MAKING IT IN CHINA

Table of ContentsMAKING IT IN CHINA ................................................................................................................................ 1

EXECUTIVE SUMMARY ............................................................................................................................ 2

1. OPPORTUNITY IN CHINA ..................................................................................................................... 3

CHINA'S ECONOMIC GROWTH HAS CREATED HUGE OPPORTUNITIES. ............................................................................. 3 THE MARKET WILL GROW EVEN MORE IN THE NEXT 10 YEARS. ................................................................................. 3 THE SUPPLY OF LOW-COST LABOR WILL DRIVE CHINA’S ECONOMY FOR THE NEXT 20-30 YEARS ................................... 4 CHINA OFFERS TREMENDOUS IT TALENT .............................................................................................................. 4

2. CHALLENGES OF DOING BUSINESS IN CHINA ............................................................................ 5

CHALLENGE #1: UNIQUE PROTOCOLS AND RELATIONSHIPS ...................................................................................... 5 CHALLENGE #2: CONTRIBUTE FIRST AND BENEFIT LATER. ....................................................................................... 6 CHALLENGE #3: HIRE SENIOR LEADERS AND NURTURE LOCAL PEOPLE ....................................................................... 7 CHALLENGE #4: PLAY BY CHINA’S MARKET RULES ............................................................................................... 7 CHALLENGE #5: THE LOCAL ECONOMY GETS TOP PRIORITY ..................................................................................... 8 CHALLENGE #6: GOOD IMAGE CAN BE ELUSIVE. .................................................................................................... 8

3. FORMULAS FOR SUCCESS IN CHINA: CASE STUDIES .............................................................. 10

FORMULA #1: LEARN THE PROTOCOLS AND FORGE TRUSTING RELATIONSHIPS ........................................................... 10 FORMULA #2: ESTABLISH A STRATEGY FOR LONG-TERM COMMITMENT ................................................................... 11 FORMULA #3: NURTURE LOCAL TALENT AND LEADERSHIP ..................................................................................... 12 FORMULA #4: BE FLEXIBLE AND OPEN TO LOCAL NEEDS AND PRACTICES. ................................................................ 12 FORMULA #5: HELP BUILD THE LOCAL BUSINESS ECOSYSTEM. ............................................................................... 13 FORMULA #6: BUILD TRUST FROM A UNIFIED, HUMBLE ORGANIZATION .................................................................... 14

4. CONCLUSION ......................................................................................................................................... 15

APPENDIX: ANALYSIS OF SUCCESSFUL MNCS IN CHINA ........................................................... 16

PAGE 1

EXECUTIVE SUMMARY

With its booming economy, untapped talent base, and growing domestic markets, China offers massive business opportunities and great strategic importance for any company. China is virtually any company’s largest opportunity for growth in the 21st century.

Yet, China’s unique cultural, business, and political environment pose significant challenges to multinational corporations that want to succeed there. Indeed, many companies have fallen prey to these challenges in the past 10-20 years of operations in China. On the surface, these challenges appear difficult to overcome; yet, when we study the histories of the multinational corporations operating in China today, it's evident that some have achieved exceptional success in China. The experiences of these successful companies can be mined to create a list of strategic formulas for success that includes making long-term commitments, building relationships, nurturing local employees, supporting local business ecosystem, being agile and flexible in local business operations, and keeping a unified and humble profile. Any company can aspire to success in China, if it learns from these companies and develop a unified China strategy. This strategy must aim to achieve long-term business success by bringing economic benefits for China, and to achieve sustainable trustworthy image by nurturing local people and local relationships. Any company will succeed if it leverages the proven formulas for success, learn from own past experiences, build a coherent strategy, and execute it consistently and persistently.

This paper presents the overall opportunity in China, discusses the six challenges, and uses case studies to illustrate six formulas to answer the six challenges.

PAGE 2

1. OPPORTUNITY IN CHINA

“The single most important thing to happen in our lifetime will be the emergence of China.” – John Thornton, former President of Goldman Sachs, now a Professor at Tsinghua University.

CHINA'S ECONOMIC GROWTH HAS CREATED HUGE OPPORTUNITIES.

“China is the hope of Davos.” – Stephen Roach, Chief Economist, Morgan Stanley, in CNN Money, Jan 2003.

Since 1978, China's GDP has grown by 9% every year and quintupled to $1.2 trillion (normalized for inflation; without normalization, the GDP growth would be twenty-five times rather than five). China’s foreign direct investment (FDI), which comprises 80% of the total for Asia, rose from $2 billion in 1986 to $47 billion in 2001.

China is the world’s second-largest PC market and the largest cell phone market. Although piracy continues to be a problem, the government is now actively

promoting legal software use. The effort seems to be working; sales in the software and services sector have more than doubled in the last two years.

THE MARKET WILL GROW EVEN MORE IN THE NEXT 10 YEARS.

“Imagine, 1.3 billion lips!”- Lindsay Owen-Jones, CEO, L’Oreal.

The enterprise market in China is very healthy: In 2002, it received the largest foreign direct investment of any country in the world. This trend is expected to continue.

Over the next 5 years China is expected to produce at least an annual growth of 25% in IT and 50% in software and related services.

Not only is the enterprise segment growing, the consumer segment also has much potential to grow. The Chinese baby boom generation, born between the 50's and early 70's, is just starting to reach its financial peak. Consumers are earning more than ever and they are saving an average of 35% of their incomes, which amounts to $1 trillion per year.

