月份：2021年11月

Opinion: Data Security Becomes a Core Issue for Doing Business in China

By Edward Tse

2021-11-03

Originally published by Caixin Global on November 3, 2021.

As many people know, China is now a major digital economy. By the end of 2020, almost a billion people had access to the internet in China. WeChat, China’s largest social media platform, surpassed 1.2 billion monthly active users in 2020, and Douyin, the Chinese twin of TikTok, now has over 600 million daily active users.

Meanwhile, over 700 million monthly users now visit e-commerce platform Pinduoduo. Alibaba-affiliated Alipay and Tencent’s WeChat Pay — the domestic e-payments giants that pioneered new payment technologies using QR codes — currently process about 95% of the digital payments market in China.

Data is being generated in China at a whirlwind pace. According to the China Academy of Information and Communications Technology, the total amount of data generated in the country went up from 2.3 zettabytes in 2017 to 3.9 zettabytes in 2019, and it is continuing to grow.

Back in 2015, Jack Ma, co-founder and then-executive chairman of Alibaba proclaimed: “We are entering a new energy era. In this era, the core resource is no longer oil, but data.” Since the wireless internet was first introduced in China, entrepreneurs have been quick to leverage it to build business models that rest on the gathering and usage of data. To this end, quite a number of successful tech platforms have emerged. Some like Alibaba Group Holding Ltd., Tencent Holding Ltd. and Bytedance Inc. have made it to the big league on a global basis.

These companies typically build their business models on a number of pillars enabled by data. The first is their ubiquity in connecting to their users through vast amounts of data. Apps such as the ones mentioned above have very large numbers of frequent users. Second is their ability to focus on each user on the data set on a “segment-of-one” basis using their algorithms. Many of these companies were able to expand very fast mainly because China didn’t have many regulations on data gathering and usage. The ingenuity of the entrepreneurs coupled with the prevalence of pain points in Chinese society allowed many of these companies to grow. Some of them were able to become “exponential organizations.”

Over time, issues related to data security began to surface in several areas. One typical question regulators and companies are asking is related to the ownership of the data. Usually, there are multiple stakeholders involved in the data value cycle, all of which might attempt to claim ownership of the data because, for instance, they created or generated data, or because they use, compile, select, structure, re-format, enrich, analyze, purchase, or add value to the data.

The second is data privacy. Keeping private data and sensitive information safe is paramount. But it is difficult to identify what data is considered private, what data can be shared and what data cannot be shared. And the third is data monopoly. Internet companies possess the personal data of millions of users, but to what extent they can actually manipulate the data by using sophisticated algorithms for their benefit is still a grey area.

Along the way, several events have exemplified the severity of these issues. In August 2020, the China Banking and Insurance Regulatory Commission (CBIRC) fined two of the country’s biggest state-owned banks, China Merchants Bank Co. Ltd. and Bank of Communications Co. Ltd., for failing to protect the personal data of their credit card customers. In order to prevent risks regarding national data security, China’s internet regulator has also ordered Didi Chuxing Technology Co. Ltd., a leading ride-hailing company in China, to stop signing up new users. Didi’s apps were forced off major app stores for two days after its IPO in July 2021. With China’s continuing cybersecurity reviews, rules for overseas listings have been tightened, and companies like the ones behind Keep, a Chinese sports-oriented social platform, and Ximalaya FM, the largest podcast platform in China, have recently canceled plans for U.S. IPOs.

Three major pieces of legislation in China have set the cornerstones for addressing issues related to data security. In June 2017, China implemented the Cybersecurity Law (CSL), which acts as the baseline for maintaining network security. The law requires that data be stored within China and that organizations and network operators submit to government-conducted security checks. In order to further protect national data security and the public interest, the Data Security Law (DSL), which took effect on Sept. 1, requires all companies in China to classify the data they handle into different categories and prescribes how such data is to be stored and transferred to other parties. On Aug. 20, China also passed the Personal Information Protection Law (PIPL), which took effect on Nov. 1. This new law imposes restraints on data collection and the transfer of personal information, and has an extraterritorial effect for companies both inside and outside of China. Once effective, the PIPL will work together with the CSL and the DSL to establish a broader regulatory architecture governing cybersecurity and data privacy protection in China.

Against this backdrop, companies are concerned about a number of key questions. Foreign-owned multinational corporations (MNC) are concerned about how to manage data across different regions, both in their home countries and in China, as well as cross-border data transfers, in compliance with the new data laws. For domestic companies planning to list overseas, strategic plans need to be put in place to comply with data security regulations. Both need to figure out how to use data to generate competitive advantages while staying away from the “red lines.”

These regulations are driving MNCs to set up research and development or innovation centers at their headquarters, increasingly in China. For MNCs, the way to operate in China has evolved quite a bit, particularly since global geopolitics started to undergo a significant shift. Data security has become a key issue that they are often not well prepared for. China has become not only a market or supply chain hub, but also a source of knowledge and inspiration because of intensive innovation. A key enabler of this is the increasing divergence in the speed, intensity and degree of sophistication of the digital infrastructure that China is building compared with other parts of the world.

Looking from a strategic standpoint, what could happen in the next few years? The big questions are where the data should be stored and secured, and where and with whom can they be shared with for the benefit of the company? Where do you draw the line? The DSL and PIPL will change how companies think about running a business in China. A lot of changes for management systems and processes as well as organizational structure will likely take place.

Looking forward, humanity expects to be even more connected. At the same time, local requirements for data sovereignty will also come to the fore. Business models will become more complicated. Those who can figure out the new game faster and better than others will likely generate new sources of competitive advantages along the way. These realities are challenging the minds of corporate executives and strategists the world over.

By Edward Tse

2021-9-7

A recent article authored by Gao Feng Advisory CEO Dr. Edward Tse was published by Caixin Global on September 7.

On August 17, 2021, President Xi Jinping explained the concept of “common prosperity” at the Central Finance Committee Meeting. He said, “common prosperity is a key requirement of socialism and a major feature of Chinese-style modernization.”

This is a clear signal that policies are in for a sea of changes, from reforming income distribution and providing more equal opportunities in education, healthcare, pension and housing to addressing monopolistic behaviors and extending boundaries of prosperity from material needs to spiritual satisfaction. The immediate focus might be put on reducing income inequality through the so-called “primary, secondary and tertiary wealth distribution.”

Many have commented on the implications of the new policy, especially for new areas of investment.

A report by China Securities says new investment opportunities will emerge in the following areas:

1) More resources for infrastructure building and upgrading in underdeveloped areas, with focus on hardware and software for the digital economy;

2) Enhanced growth opportunities for manufacturing and disruptive small and midsize enterprises in information technology, new energy and biomedical industries;

3) Better education, medical and elderly care services;

4) Expansion of channels for citizens to earn higher incomes, including “tertiary distribution” of wealth, promotion of charity foundations, and more long-term wealth management methods. This means additional capital flows into the securities market benefitting brokerages and insurance sectors;

5) Consumption upgrade to enhance growth opportunities in consumer goods, as well as services such as cultural, media, sports and entertainment.

The new policy will obviously change the operating environment, requiring local and foreign companies to evaluate if and how they should develop new strategies to address these changes.

The key objective of common prosperity is to reshape the societal structure from a pyramid-shaped structure to an oval-shaped one with the widest part representing the middle class. It also means that average income should continue to increase. One can expect continued growth in demand for a wide range of products and services leading to better healthcare and an improved lifestyle.

The importance of collective interests will heighten, though it may not outweigh legitimate individual interests. So, while companies will continue to pursue individual interests, they will have to be mindful of the redrawn “red lines” that will define excessive monopolistic market behavior, violation of data security law, distortion of certain societal values, a more balanced developmental environment for the younger generation, fulfillment of basic welfare for employees, and the like.

The pursuit of common prosperity means that at the most fundamental level, all businesses would be expected to take better care of their employees, with more benefits and more reasonable working hours. To this end, automaker Geely has already proposed a program to offer 350 million new shares (3.56% of total equity) to employees.

Societal impact and contributions will have to be increasingly important considerations for companies. “ESG” (environment, society and governance) and corporate social responsibilities will have to be assigned greater importance by companies and investors.

