MNCs Dilemma on China’s “Good-Enough” market Segment

Chinese economy is growing very fast. It is estimated that it will grow nearly 10% for the next 2 years and by 2030, 36% of world’s Incremental GDP will come from China. China is taking huge advantage of its cost efficiency & leverage manufacturing to serve other regions also. Chinese growth depends upon emergence & fast growing segment of middle group or we can say “good-enough” market segment.

Majority of MNCs provide goods & services in high margin premium segment facing huge dilemma and competition from “good-enough” market segment.

Dilemma in the sense that company is not sure whether to jump into “good-enough” segment or continue with the premium segment. If they jump into good-enough then it can cannibalize their premium segment sales or in other case if they can’t enter “good-enough” segment then other local competitors will take some of the market share locally- Chinese people gives more importance to good-enough market segment where they buy almost same quality of products at lesser price.

Good-enough segments are growing and changing very fast and it becomes more than ½ of the total Chinese market segment.

What should be MNC Company’s strategy regarding good-enough segment? How to determine whether they need to jump into this segment or not? What should be their approach in catering to this segment?

DECISION TO ENTER INTO GOOD-ENOUGH SEGMENT

It can be very tough decision for any MNCs providing services in premium segment to get attracted & involve in catering to 62% market share of good-enough segment.

They have to do their homework properly before jumping into this segment. They need to find out few question i.e. Are the premium segment is still attractive? Is it growing? Are companies still achieving high returns or returns are eroding? What is your position in a current market? Are you a market leader or niche player?

If the company finds that growth of the premium segment is slowing down & returns are eroding and there is future threat from local competitors to capture some premium segment market. In this circumstances company has to take a call to enter into good-enough segment market however they should clearly strategize their approach, how they are going to enter, whether they expand organically or acquire an existing player. How to capitalize on strong geographic distinction so that new offering couldn’t cannibalize premium offering?

However one more important reason that justifies MNCs to get into this segment is that if they don’t enter into this segment then they will face tough competition from local Chinese company not only in the local Chinese market but also in their own backyard.

HOW TO ENTER INTO GOOD-ENOUGH SEGMENT

The goal for the organization is to lower their manufacturing costs, introduce simplified product & services & broaden their network while maintaining reasonable quantity. There are 2 ways through which companies can enter into good-enough segment-

Attacking From Above

MNCs providing goods & services in premium segment should employ and offensive-defensive approach to enter middle market/good-enough  segment. They should enter good-enough segment to defend against the rise of local competitors and erosion of premium segment.

GE Healthcare strategy to enter into good-enough segment and simultaneously protect its premium segment is a very good example of attack from above.

GE Healthcare employed to expand sales of its MRI equipment in China. The company created a line of simplified machines targeted at hospitals in China’s remote and financially constrained second and third-tier cities where other MNCs rarely ventured. That good enough territory has all the right conditions. It was a fast-growing market whose customers purchasing criteria weren’t likely to change soon. GE’s cost structure allowed it to compete with other middle market players in the industry. And there was little risk that the company would cannibalize its premium line of diagnostic machines; large city hospitals were not keen on downgrading their MRI equipment.

GE Healthcare was able to defend its position against local upstarts. The company is trying to develop the optimal product portfolio and is addressing such issues as how best to service the equipment. GE captured 52% of $238 million market in 2004 generating roughly $120 million in sales. GE is replicating the same strategy in other developing countries including India.

Buying way In 

MNCs that can’t alter their cost or process quickly enough to compete with local players should use break-through approach to enter good-enough segment market by way of merger & acquisition.  

Gillette is a very good example of entering into good-enough segment by way of merger & acquisition.

Gillette’s Duracell division throughout the 1990s was losing market share to lower- price competitors like Nanfu who controlled more then 50% of the market. By 2002 Gillette’s Duracell share of the Chinese domestic battery market was mere 6.5%.