PAGE 3

THE SUPPLY OF LOW-COST LABOR WILL DRIVE CHINA’S ECONOMY FOR THE NEXT 20-30 YEARS

“Through skillful control of residency, China’s 900 million rural residents will gradually move to cities and take jobs in manufacturing or information processing, perhaps at 20-30 million per year. This could give China a sustainable supply of low-cost labor for the next 20-30 years.” – Kenichi Ohmae, The China Impact.

Coastal China has already taken work away from the Four Tigers in Asia and there are still 20-30 years of wealth upgrading as farmers move to cities and western China becomes industrialized.

At the end of this growth cycle fueled by lower cost, China could slow down like Japan and the Four Tigers or continue to grow like the United States. That will depend on whether it can develop multinational export businesses with its own IP, which is another reason for China’s push for local business ecosystem.

CHINA OFFERS TREMENDOUS IT TALENT

“I bet you didn’t know some of Microsoft’s best computer science researchers are in Beijing.” – Bill Gates, at a business review in 1999.

In addition to the low-cost labor workforce, China is also developing a huge pool of IT professionals. Thanks to its traditional focus on disciplined academics, China produces 100,000 computer science and engineering graduates every year. That number is expected to grow to 160,000 per year in three years. This will be twice as many as India, and four times as many as the United States.

Fueled by local talent, multinational corporations have been successful doing R&D in China. Microsoft’s experience clearly validates the caliber of the Chinese IT talent. In four years, MSR Asia has developed into a research lab that is indisputably one of the best in the world by any metric – the number of patents, publications, or product transfers.

China has a new but impressive local R&D success record in the PC hardware and telecommunications sectors. Several multi-billion-dollar domestic corporations have recently emerged.

PAGE 4

2. CHALLENGES OF DOING BUSINESS IN CHINA

Given all the opportunities presented by China’s growth, many multinational corporations (MNCs) are eager to gain access to this market. Chinese leaders are keenly aware of the bargaining power this gives them. That, in addition to the country's unique traditions, history, and culture, means that doing business in China can be a complicated and time-consuming undertaking. Foreign companies interested in gaining access to China face six challenges which they must attempt to solve or they will be turned away.

CHALLENGE #1: UNIQUE PROTOCOLS AND RELATIONSHIPS

Because government plays such a central role in China, it is important to understand its various protocols, systems and taboos in order to win trust.

Good government relations are everything in China. Learning how government works and how to establish good relationships is the critical first step. The government is not only a major customer (government agencies and state-owned enterprises), but it is also the main policy maker and opinion leader. A company that is considered a friend of government will be granted favors such as a heads-up on legislation changes or inside advice on how to do business. Conversely, a company that is deemed unfriendly will suffer consequences such as negative comments about its products or passage of laws that exclude it from doing certain business. Getting on the wrong side of a key government agency can be disastrous.

Relationships must be cultivated at all levels of government. Chinese government is centralized and operates in a top-down fashion, so high-level connections are important. However, it is the mid-level bureaucrats who actually propose, initiate and execute projects. Furthermore, while the central government sets important precedents, local governments make local purchasing decisions and will often consider local priorities such as protecting a local company or developing a regional software park. Without a comprehensive government relations effort, a MNC subsidiary may be rendered ineffective.

The spirit of the law can be more important than the letter of the law. In China, laws change frequently, and they are often far-reaching and vague. Interpretation of laws can vary from ministry to ministry, industry to industry, and may even be tailored for or against specific companies. The companies with good government relations will often get early notice about upcoming law changes, influence the content of the laws, and advise the interpretation of the laws. Companies unaware of the importance of government relations will become victims of their own ignorance.

China's culture is built on trust, relationships, and mutual respect. Trust takes a long time to build, but there are many ways to break trust: by showing disrespect, by failing to provide favors in exchange for favors received, by not following the protocols, by condescending, coercion, or by dwelling on controversial issues. Trust is built on

PAGE 5

fulfilled promises. Ideally, the best scenario is to make promises and fulfill them. Keep in mind that it is much better to not make promises than to over-commit and fall short.

The concept of "face" is very important. Face is all about reputation, name, and honor, and it can apply to a country, ministry, company, or person. Seeking the advice of a ministry director, even when it is not needed, will show respect and earn trust. Forgetting to include him in an important public event will cause him to lose face and destroy trust. Respecting and deferring to the government agency chief in charge of managing your company is important. Ignoring him/her could be disastrous. Recognizing and making the most of these opportunities will make the difference between success and failure.

Avoid actions that could be perceived as anti-China, coercive, or condescending. Toshiba was badly maligned when it didn’t apply a Japanese recall of faulty products to China. Recent U.S.-backed human-rights efforts have angered the Chinese people, not because of their content but because China believes that the U.S. has no right to interfere in these matters. Making indiscreet statements about ultra-sensitive issues such as Chinese sovereignty over Taiwan and Tibet can be extremely costly.

Negotiations are bottom-up and informal. The vague laws cannot be interpreted or negotiated in formal settings. The only way to make progress is to informally try out many ideas, and have these ideas bubble up for approval at the company and the government. By the time the senior officials meet, the deal will have been struck already. High-level negotiation or quid pro quo official offers are not the way business is done.

CHALLENGE #2: CONTRIBUTE FIRST AND BENEFIT LATER.

China knows that it is an extremely attractive market to MNCs which is why the government has created rules that require them to invest before they are awarded favored status. Benefits eventually come to those who contribute and help China early and sincerely.

