How do firms strategize in China where business can be more growth- than profit-driven? Or need they strategize at all? The latter is a significant question, because in China’s growth-driven economy (a) the government, through the planning process and agencies like the National Development and Reform Commission, makes key economic decisions, (b) capital is abundant for sectors favoured by government policy but scarce for other sectors, (c) profits and shareholder returns may be less important than production and employment, and (d) preserving assets may be more important than deploying assets efficiently. At the asymptote, one could argue that strategy given these conditions is either (a) unimportant since firms, including privately owned firms, must ultimately adhere to government policy, or (b) exceedingly difficult to implement and execute consistently since reversals of government policy are frequent and unpredictable.

The picture becomes more complicated because in China (a) the economy is decentralized and local governments compete for growth targets, (b) an element of competition is local protectionism, (c) protectionism gives rise to market fragmentation, and (d) fragmentation reduces or reverses the advantages of domestic enterprises in comparison with foreign enterprises. These factors together render Chinese markets hypercompetitive for firms not enjoying the protection of the state. The strategic responses of firms include (a) buffering hypercompetition by seeking government aid, (b) intensifying competition by initiating price wars, (c) pursuing opportunistic revenues by entering into seemingly profitable lines of business whether related or unrelated to existing businesses, and (d) radically decentralizing the firm in order to best accommodate demand in highly fragmented and rapidly changing markets. Interestingly, the first and second responses may be combined, where (a) the firm, consistent with the preference for growth, is a revenue- rather than a profit-maximizer, (b) revenue maximization is achieved by cutting costs and pursuing government subsidies, (c) an opportunity to sideline rivals with less government backing and hence less staying power is perceived, and (d) if successful the strategy yields a triple win for the firm, the government and government officials: the firm eliminates competitors, the government realizes higher regional domestic product (the regional counterpart of gross domestic product or GDP) and tax revenues, and officials are advanced to higher posts based on successful performance.

This article begins by establishing that China is a growth-driven economy. A recent paper (Meyer 2011) is summarized, where I coin the term institutionalized GDP growth, and I identify mechanisms through which institutionalized growth penetrates to the firm level. Next I consider how firm strategies have been shaped by (a) decentralization, regional competition and market fragmentation, (b) foreign competition and (c) relentlessly increasing costs. The ideas developed here are preliminary and intended as suggestive of the subtlety and variety of strategies Chinese firms have evolved. The third section shows that a decentralized growth-driven economy is especially conducive to price wars, and then compares the price-war strategy with an emerging counter-strategy. Interestingly, the counter-strategy is supported, among other things, by a radical decentralization of the firm paralleling and leveraging the deep decentralization of the Chinese economy. There nevertheless remains a critical difference between the price-war strategy and the counter-strategy: whereas the price wars are easily triggered and imitated, the counter-strategy is neither easily implemented nor imitated.

China as a Growth-Driven Economy

China has a growth-driven economy. GDP targets have been hardwired into successive 5-year plans, progress towards these targets is measured at four levels of government (national, provincial, prefectural/municipal and county/district) and reported semi-annually, and these targets have been fulfilled and over-fulfilled mainly owing to government policies promoting investment in fixed assets and low-cost manufacturing for export. From 2003 to 2011, Chinese GDP grew at 9% or more annually; only in 2012 did growth fall to 7.8%. Throughout, fixed-asset investment grew more rapidly than GDP, even though net exports moderated from 2009 onwards; investment-driven growth, as a consequence, shrank household consumption in proportion to GDP, inverting the increased contribution of household consumption to GDP that is normal for countries at China’s stage of development. Currently, China’s 12th Five-Year Economic Plan calls for a modest reduction of the official GDP growth target, from 7.5% to 7% coupled with a boost in consumer spending. Observers remain sceptical, however: ‘The last Five-Year plan (2005–2010) opened with similarly fervent pledges to rebalance, but exactly the opposite happened: investment now plays an even bigger role in China’s GDP formation, while the share of household consumption as a percentage of GDP continues to shrink’ (The Telegraph 2011).