Focus of growth will also shift. While the consumer internet (and the mega-platforms) has generated much buzz in China over the last decade, focus will likely shift to areas such as “hard tech,” manufacturing, life sciences, new energy, environment, sustainability, industrial internet, agriculture and others. Also, services for the burgeoning middle class will become more prevalent. More innovations can be expected in these areas in due course.

Additionally, the practice of some internet companies using sophisticated algorithms to track individuals ubiquitously will be subject to restraints, at least to ensure it isn’t blatant. Fulfilling the new data security law will be essential going forward.

The common prosperity policy must be viewed as part and parcel of other key policy initiatives including pursuing “dual circulation” economic policy, targeting technological self-sufficiency, adopting the dual approach of building major regional city clusters while revitalizing rural areas, launching central bank digital currency, achieving carbon neutrality by 2060 and others. Together, they form China’s pursuit of its own “modernity with Chinese characteristics.”

In this vein, companies across many sectors will need to address some fundamental questions. For instance, global manufacturing companies need to decide how much of their manufacturing and supply chain they should shift into, or out of, China. To what extent should China remain the hub of their supply chains? Industries such as the semiconductor industry are being disrupted by changing geopolitics and individual country policies, and need to decide how to reposition themselves in the new global industrial structure. Foreign companies that generate and capture data in China must find ways to satisfy China’s data security law while also meeting their home country’s data security requirements.

More profoundly, the fundamental nature of some of the businesses will change to some extent. As smart cities which serve the public agenda come up all over China, business models of a range of industries will need to integrate significantly with public infrastructure. In these cases, private sector businesses will no longer be able to define strategic and operational parameters simply by themselves. Close coordination and collaboration with the public sector will become necessary. Sectors such as intelligent and connected vehicles, mobility-as-a-service, digital health, smart energy and modern agriculture are areas that come to mind.

We will likely see more new ventures take the form of public-private partnerships (PPP) and new ecosystems of government, state-owned enterprises and private sector companies will be formed. Companies will have to critically examine the continued vitality of their partnerships in China.

China’s pursuit of common prosperity is a huge social undertaking and this will be a game changer in many ways. When done right, it will mean setting a foundation for more balanced and sustainable growth over time, and creating change that may have major impact on the rest of the world. It will have implications for all kinds of businesses operating in China. At the minimum, companies will need to comply with new policies and regulations. At the maximum, even the fundamental nature of some businesses will be re-defined. As such, companies need to fundamentally re-think their strategies, and for those who have global presence, this may have severe implications for their operations in the rest of the world, too.

By Edward Tse

2021-8-24

On August 24, a recent article authored by Dr. Tse was published on Dialogue Review, a leading publication associated with Duke Executive Education, USA.

Few countries demand the attention of global companies’ senior executives quite like China. Its market size, its continued growth and its importance to global supply chains make it hard to ignore. Its GDP growth of 2.3% in 2020 (as reported by the International Monetary Fund, April 2021) indicates a strong post-pandemic recovery – a performance which is all the more remarkable when compared with the negative growth experienced by the rest of the world in 2020. In the first quarter of 2021, China’s GDP grew by a record 18.3% in comparison to the same period the year before.

China has come a long way since the start of its reform and ‘opening up’ policies some four decades ago; in fact, its GDP has grown over 200 times across this period. It is set to overtake the US as the largest economy in the world before the end of this decade. Despite this, many people over the years have cast doubts on whether China’s growth is sustainable. Perhaps the most quoted narrative has been that of a 2001 book, The Coming Collapse of China, which predicted that China would collapse in the “near future.”

Yet China has delivered continued economic growth without showing any signs of imminent collapse, despite a rather challenging geopolitical environment and a pandemic. Why has this been possible? The answer lies in a three-layered system of economic development which has guided government and enterprise over many years. It’s time for global businesses to truly understand why China works – and to assess how geopolitical developments may shape its future role in the global economy.

China’s development approach

After a rather tumultuous first three decades, the People’s Republic of China (PRC) began its reform under Deng Xiaoping at the end of the 1970s. While retaining key aspects of the state planning system, Deng began to experiment with elements of a market economy to create “capitalism with Chinese characteristics”. This included allowing the return of entrepreneurship, which has become a key component of China’s economy and the most important source of commercially applied innovation. The central government continues to play a significant role in steering the economy and helping the country to develop at a sustainable pace, but China is no longer just a state economy: the private sector has become increasingly significant.

That is especially true in today’s digital economy. For instance, the government has allowed two private companies – Tencent and Alibaba – to create and dominate the country’s online payment system. China’s third-party payment transactions have reached ¥280 trillion (about US$44 trillion), of which over 80% are paid through Alipay and Tenpay. It is an example of the central government’s willingness to coordinate with private businesses to put much-needed innovations to work for the country. Collaboration with private enterprises will continue to be essential as the government prepares to launch its central bank digital currency (CBDC).

Local governments also play an important role in the Chinese system. They often function as a bridge between central government and entrepreneurs: they frequently provide funding for businesses, and select strategic positions commensurate with the directions set by the central government. Many have built their digital and smart infrastructure to support ‘smart cities’ initiatives driven by the central government.

The interaction of central government, local governments and the private sector amounts to a three-layered model for China’s economic development

In addition to this three-layered structure, China has a unique dual economic structure, comprising state-owned enterprises (SOEs) and privately-owned enterprises (POEs). While there are sometimes conflicts between companies from these two sectors, they also co-exist in symbiotic relationships, with SOEs providing public goods, such as infrastructure and environment-improvement measures. A good example is the development of the world’s most extensive high-speed railway network, built from practically nothing, in just over a decade. Such achievements are possible because these enterprises do not evaluate mission-critical infrastructure projects only on narrow economic viability. Both Chinese people and businesses, including foreign companies, benefit from such infrastructure.

We call this system a ‘three-layered duality’. It is an approach which requires constant juggling of various components to make it work. It is experimental by nature and therefore requires a strong degree of overall orchestration, plus shared vision and values from those who participate. As a result, it has an innate ability to self-adjust over time – as seen in the emergence of China’s innovative private sector.

Key achievements

China has developed a strong reputation for innovation. Broadly speaking, there are two strands of innovation. One is technological innovation which is primarily driven by the government. This includes programmes such as space missions (including lunar and Mars probes), deep sea exploration, developments in quantum computing and many others. The other strand is tech-enabled innovation in commercial applications. Prime examples are found in e-commerce, online payment and smart logistics, as well as in the automotive and mobility sectors. Private businesses play a major role in this sort of innovation, often in collaboration with local governments.

The three-layered interplay between central and local governments and both SOEs and POEs is evident in many fields. For instance, with the US government’s sanctions on high-end semiconductor chips hitting Chinese manufacturers, China has launched a major initiative to develop self-sufficiency in high-end chip supplies. The central government, many local governments, and various SOEs and POEs are involved in various ventures aiming at creating breakthroughs.

The Covid-19 response provided another very visible example. During the lockdown of Wuhan city in early 2020, two emergency hospitals were built in as little as ten days. China was able to achieve this because as soon as the central and local governments decided that the hospitals were necessary, a large number of SOEs – together with POEs and even foreign companies – quickly collaborated. The commitment to a common goal and sharing of a vision were key motivators. To simply equate this with a simplistic ‘authoritarian’ narrative does not assign enough credit to all those who participated.

This is sometimes termed a ‘whole-of-nation approach’ – one that can mobilize resources across the entire country against a certain objective and purpose. It is based on a pragmatic balance between a sense of collective responsibility and individualism by all involved. It is a balance that has driven the unprecedented intensity and pace of China’s innovation and development, as well as its resilience. Small wonder, perhaps, that a recent survey carried out by Canada’s York University found an overwhelming 98% of Chinese citizens indicated that their trust in the national government had increased since the pandemic. The notion of the “coming collapse of China” has little chance of materializing any time soon.