MNCs are expected to listen well, to make connections, and to deliver on promises. Power works in indirect ways in China, so it is critical to develop relationships first rather than attempting to negotiate deals before there is an established basis for mutual trust and respect. When dealing with the government or business, the way to build a good relationship is by finding out what they want that we can deliver, next committing to it, and finally following through. This builds a basis of trust from which benefits may be harvested. If what they want is not something we can deliver, it is better not to promise than to promise and not deliver.

Contributing first and benefiting later requires a long-term commitment. The Chinese want to be assured that foreign companies are there to work with them and help them succeed instead of simply trying to exploit the market. The MNCs that have

PAGE 6

demonstrated a willingness to help the country are often granted preferred access to its markets and human resources. The quality of their products is secondary.

Friends will be given lucrative rewards, and others will wither into oblivion. China is not hesitant to choose one “friend” per industry and reward it richly. For example, it is well known that the Chinese government favors Coke over Pepsi, Volkswagen over Toyota, Sony over Toshiba, Kodak over Fuji, and Motorola over Ericsson. Those who don’t make long-term commitments will pay dearly for their myopic views.

CHALLENGE #3: HIRE SENIOR LEADERS AND NURTURE LOCAL PEOPLE

China expects MNCs to provide good leadership models and to commit to develop local employees into capable leaders.

Respect, sincerity, and commitment from senior local and corporate leaders are critical to winning trust and partnership. While it is difficult to persuade and send senior people to move to China, MNCs that send highly qualified leaders to lead their efforts in China are taken more seriously. Conversely, sending junior people (to “challenge them with growth opportunity”) resulted in inexperience and indiscretion that cost companies dearly. Corporations whose senior corporate leaders are willing to meet with government officials, seek to their guidance, give them input on the local economy, and show them the proper respect will gain business advantages.

China prefers MNCs that develop local talent to make them more competitive internationally. Successful companies have earned trust in China by respecting local needs, hiring and training local employees, giving them a chance to become leaders in the MNC’s subsidiary. Conversely, MNCs that don’t value and develop local talent are viewed as exploitative.

CHALLENGE #4: PLAY BY CHINA’S MARKET RULES

This market has its own set of rules and behaviors and MNCs must adapt to them.

The Chinese decide for their own reasons what rules to apply and who they would like to do business with. Given what they have to offer foreign investors, it's not surprising that the Chinese are in a position of power. They feel no obligation to open their market to any multinational company simply because it has a good product or a good reputation elsewhere.

While they value global standard practices, they still expect MNCs to adapt to local rules. The Chinese have a tendency to emphasize Chinese customs and practices in every walk of life, particularly in economic development. This tendency is rooted in their tradition of self-reliance and national pride. It is also a reflection of the fact that the China market is big enough to be isolated from the rest of the world.

PAGE 7

Market conditions change rapidly and often irrationally due to an immature market economy. Because China has not yet completed its transition from a planned economy to a market economy, it is still in the process of establishing a sound and comprehensive legal framework regulating business activities. The environment is often full of volatility and irrationality, so one of China’s market rules is: The rules keep changing.

CHALLENGE #5: THE LOCAL ECONOMY GETS TOP PRIORITY

“Don’t think Chinese companies deserve to lose to foreign companies when foreign companies have a better product. It is different that a foreigner is making money and not a Chinese. The downfall of Chinese companies will come back to hurt all citizens of China” – Professor Tan Haoqiang, one of “Top 10 IT Influentials in China”.

Local companies are always preferred to foreign companies. Given China's historic dependence on the West for protection, technology, and even survival, it is critically important to them that they now become economically self-sufficient. As a result, China will always focus on ways to grow the local companies. Even as China entered the WTO, the Government Procurement Law passed in 2002 states a clear preference to purchase local products. MNCs’ only chance is to justify why their product should qualify as a local product, which in turn depends on their government relationship.

China expects multinationals to help nurture local economy in exchange for access to the China market, even if this means that the MNCs are fostering future competitors. In earlier days, simply attracting foreign investment was very important, but that's now a secondary priority. Helping local companies develop their talent, know-how, and process is viewed as the most valuable contribution an MNC can make. The MNCs ignoring this are considered self-serving. The MNCs heeding this must move up the value chain, as lower-cost local competition is inevitable. Motorola is facing exactly this challenge, as their partners are now able to make cheaper low-end handsets.

China often ignores international standards and attempts to build China standards that will avoid royalty payments or favor its own companies in China. This is contrary to what most high-tech companies believe in, but it is a reality that must be accepted when doing business in China.

CHALLENGE #6: GOOD IMAGE CAN BE ELUSIVE.

Image building is not direct, and PR efforts often backfire.

In China, establishing a good corporate image requires much more than PR. No matter how much branding or PR effort is invested in China, it won't work unless the fundamental trust and relationship are established first.

PAGE 8

Companies and people who boast excessively may be viewed suspiciously, as humility is a core virtue in Chinese culture. McKinsey China adopted a high-profile PR strategy which led to extreme public scrutiny when a consulting case failed. Juliet Wu was advertised by Microsoft China as a local heroine, and her departure sank Microsoft.

While positive PR may not help a company’s image, negative PR can damage a company’s image. Patriotism and nationalism run very strong in China. Every foreign company should expect some degree of “bad press” since they may take jobs, talent, and business away from local companies. Business stories can often be spun into stories about nationalism: Toshiba treats Chinese consumers unfairly; Microsoft sues a poor Chinese company; Samsung sells its left-overs to China.

