Doing Everything Right in China — A Primer

This article from McKinsey Quarterly [link no longer exists] details the China operations of Danfoss, a Danish manufacturer of mechanical and electrical products and controls.  Danfoss appears to have done just about everything right in its China business and their tactics there are quite instructive.

I am particularly impressed by Danfoss’s doing the following:

  • Going into China as a wholly owned foreign entity (WFOE), not as a joint venture (JV).  This has allowed Danfoss to, in the words of its CEO, Jorgen M. Clausen, avoid having “to cope with one of those joint ventures that have proved cumbersome for many Western companies.”
  • Timely recognizing China has gone from being just a cheap place for manufacturing to becoming a multi-tiered high growth market for goods.
  • Not just following the pack in determining where to locate its China operations. Danfoss chose Tianjin, which is close enough to Beijing to attract Western executives, yet far enough away to be able to draw from a cheaper labor pool. Locating outside Beijing/Shanghai also gave Danfoss the advantage of being a big fish in a small pond.
  • Truly seeing the potential for growth in China.  CEO Clausen vividly describes the two events that crystallized for him the need for Danfoss to focus heavily on the Chinese market:

There were two eye-opening events that made me start thinking about a long-term strategy for China. First, I read an article in a newspaper one day about a big European manufacturer that was happy with its 40 percent growth in China until it discovered that the entire market for its product category was growing by 80 percent, which meant the company was actually losing market share. This made me wonder how successful we really were in China and if we too were being fooled by growth rates that were vastly superior to the ones we were getting in Europe.

The second event came when my wife and I indulged ourselves by making an old dream come true: we traveled the ancient Silk Road from Almaty, in Kazakhstan, to Urumqi, in China’s western province of Xinjiang. We drove for two days in a Land Cruiser through what struck me as quite backward areas until we reached the Chinese border, where the president of our Chinese subsidiary waited for us in another Land Cruiser.

I came away from our glimpse of Greater China with the feeling that there must be many opportunities that we weren’t addressing’

Once we’d crossed into China, I was struck by the good roads and the nice pavements lining them and, in general, by how relatively modern and well organized things seemed to be in this very remote area, so far from Beijing and Shanghai. In Urumqi I peered through the window of a dressmaking factory and saw that it was highly automated, which I was surprised to see in a remote area where labor must be very cheap. In a department store, we mingled with ordinary Chinese shoppers and were surprised to find exclusive dresses and $100 ties on offer. Something that particularly caught my eye was a refrigerator with inverters that control the speed of the motor and thus save energy — a luxury category one wouldn’t find even in a large Danish town.

  • Knowing its position in China and adjusting to enlarge it.  Danfoss conducted market research to determine how it was doing in the Chinese market and, after learning it had no share of the low end market, it developed an indigenous low end product for China.  Danfoss’s CEO’s description of this realization is quite instructive:

We found that we were just skimming the surface and capturing only a few percentage points share in most of our product markets. Our products addressed the high end of the market and some of the middle, but not the low end, which in many cases we hadn’t even known existed. This shortcoming was actually not surprising, as we had simply taken our existing European product line to China. What stunned us was the size of the low-end market. We concluded that if we could offer the right products, there was a potential to increase our coverage by a factor of 10 and our profits by a factor of 30 in one segment of industrial-control devices — somewhat less in other segments, but still by a very substantial amount. Collectively, this could give us a market share of from 15 to 20 percent, roughly equal to our share in Europe.

  • Doing things right in protecting its intellectual property.  Danfoss registers its IP and it enforces its IP rights. Danfoss uses international lawyers experienced with international and China IP.  It recognizes it will always need to remain vigilant in protecting its IP rights, “just as it is in the West:”

A lot of companies copy our products, and we have now adopted a policy of going after them systematically, especially the ones that export the copies from China to other countries. There was one case in particular where we got inquiries from customers about a product that was supposedly ours and that was being sold at a very low price. We investigated and found that it looked very much like ours, had a Danfoss label that said it was made in Denmark, and came in a box that looked exactly like ours. We managed to locate the Chinese company manufacturing the copies, documented our case well, and then went to the police. The police raided the company, confiscated the goods, and the owner was sent to jail

  • Dealing with cultural differences, rather than ignoring them:

It is very important to overcome cultural barriers. In Denmark, people are raised to speak frankly and to disagree in public. The Chinese rarely disagree with a higher-ranking person and won’t speak until asked to do so. This is no good for us, because we need their help to find solutions to the challenges of growing quickly in the Chinese market. So with the help of the Copenhagen School of Economics, we have designed a three-month development program for Chinese and other Asian leadership talent. Psychologists in these programs support the participants in their personal development and teach ways to bridge cultural differences. This approach is working very well.

  • Seeking to work within the Chinese framework, rather than making it an enemy.  This is true with how it handles its IP enforcement (as set forth above) and it is also true with how it views China as its “second home market”:

It adds to our credibility when I tell Chinese government officials and customers that they shouldn’t view us as a foreign company. “We are Chinese, just like you,” I say. “Only I am Danish. The technology you buy from us is from China, and you create employment in China when you buy from us.” They hadn’t thought about it from that perspective before.

  • Lastly, and perhaps most importantly, Danfoss’s President stresses the need to spend lots of time in China:

But you cannot make a decision on China when you’re sitting behind a desk back home.  You’ve got to get up from your chair, as well, and see the opportunities and risks with your own eyes, buy a ticket not just to Beijing and Shanghai but to other parts of China.

By getting up from his chair, President Clausen positioned Danfoss to see what is really going on in China and to react accordingly.

Kudos.  And Kudos to  McKinsey as well, which presumably assisted Danfoss at various points along the way.

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