Dragon Tactics: How Chinese Entrepreneurs Thrive in Uncertainty

PART 1

THE NEED FOR UNDERSTANDING DRAGON TACTICS

1

WHY IN CHINA, DO SOME FAIL AND OTHERS SUCCEED?

1. WHY IN CHINA,

DO SOME FAIL AND OTHERS SUCCEED?

1.1 FAILURE TO ADAPT, THE BASIS FOR FAILURE

Carrefour was not the only enterprise admitting defeat in China in 2019. Arguably an even higher profile casualty was Amazon.

April 2019: Amazon announces it will stop operating its China domestic marketplace.

Amazon’s leadership role within the e-commerce industry is indisputable. Without any doubt, its global success can be attributed to the vision of its founder, its relentless drive as an innovator, and the speed at which the company has been evolving since its infancy.

And yet while highly innovative and successful in many parts of the world, Amazon was forced to admit they were not good enough to achieve success in China. Twice!

To the surprise of many, in March 2015, Amazon announced the soft launch of a virtual storefront on Alibaba Group’s Tmall.com online platform, its fiercest rival in the domestic China market.¹

‘Amazon.com vies with Tmall for China’s online consumers through its own shopping website and has invested in warehouses and logistics to deliver orders to mainland customers. By opening a flagship store on Tmall, China’s largest B2C shopping site, Amazon seeks to develop new sales channels, offering Tmall consumers a variety of premium imported brands and a quality life backed by Amazon.

‘Through Tmall and sister C2C shopping website Taobao Marketplace, Amazon is tapping into Alibaba’s e-commerce ecosystem, which has some 334 million active buyers’, said Niu Yinghua, vice president of Amazon China, in a statement at the time.

Amazon opened a store within the infrastructure of their main competitor in a bid to reach a larger audience and to boost sales! Many saw this unusual move as admitting to not being able to compete. And those critics were right, as indeed that is how the story ended.

Four years later, in April 2019, Amazon announced it would stop operating its China domestic marketplace altogether:²

‘We are notifying sellers we will no longer operate a marketplace on Amazon.cn and we will no longer be providing seller services on Amazon.cn effective July 18.

‘Instead of buying products sold locally by Amazon and its marketplace of Chinese suppliers, shoppers at Amazon.cn will be able to buy products imported by Amazon’s sites in the United States, Britain, Germany or Japan’, Amazon said in a statement.

Having enjoyed a 15% market share in China in 2011³, the US tech giant’s stake had fallen to less than 1% in eight years, leaving it in sixth place in the world’s largest e-commerce market by the time it closed its domestic store.

Although it is not unusual to see Western tech companies struggle in the Middle Kingdom, Chinese consumers don’t blindly prefer local brands, and foreign businesses do certainly not automatically fail. So how did Amazon get to this stage?

A foundation for success was there early on…

Amazon gained an early entry and foothold into China in 2004 by acquiring local online book e-tailer, Joyo.com. At that time, restrictions for foreign internet companies were still somewhat few. Also, in those early days Amazon had a positive reputation for being a site that had legitimate products and so was trusted by Chinese consumers.

In all, they had a seemingly good basis for success, yet Amazon struggled from the beginning to compete for reasons that are all too familiar to us.

Amazon did indeed face a more competitive and ambiguous legal environment than in many other markets where it is active. For example, prior to 2008 when China entered the WTO, it was legally unclear whether Amazon, as a foreign enterprise was allowed to operate there. It also had to engage in endless price wars that ate into profits and was in a constant battle against knockoffs.

But Amazon did not adapt fast enough.

The US tech giant faced broadly published criticism for failing to modify its online offer to the needs and desires of Chinese consumers and was rapidly outcompeted by local rivals with a better in-depth understanding of how to be successful.

It is often believed that Chinese e-commerce companies copied the operation model of their Western competitors. That was probably true early on, but these companies did not win because they were copycats. They were willing to make significant efforts to deliver a product or service that often far exceeded what Western internet players offered and to rapidly adapt to evolving customer needs.

