staff at the senior level!), THEN expand in China.

Another option: Make a big disaster like you did in Germany, Korea, Japan, etc. then spend lots of money to “escape” from the market and blame the whole thing on someone else or the market itself.

Hmmm…which one sounds better to you?

On Oct 2nd, Beiersdorf announced that it had purchased 85% of the stock share of C-Bons Daily Cosmetics Company under C-Bons Group for 270 million Euro. Beiersdorf also holds the priority right to buy the remaining 15% stock shares at a minimum price of 47.5 million Euro.

As I mentioned back in Feb 2007, I think this is a good move by Beiersdorf. Their China business continues to rapidly expand on the back of their excellent branding efforts and the addition of this strong local team should help them to expand further, especially into Tiers 2-4 where C-Bons is particularly strong.

Branding and distribution…the two keys to success in the China market. I guess that shows that the market is not as different as we sometimes think it is. Of course, executing good branding and good distribution is still ten times harder in China than it is in western countries.

Please see my previous post for more info and analysis.

Chinese M&A: Piecing together an effective strategy
Shanghai Business Review, May 2007

An excellent article covering M&A in China, focusing on the opportunities and pitfalls. Below, I point out some of the key points in the article and also add some additional info based on my experience in China.

Key Quotes from the Article and some Innovatize Comments:

“The significant rise in China’s M&A activity over the past couple of years has been rooted in the concurrence of two factors, namely, companies’ rush to expand and grab market share in China and a softening regulatory regime.” 

Innovatize: OK, a bit obvious, but a good starting point. In terms of regulations, there has been a loosening and concurrent tightening over the last year or so. The western business media has given a lot of attention to the recent regulations that tighten restrictions on M&A in China. But the key point that the media glosses over is that these regulations are only limiting very, very large acquisitions in which the ultimate market share of the post-acquisition company will be very large (25% or more). In just about every M&A case that I have heard about in the last year, this was not an issue. That said, even these large deals are not automatically rejected. If you do your government communication work correctly (as opposed to the mistakes that Carlyle made last year), you have a very good chance of getting these deals approved.

“Building a nationwide distribution network, gaining access to customers, acquiring local staff teams, obtaining turn-key production facilities, acquiring hard-to-get government licences and enabling rapid growth in a competitive market.”

Innovatize: Mainly applicable to industry players, i.e. companies that want to sell their existing products via the acquired company’s channels, customers, and sales teams. Keep in mind though that these are all intangibles, i.e. you are really not “buying” anything, but rather are hoping to continue existing relationships with these people. There is always a chance that they could simply decide they don’t want to do business with you…or the employees could all quit. Yes, an extreme view, but something to think about and make plans to avoid. Again, communication is key. You need to communicate in advance of the acquisition with these key people, interview them, get to know them, respect them, and make it clear to them that you plan to help THEM grow their business (or improve their careers) after the acquisition is complete. Don’t underestimate the tendency for employees and customers in China to assume the worst (they have plenty of real examples to look at, e.g. L’Oreal’s failed acquisition of Mininurse), and to then take actions to “protect themselves” in advance. Your goal is to prevent them from assuming the worst, and ultimately get them to stick around and continue business as before.

“Particularly in industries such as retail, FMCG and logistics, cash-rich MNCs are opting to buy up all equities of a Chinese enterprise to shore up solely-owned entities with full control of an immediate market presence.”

Innovatize: Brands are key in FMCG of course. You need to study the brand strength very carefully. Be careful of “well-known” brands that really do not have much real brand equity. On the other hand, keep in mind that these zero equity brands can be built up quickly if given the right strategic marketing push post-acquisition. Though you will definitely need to plan to bring in much more experienced branding staff.

“Even just a few years ago…’you could come into China and grow organically, since everyone was starting from the same low base. Many industries that did not exist 10 to 15 years ago in China are now mature.’ “

Innovatize: On the other hand, even the mature industries still have huge room for growth as they are typically only in the early stages of so-called maturity. For example, even the mature category of carbonated drinks in China is still very unsegmented compared to mature western markets (For example, you can’t get a diet-non-caffeine-cherry Coke in China, much less a Vitamin Water or any other specialist products.). That means there are still many segments that have not even been touched upon, much less developed into a significant segment. Thus there is still great potential for both medium and large players to enter the market with a segmentation strategy.

“Global management teams sitting in New York, Tokyo or London may have unrealistic expectations and time frames pressuring domestic managers to adopt a quick-results strategy. When post-deal integration ultimately falls through, it is not the integration that is fundamentally at fault, but the lack of realism of what can be achieved in a particular period of time.” “What is particularly demanding on transaction time in China is the process of uncovering documentation prior to signing the purchase agreement.”

Innovatize: Just getting a simple cash flow statement can oftentimes be a 3 month affair in China, especially with small or medium-sized businesses. And this typically causes the people overseas to scratch their heads and doubt the “seriousness” of the management of the target company. The reality is that most (nearly all!) Chinese companies do not look at cash flow. So when you ask them for this type of data, they really have to build it from scratch, study it in full, and then finally release it to you. Just one example of many why these transactions are sometimes a bit slow. People in HQ should try their best to understand this.

“Generally, accurate company information is hard to come by, given limited benchmark precedents and disclosure obligations. Sifting through that becomes detective work for the accountants, consultants, financial advisers and lawyers involved. ‘Due diligence happens to be one of the most unpredictable factors in the course of an acquisition in China,’ “ “The desire to evade tax also leads some companies to under-report their true revenues and earnings, making themselves appear much smaller than they actually are.” “Due diligence itself is not usually technically difficult from an accounting point of view, but requires a lot of experience in understanding China-specific issues”

Innovatize: Clearly, these are the “home run” sentences within the article. Keep these in mind before starting on an acquisition in China, and remind yourself about them at least once a week during the process.

One point that the article does not mention is the importance to carry out not only financial and legal DD, but to also do a thorough “commercial due diligence” check. By this I mean to look at the business structure and strategy, check the suppliers, talk to the customers, meet formally and informally with the staff, take frequent and unscheduled walks around the facilities, etc. This is the only way you will ever learn the true nature of the business. Sure, you need to look at the financial charts and have the lawyers check and recheck, but don’t forget to get your hands dirty with the real business nuts and bolts. After all, you are buying a business, not a set of financial charts and documents. Especially in China, the charts and paper are often only a small part of the real picture.

While doing your commercial due diligence, you can also begin to make plans for post-acquisition. As I mentioned earlier, massage the customers and pat the employees on the head. Make sure everyone knows that the acquisition is a good thing for THEM. Get to know the key staff and identify areas where they may need support in the future. Communicate with government people to get their “buy-in” into the concept and eventual support for the approval process. I can not stress enough how important this will be to the future chances of success of your post-acquisition business.

Experts warning: Beware the mergers that clip local brands
Xinhua and China Finance Net

Innovatize Analysis Quick Summary:

• This article inadvertently illustrates the weak understanding of branding among the “IPR experts and entrepreneurs” in China.  
• Chinese brands that are acquired by western investors are nearly always on a serious downtrend or near death due to lack of a clear and effective brand strategy for many years, and their over-reliance of building the “well-known” level of the brand.
• An excellent sales pitch to the government and to the sellers can then be, “We have no intention of killing your wonderful Chinese brand like evil P&G and Unilever…

Innovatize Full Analysis:

An interesting article in my view for two reasons: Firstly, it inadvertently illustrates the weak understanding of branding among the “IPR experts and entrepreneurs” in China. Secondly, it frames an interesting opportunity for pure financial investors in China. First the branding issue…

The experts are missing or misreading one big piece of this puzzle: Chinese brands that are acquired by western investors are nearly always on a serious downtrend or near death. Even if they are well-known and have “unique techniques and reliable quality”, from a true branding point of view, they are usually very weak or nearly useless. This is due to the lack of understanding how to build and maintain brands, and more directly to the complete absence of a true positioning concept behind these brands for many years. Typically these brands have built their entire brand value on the very simple concept of being “well-known“, but when real brands enter the market with clear positioning, these “fuzzy” Chinese brands lose their attractiveness to consumers extremely quickly. So rather than hastening the death of these local brands, the western investors probably extend their lives artificially for a few years longer than they would have normally survived. China is a tough market and only the strong brands are able to survive for very long these days.

