After China's decade of economic boom, companies in the nation now need to boost productivity to stay competitive. What must they do to succeed?
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Rethinking profitable growth - the productivity imperative for foreign multinationals in china
1. Rethinking profitable growth
The productivity imperative for
foreign multinationals in China
September 2012
Page 0 Rethinking profitable growth
2. Our view
In the business environment that is now emerging
in China, companies have an increasingly urgent
need to raise productivity if they are to maintain
profitable growth.
A detailed look at productivity
► Rethinking profitable growth is part of a major
program of research on productivity in China
► Ernst & Young and the Economist Intelligence Unit
(EIU) surveyed C-suite and senior managers from
over 200 foreign multinational corporations in
China between March and May 2012
Page 1 Rethinking profitable growth
3. Foreign multinationals remain profitable …
For the last full financial year, what was your company’s approximate
EBITDA margin? • 97 percent of
foreign
multinationals
Overall 3% 49% 39% 9% reported positive
profitability
Company’s number of years in China • Time in China was
a key determinant
Less than 5 years 13% 50% 31% 6% of profitability
5%
• Services industries
5-10 years 7% 51% 37% proved more
profitable,
suggesting that the
More than 10 years 48% 41% 11% shift toward a more
services-driven
By sector growth model has
already started to
Industrials 3% happen
53% 38% 7%
Services 4% 41% 41% 14%
Negative Less than 10 percent 10 to 20 percent Over 20 percent
Source: Ernst & Young; Economist Intelligence Unit.
Page 2 Rethinking profitable growth
4. … but past performance is no guarantee of
future success
How does your company’s current EBITDA margin compare to two years ago? • 59 percent of
respondents in
the
Manufacturing 59% 24% 18% manufacturing
sector reported
Information technology 50% 27% 23% decreasing
margins
compared to two
Professional services 45% 36% 18% years ago
Chemicals 40% 28% 32% • IT, professional
services, and
chemicals have
Retailing 33% 13% 53% not done well,
suggesting a
Consumer goods 30% 20% 50% relative decline
in overall
Telecommunications 27% 33% 40% corporate
demand and in
industrial activity
Healthcare 20% 45% 35%
• Retailing is a
strong
performer,
Overall 35% 29% 36% followed closely
by consumer
The margin has decreased The margin has stayed roughly the same The margin has increased goods
Source: Ernst & Young; Economist Intelligence Unit.
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5. What’s different now?
• China’s export growth has slowed significantly since 2010
Export growth by geography
Europe North America
100%
year-on-year growth
80%
60%
40%
20%
0%
-20%
-40%
2007 2008 2009 2010 2011 2012 2007 2008 2009 2010 2011 2012
Asia Other
100%
year-on-year growth
80%
60%
40%
20%
0%
-20%
-40%
2007 2008 2009 2010 2011 2012 2007 2008 2009 2010 2011 2012
Source: General Administration of Customs, Ernst & Young analysis.
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6. What’s different now?
• Productivity growth has
Accounting for China’s growth fallen
16% • Earlier rounds of market
liberalization and
privatization have largely
14%
run their course
12% • The mass reallocation of
labor from low productivity
6.9 agriculture to higher
10%
6.8 productivity manufacturing
is coming to an end
8% 6.3 0.2
5.6 6.9 • The size of China’s
4.7 6.5 0.2
4.3 6.8 workforce will begin a long-
6% 7.0
0.2 term decline from 2015
0.3 0.3
4%
0.5
0.3 0.2 • Very rapid growth in capital
7.2 0.1 stock without productivity
5.8 0.2
4.8 growth leads to a decine in
2% 3.5 4.1 4.1 3.5
3.3 2.7 capital efficiency, and
2.1 eventually inhibits growth
0%
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Total factor productivity Labor Capital GDP growth
Source: National Bureau of Statistics; Ernst & Young analysis.