Public media is immature, powerful, and manipulated. In a country recently initiated to limited freedom of press, public media is immature and subject to manipulation by unscrupulous journalists. Yet, the public media is very powerful, as the readers have not become adept at reading editorial comments as opinion not fact. As a result, manipulated negative papers can do great damage to an unsuspecting MNC.

PAGE 9

3. FORMULAS FOR SUCCESS IN CHINA: CASE STUDIES

In spite of the challenges previously outlined, many multinational corporations are doing very well in China. 20% of Motorola’s worldwide revenue came from China, achieving $5.7 billion in sales in 2002, leading Nokia in handset sales in China. Philips has revenue of $7 billion in 2002. At $5 billion revenue per year, Volkswagen has captured 40% of the market share of all cars in China, selling four cars in China for every three it sells in the U.S. In the IT sector, both Intel and HP well exceed $1 billion in sales in China, which is now Intel’s largest market outside US. China is the single revenue highlight for many embattled companies like Lucent, Cisco, and Nortel.

When we examine these and other successful companies, a common pattern emerges. They have all, to some extent, managed to:

1. Learn the protocols and forge trusting relationships2. Establish a strategy of long-term commitment3. Send senior talent and nurture local talent4. Be flexible and open to local needs and practices5. Help build the local business ecosystem6. Build trust from a unified, humble organization

The most successful companies have been willing to exchange short-term profits for long-term success, short-term employee productivity for long-term employee development, and short-term expedience for long-term government trust.

FORMULA #1: LEARN THE PROTOCOLS AND FORGE TRUSTING RELATIONSHIPS

“Perhaps the only way to overcome the obstacles is to develop relationships with both Chinese citizens and government bureaucrats. It cannot be overstated the importance of accommodating the government." — John Stuttard, the New Silk Road.

Multinational corporations that have thrived in China learned the value of patience and tact in order to develop a long-term, partnership-oriented strategy. For example, while other companies stayed away from China after the Tiananmen Square incident, Motorola increased its commitment to meet with government and business leaders and was rewarded with a favored partnership. For an encore, at the height of SARS, Motorola COO visited China to reaffirm commitment, which resulted in extremely positive media coverage. Motorola remains the undisputed #1 company – most people in China would say they’re “almost a Chinese company”.

It is necessary to build relationships at all levels of the government. The CEO meets ceremonially with the premier; corporate executives visit with Chinese ministers and invite them to VIP visits to the corporate headquarter; local senior managers discuss

PAGE 10

substance and deals with the directors; local managers become friends with the specialists. Only then can the MNC be informed and effective with the government.

Establishing a good relationship with government requires more than business meetings; it requires cultivating long-term friendships with the current and likely future leaders. Taking the time to build and nurture relationships by doing favors, giving credit, and making Chinese associates look good pays off. Firms such as IBM and HP courted Chinese leaders, inviting them to the US and seeking out their opinions; they now enjoy solid positions in the Chinese market. AT&T’s Bell Labs courted Jiang Zemin early in his career and he has continued to help Lucent in difficult times, bringing orders when he visited them. As universities were setting up executive MBAs for government officials, Motorola came up with an innovative idea – to have “executive Ph.D.” programs offered by a high-quality Hong Kong university. It then took the opportunity of sending its senior executives to the same classes attended by the government officials. This resulted in many added opportunities for relationship-building.

In an environment where government has such a powerful influence on public opinion, the necessity of winning its trust can't be overemphasized. The lesson here is: Don't waste time pushing a shortsighted agenda. Corporate consistency is also important; companies that speak in one voice and project a clear image generally do well.

FORMULA #2: ESTABLISH A STRATEGY FOR LONG-TERM COMMITMENT

“China has discovered its leverage. The Chinese now say, 'If you want market access, give us technology.'” – Erhfei Liu, chairman of Merrill Lynch, China.

Multinationals that demonstrate a sincere commitment to long-term investment in China earn the chance to participate as a favored entity. They have focused their initial and continuous efforts on investments and donations, training, and developing local businesses. The press and government are adept at seeing through gestures that look good but have no substance. IBM opened the first China Research Lab in 1995 and has donated more than $100 million worth of software and hardware to Chinese universities. As a result, the company has won a wide customer base in government and other state-owned sectors. Kodak bought all of China’s money-losing film companies for $1.1 billion in 1999, and grew its share in China from 20% to 60%. The easiest way to appear sincere is to be sincere.

Right now, technology is much more valuable to China than money. Originally the Chinese were interested in obtaining capital through partnerships and JV's with foreign investors. Now they are more interested in companies that are also willing to transfer technical and business knowledge. Motorola, which established many China JVs including a Beijing Research JV in 1999 and has made donations to several local universities, now earns 20% of its revenue in China, which amounted to $4.9 billion

PAGE 11

in sales in 2002. HP established the first U.S.-China joint venture, called China HP, in 1985, which involved strategic investments in technology and marketing know-how. China HP is becoming the fastest growing branch of HP worldwide, as sales hit $1.2 billion in 2001.

FORMULA #3: NURTURE LOCAL TALENT AND LEADERSHIP

“IBM China employees are known to be professional. That came from years of training, from English to table manners.” – Juliet Wu, former Regional Manager, IBM Southern China, in Flying against the Wind.