So, putting aside the weak branding history for now, this concern for local brands presents an opportunity for western financial investors (e.g. non-industry players looking to buy all or part of a local company in China). An excellent sales pitch to the government and to the sellers can then be, “We have no intention of killing your wonderful Chinese brand like evil P&G and Unilever; we don’t even have our own brands. In fact, we are basing our purchase decision 100% on the future of your wonderful well-known Chinese brand”. This kind of story can really go a long way towards convincing the buyers of your suitability as a partner and also towards getting strong government support. That also means you might get a bit better price than normal, or at very least, the entire acquisition process will go foward much smoother. Believe me, this sort of effect should not be underestimated! (Just ask J&J whose deal to acquire all or part of Da Bao has been stalled for several months now waiting for government approval)

Of course, what will be the first thing you will need to do after buying your stake? Bring in some real marketing skills to get the Chinese brand whipped into shape. In fact, you’d be smart to include this in your acquisition agreement, e.g. you agree to invest X but both sides agree in advance that the following branding issues need to be addressed within 6 months, etc. Two years later, the next group of investors (probably during your IPO roadshow) will then get an even better sales pitch based on a sexy story of a long-running Chinese company with a (now) truly strong and well-positioned brand in the booming China market!

Buying small is beautiful for private equity in China
Financial Times Business News

Innovatize Analysis Quick Summary:

• Carlyle has only themselves to blame for the troubles they have experienced with the widely-reported Xugong Construction Machinery company acquisition.  
• There are a large number of PE firms eagerly eyeing China, and therein lies the source of one big problem: Too many buyers using the exact same strategy and going after the exact same few companies.
• Buying small is a better strategy which delivers two significant benefits.

Innovatize Full Analysis:

As I have said before, Carlyle has only themselves to blame for the troubles they have experienced with the widely-reported Xugong Construction Machinery company acquisition. There is not need for buy-out firms to “now [be] more cautious about China, given what Carlyle had to go through.”

Carlyle made two mistakes: First, they went after a big company involved in a sensitive field, heavy industry. Anyone who knows anything about modern Chinese history knows that these companies were at the forefront of the Chinese government efforts in the 50’s and 60’s to “surpass the west.” Obviously, this strategy did not quite pan out, but there is still a strong nationalistic connection between these companies and the government and even the ordinary citizens of China. Secondly, Carlyle clearly did not do their pre-acquisition guanxi work. If they had, they would have found out very early (i.e. before this whole mess went public) that the deal was sensitive. What is pre-acquisition guanxi work? It means contacting the relevant government agencies in advance to discuss your ideas and to get their feedback and suggestions. This is a nice way of getting unofficial approval, and getting them involved in the success of the plan. Later, you are much more likely to receive friendly approval from these government departments as they are already aware of the deal and, in fact, tacitly gave their official thumbs-up in advance.

As the article note in the next section, there are a large number of PE firms eagerly eyeing China, and therein lies the source of one big problem: Too many buyers using the exact same strategy and going after the exact same few companies. You don’t have to be a PE expert to know what happens as a result. Prices go up. Worse still, there just aren’t any companies available to buy. Remember that the massive growth in recent years in China has NOT been driven in any way by large Chinese companies. Or even by the government. In fact, both of those parties often were hindering the growth. No, the growth came from small and medium size Chinese enterprises, mainly focusing on the manufacturing sector and later on consumer products for the hungry local consumers. Throughout this period, the large state owned companies remained relatively stagnant and in many cases saw their sales shrink dramatically. Sure a few large companies experienced growth, but in most cases, it was the opposite.

Buying small is a better strategy which delivers two significant benefits: A) It stays below the regulatory radar and thus avoids the Carlyle-type problems. B) It focuses acquisitions on the many smaller-sized companies that are the true leaders of the Chinese economic miracle, as opposed to the crumbling state-owned mega-companies that the large majority of the western PE’s are chasing after now.

OK, I know all the PE experts are sitting back now and groaning about deals being too small to merit the paperwork involved. I guess I have to say first, you should probably consider streamlining your internal processes to reduce the paperwork. Secondly, it is not as bad as it seems if you follow the magic strategy of ROLL-UP, i.e. buy one, then use this company as a vehicle to buy a string of related companies or competitors. In a relatively short period of time, you can roll-up 10 small companies into a nice sized business. If you target the right type of industry, i.e. an industry that has clear benefits from economies of scale in purchasing or production or sales or whatever, you will also reap a double reward when these synergies begin to hit the books.

Of course, the challenge will be management, so that makes your first acquisition important, not so much as a standalone company, but as a central management structure that all of the rolled up companies will merge into. This will very likely require bringing in some talented people that are probably too talented for the small-size of the first company acquired. No problem, just sit down with these candidates and layout your plans for the roll-up. Get them properly motivated of course (performance incentives, shares, etc.), and give them marching orders to develop SYSTEMS of management in each functional area. Once you feel they are ready to roll (pardon the pun), then start your roll up process.

By the way, this also opens up some interesting opportunities for buying out the entrepreneurs of the rolled up companies; you can offer them partial cash and partial shares in the total rolled-up business. If you paint the right picture for him or her, this should be quite attractive to them, i.e. they will eventually own shares in a very large, stable, and professionally-managed company.

You may have heard some recent reports about local skincare company, Da Bao, being in discussions with Johnson & Johnson (J&J) to sell all or part of their shares to J&J. A few months ago a local reporter called me to confirm, whereupon I made a few calls to contacts in Beijing, and they confirmed that J&J was in fact in talks with Da Bao. Which was interesting since those same contacts had previously told me that Avon was also talking to Da Bao. The latest news reports now  claim that Unilever is considering joining in the fun as well.

Local media reports and Reuters are saying that Da Bao has placed their assets on a “equity exchange” sales board in Beijing and is looking for bids from others as well. Their asking price is 2.3 billion RMB. Dabao in 2006 posted 41.7 million yuan in net profit on sales of 676.2 million, according to a statement posted on the Beijing Equity Exchange. Dabao had net assets of 459.6 million yuan.

Before I talk about the price, let me make some brief comments on whether this is a good idea for any of these companies:

Dabao: Yes, it is a good idea for them. They are the classic example of the strengths and weaknesses of local Chinese personal care companies: strong execution in the sales and promo channels, but VERY weak branding skills. Diaopai detergent is a very similar example. Both Diaopai and Dabao got lucky a few years back and stumbled upon a nice marketing position:

Dabao successfully developed and pushed a light lotion product that claimed to have anti-oxidant ingredient SOD in it. Nevermind that consumers had no idea what SOD was, it was a nice light lotion, with a suitable fragrance, and sold for a cheap price of RMB 6.8 per 100ml bottle. Sales went through the roof, bringing Dabao to RMB900+ million annual sales at one point.

Diaopai had a similar experience, but in their case, the lucky break was a on-target emotional TV commercial that featured a laid-off mother pinching pennies by buying Diaopai detergent. The slogan was “Don’t buy the expensive detergent, buy the right detergent” (“expensive” and “right” rhyme in Chinese). The commercial grabbed the hearts of low to middle income consumers at a time of great job uncertainty for workers in the state-owned enterprises. Result, Diaopai sales boomed as well.

