Seeking a foothold in an explosive emerging market is a bit like entering a casino: everyone is searching for the jackpot. But success may be even more difficult than winning in a real casino, because the rules of the game are not always straightforward. You're playing against skilled competitors, not just against the house. What's more, the house — the state authorities — can change the rules, and therefore the odds, at any time. By Tjun Tang, vice president and director in the Beijing office of The Boston Consulting Group and Douglas Beal, vice president and director in the firm's Hong Kong office.
China's banking market is an example, one which has been likened to a casino. Legions of foreign banks, having gained incremental access to the market since China's admission to the World Trade Organization, are placing their bets by buying minority stakes in Chinese banks (and other Chinese financial institutions) and by trying to expand their currently modest branch networks in the country.
These banks are wagering both that China's remarkable economic story - average compound annual growth in GDP of nearly 10% for the past 25 years - will continue, and that further deregulation will lead to new sources of profit by allowing the banks to compete in products and regions that have previously been off-limits.
On the one hand, this would seem to be a pretty sensible bet. China's growing ranks of middle-class households need sophisticated products and are just beginning to demand higher levels of service. The increasing presence of multinational corporations in China is creating a demand for world-class corporate financial expertise. Indeed, roughly 30% percent of new bank deposits created globally over the next five years will probably flow into China's banking market, helping it to expand far more rapidly than most other major markets. In the long term, China is widely expected to evolve into a premier banking centre as the size of its economy grows and possibly surpasses that of the US by 2040.
On the other hand, any market as vast and complex as China is fraught with risks — just like a casino. Cultural barriers and strong customer loyalties to local institutions must be overcome. Competition is intensifying in parallel with awareness of China's potential. And some regulatory constraints will continue to exist in 2007 and beyond.
In our view, companies with international aspirations would be both wise and prudent to explore what the China opportunity could mean for them. Because one thing is certain: the rush is on. Managements that do not investigate ways of tapping into China's enormous potential can be fairly sure that their competitors will. And the long-term winners in China, by virtue of sheer scale, will be able to build leading global positions.
How can financial services companies, for example, forge a potential strategy for navigating China? The first step is to gain a richer understanding of how the country's banking landscape is structured. It is diverse, to say the least. There are five basic types of domestic banks, the largest being the so-called Big Four state-owned institutions: Bank of China (BOC), China Construction Bank (CCB), Industrial and Commercial Bank of China (ICBC), and Agricultural Bank of China (ABC).
There are also ten national shareholding banks, more than 100 city commercial banks, and tens of thousands of urban and rural credit unions. In addition, there are a number of important state development banks. But this large landscape is rocky. Some Chinese banks have had severe problems with non-performing loans and have required huge capital injections from the government. And unfortunately, some Chinese banks still lack modern credit-risk management techniques.
This means that they may continue to offer loans to questionable borrowers, which could lead to new rounds of defaults in the future. Moreover, on a systemic level, other aspects of doing business — such as management processes, decision-making, internal operational controls, corporate governance, organizational design, IT functions, and general leadership — all need improvement. Several scandals have hurt consumer confidence.
Yet it is equally important to acknowledge that many Chinese banks have come a long way over the past five years toward meeting international standards. Chinese banks are also likely to benefit from their collaboration with foreign banks. However, the foreigners will need to learn what type of guidance to offer their Chinese partners and to find ways to help them increase transparency, develop stronger commercial practices, and target the right customer and product segments.
Foreigners will also have to navigate cultural differences. For example, although close relationships are important to doing business anywhere, they are perhaps more so in China, where business takes place only after trust and a degree of respect have been established - not the other way around, as can happen in Western business culture. Establishing and maintaining good guanxi (or relationships) should be as much of a priority for foreign entrants as differentiating their products and services to various market segments.
Where segments are concerned, corporate banking (which has historically served state-owned enterprises) will remain the largest banking segment in China — with market revenues projected to grow to about RMB1.6 trillion by 2010. Retail-banking revenues should climb to about RMB500 billion by 2010. Within these segments, large corporate customers and affluent retail customers are likely to have the highest profit potential.
Removal of restrictions has continued. For example, foreign banks, able to offer foreign-currency products to Chinese companies and individuals since the end of 2001, are now being permitted to deal in RMB products with all Chinese retail and corporate customers in all regions. Six specific provinces are likely be the most attractive in terms of size, income per household, and economic growth rate: Beijing, Guangdong, Jiangsu, Shandong, Shanghai, and Zhejiang.
