Deadly Sins of International Business Blog

As the English edition of the Chinese newspaper Renminbao (People’s Daily) reports, fourth quarter sales at Yum! Brands, the parent company of Kentucky Fried Chicken (KFC) and Pizza Hut have significantly declined. What has happened in the Middle Kingdom that not only has a huge love for chicken dishes, but also for foreign brands, a market that has been promising nothing but growth for the fast food giant? It all started out with a media report on China’s national TV station CCTV in December 2012. The broadcast alleged that some poultry farms, among them suppliers to KFC, ignored regulations by using hormones and antibiotics, and triggered unfavorable media attention and social media activity. An investigation by authorities in Shanghai only resulted in some vague recommendations concerning a strengthening of KFC’s supply chain, but no fine was assessed and no further action was taken. Unfortunately, as is often the case in such circumstances, the good news got much less media coverage than the original bad news. And so the Chicken scare started to nest in the minds of the Chinese consumers. As the Economist reports in its February 9th issue, KFC’s January sales in China fell by a dramatic 41 %. What makes this even worse is the fact that Yum! doesn’t operate under the usual franchise system in China, but owns most of its stores. With currently approximately 5000 restaurants in 800 Chinese cities, this is a costly development to digest – probably worse than eating a big bucket of deep fried poultry. KFC’s example just shows how tricky it can be to operate in far-away markets. Cultural, geographical and legal distance make it very difficult to first perceive and interpret the early warning signals correctly and then to react quickly and appropriately. Often in such cases, foreign companies quickly pick up the stigma of being an imperialist monster that has no respect for the local environment and whose only interest is exploitation of the local market. Or, in this case in the words of the Economist, to be the “Yucky Kentucky”!

Not too long before US-based DIY giant Home Depot announced it’s almost complete withdrawal from China, similar news emerged about Europe’s largest home improvement retailer, Kingfisher PLC. Kingfisher, founded in 1969, which owns the B&Q and Castorama brands, operates close to 1,000 stores in eight countries including Britain, Ireland, France, Poland, Spain, Turkey, Russia and China. Kingfisher has been struggling in most countries, but it’s China troubles seem to be of a different magnitude. Ever since it first entered China in 1999, it has been uphill for Kingfisher in the Middle Kingdom. When losses hit more than $ 80 million, B&Q decided to cut the number of stores by 22 in 2009. Realizing that the “big box concept” is not very appealing to the Chinese market, it also downsized operations for its remaining 40 stores. As has become apparent in the recent Home Depot case, B&Q may be struggling with exactly the same difficulties – the fact that for cultural and economic reasons, the entire DIY concept is too foreign to most Chinese consumers. And for those who like the idea of tiling their own bathrooms and flooring their own living rooms, there is a plethora of local alternatives in a highly fragmented market. After all, brand is not as important in the DIY segment as it is in more visible FMCG categories. All in all, another case of the difficulties associated with the internationalization of retail businesses.

Late last week, US-based home improvement giant Home Depot announced that it would take a $ 160 million after-tax charge and close seven of its big-box home improvement stores. Home Depot entered China with high hopes in 2006 when it acquired 12 stores across China. Over the years it had reduced the number of stores to the seven it is now closing. Home Depot, which of course also sources heavily from China, does have plans to keep two speciality stores in the city of Tianjin and also to be active in online retail, but for now the dreams of making it big in a market of more than a billion consumers are over. While it is true that many retailers in China are currently struggling as slow economic growth is curbing consumer spending, the roots of Home Depot’s failure may be somewhere else.

The first reason may be that China is not so much a Do-it-Yourself (DIY) culture, but more of a HIDBO (Have-it-done-by-others) culture. Cheap labor is abundant, but even more importantly for a culture that values status and prestige, tiling your own bathroom or painting your own window frames is not necessarily a desired activity for the masses. You may ask why it then is that IKEA is hugely successful in China – a company that also makes you assemble your own furniture. The answer leads us to the second reason behind Home Depot’s failure. Chinese are looking for guidance in acquiring Western lifestyles. IKEA provides this guidance by showing their customers how to decorate their homes in a Western fashion. The fact that you have to assemble your own furniture is a little more appealing when you know what the final product is supposed to look like. Besides, there’s always someone to assemble your IKEA furniture for you. Home Depot, however, leaves consumers largely alone and guessing about the final look and feel. Also, most Chinese live in small apartments and don’t have the room to keep tools or work on DIY projects. And ultimately, Home Depot is selling commodities – nails, screws and paints aren’t necessarily the same cultural icons like IKEA, McDonalds or KFC that so many Chinese middle class families are looking for. There may also be a third reason. Generally, as has also been featured in this blog, retail somehow doesn’t travel easily across international borders. But that’s for another time.