Now for the problem: Neither company could follow up this success with further extensions or new products or even new communications that could equal their original lucky success. So Diaopai gradually lost share over the last few years, and Dabao has also gradually lost share, despite launching many new products to try to pick up the slack.

So what does Dabao (and Diaopai) need? Marketing skills! What does J&J have? Marketing skills! A match made in heaven very similar to my previous post about Nivea and C-Bons.

Avon: Avon is already making a big mess in China, and I don’t think this will turn around anytime soon. The last thing they need now is a declining retail brand like Dabao. Avon was roundly unsuccessful in their own forays into retail over the last few years in China (I am talking about their products launched in the hypermarkets, not those 5000 useless own-brand retail stores they opened all over China). There is no reason to believe that they can fix Dabao. Their branding skills are too weak, and it is doubtful that a low-end product like Dabao would really fit into their direct sales channel well (mainly middle income consumers, not the low income consumers that Dabao is targeted at). So despite what some stock analysts think, I say that the Avon deal would be a bad move for both sides.

Unilever: A long story worthy of a separate post. Suffice it to say, Unilever is also underperforming in China due to their own mistakes. Or rather I should say their own long string of mistakes. The time is not right for Unilever to take on another local brand.

J&J: Ahhhhh, just right! They have the branding skills. They are experienced at the retail channels. They are weak in the wholesale channels where Dabao is strong. As stated above, a match made in heaven. At very least, this acquisition could be a nice wake up call to the sleepy J&J China personal care business unit and give them something to get excited about.

As for the asking price: Not sure about what others think, but Dabao’s asking price of RMB 2.3 billion works out to 55 times annual profits, which in my book is very, very, very expensive. Can they seriously be dreaming about getting such a price? Or is this just some “show” that they need to go through in order to get their equity sale to J&J or Avon approved by the government?

I’ll keep a close watch on this story for further developments.

China’s state-owned enterprises: Board governance and the Communist Party (article)
McKinsey Quarterly online

Innovatize Analysis Quick Summary:

• McKinsey, to my great disappointment, recently put out this article on the “befuddling” and “invisible” power of the Communist Party branch committes (which are normally resident in large businesses) in China.
• My response: It is nowhere near as complex as they make it seem, plus I have never seen any party committee within a business in China try to take anything more than token power. If you play it right, the existence of the party committees within your China business can be a big plus.

Innovatize Full Analysis:

McKinsey, to my great disappointment, recently put out this article on the “befuddling” and “invisible” power of the Communist Party branch committees (which are normally resident in large businesses) in China. I note my disappointment because usually McKinsey has quite interesting and accurate articles about China on their website. So I was surprised by the rather stereotypical-media-frenzy-style of this article, i.e. China is mysterious and no one can understand it, so you need to hire expensive consultants like McKinsey to figure it all out for you.

My response: It is nowhere near as complex as they make it seem, plus I have never seen any party committee within a business in China try to take anything more than token power. Sure, they want to stick their noses into various issues from time to time. Sure, they may want you to pay for new sofas for their offices so they can sit around drinking tea all day in comfort. Don’t let it worry you. Buy them their sofas and keep them happy and comfortable, and you will rarely see them poke their heads out of their office door.

Is this strategy magical or mysterious? No! It’s just common sense. You’d do the same thing if your doddering business-founder grandfather still had an office in your manufacturing site in the US…just keep him happy, make him feel like he still has some influence, give him “face”, and everything will move forward smoothly. On the other hand, if you ignore your grandfather, show him no respect in front of the staff, and try to kick him out of your factory site…then you will learn a tough lesson and find out exactly how much power your grandfather has when he wants to cause trouble using his network of old connections…Beware!

Why I am using this “cute” grandfather analogy? To make it clear that handling an issue like the Communist Party branch is not really as complicated as it may seem (or as McKinsey may want you to believe). Just use your common sense. People are people, and you will find that the cranky old communist party branch guys are actually very similar to your cranky old grandfather. They want to be treated with some respect, and be given credit for what they did in the past, but deep down inside, they know that they are out of their league in this new business world.

In fact, if you play it right, the existence of the party committees within your China business can be a big plus. They normally handle the labor union and in some cases are actually the head of the union, so they can solve lots of sticky employee issues for you. Also they have good guanxi with the government (for obvious reasons) so when you have some “oops, we did not know about that regulation” problems, they can help you sort it out. Again, in order for them to do this, you need to have built a good relationship with them over time. Include them in issues of concern to them. And don’t forget to order that new sofa for their office also.

Anheuser-Busch to expand distribution of China brands

Café looks to profit in mainland fast lane

Best Buy has big plans for China

China’s coffee demand to hit 60,000-70,000 tons in 2007

China’s Redbaby to seek listing by end-2008

GOME sees RMB150 bln sales by 2010 and to open more mobile phone shops

Hershey’s to expand its business in China

Huiyuan Juice planning to grow in the south

Mengniu investors seek HKD1.4 bln from share sale

Nestle’s first pet food plant opens in Tianjin

Noevir to set up cosmetics sales JV in Shanghai

Tesco opens first outlet in Beijing

Wal-Mart takes another China step (article)
RTE Business

Wal-Mart, the world’s biggest retailer, has bought 35% of a 101-store hypermarket chain in China, in a dramatic move to better reach the nation’s increasingly affluent customers.

Wal-Mart did not disclose how much it paid for the stake in the Taiwan-owned Trust-Mart chain. It said that, subject to ‘certain conditions’, it would acquire ownership control in the future.

Wal-Mart vice chairman Michael Duke said the investment was ‘an important step in bringing additional scale to our China retail business’.

Innovatize Analysis Quick Summary:

• Is this acquisition really such a good idea in light of the fact that Walmart is still having trouble with it’s overall strategy in China?
• The style of Trustmart is very different from Walmart, so this will be a tough intergration process.
• Despite the announcements that claim the stores will remain separate, it seems more likely that they will be merged in terms of operations.
• The new incoming CEO of Walmart China has acquisition experience, so that is good news, but can he fix the overall operations and marketing strategy of Walmart China?

Innovatize Full Analysis:

OK, for the record, I have to admit that in my last post about Walmart’s acquisition efforts in China, I said that “You’ve got to give Walmart some credit for making such a big move in China“. Now that I have had a few weeks to think about it, this move does not seem like such a good idea.

Think of it this way: Your current China operations are having trouble. Store sales per square meter are lower than your competitors, you haven’t quite got the right approach for local consumer tastes, and your famous logistics system is not really up and running yet in China…Is this the right time to add on a large acquisition which will more than double your number of stores???

Maybe you could justify this if you were acquiring Makro China stores, for example, as Makro is basically a Euro-clone of Walmart. But in this case, Walmart is acquiring Trustmart, a Taiwanese-owned and managed chain of hypermarkets with a very different culture and style than Walmart’s. Where Walmart is conservative, slow, and centrally controlled, Trustmart is wild, fast, and decentralized in terms of decision making (by the way, they are also more successful in China than Walmart). Putting these two unlikely partners together is going to take a lot of management time and attention. Now go back to the beginning of this paragraph and decide for yourself whether this is the right time for this move.

Despite the announcements that claim the stores will remain separate, it seems more likely that they will be merged in terms of operations. My guess is that this announcement is just something to keep the 68,000+ staff calm during the extended buy out process.

On the subject of staffing, Walmart recently has said goodbye to their 62-year-old outgoing chief executive of Wal-Mart China, Joe Hatfield, and brought in a Hong Kong native, Ed Y. Chan, to replace him. Mr. Chan, who will be president and CEO of Wal-Mart China, comes to the company from the Dairy Farm Group, where he was most recently regional director of North Asia. From what I have been able to learn about him, his speciality/background is in acquisitions as opposed to actually running retail stores. So I guess, from an optimistic point of view, he is well-positioned to handle the Trustmart acquisition process. On the pessimistic side, I have to wonder who is ever going to get Walmart’s real business strategy on the right track in China? The chain-smoking good ol’ boy, Joe, could never seem to quite get his finger on the pulse of the Chinese consumer after more than 10 years in China. You have to assume that Chinese-speaking Mr. Chan will have a better chance at figuring this out, but on the other hand, Hong Kong Chinese are notorious for stepping on the toes of and not listening to the mainland locals…

Count on Innovatize to keep a close watch on the progress of this ongoing story!

