Chinese Companies Global Brand - DOC

							Interview

China's refrigerator magnate

Zhang Ruimin, CEO of the Haier Group—the Chinese company that is the world’s
fifth-biggest maker of white goods—describes his plan to create a global brand.

Yibing Wu

The McKinsey Quarterly, 2003 Number 3

China has become a global manufacturing powerhouse thanks to the many
domestic and foreign companies that produce goods there and sell them to
consumers throughout the world. Most global leaders are producing and selling
products in China. Despite intense competition, the Chinese market—particularly
for consumer electronics and domestic appliances—is dominated by homegrown
giants that have built a strong awareness of their brands inside their own
country. Outside it, however, the story is different. Many Chinese companies,
finding the challenge of building their own brands and channels in the United
States and Europe daunting, have opted for the OEM route, producing goods for
global brands rather than their own. Glanz, for example, makes microwave ovens
for more than 80 brands around the world.

But now a few large Chinese companies, encouraged by their government, are
intent on creating truly international brands. First off the mark is the Haier
Group, a diversified manufacturer of more than 80 products ranging from
refrigerators, washing machines, and air conditioners—a few of the core products
that make it the world’s fifth-largest maker of white goods—to cell phones and
televisions. As China’s domestic markets have mushroomed over the past two
decades, Haier has built a reputation at home for quality, innovation, and
customer service. It enjoys leading domestic market shares in washing machines
(24 percent), refrigerators (23 percent), vacuum cleaners (18 percent), and air
conditioners (13 percent).
Today, moreover, Haier sells its products in 160 countries and owns 13 factories
outside China, including a refrigerator plant in the United States. In 2002, the
company had worldwide sales of more than $8.5 billion, an 18 percent increase
over 2001. Haier’s executives believe that they can extend its strong domestic
brand reputation into the West by introducing innovative products for niche
consumer markets and then expanding into bigger ones—a strategy that would
enable the company to enjoy the higher margins that come with brand sales
instead of slugging it out as a low-cost supplier to Western companies.
Meanwhile, stiffer competition at home from new Chinese entrants and foreign
giants such as Siemens has strengthened the company’s wish to step up sales in
the United States, Europe, and Japan.

Zhang Ruimin, Haier’s chairman and CEO, has been the architect of its domestic
success and of its strategy to grow beyond China’s borders. He took charge of
the money-losing state-governed company (a collective enterprise under the
authority of municipal and state governments) in 1984 and, through a series of
reorganizations and acquisitions, turned it into a conglomerate with more than
30,000 employees. His innovative mixture of Western and Chinese management
practices has helped instill in Haier a focus on the identification of customer
preferences and on a market-based approach to meeting them.

Having been named an alternate member of the Communist Party’s central
committee in 2002, Zhang—one of the few businessmen to gain this position—is
politically well placed to lead the company’s charge into global markets. Yet as
Haier tries to replicate its domestic success overseas, it faces enormous
challenges—everything from learning the preferences of new customers to
managing its growing foreign operations. In the United States, it has established
a beachhead by selling niche products under the Haier brand name through The
Home Depot, Sears, and Wal-Mart, but its biggest test will come when it tries to
sell more mainstream home appliances.

Zhang discussed Haier’s plan to meet all of these challenges in an interview
conducted in Beijing by Yibing Wu, a principal in McKinsey’s office in China’s
capital.

The Quarterly: What is Haier’s strategy for expanding into global markets, and
how does it differ from the approach most other Chinese companies have taken?

‘We have created an important brand in China, and we are taking that brand to
other markets’ in Europe and the United States

Zhang Ruimin: The objective of most Chinese enterprises is to export products
and earn foreign currency. This is their only purpose. Our purpose in exporting is
to establish a brand reputation overseas. We have created an important brand in
China, and we are taking that brand to other markets. In other ways, too, our
strategy is very different from that of other export-oriented Chinese enterprises.
They will usually explore easier markets first and difficult markets later. Many
Chinese enterprises will first export to Southeast Asia, for instance, which has
competitive markets but where there are no strong, dominant competitors, as
there often are in Western markets. But our strategy is the other way around:
we go to easier markets after we first penetrate difficult markets such as the
United States and Europe. These are much bigger markets. They are also the
home markets of our largest global competitors, and we believe that if we can
succeed there we can succeed in easier markets. Haier started exporting to the
United States in 1990; it has been more than ten years now and the results have
been good. We’ve established a brand reputation in the US market and earn
higher margins on sales, while many Chinese companies can do only OEM work
for foreign brands and manufacturers, at lower margins.

