Chapter 9
China: Price => Value-Add
Who wishes to fight must first count the cost.
—Sun Tzu, The Art of War
In this chapter we will look at how the Chinese have used Price (now the Value-Add P of the 5Ps) as a strong success factor in their new market or industry penetration strategy. While the Chinese manufacturing cost advantage has declined somewhat over the past few years due to the economic progress of the country, it is still worth examining due to the impact it has had on China's current global position. Moreover, China's market penetration strategy of providing low-cost production can easily be emulated by other emerging entrants, (particularly China's Asian neighbors like Indonesia and Vietnam). Western companies need to be fully aware of this and prepare accordingly.
As previously discussed, a new market entrant with an average or less-than-average product offer often goes with penetration pricing. This is a price that can seem too good to be true or an offer that a customer cannot refuse. It is so discounted (cheap) that it is worth the risk of at least checking it out.
New market entrants may also offer financing or special payment terms for those customers who cannot afford their offerings. After all, gaining market share and customer references in order to achieve some credibility are the new entrant's key objectives, whatever the cost. Some might consider this strategy the equivalent to buying customers.
Free! (Try to Beat That!)
When we think of China, we often think of cheap goods—inexpensively made, and therefore affordable. And this may be the case in some instances, particularly for select consumer goods and commoditized products, but it is not always so. In the case of high-technology products, for example, there are a couple of dimensions to China's strategy that are critical to understand.
First, its strategy of imitating products as opposed to investing in innovation and R&D reduces costs. This is a quick market-entry strategy: Leverage the design investment that has already been made and replicate what has already been tested and customer approved.
Second, China's lower labor costs also allow them to enjoy hypercompetitive manufacturing cost reductions. China also has superior supply chain efficiencies, which we will discuss in later chapters.
Third, the aggressive pricing strategy of the Chinese is strategic and selective and is often part of a longer-term investment view, based on their chosen must-win battles/strategic accounts.
Let's look at the allegedly free part of their offer.
Some Chinese vendors have been known to give product away for free as an initial entry point into a strategic account. Now, this is not just a Chinese tactic. It is used by many companies to get a foot in the door, to enable customers to try their products and to potentially gain customer references so that they can win other accounts. However, this tactic is often overdone by emerging entrants such as the Chinese, pushing the limits of WTO rules for business. It is one thing to give one or a few products away; when a supplier gives the whole tender or bid (such as an entire network build-out) away for free then competitors cry unfair play.
The point, as it relates to the Chinese pricing strategy, is that they don't give free product away all the time, everywhere, with any customer. They have a well thought-out strategy. As previously stated, they have a longer-term view; they are not in it for a short-term win and they don't have a one-deal perspective. They understand that once they are in with a customer, there is much future business to be gained. Once a supplier is entrenched, it is a harder decision for the customer to uproot and discard an existing solution than to simply put up with its challenges. Thus, customers will try to work through their current suppliers and will continue investing in future build-ons or increments. The Chinese are not foolish—they realize they can make up the loss later in subsequent deals. They understand that initial market penetration is of utmost importance and that it comes with a price—and they are willing to win at all costs.
Loss-Leader Approach as Part of Market Penetration Strategy: Discounting Till Death
The loss-leader approach to market penetration should only be used as a short-term strategy. Prolonged use of this discounting tactic to acquire new customers is not sustainable.
Emerging Entrants Will Often Try to Win on Price First
Chinese vendors have been notorious for using aggressive pricing strategies as a way to win against established suppliers that have a known brand and reputation for quality. When you are the new kid on the block, how do you get prospective customers to give you a chance? You offer deeply discounted pricing that is hard to refuse for a product offer that is seemingly identical to a known brand.
Chinese vendors will typically offer a deep discount to gain a foothold with an account, then gradually raise prices (or provide smaller discounts) for subsequent product phases. They take a longer-term view: They want to win the business and become the incumbent supplier for an account; later they can raise their prices, when they are entrenched with the customer. They don't necessarily take this approach with all products: only with certain ones, such as lower-end solutions.
This is especially appealing to certain market segments—those for whom budgets, financing, or funding is hard to come by: namely, customers in emerging countries. These customers find the discounts to be desirable, but they are also often requirements for closing a deal.
While customers often know that you get what you pay for, the discounts are so attractive and tempting that buyers find them hard to resist. Even those customers who have purchased and committed to established suppliers' products still find themselves considering new, lower-priced options. And at times it is not knowledgeable individuals at the lower end of the evaluation process but non-technical decision makers (such as the CFO or other finance people in the customer's organization) who are forcing the consideration of an alternative option.
