The original equipment manufacture (OEM)/joint venture (JV) route.
Forming joint ventures with foreign enterprises, entering into a partnership with them through original equipment manufacturing or licensing their technology, is a route chosen by many Mainland enterprises. Evidence suggests that partnership with a multinational enterprise, more so than with an overseas Chinese firm, can be an effective means of transferring modern practices to the Chinese firm thereby helping to strengthen its eventual international competitiveness (Child and Yan, 2001; Guthrie, 2005). This route amounts to a kind of ‘inward’ internationalization in which there is a close, continuing, operational and organizational relationship with one or more multinational enterprises of a kind that permits the transfer of competencies and knowledge relevant to eventual ‘outward’ internationalization through exporting and/or investment abroad.
OEM combines the cost advantage of a Chinese enterprise with the brand advantage of a foreign firm. Galanz illustrates the successful application of this strategy. A township and village enterprise (TVE) based in Shunde, Guangdong Province, Galanz has become the world's largest manufacturer of microwave ovens. It also commands two thirds of the Chinese domestic market. Originally, Galanz wanted to build its own brand in the international market, but failed to do so. It then chose the OEM route, producing microwaves for many different international brands (its website claims as many as 250). In so doing, Galanz has moved towards an ‘Intel-inside’ strategy. As it grew into a dominant manufacturer, and as its bargaining power increased accordingly, so it was able to print the label ‘made by Galanz’ on all the microwaves it produces. Its website now invites prospective customers to order directly from Galanz (http://www.galanz.com/news, October 27, 2004). Clearly, this strategy is enabling the company to build up its own strong international brand for the future (Zhang, 2003). Moreover, Galanz has now invested US$20 million in an R&D center in Seattle in order to improve its own independent technological capability (Chung, 2004).
The Chinese authorities have consistently favored international joint ventures as a means of transferring technology and expertise to Chinese firms (Peng, 2000). Many joint ventures also involve the licensing of foreign technology. Technology partnerships, in particular, have enabled some Chinese firms to acquire knowledge of considerable competitive value. Indeed, the hand of government policy can be seen here in that a willingness to provide Chinese firms with access to technology has often been a condition of permitting foreign firms to establish in China. Huawei provides an example of how the joint venture route strengthened a Chinese company's international competitive capabilities. A collective enterprise founded by a former army officer in 1988, Huawei is now seriously challenging the global market position of multinationals such as Cisco Systems in the field of network equipment. It has entered into a number of joint ventures – for example, to develop and make 3G phones with NEC and Siemens, and with the Electronic Data Systems Corporation to market Huawei's equipment in the USA. In 1999 it established a software development center in Bangalore (Business Week, 2003). Another example is Ningbo Bird, a leading mobile phone producer, which acquired its system designs through a partnership with France's Sagem and has other technology partnerships with LG of South Korea and BenQ of Taiwan. Ningbo Bird has become a major exporter, encouraged by fierce domestic competition and aided by the technology it has acquired. (Business Week, 2002).
In the process of developing a sufficient corporate reputation for the eventual launching of an international brand, the OEM route offers Chinese firms the advantages of preserving their own identity, achieving economies of scale, and gaining a reputation in their own right for manufacturing excellence. OEMs can also permit an accumulation of financial resources that can be used to acquire international assets later on. By contrast, the formation of a joint venture with a foreign partner ties a Chinese firm more closely into the internal network of that partner. This can offer a more effective channel for the transfer of tacit knowledge to the Chinese partner, not just in production and distribution but also in other areas where internationally competitive standards need to be achieved (Inkpen, 1995; Simonin, 2004). The transfer of tacit knowledge can be especially important for enabling the Chinese recipient to make good use of technology. However, the Chinese partner's identity tends to be subsumed into that of the joint venture, which is often associated with the foreign partner's name and reputation rather than with those of the Chinese partner. The Shanghai Automotive Industry Corporation (SAIC), discussed in the next section, is a case in point. Thus, while joint ventures may offer an effective path towards securing the technological basis for a differentiation advantage, they may not be as effective as the OEM route for Chinese firms to build up an independent international reputation.
