SIX
Kangnai, Haili, and Li Ning
Moving Up the Value Chain

It doesn’t make sense to have our people run in foreign clothes, with foreign ads on their backs.

—Li Ning, China’s greatest Olympic athlete

The Kangnai Group Builds a Brand

WENZHOU DISCOVERS THE LIMITS OF LOW-COST PRODUCTION

ZHENG XIUKANG began working as a shoe-making apprentice in 1979. He was living in Wenzhou, the port providing access to the sea to the mountainous interior of southeastern Zhejiang Province. The first official license to an individual to engage in private enterprise thanks to Deng Xiaoping’s economic reforms was issued in Wenzhou in November 1979, and the city was eager to embrace the tidal wave of entrepreneurialism that was about to sweep through China. But Zheng’s key priority was personal survival. He had a daytime job as a machine worker, but he couldn’t make enough money to support his wife and two children, and he needed to earn more. He was 33 years old, well beyond the age when most people learn how to make shoes.

“We were poor and we were desperate,” Zheng recalls. He had two options: Learn how to make shoes or learn how to make sofas. With a family of four crammed into a tiny space that measured barely 90 square feet, Zheng realized that there was not enough room to make sofas. Shoes won the day. Zheng’s experience was in machinery, so he naturally relied on calipers to make precise measurements for his shoes. When they began outselling most of the competition, he quit his day job and went into shoe-making full time.

A major advantage of the shoe business in Wenzhou was that it required a relatively small investment and generated a fast return. It was the ultimate low-cost, low-end manufacturing venture. The trouble was that just about everyone in Wenzhou seemed to have the same idea. At one point, more than 4,000 shoe-making enterprises in Wenzhou generated roughly $20 billion in sales per year. But as competition mushroomed, it put pressure on the shoemakers to make more shoes faster and at a lower cost. Many of these shoes were made so poorly and fell apart so quickly that they began to be referred to as “shoes for a week” and further down the line as “shoes for a day.” It became an embarrassment to be seen wearing them. Wenzhou had created a negative brand that soon promised to be disaster by association.

On August 8, 1987, authorities in Hangzhou, a city in the north of Zhejiang Province, publicly burned more than 5,000 pairs of poor-quality Wenzhou shoes. Other cities followed the Hangzhou example and began staging similar burnings. Shopping malls refused to sell Wenzhou footwear, and some even posted advertisements stating, “No products made in Wenzhou in the mall.” The shoemakers in Wenzhou felt humiliated. Roughly half quit the business altogether.

THE KANGNAI GROUP IS BORN

Zheng Xiukang refused to be discouraged, though. In 1988, he traveled around China, investigating shoe factories. He quickly realized that none of the shoemakers he met had any idea of what an assembly line was, and they knew nothing of modern technology. Zheng decided to take a look at what was happening in Taiwan and Italy. He was shocked by what he discovered. Modern factories, geared toward quality production, were clearly the answer. Since China still lacked venture capital financing, Zheng borrowed from friends and relatives. None of them had cash on hand, but Zheng got them to put up their houses as collateral for bank loans.

“The pile of title deeds was a foot thick,” Zheng recalls. After borrowing $800,000, Zheng established his first assembly line, which put 280 people to work making a single pair of shoes that previously would have been turned out by two shoemakers operating on their own. The assembly line was less likely to take short cuts than individual cobblers, and it produced more shoes in a fraction of the time. The quality was more consistent and much easier to monitor.

Zheng changed his trademark to Kangnai, which translates into Chinese as “I pursue healthy development and what can they do to me?” It did not take long for Kangnai to become one of China’s best-known brands of footwear.

Kangnai, which subsequently became known as the Kangnai Group, invested heavily in updating its craftsmanship and technology, and it soon became ISO 9002 and ISO 14001 certified. Today, its Italian design team introduces original models each season, and its 15,000 employees produce 8 million pairs of leather shoes a year. The company’s R&D team works with doctors to design shoes that are healthy to wear, and it also works directly with fashion consultants on aesthetic trends and the culture of footwear. Kangnai’s corporate literature states its dual goals as customer satisfaction and the pursuit of excellence.

The Kangnai Group put a major focus on developing its own brand. Beginning in 1996, the group began pulling back from the wholesale market and started building a franchise network in chain stores across China. By the end of 2007, it had franchised more than 2,500 outlets in China and another 100 stores in ten countries, including the United States, France, Italy, Spain, Portugal, Belgium, and Greece. Kangnai was the first of China’s shoemakers to establish its own brand in an overseas market.

