chapter 2 the evolution of china’s companies...

24 © The Economist Intelligence Unit 2005

Domestic companies in ChinaTaking on the competition

Chapter 2

The evolution of China’s companies

What is a typical Chinese company? The truth is that there is no such thing. The range of corporate entities in China is probably wider than has

existed in any other economy in modern times. The most obvious explanation is the country’s transition from a state-planned system to a market-oriented one, a process that in other communist nations had thrown up a variety of companies from fully state-owned enterprises to wholly owned private firms. The range in China, however, is more mind-boggling. This is because the country’s huge size and decentralised governance structures produce abnormally large regional differences in the economic policy and business environments.

The plethora of company forms is symptomatic of the unsettled ownership, control and legal issues that bedevil Chinese companies, and is a key reason for the contention that they are far from taking on the world in a big way. The question of ownership and control of state-owned corporations, and therefore their commitment to profitability and good corporate governance, need to be addressed before they can compete with the world’s multinational companies on the global stage.

As a corollary, examining the evolution of China’s corporate sector will foster a better understanding of the current situation and gauge the potential for future internationalisation. Differences in domestic ownership have long provided the favoured prism through which to analyse China’s domestic companies. However, the ownership spectrum in China is even more finely delineated than is often supposed. Even “state ownership”, for example, is nowadays far from a black-and-white concept.

In addition, we must include in our analysis a less-discussed metric: the companies’ degree of international exposure. Often lost in the hype

over surging bilateral trade surpluses with the US and EU is the fact that parts of China’s economy are far more open to the rest of the world than has been the case with any other economy at a comparable state of development. From automobiles to photographic film and semiconductors to cosmetics, China’s domestic markets are dominated by foreign firms.

The latter also source huge volumes from their operations in China and, increasingly, from local enterprises there. Goods produced by local companies almost invariably remain the most price-competitive. These Chinese suppliers do not just experience international best practices at close quarters, but are often given help by foreign buyers to meet them. Then there is China’s openness to international capital and foreign skilled labour. Sometimes the price of foreign capital has been full ownership, but there have also been joint ventures and minority investments. Most injections of overseas money have been accompanied to some degree by transfers of technology and managers. These inflows of capital and people are blurring the distinction between foreign and domestic companies in China.

It was all so simple during China’s centrally planned past. Chinese business companies simply did not exist. Following the end of the Chinese civil war in 1949, foreign firms were nationalised along with their local counterparts. They became branches and tools of the government’s planning administration, with their managers appointed by the state and paid as bureaucrats. Their purpose was not to earn profits, but rather to fulfil production targets set by officials and to provide their workers with the so-called iron rice bowl—the full range of social welfare services from homes to schools to hospitals.

The system arguably promoted equality, but not economic development. In 1978 urban

© The Economist Intelligence Unit 2005 25


per-capita annual disposable income in China stood at Rmb343, while rural was just Rmb134. Deng Xiaoping later launched a programme of economic reform and opening,which was pushed further forward under the leadership of Jiang Zemin in the 1990s, and is being continued by Hu Jintao. The reforms have gradually de-emphasised central planning in favour of a market-oriented economic system, albeit one with an officially “socialist” edge and “Chinese characteristics”. By 2004 the urban annual per-capita income in China had risen to Rmb9,422 and rural per-capita income was Rmb2,936. The country had become an important engine of not just regional, but also global, economic growth.

Part and parcel of the economic reforms was the resuscitation of business companies as commercial entities. This process has two strands. First, in the state sector, the authorities began to restore the independent legal status of firms in the late 1980s. Then, in the 1990s, officials required national state-owned enterprises (SOEs) to increasingly act like profit-making, commercial companies. The other strand pertains to the non-state sector. In 1981 the government granted self-employed persons legal status as geti hu (个体户individual businesses). Our survey suggests that one-third of China’s companies are wholly private today.

State-owned enterprisesLet us first examine the state-owned strand. One group comprises the so-called national champions, a group of 196 large state-owned

In which ownership structure does your company fall?(% respondents)

Minority state-owned11

Fully collective7

Wholly state-owned 31

Majority state-owned(not 100%)18

Wholly private33

Base : 150 respondents

enterprises overseen by the State Assets Supervision and Administrative Commission (SASAC). The second group consists of all other SOEs (there were some 146,000 of them in 2003) that are, notionally, left to their own devices—the B team, if you will. Another group comprises town-and-village enterprises (TVEs), initially based on collectively owned assets (land, pooled capital and in some instances the remnants of commune-owned industrial plants) and collective management, with the active participation of local officials in accessing credit, developing business plans, sales and distribution.