The Quarterly: How have you set out to establish the Haier brand in Western
markets?

Zhang Ruimin: All success relies on one thing in overseas markets—creating a
localized brand name. We have to make Americans feel that Haier is a localized
US brand instead of an imported Chinese brand. The same goes for the European
market.

‘We are organized to understand what customers want and to meet those needs,
which are sometimes quite differentiated’

We have been successful in China because we are focused on meeting customer
needs. We are organized to understand what customers want and to meet those
needs, which are sometimes quite differentiated. We are following the same
strategy in Western markets. Consumers in the United States are used to
popular brands like GE and Whirlpool, so they’ll wonder why they should choose
a brand they’ve never heard of. But large companies are established and slow
moving, and we see an opportunity to compete against them in their home
markets by being more customer focused than they are. To win over those
consumers we have two approaches: speed and differentiation—speed, of
course, to satisfy the consumers’ needs as quickly as possible, differentiation to
introduce brand-new products or products with features to meet different needs.

Let me explain the second of those two issues—differentiation—first. Total sales
of compact refrigerators in the United States last year reached 1,500,000 units.
Haier sold 670,000, nearly half of the market. We could win such a big market
share because of our thorough market analysis; we understand customer needs
and meet them. Most users of these compact refrigerators are college students.
Because they usually have very small apartments and also use computers, we
introduced a new compact refrigerator with two wooden flaps on the sides that
can be folded out to make a computer table. You can put your computer on the
refrigerator. The flaps can be folded back down when you need the extra space
in the apartment. Consumers like the features we provide. Large manufacturers
aren’t paying attention to such minor details.

Speed is also important; you win the hearts of consumers by satisfying their
needs in the quickest manner possible. In the United States, we also sell wine
storage cabinets. A large international manufacturer would spend 18 months
developing a new wine storage cabinet, but for Haier it took only 5 months.
Because we can identify and meet consumer needs quickly, we have won more
than 50 percent of the total US market; Haier made 55,000 of the 100,000 units
sold last year. Usually, those large appliance manufacturers are not as flexible,
so their response to the market is slower. This is why we can compete with
them.

The Quarterly: But compact refrigerators and wine storage units are niche
products. Will this approach work for penetrating larger and more established
white-goods markets, such as those for full-sized refrigerators and washing
machines?

Zhang Ruimin: Our strategy for selling large refrigerators is the same as for
compact refrigerators. For example, we send our R&D people to the United
States to talk directly with our customers or even with the salespeople in chain
stores to find out their specific needs. Our products for the United States are
produced locally in the United States, which means we have people do design
and production locally. This combination of understanding the consumers’ specific
needs and designing and producing goods locally means we can satisfy customer
demand in the quickest manner. This year, products from our factory in South
Carolina have features you could never find in competitors’ products. We’ve
already produced some new models of full-sized refrigerators and have placed
prototypes in the market for testing.

We are only beginning to compete in the market for full-sized refrigerators. Last
year, total sales of full-sized refrigerators in the United States were 4,470,000
units. Haier sold 80,000 units, which was only 2 percent of the market. So to
achieve our objective of a 10 percent market share in 2005, we need an output
of 500,000 units. The production capacity of our factory in South Carolina is
400,000 units a year, though we have plans to expand, so the difference will be
met by exports from China.




The Quarterly: You have also diversified quickly. How pleased are you with your
diversification efforts to date, and what are your plans going forward?

Zhang Ruimin: Diversification is still a controversial topic in China. Some people
say companies shouldn’t diversify, because some manufacturers that were very
good in the past died after they diversified. But at Haier we offer a lot of
products like refrigerators, air conditioners, washing machines, TVs, and cell
phones. We feel that from the consumer’s perspective it’s not diversification but
rather specialization. The target customer group for all these products is one and
the same. For example, a consumer satisfied with a refrigerator from Haier is
more likely to buy related products from us, too, such as washing machines or
air conditioners.

This year we’ll put more attention and effort into developing our cell phone and
plasma-TV businesses. Take cell phones. We lack a technological advantage
compared with internationally famous cell phone manufacturers like Nokia. So we
have to think about how to differentiate our products from those of our
competitors. We are introducing cell phones with features such as a laser pen for
presentations, and voice-recording functions. We’ve applied for a patent for the
design of this particular cell phone.