MOVING UP THE VALUE CHAIN

The Kangnai experience illustrates an ongoing phenomenon in the China market. The shoemakers in Wenzhou, including Zheng, rushed into the business because shoes are a simple product that is relatively easy for anyone to make, and the business promised a quick return.

But as the competition intensified, the shoemakers felt compelled to lower their prices, reducing their profit. That meant that they had to turn out more shoes faster, just to stay in business. Ultimately, they reached a limit and the market went into revolt. The problem with competing solely on price, the shoemakers discovered, is that you find yourself increasingly squeezed until the exercise is no longer worth it. The solution is either to increase productivity through automation and streamlined processes or to move up the value chain and produce more complex goods that either fit a limited niche or are simply more difficult to copy. The alternative when selling a commodity product that is difficult to differentiate from the competition based on price or superior quality is to establish a brand that makes the public perceive a difference, even if it is mostly in the imagination.

China’s Advantage

Until recently, China’s biggest advantage in trying to break into the world’s global economy has been its nearly inexhaustible supply of cheap labor. According to Chinese census statistics, by 2006, more than 200 million rural farmers had flooded into China’s cities to become industrial workers, constituting one of the largest human migrations in history. The phenomenon is not over yet. Another 740 million farmers remain on farms scattered across China’s immense territory. The continuing population explosion, combined with limited land resources, virtually guarantees that more people will crowd into the cities in search of work.

Until now, the average wage earned by these newly industrialized workers usually ranged from $63 to $125 a month, or roughly one-30th of that demanded by workers in the West. The average workday is anywhere from ten to 16 hours, and despite the economic boom, wages continue to grow at a slower rate than China’s GDP.

A spate of worker suicides in 2010 at Foxconn, which manufactures the Apple iPad, drew attention to the strain that China’s hyper-heated economy is placing on many workers. In Foxconn’s case, the company promptly responded with salary hikes and worker improvements, but the Foxconn experience served as a warning that China needs to base its competitiveness on more than low-cost production.

As more people flow in from the countryside, however, China is going to have access to workers willing to be hired at low wages for the foreseeable future. As China moves into more complex manufacturing, these workers will force the nation to put more and more of its resources into education and training, and that effort is likely to give China an even greater advantage over Western countries that are tempted to skimp on education as their business opportunities diminish.

Many emerging markets face the dilemma of having to rely on an unsophisticated workforce. China’s advantage is that it is already well advanced in investing in its human capital. Not everyone is highly educated and productive, but enough of the citizens are to produce impressive results. As George Feldenkreis—the CEO of Perry Ellis International, Inc.—stated in 2004 at the Wharton School’s China Business Forum, China’s low labor costs and high productivity gives the country an advantage over industrialized countries and emerging markets. He said:

While U.S. workers, for example, may be more productive and technologically sophisticated, they are also more expensive. Likewise, people in places such as the Dominican Republic and Romania may be willing to work just as cheaply as workers in China, but they are not as productive.¹

While wages are rising in China’s industrial areas, roughly a third of the country’s population still depends on agriculture, compared to less than 2 percent in the United States or 6 percent in South Korea. Another 30 percent of the labor force in China is composed of migrants, whose wages increase by only 4 to 6 percent a year in real terms. An analysis by Goldman Sachs noted that the role labor costs play in overall manufacturing costs is actually lower now than it was in 2001.

China’s cost advantage is augmented by other factors that are already in place, such as available real estate dedicated to industrial use, integrated transportation, energy, and machinery.

How the West also Benefits from Cheap Chinese Labor

The advantages for Western consumers are lower prices for consumer goods and an effective counterweight to inflation. Global Insight reports that as a result, real apparel prices are as low now as they were in 1990. Price reductions are likely to continue for some time, although at a more moderate rate.

China has become the world’s top producer of clothes, shoes, toys, socks, pens, neckties, lighters, and many other labor-intensive products. Back in 2003, Chinese garments and textiles constituted only 17 percent of the global market. When global textile quotas were eliminated on January 1, 2005, the demand for China’s garments and textiles increased dramatically. China’s garments and textiles were expected to grow by at least 50 percent in 2008, with $83.85 billion worth of exports in the first six months of the year. Every year, China exports 22 billion toys to the United States—roughly 80 percent of the U.S. toy market. China also produces more than 10 billion pairs of shoes every year—50 percent more than the amount needed to supply one pair for every human being on earth. China’s low-cost, labor-intensive, and export-oriented light industries have been largely responsible for keeping worldwide inflation under control during the first decade of the 21st century.