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Beiersdorf buys stake in C-BONS (article)

“German personal care manufacturer Beiersdorf has announced plans to acquire a stake in Chinese hair care brand, C-BONS.

The manufacturer has already signed a letter of intent, with the brand’s parent company, C-BONS Holding and both sides have agreed to further discussions over potential equity investment opportunities, although no terms of the deal have been released. The two companies will however start to cooperate in areas including distribution, marketing and R&D.

Beiersdorf’s interest in the Hong-Kong based hair care specialist is part of a larger plan to accelerate its expansion on the Chinese market.”

Innovatize Analysis Quick Summary:

• Nivea brand owner, Beiersdorf, announced the signing of a letter of intent with C-Bons.
• The plan appears to be to merge CBONS on-the-ground implementation strengths in China with Nivea’s branding skills.
• Innovatize predicts success with this combination, but a lot will hinge on the relationship that Nivea establishes with the “big boss” in C-Bons (Wu Yongnan, President of C-Bons).

Innovatize Full Analysis:

As the article notes, Beiersdorf announced the signing of a letter of intent with C-Bons. It should be noted that the format for such letters of intent is completely up to the two parties to decide. So the letter could be very vague or very detailed about the next steps. If this one is very vague, then that means there is still a long way to go before Nivea and C-Bons join together in any meaningful way. If it is not a vague letter, then Nivea and C-Bons could theoretically be working together (or completely merged) in China in a matter of months. (Since they did not release the actual letter of intent, we can only speculate and sit back and wait to see what happens next.)

The plan appears to be to merge the China implementation skills of C-Bons with the brand skills of the Nivea marketers. Although others have tried and failed with this strategy (see my previous most of L’Oreal’s misadventure with the acquisition of Mininurse in China), my view is that this time the strategy will be a big success. Reasons:

a. C-Bons is very strong at implementation, especially in-store implementation, which perfectly fits with the Nivea strategy (the big blue wall of products) around the world and in China.
b. Nivea has already learned some tough lessons in China. Their first entry was a total failure based on a very arrogant and overconfident approach to the market. At one point, they nearly exited from the market entirely. But they finally saw the light in year 2001 and began to build a much more “balanced” approach to the market, i.e. less European arrogance and more localization BUT still keeping the right mix of western brand characteristics. Since that time, their China business has achieved very strong annual above-market growth (that’s saying a lot in light of the fact that the China skincare market grows at 20% per year!). This type of balance seems to be very difficult for German companies to achieve; witness the near complete meltdown of Henkel’s personal care business in China now that it is back firmly in the hands of the Europeans again after experiencing several strong years under a localized turnaround team. Go figure!
c. C-Bons has been fairly humbled as well over the last 3 years as P&G cut prices and thus took a huge bite out of C-Bons’ low-price strategy. Assuming that C-Bons has now faced the reality that BRANDING will always win, they should now be ready to listen to the experienced branding people in Nivea. No doubt, these branding skills could be put to very good effect working on some of C-Bons current roster of “no position” brands (Slek, S-Dew, Hair Song; Maestro is the only brand they have with any sort of clear positioning).

One point to watch: How will the Nivea Germans build the relationship with the big boss of C-Bons, Wang Yongnan. Mr. Wang is very well-known in China as a smart business person and is listed on the list of “richest business persons” every year. You can naturally assume that he is not going to be too happy being lectured by some 20-something marketing kid from Nivea headquarters. Will the Germans be able to create a balanced relationship in which the Chinese boss gets the “face” that he needs, BUT at the same time, the branding and management progress can still be made? From my point of view, that is the key question mark in this very promising acquisition. hans van bylen, henkel china, alain bauwens

U.S. leads pack in acquiring Chinese companies (article)
ReliablePlant.com

Innovatize Analysis Quick Summary:

• The United Kingdom and Singapore are leading the way in establishing a foothold in China’s rapidly expanding economy
• With all of the frenzy about internet and high tech companies, it is nice to see that many investors are wisely choosing to invest in good ol’ industrials and consumer staples…not sexy investments, but strong and stable performers.
• Of course, financials are pulling in most of the investment capital by value. I predict that these investors will face a very bumpy ride over the next few years as the many “dead bodies” in these Chinese banks float to the surface.
• “Complex regulatory regime and its multi-faceted tax system”??? Come on…it’s not that difficult. It requires some knowledge and experience and a willingness to do things in a slightly different way, but it’s not rocket science!

Innovatize Full Analysis:

I was surprised to see how much of a lead the US is taking in investments/acquisitions in China. Living in Shanghai, it feels like I am surrounded by Europeans at all of my favorite north American-style restaurants (Malone’s, Blue Frog, Moon River).

Also, it was encouraging to see the statistics about the number of deals finalized in various sectors. [”the high-technology sector accounted for the highest number of cross-border deal activity (16 percent). This sector was closely followed by the materials (14 percent), industrials (13 percent), financial services and consumer staples sector (both with a 12 percent market share)]. There have already been so many highly publicized deals in the internet sector, so I would have expected a larger number of high tech sector deals. Funny how these internet investments get lots of free PR and then they seem to disappear quickly, or implode as in the case of eBay.

Investments in banks: Ahhh…one of my favorite dogs to kick. I hereby officially predict that every investor that put money into the recent public offering of ICBC is going to be feeling great pain over the next five years. Please write that down and send me some sort of gift when this prediction turns out to be true. Why do I think so lowly of ICBC? First of all, similar to all other major Chinese banks, it is managed like the very worst of the old state-owned enterprises. No structure, no discipline, and no clues on what to do next. Second, I guarantee you that there are loads and loads of “dead bodies” that will be floating up to the service over the next few years, e.g. much more bad debt than expected, and massive internal corruption. Third, service…ICBC has never heard of the word.

“Complex regulatory regime and its multi-faceted tax system”??? Come on…it’s not that difficult! Most of the problems that you often read about in the news (for example, Carlyle’s big trouble in buying out XuGong) could have been easily avoided with some early-stage communication with government officials. My strategy is to get them involved early, make sure they are ok with the deal, and get them committed to the success of the business investment. On the other hand, you could follow Carlyle’s approach and just assume they are going to support you because you are bringing money into China. Mr. T would say “I pity the fool that makes that mistake!”.

As for taxes, they’re fairly straightforward and suprisingly logical. Admittedly, I still get a bit confused by VAT, but that’s what the accounting department is for, right?

Takeaways: Don’t get China Internet fever, don’t invest in Chinese banks, and be smart about getting early government support (i.e. unofficial pre-approval) for your industrial or consumer sector investments/acquisitions.

There’s an interesting story about L’Oreal that I have told several times, so I finally decided to put it down in writing. It’s interesting as a glimpse into the sometimes naive or theoretical thinking of multi-nationals and their approach to China investment. Secondly, it shows how their inflexibility can sometimes seriously damage their business here. The good news is that it has a happy ending.

First of all, L’Oreal had the good idea to buy a local player in the skin care market. They looked around China and finally settled on a local company called Mininurse (ok, the brandname sounds bad in English, but it is not so bad in Chinese; sort of a somewhat serious, slightly medical/functional positioning. Not a bad idea, but of course, not so well executed. Still, I’ve got to give them credit, as most Chinese brands don’t even start with a decent position).

