Branding the Dragon

I've written a few posts about how a lack of cultural competency has affected US firms trying to do business in China, but cultural mis-communication is a two-way street. This morning I had the opportunity to meet with Wayne Cozad, owner of Cube Management. During the course of our discussion the topic of culture as it relates to business came up. Mr. Cozad told me about lectures he conducted in China about branding, and how his Chinese audience audience just couldn't grasp the concept.

An example he used was a Chinese shoe manufacturer who can produce "Nike quality" shoes for $2/pair. She'd been trying to penetrate the US market, confident that Americans would see the value of her product. However, she could not find a US distributor that was interested. Mr. Cozad tried to explain to her the concept of branding and US consumers' perception of value based on price. However, as hard as he tried she just didn't get it.

Made in China
This conversation brought up an interesting point: the "Made in China" brand is a weak one. Both American and Chinese consumers tend to associate Chinese made goods as being cheaply made and of inferior quality. However, consider for a moment the high-quality brands that source from China. Brands like Think Pad (computers), Cummins (diesel engines), and Nike (sport shoes) have stellar reputations for quality, and all source at least part of their product lines in China. These brand identities override the lesser respected "China brand", earning customer respect and brand loyalty. Obviously Chinese made goods can be of superior quality. Perhaps we (Americans) are responsible for the the Chinese brand identity due to our historic focus on price over quality?

Re-branding China
I believe the next step in China's economic development (and the next big industry) in China will be the the re-branding of the "Made in China" brand. I spoke of this in a previous post about China's economic cycle. As the cost of labor continues to rise, Chinese exports will shift from price-based to quality-based. Haier (appliances) is ahead of the curve as they are already penetrating US markets with quality appliances. Japan made this same transition. Immediately after WWII, Japan flooded the US market with cheaply made goods in an effort to generate capital to rebuild its infrastructure, earning it a reputation as a source of low-quality manufacturing. Once the Japanese economy started to pick up, so did the quality. Today Japan is known for sophisticated, high-quality exports. Why would China be any different?

In order to successfully make this shift, China will have to re-brand itself as a source of quality goods. However, unlike post-WWII Japan, China has a severe shortage of managers and less experience in dealing directly with western markets and business models. Entrepreneurs in China poised to educated Chinese manufacturers about branding and western perceptions of quality based on pricing will be instrumental in facilitating this shift, and be rewarded dearly for their efforts.

The Culture of Business or the Business of Culture?

I recently chimed in with my own two cents regarding this question on LinkedIn:

"Does cultural sensitivity and awareness deliver better business results when it comes to doing business in China?"

I've written about cultural issues in business before and cited examples of cultural incompetence which created business problems in China for both Dell and Starbucks. The author of that question responded by posting a link to an article in "China Business Services" titled "China Mobile Eats Apple for (i)Breakfast"

We can now add Apple to the list of Western companies behaving poorly in China. For those that haven't been watching, Apple approached China Mobile with a deal similar to the one it offers AT&T. Following Apples long tradition of price skimming (selling new products for a premium), Apple sold its new iPhone through AT&T at an inflated price AND demanded what is reported to be 50% of the service fees AT&T charges for the phone.

China Mobile was an ideal partner for Apple in China. Enjoying 70% market share in the Middle Kingdom, China Mobile is widely recognized and has the infrastructure to support rapid market penetration of the iPhone. However, China Mobile is much different from AT&T in one important respect: China Mobile sells cellular service, not handsets. After all, this is the country where they are made. Handsets are readily available in more variety and cheaper than China Mobile could offer them.

By offering to support iPhone sales in China, China Mobile would have been offering Apple a service, not the the other way around. Apple's response was a demand for up to 30% of the service fees charged by China Mobile for iPhones. Can you say "slap on the face"?

According to the article, China Mobile is already at work spinning the issue with the Chinese consumer. This has now become an issue of nationalistic pride. Mr. Gao Nianshu, general manager of China Mobile's date department presented lessons learned to a local group of MBA students:

• Understand the increasing power of local players and technologies (and decreasing power of foreign ones);
• Note that business drivers and perceived benefits may be different for a local firm (especially a dominant one - or even a less dominant one, such as China Unicom, that suddenly becomes partner of last resort!);
• Keep discussions private, but be ready to play the consumer PR game;
• Appoint, use, and listen to local managers who know the local market;
• Have a “Plan B”!

