China’s economic miracle moves inland

China gets a taste for coffee

LIU YONGHAO CUTS a modest figure considering he is the fifth-richest man in China and chairman and owner of New Hope Group, the country’s largest privately owned enterprise. A former schoolmaster, he sits in a chilly office in Chengdu and speaks softly of his decision to quit teaching and head to the fields in 1982.

“Back then, my monthly salary was the equivalent of $5,” he says. “I thought I’d lose $5 a month but maybe I could get the whole world in exchange, such were the benefits of Deng Xiao Peng’s reforms.”

Liu pawned his bicycle and watch, and borrowed from his family to find the $150 starting capital for his business. It proved a sound investment. New Hope is now China’s largest agribusinesses group, with sales of more than $2.5 billion, is a significant real estate developer and owns 60% of China Minsheng Bank, the People’s Republic’s largest privately held lender.

Liu’s achievements are the more remarkable since he opted to build his business empire in his home town of Chengdu, Sichuan province, in western China, rather than on the streets of Shanghai or in the corridors of power in Beijing. Liu reckoned that as China’s rapid industrialization raised living standards, consumption of meat and dairy produce would grow too. He was right.

“Before the reforms, we could only eat meat once a month, we never had enough,” he says. “Now China is the largest meat-consuming country in the world, but we are still developing. In the city, we can eat meat every day, but in the countryside it’s still only once a week.”

Liu’s clever idea was to encourage farmers in western China to farm more produce, more efficiently, by adopting western farming practices and production standards. New Hope sells the animal feeds to farmers and builds partnerships with them through its animal husbandry programmes. It has proved an enormously successful model: each year the group supplies more than 10 million farmers with 6 million tonnes of feed and sells more than 200 million poultry and half a million tonnes of milk.

Liu’s strategy dovetailed with the central government’s ‘Go west’ campaign, which began in 1990s with the objective of encouraging businesses huddled around China’s overcrowded coastal regions to invest inland. Keen to ensure that China’s economic development did not pass by inland economies, the government offered businesses significant tax and investment incentives to develop central, western and northern regions that had long lagged behind. Increasing wage pressures and resource constraints in China’s south and east, combined with the incentives, have guaranteed that the policy has been largely successful.

Laid-back west

Chengdu, an attractive laid-back city of some 10 million, is proof of that success. Office skyscrapers, five-star hotels and luxury shopping malls dwarf the imposing statue of Chairman Mao in the central square. New housing developments sprout in every direction. In 2005 alone, the city sold 15 million square metres of new homes, Liu claims. All this investment has driven the economy: Sichuan province’s annual GDP growth hit 12% in 2005 and compares favourably with the national average of 9.6%, although it still lags the 15% growth enjoyed by the coastal economies of Guangdong, Shanghai and Zhejiang.

As one of Chengdu’s key employers and taxpayers, New Hope is precisely the kind of business the Chinese government needs to develop its far-flung and less-developed inland region. Although Chengdu is growing fast, rural areas in Sichuan province have fared less well and not all locally based businesses have profited quite so fast. Sichuan Expressway Company, a state-owned toll road operator listed in Hong Kong as early as 1997, faced a much steeper climb to profitability.

With its share price still underwater from the offering price at IPO, Sichuan Expressway management explains apologetically the yawning gap between expectation and experience. The numbers also provide an indication of how far some of China’s inland economies still have to grow to catch up with the coastal regions.

“The use of our expressways has been limited,” says Mou Wan Xiong, Sichuan Expressway’s company secretary. “We’ve had only a few percent increase each year, much less than expressways in Shanghai or Zhejiang. Sichuan province’s GDP in 2005 was equivalent to Zhejiang’s or Jiangsu’s 10 years ago.”

Sichuan remains a largely rural economy and much remains to be done before the rest of the province will aspire to living standards in the city. “The government is trying to invest in education and building infrastructure, they’ve even cancelled tax in rural areas,” says Mou. “Chengdu is more eastern-like: the average GDP per capita is $3,000 and it accounts for a third of total [Sichuan] GDP.”

Liu concurs, and believes that the city will continue to prosper. “The fact that China’s largest private company is based here is a sign that Chengdu is a good place to do business,” he says. “The city will undergo a big change in the next five years. Government policy, the central location and good quality of the local people all make me confident Chengdu will play an important role in the development of western China.”