The acquisition route.
The number of international acquisitions by Chinese firms has grown markedly in recent years. They were valued at US$2.85 billion in 2003 and have been forecast to reach as much as US$7 billion in 2004 (Business Week, 2004a). The 44 foreign acquisitions by Chinese companies in the year to October 2004 were one-third higher than those in the previous year (McGregor and Guerrera, 2004). Some major acquisitions have been undertaken by large state materials processing corporations with the intention of securing raw material supplies and this type accounts for just over one half of all Chinese overseas acquisitions by value (McGregor, 2005). However, while such acquisitions may eventually support a strategy of global competition, they currently do not appear to be motivated by this consideration and we shall therefore not consider them further here.
The dominant motive among non-primary producing Chinese companies for undertaking foreign acquisitions has, by contrast, been to accrue market strength. They have undertaken acquisitions to gain access to technology, to secure research and development skills, and to acquire international brands. Acquisition provides a fast route to these benefits and it can also deny them to competitors. The ‘push’ factor of domestic institutional restriction can also apply in that while international acquisitions by Chinese firms are usually officially encouraged, domestic acquisitions often are not, which removes one path for growth. Governmental authorities concerned at the political consequences of creating industrial giants have sometimes thwarted the take over by Chinese firms of other enterprises within China, and local officials have opposed them even more frequently because of their fears of losing control of the local firms that are acquisition targets (Meyer and Lu, 2004).
The Holly Group provides an example of foreign acquisition aimed at securing proprietary technology (Warner, Ng, and Xu, 2004). Holly, which began in 1970 as a rural township and village enterprise (TVE), specializes in the production of energy-meter equipment and instruments. In 2000, it published an ‘Internationalization Strategy for the 21st Century’, in which it stated its objective of positioning itself as a successful multinational enterprise on the basis of acquiring highly competitive competencies in its specialized field. A major step forward towards implementing this strategy was Holly's acquisition in September 2001 of the CDMA hand-set reference design operation from Philips Semiconductors in the USA. Through this acquisition, Philips Semiconductors transferred to Holly its equipment, assets, know-how, and intellectual property rights connected to hand-set reference designs. Holly also secured an exclusive license to process the CDMA software protocol that Philips had earlier developed. Moreover, Philips undertook to supply Holly with key silicon components thus enabling the latter to continue to develop and market the licensed products.
The deal that SAIC negotiated for many months in 2004/05, and then decided not to pursue because of contingent liabilities, would have involved an acquisition of the UK's MG Rover Group (or at least a majority stake in its ownership). This would have given SAIC control over MG Rover's automotive brands, design, and technology. The project illustrates a major Chinese acquisition aimed both at boosting technological capability and securing access to an international brand (albeit a fading one). SAIC had already paid about US$90 million to MG Rover and its associate Powertrain to secure the rights to engines and transmissions technology. SAIC has publicly stated that it seeks to sell 1 million vehicles a year, including 50,000 of its own branded cars by 2007. It already has two successful joint ventures in China with Volkswagen and General Motors, but these large MNC partners own the brands and the crucial technology. SAIC is therefore motivated to acquire its own technology and brand through an international purchase (Financial Times, 2004a; The Guardian, 2004).
The acquisition by Lenovo (previously Legend) of IBM's PC division for US$1.75 billion, announced in December 2004, allows it to use the IBM brand for five years and gives it control of the Think trademark of IBM's popular ThinkPad laptops. The deal not only provides Lenovo with IBM's brand, it also enables it to acquire IBM's laptop production lines, product developers, and distribution networks. The President of Lenova clearly stated that this move was intended to make it possible for his company to challenge Dell and HP in global markets. He is quoted as saying that ‘we are not satisfied to be only number three’ (Financial Times, 2004b).
This particular acquisition illustrates a number of factors of importance in an analysis of Chinese internationalization. First, there is the impact of tough domestic conditions, which both impel a Chinese company to enhance its competitive advantage and also add to the attraction of foreign markets. Lenova's margins have come under increasing pressure in its domestic market from local and foreign competitors. Although still China's PC market leader, its position is coming under growing attack, especially from Dell. Its share price fell by 23 percent in 2004. Its gross margins have been less than 15 percent, while IBM's gross margins in its PC business are 20 percent.