When China began reforming its economy and opening itself to the worldwide market, most foreign direct investment flowed into primary-processing and export-oriented industries. China’s government showed that it was ready to sacrifice its environment, resources, energy, and even the welfare of its own workers to jump-start the economy.

While the strategy turned China into an industrial powerhouse in record time, it also became increasingly clear that growth based on low cost, low quality, and relatively primitive technology would not be sustainable over the long run. What the Chinese make up for in volume they lose in pricing. An example is the watch industry. China produces 1.2 billion watches a year, while Switzerland produces 26 million, yet when seen in dollar terms, Switzerland accounts for 60 percent of the world market since the average Chinese watch sells wholesale for $2, while the average Swiss watch sells for more than $500.

The production of low-cost textiles and shoes will inevitably migrate elsewhere in search of even less expensive labor, just as the industry previously migrated from Japan to South Korea, to Taiwan, to Southeast Asia, and then to China.

The Downside to Outsourcing Manufacturing

Multinationals initially went to China to manufacture their products because of their own relentless efforts to drive down costs. The transfer of so many manufacturing jobs was painful to workers in countries that lost the jobs, but it has also exacted a heavy price in China in terms of damage to its environment, air quality, and supply of fresh water. The emphasis on low wages and long working hours meant that workers received relatively few benefits, and until China could develop its own middle class with domestic buying power, China was condemned to remain overly dependent on exports. That, in turn, meant that its economy was at the mercy of forces and events beyond its control.

Today, increases in raw material and energy prices are putting pressure on China’s low-end manufacturing. Consumers who buy Chinese products are beginning to see the downside as poor quality or even dangerous materials are introduced into production lines in the interest of pushing costs down even farther.

DONGGUAN FUAN TEXTILES: A CAUTIONARY TALE

The negligence of some factory owners who felt that they had received a green light to increase production regardless of the environmental costs has bordered on the criminal, especially when it comes to the disposal of dangerous toxic waste. In one example, Chinese environmental officials were alarmed in 2007 to discover that a local river had turned dark red and become clogged with thousands of dead fish. The culprit was the 230-acre Dongguan Fuan Textiles factory—the largest knit cotton manufacturer in the world, responsible for about 6 percent of the global supply of knit cotton, with a huge volume going to the United States. In June 2006, Chinese environmental-protection officials discovered that a pipe buried underneath the factory floor was dumping roughly 22,000 tons of chemically contaminated water into the river daily.²

The textile producers had decided that it was worth risking a violation of China’s antipollution laws in order to cut the cost of disposing of the toxic waste. They were wrong. The amount saved was roughly 13 cents a metric ton, so that over the course of a year, the cost reduction might add up to a few hundred thousand dollars. The final cost to the plant’s owner, Hong Kong–based Fountain Set Group, was roughly $1.5 million in fines. The company subsequently had to spend $2.7 million to upgrade its water-treatment facilities. The crackdown was part of an aggressive Chinese government campaign to curb environmental damage, intended to serve as a warning to factory owners that the early days without limits were now over.

TEXTILES: A DOUBLE-EDGED SQUEEZE

Today, Chinese textile producers are experiencing a double-edged squeeze: Western retailers demand even lower prices, while cotton producers want more for their crops. More cotton is produced in China than anywhere else, but production demands have grown so intense that China is increasingly forced to import cotton from the United States and other countries. The textiles industry in China increased its demand for cotton by 42 percent in 2005 alone, and China will need 12 million tons a year by 2014. The price of cotton more than doubled in just six years, from $0.3 per pound in 2001 to $0.7 in 2007. It is expected to double again over the next few years. China imports more U.S. cotton than anyone else but, as a result, it is simultaneously blamed for driving up prices for American cotton and at the same time for dumping textile goods in the United States.

Labor-intensive manufacturing companies in China typically operate on razor-thin margins. Even a slight rise in costs or an unexpected decrease in foreign demand can force a factory to close. Migrant workers from the countryside have often been exploited, abused, or even enslaved and then cast aside as a result of market fluctuations beyond their control. Because China’s economic advantage is based on keeping costs at a minimum, there has been very little up to now in the way of a social safety net.