In the national champion model, a core firm (in a core sector) acts as a “pillar” supporting the growth of smaller companies. In some instances, the pillar SOE is burdened with additional weight, such as being forced to merge with weaker companies. The acquisition of Shanghai Steel by Baosteel is an example. The pillar SOE can also serve as a crossbeam, to integrate horizontal and vertically linked enterprises in the industrial sector, reminiscent of earlier Maoist self-sufficiency models.

SASAC’s stewardship of the national champions is part of Beijing’s policy of retaining control of strategic industrial sectors. The SASAC portfolio includes China Mobile, China Shipbuilding Industry Group, COSCO, Sinopec, Minmetals, COFCO, China Resources, China Merchant Ship Navigation, Baosteel, China Eastern Airlines, China Southern Airlines, Air China and China National Offshore Oil Corporation (CNOOC). Most of these companies have extensive subsidiary holdings, through which they have joint assets with other companies, or have listed spin-off companies, but the holding company is in the hands of the state through its ownership of non-tradeable shares.

In theory, the far more numerous B-team SOEs can be fully privatised or closed down. However, in China the government has been extremely reluctant to use shock therapy on large SOE employers. But the vast majority of remaining SOEs are small and medium-sized enterprises controlled by local governments, so their future depends on the local governments



and the coastal ones are more likely to favour sharp reform. Social legislation is supposed to complement the transition, through alleviating wage and labour market restrictions, transferring welfare burdens to local governments and implementing housing reforms, thus relieving SOEs of some of their non-business costs. This strategy is particularly applicable to locally owned SOEs (that is, those owned by municipal governments or sub-municipal jurisdictions).

Employee downsizing is the most sensitive issue, and once SOE managers were given the opportunity to let go redundant workers, many did so. According to the Ministry of Labour and Social Security, 32.4m people were laid off between 1998 and 2004 (or around half of the

population of the UK). But not all SOEs have been able to streamline. In 2004 the number of staff and workers in state-owned units was 64.4m. An executive at one SOE says he would like to lay off 30% of his 5,000 workers, but is unable to do. The reason? Only companies making losses are allowed to fire people. Healthier firms, like his, have had to keep excess workers, thereby contributing to social stability, but at the cost of dragging down market competitiveness.

Inevitably, the divide between the national champions and the B team has spawned tensions, particularly in sectors where local SOEs compete with state enterprises backed by the central government. One case in point is the fragmented steel industry, which Beijing wants to rationalise

Kazakhstan and Taiwan. Ten months later,

it announced a lifting of the tariffs.

In May 2005 the State Development

and Reform Commission drew up a

blueprint for consolidating China’s steel

sector into ten large, chaebol-style

companies through a series of mergers

and closures. According to the plan, the

sector is to upgrade technical standards

(notably environmental controls), and

outdated plants are to close. Also, steel

plants in interior locations are to shift

to more accessible port or railhead cities

(thus reversing the “3rd line” industrial

policy of the 1950s and 1960s, in which

key factories were relocated to the

interior provinces for better military

defence).

Implementing the new policy is going

to be a struggle. Soaring demand (and

some speculative investments) has led to

the proliferation of small steel companies

backed by local governments, which are

unwilling to hand over control of the

assets because local jobs and taxes are at

stake. In Liaoning, Anshan Iron and Steel

National versus local champions

In most economies, the steel sector

stands out for its intrinsic strategic

importance and as a symbol of national

pride. In China, steel represents the

especially emotive convergence of cen-

tral planning, protectionism and market

forces. China’s steel-making capacity

today is so extensive that the industry

was targeted for special scrutiny amid

fears of an economic overheating in

2004. Even so, domestic steel plants

have not been able to meet local order for

higher-quality steel used in automotive

assembly lines.

Just to complicate matters, steel

production and sales have also see-sawed

through trade litigation. The US imposed

tariffs on Chinese steel imports in March

2002, but dropped them after a World

Trade Organisation ruling in favour of

China (and other plaintiff countries) was

announced in July 2003. Then in January

2004, at the instigation of China’s top steel

enterprises, the Ministry of Commerce

slapped punitive tariffs on steel imports

from South Korea, Russia, Ukraine,

recently merged with Benxi Iron and Steel.

Other merger plans are problematic—

locational dispersion is a major concern

in Wuhan Iron and Steel’s plans to merge

with another Hubei-based operator, as

well as with Chongqing Iron and Steel, and

a Zhejiang-based plant.

In the meantime, new players

have emerged outside the mould of a

traditional state-owned enterprise (SOE).

Jiangsu Sha Gang沙钢(Shasteel) Group

began life in 1975 as an SOE, but is now

China’s largest private steel company,

with 9,500 employees and an annual

production capacity of 9m tons of iron,

and 13m tons of steel. Profits in 2004 were

Rmb2.67bn (US$330m), making it the

second-largest conglomerate in Jiangsu.

