Chapter 5

Brand China

The year 2008 saw scandals erupt from China at a rate that seemed to outpace the country’s supersonic economic growth rate. It was also the year China was to host the summer Olympics, which would brand the country as a thoroughly modern nation rising to superpower status. Unfortunately for the nation’s image, this was also the year consumers discovered the paint on toys that American toy maker Mattel was sourcing from China was laced with toxic lead. Soon after the toy debacle, American buyers discovered Chinese producers had tainted pet food and toothpaste exported from China with the plastics-derivative melamine. The concentration of melamine was so heavy in the pet food that thousands of family pets throughout the United States died. The scandals laid a devastating blow to the image China had been working to project to the world in the run-up to the Beijing Olympics.

Country images are important to the bottom lines of nations and the extent to which they are able to successfully export products and entire industries across borders. America after World War II successfully exported its fast-food and fast-drink culture around the world with McDonald’s and Coca-Cola leading the foray. Germany exports its image as a producer of well-designed, well-engineered, high-quality engineering products. The Danes export a spare, elegant design aesthetic in their personal-use items. China exports Fake.

Can China reverse the image its exporters and its government are conveying to the world? What change in its national and corporate psyches would it take to catalyze change? The magnitude of the alterations would involve innovations of behaviors and cultural norms that have been entrenched in the society for hundreds—if not thousands—of years. If the government has not successfully rebranded the country after all these centuries, can Chinese companies seeking to establish credible brands in international markets be successful? Unfortunately, even the orchestration of the Olympics itself ran counter to the image the country was trying to project to the world.

Certainly, thousands of goose-stepping soldiers during the opening ceremonies of the 2008 Olympics did little to dispel the lock-step, militarist image most of the Western world had of China. However, the international revelation that the little girl Lin Miaoke, who sang a welcoming song to the world, was actually lip-syncing while another, not-as-cute girl—according to Chinese political choreographers—actually did the singing backstage was a major set-back to Chinese propagandists. The occasion merely confirmed to the West that Brand China was—like so many other Chinese presentations—a sham. China’s populace eventually condemned its own government when it discovered authorities were complicit in a cover-up of enormous proportions.

For months, if not years, major dairy producers had been lacing their dairy products with the very same melamine that had meant the deaths of so many beloved pets in the United States. Since the end of the previous year China’s leaders had known Chinese children were in danger from the poisoned milk powder their parents unknowingly fed their infants. The leadership believed the 2008 Olympics, and the carefully crafted image the event was meant to portray, was far more important than the potential deaths of Chinese infants.

Eventually, the central government was unable to hide the fact that more than a dozen infants had died from drinking melamine-laced milk powder. Thousands more were stricken ill. When the scandal brooked international media channels, China’s image in the world’s eyes was once again tarnished. Most Western observers agreed that any progress central authorities had made in advancing China as “a country that had arrived” on the world stage, as a mature if misunderstood stakeholder, had evaporated with news of the scandal. Local governments and the national inspection bureau charged with ensuring the quality of consumer products—The Administration of Quality Supervision, Inspection and Quarantine (AQSIQ)—had been in collusion with dairy producers in the promotion, distribution, and export of the tainted dairy products. Foreign buyers of Chinese milk products from Switzerland to America to Japan stopped all imports and use of dairy products made in China. Cookies, chocolates, and yogurts meant for international markets tested positive for melamine. Authorities intended the executions of the director of the AQSIQ and the CEO of a leading dairy producer to signal the end of the scandal.

Central planners nationalized the dairy industry and reassured domestic consumers and international buyers of product quality. Draconian government inspections of the dairy supply chain declared the poisoning issue resolved. Late in 2009 and then again in 2010 the plastic reappeared in the dairy supply chain in half a dozen provinces. Western quality assurance engineers and plant managers in China explained to me the recurrence of melamine in the dairy products was part of the system, not an aberration. If the customer had a problem with materials or components the producer used, they said, then the factory would re-introduce the rejects later on. Producers would inject the rejected materials slowly back into the supply chain. They expected no one would notice, or believed that the relatively small number of defects would be acceptable to buyers. Domestic and foreign buyers found the government’s claims of the integrity of any of China’s products incredible.