Three decades of rapid industrial expansion have also sparked trade friction and antidumping charges, and China’s accelerating hunt for raw materials in other developing countries has not helped the country’s image abroad. Weighing costs against benefits, China’s government has an increasing incentive to move away from low-end manufacturing and to place a greater emphasis on value-added high-tech industries. The new direction is outlined in the “Catalogue for the Guidance of Foreign Invested Enterprises,” released by the National Development and Reform Commission (NDRC), which became effective on December 1, 2007. In the rush to build China’s economy, government leaders were prepared to assign a lower priority to the rights of individuals, labor conditions, and the environment. As the cost of neglecting these issues becomes more apparent, government priorities are beginning to show signs of change. The new Labor Contract Law provides improved protection for workers, stricter environmental controls, and a tighter approval process for applications. The export licenses of shoddy toy makers are being revoked, and industries that were previously subsidized now face higher taxes.

New Rules of the Game

The NDRC dramatically revised China’s foreign investment strategy when it issued the “Catalogue for the Guidance of Foreign Invested Enterprises.” This guidance shifted the goalposts from quantity to quality production. The Catalogue divided foreign investment into three categories: “encouraged,” “restricted,” and “prohibited.” Foreign investment in advanced technology, modern manufacturing, sustainable resources, and environmental protection was to be encouraged; foreign investment in traditional enterprises or export-oriented enterprises continued to be allowed; and foreign investment in enterprises that were energy-intensive, relied heavily on natural resources, and produced high levels of pollution were either restricted or prohibited entirely. The shift in policy has been a hard awakening for labor-intensive, primary-products–processing, and export-oriented enterprises.

China’s LCL, which went into effect on January 1, 2008, made hiring more difficult and may turn out to be the proverbial straw that breaks the camel’s back when it comes to cheap manufacturing. It is likely to force some industries that rely on cheap labor to find other locations where wages continue to be low. Together with the appreciation of the RMB, rising trade friction, lower demand, lower tax rebates, and rising raw material prices, Chinese export-oriented, labor-intensive companies are beginning to realize that their razor-thin margins are no longer enough to keep them afloat. A few have moved from the coast to interior provincial cities where labor costs are cheaper. Others have shifted their manufacturing to Indonesia, Bangladesh, Vietnam, and Cambodia.

The multinationals, interested in China mainly as a low-cost manufacturing platform, may eventually pull out altogether. According to “China Manufacturing Competitiveness 2007–2008,” —a study by the American Chamber of Commerce and Booz Allen Hamilton—roughly 17 percent of the companies surveyed said that they plan to move their operations out of China. The reasons cited were the appreciation of the RMB, inflation in prices for components and materials, wage increases, and poor employee retention. About 90 percent of these companies said that they had originally been drawn to China by lower labor costs, but now they are finding that other countries (India and Vietnam currently head the list) offer cheaper labor and better tax benefits. Many Chinese companies are also following the trend and either relocating to interior provinces or simply moving their manufacturing to other countries.

According to the study, the major reason for staying in China is access to its vast domestic market. Those companies that want to remain in China say they are beginning to focus on the new business model, based on quality, brand building, and moving their products to the higher end of the value chain. Chinese companies like the Kangnai Group are experiencing the same pressures. In some cases, the answer is to leave the initial business altogether or to take a momentary hiatus before returning to it with a different approach.

Haili Weathers the Storm

The story of Haili Toys also illustrates how acute sensitivity to market circumstances and timing can lead businesses in unexpected directions, which ultimately result in profitable synergies.

China’s toy exports slowed dramatically in 2008, hurt by higher costs, a stronger home currency, and safety concerns. Chinese toy companies have always been driven by fierce competition that forced the industry to operate on extremely thin margins. A toy sword, for example, that sells for $7 in a store in California is likely to net the manufacturer in China around .0016 cents, or less than a penny. Unless a manufacturer has its own brand, impressive technology, added value, and creativity, it is likely to find itself caught in the trap typical of most OEM models. The manufacturer will eventually find itself squeezed between the rising cost of raw materials and its customers’ relentless search to get the same product at a lower price. Chinese export-oriented toy companies suffered an additional blow when a series of product recalls involving toxic paint and other safety hazards made customers suspicious of Chinese products.

In August 2007, the Chinese government started a nationwide crackdown on faulty products. At least 700 toy-export licenses were revoked on the grounds that the companies involved violated safety standards. Despite these daunting setbacks in the industry, Haili Toys, a privately owned toy maker in Zhejiang Province, boasted $110 million in sales in 2007. Haili’s profit margin was five times higher than its competition.