At other times customers are not really considering the purchase of another solution; they're just using the Chinese vendor's special pricing as a negotiating tool to bring the incumbent vendor's price down further. It's just doing business.
The following table provides an example of what an emerging entrant's (EE) discounting strategy might be over time, from market entry to a more established supplier.
The Chinese became so committed to becoming the world leader in low-cost manufacturing that even other developing countries, such as Mexico, were having their goods manufactured in China. Imagine: Even with transportation costs and duty tariffs, it was still more economical for manufacturers in Mexico to contract the work out to China.
Importers were coming to China in big numbers, and one of the questions many were asking was: Why China? Why weren't importers looking to other markets for manufacturing? The answer most often given was the low cost of labor, but that was only a part of it; as mentioned, factory labor in other economies was actually often cheaper.
Speed and convenience are two other important areas in which China performs particularly well. Chinese factories can take any product and produce it quickly, as they have mastered supply-chain management. This is innovation in its own right. The Chinese are able to manage all of the essential manufacturing elements in real time by capitalizing on localization benefits (i.e., access to component and facility suppliers, etc.). This skill is difficult to replicate, as there are many moving parts that need to be integrated and optimized in order to meet aggressive time lines and special requests.
| Entry | Growth | Harvesting |
| 30–60% Cheaper | 10–20% Cheaper | Just Below Competition |
| EE entry price is 30–60% cheaper than primary competitor's price. | EE may relocate sales team to a building on a primary customer's site. | Evolved entrant's product exceeds the customer's performance measures. |
| EE gives away service and support for free. | EE may provide special perks (such as trips) to customer decision makers. | Evolved entrant leverages build-ons and current customer connections in order to acquire additional subsidiaries for expansion in other countries. |
| EE further reduces price in response to competitor discounts. | EE employs high-touch customer focus, value-add. | Evolved entrant begins investing in codevelopment based on customer requirements. |
| For example, in the Middle East/Persian Gulf region, a Western company's price was still 40% higher than the Chinese competitor's price, even after a 55% discount. | EE bundles warranty and support with product. | Evolved entrant raises prices up to par with competitors based on new credibility level. |
Price Discrimination at Factories
Because the Chinese take a big-picture strategic view, price is a moving target that is based on who the customer is and what benefit the manufacturer can get out of the engagement (such as new product designs). There is no single China price—the price varies based on the customer and ability and willingness to pay. But of course importers don't appreciate being disadvantaged in negotiations because of their ability to pay—they all want to pay the same price.1
A Deal Is Not a Deal
Chinese manufacturers also have a tendency to constantly change pricing, even after a deal is made and agreed upon. The agreement is never final. Factories raise prices for various reasons, sometimes blaming market forces over which they have no control. Often this happens because Chinese manufacturers are being subjected to the same tactics by their local suppliers, which use these same questionable business practices on each other. The idea is to land the business by undercutting price, then adjusting later. Manufacturers want to increase their margins once they have their customers secured and it is too late or difficult for them to go elsewhere. This practice—to always be renegotiating—is part of the Chinese culture.
Hidden Price Lists, Holistic Pricing
Chinese high-tech vendors, particularly privately held companies, do not always publish a global price. There are also discrepancies between prices for domestic versus international customers.
In some circumstances this places Western suppliers at a disadvantage: How can they know what they are up against when bidding in a competitive situation so that they can prepare a counter accordingly?
The Chinese also have a big-picture view within their companies. While Western companies are often organized into independent business units, and each is rewarded or compensated on individual merit, some Chinese companies look across their product-line financials and use cash cow, high-margin, high-volume revenue streams to subsidize new growth business units.
A Chinese vendor's product managers may decide on the markup for each item or group of items; pricing is all part of the local strategy. Only the total price with the overall discount is reported back to the company's headquarters. The unit prices are not important. This approach is an example of how the Chinese look at a deal holistically—as a solution for the customer. It allows for more latitude in margin control as well. Essentially, the Chinese are good at selling as a whole company as opposed to selling as individual business units. This strategy allows for margin distribution and the averaging out of profits.
Strategic Accounts: Must-Win Battles…or Buy Them
Because Chinese companies are very strategic about identifying and targeting key accounts, once these accounts have been pegged, the Chinese do all that they can to win them over. Pricing, payment terms, and financing are a big part of their strategy to win.
Try-and-Buy and Pay-as-You-Grow Arrangements
The other way the Chinese justify the free giveaways is through try-and-buy or pay-as-you-grow arrangements. What better way to alleviate a customer's quality concerns or minimize a customer's perceived risk than to give them the opportunity to try with no obligation? No need to put money down or to commit. However, depending on the type of solution, the implementation and potential removal of the giveaway may not be that simple—thus the bait and hook.
