> Rethinking profitable growth: the productivity imperative for foreign multinationals in China
Rethinking profitable growth: the productivity imperative for foreign multinationals in China
Foreign MNCs in China seek ways to sustain profitability
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In your opinion, what are the areas that could have the most impact on your company's productivity in the next 24 months?
Case study: McDonald’s – Balancing rising costs and service standards
China is the fastest growing market for McDonald’s outside the United States. In 2009, after nineteenth years in the country, the world’s largest quick service restaurant opened its 1000th restaurant in China.
Based on the accelerated growth since, it will only take another four years for the company to open its next 1,000 restaurants.
The cost of food, utilities and occupancy all have an impact on margins in the restaurant industry, but it is the cost of labor which has emerged as the leading consideration.
McDonald’s restaurant staff have seen their real wages rise steadily throughout the past decade, culminating in double-digit increases the past couple of years.
As Dan March, CFO of McDonald’s China says, “whilst the hourly wage is still not that high compared with other areas of the world, it’s the year-on-year compounding growth in wages which becomes a big challenge.”
Aside from costs, McDonald’s also monitors the external environment to gauge customers’ expectations around level of service and menu price points. Like any other retailer, food service companies like McDonald’s adjust their prices as a result of rising costs but only up to a point which the consumer can affordably accept.
For McDonald’s, the balance between rising costs and maintaining standards of customer service lies in productivity improvements.
Mr. March explains, “a key driver of success for us has been our ability to run our restaurants more efficiently, by continuing to seek ways to speed up service while not compromising the consumer experience”.
The current environment is characterized by rising cost pressure, intensifying competition, and continuing volatility in global markets.
Foreign multinationals (MNCs) have had a good run in the past decade in China, buoyed by world-beating productivity gains, an expanding labor force, and rising inflows of investment.
Demand has been supported by domestic investment in industrial capacity and infrastructure and – until the global financial crisis – steady growth in the world’s major markets.
Despite tougher conditions in the last few years, most foreign multinationals in China remain profitable. Ninety-seven percent of foreign multinationals that responded to our survey reported positive profitability (Figure 1).
Almost half of our respondents reported EBITDA of over 10 percent, compared with only 3 percent that reported negative profitability.
Time in China was a key determinant of profitability. Fifty-two percent of companies with over 10 years experience in China reported EBITDA of over 10 percent compared with 37 percent of companies that had been in the country for less than 5 years.
The survey data seems to bear out the old saying that “China is a long game”.
Breaking the data down further, services industries in aggregate, seem to be most profitable (see Figure 2), suggesting that the shift toward a more services-driven growth model has already begun to happen. 14 percent of respondents in services sectors reported EBITDA of over 20 percent, compared with only 7 percent in industrial sectors.
Despite foreign multinationals’ strong record on profitability, the future looks less certain.
There is a growing awareness that the times are changing, and potentially changing very fast.
Past performance is no guarantee of future success
As margins come under pressure and demand is redistributed, the old paradigm of doing business in China is going to change, perhaps radically.
Manufacturing, long the mainstay of foreign multinationals in China, has been hit the hardest. 59 percent of our respondents in this sector reported decreasing EBITDA margins compared with two years ago (Figure 3).
Other sectors that have not done so well include information technology, professional services, and chemicals, suggesting a relative decline in overall corporate demand and in industrial activity.
Some sectors, on the other hand, look to have benefited from increasing Chinese consumerism. Retailing is a strong performer, with 53 percent of companies reporting increased margins, followed closely by consumer goods with 50 percent.
Foreign multinationals are acutely aware that in this changing business environment, raising productivity is a strategic imperative to maintain profitable growth.
The strength of the responses we received from foreign multinationals show this quite starkly. Executives and managers across industry sectors overwhelmingly acknowledge the increasing significance of productivity (Figure 4).
Nine out of ten respondents said that the importance of improving productivity has increased in the past two years. Further, 84 percent say productivity will be either “extremely” or “very” important to business performance in the next 1-3 years.
At the same time, companies are also very focused on growing revenue in what is still a rapid-growth market. When asked what areas could have the most impact on company profitability in the next 24 months, 47 percent of respondents identified the introduction of new and better products/services (Figure 5).
Increased productivity also featured prominently (35 percent), followed by restructuring of current operations (33 percent), and the hiring of new talent/management of existing talent (29 percent).
“Productive growth” looks to be the name of the new game for foreign multinationals – capturing growth segments in the China market with targeted products and services whilst reducing inputs for every dollar of revenue generated.
The current environment is characterized by rising cost pressure, intensifying competition, and continuing volatility in global markets.
When asked what factors most impacted their companies’ profitability (Figure 6), half of respondents identified labor costs as the leading factor. Other important factors included exchange rate movements (32 percent), commodity costs, and competition from domestic companies (both 27 percent).
Foreign multinationals’ concerns about labor and commodity costs reflect what has been happening in the market.
Both labor and commodity costs have increased substantially in the past five years (Figure 7). Labor costs have increased the fastest, with average wages doubling since the beginning of 2007.
China’s productivity imperative
Driving sustainable growth for China operations