A National Image Made in China

When I spoke with Andrew Hupert, an adjunct professor at the Shanghai campus of New York University, he noted that Brand China is characterized by negatives: difficult to deal with, fussy, duplicitous, and passive-aggressive. The promoters of Brand China have been its export-driven privateers. They make and sell low-end, low-quality, low-priced products for international markets using cheap labor, cheap materials, and government subsidies. They also create world-beating pollution issues for their own country and for others. Westerners bought the products in great, unsustainable quantities specifically because they knew what they were getting. It was—and will be for the foreseeable future—very difficult for Germans, for instance, to go to a showroom factory floor in, say, Frankfurt, and buy a Chery brand car made in Wuhu, Anhui province. For most Germans—and Westerners—China has not cleaned its systemic house well enough to warrant risking the lives of consumers. However, should the same shoppers need jumpers for their toddlers made in Shenzhen, in South China, they would have no mental resistance to dropping a few euro for the low-end purchase. Country brand images are monstrously difficult to shed.

For instance, at the start of the so-called “War on Terror” the administration of George W. Bush set out to demonstrate to the Muslim world just how warm, cuddly and cool the United States really was. The cognitive dissonance, however, between images on Aljazeera news of the American-led coalitions in Afghanistan and Iraq blasting villages to smithereens, and counting mistakenly obliterated weddings in the countryside as collateral damage, actually set America’s charm offensive a blow from which, years on, it has still not recovered. The haste, waste, and off-handedness with which the Americans handled rebuilding a shattered Iraq forced the majority of the population to tire of the occupying forces long before they evacuated in 2011. China, as well, miscalculated its coolness factor with foreign audiences.

China’s attempt at rebranding its country backfired in early 2011 when the country spent millions of dollars on producing and airing a series of 60-second videos for a month in Times Square in Manhattan. The images flashed by so quickly it was difficult for any viewer—Chinese or foreign—to distinguish the rich and successful Chinese people living it up and talking about how great their lives were and how China wanted to be everyone’s friend. Some of the images were of Americans of Chinese descent. No one in Times Square, however, recognized the cast of characters screaming out at them from a virtual world. Chinese citizens, once they learned about the expensive promotion, roundly assassinated the production and the producers, and asked the pointed question, “Who are those people on the screen”? If China’s own citizens found such a propaganda push unconvincing, how would such an effort be effective in other countries? What matters to most people’s judgments are a country’s core values.

Hupert told me about five Brand China core values Chinese central government leaders seem unaware they are expressing: China is opaque and mysterious (“Being mysterious is cool at first, but after a while it just gets creepy and passive-aggressive,” he told me); state-sponsored corruption, which permeates the society and reads in China business handbooks as The Chinese Way; an angry country (“China’s feelings have been hurt (again),” Hupert said, “and it will damage trade ties (again).”); the game is fixed (“Trade barriers and indigenous innovation regulations seem to have elevated thinking that ‘it’s easy to fool a foreigner’ from a folk-saying to official policy.”); product safety and quality problems (“Americans still associate China Inc. with poor quality, dangerous products and low-cost, lower-value Walmart goods,” Hupert noted).

Chinese companies laboring under the Brand China image that want to break into the big, credible leagues of an IBM, BMW, Sony, or LG need to innovate in a variety of ways to dispel perceptions abroad about doing business with China. Corporate branding, product, operations, management, and strategic innovations must work in concert to convince buyers that Chinese corporations can meet international standards. Some argue a company’s brand image is the most important of its assets. Brand image can be so precious that sometimes a monetary value cannot be placed on it. For most Chinese companies dealing abroad, though, their brand image is their greatest liability.

When Being a Chinese Company Isn’t Cool

Brand innovation involves shifting the “personality” of a product, product line, or even company so it aligns with the expectations of potential buyers and maintains an identity customers trust and rely upon. The consistencies of message, of the quality of the offering, as well as delivery, all become part of defining the extent to which customers trust a brand.