But while it is a major player in one of

China’s wealthiest provinces, Sha Gang

is also subject to central-level industrial

planning—as well as the usual pricing

and marketing concerns. No wonder Sha

Gang believes that ensuring effective

risk management is its most difficult

challenge.



by closures and mergers (see box, National versus local champions). The situation is further complicated by the emergence of nimbler and more aggressive private enterprises attracted by soaring demand for steel in China.

TVEs, which flourished particularly in Jiangsu, Zhejiang and Guangdong provinces, were considerably more successful in transforming themselves into quasi-private enterprises, although majority ownership was usually retained by township governments. By the mid-1990s most TVEs had adopted a more formalised shareholding ownership structure, which clarified property rights and allowed for property transfers through the sale of shares. The more successful of the “transformed” TVEs went on to list on either domestic or international stock markets.

One success story is Jiangsu Hong Dou, a textiles and apparel company that has branched out into motorcycles, real estate and rubber production. Founded as a TVE in Wuxi, Jiangsu province, and later corporatised as a share-holding company, it listed in Shanghai in 2001 and now boasts sales of over Rmb7bn (US$865m). Zhou Yaoting, a key manager from the TVE days, eventually became head of the 20,000-strong company. He was succeeded as chief executive in 2004 by his 38-year-old son, Zhou Haijing, who was the recent recipient of the ultimate corporate accolade in China—being featured in a Forbes magazine cover article.

A melding of business and government functions at the local level was not necessarily harmful. Indeed, it was usually seen as supportive of the local development effort, with local governments often providing much-needed credit guarantees (through pressure on local branches of state banks) and infrastructure contributions, such as access roads and local power plants to help develop local industries. The legacy continues of close government ties and government-linked lines of credit, reinforced by the parallel experience of SOE restructuring at the local level. TVEs currently provide employment to about 135m people in the countryside.

The private entrepreneurThe second strand in the resuscitation of business enterprises in China involved the private sector. After attaining legal status, many geti hu grew quickly, outpacing the regulations governing their operations (geti hu is legally defined as small, with no more than seven employees). They kept pushing the boundaries of what was permitted. For example, geti hu above the legal limit of seven employees frequently camouflaged themselves as “collectives” by paying fees to local government.

Eventually, an “individual” business employing more than seven people was allowed to be legitimised as a privately run enterprise, tentatively defined in 1988 as a “for profit organisation that is owned by individuals and employs more than eight people”. Such businesses could take three organisational forms—sole proprietorships, partnerships and limited liability companies. Additional categories were authorised for family-run enterprises and joint household enterprises. These categories (and many others) still exist, and nominal business structure is still a crucial component in statistical records. However, such categories of business ownership are frequently misleading. A lot of the statistical fuzziness is due to the decentralised nature of economic management and the inventiveness of local government officials, reflecting strategies for coping with a regulatory vacuum, rather than a true description of ownership structure.

As de-collectivisation gathered pace, pre-revolutionary styles of family business operations re-emerged. Households pooled savings and talent to start small-scale enterprises. In behaviour typical of family-run businesses, diversified business lines became very common, as family members took on opportunistic business ventures. Additional capital was often supplied by overseas relatives sending remittance payments, and it is not surprising that many of the most adept family businesses sprang up in areas with strong pre-revolutionary commercial traditions and links to



overseas Chinese, such as Guangdong, Zhejiang, Fujian and Shanghai. In a number of counties, family-run businesses took on specialised production and emerged as dominant players in that particular area (see box, Growth with Chinese characteristics).

One result of regulations not keeping pace with business growth was deliberately opaque business registrations, as enterprises jumped categories to take advantage of preferential investment policies offered by township governments. Finally, the 1994 Company Law defined property rights and established the legal boundaries of enterprises. This development facilitated the redefinition (and restructuring) of companies as the law clarified property rights

family businesses. In some instances, the

locality may have been a manufacturing

base as a town-and-village enterprise

(TVE) in the 1980s, but almost always

it has an older, clan-based tradition for

group finance, production and marketing.

In several areas, these traditions

merged to form hybrid species of

enterprises. For example, Shunde

County in Guangdong had strong pre-

revolutionary familial ties for chain

migration to Hong Kong and South-

east Asia, and Shunde clansmen formed

credit guilds to finance passage, plus

jobs and start-up capital in the new

destination. With this tradition of group-

oriented commercial behaviour (plus a

strong clannish sense of local identity),

Shunde’s TVEs thrived, specialising in

household electronics.

