The phenomenon of shareholder value flowing from outmoded business designs to those that are better calibrated to serve customers' needs, has played out most vigorously in the US, with its relatively free-market economy, and to a lesser extent in Western Europe.
But the lessons of `value migration' apply with equal force in China, and they have particular resonance now that Beijing has decided to lower trade barriers to enter the World Trade Organisation and revitalise its economy. This important development signals a commitment by the government to accelerate the pace of reforms.
As China follows through on proposed reforms and foreign investors finally make a full commitment to its massive market, this leap heightens the need for Chinese firms to develop innovative business designs in order to compete against foreign entrants and against other Chinese firms that have successfully transformed themselves.
China's double-digit growth in the early 1990s allowed a multitude of firms to grow and prosper. Since the economic slowdown, however, tougher market conditions and greater foreign competition have begun to change the behaviour of some Chinese companies in a range of industries. Only those firms focusing not on output or market share but rather on customer-oriented business designs have been able to continue to grow shareholder value.
Mercer Management Consulting has examined the performance of all Chinese companies listed on the Shanghai, Shenzhen and Hong Kong stock exchanges from 1992 to 1999. In virtually every industry studied, from computers to appliances to retailing to autos, shareholder value has migrated from companies that have product centric business designs to firms that reinvent themselves to anticipate shifts in customer priorities.
These firms range from south China township enterprises to Beijing-based state-owned firms, and they are breaking free of the past and embracing international business practices with enthusiasm. They recognise that once design, quality and service are improved and tailored to customers' priori-ties, China's consumers will often buy local brands over foreign brands. That has come as a tough lesson for global corporations that haven't included Chinese firms on their competitive radar screen.
A look at Chinese companies in the computing industry shows how value is migrating. Stone Electronics, a pioneer in the industry, failed to anticipate and respond to changes in the market, and instead continued to make incremental improvements to outmoded products.
Between 1993 and 1998, despite the double-digit growth of the Chinese economy, Stone lost US$300m in market value. During the same period, Legend Computer gained roughly US$400m in value, and continued to grow to US$4.3bn by the end of 1999.
Why have investors rewarded Legend? The company's success lies in its intimate knowledge of customers and its control of distribution channels. Based in Beijing, Legend was established in the early 1980s by researchers from the Chinese Academy of Sciences as a distributor for foreign computer manufacturers. By the mid-1990s, anticipating explosive growth in personal computers in China, Legend decided to build and sell its own personal computers, earning much higher margins than on the foreign PCs it distributed.
At the same time, Legend recognised that in the business market, value was flowing away from the product itself and towards providing solutions. Legend thus began moving aggressively into systems integration and software, where it earns higher margins and focuses more on those business and government customers that will pay a premium for complete solutions.
The elements of Legend's new business design are:
Customer selection and value proposition
Legend targeted several customer segments, with a different value proposition for each segment. Not only did the firm develop a wide range of products, it also expanded the services provided to business and government customers. Legend adapted foreign-produced software applications to meet Chinese requirements and developed a systems integration offering.
Legend has expanded its role in the value chain well beyond distribution. As a fully integrated company, it is now able to reap profits at each step of the value chain, particularly in manufacturing and in the downstream areas of systems integration and software.
Value capture/profit model
As a distributor, Legend captured value through the small margin it could obtain by selling other firms' products. As it began to serve different customers with new value propositions, Legend expanded its methods of value capture. By producing its own PCs, it could capture value through efficient manufacturing. By moving into software, service and systems integration, it captured new value through bundled sales and after-sales service and support fees.
Legend protects its profit streams in several ways. It has exploited its original source of strategic control the distribution system ?to form strategic alliances with foreign partners, such as Computer Associates in software. These
relationships enable Legend to gain access to customers and to provide value-added services for which customers will pay a premium. Providing downstream services also builds customer allegiance. Finally, Legend is building a powerful brand both in business and consumer markets.
Legend has used organisational structure as a mechanism to build the processes and capabilities required to succeed in each of its different businesses. It created a new unit to focus on the production and distribution of its own PCs, which even competes against its original distribution business.
Doing so had the side benefit of preserving distribution relationships with other manufacturers. Legend also created a systems integration organisation, recognising that it would need very different skills and capabilities, and that it would need to integrate equipment and software from a wide variety of vendors, not just from Legend.
To be sure, Legend has enjoyed support from the central government in developing its own technology and has benefited from being courted as a partner by foreign high-technology firms entering China. Nevertheless, the group has succeeded largely because of its willingness to reinvent its business design as customer priorities changed. As a result, more than 70 percent of its profits today come from areas that prior to 1996 were not core businesses.
Legend cannot be complacent about its success to date. It must continuously monitor how customer priorities are changing and be prepared to reinvent its business design again and again.
Legend faces two crucial challenges: staying ahead of traditional foreign competitors as those rivals seek new ways to capture value, and moving quickly into the emerging markets of internet content and service provision.
Legend's success in China has not been lost on its competitors. IBM, for instance, has started to help its high-end customers set up electronic commerce operations.
Dell, meanwhile, is threatening to trans-form the traditional PC distribution approach in China, just as it has done in the US and elsewhere. Currently focused on high-end business and government customers, Dell plans to distribute its product directly rather than through third-party channels. By selling direct through its own sales force, telephone representatives and tailored websites, Dell is moving towards a global build-to-order model. That model improves margins by cutting sales costs, reducing inventories and minimising receivables.
Finally, the emergence of new local entrants into computers such as Haier will put price pressure on the consumer market, where Legend currently enjoys a favourable brand position.
Legend isn't standing still; recent moves point to further shifts in its business design. In mid-1999, Legend introduced an internet based system to link its distributors, which should speed the delivery process and reduce costs. More recently, the firm announced it would offer low-end computers with bundled internet access. Legend FM, a portal service, currently provides users with financial data, free e-mail and free computer training. Such bundling may allow Legend to continue to grow hardware sales as internet usage ramps up in China, while at the same time it seeks new ways to capture value.
This article was extracted from a commentary written by Paul Clifford and Larry Alberts, vice presidents of Mercer Management Consulting based, respectively, in Beijing and Hong Kong. It is based on Mercer's book The Profit Zone.