Local talent may be very bright, energetic, and dedicated, but they are very inexperienced in business, process, and leadership skills. Therefore, a commitment to local employees must be accompanied by a commitment to in-depth training. Access to training is one of the key reasons that college graduates cite when asked why they work for a foreign-backed enterprise. Companies like IBM have developed extensive training and development programs for local employees, which has helped recruiting and image. Carrefour hires Chinese employees and assigns them to assist key French employees, promoting the trainees as soon as they acquire the desired skills. Over time, qualified local employees filled virtually all of Carrefour’s management positions. Carrefour has become the top MNC retailer in China.

Government leaders in China eventually want to see local employees running the local operations. Local CEOs are viewed as more trustworthy and easier to communicate with, and shows stronger commitment by the MNC. The current chairman of Coca-Cola in China worked his way up from the ranks of the first Chinese employees hired in 1979. He is now a member of the National Politburo as well as a national role model and a valuable asset for the company.

It is also in the interest of the MNC to plan for a local CEO and leadership team. Local leaders are more China-savvy, are more trusted by the Chinese government, and are more cost-effective. However, as learned from Coca-Cola’s example, it could take 20 or more years to develop a local CEO (none of the major IT companies have a local CEO). This further underscores the importance of in-depth local talent training and succession and pipeline development.

FORMULA #4: BE FLEXIBLE AND OPEN TO LOCAL NEEDS AND PRACTICES.

"We take pride in viewing ourselves as a very local company in China." – Mike Zafirobski, COO Motorola, in Business Week, Jan 2003.

The development of local brands and products makes both government and consumers happy. A product created or tailored especially for China can better satisfy customer needs, and also shows a sign of respect and value for local

PAGE 12

preferences. L’Oreal invested in a local lab to develop products designed especially for Chinese people based on differences in skin and hair. The Santana, produced by a Volkswagen joint venture in Shanghai, is the most popular car in China because it was designed around the Chinese demand (city taxis needed 4-doors and fuel-efficiency, and ultra-compact size was acceptable for Chinese physique).

In order to operate effectively in China, local subs should be viewed as valued partners to China, so they need the empowerment for timely response to local conditions and preferences. Key local pricing and branding decisions shouldn’t take years to negotiate with many layers of approval from the corporate headquarters. Coca-Cola successfully avoided brand piracy by allowing its China subs to price products so affordably that it was no longer worth the effort to counterfeit them. In the last 15 years, the cost of a can of Coke has declined, even though the average salary has skyrocketed. Coca-cola also produced in their JVs soft drink brands that were tailored to local preferences and sold at even lower prices. L’Oreal prices its “Chinese complexion” products lower in China than comparable products elsewhere. Kodak offers the same product but with a lower price for China.

China is a top-tier market and should be treated as such. They don't want last-generation products and they are sophisticated enough to tell the difference. Samsung lost money and image trying to sell cheap, outdated products in China. Samsung’s recent shift to offer their hottest premium lines first in China are met with remarkable success.

FORMULA #5: HELP BUILD THE LOCAL BUSINESS ECOSYSTEM.

“While Philips brings technological know-how to Chinese partner companies today, these local partners help Philips bring product relevance to the Chinese market as well as established distribution channels to reach new Philips consumers.” – David Chang, CEO of Philips China.

Creating a strong economy where domestic companies can grow and prosper is China’s number-one goal. Ideally, they want to develop real exports in high-value sectors such as software and services.

o 60% of the products manufactured by Philips and its JVs are for export from China, thereby earning valuable export for China.

o BEA is negotiating with the government about moving one of its product lines completely to China, which would provide “software export” for China even though a US company wholly owns BEA China.

Multinational companies that have found ways to help build an ecosystem of local companies have seen these efforts pay off.

o Coca-Cola has helped create 400,000 jobs for local bottlers, retailers, and even street vendors.

PAGE 13

o Philips has built a loyal dealer network by offering them generous credit lines, which solved the problems of the cash flow-constrained dealers.

In cases where the establishment of local companies was not possible, partnerships and joint ventures have also proven a fruitful path to success.

o HP gave 30% of its China subsidiary to the Chinese government. Conditions do change however; today the government would prefer to have the local JV partner be a company and not the government.

o Volkswagen builds most of its cars through its JVs, which carry Chinese brands (such as “Red Flag”), and portray the “made in China” image.

Offering to share business culture, management concepts, and technology skills are even more helpful to building trust and business collaborations. Programs that teach local companies software development process, instead of just new technologies, especially when they come from well-established companies such as Microsoft, are considered particularly relevant and helpful.

o IBM spent time to help Huawei—a Cisco competitor in China—redesign its organization. Huawei is now Cisco’s strongest competitor.

o Kentucky Fried Chicken and Coca-Cola have been training their local suppliers and partners how to manage their businesses, and both enjoy great success in China.

FORMULA #6: BUILD TRUST FROM A UNIFIED, HUMBLE ORGANIZATION

To create a good image in China, other companies have worked hard to keep a consistent corporate message and a low PR profile. Rather than PR campaigns, they have concentrated on winning trust from government and local partners. Philips China has seventy times more revenue in China than Microsoft, but only one-tenth as much PR as Microsoft.

Building a good corporate image in China requires much more than just PR efforts. The way to gain a good image is to build trust by combining all of the formulas above, while keeping a consistent message. This means that the subsidiary must have the kind of organizational structure and leadership that allows it to craft and control a consistent message. Companies that have done well in China made sure that they have a senior person (usually CEO) who is directly responsible not for sales, but for overall coherence and messaging, and for maintaining government relations. Intel, for example, sent its VP of Corporate Communications to head up China.

