The One Hour China Book
Book notes for "The One Hour China Book", Two Peking University professors Explain All of China Business in Six Short Stories by Jeffrey Towson, Jonathan Woetzel
We have argued that six mega-trends (urbanization, manufacturing, consumers, brainpower, capital and the Internet) drive most of China business. And that these trends explain most of the China stories you see in the news.
McKinsey & Company has recently forecast that the working Chinese consumer will account for over a third of global consumption growth through 2030.
This urbanization phenomenon is adding an average of 18.5 million people to China’s cities every year. That is equivalent to adding the population of the Netherlands annually. Or the equivalent of adding the entire population of Japan every 8 years.
From 1980 to 2015, China’s urban population grew by approximately 450 million. That is more than the entire population of the USA. This brought the number of Chinese city-dwellers to about 750 million and the overall urbanization rate to 55 percent. However, this is still far below the 70-80 percent urbanization rate seen in Japan, the US and Europe.
It is a place where you always ask where someone is from, because nobody is from Shenzhen. The city was only a series of villages prior to 1980. The total population then was about 100,000. And as recently as 1995, the central business district Futian was empty fields.
This is what investors call economies of scale. It is the situation where you are so much larger than your competitors, relative to the market, that you can outspend them on research, factories, fixed assets, marketing and other fixed costs. It’s the point where you are very difficult to compete with due to your scale. It’s what Warren Buffett calls the “survival of the fattest.” What we see in China today is exceptionally large manufacturing scale that is creating an entrenched position over time.
Here’s the problem. Chinese manufacturers keep investing into expanding sales, production capacity, and R&D. For example in 2011, Chinese Mindray invests 10 percent of its revenue in R&D and launches 10 new products annually. They are all trying to become high-end medical device manufacturers. And they are moving up into the middle and higher segments where the MNCs live. This leads to the fight in the middle. Chinese companies are rapidly upgrading their technology and moving up into the second and first tier cities. Foreign companies are trying to drop their costs and move down to second and third tier cities. You frequently see MNCs acquiring Chinese companies to do this. You see this fight in the middle in sector after sector. It’s a big part of the evolution of the China market for manufactured products. Sometimes the Chinese company wins and sometimes the MNC wins.
The Western press is often populated with commentary about how China is inefficient. About how there is too much capacity, say in blast furnaces. And that this is a reflection of China’s politico-economic system. More often than not, this is just “last man standing” playing itself out. Everyone builds capacity and then everyone but a few players die.
The numbers show this pretty clearly. Over the past 30 years, approximately 300 million people have moved into China’s middle class. And according to the OECD Development Centre, the forecast is for another 200 million people to move into the middle class by 2026. This means the Asia Pacific region, which in 2009 represented 18% of the world’s middle class, will reach 66 percent by 2030. Let’s repeat that. Over the next 15 years, Asia will go from 20 percent to 66 percent of the world’s middle class.
China has followed the path of a typical developing country. It began as an export-oriented economy with low labor costs. And prior to joining the World Trade Organization in 2001, it had a protectionist strategy marked by high import barriers. This gave Chinese companies time to get their footing without being overwhelmed by foreign multinationals. Those barriers have since come down somewhat.
For Chinese consumers, these products were not a big step up. People had been buying noodles and tea in stores and restaurants for hundreds of years. What Master Kong offered was offer a standardized, quality product at a low price. Many of the Chinese consumer success stories thus far are like this.
We are now seeing another big transition. China’s consumers are starting to look to more emotional and aspirational needs. They are increasingly going to Starbucks, traveling overseas, wearing luxury brands, buying iPhones, going to the movies and choosing furniture based on how it fits their sense of self. Suddenly it’s not all about having the basics at a good price. Urban and affluent consumers, in particular, are attaching greater importance to the emotional benefits they receive from purchases.
For example, rising Chinese consumers are becoming meat-eaters. As societies become wealthier, people generally eat more meat. And we are seeing this play out in China in a startling way. For example, China is now the number one global consumer of pork and the number two consumer of chicken. China keeps a herd of 450 million pigs, about half of the global pig population. That factoid is kind of weird to try to visualize.
> I.e. China is the most important place for vegetarianism propaganda, and it is likely cheaper there (although moral arguments may not work as well intuitively)
Big four bank lending tends to go to big state-owned enterprises (SOEs) and local governments. And not to small and medium enterprises (SMEs). While SMEs employ about 80% of the Chinese work force, they account for only 20 percent of bank lending. This creates a serious mismatch and is driving a surge in the shadow banking system (discussed in the next section). Additionally, SOEs get bank loans for around one-third of the cost of loans to small private companies. This has a lot to do with the difficulty in assessing the risks of private companies in China, particularly SMEs. This follows from underdeveloped credit agencies, less stringent accounting standards, and a lack of expertise and incentives in the banks.
Its evolution from that point is a fascinating case study in ungoverned markets and life. It became a lawless city and physically grew into a dense three-dimensional maze. Homes and businesses were built at will. Sewage ran down the sides of buildings and children would jump from rooftop to rooftop. It became a chaotic interconnected mix of homes, schools, businesses, triads, brothels, gambling parlors, and opium dens. By the 1980s, it had the highest human density on the planet. It contained approximately 33,000 families and businesses in more than 300 interconnected high-rise buildings. It was eventually demolished in 1992 by the Hong Kong government.
> 九龙 walled city
As soon as the subject of Chinese brainpower comes up, someone inevitably makes a comment about Chinese being good “rote learners” but Westerners are more creative. This is mostly wishful thinking, with a bit of racial stereotyping thrown in.
Chinese companies have been exceptionally good at making incremental improvements to existing products - and at making them cheaper and cheaper. In their book Run of The Red Queen, authors Michael Murphree and Dan Breznitz write that, “China is a wonderful example of how you don’t need to have novel product innovation to be innovative.”
BIG GENERALIZATION #1: THE CHINESE K-12 EDUCATIONAL SYSTEM IS REALLY EFFECTIVE From birth right up until entering college, the Chinese system is very effective. Sometimes it is too extreme, but nobody can argue that Chinese students are not very highly trained at a young age.
> But: burn out, dependent on system for motivation, etc.
The quality of most of China’s universities remains below Western standards. This is creating a serious problem: significant unemployment amongst university graduates, even as thousands of jobs for graduates go unfilled.
“Consider engineers. China has 1.6 million young professionals, more than any other country [in the study]. Indeed, 33 percent of the university students in China study engineering, compared with 20 percent in Germany and just 4 percent in India. But…Chinese students get little practical experience in projects or teamwork compared with engineering graduates in Europe or North America…The result of these differences is that China’s pool of young engineers considered suitable for work in multinationals is just 160,000—no larger than the United Kingdom’s. Hence the paradox of shortages amid plenty (bold added).”
Warren Buffett’s partner Charlie Munger may have described this phenomenon the best when he said, “I think they have been lucky that the Communist Party in China evolved into a Confucian meritocracy where everyone’s been to engineering school.”
Alibaba’s one day promotion generated $17.8 billion in 2016. It is the world’s largest shopping event by far. At peak volume, Alibaba was registering 175,000 transactions and 120,000 payments per second.