This approach works like a deferred payment plan, with more of an attachment on the part of the vendor to the success of its customer. One way the arrangement might work is to allow customers to pay after six to nine months, after the solution has been satisfactorily deployed. Taking it one step further, vendors may also tie their own compensation proportionately to the growth of the customer. This also gives the customer a sense of ease and confidence in trying a less-known alternative.
The pay-as-you-grow option demonstrates that the supplier is in partnership with the customer, that it is there for the long haul and is confident about the customer's potential for success. The arrangement alleviates the stress and pressure of payment for customers, which is particularly important when they are just starting out or when times are a little rough or slow. At this stage the customer needs to invest to grow but doesn't have the financial wherewithal to do so comfortably at the moment.
Flexible Commercial Terms
For certain targeted accounts, Chinese companies will often offer flexible payment terms to encourage a customer to take a risk with them even though they are new and unproven. As with a pay-as-you-grow arrangement, this arrangement also demonstrates a partnership approach to the customer, signaling that the vendor is there for the long run.
New Business Models
For select must-win battles, Chinese companies will get creative with business models, taking a partnering approach. This demonstrates goodwill and commitment to a customer and is particularly valued in emerging markets, where other vendors have taken a dump-and-run approach in the past. The message from suppliers is that they care about the success of the customer, and that the customer's success is their success.
One way a partnering approach might work is to invest in a customer's business and take part in profit sharing (e.g., as Huawei did with Sunday, a telecom service provider in Asia). Customers feel suppliers are sharing the risk of the cost of investing in the new product because suppliers will get their returns from customers' future revenue stream, and therefore they feel more confident in choosing a supplier's solution.
Sometimes the model involves implementing solution-selling and combining all the key factors in the solution, including technology, services, financing, and price. There is a Chinese saying that summarizes it nicely: “Punch with a fist instead of poking with five fingers.”
Chickens for Routers: The Barter System Is Alive and Well
One of the many strengths of China's globalization strategy is that the Chinese go out into the world as a team. China Inc. encourages and supports a nationalistic approach to doing business outside of China. (More on this topic will be covered in a subsequent chapter.) In the meantime, here is a story about how the barter system has been applied by Chinese companies and China Inc.
Because of the rapid rise of China's middle class, there is now a significantly larger population that is consuming poultry. Historically most people could only afford a menu of vegetables and rice, but due to industrialization and increased wealth, demand for poultry has increased significantly. China itself was not yet equipped to provide for this burgeoning population segment, so it started to import chicken in large quantities. Neighboring countries became concerned about the amount of their poultry being bought, fearing that they would not have adequate supplies for their own population and other countries that they traded with. This resulted in some countries placing limits on the amount of chicken that could be exported to China.
The Chinese government, in all its tenacity and determination, got creative about this new trade embargo. The rumor was that a Chinese technology equipment vendor was bidding for a network build-out in Thailand. The mother company of the service provider looking to purchase networking equipment also had a food services company as part of its conglomerate. China Inc. negotiated the exchange of the network equipment purchase (i.e., routers) for payment in poultry instead of the usual currency.
Now that is being creative!
Financing: Can't Afford It? No Problem!
Now back to the microlevel discussion. Western companies have neglected emerging-market countries as viable markets not only for reasons such as distance or readiness for their products, but also because they know that these customers do not always have access to funds for payment. Double win for China. Not only has China paid emerging markets the attention that they were lacking from the West, but China Inc. has been ready to help them pay for their solutions.
This partnering/investing approach works particularly well for emerging country customers that need this kind of support and appreciate such investments of faith and higher risk taking.
Loans/Subsidies from the Chinese Government—China Development Bank
This financing strategy is enabled by the support of the CDB. In the spirit of their national expansion goals, the Chinese government has granted many Chinese companies funds to assist them with their international expansion goals. Oftentimes these funds are used to help subsidize or finance purchases by prospective customers.
Many Western companies have complained that these kinds of government subsidies constitute unfair trade practices. In past years. the European Union went as far as commissioning an investigation to examine whether Chinese government's financing of credit for export goods violated WTO rules. The Wall Street Journal highlights, “Western trade experts say that Huawei.…is a compelling example of a Chinese company that has been nurtured to global dominance using such subsidies.”2
Chinese vendors also finance customer purchases by obtaining financing from a third-party local financier (e.g., obtaining a European financier for a European customer) with the Chinese company/government securing the loan.
Whether these government-funding practices are unethical and contrary to WTO rules, or the Western companies just feel at a competitive disadvantage because their home countries do not furnish the same support is a gray zone.