After a detailed negotiation, they finally agreed on a price and acquired the company from the original owner. They then proudly announced to the world media that they would use the new acquisition to gain access to the 2nd and 3rd tier channels/markets of China. The idea being that they would begin to sell their own L’Oreal brand product down this smooth pipeline to theoretically reach 1.3 billion consumers all over China. As one senior manager at L’Oreal China put it: “After its acquisition of local beauty brands Mininurse and Yue Sai, L’Oreal now has a network of three factories, two national warehouses, three regional warehouses, and 394 distributors.” Another article covering the acquisition stated, “In China the acquisition will enhance L’Oreal’s market position in skincare and acquire distribution channels Mininurse had.”

OK, so in theory, it’s a great idea. Here’s what happened in reality.

As it turns out, Mininurse was a very typical local skincare company that relied on a network of multi-level distributors. We usually call this channel the “traditional trade” channel. Traditional trade works like this: The manufacturer sells to a top level distributor, and he sells a small amount to retailers but the majority to lower level wholesalers. These wholesalers do the same; they sell some to retailers in their area, but most of the product goes to third level wholesalers. And so on and so on. Total, there could be five or six layers of wholesalers before the goods reach the bottom tier consumer. The channel works quite efficiently and has it’s own logic and processes, BUT the big problem is that this logic and processes are totally different from what L’Oreal was used to in other countries or in China with their existing department store/modern trade business. That’s when the trouble began.

Reports from the trade at that time started out very rosy but quickly turned ugly. It seems that L’Oreal was trying to implement modern trade methods in the traditional channel, and the channel just could not accept these methods or implement them. Many of the L’Oreal requirements were based on the distributor having direct contact with retailers and consumers, but as I described above, in the traditional trade channel, much of the product is resold to wholesalers instead of being sold to retailers. So L’Oreal’s top-down methods of promotion were a total flop and their demands for bottom-up information and data were not able to be met. End result: frustration on both sides. The distributors got frustrated and angry with all the new demands, and L’Oreal got frustrated and angry with what they felt were uncooperative distributors. Next, L’Oreal made an even bigger mistake.

Faced with what they felt was an uncooperative channel, L’Oreal decide to use a different strategy. They stopped pushing sales in the traditional channel and instead focused on relaunching Mininurse in a new package, with a new formula, and a new combo brandname: Garnier Mininurse. They launched this line in modern trade and quickly phased out the original Mininurse line of products…in other words, they changed the brand, the packaging, the formula, the position, and the distribution channel…all at the same time. Optimistically speaking, you could call this “brave”. Pessimistically you might prefer to call it “sales suicide”. And in this case, your pessimistic view would be the one that turned out to be correct.

From that point, L’Oreal’s sales of Mininurse began a “downward trend”. Maybe better to say, sales “began to decrease”. Maybe more accurate to say “sales tanked”. The traditional distributors, already cranky about what they felt was arrogant treatment by L’Oreal, were not happy at all about the new line of products or brand name or any of the other changes. So they quickly turned their limited working capital in another direction, i.e. they bought something else instead (Good news for struggling brand “Long Li Qi” which then shot to the top of the sales charts in the traditional channel and now is a major player in the skin care market in China; Long Li Qi’s boss should send L’Oreal a fruit basket in thanks). In the modern trade channel, the consumers looked at this strange hybrid brand (Garnier is international while Mininurse is rural China) and their reaction was…”huh?” End result, not many sales in modern trade either, despite massive spending by L’Oreal to buy brand-walls in the major hypermarkets.

Fast forward to early 2006, Mininurse’s sales are in the toilet, and the acquisition looks like a total failure. But here’s the happy ending. L’Oreal China president Paolo Gasparrini in an interview in Chinese-language magazine “CEO-CIO” admits that their Mininurse strategy has been unsuccessful, and they plan to go back to the original channels in which Mininurse was strong….Well, you’ve got to give him a lot of credit for admitting the mistake (plus the guy still has “genius credentials” for his huge success in China with Maybelline). Still, I wonder if they can adjust their style and expectations to fit the traditional channel. It still remains to be seen.

Note:
Sorry, blog links are not working properly for the moment, so here are the links to the quotes above:
http://www.123helpme.com/view.asp?id=47241
http://www.sinomedia.net/eurobiz/v200408/event0408.html
http://english.eastday.com/epublish/gb/paper1/1114/class000100001/hwz172916.htm
http://www.ceocio.com.cn/store/detail/article.asp?articleId=6967&Columnid=2597&adId=10&view=

China Dairy Sector Ripe for M&A’s (article)
http://www.21food.com/

Innovatize Analysis: The Smart Way to Milk the China Cow

Innovatize Executive Analysis:

• The China dairy market is really flying now: 20% annual growth.
• Local companies currently have the lead due to their stronger implementation skills in this tricky market, both in production and distribution.
• But now they are reaching a plateau in terms of management skills, finances, and branding. This makes it an ideal time for western investors to enter the market to snap up some of the small to medium-sized local players.

Innovatize Full Analysis:

(First of all, I just want to mention that it was only a short 6-7 years ago that the western media was going on and on about how dairy products would never fly in China because the Chinese people lack a certain digestive enzyme to digest milk products. I heard the same story in Taiwan 15 years ago. So, where are all those media writers now??? I suppose they are now busy writing articles about the exploding dairy market in China.)

The articles listed above goes into detail about the astounding numbers in the China dairy market: 20% annual sales growth, half of the world’s total growth in dairy has been in China, livestock breeding up 27% last year. If you have not gotten the point, here it is: the market is booming.

Why? “Milk is good food”, of course, but this boom in sales is mainly linked to kids in China, i.e. growing kids, Chinese emphasis on kids, academic competition, the one-child policy, etc., etc. So there you have it: your China dairy marketing strategy should focus on kids. (Where should I send my invoice for consulting services?)

But the main point of the article, and the really juicy news in my view, is that dairy M&As are beginning to takeoff in China these days. Already, some major players are making moves in the market. Some are doing it right, in my view, and some are doing it the old-fashioned (wrong) way. For example, Denmark’s Arla has decided to go for a massive 54 million Euro joint venture with local giant Mengniu. “Joint venture”?…Aren’t those the types of investments that all the western companies did in China in the 90’s that turned out so badly and eventually had to be shut down or bought out? What is Arla thinking!? Yeah, yeah, I know they will say they are “buying the distribution channels, etc”…don’t get me started on that one. With a JV structure, you have to assume that Mengniu will be smart enough to block this from happening. In contrast, Meng Niu will be sure to learn everything about the technology and processes that Arla will shift into China.

Abbott Laboratories, on the other hand, is doing it right in my view. They are buying out full control of a nice small-sized player in Qingdao for US$24 million. A tiny investment for a company the size of Abbott, but in fact, a nicely digestible size. Also an excellent testing and learning ground for expansion with full control in the hands of Abbott, not some “previously-friendly” JV partner. When Abbott is ready to expand, they can pump some money into this Qingdao business, or use it as an acquisition tool to buy up other small players, or use it as an expansion tool to build a massive green-field site as a branch company of the Qingdao business. All of these are nice options for investment and very simple future expansion. Best of all, they can eventually take this business public in Hong Kong, the US, or the UK.

Now that is the smart way to milk the China cow!

Office Depot Announces Acquisition of Majority Stake in Leading Office Products Supplier in China (article)
www.mediarelations.officedepot.com

Innovatize Analysis: Smart Acquisition Could Allow Office Depot to Profit from Staples’ Mistakes in China

Innovatize Executive Analysis:

• Staples previously also invested in a local company in China (OA365) and announced big plans to expand.
• But then they “pulled a Walmart”, and stubbornly refused to flex to match the local market ways.
• Now they are struggling to find direction and gradually cutting back on their misdirected and heavy advertising campaign.
• If Office Depot allows the locally acquired company to continue to run the business in a localized way (albeit with corporate oversight and governance), this could be a chance for Office Depot to capitalize on Staples’ mistake in China.
   