When it comes to PR, stay humble and focus on the partnership with China (rather than company boasting or personal glorification). IBM China has had noticeable success in managing a mature but low-key corporate image. Motorola is more active in PR, but its messaging is focused on its Chinese citizenship. Most Chinese people would have a hard time naming the senior Motorola executives in China.

PAGE 14

4. CONCLUSION

The emergence of China will be the single most important economic event in the next decade. Along with it will come tremendous business opportunities, a large pool of talent, and many powerful companies.

The stakes are high for any company. If it fails, another company or product could become a Chinese national standard, its products could be excluded from government procurement, and its image could be destroyed. If it succeeds, it stands to gain sustainable and predictable profitability, win-win partnerships with the Chinese government and companies, and great employees from a pool of amazing talent.

This paper describes a high-level plan of how to achieve this success in China, by learning from other companies’ success and failures. First, a company must build a solid foundation built upon Company Values, clear understanding of protocols in China, and strong government relationships. Then, based on this foundation, it needs to build a vision and long-term strategy for its China subsidiary that extends to every employee. In addition, it needs to hire great people and develop a unified organization to implement this strategy. Finally, it needs to execute consistently by nurturing its people, adhering to clear processes, making smart local operational decisions, fostering local business ecosystem, and presenting a unified corporate image and leadership in China.

By carrying out the proposed plan, a company can realize its potential in China by assisting China to realize its potential in the 21st century.

PAGE 15

APPENDIX: ANALYSIS OF SUCCESSFUL MNCS IN CHINA

Attached is a table that shows the following companies that have been successful in China and how they apply the six formulas discussed in this paper:

Volkswagen Motorola HP Samsung IBM Coca-Cola Kodak Intel Philips

PAGE 16

Table 1 – Analysis of Successful MNCs in China

Company Success highlight Formula #1: Learn the protocols and forge trusting relationships

Formula #2: Establish a strategy for long-term commitment

Formula #3: Nurture local talent and leadership

Volkswagen • China now is VW’s second largest market after Germany.

• 40% market share in China (vs. 6% in US). Audi has over 44% of luxury auto market

• Sold over 2.7M vehicles from 1985 to 2002.

• $4.3 billion in sales in 2001.

• Established early contact with rising stars in government.• Gained political capital by learning to navigate central and local bureaucracies.• Obtained direct support from German government and business organizations to help build relationships.• Leveraged their Chinese partners to position automotive manufacturing as a "pillar industry" in the Chinese government strategy.

• Committed new investments totaling $3.2 billion over the next five years.

• Sends local employees to corporate headquarters in Germany for management training.

Motorola • Earned 20% of its global revenue in China in 2002, reaching $5.7 billion.• #1 MNC in China measured by Export Value (3.6 billion in 2002).• 26% of market share, ahead of Nokia.• 30% of its handset production worldwide is sold in China.

• Kept commitment for CEO to meet with top leaders in the government after Tiananmen Square incident and was rewarded with a favored partnership. More recently, COO visited China at the height of SARS.• Explores many avenues for forging relationships and maintaining close links to important government officials: e.g. SVP Cai Guoxiong now a member of the National “Politburo”.• Strong supporter of China's WTO accession.• Developed e-PhD. program for government officials.

• Aggressive investment: $3.4 billion total by 2002, including a giant chip plant in Tianjin. Currently the largest foreign investor in China's IT and electronics sector.• Commitment to reinvest local earnings; no profit taken out of China yet.• Relocated North Asia HQ to Beijing.• Goals for 2006 include $10 billion worth of production in China, purchases of $10 billion in local components, and $10 billion in additional direct or indirect investment.• Supports China’s Western Development: invested $278 million in a semiconductor JV in western province Sichuan.

• Established a Beijing research institute in 1999 and recently announced a $100 million expansion.• Established Motorola University in 1993 to train internal employees. Experienced senior managers serve as consultants and instructors.• Now 75% of managers are local.

PAGE 17

Company Success highlight Formula #1: Learn the protocols and forge trusting relationships

Formula #2: Establish a strategy for long-term commitment

Formula #3: Nurture local talent and leadership

HP • $1.2 billion sales in 2001.• Revenue of HP China (including Hong Kong) is bigger than HP Japan.• One of HP’s fastest growing branches.

• Courted upcoming Chinese leaders, inviting them to the U.S. and seeking out their opinions.• Frequent executive visits to maintain top-level engagement with Chinese leadership.• Top leaders express their views and protect business interests in a constructive and collaborative way.

• In 1985, established the first joint venture between China and a US company, China HP. Gave 30% ownership of China HP to Chinese government.• Supports China's Western Development initiative by making loans to IT educational programs in western China.

• "Lion Plan" puts strong emphasis on training of local employees, cultivating local leadership, and transferring marketing expertise and technical knowledge.• The HP Business Academy helps Chinese managers improve their business skills.

Samsung • $1.8 billion in electronics sales in 2001, a fivefold increase since 1998.

• Profits soared 70%.

• Began manufacturing mobile phones in China for export before seeking permission for selling to domestic market.• $2.5 billion investment so far.• Corp strategy puts China as a top priority.• Rumored to consider moving parts of headquarters to China.

IBM • Total revenue in 2001 was 6.5 times of that of 1995.