Gillette management team recognized that its Duracell unit was at a cost disadvantage compared with its rivals and concluded that it will be difficult to broaden the brand’s market penetration. Facing with such an odd Gillette decided to buy into good-enough segment market by acquiring a majority stake in Nanfu but Gillette was extremely careful to protect Duracell’s & Nanfu’s brand in their respective segment. Gillette continues to sell premium batteries in China under the Duracell brand and has maintained Nanfu as the leading national brand for the mass market. The dual branding, cost synergies, sales growth, broadened product portfolio, economies of scale, and distribution to more than 3 million outlets in China have paid off for Gillette, Which has seen significant increase in its operating margin in China.   

Finally entering into good-enough segment in China can be double bonanza for MNCs. Just like Chinese good-enough segment market Indian good-enough segment market is also very big & growing very fast. MNCs can use experience of Chinese good-enough market and replicate the same in Indian market. In order to achieve cost efficiency or economies of scale MNCs can make a hub in South-East Asia region to cater both India & China’s good-enough market segment.

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China @ ROI on Stimulus

What is China’s Return on Investment (ROI) on stimulus? China has stimulated more than $ 600 billion in its economy to achieve high GDP growth. Do you think these all are realistic investment that will provide return in future?

Majority of Chinese investment, in the last 18 months, during recession were made on development of highways, subways, flyovers etc. however it is not sure whether these developed facilities are going to provide returns in the future. These investments were made just to achieve high growth without making proper alignment of requirement & development.

Instant question arises in my mind that is it possible for a country to achieve 10% GDP growth during the time when global economy is in deep recession. Yes it can be possible if Chinese economy was domestically driven however truth is that before the recession hits china was an export driven economy with more than 60% of revenue comes from export. This triggers further question, how can a country that was export driven before recession can achieve 10% GDP growth rate during recession by enhancing domestic consumption. This seems really next to impossible as normally it takes more than a year’s time just to shift and make an alignment from export driven economy to domestic driven economy.

India has also achieved more than 7% growth during this recession however India’s growth is a real growth, from the beginning itself India was domestic driven economy and this high growth was achieved due to increase in real consumption rather than inventory pile-up or non-required development.

Now another question triggers when and how can China achieve benefits from these facilities? If these facilities can be used in future then how much will be the time lag before benefits starts coming out of it.

Does time lag between facilities buildup & usage can provide adequate desired return on investment? These are the initial trigger point that shows creation of bubble which can burst in future.

Can you imagine China as biggest bubble in world economy? Right now nobody can imagine but the way things are shaping up in China makes it reality.

One of the Consulting firms market intelligence cell has said in an Asset Allocation Submit, Asia 2010 that China is in the midst of “the greatest bubble in history” which is waiting to burst. As per the firm there is massive misallocation of wealth in China. Leveraged speculation in the stock market, wasteful allocation of resources by state-owned enterprises, off balance-sheet debt through regional governments and the country’s human rights record are concerns. Debt fuelled bubble in China may trigger a regional recession within a decade.  

Apart from this Washington based World Bank said in a quarterly report on China released in Beijing that China’s “massive monetary stimulus” risks trigger large asset-price increases, a housing bubble, and bad debts from the financing of local-government projects.

As per the firm, China doesn’t deserve any investment except for short-term speculation, only India and Brazil are two of the “real economies” among the developing countries.

However reality is that China remained the largest overseas owner of US debt after trimming its holdings by $5.8 billion in January to $889 billion. China will suffer massive losses if the debt was dumped, reducing the funds available in the US securities market and forcing the prices lower.

What’s your take on Chinese economy? Do you think it is a biggest bubble waiting to burst? It will be great to have your comment…………

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Emerging Indian Economy & Corporate growth in the coming decade…..

In 2008 Indian economy becomes trillion $ economy, it took India 60 years since independence to reach the $ trillion status, now at present it is around $1.2 trillion and estimated that at the end of the year it will be around $1.3 trillion. If we take conservative real growth rate of 7% or nominal growth rate of 12% then by 2015 it will reach around $ 2.3 trillion and by 2020 it will cross $ 4 trillion. This calculation is based on conservative approach and if we take little aggressive approach then I think Indian economy will cross $ 6 trillion by 2025.