Second, while an acquisition of this magnitude requires the formal approval of the Chinese authorities, their role in facilitating it goes much further. The Chinese government holds a 57 percent stake in Lenova's ownership, and there can be little doubt that the financing of the deal is also underwritten by the state (Business Week, 2004b).
Third, the acquisition offers Lenova a dramatic step up the world league table, quadrupling its annual sales to over US$12 billion, so long as it can retain IBM's customers and employees, and manage a large foreign business. It is, however, a major challenge for a Chinese firm without significant international experience to manage global expansion of this order. The management of this major internationalization will have to overcome major differences in managerial culture and style. It will incur a heavy liability of foreignness. This raises questions concerning its ability to build a global reputation sufficiently rapidly to retain loyalty to the acquired brand in the international marketplace. Doubts have been raised about Lenovo's ability to preserve confidence in the IBM PC brand; for example, one IBM user commented that ‘it feels uncomfortable; international IBM has become domestic Lenovo’ (Financial Times, 2004c). In order to reduce these risks and the liability of foreignness, Lenova is appointing a senior IBM vice-president as its chief executive, transferring its head office to New York, and retaining IBM as the preferred supplier of after-sales service outside China. IBM will also take an 18.9 percent stake in Lenova. This indicates the company's recognition that it has to acquire the competencies to manage a large foreign operation, which is an additional type of asset that internationalizing Chinese firms in general need to seek.
A further condition for value in an international brand is that it needs be a strong rather than a failing one. This condition is not always met. An example, just mentioned, is the Rover marque that SAIC considered purchasing. TCL's purchase of a controlling stake in France's Thomson gave it a loss-making business with a severely faded TV brand (RCA). Moreover, in the case of TCL and Thomson, major differences in culture and corporate practice have created greater management problems than expected, especially over issues such as pay levels and communication across two languages (The Economist, 2004).
In short, the acquisition route for securing international differentiation and brand advantage is being favored by an increasing number of Chinese firms. It appears to offer a rapid advance toward achieving these objectives, though it is too early to assess the extent to which Chinese companies can handle post-acquisition integration and management challenges successfully. Such problems can be formidable for acquisitions in general, and international ones in particular (Child, Faulkner and Pitkethly, 2001). Nevertheless, an increasing number of Chinese companies are undertaking international acquisitions. While some have cash resources through achieving reasonable profits – for example, Lenovo made a profit of US$128 million in 2003, despite falling domestic margins, and TCL's profit was US$163 million – it is unlikely that they could bear the financial risk without support from governmental authorities whose approval is in any case required. The revaluation of the Chinese yuan against the US dollar, by reducing the price of foreign assets, may accelerate the process of acquiring foreign assets, just as the strength of the yen encouraged a wave of Japanese foreign acquisitions in the 1980s.
The organic international expansion route.
This route toward international expansion involves the greenfield establishment of subsidiaries and facilities within targeted markets. It is initially aimed at securing differentiation advantages in terms, for example, of adjustment to local market needs and tastes. It may, as in the case of the Haier Group, also be the main component of a strategy aimed at gaining global brand recognition. It is also a route that maximizes managerial control and the possibilities for global integration.
Haier is the best-known example of a Chinese firm that has internationalized primarily through the organic expansion route. It was also one of the first Chinese enterprises to implement an internationalization strategy, when it started to export to Europe and the USA in 1990 and to Japan in 1991. Today, Haier is considered to be ‘the official template for the Chinese MNC of the new millennium’ (Warner, Ng, and Xu, 2004, p. 334), and its CEO Zhang Ruimin is probably the most respected Chinese business leader worldwide (Zhang, 2003).
