China’s market is growing, and multinational corporations (MNCs) are faced with fresh risks and challenges. McKinsey’s Kweilin Ellingrud and Jeongmin Seong, co-authors of McKinsey Global Institute’s report, The China imperative for multinational companies, talk about how MNCs in China have to reconfigure their China strategy to remain competitive, innovative, and capture local consumers.
Gautam Kumra: I am Gautam Kumra, chairman of McKinsey Asia, and you’re listening to The Future of Asia Podcast series. The Asian century has begun. The region is now the world’s largest economy. As Asia’s economies evolve further, the region has the potential to fuel and shape the next normal. In each episode, we are going to feature conversations with leaders from across the region to discuss what Asia’s rise means for businesses across the globe. Join us.
Debbi Cheong: Hello, everyone, and welcome to the latest episode of the Future of Asia Podcast. I’m Debbi Cheong, your host for today. In this episode, we will be talking about the new challenges that MNCs face in China and how they need to reconfigure for opportunity and risk. I’m joined by two senior McKinsey experts: Kweilin Ellingrud, McKinsey Global Institute (MGI) director and senior partner based in McKinsey’s Shanghai office, and Jeongmin Seong, a McKinsey Global Institute partner who is also based in the Shanghai office. They are the co-authors of MGI’s cardinal report, The China imperative for multinational companies. Kweilin, could you tell us more about the China market and how it has changed over time?
Kweilin Ellingrud: The China market is large and it’s growing faster than most mature countries around the world. Over the past few decades, China has experienced a 10 percent growth rate. It has slowed down recently, but even at this lower growth rate, it is projected to grow somewhere between 2 and 5 percent over the next ten years. If the Chinese market grows at 2 percent between now and 2030, it will add the equivalent of India’s entire GDP today to China’s GDP. That’s on the low end. On the high end at 5 percent, China would be adding the GDP equivalent of India, Indonesia, and Japan altogether.
Debbi Cheong: How have MNCs fared in China over the last few years, especially after the COVID-19 pandemic?
Kweilin Ellingrud: I think there’s a broad set of upside opportunities. The first is that significant GDP growth will come from China—as we say, “The next China globally is China because of the significant growth.” The second is the significant income growth opportunity. Over 93 cities in China are projected to become high income, according to World Bank measures. By 2030, that will be almost two-thirds of China’s GDP. In addition, a lot of innovation is taking place, with investment in technology at national and provincial level. China is also a huge hub for interregional trade across Asia.
There are risks that MNCs now need to navigate—maybe even more so than before. First is geopolitics. Growing rivalry between China and other countries, particularly the United States and some European countries, and broader global sentiment toward China, is becoming increasingly negative. Second, China’s demographics are a challenge. Aging is accelerating, people are living longer, and the birth rate is dropping significantly. The dependency ratio—the number of people above a certain age and younger than a certain age divided by the number of active workers—is increasing.
Financing is also significant. China has an over 275 percent debt to GDP ratio, which is a historic high. The country also has a disproportionate amount of climate risk exposure. More cities in China, in contrast to the global scenario, are at greater risk from heat, humidity, drought, or flooding, because of their geographical position. MNCs will have to manage these risks, as well as local companies.
Debbi Cheong: Jeongmin, do you have anything to add?
Jeongmin Seong: Our observation is that underperforming companies in China are still suffering. We analyzed about 100 multinational companies out of the Fortune 500 and the revenue of the top 25 percent companies has grown by 15 to 20 percent per year over the past decade or so. In contrast, the revenue of the bottom 25 percent of companies shrank by 3 to 5 percent a year. This trend has become even more obvious since COVID-19.
Debbi Cheong: In light of the opportunities and risks that you have outlined, should MNCs continue to expand their footprint in China? What would this entail, considering China’s complex and ever-shifting regulatory landscape?
Jeongmin Seong: MNCs operating in China will need to reconfigure their China strategies. They have a choice of strategic postures depending on their view of the other opportunities and the risks just described. The first course of action is to renew their commitment to China; in other words, stay heavily invested in the country and even increasing investments when necessary. This approach makes sense where China represents a large global market, and when a company has a competitive edge. The automotive industry is a good example: China accounts for about one-third of the global market, which is why many global OEMs keep investing in the country. The second strategic posture is to accelerate selectively by choosing to focus on segments that are more promising in China than elsewhere. For example, a beverage company built an R&D center and distillery in China to take advantage of rapidly growing whiskey segments in China.
The third action is diversification. Some multinational companies reallocate resources to other countries, especially when the concentration risks are relatively high. Prominent examples are consumer electronics and related sectors, where several electronics companies are expanding their capacity in India or Vietnam. And the last action will be about reducing stakes in China. This is relevant when the China market is not that large or when companies are losing their market share in the country. For example, given the picture of the phenomenon, a customer company sold its China infant milk formula business to a local investor.
The China imperative for multinational companies
Debbi Cheong: A key point that I would like to zoom in on is increasing local competition from Chinese companies, something that was highlighted in the MGI report you co-authored. How does this trend reflect the changing Chinese consumer base? And what can MNCs do to recapture this consumer base?
Kweilin Ellingrud: We have seen Chinese local competitors getting stronger over the years and significantly growing in revenue. Keep in mind that MNCs are also growing; they’re just not growing as fast as local competitors. As the overall market size grows, local competitors in China are capturing more of it. MNCs are still doing well—those companies in the top quartile are performing even better now than they did before and during COVID-19. Unfortunately, those that were not doing as well are doing even worse now. So, that bifurcation during COVID-19 and beyond has accelerated.