Innovatize Full Analysis:

Staples has made two deadly errors in China to date:

They will not deliver products to local offices on a COD basis. They require prepay. This is totally unheard of in the China market. Even the smallest of the small local office supply distributors will deliver on a COD basis, and many even offer end-of-month (EOM) credit terms.

They have advertised heavily to consumers, but the consumer market for office supplies in China is nearly zero.

Both of these moves have a strong “Walmart-China-style stubbornness” feeling about them. (See my comments on Walmart China in another post). Not a good sign!

Office Depot could be making the same mistake, and it remains to be seen how they will approach the market. But the article gives me the impression that they will leave the original entrepreneur boss in place to grow the business as he has done in the past…but now he will have a lot more buying power with OD behind him.

(Leaving the entrepreneur in place is not always the best strategy, of course. It has to be decided on a case by case basis with sufficient information, so admittedly I am engaging in some speculation based on this very thin article!)

Ideally, OD should also offer him small doses of corporate support such as information management systems or inventory optimization systems. “Small doses” is key though, as these local entrepreneurs tend to be great in building a strong/loyal organization but a bit slow on the uptake of academic/advanced concepts.

The race between OD and Staples in China is not over by any means…and there will very likely be some strong competition from a couple of tough local companies. In this field (B2B office supplies), I have the most confidence in the tough locals, as this industry plays right into their strengths. Their key weaknesses, branding, is not a problem as consumers will not be important in this market at least for the next few years.

Wal-Mart Makes Big Buy in China (article)
www.thestreet.com

Innovatize Analysis: Give Walmart Some Credit For Trying
 
Innovatize Executive Analysis:

• You’ve got to give Walmart some credit for making such a big move in China. Clearly, their current strategy was not working well. (see my other posts on Walmart China).
• But I have to wonder whether they will try to “Walmartize” Trustmart, or whether they will more wisely allow it to “Trustmartize” their China operations?
• The price that Walmart paid sounds very high, but without any further financials, it is hard to say for sure.

Innovatize Full Analysis: You’ve got to give Walmart some credit for making such a big move in China. Clearly, their current strategy was not working well. (see my other posts on Walmart China).Trustmart (headquartered in Taiwan, not mainland China) on the other hand has been very successful in China to date. They have grown their stores quickly, played tough with their suppliers, and developed a nice promotional rhythm that works well with the Chinese consumers’ desire for a perceived bargain. Walmart would be wise to take more than a few pages from the Trustmart strategy book to upgrade their existing Walmart China operations.Unfortunately, knowing from experience Walmart’s tendency to be inflexible in modifying strategies (see Germany, Japan, Korea, etc), I have some doubts whether they will do this or not.Nevertheless, overall it seems like a positive move for Walmart in that it allows them a “great leap forward” in their number of stores in China.As for the US$1 billion price tag…it sounds very high to my ears, but without more detailed financials, I can not make a judgment on this. I do know that Carrefour was involved in negotiations at the same time with Trustmart, so it may have escalated into a bidding war, thus leading Walmart to overpay to some extent.

McDonald’s Offer More Drive-Thru Stores In China (article)

I just wanted to make a quick comment on this one, as this reminded me of something I saw a few years ago. Namely, a few years back, when visiting Taiwan, I noted that McDonalds has very wisely “subbranded” their drive-thru windows with a special brand name. The name in Chinese, “De Lai Shu”, has always been on my list of best Chinese brand names for two reasons: First it’s meaning is really perfect - something like “get your food quickly” in a very loose translation. If that was not enough, the really great part is that this name sounds like “drive-thru”  in Chinglish!

Some other names on the list:

-Of course, Coca Cola’s “Ke Kou Ke Le”: It sounds like the English name, plus the meaning is good…this has been so over-covered in the media, i am not even going to bother with the reverse translation here.
-Oracle’s “Jia Gu Wen”: One of my favorites. It appears they thought about the meaning of the word Oracle in English, probably looked it up in a dictionary and found no good names, so then they dug into the deeper meaning of oracle and what words in Chinese would have a similar meaning. Finally they settled on “jia gu wen” which refers to the turtle shells which were used thousands of years ago by Chinese fortune tellers. (Detail: They pressed a burning hot metal poker into the shell and caused cracks to form, and then predicted the future based on these cracks; finally I get to use some of the vast knowledge I picked up in UC Berkeley by majoring in Chinese!)
-KFC’s “Ken De Ji”: Don’t know why I like it so much, except maybe just because of the word “ken” which sounds like another word “ken” which means “to chew” or to “gnaw on”.

So so brand names:

-Ironically, McDonald’s own “Mai Dang Lao”: Boring and pointless. It reminds me of the name of Donald Duck in Chinese: “Tang Lao Ya”.
-L’Oreal’s “O Lai Ya”: Reverse translation “Europe delivers elegance”. Boring, too obvious/clunky with the use of “Ou” to mean European. Also the use of the word “Lai” (obscure character for “radish” but it sounds like the verb meaning ”to come, to arrive”) is another hammer hit on the head of the consumer; it sounds like a rural brand rather than a European brand.
-Snicker’s “Shi Li Jia”: Reverse translation “Gentleman’s Energy Support”. Snicker’s trying to achieve their fantasy position as an “energy food” by clumsily forcing the use of the word “Li”, meaning energy. Reminder to self: Brand position is what exists in the mind of the consumer, NOT in the mind of the marketing director.
-Nestle’s “Que Chao”: I had no idea why they chose this name, which means “magpie’s nest”. But after checking out the Nestle package in my kitchen, I discovered that their corporate logo is, in fact, a magpie standing on the edge of a nest. A totally stupid reason to make this your Chinese brand name, but at least the mystery is solved.

 Best Buy’s China Challenge (article)
www.thestreet.com

Innovatize Analysis: Some Doubts About Best Buy in China
 
Innovatize Executive Analysis:

• In order to succeed in China, Best Buy would be wise to avoid going toe to toe with the local players such as Gome.
   
• To succeed in China, Best Buy must differentiate themselves from Gome, and focus on some area of the business in which they have a competitive advantage.

Innovatize Full Analysis:

Don’t go toe to toe:

In order to succeed in China, Best Buy would be wise to avoid going toe to toe with the local players such as Gome. Gome has the following advantages:
-Clearly the Chinese government will openly and/or secretly support Gome over Best Buy. Government leaders already feel that they were slow to protect the local food retailers and allowed Carrefour and the other western retailers to have “too much of a level playing field”. They regret this now, and will not make the same mistake in consumer electronics retailing. So you can expect to see Gome loaded with cash from many mysterious sources and/or friendly state-owned banks. They will use this cash to acquire the partners that Best Buy wants to tie up with, or the best store locations in the cities.
-Gome, and basically all other Chinese retailers, are price killers. In fact, this is literally the only strategy they know. When it doubt, cut the price. Still not working, cut the price again. Cut it again to be on the safe side.
-How can Gome afford this price cutting? They have much cheaper sources of capital than Best Buy (see above). You could probably assume that they will consider capital as free in the next few years. This gives Gome a 9% or so advantage on cost of working capital.
-Gome will pay lower salaries and aggressively avoid paying labor taxes and other taxes. Welcome to China. This is standard for local companies and in most cases they get away with it. When caught, they negotiate for the best deal which is often less than the original taxes they should have paid. When pushed by overzealous tax collectors, they go to the next level up and threaten that they will have to lay off hundreds of workers if faced with such a heavy tax burden. This threat really perks up the ears of stability-hypersensitive government leaders. (In fact, Best Buy should use the same strategy, but I don’t expect that the expat execs they will send over will understand this very local method. Also I can imagine the blank stares one would get when trying to explain this approach to headquarters in the USA!).