Pony Ma, the founder of Tencent, one of the largest Internet and technology enterprises globally and the company that among others invented the universal app WeChat, confirmed that view in a 2017 interview.⁴

‘As computer applications and the internet were invented in the USA, other countries had no other choice initially than to copy. However, here in China the situation and consumers are different, so it was only natural that we quickly launched our own development. And as we work a lot faster in China, we now even see Western players starting to copy many of our features.’

Global HQ and system hampered local success.

Restricted by a global platform that prevented significant improvements to its local user interface, Amazon unsuccessfully competed with the websites of local competitors which were very different. For example, local players had additional product offerings enabling cross-selling opportunities and were a lot more colourful, very unlike the simple, minimalist design Amazon uses around the world.

Most critically, they contained a lot more and often very detailed product information, mostly presented in pictures. This enabled customers to see every detail of the product, a crucial enabler of success. Since they cannot physically touch the product, this more in-depth product understanding is very important for Chinese customers and plays a vital role in driving purchase decisions.

Amazon also didn’t adapt well to the unique Chinese market requirement of near instant delivery. It initially controlled much of its own inventory and built its own delivery infrastructure, just like they did elsewhere. In contrast, Alibaba chose to focus on being a platform, hosting a variety of smaller vendors and using local delivery companies, enabling lower prices and faster delivery routes. Over time this approach helped Alibaba outperform Amazon.

Other local players that more closely followed Amazon’s model, like JD.com, invested more heavily in their logistics and also outcompeted the American company on delivery service. Rather surprising, given that logistics is at the core of Amazon’s global capabilities.

Amazon was not in tune with what consumers needed.

It is well documented how Alibaba gained a massive advantage due to the success of their own payment system, Alipay. While it can be understood that Amazon was not able to rapidly match such a payment system, it is surprising that Chinese competitors were able to offer their customers still more options to pay. For example, for a long time Amazon did not support a straightforward payment upon delivery service, a crucial ‘must have’ in a country where consumers are often worried about being cheated and credit cards were not widely used.

Another important driver of a great customer experience that Amazon missed out on was an online customer chat service. Local competitors provided solutions for customers to ask questions, or to facilitate direct communication between buyers and sellers, making it so much easier for customers to get nearly instant support.

Last but not least, the local players outperformed Amazon with clever marketing and sales festivals. China’s ‘Singles Day’ each year on November 11th transformed the marketing landscape in China and is now even gaining traction globally. On November 11th 2021, it delivered sales (GMV) of over US$ 84Billion in one day for Alibaba alone!

All in all, local Chinese e-commerce players were much more consumer centric than Amazon and understood from day one that when consumers go online, they don’t want to just simply buy a product, but they want a fully satisfactory shopping experience.

To keep the shopping experience exciting, Chinese marketplaces continue to bring new services and have over the last few years included major content marketing features that barely exist on Amazon global, such as livestreaming.

While essentially there is no major difference between the Amazon shopping experience from ten years ago to today, Chinese players have evolved tremendously, keeping up with, or often driving, the latest consumer experience trends.

Speed and need for local understanding were underestimated.

Not that Amazon did not try to adjust, but they underestimated the speed in which its competitors operate. In a, for us, telling quote, this was well understood by its own disillusioned employees, as cited in China Business Journal⁵ after the announcement of the shutdown:

‘Amazon’s Chinese site has already seen a lot of changes, according to one employee, but getting those changes done was difficult and took a long time.

‘That’s unlike China’s other e-commerce companies,’ the person said. ‘In those companies, as soon as the boss requests a new feature, the staff burns the midnight oil until it’s launched.’

And that may point to one other reason why Amazon failed in the Middle Kingdom. It didn’t sufficiently trust the management abilities of local employees. As Richard Liu, founder and CEO of JD.com (a key competitor of Amazon in China), has said on various occasions:

To make it in China you need people in managing positions who know the country, its people and their mentality in and out. When Amazon came to China at the beginning of the 2000s, it put foreigners in leading positions who had no experience with China at all. They implemented American — or generally speaking: Western — business practices which proved to be inferior to that of their Chinese competitors.