Global businesses in China

Global businesses who have operated in China for some time may understand the reasons for the country’s success, although many multinationals are yet to fully grasp the impact of Chinese innovation. Some, though, are beginning to recognize what they can learn from China. One large US client told me their board of directors instructed the China team to think about how to leverage Chinese knowledge to help businesses in other parts of the world. BMW has taken its Munich-based Startup Garage programme to China to gain exposure to innovative new technologies, while Herbert Diess, chairman and chief executive of Volkswagen, said at the 2021 Davos online summit that China was “moving in the right direction” – with it now being easier for foreign multinationals to invest in China than for Chinese businesses to invest in countries such as Germany.

As Diess also noted, there is a strong relationship of dependency: “they are depending on the West, we are depending on China”. Indeed, China’s role in the world is becoming ever more important. Its internally driven development approach is moving the country towards a new era of high-quality growth that will be epitomized by more innovation and greater sustainability. However, the external environment is becoming more complicated – and it doesn’t look like this will get better anytime soon.

Three geopolitical scenarios

In determining their strategic approach to China, global companies must evaluate how the evolution of geopolitics could affect their positions. As a global power, China’s relationship with many parts of the world will be critical in the years ahead – but its most important geopolitical relationship is likely to remain that with the US.

We believe there are three potential scenarios related to geopolitics and macroeconomics which will affect global businesses, especially US businesses. The first is ‘regionalized isolation’. In this scenario, Chinese companies will be forced out of the US market, with the Chinese government retaliating by virtually blocking US investment in China. The Chinese tech industry becomes self-sufficient and there is a widespread economic decoupling, with Chinese consumers becoming increasingly hostile towards US brands, shifting instead to local products.

The second scenario is ‘one world, two systems’. The US and China will remain geopolitical rivals with occasional flare-ups on specific issues, but will find agreement on common interests. Intense competition in high-tech areas will continue, though stakeholders will learn to solve disputes through dialogue. Export controls and other policy measures, as well as differences in the sophistication of digital infrastructure, will see China and the US evolve into two distinct tech systems. China will expand market access to foreign firms, but with stringent data and security policies. As intelligence and connectivity become increasingly embedded in Chinese society, consumers will gravitate towards brands that can give them the desired digital experiences, tailored to local tastes, regardless of origin.

The third scenario is one of ‘co-opetition’. The US and China remain geopolitical rivals while collaborating in certain areas of global governance. They both compete and collaborate in high-tech areas. As it grows, China will increase market access for foreign players, while exercising data sovereignty based on recognized principles of global data governance. Again, consumers seek out the brands that can tailor experiences to local tastes, irrespective of origin. In this scenario, companies’ products, services and business models have a better chance of transcending national borders – perhaps with the exception of core technology concerns.

We don’t believe a complete decoupling is likely or even possible. The ‘one world, two systems’ scenario will probably manifest under some specific conditions, while the third scenario of ‘co-opetition’ is probably more likely over the medium term – perhaps with more competition initially, moving towards greater collaboration over time.

Engaging with China

Today, a global company’s China strategy is largely dependent on which of these geopolitical and macroeconomic scenarios it expects to pan out. China’s importance to global companies’ finances and competitive positioning will become more critical going forward, despite the uncertain US-China relationship.

However the geopolitical context develops, China will continue to generate much of its own economic momentum. Its unique and still-evolving three-layered duality development framework – the whole-of-nation approach – will provide it with significant resilience. The country should be able to continue to make major progress.

Making the right bets now on how the world will look in the coming years, and what to do in China, will define the long-term competitiveness of many companies around the world – perhaps even their survival.

China’s Overhaul of Regulations in Private Education Part of Strategy

By Edward Tse

2021-7-30

A recent article authored by Dr. Tse was published by CGTN on July 30, 2021.

Editor’s note: Edward Tse is the founder and CEO of Gao Feng Advisory Company, a global strategy and management consulting firm with roots in China. The article reflects the author’s opinions and not necessarily the views of CGTN.

The recent overhaul of the regulations governing private education sector by the Chinese government has come as a surprise to many. Under the “Double Reduction” policy announced on July 24, the burden of homework and after-school excessive study hours is to be reduced.

The new regulations prohibit private education firms from offering for-profit tutoring in core school subjects on recess time. Private education firms are also not allowed to raise capital and get listed.

Online or in-person classes in core subjects to children under the age of six is also prohibited because children are increasingly pushed to start cramming for exams at a very young age.

After announcement of the new regulations, share prices of all Chinese private education companies fell within a matter of days, listed in the U.S., Chinese mainland and the Hong Kong Special Administrative Region.

China’s education industry sub-index dropped as much as 14 percent on July 26. Hong Kong-listed education companies, including New Oriental Education and Technology and Scholar Education Group fell by 40.6 percent and 28.5 percent respectively, along with the U.S.-listed companies Gaotu Techedu and TAL Education Group, both of which plunged by about 50 percent at the end of the day.

The new regulations for the education sector came soon after Chinese regulators took major actions scrutinizing Didi Chuxing, the leading ride hailing company which had recently listed in New York City for data security issues.

At around the same time, regulators banned the proposed merger between two leading games companies, one of which is owned by internet giant Tencent, because of anti-monopoly concerns. Food delivery app Meituan has been asked to pay the required benefits to its delivery people.

Earlier, Chinese regulators also put a stop to Ant Group’s IPO due to concerns on its business model, while Alibaba, Meituan and retailer Suning were all fined for anti-competition behavior.

In addition, the Chinese government has taken a number of other steps along the way. These cover areas such as relaxation of the hukou system (a household registration system), eradication of poverty, easing of child birth restriction policy, and increasing access for foreign companies’ participation in the Chinese market especially for the financial services sector.

The overhaul of the private education sector is believed to be a key step towards reducing the workload for students and also a way to reduce the costs of bringing up children in China.

One key reason why Chinese couples are reluctant to have more children is the exorbitant costs of bringing up children. This in turn has contributed to the skew of China’s demographic profile over time.

So what do these policy measures really mean? And how should investors, both foreign and local, and other observers interpret these policy adjustments? Is this series of policy changes an outlier event or does it indicate something more significant?

On top of these significant policy measures, the Chinese government has also announced its 14th Five-Year Plan in which technological innovation is the key area of focus. While technological innovation has been at the core of China’s development for the last decade and more, the need for it has been exacerbated by the U.S. government’s sanctions on transfer of core technology to China.

On top, the U.S.-China trade war and pandemic outbreak required China to take decisive decisions in addressing these challenges. China’s experience henceforth has increased the confidence in its own governance.

These are being undertaken while China searches for its own brand of modernity. In the centenary speech on July 1, Chinese President Xi Jinping mentioned nine times that ” … put conscious effort into learning from history, to create a bright future.” This epitomizes how China is searching for its own brand of modernity for which the “whole nation system” is deployed.

When thinking of the future, China often reflects at its rich past. In parallel to respecting and following traditional ways, China is open to imported ideas like Marxism as well as a reasonable degree of capitalism.

It adheres to the principles of socialism, but also embraces the dynamism of a market economy. Focusing on the “great rejuvenation of the Chinese nation,” its leader also advocates “a community with a shared future for humankind.”

The absorption of foreign thoughts into multiple strands of traditional Chinese thinking such as Buddhism, Confucianism, the long held belief of “yin and yang” into taoism, combined with the “oneness” in Chinese culture, has shaped Chinese civilization for thousands of years. The modern China has somehow created an approach that effectively addresses the multiple dimensions encountered in the search for its own brand of modernity.

This context reassures that China will continue to navigate its way forward in an inclusive manner and grow socially, economically and politically, frequently experimenting with its unique approaches.

In the context of improving the well-being of Chinese people and playing a larger role in advancing overall well-being to the entire world, China’s leaders take decisive actions on issues that matter.

While investors of the affected companies may not like these moves, the general public in China, as the beneficiary, are in general supportive. In the search for its envisioned modernity, the Chinese government is trying to promote collective interests while continuing to allow individual’s pursuit of financial well-being. The Chinese is calling this a pursuit of “common prosperity.”

At this heart of it is an institutional approach to reduction of costs of living for the country’s people, including those of giving birth, nurturing children, education and housing.

These corrective measures are expected to put future growth on a sound footing. Going forward, opportunities will come from areas such as hard tech, manufacturing, life sciences, new energy, environmental sustainability agriculture and the like.