We can compare this pattern from Chinese Economy. China achieved the status of $1 trillion economy in the year 1998. For China also, it takes around 60 years to achieve that status. But after the first trillion, pattern of Chinese growth were very surprising. It took around another 6 years to reach $ 2 trillion mark however next trillion was achieved within 3 years but more surprising last trillion was achieved in just 1 year. At the end of 2008 Chinese economy was $ 4.2 trillion economy. In 10 years time China becomes $ 1 trillion to $4.2 trillion economy.

In 1985, 93% of Indian population was living in poverty which improved to 54% in 2005 and it is estimated that it will reduced to 22% by the end of 2025. It shows that there will be huge growth of middle class which will provide great impetus to consumption and further growth to Indian economy. As per the survey, by 2005-2025 Indian middle class will grow12 fold, from 50 million in 2005 to 583 million by 2025.

Graduation of Indian society & increased savings will lead Indian consumption to quadruple ($400 billion in 2005 to $1.6 trillion in 2025 approx. as per current exchange rate) and becomes 5th largest consumer in the world. During the period pattern of consumption will also change drastically. Presently majority of expenditure were made in necessary items like food, beverages, cloths, tobacco etc. however expenditure i.e. consumption on discretionary items like entertainment, healthcare, transportation, education, communication, housing and personal products etc. were very less but this pattern is going to change very drastically. As per survey conducted by a reputed firm it is estimated that Indian discretionary spends will increase from 52% to 70% (2005-25). It was around 39% in 1995.

India’s Savings and Capital grew substantially during the period 2004-2009. Savings grow from 30% of GDP to 39% of GDP and Fixed Capital Formation grows from 25% of GDP to 35% of GDP during that period. Saving boom spells opportunity for Financial Intermediary. Once Indian economy reaches $ 2.5 trillion and if we calculate the current rate of 40% saving then it comes around $ 1 trillion of investment opportunity. It will boost India’s Insurance & Healthcare, Banking & Stock broking Industry.

Rising capital formation is properly aligned with Indian govt. thrust on infrastructure development. Allocation of expenditure for eleventh five year plan is 2.3 times more than tenth five year plan. Rising capital formation will provide investment boom opportunity for turnkey services like engineering & construction, real estate like housing, construction inputs like cement, steel, iron, paints, electrical & capital good etc.

Boom in consumption, savings & investments will lead to boom in corporate profit. India’s top 100 listed corporates had continuously outperformed Indian GDP. During 1999-2004 India’s top 100 listed corporates registered 21% CAGR and the figure was around 18% during 2004-09. In both the cases it was more then 1.5 times of Indian nominal GDP growth rate.

However in the last few years Indian overall corporate profit to GDP ratio has declined.

In the FY 2008 Corporate Profits to GDP ratio was 7.1% which come down to 4.7% in 2009 and now it looks like that it is bottoming out and will rise to a sustainable level as India sees economic boom in near future.

Now the most important question arises. Which industry, sector or corporates will take full advantage of this boom?

First in order to become high growth corporate, a company has to outperform GDP growth rate. As there will be huge jump in Indian discretionary spending so companies that will cater to these kinds of products & industry will have access to high growth opportunity. In other words we can say that the organizations that will cater to mass market will come under high growth organization.

Example of discretionary product can be car instead of necessity products like motor cycle or bicycle.

Ultra modern housing rather then govt. housing.

Private banks than Public sector banks due to value added services proved by the former.

In order to come under high growth category, organization has to deliver J curve. J curve develops when product price matches the affordability to mass buyer. It occurs when income rises or product prices fall or both happen simultaneously. As organization attains scale, benefits get passed on to customers by way of lower prices, leading to demand J-curves.

We have a very good example of J-curve in a telecom Industry. As we see subscriber base in wireless telecom has increased drastically from 13 million subscribers in 2003 to 386 million in 2009 however on the other side there was huge reduction in tariff which reduced from Rs. 2.3 per minute to Rs. 0.60 per minute during the same period.

Organizations that will cater to industry which have the capability to become large in relation to the economy will come under high growth category. For instance, Construction activity accounts for a sizable 18% of Indian economy and continues to grow rapidly. Likewise, in India, barely 5% of total retailing is organized, In contrast, in the US, a single retailing company, WAL-MART has sales of about US $400b 3% of US GDP.