Differentiate:

To succeed in China, Best Buy must differentiate themselves from Gome, and focus on some area of the business in which they have a competitive advantage. Some ideas:
-Something branding-related, perhaps the Best Buy brand itself. Build it up to stand for something important in the mind of consumers.
-Product mix: Focus on a narrower range, perhaps becoming the premium product specialist. Maybe import some choices for consumers who want better quality or larger size than is available locally. Whatever the choice, narrow the focus and be a specialist in something that Gome only touches on.
-CRM: Focus on building better long-term relationships with consumers. Form clubs, and make them active rather than just another “VIP card” in the wallet of the consumer.

Here’s another in my series of translations of local news articles (actually, my assistant Debbie does most of the hard work on the translations). I think the articles have some interesting information, plus it might be interesting for blog readers to see the different style of the media in China. 

We have tried to translate these articles relatively “directly” in order to maintain their original tone and voice. My apologies for the slightly “Chinglish” style that results from time to time.

In the article below, it is interesting to note how the reporter seems to be speaking on behalf of the government…a not-so-subtle reminder that the Chinese media is often very closely controlled and/or utilized by the government to send messages to the market and citizens.

I also think it is funny how they say that “local people are not rational enough in buying products”. I wonder what the “local people” think of this?

Also, please see my previous analysis of the true situation at Avon China despite their frequent positive PR announcements.

Summarized from a recent article in Cosmetics Weekly:

“Chinese government authorities have implemented regional restrictions on direct-sales (MLM) companies.

To date, 8 companies have received approval certificates for conducting direct sales: Avon; Nuskin; Bao Jian; Zhen Ao; Yi Li Shen; Xin Shi Dai; Ning Bo San Sheng and Nanjing Zhong Yuan. They are all regionally restricted except Avon.

Nuskin is restricted to operating in 8 districts of Shanghai with 122 skincare and cosmetic products, but no health food products. Bao Jian is limited to Beijing’s 16 districts with 16 cosmetic products and 5 health products. Zhen Ao is limited to Liaoning, Anhui, Shandong, Shanxi, and Ning Bo… all together 178 districts with 13 health products, 63 cosmetic products and 5 cleaning products. Yi Li Shen is limited to 19 districts in Liaoning with 6 health products.

The goal of the regional restriction policy is to protect consumers’ rights; improve monitoring and regulation; and better control direct sales persons. This is needed because, in China, the direct sales laws are still imperfect, and local people are not rational enough in buying products.

The reason why many companies want to develop the direct sales model is that it can cut more than 10% of the marketing costs including advertising and salepersons’ cost. Some companies are focusing now on simply getting a direct selling certificate and not worrying about the regional restrictions. They want to develop the business first and then may sell in other places illegally. But some companies like Amway want to take time to go nationally.

Because of the complicated procedure and a lot of restrictions, and the fact that many companies are not familiar with the direct sales model, some companies that earlier expressed interest are now tending to lose interest in this industry. “

For those of you who can read Chinese, here is a link to my latest branding article (”Narrow Your Focus”) in HAPPI China magazine. Since HAPPI does not make articles available online, here is a link to another site that has republished the same article:

http://www.emkt.com.cn/article/281/28165.html

English version available on request.

I normally don’t do book reviews, as the “China biz” books tend to be rehash after rehash of “Chinese are mysterious and Guanxi is important” type topics. But I just read a review of a new book that looks very interesting and I could not resist quoting some of the key points here.

The book is entitled “One Billion Customers: Lessons from the Front Lines of Doing Business in China” by James McGregor.
The review I read can be found at the Arizona State University’s W. P. Carey School website.

Here are a few quotes from the review/book that struck me with their not-often-seen accuracy. I have underlined a few of the real gems:

The Chinese — especially Chinese government officials — don’t easily forgive and forget. Many of China’s actions and positions today reflect their view of 2,000 years of history — and more importantly, their view of the last 200 years of embarrassment and subjugation at the hands of enterprising foreigners.China’s history continues to affect business behaviors and ways of thinking today in two significant ways: First, the Chinese believe that they are inherently superior to foreign “barbarians.” Second, the Chinese have been deeply humiliated by what they consider to be attempts at foreign conquest over the last two hundred years. The Chinese are committed to demonstrating their superiority and to preserving themselves from conquest by foreign powers.But it’s important to remember, McGregor says, that China’s desire to learn from foreign businesses does not indicate an interest in any sort of real partnership. “At its core, Chinese society is all about self-interest,” writes McGregor, “It is very strong on competition but very weak on cooperation.”

Procter & Gamble suspends sales of SK-II products in China, refunds continue
Forbes.com/AFX News Limited

BEIJING (XFN-ASIA) - Proctor & Gamble China said it is suspending sales of its Japanese-made SK-II cosmetics brand in China, with all retail outlets halting operations. The announcement follows a finding by Chinese authorities of banned substances chromium and neodymium in 12 SK-II products…

Innovatize Analysis:

Here’s a quick rundown of what has happened over the last 7 days:
-A week or so ago, Chinese government officials announced that illegal levels of chromium and neodymium had been found in 12 SK-II products.
-P&G claimed that there must have been a mistake and asked the government to retest.
-Over the next few days, the local Chinese media began to heavily cover the story, noting that these materials could cause liver disease, blindness, skin sensitivity, etc…i.e. very frightening effects. They did not discuss the technical details of the amounts found in the products versus the amounts needed to cause such serious medical problems.
-Monday, Sept 18: Consumers began to approach SK-II brand counters to ask for refunds for the 12 products.
-Tuesday, Sept 19: The press played up the “rush for refunds” story, and of course, the rush for refunds escalated quickly after that.
-Wednesday, Sept 20: P&G set up a central location at the Park Hotel to handle all refunds, but the center was soon swamped with unhappy consumers. Consumers were upset that they would have to wait one month to receive the refund money after handing over their products to P&G staff. The police were called in to maintain order.
-Thursday, Sept 21: P&G then announced that the central location for refunds had been shut down and posted a notice on the door noting that four new separate locations had been established to handle refunds. Consumers at these four locations continued to complain about long lines, uncomfortable conditions, etc. at these locations.
-P&G’s return policy was originally announced as “must have original invoice”, but this created a storm of complaints from consumers. They claimed that no one would likely keep a receipt for such a consumer product.
-P&G then loosened this policy but added the stipulation that only products with more that 30% remaining contents could be refunded without an invoice. Again, consumers complained loudly about this in the media.
-P&G then loosened this policy to allow empty or nearly empty containers to receive full refunds. On Sept 21, there were reports that consumers were trying to return products that they had purchased on Hong Kong and Singapore. According to news reports, P&G would not offer refunds on these goods since they were purchased outside of China
-P&G’s policy required consumers who wanted a return to sign a document confirming that the goods being returned had no quality problem. Again, loud complaints from consumers about this requirement, but apparently most of them were willing to sign this paper to get their refund. It was reported on Friday Sept 22 that local government officials had found this requirement to be illegal and that they had ordered P&G to discontinue this requirement. This has not been confirmed yet.
-Friday, Sept 21 5:21am: P&G’s website posted a notice that they had decided to discontinue sales of SK-II products in China. They announced that all brand counters would be shutdown immediately.
-When the media contacted P&G for clarification, P&G stated that they would discontinue sales and had no definite plans at this time to reenter China with SK-II in the future.

So that is where it stands at this point.

Some background: Last year, P&G was sued by a consumer in Nanjing who claimed that SK-II products had damaged her skin and also had not delivered the promised “10 years younger in 28 days” effect. The lawsuit resulted in P&G winning on the “skin damage” claim, but losing on the “false advertising” claim. P&G paid compensation to the woman and rewrote the wording for their SK-II product claims.