Moreover, a large number of start-ups will emerge in these areas and many investors will benefit. But going forward, picking the right lane to invest will be the key. From the investment standpoint, this short-term turbulence redefines the foundation for longer term growth.

As China continues to search for its own brand of modernity with Chinese characteristics, the rest of the world will increasingly get to know of the impact of what China does. People need to deepening the understanding of what China’s approach is, and how it works for the world.

By Edward Tse

2021-06-30

A recent article authored by Gao Feng Advisory CEO Dr. Edward Tse was published by Caixin Global on June 30

The world now acknowledges China’s ability to innovate. But many people question why that has happened. For many, especially those in the West, China is supposed to be under an alleged authoritarian system and so by nature, it would not be able to sustain innovation or keep it vibrant. These people have been working on the paradigm that innovation can only thrive in a free enterprise system led by private initiatives with minimal state involvement or interference.

Broadly speaking there are two strands of innovation in China. One is technological innovation, which is primarily driven by the government. This includes programs such as space missions, deep sea exploration, developments in quantum computing and many others. Another strand is tech-enabled innovation in commercial applications. Prime examples are innovations in e-commerce, social commerce, “new retail”, “big health,” fintech, automation and robotics, smart logistics as well as automobiles and mobility. Private businesses play a major role in this sort of innovation, often in collaboration with local governments.

China’s innovation capabilities and entrepreneurship have come a long way since the start of the country’s reform era. China began to experiment with the elements of a market economy and has allowed entrepreneurship based on private initiatives to return since the late 1970s. After several generations of entrepreneurs who have emerged along the way, there has been an upsurge since the end of the 2000s as Chinese entrepreneurs have begun embracing the wireless internet and have leveraged it for generating business innovations that address both the pain points of Chinese society and the emerging consumer demand for new products with new technologies offering innovative features and conveniences.

Several large and successful tech companies such as Tencent Holdings Ltd., Alibaba Group Holding Ltd., Huawei Technologies Co. Ltd., SZ DJI Technology Co. Ltd., Xiaomi Corp., ByteDance Ltd., JD.com Inc., Pinduoduo Inc. and many others now dot the economic horizon of China. And companies such as Ping An Insurance Group Co. of China Ltd., Geely Automobile Holdings Ltd., BYD Co. Ltd., Midea Group Co. Ltd. and the like that started off as “traditional” have successfully transformed themselves into innovative tech companies. According to the Hurun Global Unicorn Index 2020, the number of unicorns (unlisted companies with a valuation of more than $1 billion) has grown exponentially over the years and today China has the second-largest number of them in the world — 227, compared with 233 in the U.S.

After the rather tumultuous first three decades, the People’s Republic of China began its reform under Deng Xiaoping at the end of the 1970s. While retaining the key features of its state planning system, Deng began to experiment with some elements of a market economy, including allowing the return of entrepreneurship in China.

Entrepreneurship has now become a key component of China’s economic growth and the most important source of commercially applied innovations. China is no longer just a state economy, the private sector too has become very significant.

At the same time, the central government continues to develop policies to steer the economy in the direction that it deems appropriate and help the country’s development move at a sustainable pace. Building on successful experience over a decade in driving innovation, since around the mid-2000s, Chinese entrepreneurs have played a major role in bringing to fruition the Chinese State Council’s 2014 policy on encouraging mass entrepreneurship and innovation.

More specifically, the central government has allowed two private companies — Tencent and Alibaba — to create and dominate the country’s online payment system, which shows how the central government, where appropriate, would coordinate with private businesses to put much-needed innovations to work for the country. Today, China’s third-party payment transactions have reached 280 trillion yuan (about $44 trillion), over 80% of which are handled by Alipay and WeChat Pay. The central government is now preparing to launch its central bank digital currency (CBDC) and here too collaboration with private enterprises will be essential, considering the current dominance of private sector firms in processing of online payments.

Often local governments also play an important role as a bridge between the central government and entrepreneurs. Leading local governments frequently provide funding for businesses and also select certain strategic positions that are in conformity with the directions set by the central government. Many have built their digital and smart infrastructure to support smart cities initiatives driven by the central government.

In addition to the three-layered structure comprising the central government, local governments and businesses, China is also unique in that it has a dual economic structure of both state-owned enterprises (SOEs) and privately-owned enterprises (POEs). While there are sometimes conflicts between companies from these two sectors, they also co-exist, living in a rather symbiotic relationship.

SOEs provide public goods (for example, infrastructure and environmental improvement measures) as part of their social responsibilities for the Chinese people. A good example is that SOEs were able to build a high-speed railway network from practically nothing to the world’s most extensive in just over a decade, because they do not evaluate these mission-critical infrastructure projects only on economic viability. Today, the Chinese people and businesses, including foreign companies, benefit from this infrastructure.

This “three-layered duality” approach requires constant juggling of various components to make it work. It is experimental by nature but the all participants have a strong ability for overall orchestration and they share the vision and values, which leads to an innate ability to self-adjust along the way.

Compared with the earlier generations of entrepreneurs, Chinese entrepreneurs have become younger. Many are in their 30s and some are even younger. They are omnipresent in a range of industries including those mentioned above and many of them share the commonality of leveraging technology as the basis for innovation.

As new disruptive technologies such as artificial intelligence, the Internet of Things, 5G, cloud technology and blockchain technology are emerging and finding acceptance in the world’s leading digital economies, China is entering into a new tech-enabled innovation era. In China’s 14th Five-Year Plan, technological innovation is a key theme and China is committed to becoming self-sufficient in technology, particularly in the aftermath of sanctions by the U.S. government on key supplies of core technology, products and components.

Since the U.S. government announced sanctions on high-end semiconductor chips supplies to select Chinese manufacturers, China has launched a major initiative toward self-sufficiency in high-end chips. In this case, the central government, many local governments, various SOEs and POEs are involved in a variety of ventures aimed at making breakthroughs.

During the lockdown of the city of Wuhan at the peak of China’s outbreak last year, two emergency hospitals were built in a week to 10 days’ time. China was able to achieve this because as soon as the central and local governments decided that these hospitals were necessary, a large number of SOEs together with POEs and even foreign companies quickly collaborated to contribute. The commitment to a common goal and sharing of a vision were the key motivators. Attributing this magnificent feat to an “authoritarian” government will be too simplistic and unfair to those who participated in practically overnight building of the hospitals.

Some people call this approach a “Whole Nation Approach” (举国体制) that can mobilize resources across the entire country against a certain objective and purpose. It is based on a sense of pragmatic balance between a sense of collective responsibility and that of individualism on the part of all involved. While the state drives a sense of collective purpose and responsibility, through SOEs, it provides necessary public goods for citizens and businesses, entrepreneurs based on private initiatives are allowed and in fact encouraged to succeed against a certain state-driven rules-based order.

Some people attribute this to the historical heritage of China where the literate shared a sense of collective responsibility that comes from a lineage of vast and multiple strands of thought, mostly in the (Han-centric) Chinese civilization that later inter-mixed with imported thoughts from Buddhism. This coupled with the purpose and governance system of modern China has somehow created an inclusive culture that addresses both the collective interest as well as individual pursuits.

This has no doubt resulted in the massive and unprecedented intensity and pace of innovation and development, as well as resilience. Innovation has become an integral part of the Chinese culture and its manifestation is becoming more profound by the day.

By Edward Tse

2021-05-14

A recent article authored by Dr. Tse was published by CGTN on May 14, 2021.

Editor’s note: Edward Tse is the founder and CEO of Gao Feng Advisory Company, a global strategy and management consulting firm with roots in China. The article reflects the author’s opinions and not necessarily the views of CGTN.

China’s role in international trade, global supply chains and the world in general is expanding alongside its growing economy. Many countries in different parts of the world are currently undergoing major changes of multiple dimensions that are causing great uncertainty and unpredictability. Chinese President Xi Jinping also stated, we are now in a period of “massive change unseen in the last millennium.”

For many foreign multinational corporations (MNCs) operating in China, the expectation is that the upside potential of the Chinese market will keep growing and China being a global supply base will become even more important. The 2021 survey by the American Chamber of Commerce in China (AmCham China) shows that 75 percent of companies are optimistic about market growth and economic recovery in the next two years. Moreover, 61 percent of companies view China as a priority investment destination and are confident that China will further open itself to foreign investment.