His mention of a "Plan B" is interesting. Apple has been having the iPhone manufactured in China and Taiwan in contract factories. I know for a fact that iPhone technology has been presented to other manufacturers (non Apple affiliated) in China for mass production. We may be seeing a China Mobile version of the popular iPhone soon.

Apple really blew it on this deal. If they can't get China Mobile back to the table, they will face an uphill battle for market share in China. In fact, they may miss the huge opportunity they saw in China altogether.

Starbucks Coffee: The Visionary is Back

In the article "Can Howard Schultz Save Starbucks?", Howard Schultz has returned as CEO and is reaffirming the company's ambitious growth plans with a long-term target of 40,000 stores, half of which will be in the US. Starbucks now has 15,000 stores in the US, so international expansion is going to be aggressive.

The article alludes to Russia, Brazil and India being other focuses of international expansion, however I think China will yield the best ROI for the company. If you read two posts ago, I explained the unique opportunity Starbucks enjoys in China, selling brand rather than product. Facing pressure from less expensive competitors domestically and abroad, strategic pricing in China would give the company a competitive edge globally.

I recently read a book that illustrates this point very well. In "Winning the Profit Game", the authors make a point by linking price and brand. A 1% improvement in price yields a 7.1% improvement in profit. We discussed this financial model quite a bit in grad school, but opportunities to use it don't come along very often. Considering that Starbucks' global strategy is to develop a full 20% of its profits in China, maximizing profits there would make a huge difference to the coffee giant's bottom line.

"Grease Payments": Uncle Sam Has Long Arms

Outside the United States, bribery is fairly commonplace. In fact, in some parts of the world, Maylasia for instance, bribes are expected and businesses may find it impossible to get anything done without offering them. However, what many don't know is that US citizens can be prosecuted in the US for engaging in bribes - directly or indirectly - even when they are not on US soil.

Initiating payments to foreign government officials, even if made outside of U.S. jurisdiction, could trigger severe criminal penalties under the U.S. Foreign Corrupt Practices Act (FCPA). The U.S. Foreign Corrupt Practices Act (FCPA) prohibits U.S. firms and their overseas subsidiaries from “giving high foreign government officials either money or material items of value in return for assistance in obtaining or retaining business”.

Obviously this puts US firms overseas at a distinct disadvantage compared to their foreign competitors. Therefore, the FCPA allows specific exceptions to this rule. These include:

• Payments that facilitate or expedite “routine government action”, such as granting work permits or clearing goods through customs;
• “payments that are legal under the written laws of the host country;
  
• “bona fide expenditures (e.g. reimbursement of travel and lodging expenses) incurred for the promotion, demonstration, or explanation of products or services of the U.S. business interest"

Starbucks Changes Tactics in China

Here's an interesting article about Starbucks in China: "Starbucks adjusts its formula in China" Being somewhat familiar with Starbucks from a professional standpoint as well as a recent business student who worked on numerous Starbucks case studies, I think I can safely say that Starbucks expected to enter the Chinese market with the same business strategy it uses in the US. However, market penetration was slower than expected.

Facing declining stock prices, (what surely must be close to) domestic market saturation, and supply issues that loom in the foreseeable future, Starbucks has put a lot of its earnings expectations in the Chinese market. Starbucks is currently forecasting a full 20% of their profits to be from the growing Chinese market.

In this article it appears that they are finally starting the see the Chinese market as a different kind of animal. In contrast to the US, Chinese consumers see the coffee giant as a destination restaurant of sorts. With a cup of coffee costing as much as a days earnings for many, the newly emerging Chinese middle class see Starbucks as a trendy place to present themselves as affluent and sophisticated. I think that being seen with a cup of coffee rather than the traditional tea, they are also presenting an image of "westernization".

By increasing their seating area and focusing sales on the "Starbucks experience" or "third place", Starbucks is starting to realize its challenge and its true product in China: BRAND. This is a relatively unique situation in business. In China Starbucks' value proposition is actually its brand, and by increasing prices there, it will actually increase its value proposition to customers. This is a rare window of opportunity... I wonder if they'll get it?

Starbucks' second challenge in China will be in protecting its brand. Opening a store in the Forbidden City (which was closed by the government) and at the Great Wall was a huge mistake, outraging and alienating the proud Chinese. They'll need to balance market penetration with cultural sensitivity if they wish to continue to capitalize on their brand in China.

