Cost of Going Global - McKinsey

s t r at e g y
july 2008
The cost of going global for

China’s high-tech
companies
Chinese technology companies are competing successfully on their home turf.
Global markets may be another story, at least in the short run.
Stefan Albrecht, Ingo Beyer von Morgenstern, and Xiaoyu Xia
Article Chinese high-tech and electronics companies are continuing to improve their productivity;
at a McKinsey research shows that in most segments, private-sector Chinese companies
glance outperform the multinationals already. Coupled with a growing focus on better-designed
mass-market products and on quality, these improvements have helped Chinese technology
companies grab a larger share of the domestic market, mostly through gains in the largest and
fastest-growing consumer segment, the midrange one.
But our study shows that when these companies try to export their success, they face new
obstacles. Global costs—in particular, marketing, R&D, and labor costs—are substantially
higher, driving down already thin profit margins.
Chinese high-tech and electronics companies are outgrowing the domestic market,
improving their productivity, and forcefully defending the domestic consumer and
corporate markets against foreign challengers. But our research also shows that
most of these companies will have difficulty replicating these gains in other countries,
where they must cater to very different customers; attract global talent; and confront
higher development, sales and marketing, and labor costs.
In an ongoing project with Tsinghua University, in Beijing, we examined the

productivity and financial performance of 43,000 state-owned, domestic
private-sector, and foreign companies in China across ten technology
sectors—aerospace, consumer electronics, enterprise computing, industrial
elec-tronics and automation, medical equipment, power equipment,
semicon-ductors, services and software, telecom equipment, and transportation.
Despite reports that Chinese manufacturing has lost some of its shine to rising labor
costs, our analysis shows that its productivity in these technology sectors rose 11
percent a year from 2001 to 2006, outpacing labor cost increases of 10 percent a
year. Productivity measured against unit labor costs remains competitively high
compared with that of other low-cost countries, to say nothing of developed ones
(Exhibit 1). As long as productivity grows more rapidly than labor costs, China
should remain an attractive location for technology manufacturing.
EX HI B IT 1
A productive location
1
Our research suggests that productivity gains, together with quality improvements
and an emphasis on midrange product segments, will continue to propel the growth
of Chinese technology companies, raising their share of the domestic market to
around 75 percent by 2010, from 60 percent in 2002. A closer look at the numbers
shows that in value-added per employee, private-sector Chinese technology
companies are reaching and, at times, surpassing the productivity levels of their
foreign-owned rivals in China (Exhibit 2). Among the largest private-sector Chinese
companies—those with annual revenues of about 10 billion renminbi ($1.4
billion)—revenues per employee rose from 226,000 renminbi in 2001 to 417,000
renminbi in 2006, almost matching the 420,000 renminbi of their foreign
counterparts. Productivity at state-owned Chinese companies also increased
during this period but still trails significantly.
EX HI B IT 2
Local heroes
2
Some of the recent productivity improvements at Chinese technology companies
result from increased scale. In 2006, 370 of them—three times as many as in
2001—had annual revenues of 1 billion renminbi or more. At the same time, our
analysis shows that the largest companies, domestic and foreign, are easily the most
productive. Productivity at companies with annual revenues of more than 10 billion
renminbi, for example, is at least twice that of smaller companies. Those with annual
revenues in excess of 1 billion renminbi also have an edge over small and midsize
companies.
Scale has spurred productivity and helps Chinese companies to dominate the market
in their homeland. However, to secure continued growth, companies must push into
overseas markets, which require different skills and higher expenditures on
marketing, research, and labor. Our research suggests that by the time a Chinese
company’s sales exceed roughly 10 billion renminbi, exports become significantly
more important—48 percent of sales, versus 21 percent for companies with sales
from 1 billion to 10 billion renminbi—and costs increase drastically. For public- and
private-sector companies combined, the largest companies get 39 percent of total
sales from exports, compared with 20 percent for the next-largest companies.
Paradoxically, as Chinese technology companies grow in the domestic market, the

ratio between R&D costs and revenue falls, since R&D expenses are spread across a
rising revenue base. Once a company expands globally, the trend reverses abruptly:
for example, as a percentage of revenues, the largest private-sector Chinese
companies spend more than twice as much—3.6 percent—on R&D as do the
next-largest ones (Exhibit 3). Globalizing Chinese companies also face cost
increases for marketing (because they must build brand recognition and learn the
ways of unfamiliar consumers) and for labor (as they begin hiring talent outside
their own low-wage domestic market).
Weighed down by higher costs, Chinese technology companies with annual

revenues of more than 10 billion renminbi average profit margins of 2.6 percent,
compared with 4 percent at those with revenues from 1 billion to 10 billion
renminbi. Margins are likely to be hardest hit during the initial phase of
globalization, when companies make large investments to raise their game. But when
Chinese companies start learning to serve global markets, margins improve as costs
stabilize and as the volume of foreign sales increases.
3
EX HI B IT 3
Investing in research
While technology businesses are in the vanguard of China’s foray into global
markets, a company wishing to follow pioneers such as the computer maker Lenovo
and the telecom giant Huawei must judge whether its operations and management
capabilities are strong enough to absorb the shock of higher costs. A strong
domestic position, capable talent management, and a detailed understanding of
target markets are elements of a thoughtful globalization strategy. Our study also
shows that companies must have the strength and patience to endure a short-term
decline in margins.
About the Authors

Stefan Albrecht is a director and Xiaoyu Xia is a principal in McKinsey’s Beijing office; Ingo Beyer von
Morgenstern is a director in the Shanghai office.
Related Articles on mckinseyquarterly.com
“China’s high-tech market: A race to the middle”
“How foreign companies can compete in China’s high-tech market”
“When Chinese companies go global: An interview with Lenovo’s Mary Ma”
We welcome your comments on this article: [email protected]
Copyright © 2008 McKinsey & Company. All rights reserved.

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s t r at e g y

The cost of going global for

Stefan Albrecht, Ingo Beyer von Morgenstern, and Xiaoyu Xia

In an ongoing project with Tsinghua University, in Beijing, we examined the

Paradoxically, as Chinese technology companies grow in the domestic market, the

Weighed down by higher costs, Chinese technology companies with annual

About the Authors

Related Articles on mckinseyquarterly.com

“China’s high-tech market: A race to the middle”

“How foreign companies can compete in China’s high-tech market”

“When Chinese companies go global: An interview with Lenovo’s Mary Ma”

We welcome your comments on this article: [email protected]

Copyright © 2008 McKinsey & Company. All rights reserved.

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