It is less clear whether Chinese firms, as distinct from China, are more growth- than profit-driven; in other words, whether preternatural or institutionalized growth operates at the level of firms. The Chinese central government has clearly favoured large firms, evident in the policy of ‘grasping the large while letting go of the small’ (zhua da fang xiao) adopted by the 15th Communist Party Congress in 1997. Still, profit-seeking behaviour abounds as evident by the fact that (a) some of the largest state owned enterprises remain highly profitable and seek to retain their earnings while the State-owned Assets Supervision and Administration Commission (SASAC) has been trying to extract a portion of these earnings, as dividends, from these enterprises, and (b) according to the latest Hurun rich list (Hurun Report 2013), 251 individual Chinese amassed fortunes in excess of US$1 billion in 2012, the wealthiest concentrated in real estate. However, profit-seeking may be attenuated by (a) weak corporate governance, as evidenced by the presence of a controlling shareholder in more than 99% of Shanghai-listed firms (Amit et al. 2010: Table 1), (b) SASAC and China Securities Regulatory Commission (CSRC) regulations, dating from 2006, severely limiting stock options and grants of restricted stock to managers, and (c) various government policies forcing large enterprises to swallow increased commodity prices rather than passing them on to customers. Whether and how growth targets are communicated directly to Chinese managers, and with what effect, is for the most part unexplored. However, interaction between the government officials and senior management can be intense, as indicated by the following: (a) unscheduled meetings with the government may consume half or more of senior managers’ time, and (b) the proportion of former government officials, communist party officials and former state-owned enterprise managers among private business owners has risen dramatically, from one in three in 2004 to two in three in 2007 (Asia Times 2007). A reasonable hypothesis is that the closer and denser the ties between managers and the government, the greater the salience and the stronger the incentives to meet growth targets, and hence the more responsive the firm to these targets. Thus, SOEs will be more sensitive to growth targets than private firms, and firms closer to Beijing or located in inland regions anticipating especially rapid development will be more sensitive to growth targets than firms in the south of China.

Strategies in a Growth-Driven Economy

Strategies in Response to Decentralization, Regional Competition and Fragmentation

If China were a Soviet-style centrally planned economy with targets assigned annually to sectors and firms, then growth would be attenuated owing to the well-known ratchet effect (Weitzman 1980). However, China has (a) pursued administrative decentralization where state ownership, defined as ownership by the whole people, is retained but responsibility for enterprise operations and results in all but the largest firms is delegated to local officials and enterprise managers (Wu 2005), and (b) pitted local governments against each other (Xu 2011) by proffering political advancement to officials achieving the highest rates of GRP (gross regional product) and employment growth (Li and Zhou 2005; see, however, Shih et al. (2012), who argue that network ties are more important to advancement than growth). The combination of administrative decentralization and competition for regional growth has led to regional preferences if not outright protectionism (though the strongest evidence for regionalism comes from the late 1990s – see Young 2000; Poncet 2003, 2005; Bai et al. 2004); local preferences and protectionism, in turn, have rendered many industries fragmented and markets hypercompetitive (Section 7 of the 2008 Anti-Monopoly Law bans administrative or local-government monopoly, but its enforcement remains uneven). As a consequence, building firms of national scope and consolidating markets has been a strategic priority for the Chinese central government and many managers, yet remains elusive for most firms.

Fragmentation remains greatest in legacy industries like steel. At the behest of the central and Shanghai governments, one of China’s leading steel firms, Shanghai-based Baosteel Group, merged with two local steel producers, Shanghai Steel and Meishan Steel, in 1988, combining a highly efficient producer with two inefficient producers. A decade later, Baosteel was encouraged to absorb the Guangdong Steel Group, also an inefficient producer. The integration of Baosteel with Guangdong Steel remains incomplete because the interests of Baosteel, a State Council company, are at odds with the Guangdong and Guangzhou governments: whereas Baosteel has sought both to reduce the capacity of Guangzhou Steel and to realize gains from labour-saving technology, the Guangzhou government has sought to protect the workforce as well as its investment in Guangzhou Steel.

Consolidation of non-legacy industries is more or less daunting depending on (a) the number of jobs at stake, (b) the threat, if any, to a local monopoly, and (c) the impact on local government revenues. China International Marine Container (CIMC), a leading manufacturer of transportation equipment, successfully integrated the Chinese shipping container industry in the early 1990s, owing to a compelling value proposition and support of the Shenzhen government: (a) integration would yield substantial scale and scope efficiencies; (b) few jobs were at stake since the Chinese shipping container industry was undeveloped; (c) there were no local monopolies since shipping containers were built to global standards and sold to global customers; and (d) local government shareholders of CIMC subsidiaries would earn dividends based on production rather than profitability. So compelling was this proposition that, despite staunch opposition from China Ocean Shipping Company, COSCO, one of two major shareholders and a State Council company, CIMC implemented the strategy, consolidated the Chinese shipping container industry and, ultimately, dominated the global shipping container market (Meyer and Lu 2005). CIMC subsequently diversified into semi-trailers. However, replicating the container strategy in the semi-trailer business proved challenging because standards and specifications for domestic semi-trailers were controlled by local governments intent on protecting local producers. CIMC chose not to challenge local standards and specifications but, rather, to manufacture semi-trailer modules assembled to multiple standards and specifications; in the long run, of course, CIMC aims to reduce the panoply of local standards currently in place.