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7. Productivity is firmly on the government
agenda
12th five-year plan targets
2010 2015
26,810 80.9
10.3%
10,109
7.0% 68.0 2.20
1.75
GDP growth Urban disposable income (CNY) Energy consumption per GDP R&D as percentage of GDP
(TCE/CNY millions)
47.0%
43.0% 1,603 8.33
6.91 8.0%
870
3.0%
Service sector value-added Minimum wage standard (CNY) Carbon emissions (billion tonnes) Strategic emerging industries as
output as percentage of GDP percentage of GDP
Growth Labor Resources Innovation
Government
• Lower growth, but more efficient and • Raise urban disposable • Increase carbon and energy • Movement up the value
sustainable income efficiency chain for the entire
economy
• Shift away from capital-intensive • Gradual increase in social • Reduce water and land use
industrial production welfare benefits and minimum per unit of GDP • Supported by an increase
wage in R&D spending
•
Companies
• Move to targeted, efficient growth • Pressure to boost labor • Pressure to boost resource • Incentives for innovation
productivity efficiency
Source: National Bureau of Statistics; Ministry of Human Resources and Social Security; Xinhua; Reuters; Ernst & Young analysis.
Page 6 Rethinking profitable growth
8. Companies overwhelmingly acknowledge the
importance of productivity
Has the importance of improving productivity increased in the
past two years?
• Nine out of ten respondents
said that the importance of
Yes 91%
improving productivity has
increased in the past two
No 9%
years
How important is increasing productivity to your company’s
performance in the next 1-3 years?
• 84 percent said productivity
is either “extremely” or “very”
important to business
Extremely important 26%
performance in the next 1-3
years
Very important 58%
Somewhat important 16%
A little important 0.5%
Not at all important 0%
Source: Ernst & Young; Economist Intelligence Unit.
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9. A focus on profitable growth
• Foreign multinationals are focused capturing growth segments in the China market with targeted products
and services whilst reducing inputs for every dollar of revenue generated
What areas could have the most impact on company profitability in the next 24 months?
Introduction of new and better products/services 47%
Increased productivity 35%
Restructuring of current operations 33%
Hiring of new talent/management of existing talent 29%
Increased focus on research and development 24%
More sophisticated pricing management 23%
Better use of outsourcing/subcontracting 21%
Geographic expansion into new/more profitable markets 18%
Exit from certain less attractive markets 16%
Undertaking mergers and acquisitions 8%
Respondents were asked to choose up to three.
Source: Ernst & Young; Economist Intelligence Unit.
Page 8 Rethinking profitable growth
10. Companies are already feeling the pressure
What drivers are having the most impact on your company’s
overall cost structure and profitability?
Labor costs 50% • The current
environment is
Exchange rate movements 32% characterized by rising
cost pressure,
Commodity costs 27% intensifying
competition, and
continuing volatility in
Competition from domestic 27% global markets
companies
Cost of capital 22%
Competition from foreign 22% • Foreign multinationals’
companies concerns about labor
and commodity costs
Energy costs 22%
reflect what has been
happening in the
Regulatory costs 21% market
Reduced demand 19%
Rising input costs
Other, please specify 2%
Respondents were asked to choose up to three.
Source: Ernst & Young; Economist Intelligence Unit.
Page 9 Rethinking profitable growth
11. Companies are already feeling the pressure
Weighted cost indices, China domestic
(Jan 2007=100%)
220% Cost increases
200% since 2007
180%
160%
100%
Labor
140%
120%
77%
100% Energy
80%
60% 19%
Metals
40%
20%
60%
0% Soft commodities
2007 2008 2009 2010 2011
Labor Soft commodities Metals Energy
Source: National Bureau of Statistics; National Development and Reform Commission; United States Department of Agriculture; United States Geological
Survey; BP Statistical Review of World Energy; Ernst & Young analysis.
