Created in China

0June 23, 2010

Upgrading the Chinese Economy

The Historic Transition from “Made in China” to ”Created in China”

Copyright 2010 SmithStreetSolutions. All rights reserved.

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Table of Contents

1. What “Created in China” Means

2. Why China Must Create

3. Enablers of Chinese Creation

4. Challenges to Chinese Creation

5. Implications of “Created in China”

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Quotes from Beijing’s 2005 China Economic Summit

I think now it’s time for Chinese companies to build their own brands. The Chinese government should push healthy developments of the economy.

Robert A. Mundell, winner of the 1999 Noble Prize in Economics

I think now it’s time for Chinese companies to build their own brands. The Chinese government should push healthy developments of the economy.

Robert A. Mundell, winner of the 1999 Noble Prize in Economics

Japanese products completed the transition from manufacturing tocreation in over 10 years, setting a good example for Chinese companies. This transition is necessary for the development of China’s manufacturing.

John Forbes Nash, winner of the 1994 Noble Prize in Economics

Japanese products completed the transition from manufacturing tocreation in over 10 years, setting a good example for Chinese companies. This transition is necessary for the development of China’s manufacturing.

John Forbes Nash, winner of the 1994 Noble Prize in Economics

Unique and creative designs will give China’s manufacturing a major boost and higher technological maturity will make Chinese products more competitive.

Sir James Alexander Mirrlees, winner of the 1996 Noble Prize in Economics

Unique and creative designs will give China’s manufacturing a major boost and higher technological maturity will make Chinese products more competitive.

Sir James Alexander Mirrlees, winner of the 1996 Noble Prize in Economics

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What Makes Creation

Four basic elements are necessary for “creation” in the industrial sense to happen.

The difference between Manufacturing an iPod and Creating an iPod

Source: SmithStreet Analysis

I. Sound Market Strategy

II. Smart Product Design

III. Successful Technology

IV. Shrewd Branding

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As a country’s economy transitions from basic manufacturing to innovation andcreation, it will see its industries moving up the value chain.

Moving up the Value Chain


� In the 1970s, the image of Japanese brands in the international market was defined by cheap price and low cost

� To move up the value chain, the Japanese government did two things:

– The government stepped in to increase corporate identity awareness among large Japanese companies, and helped them establish their Corporate Identity Strategies

– The government spent many resources to promote demand for good design among consumers

� Now Tokyo is one of the world’s leading innovation capitals and “Made in Japan” is linked to high quality and superior design

Case Study: The Rise of “Made in Japan”

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As an economy becomes more and more innovation- and creation-oriented, its service industry becomes increasingly important.

An Increasingly Important Service Sector

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1982 1987 1992 1997 2002 2007

Service Sector as a Percentage of China’s GDP over Time

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

China Korea Germany Japan UK US

Service Sector as a Percentage of GDP across Countries, 2007

68.9%, OECD Average

Source: National Bureau of Statistics of China; OECD

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Since China’s opening-up, its manufacturing industry has made great achievements and is now at the point to usher in a new era of innovation.

The Maturing Chinese Manufacturing Industry

Source: National Bureau of Statistics of China; Ministry of Commerce of China; WTO

China has become an indispensable part of the international division of labor, with manufactured goods making up 94.6% of China's total exports in 2008 compared with the 1980’s 49.7%. China is a major global supplier of manufactured goods, and is no longer a pure exporter of resources and primary products.

China’s has a huge domestic market, superior infrastructure, and the world’s largest talent pool to match its titanic manufacturing capability.

For the past 30 years, the CAGR of China’s trade volume was higher than the CAGR of China’s GDP (17.4% vs. 15.6%). Now, China is the third largest trading nation and the world’s second largest exporter.

Player in Global

Trade

The World’s

Manufacturing

Base

Strong Domestic

Resource Base

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With the trade surplus China has accumulated, the Renminbi is bound to appreciate, which in turn creates an environment allowing China to upgrade its manufacturing sector.

“The China Price“ in USD Technology Price in RMB


The Currency Factor

9Source: SmithStreet Analysis

Trading Prices Down

The global financial crisis drives down the price of undifferentiated goods and erodes the margins of low-end producers.

10Source: Ministry of Labor and Social Security of China

Rising Labor Costs

The new labor law introduced in China last year enhances rights for Chinese workers and requires higher product prices to cover the raised production costs.


China’s traditional low-end manufacturing has been developed at the cost of the deterioration of the environment, and is unsustainable given the sheer size of the country’s capacity.

Environmental Concerns

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� “Optimizing and upgrading industrial structure” is one of the major goals in China’s Five-Year Plan for the 2006 – 2010 period, ratified by National People’s Congress in 2006

� The Guideline for the National Medium- and Long-Term Science and Technology Development Plan (2006-2020) issued later by the State Council echoes the principles of the Five-Year Plan

Source: Gov.cn

Government Support

The Chinese government has taken the upgrading of the country’s industries seriously and industrial technological advancement has been a repeated focus of recent government guidelines.

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China is steadily building up the soundness of its financial system, against the background of an upgrading manufacturing sector.

China Is Building its Financial Infrastructure

� The Red Chip Model used to provide an exit strategy for dollar dominated funds’China investments

� The Chinese government’s 2006 M&A regulations effectively froze approvals for overseas listings and hampered the exit of foreign venture investors

� In December of 2008, the China Banking Regulatory Commission (CBRC) issued a guideline allowing Chinese banks to grant loans to enterprises, not excluding foreign holding companies or Private Equity, to acquire the equity and assets of a target firm

� Primarily triggered by this new guideline, we have seen a recent hustle of foreign PE firms trying to set up Yuan-denominated funds in China

Pushing Away Dollar-Denominated Funds

Encouraging Yuan-Dominated Funds

Source: Ministry of Commerce of China; China Banking Regulatory Commission

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Relatively Cheaper US Assets

US assets are relatively cheaper due to falling US equity and the rising value of the RMB.