A somewhat diluted example of

this tendency is Chang Yuan County in

Henan, which also has an out-migration

tradition, and TVE industrial base, from

which Chang Yuan rapidly developed

its private enterprise manufacturing

Growth with Chinese characteristics

Shortage of capital at the start-up stage

is endemic to small businesses, and was

especially so in the regulatory void of

China in the 1980s. Relationships with

local government could also be prob-

lematic, as there were often inescapable

“client” dependencies (such as the reli-

ance on local officials to register over-

scaled geti hu as collectives), as well

as more generalised rent-seeking. Not

surprisingly, the instinctive response on

the part of many family-run businesses

was caution—which was manifested in

pragmatic avoidance strategies (such as

keeping multiple sets of accounts).

A refinement of the family-run

business model is its replication, on a

broader spatial scale, involving more

comprehensive business cycles. This is

found in localities that have taken on

specialised production to the point that

they dominate the market, and engage in

quasi-cartel behaviour. Various counties

in China are famous for this “cluster”

style of commercial behaviour, where the

enterprises involved are privately owned

capacity in two rather unlikely product

lines: mid-size crane manufacturing, and

medical paper supplies.

The most unadulterated example of

guild-like behaviour is found in Wenzhou,

Zhejiang province. Wenzhou has very

strong migrant communities in Europe

and South-east Asia, bound by “native-

place association” linkages. Wenzhou’s

sensitive geographic position meant that

it received little fixed asset investment, or

policy attention during the

Maoist years.

It quickly reverted to “default mode”

mercantilist behaviour once economic

reforms were initiated, and Wenzhou

private manufacturers and traders now

dominate a number of light industry

product lines (such as cigarette lighters),

via formal and informal marketing

networks throughout China and offshore.

Wenzhou’s clustering of enterprises

encompasses sourcing, manufacturing

and distribution lines, and its business

style is characterised by a gutsy disregard

for regulatory niceties.

and permitted the sale of individual business shares.

The most recent phenomenon in China’s corporate evolution has been the growth of private domestic start-ups, particularly in information technology (IT). Like their global counterparts, these companies tend to be young, nimble, long on ideas and short on working capital. As the new generation of Chinese entrepreneurs, their founders have come of age in relative affluence, and in a much less restrictive regulatory environment—and have far more in common with their international counterparts than did the preceding generation.

China’s IT sector also benefits from the fact that digitalised technology can be manipulated



and processed generally without the need for physical proximity that a manufacturing supply chain requires. This trait adds to the rootlessness of IT firms everywhere, but in China, it is localisation that is fuelling growth. The most common business model is the development of bespoke Chinese-language versions of IT applications. Two from this cohort interviewed for our study exemplify the challenges and rewards of this most recent business model, which is characterised by a very high level of integration with the global industry, and a seemingly effortless glide between local and international business cultures.

Shanghai iResearch was founded by Henry Yang in 2002 as an Internet marketing and IT research firm. Mr Yang sees his company’s strength in its high technical quality and reputation, and its level of customer service. His main focus is the local market, and North Asia (Taiwan, Japan and Hong Kong). As a new company, iResearch is still building its customer base, and Mr Yang thinks that a strategic alliance would be helpful to reinforce size and strength. Employees are hired on merit, and are usually new graduates, or from other private enterprises—they are young, and often lack the strategic thinking or people management skills that are essential in a professional services industry. A persistent headache is securing working capital,

as iReseach relies on retained earnings to support its expansion. The company must also race to keep abreast of technical advances in arguably one of the fastest-paced sectors.

By contrast, Baidu, China’s biggest search engine, appears well entrenched. Baidu already controls 45% of the China market, and its Nasdaq listing in mid-August 2005 created a frenzy (its stock surged 300% on the first day). Baidu has modelled itself as a Chinese-language version of Google, and hosts over 400m web pages. Baidu has already developed some of its own patents, but the capital requirements to stay at the top of this game are daunting. Although its revenue is expected to reach US$40m this year, Baidu’s motivation in listing is to source new funding—and it has indicated that it would not be averse to a merger and acquisition (M&A) to strengthen its resource base. Google has a 4% stake in Baidu. Some of the excitement generated by Baidu’s listing has been attributed to its potential as a ripe target for M&A by a global player.

Foreign flavourOn paper, the distinction between foreign and domestic companies is clear. Foreign firms are wholly owned by non-Chinese citizens (investors from Hong Kong, Macau and Taiwan are included in this category) or are partly funded by them. But the phenomenon of “fake foreign funds”

Gao Dekang, is still a major shareholder)

but plans to list in Hong Kong.

Although Bosideng has developed

its own trademarks, it has successfully

linked up with international brands such

as Nike, Gap, Polo and Boss for sales to

Japan, the US, Russia and Switzerland.