The Entrepreneurial company that stopped being entrepreneurial.

So, in the end, Amazon was outcompeted by e-commerce giants like JD and Alibaba, who were often able to offer a broader array of products that came with a lot more relevant and sales-encouraging product information and pictures, that they were able to deliver to Chinese customers faster, with payment options more acceptable to a local audience.

Amazon, an aggressive entrepreneurial firm with many capabilities that has made them a globally feared and insatiable competitor got outmanoeuvred by what we call Dragon Tactics.

To us, both the Amazon and Carrefour developments came less as a surprise. They were simply two more defeats on what was already a long list of businesses that did not make it.

1.2 SUCCESS IN CHINA IS POSSIBLE, PROVIDED YOU CREATE THE RIGHT CIRCUMSTANCES

Many foreign companies that entered China since the country opened up in the late 1980s have failed to become successful. Sadly, the number of failures is much higher than the success stories.

We have compiled a list of often quoted reasons for not achieving business success, arguments given by a variety of business leaders over the years to explain why their business endeavours failed in the Chinese market. We identified two main blocks:

THE ‘GREAT RED WALL’ – whether intentionally organized or not, it is often claimed that the Chinese government and local competitors utilize their power and control and will go to extreme lengths to preserve sovereignty or win market share. To be more specific:

1.EXTREME AND UNFAIR COMPETITION – Competitors offer unfair pricing, copy products, or poach good staff.

2.POOR PROTECTION FOR INNOVATION AND INTELLECTUAL PROPERTY – The legal environment in China is less mature, notably in intellectual property. It is often impossible to protect your business model, product, brand, or user interface.

3.UNCLEAR LEGAL ENVIRONMENT – China’s laws are often vague and not well enforced, leaving a lot of room for interpretation that provides ample opportunity for unfair competition.

4.CENSORSHIP BY THE CHINESE GOVERNMENT – Companies need to abide by the rules of a repressive, autocratic government.

THE ‘CULTURAL DIVIDE’ – There is broad consensus that there are differences in how things are done in China compared to other markets. But from what leaders claim as failure reasons, it is clear they have not understood how to deal with that. Specifically, they state:

1.FAILED LOCAL PARTNERSHIP – Misaligned objectives for entering a business partnership or JV. The foreign company getting a license to operate and aiming to learn how to run the business in China whereas the local partner wants to obtain transferable skills and learn the technology from their foreign partner.

2.LACK OF (LOYAL) CHINESE TALENTS – An endless but unwinnable fight for capable people that move on quickly when they are offered better terms elsewhere.

3.NATIONALISM – Chinese customers prefer local products and solutions.

4.SLOW DECISION-MAKING AND CENTRALIZED ORGANISATIONAL STRUCTURES – Not localizing the China business quickly enough, teams that are too foreign and global management that does not ‘get’ China.

On the surface these arguments are not without merit and have most certainly contributed to the demise of many business endeavours. But when one digs deeper it becomes clear it is not the full story. There is more at play.

For example, Feng Li, a researcher at City University of London, published in 2019 the results of an interesting study held among ex-insiders of various multinational internet firms that failed in China (Why Have All Western Internet Firms (WIFs) Failed in China?).⁶ He concluded that many of the same unsuccessful firms, did succeed in dominating many other foreign markets that have radically different political systems and cultures compared to their home markets (for example Indonesia, Thailand, and Saudi Arabia).

Also, the factors listed above have not stopped other Western multinationals from succeeding in China, notably in car manufacturing, consumer electronics, fast-moving consumer goods, and even sectors where culture plays a key role, such as sportswear, coffee shops, fast food, and even the film industry. And the list goes on.