Page 10 Rethinking profitable growth
12. We expect these cost increases to continue
► The roll out of mandatory employer social welfare contributions,
1
Labor accompanied by government targets to increase the minimum wage,
rising expectations from employees, and the increasing cost of living, will
undoubtedly put continuous upward pressure on labor costs
► The price of commodities, generally lower in China than globally, will also
continue to rise in the medium term as the Chinese government removes
2 Commodities administrative controls. Commodities prices are likely to remain volatile,
and will be subject to spikes and sharp corrections depending on global
conditions
► Volatility in global markets itself also imposes a significant cost upon
3 Volatility companies, who must hedge against uncertain movements in prices.
These costs especially impact on firms that source components and
raw materials internationally
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13. Nowhere to pass on costs
What percentage of rising costs do you expect your company to be able to
pass on to your customers?
• 85 percent of
None or very little 43% respondents expect
they can pass on at
Less than 33 percent 42% most a third of rising
costs to the final
Between 33 to 66 percent 12% customer. There was
remarkably little
More than 66 percent 3% variation between
industries in the extent
All 1% to which they could
pass on rising costs
Source: Ernst & Young; Economist Intelligence Unit.
Input/output price growth ratio, manufacturing • In manufacturing, for
example, input prices
115.00 have consistently risen
110.00 faster than output
prices. The gap
105.00 between the two has
increased from an
100.00 average of 4.5 percent
in 2009 to 10.0 percent
95.00 in 2011
2008 2009 2010 2011
Source: National Bureau of Statistics, Ernst & Young analysis.
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14. Case Study: McDonald’s
Balancing rising costs and service standards
McDonald’s also monitors the external
The cost of food, utilities, and occupancy all environment to gauge customers’
impact McDonald’s profit in China, but it is the expectations around level of service and at
cost of labor which has emerged as the what price points. Year-on-year, the company
leading consideration. McDonald’s staff have is only able to recover a fraction of rising
seen their real wages rise steadily throughout input costs through pricing. Like many of its
the past decade, culminating in a 15-17 competitors in the fast food industry, it has
percent increase in 2011. had to keep its annual price adjustment to low
single digits.
For McDonald’s, the balance between rising costs and
maintaining standards of customer service lies in
productivity improvements.
“The main driver of success for us has always been our ability to run our
restaurants efficiently – the number of customers served per hour of labor.”
-- Dan March, CEO of McDonald’s China
Page 13 Rethinking profitable growth
15. Concern about operating model alignment
• 64 percent of
Please indicate your level of agreement with the following statements. respondents agreed
Please indicate your level of agreement with the following statements. that their company’s
operating model
Our company’s current operating model impairs our competitiveness. impaired their
competitiveness
36% 28% 21% 14% 3%
• Productivity should
be understood in its
widest sense –
improving
Our company’s operating model does not allow us to keep pace with rapid growth. processes and
organization within
23% 37% 21% 16% 4% a business
• This requires a
competitive
We need to overhaul our organizational structure in China to tap new opportunities. operating model
suited to the fast
19% 43% 29% 8% 2% pace of the
domestic
environment in
China
Strongly agree Agree Neither agree or disagree Disagree Strongly disagree
Source: Ernst & Young; Economist Intelligence Unit.
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16. More productivity gains will come from
front office
• operations (45 percent), and
In your opinion, which functional areas in your company offer the marketing and sales (37
most scope for productivity improvements over the next 24 months? percent) are the two
functional areas that offered
the most scope for
productivity improvements
Operations 45%
Marketing and sales 37%
• These two areas are also
traditionally the biggest in
Research and terms of cost, where
development 23% productivity initiatives
usually have the biggest
Finance 21% impact.
IT 16% • many foreign multinationals
have already achieved
Customer service 14% gains from back office
initiatives, and it seems that
HR 6% they are new moving the
focus of performance
Other, please specify 1% improvement programs to
the front office
Respondents were asked to choose up to two.
Source: Ernst & Young; Economist Intelligence Unit.