Consolidated industry will grow more as compare to fragment one. If an industry is highly fragmented, then even if it scales up, the benefits get diluted and are shared by a large number of players (e.g. Real estate). In contrast, industry which enjoys scale and are consolidated in nature gets more benefited as incremental growth is shared by few incumbent players. For instance, Oil marketing in India is US$125b industry, largely shared by just three players.

Organization that provides entry barrier or you can say sustainable competitive advantage will come under high growth category. An organization can attain sustainable advantage or entry barrier if it enjoys market stability & high return on capital.

Following are the ways through which entry barrier or sustainable competitive advantage can be achieved-

Value innovation- It does not make sense to other company’s conventional logic

Organization’s strategy may conflict with other company’s brand image.

Organization enjoys natural monopoly.

Patents or legal permit block imitation

High volume leads to rapid cost advantage for the value innovator, discouraging followers from entering the market.

Network externalities discourage imitation.

Significant political, operational and cultural barrier makes hindrance in imitation.

Companies that value-innovate earn brand buzz and loyal customers that tends to shun imitators.

The organization that enjoys these advantages naturally maintains market stability & high return on capital.

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Do you think Chinese economy can drag down?What will be the impact on US, India & Other Developing Countries?

Today everybody concerns about the fast growth of China as compare to world economy. The question arises “Will crash in Chinese economy drags down US & Indian economy”. I don’t think crash in Chinese economy will drag down US or Indian economy. Yes China is one of the largest consumer of commodity and the main cause of exceptional high commodity prices in 2008. In 2008 oil prices reach $ 147 barrel due to exceptional high consumption of oil in china. If Chinese economy goes down then it makes commodity prices to be stabilize on lower side and provide great impetus to Indian & other developing economy to in-cash low commodity prices on their infrastructure development so they can be more competitive to china and other countries. Presently India is lacking on infrastructure front as compare to China. India requires huge investment in infrastructure sector which are mostly commodity driven. Once commodity prices stabilize on lower side then India can use it for optimum advantage to build infrastructure so that in future foreign companies choose India as compare to china to setup R & D and manufacturing HUB. India has advantage over China in terms of education & english speaking which is hugely untapped due to lack of infrastructure in the country. Once India develops adequate infrastructure then foreign companies will prefer India to China due to quality manpower. Apart from this, India already has advantage in service industry e.g. software industry over China and once India develops adequate infrastructure then foreigners will treat India as “Complete Economy” and becomes ready to create reverse innovation in India.

Yes, crash in Chinese market will impact in a great deal to US economy. China is an export oriented country and its more than 60% revenue comes from exports. China invests heavily in US treasury and stock, at one point of time it was more than $ 1 trillion and has major say in US financial crises. If Chinese economy goes down then china will take out all their money from US treasury and it affects US economy by drastic reduction in the value of US treasury and brings in liquidity crisis in US economy.

Chinese crises will impact India little bit indirectly due to erosion in the value of US treasury and liquidity crisis. Erosion in the value of US treasury hampers US $ and depreciates its value via all global currency. It makes Indian export little expensive and generate outflow of money in the Indian stock market as FII takes short term advantage of strengthening rupee against US $ by way of profit booking.

In order to boost its economy growth china has made huge investment in infrastructure development and totally ignore social security net & healthcare. Yes lastly they have allocated some amount for healthcare segment but still it is very less as compare to requirement. I am not sure whether these infrastructure investments will be productively used in future. I can say these investments are totally misaligned against current & future requirement.

Today I have posted another article Why Dubai Defaulted? Dubai world quashi- defaulted and the main reason is that Dubai has made investment in unproductive assets like biggest shopping mall, man made island, indoor sky slope etc. If china can’t align its investments properly then they will face the same kind of situation.

Apart from this china has huge investment in US TRESURY however value of US $ is continuously declines and there is a great danger that in future US $ will be taken out from reserve currency basket due to huge fiscal deficit. In that case china will lose huge money.  

I think Chinese have done something beyond basics and these things can impact their economy in future. But for Indian perspective it will be good as it provides India and other developing countries an opportunity to make their presence felt globally otherwise in most of the cases they lose to china globally due to pricing, infrastructure and other issues.

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