The company knew it had to upgrade its

products in order to meet the sanitary

and quality standards required by such

foreign multinational companies, so it

Bosideng Downwear: from duck pond to North Pole

Bosideng, a Jiangsu-based apparel com-

pany, has grown over the years, in line

with China’s economic evolution. Bosi-

deng began as a peasants’ co-operative

in 1976, with an 11-person production

team and eight family-owned sewing

machines. It now employs over 11,000

workers, and is one of China’s largest out-

erwear makers, with down, knitwear and

cashmere products. It is currently a pri-

vately held company (its founder/owner,

embarked on technical improvements

to obtain requisite certification, and

collaborated with the Chinese Academy

of Sciences to ensure that its down-filled

thermal wear products were bacteria-free.

Its current marketing strategy is to build

recognition for its own brand, through

sponsorships and advertising as a supplier

to China’s ski teams, and—in the ultimate

field test—for Chinese expeditions to Mt

Everest and the North Pole.



(domestic capital that round-trips through off-shore tax havens, returning to China as foreign capital to take advantage of tax incentives for foreign direct investment) is blurring that distinction.

There is also a whole range of corporate entities, Chinese in the sense that most of their operations and staff are in China, but boasting varying proportions of foreign ownership, capital and management. They include what is colloquially described in China as “fake foreign devil” companies that are registered off-shore in such localities as Hong Kong, the British Virgin Islands or Cayman Islands. At similar stages in the development of other economies, such as the US in the 1920s, Japan in the 1950s and South Korea in the 1960s, it was generally clear whether companies were domestic or foreign. In China there has been much more of a continuum.

China’s accession to the World Trade Organisation (WTO) has further accelerated foreign investment. Even the sensitive financial-services sector is gradually opening to foreign minority ownership. Despite their status as minority investors, foreign banks and insurance companies have been active: within the last three years, there has been a wave of strategic foreign investments in China’s banking sector, including HSBC’s US$1.9bn bet on Bank of Communications, and Bank of America’s even bigger US$3bn punt on China Construction Bank. Deals in the insurance sector have included Fortis’s purchase of 24.9% of upstart Taiping Life, and AIG’s 9.9% investment in the property insurance behemoth, the People's Insurance Company of China or PICC.

Although these investments are substantial, they still represent minority ownership, and as such their impact is likely to be gradual. But these minority investments are spawning other businesses with a more distinct character. HSBC’s credit-card business with the Bank of Communications, while officially part of the Chinese bank and headed by executives from both banks, has an independent management committee. HSBC is keen to raise its stake above the current allowed limit of 20%.

In other instances the start-up operation is in

fact the main business. Most of the Sino-foreign tie-ups in the asset management industry (where regulations state the Chinese side must hold a majority share) involve new businesses. Taiping Life, while officially a state-owned firm, is also a new entity, having begun operations only in 2001. Fortis’s purchase is not Taiping Life’s only brush with foreign investors. The firm is owned by Hong Kong-listed China Insurance Holdings, which took charge of China’s overseas insurance holdings after the state’s monopoly was dismantled in 1998. Taiping Life’s relatively young corporate history gives the three senior managers who represent Fortis an unusual ability to shape the character of the business.

Taiping’s history may seem exceptional, but it is quite common to find domestic Chinese companies with some degree of foreign heritage. For example, China’s biggest maker of telecoms components, Shengyi Technology, was originally started by a Hong Kong company, but is now a joint venture listed on the Shanghai stock exchange. A mobile-phone maker, Shenzhen Sang Fei Consumer Communications, was previously 90%-owned by the Dutch giant, Philips, but since 2003 has been majority-owned by the state-controlled China Electronics Corporation. China’s largest non-state broadcaster, Phoenix Television, was founded by a mainland national, but the company operates out of Hong Kong.

Many of China’s more successful private firms have even stronger foreign roots, with many being incorporated and listed overseas. Sohu, an Internet portal, is incorporated in Delaware, US, while China’s two other portals, Sina and Netease, as well as Baidu, are all registered in the Cayman Islands. The trend to register overseas is most prevalent among technology firms, but it is not exclusive to them. China’s largest seller of laminated flooring, Asia Dekor, is incorporated in Bermuda.

To market, to marketClearly, the nearly three decades China has spent resuscitating its business companies have not produced a uniform corporate environment of the type found in developed economies. A look at the



number of Chinese industrial enterprises with annual sales of Rmb5m (US$617,740) grouped by status of registration, brings this point home.