Page 15 Rethinking profitable growth
17. Case Study: Li & Fung
Moving the productivity focus to front office
Introduced tablet computers
to the company’s sales force
Shared service center model:
to increase their effectiveness
centralizing finance, human
and efficiency.
resources, and IT functions to
reduce back office costs per unit
of output.
Conduct more business
Move the productivity
online, both for its obvious focus from back
cost advantages, and to office to sales and
access the vast online marketing.
Many support services are population in China.
concentrated in Nanjing, where
labor costs are relatively cheaper
than first tier cities like Beijing or
Shanghai.
Experiment with selling
account services to its
existing customers.
“For the next few years, technology is what we will focus on, because
outsourcing and shared services has been a model which we’ve been using
for many years. ”
-- Herman So, Executive Vice President of Finance at Li & Fung
Page 16 Rethinking profitable growth
18. A failure to capitalize on information
technology
Has your company adopted any of the following methods to increase
productivity?
• Given the potential, a
Workforce mobility tools 40% surprisingly low number of
foreign multinationals
have adopted IT initiatives
CRM systems 39% to drive productivity. More
needs to be done to
capitalize on IT
Cloud computing services 37% investments already
made in core business
systems such as
Data center capacity 33% enterprise resource
planning
Supply chain management systems 30%
Enterprise resource planning tools 30% • Examples of Information
technology enabler:
Mobile internet and e-
Staff collaboration tools 23% commerce, cloud
computing, and data
analytics
Data analytics 15%
Source: Ernst & Young; Economist Intelligence Unit.
Page 17 Rethinking profitable growth
19. Case Study: Cisco
Time to capitalize on IT
The company employs common
productivity metrics globally, and
tries to limit administrative
complexity – for example by
simplifying its legal entity structure.
TelePresence is a collaboration
platform developed by Cisco to
It sees great potential in cloud
help geographically dispersed
computing to raise utilization
organizations overcome physical
rates while slashing IT costs by
barriers, and cut down on
20 percent or more.
travelling costs.
Capitalize on IT to reduce costs and increase productivity.
“Cisco is in the business of selling productivity tools, but we’re also a primary
user of the same technology – often before it goes to market.”
-- Michael Foy, Finance Director of Cisco China
Page 18 Rethinking profitable growth
20. Barriers to improve productivity
What barriers are most likely to hamper your organization’s efforts to improve
productivity?
Shortage of labor or management talent
30%
Inappropriate business model 29%
Unclear accountability 25%
Lack of communication between management
and workforce 25%
Overly centralized control by home country
headquarters
23%
Excessive government 20%
regulation
Lack of access to up-to-date productivity 15%
information
Incompatible information systems 14%
Other 3%
Respondents were asked to choose up to three.
Source: Ernst & Young; Economist Intelligence Unit.
Page 19 Rethinking profitable growth
21. The top 5 productivity initiatives among top-
performing MNCs:
Has your company adopted any of the following methods to increase productivity?
49%
Business unit strategy reviews
32%
Improved people development and 48%
management 39%
45%
Cost reduction programs
29%
38%
Enterprise resource planning tools
24%
Greater autonomy for regional or
33%
country management from
global/regional headquarters 18%
Source: Ernst & Young; Economist Intelligence Unit. High performers Others
Page 20 Rethinking profitable growth
22. Case Study: Ford
Raising productivity on many fronts
Within each business unit and
region, Ford assesses
performance against its peers
around the world.
The company continues to invest
in training and development to
accelerate labor productivity in its
Raise productivity and aim
relatively young workforce. for global best practice.
Globally consolidated functions
work across geographies in a
matrix structure.