Stuck in the middle

Wuhan is another city claiming a key role in the development of inland China. The capital of Hubei province in central China, it is an unappealing, industrialized urban sprawl with some 8 million inhabitants. Wuhan has pretensions to play a key logistical role in transportation and communications by dint of its location in the Yangtze River valley in the heart of the country. It is a little difficult to take this ambition seriously given the appalling state of Wuhan’s international airport, a relic from China’s socialist past, but the government is busy building a new one, locals say, and several multinational corporations have established significant operations in the province, including PepsiCo and Coca-Cola. Budweiser even established its China operation’s headquarters in Wuhan.

One of the reasons for this is the low cost of labour compared with coastal regions, says Eddie Zhu, branch manager of HSBC’s Wuhan branch. “The average monthly salary is Rmb1,000 [$124],” he says. “That’s much lower than Beijing or Shanghai. Wuhan also has good auxiliary support: it’s one of the best education bases in China; the third in number of universities.”

The arrival of more international businesses is rapidly changing the local economy, Zhu says, and HSBC is benefiting from this. “In absolute terms, Wuhan is in the middle of the table of economic size but in the past few years its growth rate has been faster than the coastal areas,” he says. “Industrial output increased 28% last year compared with 16% elsewhere. Wuhan used to be a domestically oriented economy but that’s changing. Our customer base is now almost 50:50 local-invested and foreign-invested enterprises.”

Despite growing international investment, big state-owned industrial enterprises still dominate the local economy, the largest being Wuhan Steel, China’s second-largest steel manufacturer. Auto manufacturing is the other key industry, dominated by Dong Feng Motor Holdings, China’s third-largest auto manufacturer, a main contributor to the local economy as well as a beneficiary of it.

Although the company is still state owned, management stresses that it has earned its operational independence. “We can hardly say the government still controls Dong Feng,” says Guo Miao, the company’s vice-general accountant and chief of planning and financial department. “We’ve returned 10 Dong Fengs already! Although the government still owns the company, they have no control other than at a macro level. The government hasn’t made any investment in the company since 1992.”

Instead, government in Wuhan treats Dong Feng like any other large private corporation. “The provincial government offers us very preferential treatment,” says Liu Zhangming, the company’s vice-president and senior accountant. “The location of our headquarters is a very important consideration and each city has advantages and disadvantages. Wuhan’s geographic position, its education base and its reputation as a long-established industrial base give us a competitive advantage.”

Cheap energy from Hubei province’s Three Gorges hydroelectric power project and a good network of supporting industries and suppliers are also compelling arguments for Wuhan, says Cai Wei, Dong Feng’s vice-president and secretary of the board. Dong Feng has managed to persuade international investors that its business case is sound: it has signed joint ventures to manufacture automobiles and parts for the domestic market with PSA (Citroën), Nissan, Honda, Kia and Volkswagen Audi. Now the vision is to develop brands of its own.

“We want to build Dong Feng into one of the top manufacturers in the internal market – not just in terms of market share, but also profitability,” says Hu Xindong, managing director and company secretary. “We have our own brand strategy and want to produce vehicles of our own, with full IPR [intellectual property rights]. We’ll base this in Wuhan.”

The city’s burgeoning industrial economy has spilled over into the local economy. Real estate prices have jumped, although they are still relatively attractive, says HSBC’s Zhu. “Real estate is playing an increasing role in Wuhan,” he says. “When I came here in 2002, the average property price was Rmb2,000 per square metre, now it’s Rmb3,500 to Rmb4,000. That’s not a bad increase, but it’s still pretty cheap compared with Beijing or Shanghai. Before there were two five-star hotels, now we have five or six.”

Hong Kong property developers are already moving in to Wuhan. Hutchison Whampoa and Shui On have together invested Rmb4 billion (approximately $500 million) in land banks.

Beaches, beer and brands

Real estate is also driving the economy of Qingdao, the principal city in Shandong province on China’s northeastern coast. It is a clean, pleasant seaside centre with 8 million inhabitants, whose seafront is lined by rows of expensive villas, condominiums and apartment blocks. This is where China’s rich and famous come to relax and rub shoulders with the significant expatriate populations of Japanese and Korean businessmen investing in the city’s industrial hinterland. It is already the third most expensive property market after Beijing and Shanghai, and prices are set to increase even further when the Olympics hits China in 2008. Qingdao will host all of the sailing events at the Beijing Games and a huge new marina is already nearing completion on the site of an old dock.