Local protectionism and industry fragmentation increase costs on several dimensions, including (a) capacity costs (owing to the penchant for fixed-asset investment), (b) operating costs (owing in part to inland logistics costs, higher in China than the US or India), and (c) transaction and administrative costs (owing to the labyrinth of regulations and government entities). Short-run capacity costs are deferred by rolling over bank loans financing expansion. Operating costs are offset by subcontracting, adding to the risk of the well-known ‘bullwhip effect’ in supply chains and placing quality at risk (Lyles et al. 2008). It is expected that massive infrastructure development will curb logistics costs directly, by reducing the cost of transport, and indirectly, by encouraging industry consolidation. Transaction and administrative costs are managed by cultivating officials whose action or inaction can affect these costs dramatically, making the relationship with government a strategic priority for many firms.

Strategies in Response to Foreign Competition

With reform and opening beginning in 1978, China adopted policies designed to attract foreign investment. These policies included special economic zones and free trade zones, preferential tax policies and ‘one-stop shopping’, facilitating licensing and hiring of qualified workers by foreign-invested and wholly foreign-owned enterprises. While these policies drew manufacturing to China and created much-needed employment, they left domestic firms disadvantaged in several respects, including (a) key capabilities, including product design, remaining offshore; (b) branding of domestic firms; and (c) weak domestic institutions such that the environment most conducive to financing and operating large business firms, including a predictable legal process, also remaining offshore. In response, Chinese firms took several tacks, among them (a) paralleling the earlier experience of the ‘tiger’ nations of South East Asia, upgrading from OEM to ODM (original design manufacturing) capability; (b) acquiring Western brands, most notably Lenovo’s acquisition of the ThinkPad brand and Geeley’s acquisition of Volvo; and (c) ‘round-tripping’, that is, investing in overseas (mainly Hong Kong) holding companies whose operating units are, in turn, located in China (Lenovo is again illustrative). In markets for complicated machinery, for example, elevators or electrical generating equipment, dominated by foreign firms, domestic firms have also pursued a niche or ‘sandwich’ strategies of providing replacement parts or maintenance, since they can operate on a smaller scale than global firms.

The ODM, brand acquisition, round-tripping and sandwich strategies are largely piecemeal, and the Chinese government has encouraged firms to pursue more comprehensive strategies including: (a) innovation and (b) development of rural distribution. Concerning innovation, China has issued a ‘National Patent Development Strategy (2011–2020)’, calling for two million patents to be filed annually by 2020 (compared to 244,000 US patents in 2010). The patent development strategy may be accompanied by a dramatic increase of national investment in R&D: the Battelle Institute (2013) projects that 2013 Chinese R&D expenditures will be 1.65% of GDP, compared with 1.55% in 2011. (By comparison, 2013 US R&D expenditures are projected at 2.66% of GDP compared with 2.7% in 2011). Less visible but potentially quite significant is the development of rural distribution in China. Markets in the countryside, still half of China’s population, are pursued by (a) word-of-mouth marketing campaigns in rural villages, (b) Internet-based information kiosks in locales too small to support retail outlets, (c) unique countryside logistics systems where delivery vans circle among multiple towns and villages rather than travelling to and from a central distribution point, and (d) products uniquely suited for rural customers, for example, inexpensive single-use sachets of personal care and cleaning products, and clothes washers that are rat-proof and can double as vegetable washers.

