Because of the turbulence in the Chinese market, managers frequently encounter unexpected problems that can grow into crises. For example, once a company becomes profitable, jealous officials may change regulations to exploit the situation. This danger looms particularly large for foreign companies, which lack the protection that the state provides especially to Chinese public enterprises.
Despite the potential dangers, few companies are really prepared to deal with these shocks. Managers tend to be occupied with the day-to-day problems of operating in China and do not think ahead. Nor are structures, systems and processes designed to deal with unexpected events. Very often, the China operation is remote-controlled from the corporate headquarters. All this means that, when a crisis strikes, managers are likely to make the wrong decisions.
This article suggests how to prepare for crises, deal with them and learn from them.
A disappearing core business
Tianjin SmithKline (TSK), a Chinese unit of GlaxoSmithKline Plc, has long been a leading pharmaceutical company in China, making products on the basis of foreign patents. Its main product, Contac Sustained- Release Capsules, a cold and cough medication, together with Xian-Janssen's Motilium, a gastro kinetic and anti-emetic drug, are the best-selling Western drugs in the Chinese market in terms of volume.
Contac captured 40 percent of the Chinese cold medicine market. Its competitive advantage was based on its perception among the public as a quality product offering the most effective treatment in the early stages of a cold. Four tablets spread over two days usually achieved excellent results. The slow release technology made the medicine effective for about 12 hours. There were also high barriers to entry, no real substitutes and the bargaining power of most suppliers was low.
But suddenly and unexpectedly, TSK's world changed completely. A five-year study by a research team at Yale Medical School discovered potentially life-threatening side effects of one of the key chemical ingredients of Contac: Phenylpropanolamine (PPA). This substance has the advantage of narrowing or constricting the blood vessels and thus curing stuffy noses. It also suppresses appetite, an important selling point for people on a diet. But if overdosed, it was found to cause health problems such as insomnia, allergies, hypertension, kidney failure, arrhythmia and hemorrhagic stroke.
As a result, in November 2000 the Food and Drug Administration (FDA) in the US published a public health advisory against the substance. The US pharmaceutical industry immediately announced that it would use substitutes. The same month, China's State Drug Administration (SDA) followed suit by cancelling the registration numbers of all drugs containing the chemical and ordering all stocks of the pharmaceutical to be destroyed under the supervision of local drug administration authorities. Among the 15 pharmaceuticals affected, Contac (and TSK's other PPA-containing product, Contac Maximum Strength Capsules) was the hardest hit, since it was China's most popular cold remedy, used by millions of people.
Through the ruling, TSK was banned from the very attractive over-the-counter drugs market. Other companies such as Sanjiu Pharmaceuticals, its main competitor, and Haiwang Pharmaceuticals, which previously did not compete with TSK, started to produce cold treatment drugs on a large scale after Contac exited.
However, TSK managed to cope with this unusually visible crisis. Successful crises management involves crucial decisions along three stages, which I call the three Ls: lessening through early warning systems, leverage through stakeholder management and learning from organisational catharsis.
1.) Early warning systems
Problems are best avoided in advance through preventive measures. For example, an effective relationship network in China may ensure that regulations remain favourable for the company. Companies should reach out to the sources of potential change, such as research laboratories, to pick up early warning signals.
If prevention is impossible, problems should be solved when they are big enough to be seen and small enough still to be handled easily. It is important for managers to engage in regular scenario sessions in which they are forced to think the unthinkable. To a large degree, their success in managing a crisis depends on their preparation and, more important, their character.
TSK failed in these respects. Because of its long lasting and unrivalled market leadership, managers believed that the future would be just like the past. They ignored first signals that PPA might be suspended, which surfaced at least six months before the FDA decision. Even after the news from America, TSK's management did not believe that the Chinese government would dare to unsettle such a powerful company. The crisis thus took TSK completely unprepared.
2.) Stakeholder management
Competitive advantage may be fleeting in a fluid and fast-changing environment. But the accumulation of temporary advantages can result in above-average performance. Crises represent a chance to break ossified structures. They can be used for creative destruction, which is the base for innovation. Smart companies also leverage the impetus of crises to implement other changes that they previously could not push through.
Because of the exceptionally difficult human relations in China, many companies fail to recover from a crisis. The key players are the managers and the stakeholders with whom they deal. Stakeholder management starts with self-management. Successful crisis managers trust that the worst things always arise for a reason and contain the causes of the best things.
TSK's leaders first asserted their determination to exit the PPA crisis successfully. They then interacted intensively with several key stakeholders: shareholders, distributors, customers and employees. Dealing with the crisis required effective management of people in all stages of the value chain, such as research and development, production, distribution, marketing and sales. At the same time, a new plan was developed to fill the void left by the suspension of its core products.
Shareholders TSK invited major shareholders to its plants to show that production continued as usual, that spirits were high and that there was no reason to panic. As a result, shareholders maintained their confidence and were willing to contribute funds to new investments. TSK also managed its corporate headquarters successfully by reassuring it about the long-term prospects of the market. Thus, the centre was willing to grant fresh funds for new ventures. As a result, despite total damages of Yn700m, the company still had enough working capital and long-term finance to expand, including research for a new product to replace PPA. It invested Yn145m on a new formula.