Unfortunately, when Americans hear of a potential Chinese acquisition of an American company they automatically think the acquirer has Chinese government backing, or that there is some evil plot to subvert American values. In the case of China National Offshore Oil Corporation’s (CNOOC) attempted acquisition in 2005 of Unocal, an American oil company, they would have felt justified. In the instance of Huawei, a communications equipment manufacturer that has attempted several acquisitions in the American market since the turn of the century, they may also have felt their supposition supported. Huawei has been unable to shed its convoluted holding structure, which involves the People’s Liberation Army. And though Chinese Internet service providers Sina.com and Baidu.com are not household names in the West, they are listed companies in the United States. The companies gained the greater portions of their vast market share in China at the behest of the Chinese Communist Party (CCP). The CCP in 2008 enacted restrictive regulations that made it very difficult for foreign online operators to capture but a small part of Chinese commercial cyberspace. Central government curbs to control domestic markets and the de facto support of state-owned enterprises adversely impact the trajectory of Chinese companies that want to establish brands overseas. Andrew Hupert pointed out to me that China doesn’t have an Apple or a Benetton to give voice to individual aspirations or personal ambitions.1

Companies like Haier—a white goods manufacturer, Lenovo, the computer maker, and Geely, which produces air conditioners—are well known by Chinese consumers. Whereas Geely was struggling to break into international markets in 2010, Haier remained the leading white goods manufacturer of the small refrigerators found in college dorm rooms the world over, among other product lines. Lenovo, though, has been the most successful at rebranding itself and recasting its image as an international player.

Lenovo originally began as Legend in the mid-1980s. The central government asked Liu Chuanzhi to distribute the then new-fangled personal computers throughout government agencies and SOEs. Liu did such a great job in distribution and training on the new technology, the government backed the establishment of Legend, sanctioning the design and construction of home-built machines. Lenovo continues to have strong ties with the Chinese Academy of Sciences. The government also provided a ready-made customer base for Liu to sell into, providing a platform from which the company could attain more than US$2 billion in revenues and more than US$40 million in annual profits in 2000. Legend rebranded as Lenovo in 2003 when it felt it was ready to break into international markets, by which time it was the ninth largest PC maker in the world.2 Legend would have preferred to retain its name in foreign markets; however, the name “Legend” was already registered in the countries into which they wanted to sell their products.

Lenovo preferred to keep its Chinese name within the Chinese market. However, overseas, it chose a neutral, international-sounding name to distance itself from the image Brand China encouraged in the minds of potential buyers. The strategy paid off in 2004 when Lenovo successfully acquired the laptop division of IBM, which had been exploring ways of divesting itself of its PC hardware business at the time. The key in the rebranding strategy that catapulted Lenovo from ninth largest PC maker in the world in 2004 to number four in 2010 involved an agreement with IBM to use the IBM brand for five years, which included the use of the “Think” badge. “Think” was the label IBM used for its laptop series, popular with corporate customers. IBM also promised to support the success of the Think product line under new ownership through use of its own corporate sales force. The agreement dramatically reduced Lenovo’s risk of losing the customer base with companies outside China that had bought laptop products from IBM. The concern was that customers would have fled because of quality and accountability problems related to the perception of Brand China.

Beyond Cheap

Chinese manufacturing has the dubious distinction of being of low-value and poor quality—i.e., cheap. Not even Chinese people trust many of their own brands. One of the habits I had to learn whenever I bought electrical appliances and other products in Chinese stores and malls was inspection. Service staff consistently pulled the item I wanted to purchase from its sealed box and plugged the appliance in and turned it on. They wanted to prove to me there on the spot that what I had bought was indeed operating as advertised. Nevertheless, the stigma infects nearly every product exported from Chinese suppliers. The preconception also adversely affects the efforts of the country to move up the value scale with increasing credibility.

Typically, product innovation involves making a better widget, or one with added features, or something that actually does the job it was bought to do. A British manager, named Peter, suggested to me that his staff did not have “application knowledge” when he first started up a factory in 2000. His factory made Do-It-Yourself (DIY) tools. He posed the question to me, “How can engineers extend a tool or create a new one if they’ve never used tools before?” He recalled an instance in the early days of his company when engineers had been assigned to modify an appliance for the local market. The staff returned several weeks later with a range of colored, detachable ears consumers could affix to the appliance. “My engineers would come to me with ideas I already knew were not workable,” Peter said. “So, to encourage their creativity and also bring them down to earth, I would tell them, ‘OK, there’s the machining equipment—bring me back a prototype in a couple days. At the beginning, they would always come back and admit their idea was not workable. After time and experience handling and working with the tools, they eventually succeeded in producing some real changes for the product. Eventually, I made these innovators responsible for guiding someone more junior in their own department in the same way.”