Many MNCs are trying to figure out what the latest policy announcements, such as the 14th Five-Year Plan and Vision 2035, really mean.

The 14th Five-Year Plan put its emphasis on the quality of development, implying that innovation and technological independence are to be treated as critical areas. The Trump administration’s restraints on exports of certain core technology products such as high-end semiconductor chips to China has triggered China’s resolve to pursue technological self-reliance. Advanced manufacturing is to be used to fix issues in areas such as key components, materials, software and fundamental systems to develop more innovative and competitive value chains with a higher “value-added”content in priority areas.

Peter Wennink, head of ASML, a leading manufacturer of chip-making equipment in the semiconductor industry, told POLITICO in an interview that Europe should not close off exports to China like the U.S. since “If you shut out the Chinese with export control measures, you’ll force them to strive toward tech sovereignty, in their case real tech sovereignty, in 15 years’ time they’ll be able to do it all by themselves, the market [for European suppliers] will be gone.”

The 14th Five-Year Plan proposes a “dual circulation” economic strategy, to push both the domestic market, as well as overseas markets, with progress in the two complementing each other. Acceleration of growth in domestic production, distribution and consumption will be the driving force, spurring technological innovation, expansion of domestic supply chains and at the same time, helping to cement China’s role in the global value chain.

The Vision 2035 lays out the social and economic development goals over the next 15 years with the target being to build a modernized economy by 2035. Continued promotion of urbanization and further strengthening of regional trade with ASEAN countries, Belt and Road Initiative participants, as well as other economies are the other principal features.

China is seeking a quicker evolution of its role in the global geopolitical environment. China’s relationships with the U.S., EU and neighboring countries are viewed as the key to the shifting geopolitical equations.

One major milestone has been the Foreign Investment Law promulgated in March 2019, which puts foreign enterprises at par with domestic companies in many ways. Another landmark reform was the Unreliable Entity List (September 2020) that protects legitimate rights and interests of all kinds of market entities. Additionally, the National Negative List has pruned the number of restrictive measures by 17.5 percent compared to its 2019 version.

These are clear signals of how China is trying to make life easier for foreign companies. Volkswagen CEO Herbert Diess told China Daily, “For me, it is easier to invest in China than China is allowed to invest in Germany or some other places.”

China is accelerating deregulation and its domestic market is expanding. Supportive policies and the growing ingenuity of local enterprises are together generating what’s possibly the world’s most competitive economy. The dynamics of competition and collaboration are highly intensive and are expected to impact growth significantly, going forward.

Though the U.S. has imposed sanctions on Huawei, ZTE and some other Chinese tech companies citing “national security”, so far, China has not sanctioned U.S. or other western tech companies in a similar manner. In July 2020, President Xi Jinping wrote to CEOs of 18 global MNCs underscoring China’s desire to welcome foreign MNCs to stay and continue to operate in China.

For global MNCs, this changing context raises a whole new set of questions and considerations:

– What explicit and salient changes are taking place in terms of market access for specific industry sectors?

– What does the evolving geopolitics mean to MNCs in China? For example, to what extent would “decoupling”take place and how?

– What are China’s “red lines” (that is, boundaries that foreign companies should not trespass)?

– How would new trade agreements such as the Regional Comprehensive Economic Partnership (RCEP) and the Comprehensive Agreement on Investment (CAI) shift the composition of the Chinese market, particularly as a hub of supply chains?

– What does “self-sufficiency in technology” mean for foreign MNCs operating in China?

– How would data sovereignty issues be addressed?

– What are the possible scenarios of the future and how should companies interpret the likely scenarios for strategic business decisions?

– Is the changing landscape likely to impact footprints of MNCs in China and their global supply chains?

– Against the evolving strategic context, how should global MNCs re-define corporate structures in China and whether they need to redefine relationships with other companies and organizations?

In many cases, organizational structure and corporate relationships were built decades ago. As the landscape and the goalposts change, these dimensions too may have to change.

Many MNCs believe China’s role in the world will continue to expand and yet externalities such as geopolitics and policy promulgations give rise to questions that need to be addressed. Company strategists need to envision and draw plausible scenarios to make tangible business decisions. However, the knowledge and information disconnect between the global headquarters and the China team of MNCs are often significant.

Foreign MNCs clearly need to ask themselves if and how they should continue to invest more in China, navigating through the path the most recent changes are likely to lead to. In the extreme case, those who don’t see a future in China need to figure out how to cash out and that can be a very tough decision to make.

Companies need to be much more sophisticated and nuanced in sorting out these questions, guarding against risks and keeping growth options open. China is not simply a market or a global supply base. It is fast becoming a platform where the best strategic thinking is being developed and institutionalized. Companies operating in China can now find and acquire global competitive advantages.

China’s Importance to Multinationals Means They Must Approach It With Greater Nuance

By Edward Tse

2021-05-05

Originally published on Caixin Global on May 5, 2021.

Many multinational corporations (MNCs) have China at the top their minds these days. China has become an important, if not the most important, market for many MNCs.

Then there are those who are just entering China or have recently expanded their operations in China. These companies are trying to figure out ways to capture the upside of the China market. And of course, some who have been affected by geopolitical issues like Xinjiang cotton are pondering over what to do next.

China’s economy is not stagnant and continues to evolve. GDP grew 2.3% in 2020 despite the pandemic and was up an incredible 18.3% in the first quarter this year, indicating a strong recovery. GDP growth for the whole of 2021 is expected to be 6%. FDI inflows in 2020 at $163 billion was the highest in the world and external trade continues to be vibrant. Two-way trade with the U.S. shot up to $659.5 billion and that with the EU was $710 billion in 2020.

A recent study by the American Chamber of Commerce has shown that 70% of US companies are planning further investments in China, and according to the “Business Confidence Survey” released by the German Chamber of Commerce, 72% of respondents are planning further investments in China.

Despite the antagonism during the Trump era, China has continued to tread the reform path and expand market access to foreign companies.

One example is opening of the previously rather restricted financial services sector. BlackRock is to set up a wholly-owned asset management business in China and in January, PayPal became the first third-party payment platform with 100% foreign ownership in China.

Foreign automakers are no longer required to form joint ventures with local companies. Tesla has its Gigafactory in Shanghai and Volkswagen has raised its stake in its joint venture with local automaker JAC to 75%.

A major reform milestone was the Foreign Investment Law promulgated in March 2019 which puts foreign enterprises at par with domestic counterparts in many ways. Another landmark piece of reform was the Unreliable Entity List announced in September 2020 to protect legitimate rights and interests of all kinds of market entities. Besides, the National Negative List has pruned the number of restrictive measures by 17.5% compared to its 2019 version. These are clear signals of how China is trying to reduce barriers to foreign companies.

The new 14th Five-Year Plan stipulates that quality of development will be a top priority for China through 2025, making innovation and technological independence even more critical. Advanced manufacturing shall be used to fix issues in areas such as key components, materials, software, and fundamental systems while developing a more innovative and competitive value chain with a higher “value-added” content in priority areas. External and internal components are expected to complement each other.

In addition, Vision 2035 lays out social and economic development goals for the next 15 years, the target being to build a modernized economy by 2035. Continued promotion of urbanization and further strengthening of regional trade and investment partnerships with ASEAN, Belt and Road participants, as well as other economies are the other principal features.

China’s goal to achieve carbon neutrality by 2060 is massive, ambitious and challenging. It will require close collaboration with many stakeholders.

While a range of new business models have already emerged in China during the pandemic. The above major initiatives will inevitably create many more major opportunities across the board and for some, potential risks.

China is accelerating deregulation and its market is expanding. The right government policies and the growing ingenuity of local enterprises are together generating what’s possibly the world’s most competitive economy. The dynamics of competition and collaboration is highly intensive in China and is expected to stay intensive going forward.

As innovation continues to progress rapidly, the ability of foreign MNCs to participate in China’s innovation game is both an opportunity and a challenge. Opportunity — because innovation implies new sources of value creation. Challenge — because others too will innovate. MNCs who were earlier into copying products from home and pasting them in Chinese markets are now trying to tailor products for the Chinese customer. They are learning from China and are innovating in and for China.

