China’s Outbound Direct Investment (ODI) has been increasing sharply and is likely to continue this trend in the coming year. The ODI structure is concentrated in Asia and is currently oriented towards natural resources, although there may be some diversification in the future. From a long-term perspective, Chinese companies should consider three key factors when investing in foreign markets: exploit market opportunity; accelerate technical and business skill evolution and improve the overall risk or opportunity profile. Although expanding into new markets is a complex process, there are many lessons that Chinese companies could learn from other countries. This could help them to successfully manage the process by addressing critical issues. By Enrico Lanzavecchia, director, and Claire Zhong, manager at Value Partners, Beijing.

1. PERSPECTIVE
Key drivers and success factors for Chinese companies
investing abroad
China’s Outbound Direct Investment (ODI) has been increasing sharply and is likely to continue
Enrico Lanzavecchia this trend in the coming year. The ODI structure is concentrated in Asia and is currently oriented
Director towards natural resources, although there may be some diversification in the future. From a
long-term perspective, Chinese companies should consider three key factors when investing in
foreign markets: exploit market opportunity; accelerate technical and business skill evolution
Claire Zhong
and improve the overall risk or opportunity profile. Although expanding into new markets is
Manager
a complex process, there are many lessons that Chinese companies could learn from other
countries. This could help them to successfully manage the process by addressing critical issues
China’s Outbound Direct Investment (ODI) increases sharply
A consistent growth of current account surplus has accumulated huge assets for both foreign currency reserve
and outbound investment. Under the macro scenario, that China growth model is changing – and the Chinese
government has strongly supported Chinese companies who want to invest internationally through a series of
policy incentives. China’s ODI has been increasing sharply, with a narrowing gap between ODI and Foreign Direct
Investment (FDI).
Chinese Outbound Direct Investment increases sharply
China current account surplus evolution China ODI, FDI and outbound M&A evolution
ODI
CAGR ‘03-’08
US$ billion US$ billion FDI
Outbound M&A
100 CAGR ‘03-’08
450 56% 92
426 • Sharp
400 372 75 decrease
80 due to
financial
350 66 crisis
61 60
300 253 60 54
52 12%
250
43
200 161 40
27
150 26
21
69 20 78%
100 12 12*
46 6 8 6
50 3 7
3** 3* 121%
0
0 2003 2004 2005 2006 2007 2008 1H2009
2003 2004 2005 2006 2007 2008
% of
outbound 17% 45% 53% 39% 24% 50% 22%
M&A vs.
ODI
* 1H2009 ODI data not include outbound investment for financial sectors; M&A data is from Merger Market database
** 2004 Outbound M&A data is calculated based on growth trends between 2003 and 2005
Source: Ministry of Commerce, Sate Administration of Foreign Exchange; Statistic Bureau, Value Partners analysis
However, China’s ODI still represents a much smaller fraction of its GDP than in other countries. By 2007, China’s
cumulative ODI was only 3% of its GDP, while for the same period, the UK’s ODI was 61.5%, France’s 54.7%,
Germany’s 37.3% and the USA’s, 20.2%. Such a low ODI reflects the fact that Chinese companies still rely heavily
on the domestic market, as well as on the natural resources sector. Going forward, along with GDP growth and the
globalization of Chinese companies, there is huge potential for an increase in Chinese ODI.
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2. PERSPECTIVE
In terms of ODI geographical and industrial structure, Chinese companies used to rely on nearby countries, where
they could leverage an established supply chain and familiarity with local markets. A shift to North America and
Europe, though, indicates that they are now looking to mature markets for new opportunities and business
capabilities. Competing for natural resources has consistently been the main theme of China’s ODI, and this
activity has traditionally been conducted by huge state-owned enterprises (SOEs). Since 2006, Chinese financial
institutions have started to aggressively purchase overseas assets. This is due to a rapid growth in the financial
industry, with huge funding capability following the spin off of Non Performing Loans (NPL).