Product innovation, of course, differs from process innovation in that product innovation is punctuated by stages of product development with tangible results. Process improvement, however, should be a continuous activity, built into the character of the organization. Process improvement incubates product innovation. The Chinese HR director of a Western plant near Shanghai explained to me his company had a rewards system in place in which any and all employees are recognized for making genuinely innovative changes in their production processes. During the economic downturn of 2008–2009, the company began hiring engineers for an R&D department it decided to build. A year in, in January 2010, the company had already hired 13 engineers; they intended to double the size of the staff by summer of the same year. The department was responsible for localizing products its Western counterparts designed. Legend in the late 1990s also localized Western products. The incremental, “small-i” innovation increased its fortunes immeasurably.

Liu Chuanzhi, the founder of Legend, noticed that only well-educated Chinese users who had English-language training were able to use the personal computers the company was distributing. This was especially problematic as most of the customers were government agencies. Government workers were notoriously hide-bound bureaucrats who had missed out on a university education because of the Cultural Revolution (1966–1976). Struggles against educational institutions saw all of the universities and many schools closed and teachers shipped off for hard labor. Very few Chinese would have received English-language education by the time they were middle managers in the state-owned enterprises to which Liu sold the computer systems. Liu took the initiative to develop a Chinese language keyboard to facilitate the use of the computer for the millions of users who were not literate in the English language. Legend sales leaped with the innovation, which has since been replaced by the innovation of software and operating systems that depict the myriad characters of the Chinese language onscreen. Nevertheless, even with the most innovative kit, Chinese multinationals are finding that traditional management structures are liabilities when entering foreign markets.

Management Innovation

Management innovation involves creating frameworks for mobilizing the energies of human resources to provide products and services that prospective buyers want to purchase and customers continue to want to buy. Management succeeds when revenues per staff member are high, costs are low, and customers are happy. Management innovations are contextual; that is, they depend on the business conditions and the goals of the company. In the 1990s cutting middle managers from organizations to “flatten” company hierarchies was in fashion in America. Re-engineering organizations was closely coupled with “empowering” employees; that is, allowing those who worked directly with customers to be able to make decisions without having to call a supervisor. It could be argued that the MBA-degree is a management innovation. An entire industry grew up in academia, priming armies of corporate staff with rationalized skill sets to theoretically manage organizations with greater effectiveness.

Certainly, innovating arcane management structures will help Chinese companies gain the trust of foreign buyers. Re-energized organizations that have a higher degree of integrity and alignment between the inner-workings of the company and the customer target pool should realize greater gains. The greatest management innovation challenge for Chinese companies—especially those that wish to enter international markets as more than just an exporter—is to “de-Confucianize” their organizations. Chinese companies are far more hierarchical in their management structures than Western companies, especially American companies.

American companies pride themselves on being relatively “flat,” with few layers of management separating leaders from front-line staff. Further, flat organizations rely on the experience front-line staff have with customers to re-adjust the organization to meet changing industry and economic circumstances. Confucian business structures, however, see a more pyramidal reporting structure, in which junior staff and back-office functions defer to an all-seeing, all-knowing leader who makes every decision. The organization structure mirrors Chinese society itself, at almost every level of life. Throughout society, the level of the hierarchy into which one is born or is able to insert oneself professionally may even be able to trump the law itself. In China, people see their positions in organizations as not only gaining them higher salaries and perquisites—or, if they are the business owners, greater profits—but as gaining them access to high-power individuals who will allow them to obviate the rules others are meant to follow.

Chinese professionals whose experience has solely been in Asian companies are not accustomed to voicing their ideas to management. “Most Chinese companies are extremely hierarchical,” Peter, the DIY-company manager, told me. He has spent a great deal of time personally working with Chinese suppliers to improve the quality of their components and to meet international standards. “Most of the companies are run by a ‘big boss.’ Everyone hangs on his every word for a decision on matters. And no one dares make a mistake. So, everyone pretty much keeps their head down.”

Both product and process innovation require “flatter” organizations. Optimally, in such businesses, management encourages the exchange of information and ideas. Leaders reward thinking that may even be outside an employee’s immediate job description. Managers also tend to overlook mistakes or dead ends that do not disrupt regular company operations. Invention—especially disruptive innovations that create new product categories and even new industries—cannot be scripted. This kind of business model runs counter to the traditional Chinese standard.