Whatever their ownership structure, however, many Chinese enterprises have made a beeline to the stock market. Large SOEs headed the queue, mainly because the bourses in Shanghai and Shenzhen gave them priority over smaller state enterprises and privately run companies. By 2004, almost 1,400 companies, the vast majority of them SOEs, had listed on China’s two stock exchanges. Between 1993 and 2004, national champions like China Mobile and PetroChina also raised a cumulative HK$854.5bn (US$110bn) from the Hong Kong stock market. These and other firms, including IT start- ups, also listed shares in New York, London, Singapore and Tokyo.

The SOE sell-offs that have occurred have generally only been partial privatisations, with just 30% or so of equity sold to the public, mostly in the form of A shares open mainly to domestic investors, but also B shares for foreigners, H shares in Hong Kong, and depositary receipts in the US and other foreign markets. A further third of shares (so-called state shares) were distributed to government agencies and the final third (legal person shares) were held by the parent company, creating an overhang that has led to a prolonged slump in the domestic stock markets. Investors feared that these non-tradeable shares may be made tradeable and then dumped on the markets, causing a plunge in share values.

On August 24th 2005, five departments under the State Council announced guidelines for the conversion of non-tradeable shares, giving the go-ahead for the gradual disposal of some US$270bn worth of such stock in all listed SOEs. In an earlier trial programme, 46 companies had won minority shareholder approval for the conversion by promising compensation for any resulting loss in the form of cash or shares. The guidelines require such approvals from A share stockholders, but are vague on B and H shares as well as non-tradeable legal person shares owned by foreign entities. The expectation is that the ambiguities would be cleared when the

implementing rules are released. The guidelines on non-tradeable shares apply as well to all future initial public offerings, which at this point include two of China’s biggest banks: Bank of China and China Construction Bank.

The unlistedBut what about unlisted SOEs? The vast majority of them are small and medium-sized companies aligned with local governments, and they compete in sectors that are best left to private enterprises. In 2001 less than 4,000 of Chinese SOEs were in the coal and metallurgy sectors, for example. Many more were in commerce (over 50,000 firms), transport (around 25,000), machinery (just over 10,000) and food (nearly 6,500).

The difference in the treatment of large and small SOEs was made explicit in 1995 when the government adopted the reform guideline “grasp the big and let go of the small”. Local authorities embraced the policy enthusiastically—too enthusiastically for the central government which, fearing social unrest and the loss of state assets, issued a directive in mid-1998 reining in the process. In 1999, however, the central government reiterated the policy, and in the following years the sell-off process accelerated. Between 1997 and 2001 the number of centrally held SOEs fell by 9,000, while the number controlled by local authorities declined by almost 80,000.

There are still too many of them, however, and the preferential treatment they receive not only contributes to their own inefficiencies, but also siphons capital that could otherwise be used by private enterprises. The conventional wisdom is that privatisation or at least the introduction of private investment in SOEs, including foreign money, is the best way to reform them.

But a recent study of SOE restructuring commissioned by the World Bank and the Enterprise Research Institute, a unit of the State Council’s Development Research Centre, suggests that the most crucial element is the ability and will to close inefficient operations. According to Brunel University’s Prof Guy Liu, one of the authors of the study, “Reorganisation



is more effective and complete [compared with mere] state ownership exit from enterprise management.”

This conclusion is buttressed by the experience of Satjit Singh, formerly project director of the State Owned Enterprise Restructuring and Economic Development project, which was involved in the restructuring of 12 mid-sized SOEs in Sichuan, and another 12 in Liaoning. (The research was under the Department for International Development, which is a UK government agency that funds development projects around the world.) Management quality and motivation appear to be far more crucial determinants for success than enterprise ownership per se, he concludes. While ownership issues certainly affect motivation, the quality of management has a strong direct correlation to the bottom line.

That said, political interference in day-to-day management of the enterprise or rent-seeking behaviour by government officials will certainly undermine operations, no matter the quality of the SOE’s management. In both listed and unlisted SOEs, a key requirement is that the state-held shares should be collateral only for political support, not direct management. Another negative of state ownership is the corrosive dependency on local bank financing for soft loans. It remains to be seen whether government efforts to force banks to conduct more commercialised lending terms and stricter

accounting requirements will force SOEs to practise budget discipline.

A question of ownershipAll things considered, private ownership, whether through privatisation or a listing on the stock market, is still the best solution to the problem of SOE reform. It is also an important factor in the larger issue of the emergence of Chinese multinationals. True, in a transitional economy like China, political backing can help win contracts, fund infrastructure projects important to the enterprise, and attract foreign investors. However, the unequal playing field this creates not only holds back the development of the private sector, a potential rich source of global players. It also fortifies opposition in the US and other countries to the entry of Chinese companies in their markets, as shown recently by the failure of CNOOC to acquire Unocal. Political opposition in the US scuppered that deal.