Distributors TSK also called more than 50 key account managers to its headquarters in Tianjin and gave them an action plan and letter for their key clients – hospitals and retail customers. Distributors were granted the right to return the hazardous product or to waive payment for outstanding balances. This generous move repeated the success of Perrier, which withdrew all its bottles when one factory was found to have produced contaminated water. As a result, TSK earned great respect and concomitant loyalty among its distribution partners.
Customers The company also proactively communicated with customers. Within five days of the product suspension, it set up dozens of hotlines and trained many operators to staff them. Operators learned how to reassure anxious customers on the basis of solid information. TSK also elicited compassion from the media by holding a press conference where it promulgated two principles: TSK never stops investing and the safety of the public is its most important concern. It pledged to find a satisfactory solution to the problem. As an example of the media sympathy generated, China Daily later published a story headlined 'Banned medicine on way back to nation'.
Employees TSK decided to retain all employees, believing that they constitute valuable assets because of their rare technical skills. The cost of keeping them was estimated to be lower than the cost involved in rehiring them after an anticipated business revival. Besides, a stable workforce was needed to maintain the quality of other products; any firing might have harmed morale. Leaders clearly communicated to staff the nature of the problem, what action they planned to take and the role each individual had to play. As a result of all these measures, TSK earned employee loyalty.
In parallel to 'fighting the fire,' TSK planted the seeds for new success. After the Chinese CEO espoused the vision of rapidly introducing a replacement cold-treatment drug, the company started an inquiry and encouraged innovative ways of thinking about the problem. TSK invited specialists from its operations in the UK and the US to examine the feasibility of a new cold-treatment drug. It sent a master plan to the headquarters outlining the action it proposed to deal with the problems and the resources it needed.
A new product was successfully developed for the Chinese market and introduced under the name of New Contac within 10 months of the ban. The use of the same name component and packaging as before showed the strong goodwill and brand equity that the company was able to maintain in China, and its confidence. According to a company survey, 90 percent of customers intended to try the new product. At Yn13.50 a pack, New Contac costs 10 percent more than the famous predecessor and thus may create even greater revenues, if the extra income is not absorbed completely by the higher cost of the PPA replacement.
TSK's competitors, too, had the chance to profit from the discontinuity and capture greater market share. However, they failed because they unleashed negative energies instead of engaging in constructive effort. They highlighted the poisonous effects of Contac, which only served to undermine customers' confidence in them (because they felt misled) and the pharmaceutical industry in general.
3.) Organisational catharsis
By definition, a shock is unexpected and often creates new challenges. The lessons learned in one crisis may not be applicable next time around. Learning therefore needs to focus not only on the contents, but also on organisational and individual skills, which enable effective crisis management under any circumstances.
At the individual level, managers and employees need to be aware of dangers. This happened at TSK, when the crisis set off a process of inquiry into the fundamentals of doing business. TSK employees also became proud of their track record of going through good and bad times – especially of not deserting the company in times of need. Before, employees had drawn their own territories in the company and engaged in turf wars. After the crisis, the entire staff became united, ready for the next challenge.
At the organisational level, structures, systems, and processes, including culture, need to allow employees the flexibility to adjust to new contingencies.
Success in managing crises strongly depends on what I call the 'inner game'. In a crisis, leaders should emanate calmness and faith in being able to master the challenge, even if they have their own doubts. Selection and training needs to ensure that leaders possess the right inner qualities.
Many companies only focus on how to communicate with the public, but do not think about the internal 'propaganda'. They need to master psychological warfare in this area, too. Followers need to be treated with at least the same care as external constituencies. Every word and detail matters in a crisis and will be magnified externally. Skilful leaders actually elicit pride in employees for needing to cope with greater difficulties than others and for mastering complex problems.
Telling the truth
Honesty is of paramount importance. To gain trust in the leader, all internal and external stakeholders need to know the real story. An element of generosity also matters. It implies letting go of the past and looking to the future. This can mean that temporary losses need to be tolerated, especially to build up invisible resources, such as brand equity and customer goodwill. Leaders should not try to find fault and attribute blame, but to focus on creating new things.
A crisis can be leveraged to create internal and external disruptions, which break old imprisoning structures and make the company stronger. The case of TSK shows that leaders often need to initiate creative and counterintuitive steps: instead of firing people, you may want to keep them; increasing investment may be better than decreasing it; instead of defending an old product, you may want to switch to a new one.
The playwright Anton Chekhov once said: "Any idiot can face a crisis. It's this day-to-day living that wears you out." In contrast, I believe that the day-to-day thinking and action prepare you for managing crises successfully in China and other emerging markets and situations.
Dr. Kai-Alexander Schlevogt (PhD Oxford), an internationally renowned expert in strategic studies, is the founder and president of the Schlevogt Business School, the first higher education institution in Germany to focus on emerging markets, especially China. He became the first permanent foreign professor in China (at Peking University) and served as a senior faculty member at the Australian Graduate School of Management (UNSW). He often leads education programmes for top managers and government officials in China and overseas. Website: firstname.lastname@example.org. E-mail: email@example.com.