It’s been a cliché to say that the great majority of foreign MNCs cannot ignore China. It is even truer these days because of China’s vital importance in MNCs’ global value chains as both a market and a supply base, besides a source of inspiration for knowledge and ideas.

Going forward, China’s major initiatives are providing more opportunities for businesses local and foreign. However, to capture the upside, MNCs need to approach China in a much more sophisticated manner, knowing where and how the risks will manifest and how they can be handled.

One source of risk is geopolitics which have seeped into all walks of life. The recent imbroglio about Xinjiang cotton suggests that MNCs need to understand that like many other markets, there are some “red lines” in the Chinese market too and these have to be carefully taken into account when making decisions. CEOs need to have greater clarity of thought for effective strategic decision-making.

Companies need to communicate with their target consumers in a manner aligned with the evolving consumer needs and technological changes. A digital mindset and approach can be very critical when determining the winners. Brand winners in China will increasingly be those that can tick as many of the relevant success factor boxes as possible, whilst not crossing the Chinese consumers’ red lines. It is a function of a (foreign) company’s understanding of and capabilities in the China context.

Geopolitics would impact how the future interplay between globalization and deglobalization would evolve and the role of China in this interplay. It will in turn impact issues such as global governance, technology, data sovereignty and local requirements. These issues and people’s needs embody implications for strategic plans for MNCs’ operations in China or for that matter their global strategies with China at the core.

MNCs need to develop different ways of capturing China’s upside while responding to different risks and they must always know where the red line is. The right strategic evaluation of plans and actions is mandatory for all multinational companies who aspire to stay relevant in the global ballgame. China offers MNCs lots of upside but approaching China will also require more sophistication.

By Edward Tse

2021-04-09

Originally published by Caixin Global on April 9, 2021.

The recent row over Xinjiang cotton has caused much debate and discussion on whether this controversy constitutes an opportunity for local Chinese brands in apparel and sportswear to capitalize on the situation as Chinese consumers boycott foreign brands like H&M, Nike and others.

Some observers suggested that Chinese consumers are shunning foreign brands due to nationalistic inclinations, and so local brands now have the upper hand.

Some say foreign brands don’t have a chance in China anymore. They should get out soon. So, do foreign brands have a future in China?

In apparel and sportswear, as in other consumer product categories, competition in China has been fierce for some time with a wide range of foreign and local brands fighting it out in arguably the world’s most competitive and fastest growing market.

For a long time, foreign brands have led in this competition, especially major players such as Nike and Adidas. However, local brands are catching up over the years, narrowing the gap between the two groups. The recent Xinjiang cotton episode has given these local brands a further boost. For example, Li Ning’s share price on the Hong Kong Stock Exchange surged about 10% on March 25th, while Anta’s rose about 7.8%.

According to the latest financial report, Anta earned a net profit of $794 million in 2020, surpassing Adidas’ net profit of $504 million for the first time.

The cotton episode has certainly given local brands a chance to increase their market share at the expense of foreign brands. But, what’s the real interplay between local and global brands in China? To understand this, we should also look at some other sectors.

In the auto sector, foreign brands, particularly leading German and Japanese brands have traditionally dominated the premium segment. More recently, American brands such as Cadillac and Lincoln have also expanded their presence in this segment.

On the other hand, local brands dominate in the mid-to-lower tier segments, but some foreign brands are also active.

In the electric vehicles sector, U.S. brand Tesla is the front runner, with the Chinese “new force” brands such as Nio, Xpeng, Li Auto and others all trying to get a piece of the action.

At the same time, incumbent OEMs, whether foreign or local, are also offering electric vehicles while other players such as internet giants Xiaomi and Baidu, mobility player Didi Chuxing, contract manufacturer Foxconn, and real estate developer Evergrande have all entered the race.

The EV market is sure to become ultra-competitive and, so far there is no clear winner in the auto-and-mobility sector.

In smartphones, local brands Xiaomi, Oppo and Vivo are the market share leaders. Huawei, severely hit by U.S. sanctions on its chips supply, remains popular among Chinese consumers despite an appreciable drop in its market share. And Apple is still popular among Chinese consumers especially at the top end of the market.

In the cosmetics sector, Western brands such as Guerlain, Chanel, and Lancome have dominated the premium and luxury segments for years, accounting for about 50% of the total cosmetics market. Japanese brands such as Shiseido and Korean brands such as Sulwhasoo and Whoo are also quite popular in the middle segment. In the mid-to-lower tier segments, local brands, including Pechoin, Perfect Diary, and Herborist have registered huge growth in recent years. According to a joint report issued by Tencent and Kantar released in May 2019, local cosmetics products accounted for 56% of the market in the mid-to-lower tier segments.

In the appliances sector, Chinese brands now dominate the market. Leading brands include Midea, Gree and Haier, all local. However, foreign brand Dyson has carved its own niche position given its innovative image and great reputation in China.

There’s no question that the quality and quantity of Chinese brands have taken large strides over the years. Incumbent players in general have become more competitive, while new players have emerged all over, with some dropping out along the way but some growing into major competitors in their own right. They have increasingly shed the image of being of low quality and cheap, and have built their respective brand positions.

Surveys such as the Prophet Brand Relevance Index have shown that over the years there has been a marked shift in consumer preference for local brands over global brands. In the 2019 Prophet Brand Relevance Index, seven of the top 10 relevant brands are local whereas a decade ago, the top 10 would have been predominantly, if not entirely, foreign brands.

Chinese consumers are also evolving. As their incomes increase, they are becoming more health, lifestyle and quality conscious, especially those who reside in upper-tier cities. They have also become more confident and more knowledgeable across the board as access to the world has become easier.

For brands to connect with their target consumers, their go-to-market techniques are also becoming increasingly more critical as Chinese consumers are becoming more digital savvy. Social commerce, for instance, has become an important way to connect.

To this end, Chinese brands are often leading the trend as these brand operators are often closer to the dynamism of Chinese consumers. Foreign brands, on the other hand, typically tend to play catch-up.

Pundits have long asserted that nationalism plays a significant role in Chinese consumers’ brand preferences. There is possibly some truth in that, but to assume that it is the only, or the predominant factor affecting the choice of brands is overly simplistic. However, this has often been used by failing foreign brand managers as an excuse for losing out to local brands.

The impact of the Xinjiang cotton episode will likely evolve over time in a manner similar to that of the NBA episode in 2019. (Chinese NBA fans reacted strongly to the then Houston Rockets General Manager Daryl Morey’s tweet on Hong Kong’s politics and China’s CCTV suspended broadcasts of NBA games which returned to the Chinese TV screens only after about 15 months). However, incidents of this kind simply highlight the fact that there are “red lines” in the Chinese market (as in many other markets) that companies need to fully understand and carefully take into account in their decision-making process.

Company executives understand the importance of “putting the customers first,” a basic tenet to doing business. As geopolitics have seeped into all business sectors these days, CEOs need to have sharper clarity of thought in the process of strategic decision-making. Any compromise with the basic tenet must be made in face of clear tradeoffs between its pros and cons.

So, we must to go back to the basics of business. Brands who will win in China are those who understand the quickly evolving consumer needs, can anticipate and properly interpret Chinese government’s policies, and how technology’s evolution would impact both the demand side and the supply side of the picture.

Importantly, companies need to better understand how to communicate with their target consumers in a manner that is commensurate with the evolving consumer needs and technological changes. A digital mindset and approach are increasingly critical in determining the winners. Foreign companies which are structurally behind the local companies in this regard must figure out an approach that is closer to the real happenings in the market to prevent themselves from losing out on this.

In the end, brands winning in China will increasingly be those that can tick as many of the relevant boxes in key factors of success as possible while making sure not to cross the Chinese consumers’ red lines. It is a function of the company’s capabilities in the China context, where its leadership plays a major role. Ultimately, whether your brand is foreign or local is probably not the most important factor.

What Lessons Can Foreign Companies Learn from Xinjiang Cotton Episode?

