Taking The Middle Path To The Middle Kingdom

I was in Shanghai last week and had some eye-opening discussions with senior executives from multinational companies, companies with long histories of doing business in China. There is a predictable strategic narrative unfolding in China. Those who know this narrative have a chance to build enormous value for their companies. Those who do not are likely to miss out. (View my blogcast here)

China holds immense potential. Its GDP has been growing at a double-digit pace. In coming years it is projected to grow at about 8% per year. The middle class is growing, environmental regulations are improving, and the outlook for intellectual property (IP) protection is, as one executive put it, "positive." To get to all of this promising "cheese," foreign corporations must navigate a daunting maze, which is why so many are taking only timid steps to enter China, or staying out entirely.

The maze becomes significantly less daunting if you take a perspective that one executive shared: "You have to understand that the Chinese government's aim is self-sufficiency; they want local competition, they want to build local capability." The idea that a foreign company could enter China and end up dominating its sector, just because it dominates it everywhere else in the world, is simply not realistic.

There is a Chinese stratagem called "borrow the road to conquer Gao," which draws its name from an ancient story about a state that wants to attack another state. Because it does not share a border with that state, it borrows access from a smaller neighbor who allows this state free passage. The aggressor state attacks its target, succeeds, and while marching back home is surprised to find its smaller neighbor, who provided passage, has left its city gates open. So the aggressor takes advantage of the situation and defeats its smaller ally.

There are two important strategic principles to draw from this story. First, when you do not have access (to a customer, to a key resource, to some capability), you can borrow it from someone else. Second, alliances do not last forever and you should plan for what will come after the alliance's logic expires.

Lenovo adopted this stratagem to grow from a small, governmental science organization into a leading PC manufacturer. The company, called Legend at the time, entered into a partnership with HP in which Legend distributed HP computers in China. They learned the PC business from their partner and then started competing with HP by producing their own brand of computer. This business grew and grew until they bought IBM's PC business and changed their name from Legend to Lenovo, or the "new legend."

If you are doing business in China you can be pretty sure that this strategy is at work. You have to enter through a local partnership, and that partner is going to learn from you. But this does not mean that you cannot end up ahead by entering such a temporary partnership. HP benefited in many ways from its Legend partnership. It enjoyed years of revenue from the partnership and now benefits from a strong brand and years of experience in China. You know that if you enter, your partner will learn from you and will eventually become a competitor. So you have three basic choices:

1. Stay out completely, in which case you will miss out on years of growth in China, miss a chance to learn how to operate in the country, and miss the possibility of establishing some brand positioning there.

2. Enter blindly, by jumping in with a partner and hoping that your marriage will last forever. If you do this you will be blindsided, like the small state that gave access to its larger ally and then was taken over.

3. Make the most out of a temporary partnership, understanding that it will eventually end. Some of the things you can do during this partnership period include making as much money as you can while the partnership is strong, becoming an expert in doing business in China, starting to parse out the business with your partner to agree on certain pieces of the business that you might hold on to when the partnership ends, or hiring Chinese talent and assimilating into China's fabric.

To stay out or enter blindly are short-sighted choices. Forward-looking companies succeed by thinking through and managing the complexities of the third option. One of the companies I spoke to won a huge contract to be the exclusive provider of a specific component. Another has acquired seven local companies and is assimilating itself as a sort-of Chinese company.

Another client I am working with is standing on the sidelines, considering if and how to enter. It knows that to stay out is to miss out, potentially on a valuable long-term future. But it also knows that to jump in naively is a mistake. Thinking through the middle-path, maintaining the right balance along the way, is more complicated.

China has called itself the "Middle Kingdom" for millennia; it has defied black and white categorization, so why would we expect it to offer an easy, straightforward approach now?

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