• No.1 China market share (6.8%) in terms of revenue ($111 million) in packaged software, in 2001.

• Courted upcoming Chinese leaders, inviting them to the U.S. and seeking out their opinions.• First China CEO was a master of relationships (currently retired and serves as a consultant to Microsoft).• Strong in-house capacity dedicated to government and public relations.• Vigorously follows and supports government-directed priorities.• IBM CEOs visited China 27 times since 1981.

• Opened the first China Research Lab in 1995 (first IT company to invest in Chinese research) and donated more than $100 million in software and hardware to Chinese universities, winning a wide customer base in government and other state-owned sectors.• Invested $300 million in a chip-sealing venture in Shanghai.• Supported China’s Western Development strategy: Invested $20 million in a venture in the city of Xi’an to build online software development capacity.• Donates software and hardware to government and universities.

• Offers training that includes everything from career development and succession planning to English language skills and table manners.• Maintains stable local pipeline to help cultivate and sustain relationships.• Supports some degree of turnover from managers leaving IBM to join local companies.• Uses training to position itself as a great employer.• IBM China CEO Henry Chow was one of the first employees in Greater China (in 1968).

PAGE 18

Company Success highlight Formula #1: Learn the protocols and forge trusting relationships

Formula #2: Establish a strategy for long-term commitment

Formula #3: Nurture local talent and leadership

Coca-Cola • Has an impact of $4 billion to China’s GDP in its ecosystem.• Entered Chinese market one year before Pepsi and now enjoys revenues 3 times higher than its rival.

• Was the 1st company to distribute its products in China after China was open to foreign investors in 1979.• Leverage well-established social networks of its Chinese partners though joint ventures.• Current Chairman of Coco-Cola China is a member of the National Politburo of China.

• The company plans to double its previous commitments by investing another $1 billion in the China market in the next five years.

• Current Chinese chairman worked his way up from the ranks of the first employees hired in 1979, and became a national role model.• Worked with the Chinese government to create the Tianjin Soft Drink Training Center, which has provided training for the entire Chinese soft-drink industry since 1988.

Kodak • Has a domestic market share of over 60%.• Chinese market moved from 17th

largest of Kodak’s global markets 4 years ago to 2nd.

• Chairman and CEO George Fisher has built strong relationship with the Chinese government while with Motorola. Kodak leveraged these relationships after Fisher joined.• After 3 years of negotiations, Kodak reached an agreement with China to buy almost all failing local film companies for $1.1billion. Selling local companies to MNCs at this scale is unprecedented in China, and shows an extraordinary level of trust.

• Spending $1.1B on money-losing plants shows an extraordinary long-term commitment to China.• Recently made its biggest foreign investment in 25 years by opening a production facility in Xiamen, Fujian province.• Has plans to respond to the government's western development strategy.

Intel • $2 Billon revenue in China in 2000.

• 13 branch offices in China.

• Gained high degree of trust from the government by sending VP of investor relations / government relations to head the subsidiary in China in 1996.

• After initial failure in China, in 1994 Andrew Grove mandated a re-organization of the Intel Chinese management, and formulated a whole set of strategies to emulate Motorola’s China strategy:• Invested $200 M and opened Intel

Tech. (China) Ltd. in Shanghai Pudong in 1998. Employees 800+ people.

• Opened Intel China Research Center in 1998.

• Intel venture capital has made 20 investments in China.

• Sponsors annual National College Students Electronics Design Contest to encourage creativity

PAGE 19

Company Success highlight Formula #1: Learn the protocols and forge trusting relationships

Formula #2: Establish a strategy for long-term commitment

Formula #3: Nurture local talent and leadership

Philips • Revenue reached $6 billion in China in 2002.• China makes up 20% of total global production.• 2nd largest share in Chinese semiconductor market (11th in the global market).

• Built good relationships with governments from the start, met with country leaders regularly. • Followed the rules and behave

responsibly; values local customs• Early entry –helped write the Chinese joint venture law.• Helped Chinese government by lobbying Dutch and other European governments to be more favorable to China in spite of the human rights concerns.

• Set China to be the leading part of its Asia strategy.• China accounts for 50% of Philips’s employees in Asia Pacific.• Invested $2.5 billion in China.• Founded R&D and research center in China.• Moved many core businesses to China, such as DVD drive, TV, wireless communications.

• Helps several leading Chinese universities in engineering and management training, and provided career opportunities to the students

PAGE 20

Table 2 – Analysis of Successful MNCs in China (continued)

Company Formula #4: Be flexible and open to local needs and practices.

Formula #5: Help build the local business ecosystem

Formula #6: Build trustworthy image by action and unified message

Volkswagen • Worked to comply with government requirements for local content.• Adjusted business tactics to move from working within a centrally planned system to an evolving regulatory environment.• Started out by producing only a single car model and focusing on fleet sales to government, then eventually moved to a system of introducing 1-2 models/year with growing sales to private consumers.• The Santana, produced by a JV in Shanghai, was designed to answer local need for small, fuel efficient, 4-door passenger cars and is now the most popular car in China.

• Formed several joint venture automobile manufacturing partnerships in China.• Employs 16,000 people not including jobs created for suppliers, distributors, etc.

• Opened automotive design centers in Tsinghua and Shanghai Jiaotong University.

Motorola • Adjusted product line to offer better Chinese language text messaging and more design features in order to compete with locally produced models.• Aggressive local sourcing programs make them the largest single buyer of Chinese goods, $1.4 billion in 2001, 69% of its global parts purchases, 2.6 billion in 2002.• Introduced technology transfer programs.