In fact, there are many interesting cases within various categories that demonstrate that success in China is often related to how these businesses are being managed, how much freedom local management is given to optimize their local business model or product offering and how autonomously they can make decisions. And equally important, how well global management understands China and how truly committed they really are to achieving success in the Chinese market to begin with.

In the following section, we highlight three such cases which demonstrate that with the right approach, foreign companies can be very successful in the Middle Kingdom.

These companies were willing from the beginning to compromise global strategy, positioning, or efficiencies to adapt to local circumstances. They created the capabilities needed to operate in an environment dissimilar to conditions elsewhere.

Each case is unique, but for the sake of comparability, we have summarized the reasons behind each success in four areas:

—‘China for China’ (Strategic deviation from global strategy)

—‘Adapt to consumer needs’ ((Product) offer needed for market success)

—‘Scale, Speed, and Flexibility’ (Capabilities that ensure agility and drive efficiencies)

—‘Maintain Global Strengths’ (Global capabilities providing a competitive advantage)

KENTUCKY FRIED CHICKEN – FINGER LICKIN’ SUCCESS.

Kentucky Fried Chicken (KFC) China is often referred to as the one of the most impressive success stories for a US company abroad. In the early 1990s, after an initially slow learning phase, KFC China positioned itself for the long haul and developed a vision that was radically different from what made them successful in the United States. This strategy not only ensured survival and success in the Chinese market until the present day, it also gave them a lasting competitive edge over various local fast-food players and its key global rival McDonald’s, which, for many years chose to stay close to its global positioning and product line-up. KFC opened their first store in China in 1987. McDonalds followed suit in 1990. And they have taken a very different path since. KFC is still market leader and had 6500 locations in 1300 cities, end 2019. McDonald’s had 3300 locations nationwide. It is easy to argue that fried chicken is closer to the Chinese palate than hamburgers and thus that KFC had a ‘natural’ advantage. But that would not do justice to the visionary and entrepreneurial managers behind the KFC success in China. Adopting a strategic direction that took the Chinese business rapidly away from the global positioning and strategy, the KFC team has consistently delivered on the following:

‘CHINA FOR CHINA’ STRATEGY

—Localized and empowered team, free to pursue its homegrown strategy

—Local vision to ‘make China a better place’

—A brand that is seen as part of the local community

—Localized marketing and celebrity endorsements

ADAPT TO CONSUMER NEEDS

—Inviting restaurant ambience where people like to linger and that encouraged group visits instead of a quick take-out

—Variety of foods and traditional dishes that appeal to Chinese customers rather than selling ‘regular Western fast food’

—A much broader product offer (initially 50 compared to 29 in the US) to ensure repeat visits and to take local and regional tastes into account

—Innovate: often 50 new products a year compared to two or three in the US

SCALE, SPEED, AND FLEXIBILITY

—Penetrating early into smaller cities

•To generate sufficient liquidity to compete against McDonald’s in the big cities and to grow even faster elsewhere

•First mover advantage means getting the best locations and the highest free publicity

•A broader presence also meant a better negotiation position with mall developers

—Deliver a new store from design to opening in half the time vs the home market

—Fully controlled and inhouse logistics network

MAINTAIN RELEVANT GLOBAL STRENGTHS

—KFC kept ‘The System’, its well-developed set of processes which oversees every detail of the business, from making the product, to service standards, to site development, to staff training and management. This turned out to be a major differentiator in overcoming local competition.

After a multiyear sales slowdown and a food quality scandal in 2015, the global KFC Board decided to spin-off their China subsidiary and create a separate stock market listing in 2016. Yum China has since regained significant sales momentum and has set global standards in digitalisation of their business. For details on this see the Yum China case in Part 2, Chapter 5 It All Starts with Data.

Source: Harvard Business Review ⁷

ADIDAS – IMPOSSIBLE WAS NOTHING!

