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It is true that Chinese consumers are spoilt for choice as competition for their attention continues to intensify.

 

The figures certainly support this assertion. Shampoo sales were more than 20 billion yuan (US$2.5 billion) last year, up from less than 10 million yuan (US$1.25 million) at the end of the 1980s. For the numerically-minded, that's 2,000 times in a matter of about two decades.

 

Companies selling the stuff should be jumping for joy, but the sobering truth bringing them down to earth is that there were only five or six brands in the 1980s, whereas now there are nearly 3,000.

 

Some more numbers: Over the same period, the number of toothpaste brands rose from 100 to almost 800. Fruit juice makers were unknown two decades ago, now there are more than 160. More than 100 car models were launched in 2004, double from only two years before.

 

"China's market is not just big, it is also increasingly crowded. For foreign companies, making money here demands more effort," says Alan Horton, an analyst at US-based Summit Consulting Co.

 

He won't say it but it is clear that sheer brand power will not carry the day, or the cash register, any more. It is not just a gentleman's contest among themselves, but also against aggressive domestic competitors.

 

"This is a new strategic challenge for multinationals. The emergence of strong local companies is creating a formidable challenge," he says.

 

Competition, which in many markets was almost non-existent in the 1980s and 1990s, is becoming intense, agrees Wang Zhile of the Chinese Academy of International Trade and Economic Cooperation. Wang is an expert on multinationals in China.

 

It's tough out there. Big multinationals, smaller firms from Europe and the United States, ambitious companies from the rest of the Asia and domestic players all want a slice of the market.

 

The challenge from domestic companies is particularly intense, Wang observes.

 

Domestic companies have grown in confidence and have improved the quality of their products, helping them move into the middle and even upper segments, he says. "This has been a painful development for multinationals."

 

Foreign firms have been forced to move in the other direction, cutting prices in an attempt to hang onto market share, but losing profitability in the process.

 

For instance, domestic companies' forays into flat panel TV production has meant profit margins have plunged for the likes of Sony and Matsushita, which have been forced into price cutting.

 

Procter & Gamble (P&G) and Unilever are well entrenched in China, but their early dominance of some markets has been whittled down by domestic competition. According to Euromonitor, a global market research company, the domestic Diao brand now dominates China's detergent market, with a share of almost 25 percent. Unilever's Omo is in third place, with a share of just 10 percent.

 

"Margins were very high till 2003 but there have been several price reductions since then, and there will continue to be additional reductions as consumers have more choices and as more competitors come to the market," says Troy Clarke, head of GM's Asia-Pacific division.

 

"With competition coming in with even cheaper, better products, those that can't come up with new strategies could be in trouble," Wang says.

 

Going local

 

So how do multinationals cope? Going Chinese seems to be the direction chosen by most, either by cutting costs or by developing more locally popular products.

 

"You can't survive in China without becoming a Chinese company. That includes local technology development, product design, procurement, manufacturing and sales," says Yun Jong-Yong, chief executive of Samsung Electronics, the most profitable technology company in the world.

 

If Samsung tries to sell products developed in South Korea, it could fail because the same products can be developed in China much more cheaply, Yun says.

 

Until 2004, the company did almost all product development and design at home and used China only for manufacturing.

 

"Gradually we are transferring development and design functions to China up to a certain level. We now also use Chinese parts," he says.

 

Gary Coleman, global managing director of Manufacturing Industry Practice with Deloitte, says multinationals should not use traditional ways to grow profitably in emerging markets like China, despite their strong international management experience.

 

"Emerging markets around the world offer significant growth potential, but the most successful and profitable companies will be those that really understand their customers and take a different approach," he says.

 

"Companies will need to acquire a new set of competencies and organizational structures to generate a continuing stream of innovative products tailored to the needs of consumers and industrial buyers in emerging markets."

 

He says multinationals now need to look at developing tailored product offerings for the local market, building local research and development (R&D) capabilities, integrating local supply chains onto the global level, and maintaining margins.

 

It is also important to acquire deeper customer knowledge and find the best talent, he adds.

 

Some multinationals have rised to the challenge of slimmer profits in China, but that is only the beginning, because they will need more strategic planning and deeper reforms, says Xu Deyin, a professor with Guanghua School of Management, Peking University.

 

There is no one-size-fits-all solution, and different companies need a different mix of strategies, he says.

 

Companies such as Siemens, P&G and UPS have stopped working with their Chinese partners and have become wholly foreign funded companies, as wholly owned ventures are, on average, more profitable than alliances, Xu says.

 

Many international giants are restructuring their operations and promoting internal reforms.

 

They aim to apply a common strategy by setting a single goal, a single plan and a single brand. The most apparent benefit is in financial flow, Xu says, adding a unified financial system could help shave a third off overall costs for multinationals in China.

 

But cutting costs is only part of the equation. Since many foreign corporations may never be able to reach cost parity with their Chinese rivals, they will have to think of other ways to create value, Xu says, adding that the most common approach is to rethink their distribution systems and have more R&D facilities locally.

 

Profit margins

 

But generally speaking, the profit margins of foreign companies are better than domestic companies, says the Chinese Academy of International Trade and Economic Cooperation's Wang.

 

According to the Beijing Statistics Bureau, profits of foreign companies were eight times that of local companies in 2004.

 

Exactly how much profit multinationals make in China is not an easy question to answer, however. Hard data on profitability is usually difficult to come by, partly, observers say, because enterprises tend to understate the amount of money they make in order to avoid taxation.

 

Some multinationals also lower their stated profits to have an impact on Chinese companies and erode the time cushion that domestic firms would need on a more gradual, organic path to expansion.

 

It is true that foreign companies face a future of slimmer profit margins as their numbers multiply and competition becomes tougher, says American Chamber of Commerce President Charles Martin.

 

A survey of AmCham member companies last year suggested that about 30 percent were seeing better profits in China than in the world as a whole, down from 40 percent in previous years.

 

"China is acting more like a normal competitive market and we would expect that to continue to happen over the coming years," he says.

 

However, the biggest profit source for foreign companies in China is often overlooked because it is difficult to record, says Wang. The financial gains generated by cheap sourcing in China are impossible to document because they show up in the profits of multinationals in their traditional markets in the United States and Europe.

 

The export businesses of foreign firms similarly often show little or no profit. This is less a reflection of reality than of transfer pricing as foreign firms attempt to avoid capital controls and taxes in China. For instance, Wal-Mart buys more than US$12 billion worth of goods in China every year - and more than 50 percent of China's total exports are produced in foreign-invested factories.

 

(China Business Weekly February 20, 2006)