So far a large share of China’S ODI flow has been concentrated geographically in Asia and oriented towards natural
resources and commercial services
ODI distribution by regions ODI distribution by industry sectors
100% 100% 100% 100% 100% 100% 100% 100% 100% 100%
1% Asia Energy &
1% 2% 2% 3% 5% 4%
2% 1% Latin America* 10% 6% 9% mining
2% 3% 3% 4%
5% 4% Commercial
3% 3% 3% 6% Africa
3% 3% 22% 19% 8% service**
6% Europe 14%
6% 17% Financial
6%
North America service
18% Manuafcturing
36% 32% 48% Oceania
53% Other sectors
26%
44% 33%
63% 61%
63%
53% 55%
43% 48%
36% 40%
33%
14% 15%
2003 2004 2005 2006 2007 2003 2004 2005 2006 2007
• Possible over count % of Asia and LA, because companies report
the first stop of investment (HK or Tax heaven) instead of destination
*: Mostly to Cayman Iland or BVI **: including wholesale& retail trde, transport Source: MOFCOM, Value Partners a nalysis
An analysis of the outbound M&As of Chinese companies shows that, since 2005, 85% of the large deals have
been strategically motivated. Among the strategic outbound M&A deals, 70% are aimed at acquiring natural
resources and entering new markets.
Up to now, important drivers for Chinese companies going abroad are entering new market and gaining access to
natural resources
US$ billion, Jan. 2005 - Aug. 2009
No. of outbound M&A with deal size over US$ 10 million • Seems to show that Chinese
companies tend to adopt
defensive strategy in outbound
122 18 M&As
15% 104 37
30%
100%
34
85%
28%
21
17% 12
10%
Total Finance Strategic Access to Access to Access to Access to
resources new skill/tech. product
markets facilities
Deal Value 85.0 8.1 76.9 46.2 11.8 13.2 5.8
Top 3 countries •Hong Kong •Hong Kong •Hong Kong •Australia •Hong Kong •Hong Kong •Hong Kong
•Australia •USA •Australia •Canada •Singapore •USA •Canada
(by Deal No.) •Indonesia
•Canada •Canada •USA •USA •UK •Vietnam
Top 3 sectors (by •Energy •Finance •Energy •Energy •Finance •Finance •Mining
Deal No.) •Mining •Energy •Mining •Mining •Industrial •Industrial •Consumer
•Finance •Media •Industrial •Industrial products products •IT
products products •Energy •Telecom
Source: Merger Markets, Value Partners analysis
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3. PERSPECTIVE
If the ODI structure of Japan and Korea is compared to that of China, what is apparent is that Japan has shifted
away from Asia and now invests more heavily in North America, Europe and Latin America – and that nearly 80%
of ODI has been devoted to the financial and manufacturing sectors. Korea also invests considerably in the Middle
East and Latin America, and is more focused on manufacturing, trade and mining. Based on this, it is expected that
China’s ODI is likely to see greater diversification in both regions and sector structure.
Three key drivers to foreign investment for Chinese companies
Exploit market opportunities
Chinese companies are sustaining a relatively favorable economic performance despite the financial crisis. While
developed countries and regions such as the United States and Europe are experiencing negative economic growth,
China is expected to maintain a GDP growth rate of 8%. According to a forecast by the International Monetary Fund
(IMF), China’s contribution to the rate of global economic growth will increase from 29.9% in 2008 to 46.4% in
2009.
The stock market capitalizations of developed countries, affected by the recent economic downturn, have been
reduced by more than 15%, compared to pre-crisis figures. Bank credit was reduced by a similar amount. Foreign
companies have difficulties in obtaining financing from both capital market and bank loans, leading to a strong
need for the injection of capital. Foreign companies are also interested in working with Chinese partners because of
their interest in the Chinese market. As Dr. Tadao Kasahara, CEO of MSK, commented about Suntech’s acquisition of
MSK, one of Japan’s largest photovoltaic (PV) manufacturers: “As a subsidiary of Suntech, MSK will be able to access
Suntech’s support in terms of advanced PV cell/module products and cost competitiveness, financial resources,
and distribution channels, as well as have the possibility of pioneering BIPV applications in the Chinese market.’’
Generally speaking, foreign markets are attractive, not least because their consumption expenditure levels are
much higher than China’s. If evaluated by consumption expenditure, the Chinese purchase capability per capita
is significantly lower than that of developed countries. According to UN statistics, in 2008, Chinese household
consumption expenditure per capita was US$ 1,030, while in the same period, American expenditure was US$
32,564 and Japan’s US$ 21,747. Even taking into account that Chinese first and second tier cities have a higher than
average expenditure, there is still a big gap compared to developed countries. This creates significant potential for
Chinese companies in terms of both market size and margin.
