China’s economy has experienced a transformation in the last 30 years, from total reliance on state-owned enterprises (SOEs) and collectives to a mixed economy where private enterprises are gaining in importance. Winter Nie, Katherine Xin, and Lily Zhang show the beginnings, growth, and moves up the value chain of Chinese POEs. Most Chinese private-owned enterprises (POEs), unlike their state-owned counterparts, have humble beginnings with limited resources and compete in low-margin businesses. As they grow, they are increasingly becoming the engines of the local economy as well as tough competition for multinational companies (MNCs) in the China market. For example, 70% of the revenue of Zhejiang province – with a GDP of US$245 billion in 2007 (roughly the size of Finland’s) – comes from private businesses.
Starting at the low end of the market
Initially, many POEs targeted the low-end markets. Typically, this was not a conscious strategic choice. Rather, it resulted from a lack of financing and the necessary know-how to reach beyond these segments. Most POE funding would be borrowed from relatives and friends. At least at the beginning, the staff often consisted solely of spouses, children and relatives. However, even in such modest circumstances, one thing worked to their advantage: The entrepreneurs had intimate knowledge of their target market. They had an intuitive understanding of China’s huge potential as its citizens began to move towards a more material world. These customers are extremely price conscious, so grabbing a share of this segment of the market requires an appreciation of their needs without losing sight of the limitation of their wallet size.
From the countryside to the cities
Rural areas, where people generally have limited income opportunities, account for the great majority of China’s low-end mass market. In their early stages, POEs usually made and/or sold products targeting low-end markets, expanding market share and building their brand through distribution networks covering the extensive rural areas. Once they had built up enough strength, they tried to break into urban areas and move to the mid-tier or high-end markets, where they might pose a challenge to the dominance of MNCs.
The competition between Nice Group – China’s leading detergent manufacturer – and P&G is a pertinent example. Nice’s precursor was a rural workshop located in a remote village that no one had heard of. It made its name with two laundry soaps under the Eagle brand that targeted the rural market. As washing machines became more common in Chinese households, Nice expanded into the mid-tier urban market by moving into the laundry detergent business in 1999. Having established the Eagle brand name with its laundry soaps, Nice in its advertising campaign emphasized the message “Choose what is right, not what is high price.” Helped by its lower pricing relative to similar products made by MNCs, in just one year Nice quickly captured by far the largest share of the market. A year later, in 2001, its sales volume was five times the total of all MNC competitors in China. Later, Nice introduced two new products – natural soap powder, designed to be the next-generation laundry detergent, and nutrition toothpaste – both targeting the mid- and high-end markets. At the end of 2003, when it began to reconsider the importance of its “mid-tier market strategy,” P&G announced its Eagle Shooting Campaign – a clear indication that it considered Nice a strong and serious rival.
Benefiting from gaps in the market
With many POEs starting in low-end markets, and with MNCs entering the Chinese market by focusing on high-end markets in urban areas, this often left a void – the mid-tier markets, which supposedly demand products of sufficient quality at a reasonable price. Some POE entrepreneurs had the insight to spot this market opportunity and act quickly. Having achieved success in the mid-tier markets, they could attempt to penetrate the high-end markets, posing a direct threat to the MNCs.
Opple Lighting – established in 1996 and now the world’s leading lighting manufacturer – is a case in point. The Chinese household lighting fixture and lamp market was highly fragmented, with over 10,000 small local manufacturers engaged at the low end. Several global industry leaders, such as Philips, GE and Osram mainly targeting the high end, accounted for less than 10% of the whole market. After three years’ experience assembling lighting fixtures, Opple began producing lighting fixtures and lamps aimed at the middle segment. Opple’s products were of better quality than local products and cost less than the international brands. This enabled it to avoid both the price war between local manufacturers and the head-on competition from MNCs. The mid-tier strategy proved to be a success, and by 2006 Opple was a domestic industry leader with revenues of over RMB 1 billion.
Moving up the value chain
Most POEs follow the typical three-stage growth path: From trader to manufacturer to technology developer. In the trading stage, POEs gain know-how about the market, products, sales and management, as well as building up their distribution networks and accumulating funds. As they master manufacturing techniques and gain production management expertise, they enter the second stage of scale production (as OEMs in many cases). Eventually, in the third stage, some go on to invest in R&D to establish their own brands. The time taken for this evolution varies according to the industry.
Nimble today, formidable tomorrow
The speed and flexibility with which POEs operate can be surprising to outsiders. In our opinion, MNCs would do well to consider them as serious competitors, not only in the Chinese market but also globally, rather than continuing under the misapprehension that the most challenging competition they face in China comes from other MNCs.
Tharawat Magazine, Issue 3, 2009