Dell Rethinks its Chinese Market Strategy

Dell came met with the harsh reality of the Chinese market. Relying on the business plan that made it so successful in the US, it intended to duplicate its systems in China. Offering online sales, Dell has always been able to offer cutting-edge technology to it customers for far less than its competitors by building each machine to the specifications of buyers. Carrying costs and overhead associated with traditional "brick and mortar" businesses were eliminated, streamlining Dell's finances.

In China Dell tripped up for the first time. In a country rapidly emerging from 3rd World status, most consumers generally want to actually see and feel the product before buying, especially for an enormously expensive "luxury" item like a computer. Remember, this is a country where the average annual income for urban Chinese is $1,000/year, and those in rural areas average around $300/year. Further, internet access is not widely available and credit cards are non-existent. China is a cash society.

Dell has addressed these issues by going brick and mortar in China, attempting to build a presence in a relationship-based culture. Further, they recently launched the EC280, a computer Dell hopes will meet demand for first-time PC buyers in China's rural areas according to the Shanghai Daily. However, priced at 2,300 Yuan or approximately $310 US, I think they're still missing the mark.

OLPC's XO laptop is a mere $100 in comparison, and is designed specifically for the relatively harsh conditions of a 3rd World rural area. It also has networking capabilities that Dell's computer will not, increasing the range of wireless internet to ridiculous distances, something that will be needed in rural China. Moreover, OLPC is working through United Nation's education programs which will likely give the company an edge over Dell, a US for profit company. With products like this on the market, I think that Dell's will be a tough sell in rural areas.

Dell's change of strategy will give it the edge it needs - in the urban areas of China. But if they intend to get any market share in rural China, they're going to have to go on a field trip to see what the market actually looks like.

Mattel's Apology to China: Cultural Lessons Learned

I was reading another blogger's response to Mattel's public apology to China regarding the massive toy recall that Mattel was forced to implement when it was discovered that its toys being manufactured in China were contaminated with lead paint. His reaction was outrage:

"Mattel's apology should be publicly and vociferously deplored, not simply for the craven act itself, then for its assuredly lasting after-effects upon other foreign firms, who will now find themselves pressured to act similarly, at pain of who knows what sanction."

I think that Mattel's decision confused most Americans, and I still wonder if it might open them up to potential legal liability. HOWEVER, I strongly feel they made the right decision, considering the circumstances.

When the story broke, Mattel laid a good share of the blame on Chinese manufacturers, and by default the Chinese government that represents them. Mattel's strategy was to pass negative press on to a logical scape goat. After all, the Chinese government has no share holders, and to this day no one knows the names of the contract factories Mattel was using to make the lead-laden toys. Mattel saw this as a PR issue and passed the problem to an anonymous Chinese system. This is a typical American response to a PR nightmare like this.

However, the massive publicity the story got was an embarrassment to the Chinese. Those of you who are familiar with Asian culture will recognize the importance of saving "face", especially with the 2008 Olympics right around the corner. (The 2008 Olympics are causing face saving headaches for the communists already).

The communists were backed into a PR corner and had no recourse but to penalize Mattel - and perhaps every other Western business operating in China. In a country of inexpensive labor, government officials that turn a blind-eye to labor laws and no government inspectors to insure the quality of manufactured goods, Western manufacturers operating in China had a LOT to potentially lose. My guess is that other manufacturers got to Mattel before the Chinese government had to formalize a response, their message being: "Don't rock the boat!"

The "Secret" About Trade Secrets

In my last post I discussed various forms of intellectual property (IP) protection. Today I'd like to discuss trade secrets in a bit more detail. When dealing with intellectual property it's been my experience that most businesses/IP owners favor what is perceived as the more traditional, tangible protection afforded by patents. However, in many cases patents actually expedite the theft of IP.

When filing a patent, IP owners must provide detailed drawings, recipes or procedures on what the IP is that is going to be protected. Suppose you have invented a revolutionary widget... when you file a patent on your widget, you will have to provide engineers drawings or blueprints on exactly how you make your widget including materials, processes, etc.

While the patent you filed gives you positive protection for your widget, drawbacks of the patent process are:

• The patent is available to the public. The detailed information you provide could be used by unscrupulous competitors to bypass the research and development expenses you laid out to develop your widget, allowing them to mass produce it immediately.
• Your patent filing alerts the world that there is a new widget technology available, allowing competitors to react before your widget goes into production.
• A patent is only valid in the US for a term of 20 years.
• Patents can only be protected through costly litigation.
  