We are seeing greater competitiveness in a few ways. This comes through in terms of nimbleness and pace of change and adaptation, as local competitors in many ways are faster to adapt. In some instances, this has to do with tailoring to local market tastes and needs. In a few industries, however, MNCs are capturing more of the market. For example, the majority of future growth in auto manufacturing and auto sales is going to be in China. Whether global or Chinese, companies in these sectors cannot afford to not compete in China. The same is true for the luxury-goods sector.
The inverse, though, would be industries such as pharmaceuticals. Global pharmaceutical players do not need to participate in the Chinese market. Not do global insurances companies.
Jeongmin Seong: Chinese companies are changing as well. In the past, Chinese consumers put a premium on foreign brands, but this seems to have changed. Based on the survey done last year, about half of Chinese consumers mentioned that the quality of Chinese brands is better than that of foreign brands and only 23 percent said the reverse. There are emerging examples to show this. In electric-vehicle smartphone categories, Chinese brands account for 80 percent of the total market. And in the apparel segment, leading Chinese brands are growing faster than any foreign brands. This is a reflection of improving the quality and innovation of Chinese brands, not just low prices or a sense of national pride.
In terms of what MNCs can do tactically, they can localize their brands and distribution channels. For example, a European company has acquired a Chinese beauty brand to expand its brand portfolio and reach a new Chinese consumer base. Another MNC is localizing its products and marketing campaigns by releasing a collection of tiger-themed clothing and accessories to celebrate the Year of the Tiger. But, fundamentally, MNCs need to keep innovating and strengthening their value propositions because the Chinese consumer bar is rising.
Debbi Cheong: Leading Chinese companies seem to be making great strides and in some ways are outpacing international MNCs, as seen in their increasing market shares across different industries. What can multinationals learn from this?
Kweilin Ellingrud: MNCs are looking to local Chinese competitors to learn but also to examine their own operational and strategic choices. They’re doing this across six key areas and, across each of these, there is a broad spectrum of how MNCs are making choices—from low levels of risk mitigation and management to pretty high-risk mitigation or investment into the Chinese market. The first dimension that MNCs are exploring is supply chains. Here, there is a range from investing in broader Asia but not China-specific factories (such as assembly plants) to much more explicit investment in local Chinese factories as part of the global supply chain.
On the innovation front, this ranges from creating China-specific teams for innovation R&D to innovating completely from end-to-end in China. For example, GM launched its global small EV platform through a joint venture in China and now has one of the best-selling EVs in China.
From the talent point of view, many MNCs think about China as part of a broader global rotational program. They might hire local talent, perhaps as a rotation more globally. On the other end of the spectrum, companies are committing to Chinese talent in the Chinese market. Honeywell, as an example, said that it no longer requires English as a prerequisite to work at the company. That opened a much broader set of local talent for recruiting, retention, and career pathing than they had before.
The fourth dimension is around capital and ownership. We’ve seen joint ventures for decades now, such as BMW and Goldman Sachs buying out the equity shares of their joint venture partners. On the other end of the spectrum, we have AB InBev raising capital for an IPO for Asia-specific subsidiaries—they raised $5 billion and accomplished their goal. Yum brands spent out Yum China specifically to two Chinese companies and invested about $460 million in the new organization. Sometimes it is China-specific capital, sometimes it’s broader Asia capital, but China-specific and Asia-specific IPOs are happening.
The fifth dimension is technology and data. Of course, this is evolving quickly, with local regulations being put on data, data centers, and IP. Some companies, like Apple, comply with local regulations and have local data centers. Others, like Siemens, commit broader investments but use global providers to comply to local regulation.
The last dimension is branding. Jeongmin earlier mentioned local branding; for example, Gucci is being tailored to local tastes, while a company like L’Oréal is buying Chinese companies and deeply considering local customers’ tastes and needs.
Across all six dimensions, MNCs are rethinking what they did before. They need to consider what the best way forward is, given the fast pace of competition. There is growing opportunity but there are also increasing geopolitical risks. Across supply chain, innovation, talent, capital and ownership, technology and data, and branding, MNCs will need to make different choices going forward.
Jeongmin Seong: Out of six dimensions that Kweilin mentioned, I’d like to highlight the importance of innovation, especially as a lesson to be learned from the local companies. We are seeing the rapid improvement of local companies’ innovation capacity. For example, between 2017 and 2021, local firms’ R&D spending grew three times as quickly as MNCs spend on global R&D. These investments have translated into some local companies establishing strong positions within both the local and global markets. Look at the solar panels industry, for example, where Chinese companies hold more than 70 percent of the global market share. To continue to win in China, MNCs will need to consider how they can maintain their innovation premium over local competition.
Debbi Cheong: Kweilin and Jeongmin, if you have one piece of advice for MNCs trying to expand in China, what would it be?
Kweilin Ellingrud: First and foremost, get clarity on what your current stake in China is and what you want your future state to be. If it’s a small investment compared to the global organization and you’re not expecting to do much more going forward, then it might be best to minimize the stake, accelerate selectively, or frankly, back out a bit and rationalize exposure. But if it’s either a big stake now or likely to be a big stake in the future, given the nature of the industry that you’re in, then you need to work through the six dimensions mentioned. Getting alignment between global leadership and local Chinese leadership will be critical. This is not an easy market; it’s much more competitive than it was ten to 20 years ago. Unless you have clear alignment across global and local Chinese leadership, winning will be difficult.
Jeongmin Seong: My advice is to come and visit China. There has often been very limited interaction between local and global executive teams. Many global executive teams gain their understanding of the country from the media. Come to China, look at and feel the real market, and then make more fact-based decisions on your China strategy.
Debbi Cheong: Thank you, Kweilin and Jeongmin, for your time today, and thank you for listening to the McKinsey Future of Asia Podcast. If this topic interested you and you would like to know more, please head over to mckinsey.com/FutureOfAsia.