Fang Guangming, a self-made millionaire, was one of the company’s founders. Fang built his first toy factory in Haiyan in 1992. He was 25 years old at the time and he used his family’s entire savings of $4,000 to launch the company. Haiyan is a city of around 300,000 people about 60 miles from both Shanghai and Hangzhou. Since the toy business is a labor-intensive industry, it has a very low investment entry threshold, and the designs are easy to copy. In Haiyan, the number of toy companies increased ten-fold in just a few years. Fang’s toy business soon faced fierce local competition. With increasingly low margins, he and his company had to struggle to survive.

FROM FINISHED TOYS TO THE FIBER INSIDE AND BEYOND

Most of the local toy manufacturers responded to the competition by putting pressure on their employees to work harder and faster. Fang was convinced that this approach could go only so far. He decided instead to focus on reducing the cost of a key component of stuffed toys—the synthetic fiber used for stuffing, which accounts for about a third of the toys’ production cost. In the 1990s, toy companies in China had to pay high prices for imported fibers, and Fang was convinced that replacing the imported fiber with a domestic product would save money. He acquired a local fiber company and set up a joint venture with a South Korean company that provided the technology and equipment to produce the polypropylene fiber used to fill stuffed animals. Fang found that he could lower the cost of the stuffing by more than $800 per ton. The savings gave him a significant cost advantage over the competition.

The advantage proved short-lived, however. Within three years, the other local toy manufacturers were copying his idea. By 1998, Fang’s toy business again faced declining profits. He began to look for more attractive business opportunities.

THE MATTER OF FREQUENCY CONVERTERS

In analyzing his costs, Fang realized that an unexpected expense resulted from the fact that the frequency converters that controlled the automatic textile production line kept breaking down. The effect was to stop the entire assembly line, and if Fang couldn’t find someone to repair the equipment immediately, he had to pay for factory time during which nothing was being produced. Fang noted that the frequency converters were expensive and costly to repair, and he realized that this might be a new business opportunity. He knew that the Haiyan city government was ready to help local companies move into high technology. With a few partners, Fang founded a new company, Holip, to manufacture and service locally assembled and serviced frequency converters.

Manufacturing converters and repairing them were clearly two very different businesses. Holip started by reverse-engineering Japanese mainstream products. With limited R&D and design capabilities, Holip was anxious not to overdesign its products, and it outsourced some of the more capital-intensive parts of the manufacturing process, such as printing circuit boards, to local contractors so that its own role was largely limited to final assembly and testing. Even basic converters were assembled from about 1,000 components, half of which were sourced internationally. Fang believed that the key to success was selecting the right components and maintaining high quality during the assembly process. In the first year, nine out of ten converters the company produced either failed or were returned because of faulty components or mistakes in the assembly process. That year, Holip suffered a net loss of $84,550 on sales of $241,572.

The management team was appalled at the losses, especially since the repair and maintenance side of the business had always been profitable. Fang remained adamant about making the idea work. “To become an industry leader,” he told his management team, “we need to be a pioneer. Innovation doesn’t come cheaply.”

The team soon realized that if it could not improve the quality of the converters, Holip was going to go under. In 2002, Fang hired a Taiwanese consultant to help with new product development and quality control. It worked, and the improved quality—combined with prices that were 40 percent lower than the competition’s—helped to boost sales to $966,533 for 2002. Holip was able to break even on its 30 percent net margin, thanks to its low-cost structure. Sales reached $2,416,334 in 2003, with $845,717 in net profits. In 2004, sales quadrupled to $10,270,041, and net profit hit $3,141,424. Holip became one of the leading domestic producers of frequency converters with a 2 percent market share.

Holip’s founders had lofty ambitions. The company not only wanted to capture the segment of the market for purchasers that were easily satisfied with “good enough” converters—it also wanted to capture the high end of the market occupied by the products considered to be the best available anywhere. With a limited internal R&D capability, the company turned to the universities to develop new technology and products. In 2004, in conjunction with a professor at Tsinghua University, Holip embarked on a $241,648 project to develop frequency converters capable of generating higher torque. When the project failed, Holip’s management team realized that its lack of the right technology was a significant roadblock to future growth. As Fang put it, “Now we know how deep the water is.”

To develop or acquire the technology it needed, Holip required additional funding. It hired PriceWaterhouseCoopers to help prepare an IPO to raise money and to release some of the initial investors’ funds. The urge to cash out was strong among some of the shareholders. Fang needed extra funds to increase the scale of his toy business and upgrade his online toy business model. He had several other ventures in mind, many of which required significant initial funding, and he also saw an advantage in cashing out rather than proceeding with an IPO.