Today, Adidas China is a top market subsidiary for Adidas globally. A business that grew from very humble beginnings, in 1994, out of a living room in Shanghai. Its current success would not have been possible without early strategic decisions that took the brand away from its original roots but that ensured growth in difficult circumstances. Some of these strategic changes ultimately found their way back into the global business vision. An added benefit was that Adidas was able to develop a much stronger competitive position compared to its global rival Nike that still outpaces Adidas in many markets around the world. And it contributed to the brand staying competitive compared to various local players. Adopting a strategic direction that took the Chinese business rapidly away from the global positioning and strategy, the Adidas team delivered on:

‘CHINA FOR CHINA’ STRATEGY

—Localized and empowered team, relatively free to pursue its homegrown strategy

—Verticalized Distribution. Sales via Mono branded stores; self-owned as well as operated by local franchisees

—Pricing at a premium as opposed to ‘for everyone’ globally

—‘Sport’ as brand differentiator, but casual usage as reason to buy

—Brand focused more on ‘winning’ than ‘participation’ globally

—Locally developed marketing campaigns for lifestyle products

—Inhouse production as opposed to ‘fully outsourced’ globally

ADAPT TO CONSUMER NEEDS

—Product quality and materials where possible above global standards

—Basketball as brand and sales driver rather than football globally

—Running category as volume driver. Not because people would run, but because the shoes were high quality and comfortable for everyday use.

—Apparel products also skewed towards casual, everyday usage, e.g. high share of polo shirts

—Significantly larger number of colour options than the global range

—Creation of a third strategic brand pillar ‘Adidas NEO’, in addition to global segments ‘Performance’ and ‘Originals’

SCALE, SPEED, AND FLEXIBILITY

—Mono brand store franchise model to rapidly penetrate beyond key Tier 1 and 2 cities

—Low-cost store design (up to 50% less than global), while maintaining global brand image

—Deliver a new store from design to opening in a fraction of the time of the home market

—Fully controlled and inhouse logistics

MAINTAIN RELEVANT GLOBAL STRENGTHS

—Global athletes as brand icons

—Global advertising at brand and technical product level to enhance sports credibility

Source: Authors

STARBUCKS – TURNING A TEA NATION INTO COFFEE AFICIONADOS.

For the first 12 years of its presence in China, Starbucks was a very US-centric company struggling with various typical China issues. As a result, when it celebrated its tenth anniversary in 2009 it barely operated 300 stores, including those of their joint venture with Unipresident, which covered Eastern China. The organisation was matrixed with the entire first line of management reporting to global function heads. The China business was centrally run and controlled like any other foreign market, much to the frustration of the local team. In 2012, a new China CEO was hired. Simultaneously, Howard Schultz, the founder of Starbucks, realized change was needed and ‘empowerment’ became the new key word. No more matrix. Let China find their way in China. Full local responsibility. The first country within the Starbucks universe ever to see such an organisational reform. Massive growth was unleashed. As of 2020, Starbucks has more than 5000 stores Chinawide and 600 to 700 more are added every year. In late 2017, the brand opened its then globally largest Flagship store, in Shanghai. A ‘roastery store’ designed to turn coffee into entertainment. One of the key features of the store — an almost permanent queue of people waiting patiently to get inside. So, how did Starbucks achieve such a turnaround?

‘CHINA FOR CHINA’ STRATEGY

—Localized and empowered team, free to pursue its homegrown strategy

—Created Product Innovation and R&D center

—Freedom to create market relevant store designs and formats (e.g., community stores, pet friendly stores)

—Creation of ‘Starbucks Now’, smaller outlets for quick online order collection

—Selected ‘Reserve’ store format locations used as a wine bar in the evening

•China as the global digital business model laboratory. [See full details in Chapter 7.]

—HR policies optimized for local realities (e.g., providing social insurance to employees’ parents)

ADAPT TO LOCAL NEEDS

—Menu: Food 100% localized. Beverages only partially localized as global drinks recipes perform well

—Introduction of heated food items

—Consistent stream of innovative products. (e.g., for local occasions such as Chinese New Year, Mid-autumn, Dragon Boat Festival)

—90% of merchandising items China for