One noteworthy difference between the banking business model in China and that in many other parts of the world is the relatively low percentage of fee-based income among Chinese banks. Today, non-interest income represents about 10% of total revenue for the Chinese banking market, compared with roughly 48% for the global banking market. Although fee-based income is expected to rise somewhat in China, foreign institutions will have to work hard to find ways to make fees — not a traditional part of domestic-banking charges in China — more palatable to Chinese customers in both the corporate and the retail segments.
Numerous global banks have already established a sizable footprint in China. Moreover, when limitations on foreign ownership stakes (currently capped at 20 percent for any single foreign institution) are further relaxed, the presence of international banks will intensify.
Having a presence doesn't necessarily mean being profitable, of course, but foreign institutions that have taken the time to understand the Chinese market, develop close relationships, and follow through with effective execution will benefit handsomely. All of China's Big Four banks, for example, have partners and suitors, and virtually all joint-stock banks and city commercial banks in high-growth areas that do not yet have foreign strategic partners are currently entertaining troops of overseas banking executives.
Of course, each of the many ways in which banks can establish potential long-term positions in China has its own market and organizational challenges. For example, building organically branch by branch may maximize control and independence, but it also presents tall hurdles in scale, geographic coverage, brand building, and navigating cultural differences. Buying a sizable stake in another institution may provide entry through an established entity, but it requires a considerable up-front investment for relatively little management control. Starting a joint venture may well be a viable way of sharing initial investments and management influence, but such projects are extremely difficult to pull off.
Deciding which of these potential paths might be most suitable requires a thorough assessment of your own international aspirations, cultural and organizational capabilities, appetite for risk, and time horizon for a possible initial investment.
For banks, competition both in mainstream product areas and in the largest cities will become increasingly intense in the short and medium terms. Would they might fare better by placing their bets on products or regions in which they can achieve greater scale and face less competition? Options include focusing on higher-growth and less contested locales (such as smaller coastal and large inland cities), products such as credit cards and mortgages, and value-chain processing services to mainstream banks.
In addition, a certain degree of business model innovation may be necessary in order to successfully pursue small-to-medium-size enterprises, large state-owned enterprises, mass-market consumers, and wealthy individuals — especially considering that fact that fee-based services are not yet fully accepted in China.
Newcomers should also study, as much as they can, the experiences of all early movers into China, not only in financial services, but also in industries that have been open to foreign companies for a longer period — such as consumer goods, engineering, and chemicals. The goal is to identify best practices in navigating partnerships, organizing effectively, dealing with employee displacement issues, and managing headquarters' aspirations and expectations.
Thinking through growth strategies is a difficult exercise for any corporation. Should expansion be organic or should it occur through partnerships or acquisitions? Should the product line be expanded or streamlined? Should a previously targeted segment be dropped and a different one pursued. Another common question applies to the China opportunity: should growth be sought domestically or across borders? China is something of a special case, however, because of its vast geography, its upwardly mobile population of 1.3 billion, and its enormous potential for banking services.
Getting established in China is an arduous, long-term endeavour. And China is the type of market in which there will always be a strong element of the unknown. Despite the risks, opportunities in China are very significant, and even in a sector like banking, relatively few foreign entrants have a strategy in place to ensure that they can take maximum advantage of the potential.
Ultimately, there are five basic imperatives that foreign institutions considering entry into China should address now:
• Invest the time and effort to learn about the Chinese market
• Build 'China capabilities' institutionally and culturally
• Develop a full set of strategic options
• Explore the growing importance of linkages, such as those between banking and other financial services, such as insurance
• Think through a path to profitability in China, considering various market scenarios
Institutions that take too long to size up the China game and decide how to approach it may find themselves without even a small share of a potential jackpot of growth and profitability - while their competitors hit that jackpot big.
Tjun Tang is a vice president and director in the Beijing office of The Boston Consulting Group. Douglas Beal is a vice president and director in the firm's Hong Kong office.
Contact: tang.tjun[at]bcg.com and beal.douglas[at]bcg.com
The articles published here in the Thinking CEO are internet updates of the latest management knowledge and practice, which have been commissioned by Sovereign Publications for their bi-annual magazine, CEO Today, and will appear later in the first 2007 issue of this publication. To contact Sovereign and CEO Today, go to:
http://www.sovereign-publications.com/ceo-art.htm
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