Haier began in 1984 as a collectively-owned enterprise – the Qingdao Refrigerator Factory. Its range of manufactured goods today includes various white goods, air conditioners, microwave ovens, and color TVs. It has 19 production factories outside China and two ‘production parks’ in the USA and Pakistan. Although it established subsidiaries after 1996 in nearby developing countries such as Indonesia, the Philippines and Malaysia, its main internationalization thrust has been directed at highly developed regions. Thus Haier started exporting to Europe, Japan and the USA in the early 1990s, in keeping with the philosophy of CEO Zhang, namely ‘enter a difficult advanced market first, then go to easy, underdeveloped markets’ (Kiran, 2004, p. 2). The idea behind this strategy is to build an international brand name by competing in the markets that are the hardest to enter and then gradually to expand to other markets. Addressing difficult markets first is seen as a way of obliging the company to achieve high quality, innovation and customer service – foundations on which a recognized brand can be built. This approach reflects the company's own historical experience. Its emphasis on quality dates from its near bankruptcy in 1985 due to a collapse in sales of poor quality products. After this crisis, Zhang Ruimin, as newly appointed CEO, introduced a rigorous total quality system. The company at that stage imported a considerable amount of foreign know-how and technology.
Despite undertaking some acquisitions and joint ventures in its overseas expansion, Haier has to a significant extent followed the path of organic diversification. This has been particularly apparent in the United States. Haier started to export to the US market in 1990, but realized that it was handicapped by not having a locally recognized brand name. It was also vulnerable to American quota restrictions and potential anti-dumping suits (Deng, 2004). Returning in the late 1990s, it invested US$40 million in a new production plant in South Carolina that started operation in 2000. It established a design center in Los Angeles and a trade center in New York. Haier initially aimed its US production at niche segments in the household appliances market with innovative products, having the intention to enter the regular white-goods market later. After gaining customer loyalty through product differentiation, such as small refrigerators and wine coolers where US manufacturers had a small presence, Haier's products started to be sold in large chain stores such as Wal-Mart and Sears. By 2003, it had gained 50 percent of the compact refrigerator market and 70 percent of that for wine coolers (Kiran, 2004).
Haier is in some respects an unusual case among Chinese internationalizing firms, but it is nonetheless a leading example that others may follow. Its policy of opening up sophisticated foreign markets with direct investment after only a short period of exporting does not conform to the economic argument that firms will engage in international business primarily on the basis of factor advantage. On those grounds, Haier should have concentrated its entry to international markets on the advantage of low-cost production from China, producing conventional appliances of standard quality for developing country markets. Although it has targeted some nearby developing country markets in south east Asia, it focused on Europe and the USA quite early on. It has also opted for local manufacture at a relatively early stage even in high-cost locations, most notably in the USA followed by Europe. Despite the apparent success of its strategy so far, judgment has still to be reserved. For Haier could be said to be pursuing a high-risk policy, and the company does appear to be incurring high initial investment costs which have been financed by a steady cash stream from its domestic operations. Doubts have been expressed as to how long this policy can be maintained in view of the mounting pressures it is facing on margins in its domestic market (Business Week, 2004c). Moreover, the company's distinct approach is very much a reflection of an outstanding CEO and it also remains to be seen whether it can support its rapid international expansion with sufficient management in depth. Like Lenova, it is trying to enhance the managerial assets it requires through local recruitment.
Internationalization through organic expansion exhibits elements both of asset-exploitation and asset-seeking. Haier had worked hard to establish domestic strengths based on a combination of innovativeness and high quality. These became assets that it exploited when entering sophisticated developed country markets. In Germany, for example, it helped to establish its local reputation for quality through encouraging the ‘blind’ testing of its products against those of local manufacturers. In the US market, the company soon became known for the innovative extra features that its products offered. Moreover, Haier may continue to seek to exploit the asset of low-cost production in China when acquiring new assets abroad. It is, for example, reported that in bidding for the troubled US white goods Maytag company, Haier saw an opportunity of reviving the competitiveness of the Maytag brand by shifting production from high cost USA to mainland China (The Economist, 2005).
Nevertheless, the fact that Haier felt obliged to establish design, manufacturing and marketing facilities in the USA, staffed by Americans, indicates that it has been continuing to seek appropriate assets in its internationalization. In particular, Haier has justified its policy of moving into advanced markets as a means of forcing an acceleration in its learning process which reflects an awareness of a need to catch up with the top players.