Accelerate technical/business skill evolution
If we consider the intellectual property figures of its main industries as a guide to its technological development
level, China still has a long way to go to catch up with developed countries. In 2007, for example, the number of
effective patents per 100,000 inhabitants for the Chinese mainland was 22, while Korea had 1,170, Japan 968, and
the United States, 593.
Large Chinese companies have already committed significant technology investment abroad. For example,
Huawei has established its R&D centres in Silicon Valley, California, and in Bangalore, India, and hired thousands of
local experts in those centres. These decisions have played a crucial role in helping Huawei keep abreast of cutting-
edge overseas technologies and product development. This strategy has allowed the company to minimize its time
spent catching up with competitors and fully seize the rapidly changing opportunities in international markets.
Some Chinese SMEs have leveraged overseas technology investment to upgrade their market positioning.
Pearl River Piano acquired, for instance, the R&D centre of Rudisheimer, obtaining its advanced technology in piano
manufacturing and gaining a 40% market share of the US vertical pianos segment. It later acquired the R&D centre
of Herman Miller in the US and further expanded its market share by leveraging its techniques in baby grand
pianos, a piano design in line with modern American furniture styles.
For most Chinese enterprises, expanding in the global value chain is a shortcut to gaining complementary business
skills. They could obtain an advanced overseas R&D centre, leveraging the local high-tech incubator to accelerate
innovation, or develop a global brand to enhance their anti-risk capability and profitability. Similarly, they could
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4. PERSPECTIVE
leverage a local distribution network to effectively penetrate local markets, or acquire local expertise, which is
crucial for Chinese enterprises building global competitiveness.
Chinese companies could strengthen their skills portfolio through overseas investment
Assessment of Chinese companies positioning along global value chain
Industry R&D Raw material Manufacture Brand Distribution Customer services
Home
appliances  Lack of high-  Improved  Own brand and  Some
end product sharply, while OEM coexist , enterprises has
industrial crafts  Lack in set up his own
gap still exists worldwide outbound
advanced player distribution
Plastics
 Imitation  Large  Mostly own brand  Mostly
 Limited production  Lack in wholesale
investment in capacity and worldwide
R&D low price advanced
player
Clothing 
 Mainly imitate  The raw for  Large production  Mainly OEM  Few players
 Lack in design advanced capacity and low Lack of own set up their own
and innovation products need price brands especially distribution
to be imported in high-end network
market worldwide
Consumer
goods-  Improving  Large production  Mainly OEM  Few players
rapidly while capacity and low  Lack of set up their own
Electrics advanced price worldwide distribution
know-how is brand network
limited worldwide
Toys and
 Weak design  The raw for  Overcapacity in  Mainly OEM  Few players
children's traditional  Lack of own set up their own
capability in advanced
products high-end products need products while brand distribution
products to be imported lack in high-end network
ones worldwide
Source: Industry research, Value Partners analysis
Improve the overall risk or opportunity profile
Although China is the largest country in terms of population, and is growing fast, in many leading industries, the
Chinese market still accounts for a limited share of global demand and will continue to do so for the near future.
For example, China’s market values as a percentage of the global market are lower than 10% for the banking,
construction, chemical and telecom industries.
In many industries, the domestic market experiences significant, though temporary, fluctuation, and companies
that have diversified their business in secondary markets could be better positioned to offset the impact of a
downturn. Considering that several industry sectors already face the risk of a short-term saturation or slow down, it
is important for companies not to invest exclusively in local markets.
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5. PERSPECTIVE
Chinese companies could strengthen their skills portfolio through overseas investment
China
%, growth rate world
Growth of Auto industry Growth of chemical industry
40%
20%
20%
0%
10%
2001 2003 2005 2007
-20%
0%
-40% 2004 2005 2006 2007
Growth of construction industry Growth of consumer good* industry
30% 20%
20% 10%
10%
0%
2002 2004 2006 2008
0%
2001 2003 2005 2007 2009 2011 2013 -10%
* Consumer good without food market value
Source: Global Insight's Global Construction Outlook 2008, Datamonitor , Euromonitor, EIU; Value Partners analysis
Lessons and experiences developed by other countries
For Chinese companies, moving into foreign markets seems to be a complicated process, due to a lack of international
experience. A study of instances in which Chinese companies failed to succeed in foreign environments suggests
that these companies have some key weaknesses. For example, they have a limited knowledge of international
markets, including market situation, regulations and customer base. There is also a limited availability of managers
who can operate in an international context, with sufficient language proficiency, foreign culture understanding
and an established social network. Last but not least, they seem to lack systematic process, for instance in strategy
definition, roadmap development and execution.