By NOT filing a patent on your widget, you could enjoy all the benefits of a patent without the drawbacks. Trade secrets are enforceable by law just like patents, as long as the IP owner follows specific guidelines to insure that the proprietary information involved in their widget is kept secret (i.e. employees are aware that your widget is a trade secret). Trade secrets can be protected this way in perpetuity.

Let's look at our KFC example from my last post. If KFC filed a patent on the process it uses to make its chicken (including ingredients), competitors could make chicken very similar to that of KFC. Further, since KFC has been in the marketplace more than 20 years, their patent would have expired long ago, ushering in competitors offering the same product.

Trade secrets can be a better option than patents for IP owners with revolutionary or difficult to reproduce technology.

Intellectual Property Rights

Intellectual property rights protection issues get a lot of attention in the media, but it seems like the terminology used in discussions about IP protection is almost interchangeable. In fact, the methods which you use to protect IP have significant strategic importance to your firm.

Patent
Patents protect tangible items or processes by prohibiting others from making, selling or importing material that utilizes the ideas contained in the patent. Patented items could be processes, machines, manufacture processes or compositions. In the U.S. a patent is protected by law for a term of twenty years.

An example of a patent would be a new drug which a pharmaceutical company developed after substantial research and development costs. The patent protects the pharmaceutical company’s investment in the new drug, preventing other companies from copying it, while its costs are recouped in the market.

Copyright
Copyrights protect intangible intellectual property such as works of authorship (i.e. books, movies, pictures and software) by preventing others from copying, making derivative works, displaying, performing or distributing that property. Copyrighted material is protected for seventy years after the death of the author/artist or a total of 95 years from publication for a company.

An example of a copyright would be a movie produced and distributed on DVD. Copyrighting the material makes it illegal for others from simply copying the DVD and distributing it themselves for a profit. The copyright law allows the company who produced the work to recoup the costs, etc. involved in producing the movie.

Trademark
A trademark is a symbol, name, slogan, or image which is used to identify a company or brand with consumers. Trademarks allow a company or brand to capitalize on consumer’s past experience and expectations of the product or service it represents, thus reducing marketing costs. Trademarks are protected indefinitely in the U.S. provided that the owner of the trademark utilizes the trademark properly.

An example of a trademark would be the Coca-Cola symbol. The symbol is known around the world and customers who see that symbol are familiar with the Coca-Cola beverage as well as the Coca-Cola family of beverages associated with it. Because of its nearly universal recognition, Coca-Cola saves money in advertising what the product tastes like and what to expect when they purchase their product.

Trade Secret
Trade secrets are information that a company holds secret to prevent competitors from gaining and advantage on that company. Trade secrets usually hold information that allows a market advantage to a company, or a method to reduce costs, thus directly affecting profitability. Trade secrets are not patented as this would entail the release of the details of that secret.

An example of a trade secret would be what the eleven herbs and spices are in Kentucky Fried Chicken’s secret recipe. By keeping this a secret, KFC prevents competitors from directly copying their product offering to the market.

Foreign Market Entry: Business structure

Before expanding into a foreign market, careful consideration must be made regarding the type of business entity with which the firm will enter that market. Each organization type has specific strengths and weaknesses that should be carefully weighed according to the business and legal climate of the country we are entering and our business strategy. Following are three types of business organizations typically utilized when entering a foreign market: joint venture, distributorship, and wholly-owned subsidiary.

Joint Venture
A joint venture is a business partnership between our firm and another. Typically (but not always) this type of business partnership is forged with a firm already in the market which will be entered.

A joint venture with a company in the target country would allow our firm to enter that foreign market capitalizing on the pre-existing business network/systems and reputation of that business partner. In addition to deferring part of the risk involved in this type of business endeavor, a joint venture market entry allows minimal entry costs as the joint venture partners’ pre-existing presence can be exploited by our firm. The customer base, reputation and distribution network of our partner firm will allow our firm rapid market penetration with a minimum of supply chain and marketing problems. Additionally, our joint venture partners’ access to suppliers and local financing will ease potential problems associated with a foreign business operating in that country.

However, a joint venture endeavor does have potential risks and drawbacks. In addition to sharing profits, a joint venture business partner will likely be involved in the management of our business concerns in that country to some extent. This could potentially lead to conflicts in business/management priorities. These conflicts could include issues which affect profitability, ethics, and situations that could potentially lead to litigation. As a part of performing due diligence, our firms’ “exit strategy” (i.e. the expected length of this business relationship and the terms of its termination and contingencies should problems with the venture partner arise) should be fully explored with an attorney experienced in joint ventures between the US and firms of the foreign country.