In November 2004, Holip’s senior management met with a team headed by Erhardt Jessen, a vice president of the Motion Controls division of Danfoss China. After a detailed analysis of what both companies had to offer, Holip reached the conclusion that selling the company to Danfoss would be a better alternative than resorting to an IPO. In addition, tapping into Danfoss’s technology would enable Holip to upgrade its product line, and it might then be able to expand into new markets. In November 2005, Danfoss Motion Controls purchased Holip.

THE WEBKINZ WORLD

Fang Guangming considered himself wiser for the experience. “As an entrepreneur,” he explained, “you need to realize what you can change, and what you cannot change. You need to be brave and decide to push forward or pull back. Innovation is not limited to technology, and creative ideas are the soul of innovation.”

In 2004, Haili Toys entered into a partnership with the Canadian company Ganz to sell stuffed animals online. Ganz invested $20 million to build the website, and Haili supplied all the cute and cuddly toys. On April 29, 2005, the company released its most innovative new idea for stuffed toy pets. They were called Webkinz, and according to the company’s promotional literature, they were lovable plush pets that each came with a unique secret code. If you had the secret code, you could enter Webkinz World online, where you cared for your virtual pet, answered trivia questions, earned KinzCash (the Webkinz World’s “currency”), and played the best kids’ games on the Net.

Webkinz became an instant, overwhelming hit. The Webkinz World was presented as an online play area where kids could create an online identity for their pets, adopt them, feed and dress them, and even furnish rooms for them. Kids could also earn KinzCash by adopting new pets, playing online games, doing small jobs, and answering questions. The Webkinz World was actually educational in that kids could theoretically learn to grow with their pets, play games, and expand their knowledge.

The success of Webkinz in the overseas market engendered explosive growth for Haili Toys. In 2008, Haili Toys licensed the website from Ganz to recreate the concept in China. Combining traditional toy making with the Internet upgraded Haili’s business model, added more value to the products, and paved new paths for growth in a very competitive industry.

Lessons Learned

In the cases of both Kangnai and Haili, it was unlikely that a low-cost business model would be able to keep up with market changes for very long. Moving factories out of China to find cheaper labor might have worked for a while, but it made more sense to move up the value chain. The Kangnai Group survived precisely because its products established brand recognition for their reliability at a time when price competition was driving the competition out of business. As more of its competitors were driven into bankruptcy, Kangnai was able to capture market share and absorb the assets of its competitors.

As for Haili Toys, instead of blindly trying to produce a greater quantity with thinner resources, the company analyzed its own processes and detected market opportunities. It moved into these new market areas at a time when it was possible to maximize profits, and it pulled out of them at precisely the moment of diminishing returns. As a result, Haili’s capital resources increased to the point where the company was able to take advantage of new opportunities and strengthen its overall market position.

In the cases of both companies, innovation was the key to survival for what had at first appeared to be a simple, low-cost, labor-intensive industry.

Li Ning Builds a Purely Chinese Brand Based on Celebrity

The difference between one athletic shoe and another tends to be more emotional than physical, but athletics are about pushing the limits, and sports enthusiasts look for anything that will give them even a slight edge. Even for those who aren’t champions but want to be, wearing a brand name can establish an emotional connection to a winner. When it comes to sports apparel and footwear, endorsements by sports champions often make a decisive difference. Brand names like Nike and Adidas have pushed the business a long way beyond the 4,000 shoemakers in Wenzhou, who found themselves squeezed into creating a negative brand. When you wear a Nike shoe, with its distinctive “swoosh” logo, or an Adidas, you get the feeling—rightly or wrongly—that somehow you are in the same club as the Olympic champion who also wears that shoe. For a manufacturer trying to sell a shirt, a pair of sports pants, or a shoe that almost any manufacturer can produce, this identification adds powerful value to an otherwise indistinguishable product.

The main problem that Nike and Adidas face in trying to establish that magical connection in China is that they are not Chinese. The advantage that Li Ning Company Ltd. has is that it is Chinese, at least to a certain point. While Li Ning’s sports apparel and running shoes are manufactured in China, the company has made a major effort to sign up leading American sports stars, including NBA players Shaquille O’Neal and Evan Turner. A number of market analysts have speculated that the foreign athletes provide credibility that counters a residue of distrust of local production that still lingers in the minds of many Chinese consumers. The endorsement of a Chinese brand by an American or international star athlete goes a long way toward convincing the average Chinese consumer that the brand meets international standards despite the fact that it is home-grown. According to that logic, signing up American sports stars is aimed more at boosting sales in China’s own market than internationally. That is not to say that Li Ning lacks global ambitions, despite the fact that only 2 percent of its sales are actually made outside China.