Who would have ever thought? Not only is Volvo in Chinese hands, now Saab is, too! Zhejiang Youngman Lotus Automobile Co. and Pang Da Automobile Trade Co. of China have announced that they will purchase insolvent Saab for approximately 100 million Euros. What remains to be seen are two things – first, if the Chinese will really be able to pull off the deal. Not too long ago, another Chinese carmaker’s plans to take acquire Hummer from General Motors have been barred by Chinese authorities. Second, if the deal comes through, will Swedish and Chinese cultures be compatible with each other?

Interesting piece in the McKinseyQuarterly about metrics for Chinese exports. Very much in line with my recent postings, this contributes a bit to the debunking of the China myth. Don’t be afraid! All will be good!

Not too long ago, at the end of the 1980s (although I acknowledge that for some of the followers of this blog this equals a lifetime), Japanese investment in the United States peaked at about US$ 20 billion. By then, management scholars had long begun to study the Japanese miracle. Based on a general fear that Japanese companies would completely control the US economy, US authors such as Bill Ouchi (in his 1981 book ‘Theory Z: How American Management Can Meet the Japanese Challenge) introduced new ideas, and US companies implemented new processes such as the Toyota system of manufacturing. Everybody was up in arms about the Japanese threat. As always, history seems to repeat itself.

In the context of Chinese president Hu Jintao’s recent visit to the US, there have been nervous reports about Chinese companies taking over US businesses. And indeed, there have been some well-publicized cases – Chinese consumer electronics producer Haier’s early Greenfield investment in 2002, or the more recent Beijing Automotive Industry Company’s (BAIC) acquisition of General Motors’ Saab division, Beijing West Industries’ purchase of Michigan-based automotive supplier Delphi Corporation, or numerous smaller investments in US companies by China Investment Corporation (CIC). Obviously there’s enough activity to make The Economist cry out that China’s buying the world and to ask the question what it is like to be ‘eaten by the dragon’ (The Economist, November 13th, 2010). Relax, knowledge of foreign languages is always a good thing, but it isn’t time yet that we all learn Mandarin. Why? Let’s take a closer look at the data: Out of the total book value of foreign direct investors’ equity in US companies in 2009 (it’ll take a while until we have 2010 data) of US$ 2,319.6 billion, China’s share is still insignificant. The largest investing countries are still based in the Western Hemisphere – the United Kingdom (19.6%), the Netherlands (10.3%), Canada (9.7%), Germany (9.4%), Switzerland (8.2%), and France (8.2%). The only exception, of course, is Japan which holds about 11.4 % of the total foreign direct investment in the United States. In a July 2010 report by the Bureau of Economic Analysis (BEA), China isn’t even mentioned – and that’s for a good reason: China’s total assets in the US are about a 300 times smaller than those of Japan. Even small countries’ foreign direct investments in the United States such as Austria or Panama are larger than China’s. Of course, there’s no question that Chinese investment in the US is growing fast and may soon outgrow the “Other” category on the BEA pie charts, but it’s still to early to panic. And even if China held a lot more assets in the United States, it probably would not mean the end of the world just like Japanese investment in the United States hasn’t. The world is flat, and an increased involvement of China in US companies may be a source of (desperately needed) capital, (desparately needed) new energy and motivation, learning, and global stability.

News agency Reuters reported on Friday that Disney and Shanghai Shendi Group have signed an agreement on the establishment of a Disneyland theme park in Shanghai. On an area of about four square kilometers, a total investment of approximately $3.75 billion will bring Mickey & Co. to Middle Kingdom.This should have really been big news, but it wasn’t. The media didn’t jump on it, and even the stock markets didn’t seem to notice (yet). Why not? One possible explanation could be that no one is really certain yet what the expansion into Mainland China will do for Disney. Disney’s Hong Kong theme park hasn’t really attracted as many visitors as it has hoped so far, and has reported a loss last year. Then again, it doesn’t seem to be as big a blunder as Eurodisney has been for the longest time. So, nobody really knew if the Shanghai theme park will be a source of revenue or a source of ridicule for Disney.
Another explanation is that the news is really old news. As of now, the plans are to open the Shanghai Theme Park in 2014. Considering that the negotiations have been going on for about a decade, and given that even one year ago there have already been announcements about an agreement, why should anybody bother to look up from their cup of green tea now? Approval from China’s central government is still pending, and it’s almost certain that there will be more hurdles and milestones after that.
Everyone familiar with the story of Disney’s resort in Paris can only hope that this time Disney will look beyond the mere potential of a huge market. If Disney wants to be successful from the outset, it needs to focus on the cultural differences that stand between their business model and Chinese visitors.