“You have to look at every cost element, to pay attention to every line on the
income statement. You need to balance the global capacity to share assets,
ideas, and technologies, with an in-depth knowledge of local business and
employee practices. ”
-- John Lawler, CFO of Ford Asia-Pacific & Africa
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23. Five lessons for foreign multinationals
► Companies should adopt strategic, cross-functional approaches to raise
productivity across the organization
1 Productivity as a
strategic imperative
►
►
A strategy with focus and clarity is needed to avoid complexity and
wasted effort
Companies should prioritize operational improvement initiatives that drive
productivity improvements and allocate resources accordingly
► Local autonomy needs to be balanced with a strong risk and controls
framework
Operating model
2
► Companies should pursue opportunities for active mergers and
alignment acquisition activities in China in order to increase local market presence
► opportunity to collaborate should be better explored
► Prioritizing locally initiated cost management programs enables
management to deliver on bottom line commitments and retain more
Proactive cost
3 management
►
control
Processes ought to be streamlined and non-core functions outsourced,
while making sure that core information and expertise is retained
► Increase efficiency and flexibility of core business processes with
sophisticated techniques such as identifying cost drivers and using
analytics techniques to target cost areas
Page 22 Rethinking profitable growth
24. Five lessons for foreign multinationals
(continued)
► Management should do more to capitalize on information technology
investments
Driving business value
4 from information
technology
►
►
Improve the level of compliance, ensuring workarounds are minimized
and all users are using the IT system as they are supposed to
leverage the data generated by the IT system through the use of
business analytics and customer relationship management (CRM) tools
to improve their operational efficiency, more closely target customers,
and better predict outcomes and risks
► Boost the productivity of their employees through innovative ways to
5
Enhancing people incentivize staff, and transforming process flows so as to reduce physical
development and technical barriers between employees
► Effective managers should possess balanced management skills and
sales ability, as well as the ability to manage every aspect of the P&L.
► The focus of training programs ought to put a greater emphasis on
productivity topics such as reengineering business processes, reducing
costs, and improving sales effectiveness
Page 23 Rethinking profitable growth
25. Questions for management
► How well are you doing against industry and internal peers?
► Do you know how the major drivers of margin are trending in your industry
► What actions are you taking to boost productivity?
► Are there any short term cost reduction initiatives?
► Have you started to think about the longer term operational improvements that can be made?
► Does your company have the governance structures in place to enable productivity
improvement?
► Does your company have the capability for sustained productivity gains to match long-term
cost increases?
Page 24 Rethinking profitable growth
27. Survey respondent demographics
Global revenues Headquarters by country
17%
$500 million or less
10% 41% Europe
$500 million to $1 billion
24%
$1 billion to $5 billion
11% $5 billion to $10 billion 31% North America
37% $10 billion or more
27% Asia-Pacific
1% Other
Page 26 Rethinking profitable growth
28. Survey respondent demographics
Industry Job title
5%
Board member
13% Chemicals
11% CEO
Manufacturing 29% President
Managing Director
11%
Information technology
5% CFO/Treasurer
10%
Consumer goods 4% Other C-level executive
10% Healthcare, pharmaceuticals and
biotechnology
7%
Professional services
40% Senior Vice President
7%
Retailing Vice President
7% Director
Telecommunications
7%
Construction and real estate
6% Energy and natural resources 4% Head of business unit
4%
Financial services Head of department
6% 12%
Other
Page 27 Rethinking profitable growth
29. China still has a long way to go when it
comes to productivity
World technological frontier, 2010
90
80
United States Japan
70
60
thousands USD/worker
United Kingdom
Labor productivity
Inset
France Germany 8
50
Australia
7
Peru Colombia
Canada Italy
40 6 Egypt Romani
a
Morocco
South Korea 5
Thailand
30 Philippines
Spain 4
Indonesi
China, 2010
Poland Argentina 3 a
India
20 Malaysia Turkey
2
Mexico China, 2001
Venezuela, RB 1
10 Vietnam
Brazil 0 Bangladesh
South Africa
China 0 5 10 15 20
0
0 50 100 150 200 250
Capital intensity (K/L)
Source: World Bank, Ernst & Young analysis. thousands USD/worker
Page 28 Rethinking profitable growth