By Edward Tse and Gao Yanping

2020-04-01

A recent article authored by Dr. Tse was published by CGTN on April 1, 2021. It was co-authored with Gao Yanping.

Editor’s note: Edward Tse is the founder and CEO of Gao Feng Advisory Company, and Gao Yanping is a researcher and a former senior editor of Guancha.cn and a business journalist at Oriental Outlook and Xinhua News Agency.The article reflects the author’s opinions and not necessarily the views of CGTN.

Several multinational retail brands including H&M, Nike, Adidas, Gap, New Balance, Burberry and Uniqlo are being criticized by Chinese consumers over their stance on alleged “forced labor” in China’s Xinjiang Uygur Autonomous Region.

These companies have launched statements on their position on Xinjiang’s affairs and would not use Xinjiang’s cotton in their products. The statements were based on a report released by the Better Cotton Initiative (BCI), a non-governmental organization that claims to promote better standards in cotton farming and practices across 21 countries.

This series of events enraged Chinese netizens who have called for boycotts of these brands. Chinese business partners of the brands have moved quickly to cut ties with them. From popular Chinese celebrities who have called off their endorsement deals to shopping malls taking down H&M’s billboards, to online shopping giants dropping H&M products, to mobile phone app stores removing H&M apps, Chinese responses have been overwhelming. Chinese netizens’ reaction has been contagious on social media. On Weibo, one of China’s most popular social media platforms, the hashtag “I support Xinjiang cotton” has been the top trending topic on Weibo with more than 7.11 billion hits by March 30.

Unlike Apple which removed a police-tracking app during Hong Kong’s protests last year and admitted “the app violated its rules,” these retail companies seem to be indifferent to the public mood so far. H&M released a statement saying that it “respects Chinese consumers as always” and that it “does not represent any political position.”

It’s very clear that today, geopolitics has seeped into businesses big time. Geopolitics has always been a major role historically in some industries like oil and gas where the location and quality of resources are intricately tied to the national sovereignty of countries.

But since the former Donald Trump administration exercised American foreign policy especially on China, geopolitics has become the center stage for many businesses.

Tech companies like Huawei and ZTE were sanctioned by the U.S. government on national security grounds. Chinese tech companies includin the likes of SenseTime and DJI were placed on the “Entity List” of the U.S. government as the U.S. believes they pose a national threat. Companies on the “Entity List” are subject to U.S. restrictions in the export and transfer of certain sensitive technologies.

But it’s not only tech companies that are affected by geopolitics. The argument over “forced labor” on Xinjiang cotton-picking shows that industries such as apparel and sportswear can also be sucked into such a swirl.

In a way, this is unfortunate because it does not need to be so complicated but external forces seem to be driving businesses in that direction and it seems like geopolitics has become a part of normal strategic decision-making for company executives. No longer can company executives only focus on business operations per se, they also need to incorporate institutional capabilities to address issues that go beyond day-to-day business operations.

Company executives should exercise common-sense judgment before they make decisions that could have serious implications. In this case, a simple check on the level of mechanization of cotton harvesting in Xinjiang would cause the CEO of any large multinational company to double-check if the alleged “forced labor” in Xinjiang is true.

According to the Department of Agriculture and Rural Affairs of Xinjiang Uygur Autonomous Region, more than 90 percent of cotton picking in northern Xinjiang is highly mechanized, while southern Xinjiang has raised its mechanization rate to around 40 percent, resulting in an overall mechanization rate of over 75 percent. Paradoxically, BCI’s Shanghai office has issued a statement saying that after careful audits, they did not find any use of forced labor in cotton picking in Xinjiang, a position that is contradictory to that of BCI headquarters.

Beyond cotton picking, the claim that “forced labor” is used in Xinjiang is controversial and for many, has not been substantiated. While there are plenty of allegations, there are also plenty who have pointed out that the claims are not substantiated, with the alleged evidence unfounded or manipulated.

Foreign companies’ CEOs need to think carefully about the implications of their actions. What reactions would be generated among the Chinese consumers? How would the competitive landscape shift in particular in favor of the local brands, whose competitiveness has been improving anyway? What would be the financial implications to the company because of the action taken, not only within the China market, but also outside?

Companies’ CEOs like to say, “We always put our customers first.” However, the Xinjiang cotton episode has shown that many CEOs don’t necessarily abide by that rule with respect to Chinese consumers – arguably one of the most important consumer groups in the world. At least the business leaders haven’t shown they have explicitly and carefully gone through a thought process of making sure they understand the full implications of what they do.

We are not advocating that foreign companies must kowtow to China because of the financial implications to their businesses. We are suggesting that companies’ CEOs should have clarity in their thought processes in matters of such critical importance and to always keep the basic value of any business, which is to put its customer value as a top priority, in mind. Any compromise of that basic tenet must be weighed carefully against the trading off between its pros and cons.

By Edward Tse

2021-03-13

Gao Feng Advisory’s CEO, Dr. Edward Tse’s latest op-ed on CGTN on Hong Kong. He pointed out that there are actually two Hong Kong’s- an “Elite HK” and a “Mass HK.” And there is little trickling down from top to bottom. HK needs to address these deep-rooted issues. It will take some time and won’t be easy but with boldness, skills and commitment, Hong Kong can do it!

Editor’s note: Edward Tse is the founder and CEO of Gao Feng Advisory Company, a global strategy and management consulting firm with roots in Greater China. He was born and raised in Hong Kong and lives in the HKSAR. The article reflects the author’s opinions and not necessarily the views of CGTN.

With the enactment of the national security law in June 2020, the situation in Hong Kong is finally stabilizing and slowly returning to order. The riots and unlawful protests that have prevailed for over 12 months created major havoc to the entire Hong Kong community.

On March 11, China’s National People’s Congress approved the decision to improve Hong Kong’s electoral system, enforcing the notion of “patriots governing Hong Kong” which will in turn ensure the long-term viability of “One Country, Two Systems.” These changes were needed as radical politics in the past had severely hindered the operations of Hong Kong’s legislative process, causing for some time an almost “ungovernable” situation.

What’s the root cause of Hong Kong’s demise?

Wendy Hong, head of research of a large Hong Kong conglomerate group, pointed out that Hong Kong actually consists of “two Hong Kongs.” I agree with her assessment.

For a long time even before the handover, Hong Kong has suffered high levels of income inequality. This situation has become worse over time, resulting in two different Hong Kongs.

One Hong Kong – let’s call it “Elite Hong Kong” – is where Hong Kong’s businesses and professionals ruled. They are mostly in financial services, property development and high-end services sectors. They roam in Central, Admiralty and West Kowloon. With Hong Kong’s strong position as a regional financial hub, people and businesses engaging in this Hong Kong were doing very well financially. In fact, many of these people are recent returnees of highly educated people from the Chinese mainland or expatriates.

The other Hong Kong – let’s call it “Mass Hong Kong” – is where most Hong Kongers are and they are prevalent in sectors such as retail, food, construction, low-end services and others. The living standard of people in “Mass Hong Kong” has not improved much over the last couple of decades, while the general housing prices in Hong Kong have risen significantly in the meantime – thanks to a large part to the “Elite Hong Kong.” Many people in this Hong Kong live in poorly-conditioned sub-divided flats and many young people were disillusioned about their future.

There is little “trickling down” from “Elite Hong Kong.” People in “Mass Hong Kong” feel that they have been left behind. Most of them are local Hong Kongers or descendants of recent “single entry permit” immigrants from the Chinese mainland. When they saw people in “Elite Hong Kong” or even well-off visitors from the Chinese mainland buying high-end properties in Hong Kong, they placed their anger on anything and everything that was “mainland” or what they viewed as vested interest groups.

While the Chinese mainland has lifted 98.99 million poor rural residents out of poverty over the past eight years, Hong Kong has a poverty population of close to 1.5 million as of 2019, according to the Hong Kong Poverty Situation Report, in a city of population that is less than eight million.

There are a number of reasons for this.

Since the mainland’s opening up over 40 years ago, Hong Kong’s manufacturing has been hollowed out. Even though most of Hong Kong’s manufacturing back then wasn’t really sophisticated, it was a key source of employment for local people. Since then, many people were deprived of decent-quality job opportunities.