Innovatize Comments:

-This is just another in a long string of this type of PR problem for multinational AND local consumer product companies in China. So there is really no excuse for P&G to not be prepared with a reasonable and “localized” plan for how to handle such a situation. Last year, Colgate, J&J, KFC, and even P&G/SK-II already experienced these types of problems. It’s clear, that if handled correctly, these problems can be managed and diffused relatively easily.

-P&G really flubbed this one from a PR point of view. First of all, on the first day, they should have been very forthcoming about allowing refunds. In fact, they should have publicly and proactively “encouraged” product returns “just to be on the safe side”. For example, they could have announced: “We believe that there is absolutely no problem with the products in question, and we have asked the government to retest the products. They have advised that this will require 30 days to complete. In the meantime, we suggest that consumers holding these products refrain from using them until the results are announced. For consumers that wish to return the products, we will offer a full refund at any time within the next 90 days.” The problem would have been 60% diffused with a simple sentence like that.

This “open” approach would have been welcomed by the media and the public, and the long time window for full refunds would have calmed concerns that consumers needed to rush to get a refund. Sure, this would have cost them a nice chunk of money, but it would have saved their very profitable SK-II China business and avoided the current disaster of terrible PR and total exit from the market.

After last year’s SK-II PR disaster round one, you would have thought that P&G would have greatly improved their PR readiness. Following this latest “nuclear” disaster, it seems likely that some “heads will roll” at the senior management level of P&G China.

First Gap Franchises Set for Far East (article)
www.wwd.com

Innovatize Analysis: Gap still asleep in China; Is it too late now?
 
Innovatize Analysis Summary:

While Gap was focusing on the US market, their Chinese suppliers opened and developed successful branded stores in China under their own brand.

Is it too late for Gap to enter?

Innovatize Analysis:

While Gap was focusing on the US market these past years, their Chinese suppliers opened and developed successful branded stores in China under their own brands: Net, Giordano, Sparkle, and Jeans West to name a few of the more successful chains.

The basic approach of the Gap-alikes is to open stores in fashionable areas and offer products at medium-low to medium price level. Target consumers are young, white-collar women, with a smattering of men’s business. So far, this seems to have been a successful approach, and these stores can now be found all over China.

Is it too late for Gap to enter? Perhaps. If they try to be a Gap-alike-alike, then their chance of success is not good. If, on the other hand, they take a differentiated approach, they could still have a good chance.

Case study: Zara has recently entered the China market with medium to medium-high pricing, a more premium store atmosphere, and of course slightly more fashionable and fast-moving styles. So far, the results are very good for Zara.

Summarized from local Chinese media reports:

In March 2006, Japan’s No.1 pharmaceutical brand, Futurelabo, entered the China market, and within half a year, it has successfully occupied ten 1st tier markets.

Spring is a slow period for the cosmetic market, but Futurelabo chose this period to start its business because they felt they could have more time to evaluate the distributors and the market. The distributors could also spend more energy to understand the brand and the products. Futurelabo felt this timing would be better for them to develop long term cooperation.

Futurelabo is famous for its pharmaceutical store distribution pattern in Japan, but in China, they chose an “exclusive store” pattern because they found that in China, the pharmaceutical store channel is not very mature. People are not used to buying cosmetic products from pharmaceutical stores. Even if they go there, they only buy confirmed brands, and it is not easy for them to convince customers to switch brands in a short period of time.

On the other hand, the “exclusive stores” distribution pattern is very popular now because the high cost of entry into chain stores and department stores as well as the decline of traditional distribution. More and more distributors favor this pattern because of its low cost and simple operation.

Futurelabo is very confident in the future China market. They have set a long term development strategy to build Futurelabo into the 1st herbal plant therapy skincare brand in China.

Summarized from a recent report in the Chinese media:

A recent research project conducted by the Shanghai Business Information Center shows that suppliers’ comprehensive satisfaction scores in regards to the big retailers are low. The research covered 98 large suppliers carrying a range of products including alcoholic beverages; health products; beverage; oil; milk; leisure food; one-off product and textiles.

According to the research, the satisfaction scores for big retailers were very low. The highest one was Wal-Mart which received a score of 3.78 (out of maximum 5 points). Others included Metro, E-mart and Auchan.  Trustmart received the lowest score, 2.53, because of its long credit terms, confusing management processes, and high fees charged.
 
Carrefour was claimed to have the highest fees for suppliers according to the research. Most suppliers mentioned that Carrefour charges many fees such as a promotion fee; management fee; layout fee; holiday fee and others. It sometimes charges these same charge twice.

More than 80% of the suppliers confidentially noted that the purchasing staff from the big retailers tend to ask for large kickbacks.

The management fees and entry fees charged by the retailers are still increasing.

Burger King Looks Overseas for Growth (article)

Innovatize Analysis Title: Burger King Status in China

Innovatize Analysis Executive Summary:

Burger King is just starting out in China after a fairly extensive effort to understand the market and modify recipes.

Initial steps look interesting, but the classic weaknesses of Burger King from the United States seem to be making their appearance in China as well.

Plans to jump into franchising in China may be overly optimistic.

Innovatize Analysis:

Burger King came very late to the party in China with McDonald’s and KFC far ahead of the game (Nevertheless, KFC and McDonalds both have different strengths and weaknesses in China to date).

Burger King started smart by setting up a small pilot restaurant in a hidden location in the Shanghai area, and running food tests for a quite long period of time. During this period, there were a few rumors about the upcoming entry of Burger King, but overall it was kept very low key.

They opened their first restaurant in Shanghai in the middle of 2006 and received a reasonable amount of positive publicity in the media. Store traffic in the opening days was crazy as expected, and customers could barely squeeze into the restaurant, much less place an order for a “Huang Bao” Whopper at the crowded counter.

But things settled down after a month or so, and since that time, Burger King has developed a loyal following, firstly among the expats who seem to flock to the central business location on Nanjing Road, but also among locals (especially teens and white collars). The “little kid and Mom” crowd seems less enamored with Burger King to date, which probably is a good sign, as Burger King’s success in China will hinge on capturing the teens and young white collars. Leave the kiddies to McDonalds.

OK, so far so good. Now for the bad news:

Management: As is my impression of Burger King in the US, their store management (and presumably training) in China is not up to the level of McDonalds’. The restaurant, despite being nearly brand new, is already showing signs of age (e.g. simple maintenance work is not being done). Table tops appear clean, but staff can be seen carrying around wet gray (dirty) towels to wipe the tables. Spray cleaning “disinfectant” bottles attached to their belts seem to be there only for show. Uniforms, despite being new, are slightly dirty and askew. Hair styles of the staff border on unkept or over-gelled/overdyed.

Granted, execution and day-to-day management in China are some of the the biggest challenges for every western invested business in China. But Burger King senior management in China needs to get these problems under control before even considering to expand this platform. This is a “flagship” after all, and even small problems will be exponentially magnified as they open more and more stores. Especially if the new stores are not tightly managed, which brings me to my next point.

Franchising: Burger King China has a far too aggressive plan for franchising too soon and too quickly. The franchise laws in China are still being gradually reformulated, and needless to say, basic business ethics are not quite there yet either. Further, any franchise problems would be difficult to handle in the courts which have yet to reach a level of objectivity and transparency that a full-speed franchise operation would need to keep franchisees following strict guidelines. McDonalds and KFC are both moving very slowly to expand franchising, and my recommendation would be for Burger King to follow their lead in this case.

In summary, Burger King China has made some nice first steps into China, but management needs to be tightened up, and the overly aggressive franchising plan needs to be slowed down a bit to allow the laws and courts to catch up.

Overall, I give Burger King a grade of B- in China with subcategory grades of:
First Steps and Planning: A-
Execution: C
Franchise Strategy: C-