*Note: Calculated based on the change from the original pegged price of 0.121 RMB/USD to 0.1463 RMB/USD on 12/17/09.Source: Bloomberg; Oanda.com

Falling US Equity Appreciating RMB

0.120

0.125

0.130

0.135

0.140

0.145

0.150

7/1

/2005

10/1

/2005

1/1

/2006

4/1

/2006

7/1

/2006

10/1

/2006

1/1

/2007

4/1

/2007

7/1

/2007

10/1

/2007

1/1

/2008

4/1

/2008

7/1

/2008

10/1

/2008

The Chinese Yuan has appreciated 20.9% since the RMB was unpegged

from the USD in July of 2005.*

The Chinese Yuan has appreciated 20.9% since the RMB was unpegged

from the USD in July of 2005.*

RMB/USD

Exchange Rate

Both the S&P500 and Dow Jones have fallen over 25% in the past year.

Both the S&P500 and Dow Jones have fallen over 25% in the past year.

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China’s Cash Holdings

China’s foreign exchange reserve has been growing rapidly in recent years.

China’s Foreign Exchange ReservesUSD Bn

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008

CAGR = 29.7%

Source: State Administration of Foreign Exchange

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Inbound M&A Moving Toward Value-added Industries

Foreign investments in higher value-added industries are growing faster than investments in traditional enterprises.

Total = RMB 4.67 billion Total = RMB 10.47 billion

Retail, 0%

IT, 0%

Transport &

Logistics, 0%

Real Estate,

5%

Social

Services, 3%

Finance &

Insurance,

28%

Source: China Mergers & Acquisitions Yearbook 2005, 2008

Social

Services, 12%

Retail, 2%IT, 11%

Transport &

Logistics,

10%

Finance &

Insurance,

1%

Real Estate,

14%

Manufacturing, 64%Manufacturing, 50%

China Inbound M&A 2004 China Inbound M&A 2007

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Table of Contents







Intellectual Property Protection

To boost innovation, China has to enhance its anonymous intellectual property protection.


Education System

China’s education system focuses more on memorization than on innovation , which can be a drawback in creating an innovative environment.


Distorted Financing Channels

In spite of the high amount of bad assets in China’s banking system, Small- and Medium-sized Enterprises (SMEs), the major driver of innovation and creation in China, find it very difficult to get loans from banks.

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China’s reputation for poor quality products and the compete-on-price mindset of Chinese manufacturers could stand in the way of China’s moving up towards creation and innovation.

Quality Control

Source: SmithStreet Analysis; Amazon.com

Recent product and food safety scandals have only worsened China’s reputation for poor

quality goods

Recent product and food safety scandals have only worsened China’s reputation for poor

quality goods

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While the value of luxury brands is well understood, the mentality that a brand is only a ‘name-on-a-box’ is still

common among manufacturers

While the value of luxury brands is well understood, the mentality that a brand is only a ‘name-on-a-box’ is still

common among manufacturers

Chinese companies traditionally focus on increasing sales and market share, and have been reluctant to make long-term investments in intangible areas such as brand building.

Branding

Source: SmithStreet Analysis and Primary Research

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Increased Outbound M&A

In 2008, China’s overseas investment doubled to $52.2 billion, a figure that has already been surpassed this year due in large part to surging outbound M&A.

Source: China Ministry of Commerce; Thomson Reuters

0

10

20

30

40

50

60

2003 2004 2005 2006 2007 2008

CAGR = 97.3%

Outbound M&A Deal ValueUSD Bn

Outbound M&A will increase as Chinese manufacturing continues to move up the value chain and weans itself from price-based competition.

Outbound M&A will increase as Chinese manufacturing continues to move up the value chain and weans itself from price-based competition.

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An Emerging Group of Chinese Brands

With Chinese manufacturers’ awareness of branding aroused and more attention being paid to product design and innovation, we expect a group of Chinese brands to achieve global recognition in the next 10 years.

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025

The rise of Japanese brands started in the 1970s.

A group of Korean brands began to take off in the late 1990s.

More Chinese brands, other than Lenovo and Haier, will enter global customers’horizons in the years to come.

Leading Chinese Brands



The Renminbi as a Global Reserve Currency

As China’s manufacturing moves up the value chain and Chinese producers are no longer competing on a cost basis, the Renminbi’s lack of free convertibility, a major impediment to becoming a global reserve currency, will gradually disappear.

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Innovation in the Last 150 Years

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What Will a Chinese Future Look Like?

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Franklin YaoChief Executive Officer

US Mobile: +1 (917) 775 2611 China Mobile: +86 134 8266 7778Email: [email protected]

Cynthia ZhangMarketing Manager

China Mobile: +86 137 7424 8340 Email: [email protected]

Franklin YaoChief Executive Officer

US Mobile: +1 (917) 775 2611 China Mobile: +86 134 8266 7778Email: [email protected]

Cynthia ZhangMarketing Manager

China Mobile: +86 137 7424 8340 Email: [email protected]

Contact Information

New York Office521 Fifth Avenue, 17th Floor

New York, NY 10175+1 (212) 292 4420

Shanghai Office20 Jinchuang Road, 10th Floor

Yangpu, Shanghai 200433+86 (21) 6565 6533

www.smithstreetsolutions.comwww.smithstreetsolutions.com

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