There’s something remarkable going on in China’s automotive industry. Yes, there’s growth, but there’s more to it. Chinese automaker BYD that is backed by Warren Buffet’s Berkshire Hathaway, Inc has set up a Chinese 50-50 joint venture with Daimler in late May. The goal of the joint venture is to jointly design and produce an all-electric vehicle for the Chinese market. This will add a new dimension to Daimler’s expansion in China. Having recently experienced above average sales growth, Daimler also has plans for an engine factory in China – the first one ever outside of Germany. Naturally, Daimler as a corporation thinks of opportunities first and I, as an academic, think of the risks first. Joint ventures haven’t been known to be among the easiest ways to cooperate across borders, especially in China. This one, however, seems to be on a straight trajectory to success. The Chinese government is reported to have announced that it will order 100,000 of the new vehicles come out of the Daimler-BYD joint venture. Although details of the agreement haven’t been made public yet, the government is expected to honor its commitment by 2012. What’s interesting about this is that initial plans to subsidize private consumers for buying electric cars seem to have been scrapped after they drew criticism from the Chinese Communist Party for benefiting mostly the nouveau riche in China. Someone has been doing an excellent job lobbying the Chinese government. For once, it seems that what’s good for an automotive manufacturer will also be good for the environment. And for BYD, the deal is a godsend, too. After record increases in 2009 (by an astonishing 160 percent), it had to announce in early August that it’ll cut its sales targets by 25 %. Obviously, ‘too big to fail’ exists in other countries, too…

Of course, what is commonly referred to as the Chinese phoenix, the fenghuang, only distantly resembles the phoenix of the West. So, erudite reader, please forgive the amateurish use of the phoenix as a metaphor for what’s going on in China’s automotive sector. Mercedes, BMW, or Audi are all reporting very positive developments from the Chinese market. This confirms what insiders to the automotive industry and experts in cross-cultural marketing have long pointed out silently. It’s not necessarily (only) available income that drives purchasing decisions, but national culture plays a big role, too. Income levels in China would suggest that smaller models are sought after, but the opposite is true. Status, power and prestige are very important elements of Chinese culture. Several years ago now, Volkswagen had planned to rapidly increase market share in China by offering a small car – assuming that with rising levels of affluence, everyone would buy a small, entry-level car. Guess what, they didn’t. The polo was simply too small for the Chinese market. Today, larger Volkswagen models such as the Passat or the Tiguan are doing a lot better. Owning a luxury car is the ultimate sign of social status, and so demand in the premium automotive segment is on a constant rise. In July, Audi sold about 50 percent more cars in China than last year, BMW about 80 % more and Mercedes-Benz even tripled its sales. And all of this despite the rather high luxury taxes in China which raise the prices of the flagship models – the S-Class, the 7-series, or the A8 – to about double from what they are in Europe. These developments certainly come at the right time for luxury carmakers whose sales have been less than favorable in their core markets in the West in past years. The Chinese fenghuang is a symbol of virtue and grace – very similar to what the Mercedes brand stands for. Maybe my use of the metaphor isn’t that off after all.

It looks like Honda’s China troubles are over for now. Its Chinese joint ventures, Guangqi Honda Automobile and Dongfeng Honda Automobile, will resume operations after having made significant concessions to workers who went on strike mid-May. There were complaints of working conditions and low wages. Honda agreed to raise wages by 25 %. Yes, twentyfive percent. Such a significant increase can only mean (or at least hint to) that Honda has been doing what many multinationals are often accused of – the exploitation of cheap local resources, such as labor. And in fact, workers at Honda or at similar plants earn as low as 1,000 Renminbi monthly, about 150 US$ and have not received a wage increase in five years. What’s the lesson to be learned? Moving production to a low-cost location is not necessarily a bad thing – after all, there’s very little choice for companies in some industries if they want to stay competitive. Besides, foreign direct investment is also helping the development of local economies. However, creating ever worsening wage disparities at foreign subsidiaries of multinational companies over time makes them less welcome than they may have initially been. Besides, in Honda’s case, the company has ambitious plans of growth in the Chinese market. Last year, it produced about 600,00 vehicles in China, but it is looking to increase its capacity by 30 percent to more than 800,000 cars by 2012. The expansion banks on increases in domestic purchasing power. And this is where being not locally responsible becomes a very short-sighted strategy – not only did Honda nothing to contribute to increases in purchasing power, it is also slaughtering its own image.

Other Japanese multinationals in China have recently announced similar increases in output – Nissan plans to produce more than one million cars by 2012, Sharp will double the number of retail outlets, fashion retailer Uniqlo intends to open 1,000 stores by 2020. What happened to Honda recently provides a good lesson for these Japanese companies and for all multinationals from other countries.