Strategies in Response to Inflation

China has experienced periodic bouts of high inflation as recently as 2007–2008 and 2010–2011. Quite apart from inflation driven by currency exchange policies, an inflow of ‘hot money’ seeking RMB appreciation, and the massive 2008–2010 fiscal stimulus, the economy appears to have passed the ‘Lewis turning point’, where a labour surplus turns into a shortage, reflected initially in rural wages and subsequently in urban wages. New evidence suggests that rural wages began rising dramatically from 2003 and urban wages from 2006 (Zhang et al. 2011), even though wage inflation paused in 2008–2009. The strategic implications are profound given China’s dependence on low-cost manufacturing for export. Among other possibilities, firms may seek to: (a) substitute capital in the form of machinery, process efficiency and so on for labour (e.g., China’s largest auto producer, SAIC, is automating rapidly), (b) relocate inland where labour costs are lower (e.g., Foxconn’s relocation of assembly operations from Shenzhen to Chengdu), or (c) migrate from low-value to high value products (e.g., the Wenzhou button industry has moved from ordinary to laser-etched buttons commanding premium prices). For pillar Chinese industries, however, the choices are more daunting. Steel again is illustrative. China imports iron ore. As wages and commodity prices increase, largely owing to Chinese demand, the iron ore exporters, principally Australia and Brazil, are attempting vertical integration of the industry by initially acquiring shipping capacity and later developing domestic production capacity. (Australia and Brazil have already acquired shipping capacity, glutting the market and driving bulk shipping rates towards historic lows.) The Chinese are also attempting vertical integration by investing in overseas iron ore producers to stabilize prices and preclude their vertical integration. (Chinalco tried unsuccessfully to acquire a substantial interest in Australia’s Rio Tinto.) Whether China’s experience in steel will be repeated in other key industries, coal for example, is less clear. Regardless, the joining of wage and commodity inflation with China’s dependence on imported iron ore and, increasingly, coal, reduces the likelihood that the global steel industry will remain centred in China.

Strategies in Response to Price Wars

Price wars, as mentioned, are commonplace in China, hardly surprising since one would expect price competition to be more frequent where growth takes precedence over profitability, markets are fragmented, and accountability to shareholders remains weak in comparison with the US and the EU. A crucial strategic question for certain Chinese firms, a small number to be sure, is not how and when to initiate price wars but, rather, how to compete effectively while avoiding price wars. The conventional Western answers lie in branding and innovation: teach the customer to value the brand; create products adding value for the customer wants faster than your competitors can. A less conventional answer pursued by Haier, China’s largest appliance maker, lies in accounting and management systems diverting attention from growth targets by focusing relentlessly on profit. Rather than setting sales targets and rewarding sales in excess of targets, Haier’s management and accounting systems allow individual employees to (a) discriminate profitable from unprofitable products, (b) discriminate profitable from unprofitable customers, (c) calculate individual and team contribution to bottom-line profitability, and (d) calculate individual and team earnings based on contribution to profitability. The management system is supported by some unusual managerial practices, including: (a) decentralization of target-setting to 2000 ‘self-owned’ teams where setting and meeting aggressive yet realistic targets is rewarded (while setting low-ball targets or missing aggressive targets are punished), (b) inversion of the organizational hierarchy where teams have authority to choose members, compensate performance, and ‘push back’ on the organization for improved or redesigned products and services and responsibility to pay for improvements and new designs, as well as (c) a culture of ‘end-to-end’, reminding employees that the path to profitability lies in meeting end users’ requirements.

There are many sources of resistance to accounting systems where profitability is calculated at every point in the organization, including support functions, and to managerial practices essentially gutting middle management and holding front-line employees responsible for bottom-line results. Little is known, for example, on whether market-like transactions are feasible in highly interdependent systems, and on whether focus on the bottom line will be conducive to teamwork or corrosive of it. It is possible, of course, that these issues will be rendered moot as China evolves towards more normal rates of economic growth and stronger corporate governance. But it is also possible that growth and fragmented markets have become deeply institutionalized and corporate governance not, in which case the burden will fall mainly on management to produce the sustainable profits firms require.

Summary

The most important point is that China is not a simple command economy where strategy, such as it is, emanates from the centre. Nor is China entirely capitalistic and profit-driven. Rather, China is a decentralized and regionalized economy where local units compete for growth, with unanticipated and, in some respects, untoward consequences for firms and markets. These consequences include economic fragmentation, hypercompetition and frequent price wars. Firms engage in diverse strategic responses to these conditions, including initiatives aimed at industry consolidation, extensive subcontracting, pursuit of favourable government policies, acquisition of foreign brands and so-called ‘round-tripping’, whereby domestic firms reorganize as foreign firms, in effect co-opting overseas institutions while operating in China. Some Chinese firms, additionally, are today looking inward to their accounting and management systems rather than outward to broad strategic initiatives in their quest for sustained profitability. These efforts are nascent and substantial departures from Western practice. Hence, it is possible that China will look to fundamental managerial innovation rather than to strategies drawn from Western experience to build firms of global scale and scope.

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