‘Haier’s advantage is in white appliances, where we’re currently ranked number
five in the world. Our objective is...number three’

Success in diversification depends upon the ability to execute in each new area.
But there are limits. So, for instance, if Haier decided to make a car, consumers
probably wouldn’t trust it in the way they trust our refrigerators. Haier’s
advantage is in white appliances, where we’re currently ranked number five in
the world. Our objective is to push that to number three. The emphasis of our
diversification would continue to be consumer electronics, leveraging the synergy
of our customer base.

The Quarterly: How do you manage the cost of rapid product innovation? For
instance, you are making refrigerators for the US market in the United States,
where you don’t have a labor cost advantage.

Zhang Ruimin: Of course, labor costs are much higher in the United States than
they are in China. They can be ten times higher. But our strategy in the US
market is not to manufacture cheap products, take them out of the factory, and
push them into the market. We intend to manufacture quality products that we
can sell at a premium.

In terms of production, we are trying to analyze customer groups and
understand their needs thoroughly so as to provide specific products for each
distributor or customer. For instance, we have to analyze Wal-Mart’s customer
groups to understand the kinds of products consumers want to buy from Wal-
Mart. And we have to look at Carrefour’s customer groups and the customer
groups for big shopping centers in Beijing. In China, we make a wide range of
products in small production lots for a retailer like Carrefour. The retailer wants
to offer products with a variety of features. To manage the costs of
manufacturing our many different product models, our products are based on
modules of components and subsystems and on basic platforms that we can
vary. Periodically, we will add some new features, but the basic model is there.
We don’t change them randomly.

The Quarterly: Your company is growing very quickly. How can you keep that
speed as you get bigger and bigger?

Zhang Ruimin: At Haier, every person has a market and each has an objective
for that market. This allows us to convert external market competition into a kind
of internal competition. For example, a worker in the R&D department
responsible for designing products is rewarded not on how attractive these
products are but on how they sell in the market. If we have a product with a
break-even point of 30,000 units and sales outperform that level, then the
designer will earn a bonus from the profits earned.

To institutionalize this approach, in each department we introduced a new term,
the "resource passbook." This passbook has two columns: one for income, one
for expenses. So for a product design employee, say, the income column
contains the total amount that the employee’s products have earned from the
market. The expense column is the total amount put into developing these
products. So in the end, if you have sold only 10,000 units, the other 20,000 will
be recorded as an expense in this passbook. We will not require the employee to
pay this money immediately. The loss is carried over. Instead, in the future, if
the employee designs another product that sells well, then the surplus from that
product will be used to compensate for the losses on past products.

Let me give you another example of how each employee has a market. We have
a buyer in our logistics department responsible for purchasing steel for the whole
group. Every year, our total consumption of steel is more than 100,000 tons. At
the beginning of the year, we negotiate a steel price with the buyer. Throughout
that year, the price of steel cannot exceed the price we agreed on during the
negotiations at the beginning of the year. So the buyer has to think about how to
reduce that price, and then the reduced amount will be converted into a bonus
for him. Because the price of steel in the Chinese market went up last year, the
buyer had to do a lot of research to find substitute materials. He finally
succeeded and received a bonus at the end of the year.

The Quarterly: What other managerial innovations have you adopted to keep
your employees’ attention focused on market factors?

‘In the past, the responsibility was placed entirely on the department head, but
the responsibility is now distributed among everyone’

Zhang Ruimin: Most companies have three financial statements—a balance
sheet, a profit-and-loss statement, and a cash flow statement. At Haier, every
person has to prepare his or her own three statements. For example,
remuneration will be related to an employee’s market performance compared
with that of others within Haier. In the past, the responsibility was placed
entirely on the department head, but the responsibility is now distributed among
everyone in a department. Instead of having a director with three financial
statements, all employees must have three statements for themselves. In this
way, the performance of each person can be judged.

We pay close attention to new management styles around the world. We hope to
introduce them in a constructive manner, but we have to analyze how to make
the best use of them.

The Quarterly: What issue do you spend the most time thinking about?

Zhang Ruimin: The question I think about almost every day is how to avoid the
disadvantages of a large enterprise. In large companies, sometimes people don’t
notice a problem until it has gone beyond being solvable. To avoid this, we have
to consider how to make every person respond very quickly to the market. We
are trying to make each employee at Haier work like an SBU, a strategic
business unit. This way, pressure from the market is the driver of our
development. I don’t want Haier to become like the Titanic. I want everyone to
share responsibility with the captain instead of the captain bearing the