Western companies failing in China

Companies entering foreign markets can make large mistakes by not adjusting sufficiently to the local environment. This is especially the case with Western companies entering China, because the cultural gap is large. This note will focus on failures relating to strategy.

Failures in China

I will focus on China, but the same arguments can be made for any two countries, between which the cultural gap is sufficiently large. Business history is full of companies entering foreign markets without doing the necessary homework before entering. Many companies assume that replicating the home country strategy abroad will lead to success. A few examples from recent years:

• In the late 1990s, Kodak entered China. The idea was to sell photographic film under the assumptions that the Chinese would not adopt digital photography for another decade. It turned out that the Chinese were not far behind other countries in adopting digital cameras.
• Ebay largely exited China in 2006. Ebay did not understand the Chinese customer as well as the local company Alibaba.
• Home Depot closed all its big, do-it-yourself stores in 2011. The Chinese owning their property were not into home improvement projects and, no surprise, those not owning their property were even less interested. Currently, Home Depot has two speciality stores selling products to tradesmen. 
• Best Buy closed its eleven big stores in 2011. Five Star, an acquired Chinese company, with small stores with in smaller cities, has been successful.
• Mattel  opened a six-floor store in Shanghai, but closed it in 2011. Chinese parents were not too happy letting the Barbie doll be a role model for their daughters, at least not the expensive version produced by Mattel.
• Revlon is closing down its cosmetics business in China in 2014. 

Unfortunately, we do not know how well the average foreign company is doing in China. Everyone would agree that it is a tough market, but just how tough is impossible to tell. Most companies do not provide any financial information about their Chinese operations. It is probably not because they are making a lot of money in China.

There are two different factors explaining the failure of these companies. First, the companies have not understood the cultural differences between their home country and China. Second, the companies have not understand the industry structure and competitive positioning in China. It is often difficult for an outsider to determine which of the two factors is the most important in each case. In fact, the two factors are often interrelated. Surprisingly often, companies fail to understand that the industry structure and competitive positioning in a foreign country is different. A good analyst can still understand the differences, but most managers are not good analysts.

The problem is exacerbated with some large US companies still largely staffed with American executives without Asian experience. European companies are also at risk, but due to the smaller home market they might be a bit more attuned to a foreign country being different.

Niche strategy for beginners

It is generally not possible for a foreign company to use the same strategy in China as in the home market. The realisation that the foreign company starts with 0% market share means that any industry-wide strategy is unrealistic in most situations. The obvious strategy of choice is the niche strategy. Unfortunately, it has taken years and millions of dollars before some companies made this simple realisation. It is so difficult for a large multinational to be humble and realise that they start from scratch in China.

Even after a niche strategy has been chosen, further adaptations are needed for the strategy to work. When Home Depot closed down its US-style stores, it kept two smaller stores targeting tradesmen. That was a suitable adaptation to the Chinese market. Some companies are lucky in that they only have to do smaller changes to their home country strategy. McDonalds has almost an identical offering in China as in the home country (as well as most of the world). They have not tried to adjust their food menu to Chinese customers. Instead they appeal to the Chinese customers that would like to have a hamburger meal. The companies listed above faired less well. Without market research, it is difficult to know whether a strategy will require small or large adaptations. 

Differentiation strategy for the ambitious

Companies have different aspiration levels with their China strategy. Some companies are happy with a more modest goal, while others have more ambitious long term goals. Yum Brands entered the Chinese market with the KFC brand of fast food restaurants in the late 1980s. After more than ten years in the country with some success, the company decided to change from a niche strategy to a differentiation strategy. It began a long process of localising the food menu. The result has been spectacularly successful. KFC in now the largest fast food restaurant chain in China. The market share is above 20% of chain fast food sales in China. To be able to serve small cities, KFC has invested heavily in the upstream supply chain. This has given them a core competence in opening new restaurant outlets in both small and large Chinese cities.

Many companies make it difficult to grow in China because they are unwilling to deviate too much from their home country strategy. The most well-known trade-off described in the international management literature is the one between global integration and local responsiveness. It is especially hard for companies with a global integration strategy be flexible enough.

Low cost strategy for the fool hearty
It is unlikely that a Western company would have a major success with a low-cost strategy in China; it cost position would simply be too high.