Confucian management structures operate against information and knowledge transfer. The businesses become ingrown, with company politics focused on gaining access to higher echelons in the company to curry favor with leadership and to beat out real and imagined internal competition. Addressing customer needs is a distant priority as staff literally waits to be told by their immediate supervisor what they should be doing next. Western management models tend to thrive on a level of decentralization that, in the best of conditions, allows creativity and innovation to flourish. Junior staff is expected to discover or invent disruptive product or service offerings they present to senior staff. Silicon Valley is the most obvious example of the sort of flat, innovative business environments companies in America, and to a lesser extent in the European Union, try to emulate. Chinese companies and bosses, fixed by a sociopolitical system that rewards business and government “emperors,” are far from realizing the Silicon Valley model of “contra-management.” It becomes near impossible, then, for traditional Chinese managers to create operations that germinate invention.

The Operation Was a Success . . .

The objective of operations innovation is to achieve greater effectiveness and efficiency of the processes through which work is accomplished: how paychecks are processed in a hospital; how claims forms are processed in an insurance company; how products are made and checked for quality as they come off a manufacturing line. In the West, management has entrusted a great deal of decision-making to line staff, from production workers to customer service representatives, to make operations more efficient and the customer experience more rewarding. In China, cultural and educational conditioning makes operational innovation and related product innovation a challenge for managers to implement.

Michael, a British engineering manager at a foreign-invested cleantech factory in China, lamented to me, “They [my staff] won’t think outside the channel. I keep hearing, ‘it’s not in my job description!’” It’s a common complaint in Western companies that are trying to get their local employees to think creatively about how to improve business and production processes, and even product design, in China.

The Chinese rocket scientist Qian Xuesan once asked, “Why does China produce so many clever people, but so few geniuses?” He died in 2009, at the age of 97, with the question still unanswered. Westerners and Chinese alike point the finger at the education system, which values rote-study and regurgitation of facts over exploration, discovery, and dialogue. One Chinese university student told me, “Professors don’t have office hours [in which students can ask help with difficult subject matter]. If you ask the professor a question, he tells you in front of others you are stupid.” For all that, many university students simply show up for examinations, having spent days and nights memorizing cardboard cut-out questions to pre-figured answers. Another barrier that discourages learning innovation from early on is family- and peer-pressure that molds the value of face in the society. Making mistakes, having a minor failure or any other action that loses one face is disgraceful.

As any politician in the West knows, oftentimes the longevity of his career hinges on the number of jobs he generates in his district. In China, a lack of new jobs in local and national economies can mean the undoing of the entire Chinese Communist Party (CCP). Since the late 1970s the CCP has relied on job creation to maintain its mandate to rule. The ideological posture of Communism with Chinese characteristics is essentially raw capitalism in the mold of the American robber barons of the early 20th century. However, China’s preferred model for modernization actually emphasizes social stability over growth rates. Few other institutions in China illustrate that equation better than State-owned Enterprises (SOEs).

In the mid- to late-1990s central and local governments embarked on what was for them a frightening experiment: dismantling the thousands of SOEs that were dragging the entire economy into illiquidity. For decades SOEs had been the core of local communities: where people lived, schooled, retired and died. In 2004 in Shenyang, capital of the northern province of Liaoning, local government officials took me on a tour of a huge State-owned factory named the Silver Elephant. Local company and government representatives were looking for foreign buyers to buy parts of the company, or even form joint ventures with various superfluous divisions of the business. I was awestruck by the scale of the operation, which made a variety of products for the ship-building industry. Scores of great black vulcanized rubber bumpers, two meters high, stood in rank-and-file with no one to inspect them. I was also surprised by the sheer lack of activity and dynamism to which I had become accustomed in southern China, where SOEs were less a constituent of regional economies.

Privatization forced millions of workers into unemployment, their iron rice bowls melted down for the sake of privatization. The iron rice bowl was a metaphor for the enduring social security benefits SOEs would provide workers. Protests throughout the country became rife. The central government bet that with the ensuing chaos, privatization would stimulate management and operational innovations that would energize dispirited individuals and revive moribund organizations. Many local governments encouraged workers to take management responsibility, maintaining various levels of ownership in the local companies. Zhang Ruimin was one such employee-beneficiary. He understood the extent to which the entitlement mentality of workers at SOEs stymied business competitiveness. In the mid-1980s he set about reforming management structures and operational procedures to transform the business into the international white goods maker Haier.