By examining the experience of companies who have already invested in developed countries, Chinese firms could
prepare for some unavoidable issues:
• Culture clash: generally speaking, English proficiency is limited for the Chinese, and the Chinese “vague”
communication style is different from the direct style of western business practices. The Chinese work-life balance
is also quite different to that seen in Europe;
• Higher uncertainty in a global context: rapid changes in global social, environmental, technological and business
trends could lead to systematic risks, such as financial crises or regional conflicts;
• Lack of availability of many professional managers who have solid overseas business experiences and local
background;
• Stronger social tension: needing to manage a multinational environment in-house, while externally needing to
deal with local government, communities, partners, etc
Developed countries have accumulated many overseas investment experiences to tackle these basic problems,
which could be valuable references for Chinese companies. First and foremost, they need to build a dedicated team
that focuses on international expansion, including recruiting local professional managers with international business
experience, seeking help from third-party professionals such as consulting firms, lawyers, PR agencies, and lobbyists,
and get training on culture difference management and international communication.
It is critical to develop an effective model of international governance. One method would be to choose an appropriate
governance model based on the target country’s business climate. This would mean caution in shareholding investment
in emerging countries, for instance, due to the high risk of partner default, and flexibility during transition periods.
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6. PERSPECTIVE
It is necessary to engage in comprehensive planning to fully understand local context and possible changing factors
and to reduce setback risks. ,It is advisable not only to prepare a contingency plan – after thoroughly considering all
the possible risks in strategy, social environment, and economy – but also to have a proper exit plan.
Being committed to developing local networks is also important – for example, by hiring a key relationships contact
person who could operate effectively in the local business community and apply a PR approach to promoting the
company’s commitments and contributions to the local community.
Chinese companies have many possibilities on the spectrum that fall between resisting overseas investment and
duplicating domestic models. The first approach could be to form an alliance with peers or strong players to share
the resources and risks. For example, a large SOE could build partnerships with other sizeable players in some
negotiations, so as to avoid internal competition and to get a lower price. SMEs could form a consortium with other
SMEs, or work with large players as their suppliers, service providers, or distribution partners.
Target areas might be the ones where a company has already done business in the past, or even the regions where
many Chinese communities exist. The firms could set up a joint venture with a local partner, leveraging their local
resources and learning about the local market and culture.
It is important to focus on a niche market in which the company has its core expertise – identifying those markets
that have a good return and less competition, thereby avoiding having to compete in the mass market. This unique
expertise should be strengthened, and differentiated products and services should be provided to local customers.
As for organization and HR, it is best to build through practice. Organization formats could be structured as sales
agent-sales subsidiary-manufacturing facility-full operation, which creates the right governance structure. Chinese
talent should be trained on the job, and local talent should be motivated from a long-term perspective.
It is also essential to adapt to the local rules of the game, fitting in to the community and building business models
that are a win-win for both parties, by maintaining certain levels of local employment, instead of just acquiring a
small expert team while dismissing all manufacturing labourers.
Finally, it could be helpful to assess the critical issues in each step of foreign investment. Focusing on four steps in
particular, the main critical issues could be:
• Defining the objective:
- What is the main investment target – for market, technology, skills, or profits?
- What is the minimum target?
- What is the time frame for the target?
- How much funding is needed, considering both the whole investment cycle and the contingency scenario?
- What are the main risks and how can we reduce or migrate them?
• Preparing to go:
- What are the top three criteria to evaluate targets and investment results?
- Who are the right people to join a dedicated international expansion team?
- What external resources could be leveraged, in order to understand the feasibility and the risks of targets, and also
to grant support, so as to make things happen?
• Manage the process:
- Which is the appropriate governance model?
- How is it possible to communicate proactively with all stakeholders?
- How could a positive image of the company be promoted and how could branding be established in local
communities?
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7. PERSPECTIVE
• Integrate effectively:
- What is the integration blueprint, with specific milestones, timelines, and key actions?
- What is the integration plan and the governance structure during the transition period?
- What is the new business model and how should it be implemented?
- Who should be appointed to the board?
- How can company culture be rapidly integrated and communication efficiency improved?
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