Distributorship
A distributor is a local business entity that agrees to purchase our goods and, in turn, re-sell them locally. Typically, the distributor is responsible for carrying inventory for the market and is the local service provider for warranty claims. As far as the buyer is concerned, the distributor is the “face” behind our products.

This type of relationship allows market entry with yet lower entry costs, and offers the added benefit of deferring direct costs of doing business in the foreign country to the distributor. As a result, start up costs are nearly non-existent; the distributors existing business operations are used exclusively. Because of this, this arrangement allows immediate market penetration.

It should be noted that distributors do typically take a larger percentage of profits than partners in a joint venture relationship. Therefore, over time the distributorship relationship will be more costly. Further, with this type of market entry, our firm will have no contact with the market and no control over how our products are represented there. Other unrelated products sold by the distributor may also compete with ours for representation, especially if they have higher profit margins. If our products are poorly represented in a situation like this, our firm may have little or no recourse to remedy the situation. Worse yet, it may be costly and time consuming to end a distributorship should our firm choose to alter our presence in that market. Again, an attorney with experience with US firms seeking distributorship relationships in the foreign country should be consulted prior to taking any action to thoroughly explore the risks and possible contingencies involved.

Wholly-Owned Subsidiary
A wholly-owned subsidiary is a new business entity in the foreign market owned completely by our firm. The manner of organization of the new business entity (i.e. LLC, Corporation, or a different legal organization specific to the foreign country) would be determined by the needs of our firm and the laws and regulations of the foreign country.

A wholly-owned subsidiary presents the best option for greatest control over market entry. It also allows for greater profitability as profits will not be disbursed between business partners or consumed by a distributor. Our firm will have direct contact with customers, the distribution chain, creditors and the local industry. As a result, this presents the best opportunity for long term growth in the foreign country and will allow for easier future expansion in the region.

Entering the foreign market does increase risk considerably, however. Our firm would have to bear 100% of the expenses involved in market entry, and should the entry fail, 100% of the losses. Further, local regulations may restrict or even prevent a foreign business from entering the market without a local business partner. As a result, delays in entering the foreign market due to legal problems could be lengthy and costly. Further, entering as a wholly-owned subsidiary may present potential conflicts between local law and US law, and local business practices may create cultural/ethical problems that will be difficult to resolve without local partners. As a wholly foreign owned company, future legal problems of any kind could be problematic depending on the structure and temper of the local legal system. Arbitrary findings against foreign corporations operating overseas are not entirely unheard of. A lawyer experienced in the country targeted for expansion into should be consulted to explore the viability of entering the country as a wholly-owned subsidiary as a part of performing due diligence.

Each form of business structure has strengths and weaknesses. In deciding which structure to utilize in entering a foreign market, careful consideration should be made regarding both our firms’ strategy and the legal risks and ramifications associated with that strategy. It is imperative that competent, experienced legal counsel be consulted to examine that strategy prior to committing to any action.

Building a Performance Culture

In the past 100 years it has been innovation in business management more than any other factor that has allowed businesses to cross new performance thresholds. Consider for a moment the business landscape in which we operate:

• Sophisticated brand segmentation
• Educated consumers
• Extremely competitive marketplace
• Mature markets
• Extreme transparency

Management is really the only factor that can set a business apart from its competitors. By creating a corporate culture that is performance oriented, businesses can maximize their competitive edge.

What is a Performance Culture?
A performance culture is developed by throwing out conventions on the way things are or have been done in the past and instead focusing on processes that achieve results, and specific metrics that objectively and reliably measure those results according to the organization's goals.

The first step toward developing a performance culture is development of strategy. By developing strategy, a firm can identify its strategic intent, looking at marketplace insights with a focus on innovation to help develop a business design. Once this is determined, the human assets necessary to implement the strategy can be identified.

Human Resources plays a vital role in building a performance culture within an organization. Once strategy has been devised at the corporate level, execution is arrived at by aligning talent (i.e. personnel), modifying corporate climate and culture and critical tasks to affect the formal organization of the firm. In order to enact this change within an organization, Human Resources must be drawn into the strategic processes of the firm, which is a huge departure from the role HR plays in today's business environment.