Driving profitable growth: China’s productivity challenge

China market environment: a snapshot

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The consistent message across different industry sectors and ownership groups was the urgent need to drive productivity improvement.

Companies remain profitable

Companies in general continue to be profitable in China, suggesting that the economy remains in good health. Average earnings before tax, depreciation and amortization (EBITDA) was an impressive 20.9% overall. The gap between companies’ financial performance though is substantial.

3%   of companies surveyed reported that they were unprofitable in the past financial year.

Overall, there was surprisingly little variance between ownership groups in terms of average profitability.

Most significantly, the survey revealed big gaps in financial performance within the same sectors with a long ‘tail’ of poorer performing companies. Against a background of increasing competitiveness in each sector, we expect the gap in profitability to widen over the next 24 months.

Companies are focused on profitable growth

All in all, companies continue to be optimistic about China’s potential domestic demand in the years ahead, and are still very much focused on growing revenue.

When asked which areas could have the most impact on company profitability in the next 24 months, the second most important area identified by our survey respondents was the need to increase productivity.

Profit margins increasingly under pressure

One reason for the increased focus on productivity is that profit margins are increasingly coming under pressure.

48%   of our respondents reported that their companies’ margins had fallen compared to two years ago, twice as many as those that said their margins had risen.

In most sectors, revenue growth has slowed but cost inflation continues unabated, resulting in a considerable profit squeeze.

Our sector analysis shows that the services sectors generally fared better, among them healthcare, and financial services.

The slowdown looks to have hit the hardest in the industrial sector, particularly telecommunications, industrial goods, and consumer goods.

Little scope for companies to pass on cost increases

Our respondents were united in telling us that there was little scope for customers to absorb expected cost increases. Presumably as a result of stiff competition, 58% of respondents expect that they can pass on 20% or less of rising costs to the final customer.

5%   of our respondents expected to be able to fully pass on the cost increases they expect to incur.

State-owned enterprises believed they were less able to pass on costs compared to other ownership groups. Overall, there was little variation between sectors in terms of the extent to which companies were able to pass on rising costs, suggesting that this is a pervasive issue across the Chinese economy.

Productivity is high on the agenda

Companies are well aware that in the business environment that is now emerging, continued success will demand continuous and aggressive improvement in productivity. Executives and managers across industry sectors and ownership groups overwhelmingly acknowledge the increasing significance of productivity.

73%   of our respondents said productivity will be either “extremely” or “very” important to their business performance in the next 1–3 years.