• Facilities in China include a wholly-owned company, a holding company, 9 JVs, and 24 sites, with more than 12,000 employees (12% of its worldwide workforce).• Motorola China R&D Institute employs 1,300 local workers doing researching products such as phone handsets, semiconductors, and speech software in 16 R&D centers. To increase total R&D investment to $1.3 billion and R&D engineers to 4000 by year 2006.• Developed many programs targeting senior and midlevel managers from its local suppliers, strategic partners and customers.• Co-initiated with SDPC, Motorola established the Center for Enterprise Excellence. Motorola Global Software Group offered CMM training to 45 Chinese software enterprises.

• Very consistent communications from every part of Motorola – positions the company as a good citizen in China that makes win-win with China its top priority.• Made donations to local universities, including $1.5 million in scholarship.• Donated $3 million to set up 50 primary schools in rural areas; and funded 10,000 poor children to return to school.• Contributed to disaster relief, sporting events and environmental protection.• Sports Sponsorship: Asian and National Games, CNBA, Special Olympics• Environmental Protection: "Green China" Program in six major cities. Pioneered role in the collection and recycling of mobile phone components and batteries.

HP • Actively buys Chinese goods. Built procurement center in Shenzhen. Its procurement in China accounts for 30% of its global procurement.

• Currently employs 4,000 local workers.• Grow with channels – active plan to share marketing expertise and transfers knowledge to partners.

• Made donations to support IT R&D programs, hospitals, Asian Games, and other community causes.• Donated to the Ministry of Education and Chinese universities.

PAGE 21

Company Formula #4: Be flexible and open to local needs and practices.

Formula #5: Help build the local business ecosystem

Formula #6: Build trustworthy image by action and unified message

Samsung • After losing money on a stripped down version of a domestically manufactured washing machine, the company switched to market in China its top-of-the-lien model, turned a profit.•Introduces high-end mobile phones first in China, using customer requirements generated from China.

• Makes sure that its partners' profits are higher than others, in order to win their trust: margins for Samsung’s sales agents can be nearly double those for other phone makers.

• Rebranded Samsung to represent product quality in Chinese market.

IBM • Located a procurement center in Shenzhen and increased local procurement from $30 million in 1993 to $3.2 billion in 2001.• Setup some export oriented JVs.• Nimble organization responding quickly

to government needs – donated a Java center to Beijing within days after finding out BillG’s visit to the Beijing government.

• Employs 3,000 local employees in China.• Started more than 10 joint ventures to lessen fears about competing with export-oriented Chinese industries and earned a reputation for contributing to the local economy.• Outsourced software localization to China, and provided know-how transfer to partners.• Invested in software parks -- $12M in the Xi’an park, and much more to come in others.• Trains local companies on leadership and organizational skills – Huawei was trained by IBM, and is now a top competitor to Cisco.

• Maintains a low-key corporate profile, and policy of doing more and talking less.• Donated to education 5 years before China sub made profitable, and total donation reached $100 million. • IBM KidSmart program for early-stage child intelligence development.

Coca-Cola • Adjusted soft-drink flavor profiles to match local preferences by creating Xingmu, a new local brand of carbonated fruit drinks aimed at Chinese tastes.• Gives local managers the power to develop local advertising strategies.• Successfully avoided brand piracy by allowing China subs to price soft drinks so affordably that it was no longer worth the effort to counterfeit them.

• Directly employs 14,000 in China• Helped create 400,000 jobs for local bottlers, retailers, and vendors.• Trained local suppliers and partners how to manage their business.• Worked with city officials in Harbin and Jiamusi to provide training to laid-off workers.• Worked with the Chinese government to create the Tianjin Soft Drink Training Center, which has provided training for the entire Chinese soft-drink industry since 1988.

• Donated primary schools for the rural areas in each of last 10 years, 52 schools in total. This is the high-profile “Hope” Project. (MS contributed to one school)

Kodak • Offers special pricing in China. • Won loyalty and trust by buying and reviving failing local film companies so that neither the media nor the government speaks up against it monopolizing the market.

PAGE 22

Company Formula #4: Be flexible and open to local needs and practices.

Formula #5: Help build the local business ecosystem

Formula #6: Build trustworthy image by action and unified message

Intel • Offer cheaper prices to local manufactures.

• Serious about GuanXi (relationships) - Andy Grove personally attended the celebration of the production of Legend’s 1-millionth PC in 1998. He also met with CEO’s of 12 Chinese PC companies.

• Actively supported local PC manufacturers.Close partnership with Legend, the leading local PC manufacturer.

• Sponsored free educational seminars on basic PC and Internet usage for Chinese consumers in more than 40 cities, most of which are in remote areas.

• Donated more than $100M to schools and universities in the past few years.

Philips • Philips’ exports from its China JVs has grown at 27% annually. • Supports the Chinese 3G standard.• The Philishave, one of Philips’ top selling global products, was significantly tailored for the Asian consumer. • 60% of Philips products made in China are considered exports from China.

• 30+ wholly-owned subsidiaries and joint ventures in China in areas of Philips’ primary business.• Significant know-how transfer to the JVs.• Established credit line to local dealer networks, so that they can grow (and prefer Philips products) when they have limited cash flow.

• Sponsored local sports such as the Chinese soccer game.• Keeps low profile (has only 10% of press coverage compared with Microsoft).

PAGE 23