THE COMPANY IS BORN

The company was founded as Guangdong Li Ning Company Ltd. in 1989, almost as an afterthought, when the sports star Li Ning retired from competition and put his energy into creating a first-class training facility for Chinese gymnasts. “We can do nothing without money,” observed Li, so he started a sports equipment company in order to raise the funds needed to promote athleticism in China.

At the time, Li was not only China’s greatest sports hero but an international star as well. He was named by an international jury in 1999 as one of the greatest all-time athletes of the 20th century. His accomplishments put him in a select group of world stars that includes Muhammad Ali, Pele, and Michael Jordan.

Over a 19-year career, Li Ning, who was born in 1963 in Liuzhou in China’s southern Guangxi Province, won a total of 106 medals in gymnastics. During the 1982 World Cup gymnastics competition in Zagreb, he earned the title “prince of gymnastics” after carrying away six of the seven gold medals open to men. In the 1984 Los Angeles Olympics, he won more medals than any other participant and walked off with three gold medals, two silvers, and a bronze. He was also both World Amateur Champion and Asia Games Amateur Athletic Champion. Li was injured during the 1988 Seoul Olympics and retired shortly after, although he had already begun to participate in the Athletic Commission of the Inter national Olympics Committee.

Looking for a new career, Li decided to dedicate himself to addressing the critical shortages in equipment and facilities that he felt were hindering the training of young Chinese athletes. He noted that China’s best soccer players had had to learn the game by playing on city streets and roads. China’s vaunted table tennis champions had been forced to learn the game on tables that were actually slabs of concrete.

In 1989, Li—who had already gained management experience working as a special assistant to the general manager of the Jianlibao Group in Guangdong—learned that bids were being accepted to provide sports equipment for the Asian Games torch relay, slated to take place in Beijing in 1990. A number of established foreign sports apparel companies had bid on providing the clothing for the Asian Games, but Li argued that it made no sense to have foreigners advertising their companies on the backs of Asians participating in the games, and he won the contract to provide 10,000 athletic suits for the event. Li decided to use his own name as the brand for the clothing, reasoning that his popularity as a sports star would be a powerful selling point.

Having succeeded at the Asian Games, Li moved his company to Beijing and decided to focus on providing clothing and equipment to other sports enthusiasts. On June 28, 2004, the company was listed on the Hong Kong Stock Exchange. The IPO raised $70.54 million, which enabled it to evolve into a professionally managed corporation. At the same time, the company established an R&D center in Hong Kong. The idea was to be in touch with global trends, provide new designs, and make Li Ning’s products internationally competitive.

GROWTH AND DEVELOPMENT

In 2003, Li Ning was still trailing behind foreign brands like Nike and Adidas, but it was already producing more than half of the sports apparel and footwear sold by Chinese companies in China. From 2004 to 2008, the company added around 800 stores a year. By August 2010, there were more than 7,000 outlets across China, 11 flagship stores in major cities, and new stores opening at a rapid clip. The vast majority of the outlets were franchises supplied by 130 distributors. The company was also introducing 600 new shoe models a year. The flagship stores were intended to build brand recognition and credibility. Li Ning was actively talking about plans to have more than 9,000 stores by 2013. At the same time, it announced plans to consolidate or drop some 600 stores that were not doing well, replacing them with others in more promising locations.

By the summer of 2010, Li Ning had 14.2 percent of China’s market share for sports gear. It was still trailing behind Nike, which had 16.7 percent, but it had managed to pass Adidas, which had dropped slightly to 13.9 percent. Li Ning’s gross profit margin was running at 46 to 47 percent, and it meant to maintain that despite a 7 percent drop in its sales of sports apparel and an 8 percent drop in footwear. Li Ning’s strategy was to go for second- and third-tier cities in China’s rural areas, which were now beginning to have enough spendable income to invest in sports.