Admittedly, China is unlikely to fully privatise CNOOC and other companies deemed of strategic importance to the country’s security. But the government has signalled that it is open to private ownership in most other sectors. Li Rongrong, chairman of SASAC, has stated that state ownership is not always appropriate in China, adding that the government should only own firms associated with national security, a natural monopoly, national resources, important public services or goods, and “pillar industries” such as vehicle manufacturing

computers and stock trading.

Through loose credit terms, D’Long

was able to access additional loans to

fund its expansion. At its height, D’Long

had US$2.6bn in stock holdings and

30,000 employees.

However, when the government

imposed credit-tightening measures in

early 2004 to cool what it feared was an

overheating economy, D’Long could no

D’Long was too big to fail?

After piling up experience in dealing

with bankrupt state-owned enterprises,

Beijing is now facing a new challenge—

bailing out a private investment group.

D’Long International Strategic Invest-

ment was started as a private company in

1986 in Urumqi, Xinjiang province. It was

founded by two brothers, Tang Wanxin

and Tang Wanli, and quickly spun off

subsidiary companies in entertainment,

longer fuel its growth with borrowings.

Trading in its stock was suspended in

March 2004.

By then, D’Long had become a majority

shareholder in various companies, and

there were fears of a run on the market.

D’Long was put under the supervision of

Huarong Asset Management Company to

have its finances reorganised, and the

Tang brothers were arrested.



and information technology. This attitude was also reflected in some startlingly pro-market language in a recent communiqué from a plenum of the Chinese Communist Party, which stated that “SOEs in other sectors and areas must face survival of the fittest in fair competition in the market”. This is likely to be a long-drawn-out process and subject to obstruction by numerous parties, not least local governments that have to cope with the resulting job losses and narrowed tax base.

Given this formative background, it should not be surprising that China has produced its own crop of homegrown corporate scandals, the most recent being the misadventure of China Aviation Oil in Singapore. Weak corporate governance systems enabled company executives to engage in unauthorised derivatives trading, resulting in huge losses. Fears of market or social instability arising from a major corporate collapse have prompted bail-

outs by government. But these actions increase moral hazard, and not only among SOEs. The government is now faced with the novel experience of administering a private enterprise in D’Long International Strategic Investment (see box, D’Long was too big to fail?).

To be sure, individual companies can and do rise above these limitations. Vanke, a former SOE in Shenzhen, is regarded as a pioneer in moulding a new type of management cadre (see box, Vanke is ahead of the curve). The company remains a domestic operation, but others have boldly ventured to places they are not ready yet to go. The best examples are Lenovo’s purchase of IBM’s personal-computer business and TCL’s acquisition of the TV assets of French multinational Thomson. The jury is still out on whether these high-profile international forays will succeed, but China International Marine Containers has already

Not bad for a company that was

originally a state-owned enterprise

(SOE) set up in 1984 in Shenzhen. Its

current ownership is best described as

“pluralistic”. In 1993 Vanke realised that

its business operations had become too

diffused, and so decided to focus on

property development. The decision was

timely, as the government monopoly on

real estate was ending, but shedding

its superfluous business lines, which

ranged from food processing, apparel

wear, exhibition and media companies,

took several more years. Today, Vanke

is China’s leading property developer,

and an example to other SOEs of how to

transform themselves.

Vanke’s majority owner is China

Resources, which in turn is owned by

China Resources National Corporation, a

national champion under the supervision

of the State Assets Supervision and

Administrative Commission or SASAC.

Minority stakes are owned by China

Vanke is ahead of the curve

The corporate image of Vanke is that of a

xinying qiye(新营企业), meaning a new

kind of company. Part of this pioneering

vision has been a conscious decision to

mould a new management cadre capable

of leading a modern enterprise. Since

the 1980s Vanke has served as a train-

ing ground for many managers who have

gone on to other enterprises. Vanke has

been so formative in Chinese corporate

growth that it earned the nickname 黄埔

军校—the (Huangpu) Whampoa Military

Academy, a reference to the elite military

college established by Sun Yat-sen in

Guangzhou in the 1920s, which trained

future leaders of both the Kuomintang

and Communist armies. Vanke’s senior

management team today is an inclusive

mix of ages (50s, 40s) and includes grad-

uates from mainland universities, return-

ees, state-owned enterprise managers—

as well as Hong Kongers such as Eric Li Ka

Cheung, a former Hong Kong Legislative

Council member.

National Cereals, Oils and Foodstuffs,

China Minmetals and SinoChem.

The career of Vanke’s chairman, Wang

Shi, illustrates some of the dramatic

twists and turns of Chinese economic

history. Born in 1951, he joined the

People’s Liberation Army in 1968.

