The One Hour China Book

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

Last annotated on May 7, 2017

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. loc 126

McKinsey & Company has recently forecast that the working Chinese
consumer will account for over a third of global consumption growth
through 2030. loc 131

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. loc 301

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. loc 321

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. loc 345

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. loc 557

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. loc 727

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. loc 752

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. loc 778

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. loc 787

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. loc 814

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. loc 824

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. loc 865

> if you are trying to promote vegetarianism, China is going to be the
> biggest bang for the buck place to do that

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. loc 1107

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. loc 1148

> Kolwoon 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. loc 1306

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.” loc 1311

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. loc

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. loc 1397

“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鈥hinese students get little
practical experience in projects or teamwork compared with engineering
graduates in Europe or North America鈥he 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).” loc 1401

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.” loc 1429

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. loc