Li Ning had early on adopted a logo that resembled a stylized liquid L that bore a striking resemblance to the famous Nike swoosh, except that it was red. In addition, the company’s original motto, “Anything is possible,” recalled Adidas’s slogan, “Impossible is nothing.” By the summer of 2010, the company announced that it was adopting a new logo, essentially separating the L at its base so that it resembled the Chinese character for “people.” A new company slogan, “Make the change,” was introduced. The message was clear: From now on, Li Ning intended to compete on its own merits and wanted to distinguish itself from its leading foreign competitors, Nike and Adidas. It no longer wanted to be seen as a pale copy. In general, Li Ning’s quality was considered close to that of Nike, Adidas, and Reebok, while the price was significantly less. Li Ning’s product line was much better than that of any of its domestic competitors.

THE INTERNATIONAL STRATEGY AND FOREIGN COMPETITION

Li Ning had been pondering an international expansion since 1999, but as of 2008, 98.8 percent of its revenues were still coming from sales in China. Some of the company’s board members expressed concern that spending money on international stores risked starving Li Ning’s China operations for cash at a time when it was encountering increased foreign competition. In 2007, the company opened a store in Maastricht, Netherlands, mostly at the suggestion of two Dutch entrepreneurs. The company was still not fully committed to selling in Europe. Disputes among the company’s senior management resulted in the Maastricht store not being outfitted with European sizes. After a year, the store closed.

Although Li Ning was the biggest player in the China market, it was not certain how long it could continue to hold that position. It was running into mounting competition from domestic companies, and both Nike and Adidas were beginning to look at the China market with new interest. Nike had previously divided the world into four regions. China was lumped together with Japan and other Asian countries spread across the Asia-Pacific region. By the time the Beijing Olympics took place in 2008, Nike had already reorganized itself into six regions, assigning “greater China” to a region by itself. Nike, which had nearly 40 percent of the China market, suggested that China might well become its largest market. The prospect of a surge in foreign competition seemed to energize Li Ning. To avoid taking on the multinationals in territory that they already dominated, Li Ning opened a flagship store in Singapore and planned to open up to 100 outlets across southeast Asia, mostly in Indonesia, Singapore, and Malaysia. In December 2009, Li Ning opened a flagship store in Hong Kong. A month later, it opened its first store in the United States, in Portland, Oregon—less than a mile from Nike’s own flagship store.

This time, the international strategy served two purposes. It provided a tentative venture into a potentially lucrative market as yet untapped by the company, but more than that, it also served to give Li Ning the kind of international credibility that it felt it needed to compete with Nike, Adidas, and Reebok in the China market. If Li Ning could actually cut into Nike’s and Adidas’s market share in their home territories by providing comparative or better quality at an affordable price, so much the better.

The company had scored a major coup for the China market during the Beijing Olympics. During the opening ceremony, Li Ning was chosen to light the Olympic torch. In a remarkable piece of showmanship, he was lifted high into the air by wires attached to a harness. He seemed to be running through the air as a spotlight followed him around the walls of the stadium until he finally lit the torch for all athletes around the world. Following that, the company set out to secure endorsements from a wide range of international sports stars. Signing on Shaquille O’Neal and Evan Turner was considered a major coup, but the company also signed a contract with NBA properties to ensure that its ads would appear at NBA games and that NBA stars would endorse its products. In addition, Li Ning became an official apparel sponsor for the U.S. Diving Team through 2012, and it also sponsored the U.S. Table Tennis Team (clearly an endorsement that meant more to the Chinese public than to most Americans).

To get its message across to a wider audience, the company developed a series of slick television commercials. One shows three inchworms, sporting logos from Nike, Adidas, and Li Ning, slowly moving across a white expanse. Suddenly, sneakers with the Li Ning label rain down on them. The camera pulls back to show an endless formation of Li Ning sneakers stamping on the ground.

The question remains, of course, whether Li Ning can grow big enough and fast enough not only to tap into the markets outside China but also to survive against stiff foreign competition on its own purely Chinese turf. To increase its chances, it dramatically stepped up its advertising budget and increased its ad spending in the United States by $10 million. American sales, handled through Foot Locker, had lagged, partly because the company was still trying to sell shoes that had been designed and manufactured for Chinese customers, not American. To get over that hurdle, the company announced that it was hiring 20 product designers to specifically target foreign markets. Li Ning’s executives declared boldly that they intended to be one of the top five sporting brands in the world by 2018. It is a long shot, but not an impossible one.

NOTES

1. “Sourcing: How China Compares with the Rest of the World,” September 8, 2004, www.wharton.universia.net.

2. “China Pays Steep Price as Textile Exports Boom,” August 22, 2007, online.wsj.com.