Qingdao is famous not just for its beaches and expensive real estate, however. The city is home to some of China’s most famous brands, many of which have global ambitions. Tsingtao Brewery, the owner of China’s leading beer brand, is arguably already internationally renowned; it has certainly had long enough to establish itself, having been founded during the German concession at the beginning of the 20th century. Just behind Tsingtao perhaps in international recognition but far ahead in ambition is electrical goods manufacturer Haier, founded by local businessman Zhang Ruimin.

Haier is already a household name in China but is rapidly becoming a major international brand and already adopts a multinational corporation philosophy. “Our strategy is to build our brand not like traditional Chinese companies that grow market share by price alone. We want to focus on quality, to differentiate our products and to control our distribution channels,” says Wu Ke Song, vice-chairman of the Haier board of directors,

The vision is clear, based on the company philosophy that China’s brands will either be global players or slaves to global players. Despite Haier’s substantial success, the company remains modest. “We still have a lot to do,” says Wu. “Although we’re number one in China, we want to build our brand globally. If you can’t do that in China, how can you do it in the US? We’re only a top-10 player in western markets and in Japan.”

Qingdao’s brand business culture has spawned other brand-driven businesses. In addition to Tsingtao and Haier, the city hosts appliance manufacturers Hisense and Acuma and shoe manufacturer Double Star.

If Zhang Jian Hua, chairman and president of Hiking Group, has his way, Qingdao’s leading trading company will soon be adding its own brand to the city’s list of brand leaders.

Formed from the restructuring of five state-owned import-export agencies, Hiking focuses on international trade. “We’ve set up trading relations with all of the major countries,” says Zhang. “We are concentrating our product focus on textiles, clothing, food – everything you can think of that people need to live, except automobiles.”

Although Hiking boasts trading revenues of some $1.9 billion, the company is still in the throes of reorganization. The new business is ring-fenced from the huge loans owed to domestic banks, but management is still responsible for resolving the non-performing loan position and has even bought some of these debts from Cinda Asset Management Company, one of China’s key specialist NPL funds, with a view to accelerating the restructuring. Hiking has also shouldered the responsibility for ongoing obligations to staff of the former agencies, a cost that Zhang estimates at some Rmb154 million.

Once the group’s reorganization is complete, Zhang will focus on development, with an increase in the proportion of own-manufactured goods sold by the group at the top of the list. “We plan to industrialize our own trading business,” says Zhang. “We think we’ll have 50% of our sold exports manufactured in house by Hiking Group within five years, compared with 22% now.”

As with Qingdao’s long-established brand businesses, Zhang cites active local government policies and favourable investment incentives, as well as good port and logistics facilities, as key reasons for basing his business in the city. HSBC local branch manager Maria Liu says that local government is very keen to consult foreign expertise. “We spend a lot of time with the provincial government – much more than in Shanghai or Beijing,” she says. “They want to see us a lot more. They want to do business the right way and we can really add value to the local economy.”

Power to the provinces

Critical to the central government’s aim of spreading economic growth out of Beijing, Shanghai and the key coastal areas is the devolution of power and decision-making from central government to city and provincial administrations. That change, says Richard Yorke, chief executive officer China for HSBC, is highly significant. “Travel around China and you will find city after city with a well-thought-through and developed plan, from the way they’ll build out their industrial base and services sector right down to detailed infrastructure investment,” he says. “The level of competition for investment in China is intense, so these governments have to make sure the area’s attractive.”

Partnered with China’s fifth-largest lender, Bank of Communications, HSBC plans a big expansion of its business in China (see following story). Its own experience in opening branches is instructive, says Yorke. “When you go to these cities, the authorities ask: ‘How was your experience of opening the branch? Did you get the right help? Is there anything you need?’ These are not throw-away comments.”

China’s economic story is still unfolding and is rapidly becoming multi-dimensional. As the economic transformation seeps inland and away from its cradle in the east and south, the vast interior will undergo rapid urbanization. If buoyant economic conditions persist, there will be more shopping malls peddling designer brands, more five-star hotels and more cars on China’s developing road systems.

The growth of China’s consumer economy offers business opportunities of massive proportions, a fact not lost on one famous western brand (see box). What is less clear however, is just how far China’s urbanization will ultimately extend, how much of the rural population will be pulled from poverty and what will happen to those that get left behind.