Since the trauma of the great SOE sell-off, the Chinese government has been loath to see companies en masse introducing further tumultuous change into their operations. The beginning of 2009 saw the dawn of new central government policy involving the re-nationalization of successful private industries. The drive, known as guojin, mintui, literally means, “advancing the state and pushing the private sector back.” Simply put, Beijing has been methodically absorbing successful private companies back into SOEs. SOEs deliver the CCP a greater degree of control over the economy. Guojin, mintui targeted aviation, oil refining, steel production, food and beverage, and the renewable energy sector, among others.

SOEs are also China’s largest employers. In 2006, three of the five largest employers in the world were Chinese: State Grid, the electricity distributor (1,504,000 employees); China National Petroleum, the refiner (1,086,966 staff); and Sinopec, also an oil refiner (with a headcount of 681,000). Walmart was the largest employer at the time, with nearly 2 million employees; while the US Postal Service beat out Sinopec for the number four spot with almost 800,000 workers.3

SOEs do not have the same latitude as Walmart, however, in reducing headcount when times get tough or when the company adopts a new growth strategy that requires a leaner operation. Walmart is known as a major employer in many rural areas in the United States. The retailer is given to shuttering its doors when local economies become too weak to provide profitability for the behemoth. SOEs, though, must await direction from central government authorities to make wholesale layoffs. During the global economic downturn of 2008–2009, Beijing directed SOEs to create openings to absorb the surfeit of university graduates who were unable to find jobs in the wounded private sector. The CCP’s obsession with social stability trumped operational efficiency. Beijing policy restricts China’s top employers to incremental operational innovation. SOEs greatest responsibility when times get tough is to provide the least amount of disruption to the society.

Even if a SOE or a private company has a killer-widget it wants to sell into Western markets, it needs to have a plan that reflects an understanding of international norms and product lifecycles. International markets tend to be less forgiving of product failures than the manic domestic markets in which businesses in China launch and recall products with breathtaking speed.

What Was the Plan Again?

Strategic innovation means engaging current or new markets in a way that the company or industry had never done before to the end of greater profit. For instance, investing in operations in China was a huge strategic innovation for many American companies, most of which had made their fortunes within the borders of the continental United States. Most American companies that invested in China during the first decade of the new century had never had experience with any other market than the American: the domestic United States market had always seemed lucrative enough. When China had been accepted into the WTO in 2001 most American—and European—companies wanted to reduce their costs of manufacturing at home by setting up operations in China. By 2008, most American companies said in a poll with the American Chamber of Commerce in Shanghai that they were in China to sell into the Chinese marketplace. The marketplace in their home countries had changed dramatically, and the companies changed their direction to seek their fortunes on other shores.

What Western companies discovered in China as business strategy per se surprised them greatly. In some ways, the Chinese approach to business rather seemed more like anti-strategy: characterized by short-term thinking, immediate gratification, a lack of transparency in corporate governance, and a drive to conquer market share rather than to making profits. Donald Sull, author of Made in China: What Western Managers Can Learn from Trailblazing Chinese Entrepreneurs, actually codified the approach Chinese managers take in their own domestic market. He found that their approach was congruent with the way that business owners and managers in other developing countries like India and Mexico also developed and implemented business strategy. The acronym he gave the approach was SAPE: Sense-Anticipate-Prioritize-Execute.

The approach involves business managers in developing highly dynamic marketplaces, sensing the major trends affecting business, anticipating the next big trend, prioritizing their business tasks and resources to aggressively engage the trend, and then executing a conquest of market share in a take-no-prisoners fashion to drive the competition off the playing field. Sull discusses such winners in the Chinese market as Qinghou Zong, founder of the drinks company Wahaha, and UT Starcomm, maker of a mobile phone service for communities. However, much of what Sull codifies is simply reflexive behavior for Chinese executives. Business leaders in China perform little in the way of structured reflection on business approaches. Scopes for return on investment in China run in six-month cycles, twelve months for the longest-term thinkers.