Specialising in hydro-engineering at

Lanzhou Railway College, he was assigned

to Guangzhou, first to the Railway Bureau

and later to the Guangzhou Foreign Trade

office.

Mr Wang then became general manager

of the Shenzhen Exhibition Centre of

Modern Science and Education Equipment

in 1984, as the new special economic zone

was being constructed. This centre later

became a shareholding company, taking

the name Vanke (万科) in 1988. Vanke

listed on the Shenzhen Stock Exchange in

1991 (its stock listing was 0002, as it was

the second company to be listed), and in

1993 began to issue B shares to overseas

investors.



quietly become the global leader in standard freight and refrigerated containers (see box, CIMC becomes world class).

China’s openness to outside capital and management expertise also should not be discounted. Through interaction with foreigners, many domestic companies now have direct experience of what it means to be a world-class operation and how to compete with such enterprises. To this is added the modularisation of production techniques, which spurs technology transfer and thus aids the emergence of a Chinese multinational. The world’s multinational companies are increasingly relying on standardised components for assembly lines, and China is the workshop of choice because of its infrastructure, abundant and cheap labour, government incentives and the potential to become a huge market in its own right.

Finally, we acknowledge the arguments of many Chinese, and indeed quite a few foreigners, that China has an advantage in the natural

flair for business of its people, evidenced by the mercantilist tradition of imperial China, the entrepreneurial spirit of 1920s Shanghai, the more recent development of Hong Kong and Taiwan, as well as the economic success of overseas Chinese in South-east Asia. In particular, a recent study, entitled Chinese entrepreneurship in a cultural and economic perspective by AM Zapalska and W Edwards, points to “the importance placed on reputation achieved, hard work and successful enterprise” in Chinese culture and history as a factor that contributed to ethnic Chinese being “highly dependent on entrepreneurial culture for direction in life”.

Evolution, not revolutionBut too much emphasis should not be placed on this supposed advantage. In a study of Chinese family firms in the San Francisco Bay Area, for example, Wong, McReynolds and Wong argue that while ethnic resources and kinship

business is container manufacturing,

but it has also diversified into trailers,

and transport and airport equipment. In

line with the growth of aviation in China,

CIMC also makes passenger boarding

bridges, automatic cargo and logistics

management systems.

Luck played a role in the company’s

success. The container industry was

not allied with central ministries and

entrenched State-owned enterprises

(SOE) interests, and was too specialised

for local governments to consider it as

a local “pillar” around which they could

prop associated enterprises.

Benefiting from benign neglect, CIMC

was able to develop its business as it saw

fit. Management’s independence was also

enhanced by the fact that none of its SOE

CIMC becomes world class

China International Marine Containers

(CIMC) was founded in 1980 by China

Merchant Holdings and East Asiatic

Company. The joint venture became a

tripartite partnership when Cosco,

China’s biggest shipping firm, bought

a stake in 1987. CIMC went public on

the Shenzhen Stock Exchange in 1994,

a notable listing because it floated its

group operations rather than follow the

approach at that time of hiving off a

subsidiary.

Well-timed for the shift from bulk

cargo to container shipping in China,

CIMC has become a major global supplier

of transport equipment, and now has

total assets of Rmb17bn (US$2.1bn),

over 30 subsidiary companies, and more

than 28,000 employees. CMIC’s core

owners could unilaterally exert authority

over their mutual subsidiary.

CIMC has been able to use mergers

and acquisitions to gain technological

advances—and, via large-scale production

techniques and low cost, then short-

cut its way to market advantage. In 1997

it bought Hyundai’s container-making

operations in China, primarily for the

refrigerated-container manufacturing

technology. Within five years CIMC

had captured half the world market for

refrigerated containers.

Along with global presence comes best-

practice human-resources management.

CIMC employees are shareholders and

their bonuses are based on performance

reviews, not set by seniority and

favouritism as in some other SOEs.



are key elements of entrepreneurship among first-generation immigrant Chinese, “we do not claim that Chinese are more predisposed to entrepreneurship than other ethnic groups”. The reason? Ethnic entrepreneurship must consider “the numerous interactive processes and structural opportunities and constraints in operation, as well as the role of active, decision-making individuals”, says the study.

Our reading of the ownership structures and predilections of China’s domestic companies is that while only a few Chinese corporations will try to take on the whole world, more will try to

take on wider regional markets. And even more will succeed in penetrating global supply chains. For most companies, whether state-owned or privately run, and the wide range of corporate forms in between, the watchword is evolution, not revolution.

Several interviewees used the metaphor of Chinese herbal medicine to describe their approach to business, as opposed to harsher Western surgical cuts and strong antibiotics. China’s policy makers and regulators will move gradually, and so will its evolving corporate sector.

chapter 2 the evolution of china’s companies...

Documents