The land supply has chronically been limited to both real and man-made reasons. It has been a major reason why the housing prices have gone up so rapidly over the last several decades. Also, the small percentage of people in “Elite Hong Kong” who were able to afford the top-end Hong Kong properties was viewed as villains by many Hong Kongers who saw that home ownership is increasingly out of their reach.

Hong Kong’s government has a long-held approach of non-intervention, believing that market forces by themselves can sort everything out. This is a legacy left behind from the British colonial days and the administrative officers of the Hong Kong SAR government simply inherited that approach without seriously reflecting on the effectiveness of it as the general context evolved.

With the national security law now in place and the integration of the Greater Bay Area underway, we now have the opportunity to address these fundamental issues.

1. The Hong Kong government should be much bolder in creating new sources of land supply through “combined punches:” revitalization of “brown land,” including allocating a very small percentage of the most fringe areas in the parks for housing and a reasonable amount of reclamation in appropriate locations.

2. Hong Kong should leverage the Greater Bay Area which offers much more capacity in technology innovation and supply cluster bases. A lot has been written about this plan already and much of the focus will be on how Hong Kong should participate in the area’s technology and innovation development, leveraging especially Hong Kong’s capacity in universities and other higher institutions in research and development.

3. Hong Kong needs to cultivate new growth through what Wendy Hong calls “Industry 2.5.” Capitalizing on the strengths of Hong Kong’s services industries, “Industry 2.5” transforms the services industries by combining them with manufacturing-based industries, with areas such as luxury fashion, medical devices and aircraft parts services prime for the development of Hong Kong. The process will allow greater industrialization and diversification in Hong Kong’s economy, create more varied investment options and provide fresh employment opportunities.

4. Hong Kong should build investment funds investing in companies of various sizes. Hong Kong can undertake some of these funds by itself and some in collaboration with other cities in the Greater Bay Area. In fact, Shenzhen, for example, has been leveraging their own funds to nurture a large number of tech companies over the last several decades, transforming the city into a leading tech hub. By investing into portfolio companies, these companies can also be a source of innovation and “re-manufacturing” to Hong Kong and a source of employment for Hong Kong people.

5. Hong Kong should find a much better way to balance the interests between the big businesses and the masses. An extreme form of capitalism has been manifesting in Hong Kong for a long time, causing a structurally close relationship between certain big businesses and the local government. This imbalance is the root cause of many of Hong Kong’s deep-rooted issues and it should be rectified.

The incredible economic growth of the Chinese mainland over the last several decades was epitomized by how the government and businesses, big and small, state-owned and non-state-owned, synchronize in a rather sophisticated manner. The Hong Kong SAR government should learn from it about what works and evolve itself into an appropriate strategic position that will make the entire Hong Kong work.

From chaos to order, it’s now time to close the divide between the “two Hong Kongs.”

By Edward Tse

February 16, 2021

Originally published by Caixin Global on February 16, 2021.

Significant and fundamental changes are happening in the business sphere in China. Instead of leaving China as some asserted at the peak of the pandemic in China last year, multination corporations (MNCs) are doubling down in China. In fact, China’s foreign direct investment in 2020 rose by 4%, while in the U.S., it declined 49%, making 2020 the first year China has overtaken the U.S. as the top foreign investment destination.

Recent data from MNCs in China echoes similar sentiments. The American Chamber of Commerce in South China’s 2021 studies showed that over 70% of US companies surveyed have budgeted to reinvest and expand their businesses and market share in China this year. In the “Business Confidence Survey” released this month by the German Chamber of Commerce in China, 72% of respondents are also planning further investments in China.

Despite the pressure applied throughout the Trump era from the U.S. causing major antagonism towards China, China has continued on a path to reform and open up market access to foreign companies. For example, China has started to open up the previously rather restricted financial services sector.

BlackRock has approval to set up a wholly-owned asset management business in China and earlier this month, PayPal became the first third-party payment platform with 100% foreign ownership in China.

China has also abandoned the policy requiring foreign automakers to form 50-50 joint ventures with local companies. Tesla quickly took advantage of this change and built its state-of-the-art “gigafactory” in Shanghai, while Volkswagen raised its stake in its joint venture with local partner JAC Motors to 75%.

With China accelerating deregulation, the size of its market coupled with the government policies and the ingenuity of local enterprises are generating what’s possibly the world’s most competitive sectors at this moment. MNCs have largely awakened to the fact that China is innovative and for them to compete effectively, they will need to learn from China and create the best innovative approach for the China market.

For example, when the Chinese government push for new energy vehicles, Tesla is just one competitor, other Chinese players such as Nio, Xpeng, and BYD are also active in the same space.

Furthermore, connectivity and autonomous driving technologies are all being incorporated into vehicles, requiring automakers to consistently and continuously to innovate. In order to remain competitive, large incumbent foreign automakers are trying to innovate, but also adopt China-specific products and service models. Herbert Diess, CEO of Volkswagen, recently said “China is a huge opportunity. China is also technologically advancing fast.”

In the consumer sector, local companies are also challenging the fast-moving consumer goods giants like Procter and Gamble, Unilever and L’Oreal with innovations in areas such as social commerce. The use of key opinion leaders (KOLs) has revolutionized the entire shopping experience by creating powerful social interactions with consumers through popular apps including Douyin (the Chinese version of TikTok), Billibilli and Kuaishou. Chinese beauty brand Perfect Diary has mastered the use of KOLs, activating the entire spectrum of KOLs (celebrity, top-tier, mid-tier, micro and key opinion consumers). From January 2019 to September 2020, Perfect Diary was the only color cosmetics brand on leading Chinese e-commerce platform Tmall, to achieve over 100 million yuan ($15.4 million) in monthly sales.

MNCs are increasingly finding that innovations developed in China have further potential in other parts of the world. When Panasonic developed a sterilization function for their washing machines specifically targeted for Chinese consumers, the same function was adapted to refrigerators for Japan’s consumers. Many Western retailers are now actively studying the omni-channel constructs and fulfillment models of local e-commerce pioneers like Taobao and JD.com.

The China head of a large U.S. industrial company once told me he thought he came to China to teach but after some time, he recognized he was in China to learn. Another large U.S. client told me their board of directors instructed the China team to seek how to leverage the China knowledge to help businesses in other parts of the world. BMW has taken its Munich-based Startup Garage program to China in order to gain exposure to new innovative technologies, such as electrification and automation, from a more advanced local ecosystem.

These latest views indicate a material change in the MNCs’ perspective on China. China isn’t just about a source of hard power (market size, profit and supply chain), it’s also becoming a source of soft power (innovation, knowledge and inspiration). This is due to China’s innate capabilities built by rigorous experimentations via the country’s governance approach — a combination of efficient top down planning by the central government alongside an incredibly dynamic entrepreneur class. Local governments help provide the glue between these two as they implement the central government’s policies while supporting businesses to grow.

MNCs and their lobbyists have long complained about problems with operating in China, e.g., intellectual property theft, lack of market access, unfair competition and lack of transparency. While perhaps some of these might indeed be — or have been — problems, in the larger scheme of things, they are no longer the defining factors.

MNCs are now coming to realize this fundamental shift, that China’s growth and resilience have been driven largely by an internally-driven momentum and governance approach, aided by its connectivity with the rest of the world through international trade. MNCs can benefit by being a part of the game and strengthening their own overall competitive advantages, or end up being marginalized if they choose not to participate.

So, what does this mean to the new U.S. administration team? By now, people should realize that some form of collaboration while competing with China would generate the best return. The big question is how.

I believe the key is to accept that China has gone through rounds of material changes over the last several decades. The new reality renders the assertions of the “coming collapse of China” and the “Thucydides Trap” not helpful as policy guidelines. The Joe Biden team should also get out of the aggressor mentality and the blame or mockery mindset that have plagued many U.S. policymakers and influencers over the past four years. Instead, a better approach would be to develop an objective view and a deeper understanding of why China works, or doesn’t, and learn from the Chinese experiences, not simply brush aside everything that China has done due to ideological differences.

The U.S. shouldn’t just follow the old game book. It needs to find a new game, but that new game should probably start from within.