One Fortune 500 company group of executives, with whom I participated in negotiations in the automotive sector, was appalled at what they saw as the lack of patience, foresight and sense of win-win on the part of the Chinese counter-party. The Chinese side kept insisting that the US$10 million the Americans planned to invest was far too much for the size operation under discussion. The joint-venture factory was to be placed in Chongqing, in the interior of China. “We can buy so much land with that money,” the Chinese pushed, “and build a huge factory! Several factories!” For them, they saw such an amount of money to be used over a 5-year period as a waste of capital that could be put to use immediately, and thought the Americans rather naive about the possibilities of the Chinese market. The Americans simply saw three greedy Chinese business owners sitting across the hotel conference table from them. Perceptions on business strategy diverged so greatly negotiations never passed beyond a Memorandum of Understanding between the parties.

Chinese businesses that want to venture beyond their borders to diversify their interests in Western markets have to adopt Western-style strategies. Potential partners and managers and investors in the West want to see 5-year plans, balance sheets, and profit-and-loss statements. They want to review a single set of accounting books—instead of one set for the tax man, and one set for the business owners. Chinese companies that want to list on Western bourses like those found in New York, London, and even Singapore are finding that they must make their governance structures and inner workings far more transparent than they could have imagined. Chinese computer maker Lenovo simply left in place the American management structure and the laptop computer division team it acquired from IBM. The radical change in strategy most Chinese domestic firms are finding they have to take when they cross international borders are incredibly disruptive to their operations. Yet the changes are necessary if the companies want to effectively compete in foreign lands.

China’s central government can do a lot to improve its country’s image. It can also improve its companies’ capacities for innovation. National policy may even facilitate the expansion of its multinational wannabes beyond merely gobbling up resource-rich deposits around the world by firmly enforcing corporate governance structures that meet international standards of transparency and objectivity. Still, for every Lenovo, it seems, there are scores of Chinese companies on international bourses that have reaped the scorn and distrust of investors the world over.

Red Flags

The most high-profile of the dozens of companies that came under suspicion in America for fraud was SinoForest. SinoForest was a Chinese tree plantation company listed on the Toronto stock exchange. Instead of filing for an initial public offering (IPO), the company took a less onerous route to becoming a publicly held company through what is called a “backdoor listing.” Backdoor listings involve a company buying the stock market placement of a company that, effectively, has gone out of business. Backdoor listings, also known as reverse-mergers—in contrast to initial public offerings (IPOs)—have few regulatory requirements and little need for the level of transparency IPOs demand.

American short-seller Muddy Waters LLC researched the company’s published financial statements and compared them to what researchers on the ground in China tallied. The firm uncovered a gross discrepancy about which Muddy Waters principal Carson Block published a report. The share price of the Chinese company quickly dived, but not before Block had sold the shares he had bought in the company. Buying and then selling shares in companies within a short timeframe is called “shorting” stocks. Block made millions of dollars anticipating that Chinese companies that had short-circuited the due diligence involved in IPOs were simply betting on the gullibility of investors. Block also called out the Chinese company Rino International, which had been falsifying sales contracts.4 But as Patrick Chovanec of Tsinghua University pointed out, denial and confession were beside the point in such cases: “It’s not that people concluded he’s [Block’s] right about these companies. It’s that they realized they don’t know whether he’s right or not.”5

Chinese central authorities, though, cared little about the governance structures of domestic companies. They paid even less attention to those making forays into international markets. The majority of Chinese companies listed on domestic stock markets are state-owned, and of those, typically only about 30-percent of the shares are on offer to the public. The State controls the rest of the shares. The State also controls the top positions in the companies, making profitability and shareholder rights secondary to personal wealth creation and political expediency. The Chinese Communist Party, however, does care if the trouble the companies get into involves government officials exposed for acts of corruption.

Mingyi Hung, T.J. Wong, and Fang Zhang observed in their study “The Value of Relationship-based and Market-based Contracting: Evidence from Corporate Scandals in China,” that companies listed on Mainland bourses and involved in accounting scandals saw their shares drop nearly 10 percent, on average, over the six months on either side of the incident. The stock fell by almost a third, though, for companies involved in the bribery of government officials or the theft of state assets.6 Central government authorities gave scant attention to the spate of scandals involving companies like SinoForest and Rino International, since no CCP members were involved. Beijing considered these companies and the dozens of others investigated by the United States Securities and Exchange Commission (SEC) as merely isolated instances of questionable fraud. The transgressions were not worth creating an international incident over.

