Business leaders across China’s industrial landscape just waved goodbye to a challenging and, for many, probably a worse-than-expected 2015. As we head into 2016, the outlook for many players remains rather murky. Though the market is never easily predicted, by analysing past trends and events a picture of the opportunities that lie ahead does start to emerge. Michel Brekelmans and Steve Cao of L.E.K. Consulting provide the analysis.
Let’s start with the economic outlook. The days of double digit growth are definitely over. An average of 6.5 per cent is the ‘new normal’, but is this really that bad? Yes, when you compare it to the 14 per cent growth in 2007. But seven per cent growth equates to CNY 5 trillion in incremental GDP in 2016, which is the same as the entire Chinese economy 20 years ago or the size of the entire Indonesian economy in 2014. In any major economy, seven per cent would be considered an economic miracle – in China, we call it a slowdown!
The headwinds that many industrial companies have been facing in the past two to three years are not necessarily a market growth issue, nor will that be the case going forward. Growth of six to seven per cent per annum means the economy in 10 years will be twice its current size. In most cases underlying end-market growth across many industrial sectors will remain robust. However, other factors are impacting company performance in the short term, such as overcapacity, cutthroat competition and the delay in capital spending caused by China’s anti-corruption drive.
China’s easy days of catch-up growth are over. Ten years ago, all you had to do was be in the right place at the right time and you had a great business. The more critical issue for business leaders now is whether they have the right capabilities, business model and product offering to compete in this new environment.
China’s multispeed economy
Growth in China is not evenly distributed across the economy – China has become a multispeed economy. Some sectors are still showing very fast double-digit growth. For instance healthcare and environmental protection are doing very well and the digital space continues to explode. But other sectors such as automotive are slowing down to single digit growth.
So with average GDP growth around seven per cent and some parts of the economy growing much faster than that, by definition we are seeing some sectors that are flat or even in decline. Suppliers of capital equipment have been hit hard by a fall in demand due to overcapacity. Also, the government is trying actively to rebalance the economy toward more consumption and services and away from investment and infrastructure-led growth.
The demography impact
The Chinese population is greying rapidly, and the size of the working population is shrinking. This trend means labour cost pressures are likely to remain and rising prices in service sectors will prevail. Labour-intensive and low-value-added activities will continue to shift to cheaper locations either within or outside China. Another key trend is the migration into towns and cities. China’s urban population is expected to reach one billion in 2030, which will provide some buffer against the shrinking working-age pool as new workers move from rural subsistence farming into the secondary and tertiary sectors.
The political dimension
More so than in any other market, the business climate in China is shaped by government policy and regulatory developments, and sometimes the lack thereof. The Third Plenum in late 2013 set the stage for China’s reform direction under Xi Jinping over the next 10 years.
The government announced some major paradigm shifts, which have since been given more colour – from quantity to quality, accepting a lower level of growth and a focus on the environment. The role of the government was also to change: from participating in and planning the economy to stepping back. The economy is now too large and complex for the government to control all aspects of it the way it had in the past – the stock market turmoil over the past six months made this abundantly clear. Whether China actually follows through with concrete actions to liberalise key aspects of the economy remains to be seen.
In addition to these promises, China last year proposed several industrial upgrade initiatives, including Made in China 2025, aimed at boosting high technology and innovation over the long term.
Made in China 2025…
The Made in China 2025 programme has begun to provide a level of specificity that gives more direction as to where China is heading and how company leaders should align their strategies. It is interesting that the programme focuses on a 10-year horizon rather than the more typical five-year period. China’s ambition is to become a manufacturing power that leads through innovation and not through scale or costs. There is no long-term value in the latter.
Made in China 2025 specifies the key tasks necessary to achieve China’s industrial ambitions. These include improving manufacturing innovation; integrating technology and industry; strengthening the industrial base; fostering Chinese brands; enforcing green manufacturing; promoting breakthroughs in 10 key sectors; advancing restructuring of the manufacturing sector; promoting service-orientated manufacturing and manufacturing-related service industries; and internationalising manufacturing.
The plan also identifies the 10 key industries that will likely enjoy high-growth prospects within China’s multispeed economy: new information technology; numerical control tools and robotics; aerospace equipment; ocean engineering equipment and high-tech ships; railway equipment; energy-saving and new-energy vehicles; power equipment; new materials; medicine and medical devices; and agricultural machinery.
… or Made in India?
The key theme that cuts across the plan is innovation: China needs to upgrade manufacturing from quantity to quality. There is recognition that China needs to follow this path as it is at risk of getting stuck in the middle. China is not yet able to compete with advanced nations such as the US, Germany and Japan in terms of advanced manufacturing and innovation. At the same time, emerging economies with their own advantages are catching up and could potentially pose a threat from the bottom. Indian Prime Minister Modi last year introduced the ‘Made in India’ concept.
So what does it all mean?
If you are running an industrial product or business service company in China, what’s next? What does it all mean for laymen trying to run a business? They are paid to grow their business in a sustainable and profitable way in order to keep shareholders happy. So what are the concrete opportunities for businesses in China?
Overall, the outlook seems quite positive for those who can bear some of the short-term wobbles:
- Market forces will play a more prominent role in the economy.
- The size of the economy will double in the next 10 years.
- A drive towards innovation and globalisation means a more level playing field.
- Innovation, quality and manufacturing excellence become key competitive levers – pure cost-driven competition or government-relationship models are less likely to succeed.
But the easy days are over. Companies have to pick their battles carefully and develop strategies and capabilities to have lasting success. There are three investment themes that align against the major macro trends and that can support continued development of industrial product and service providers in China.
Automation and robotics
With labour costs going up, many Chinese manufacturing businesses are now experimenting with introducing automation and robotics into their production processes in an effort to save costs and improve productivity.
Green energy and new materials
After the recent commitments from China at the UN Climate Change Conference in Paris the government will double down on its efforts to control environmental impact, creating opportunities for suppliers of technology and solutions in clean energy, lightweight materials, etc.
Business model evolution – from product to solution
Driven by rising labour costs and more demanding customer needs, we are seeing a gradual shift away from competing purely on cost in the industrial product and service space. Customers are increasingly looking at value, and suppliers are increasingly looking at lowering total cost of ownership (TCO) – reducing downtime, optimising maintenance and repair, and improving product life time.
No doubt many others opportunities exist – each will need to be carefully weighed against China’s macro trends and individual company’s resources and capabilities to compete effectively in China’s multispeed economy.
L.E.K. Consulting is a global management consulting firm that uses deep industry expertise and rigorous analysis to help business leaders achieve practical results with real impact. We are uncompromising in our approach to helping clients consistently make better decisions, deliver improved business performance and create greater shareholder returns. The firm advises and supports global companies that are leaders in their industries – including the largest private and public sector organisations, private equity firms and emerging entrepreneurial businesses. Founded more than 30 years ago, L.E.K. employs more than 1,000 professionals across the Americas, Asia-Pacific and Europe. For more information, go to www.lek.com.