Branding Beyond Nationality

As long as a self-interested, short-sighted tone of governance is embedded in Chinese society, the greatest innovation Chinese companies will have as they penetrate international markets and seek credibility along with sales, is to bury the fact they are Chinese. Lenovo and Haier are among the most successful to shed their national flags. Scandals in the country continue to stream through media channels, inflicting damage on China’s image in irreparable ways. The national brand the central government seems to be supporting is not only impacting the image foreigners have of the country, but, increasingly, that of Chinese citizens, as well. Food safety, for instance, became a major concern to consumers in China with revelations of illegal steroids being injected into animals to grow lean meat quickly; re-cycled cooking oil skimmed from gutters and conditioned with chemicals for resale to restaurants; and poisonous insecticides sold to unwitting farmers in south China to increase the yields in their crops. Nightly, local television news spends upwards of 20 percent of its programming on stories related to fraud.

Given what seems to involve government complicity—if not simply malfeasance—at various levels to the transgressions, domestic companies find it difficult to differentiate their corporate images and product identities from those their own country projects to the world. They also have to defend themselves from the opprobrium heaped upon the competitors in their industries that have been caught defrauding customers. If companies choose to become national champions they face a series of hurdles that require innovations to the image they portray, the way they manage their business and manufacture their products and offer their services. To meet international competitors in the global arena, however, leaves Chinese companies at a disadvantage when compared with German, American, Swiss or a basket of other national identities from which companies with national ambitions are able to draw marketing prowess.

Chinese companies that wish to break into international markets actually work at a disadvantage because of the country’s national brand identity: cheap goods sold without accountability that are most likely fake anyway. Companies may dramatically revise their work processes and revitalize their product images to suit buyers in other countries; however, the taint of being a Chinese company will continue to work against aspirants for at least another generation. Companies may be able to escape the crushing weight of their country’s bad press by changing their names to something Western-sounding (like Lenovo), or acquiring Western product lines to brandish their owner’s credibility. Geely, the Chinese car company, did exactly that with its purchase of Volvo, the Swedish car maker. The acquisition gave Geely access to the European market, much-needed technology, and allowed the Chinese car company to hide behind an established Western brand that portrayed quality and integrity. In time, as long as Geely does not try to eclipse the Volvo brand, Western consumers may express pleasant surprise that the Volvos they had been buying and driving since 2009 were actually Chinese made. Large corporate accounts have relaxed considerably about Lenovo’s purchase of IBM’s laptop computer division. Big companies have not seen any drop in the quality of product and service delivery that had persuaded them to buy IBM products at the outset.

Through a gradual but quiet accumulation of corporate reassurances, the national identity China’s leadership has been clumsily attempting to project to the world may actually come to pass. The central government may itself one day be pleasantly surprised by passing commentary on the high level of quality and support of some of their own national corporate champions. The transition, however, will come despite their stewardship of international relations, not because of it. Private companies—the freer of government ties the better—will be the new ambassadors for a country that will one day find itself becoming increasingly mired in the middle age of modernity. The leadership will no longer be able to paper over the country’s shortcomings with largesse to developing countries, and will have to whip its domestic industries in shape and truly liberalize its financial markets. It will have to deal head-on with a growing image abroad of a country interested in dealing with other countries solely for the natural resources partners have to offer.

In the long-run China’s manufacturing prowess in the world will amount to little when compared to two new-century realities with which the country will have to come to grips. China’s image as a bastion of Fake will gradually be supplanted by a reputation as the largest energy consumer in the world and the largest polluter on the planet. Solutions for the new-age challenges will require more than just corporate restructurings and bland reassurances.

Notes

1. Andrew Hupert, “China’s Other Branding Problem,” China Economic Review, January 24, 2011. Available online at www.chinaeconomicreview.com/today-in-china/2011_01_24/Chinas_other_branding_problem.html.

2. John G. Spooner and Michael Kanellos, “IBM Sells PC Group to Lenovo,” CNET News, December 8, 2004. Available online at http://news.cnet.com/IBM-sells-PC-group-to-Lenovo/2100–1042_3–5482284.html.

3. Xiao Geng, Xiuke Yang, and Anna Janus, China’s New Place in a World in Crisis, Australia National University, 160.

4. “Red Flag Raises,” The Economist, July 7, 2011. Available online at www.economist.com/node/18929130.

5. Ibid.

6. “When It Matters,” The Economist, August 20, 2011. Available online at www.economist.com/node/21526407.