Special Report: Inside China - Hot opportunities

The country's booming economy has opened up plenty of sectors where foreign investors can find significant profits.

by Geoff Dyer, World Business
Last Updated: 23 Jul 2013

For all the breathless hype about the Chinese economy, foreign companies have often found it hard going. Joe Studwell's classic book, The China Dream (2002) chronicles the disastrous joint ventures, naive strategies and giddy over-optimism of a whole host of multinationals that were tempted in the 1990s by the prospect of a billion customers. Better to manufacture in China and sell abroad, so the common mantra went, than to sell to the Chinese. In the last few years, however, this conventional wisdom has started to break down.

When an economy is growing at 10% a year, there have to be plenty of opportunities. As China has become richer and the foreign companies more savvy, multinationals have started to make significant profits. Here are four sectors where the opportunities are particularly interesting.

RETAIL/CONSUMER

Calculating the exact size of the Chinese middle class is an exercise in guesswork, but many economists put the figure at about 65 million and estimate that it is expanding at more than 10% a year. That means that every year several million people become consumers of products from shampoo to cars. In the 1990s, consumer goods companies such as Procter & Gamble often suffered in a tough market: the Chinese found their products too expensive and rivals copied them relentlessly. But after investing about $1 billion in China and making its products more competitive, P&G is now profitable there. While companies such as L'Oreal have expanded sales rapidly in China by focusing on the urban elite, P&G has gone for the grassroots: its distribution network reaches 2,000 cities around the country.

The bulging middle class is also attracting multinational retailers, who have been testing the waters in China for some time, but have substantially stepped up their interest in the past two years. In the hypermarket sector, the headline battle is between Wal-Mart and Carrefour. The French group was quicker out of the blocks, establishing a joint venture with a leading retailer in Shanghai, which helped it buy some well-placed sites. It now has 70 hypermarkets in China.

Wal-Mart was more cautious at first, but is now ramping up. It already has 55 superstores and plans to hire 150,000 people over the next five years - five times the number it currently employs. Other foreign supermarket groups investing in China include UK supermarket chain Tesco, which has a 50% stake in the Hymall chain. Some regions have strong domestic competitors.

The most respected is a Beijing supermarket company called Wu-Mart, which, like its near-namesake from Arkansas, has a reputation for ruthless cost control. The growth in property ownership has spurred a huge demand for home improvements and the UK's B&Q, part of the Kingfisher Group, is the market leader with 50 stores and has been making profits since 2003. Home Depot, the largest US home improvement retailer, is negotiating a potential investment in one of the biggest Chinese chains.

A fast-growing segment dominated by domestic companies is electronic appliances. For the past two years, market leaders Gome and Suning have both been running flat out to build a national network. Gome plans to open 200 stores this year alone. Best Buy of the US is setting up its own flagship store in Shanghai, but it has also made an acquisition to keep up with the locals, buying Five Star's 136 stores in May.

IT OUTSOURCING

Although China dominates manufacturing, the outsourcing of IT services has been going to India. But China is also trying to get in on the IT act: with heavy government support, including generous tax breaks and large technology parks, a number of Chinese companies are breaking into this area - especially in business process outsourcing (BPO), such as processing bills and credit card applications.

It is a measure of the potential in China, which produces 16 million graduates a year, that several of the largest Indian companies are investing heavily in the country. Infosys Technologies is in the process of hiring 6,000 software programmers at its Shanghai operation, while Genpact, India's largest BPO group, is looking to add 3,500 more staff to the 1,800 it already has at its centre in Dalian in the north-east.

With salaries for scientists well below those in developed countries, China is also an increasingly attractive destination for multinationals to do research and development work. There are now about 250 foreign companies with research operations in the country, although because of concerns about intellectual property, many keep their most sensitive research work elsewhere. However, the outsourcing of services to China faces one very large problem - finding the right employees. Despite the huge numbers of graduates being churned out, employers say it is hard to recruit people with the necessary practical and English language skills. A recent report by McKinsey estimated that only 10% of engineering graduates were qualified to work for a multinational company (for India, the figure was 25%). "China has a paradox of shortage among plenty," says Andrew Grant at McKinsey's Shanghai office. "Few of the huge number of graduates are capable of working in the services sector."

PROPERTY

Over the next decade and a half, 300 million Chinese will move to the city - equivalent to the entire population of the US. No wonder many property investors are eyeing up the market. Until recently, foreigners were uncertain about their legal rights, but over the last two years they have become more comfortable and have started to make significant inroads.

Capitaland, the Singapore group, now has a portfolio of properties on the mainland worth $4.6 billion. To fund these acquisitions in China, it sold a group of hotels, including the Raffles Hotel in Singapore, last year. Institutional investors that have bought properties in China include Goldman Sachs, Morgan Stanley and Australian bank Macquarie. Even the Duke of Westminster, who runs property company Grosvenor, is looking at Shanghai.

Partly because of fears of a bubble in luxury housing in cities such as Shanghai, most of these institutions are focusing on high-quality offices, for which the supply is generally thin. One of Morgan Stanley's strategies is to invest in shopping centres that will be anchored by Wal-Mart stores.

International hotel operators are also flooding into the country. Most of the attention is concentrated on Beijing, ahead of the Olympics, and Shanghai - the city's financial district will see four new five-star hotels in the next three years alone - but some, such as InterContinental, are moving aggressively into smaller cities.

Although the regulatory climate has become clearer, there are still risks. Foreign investors are responsible for only 5% of total spending on new property, yet in its efforts to slow investment, the government recently announced a set of measures aimed specifically at foreign investors. At the very least time-consuming, these rules could dissuade some funds altogether.

CONSTRUCTION/ENGINEERING

Property is only one part of a broader construction boom that is fanning out across the country. The world's tallest building is going up in Shanghai, the highest railway line (in Tibet) was finished earlier this year and one of the longest sea bridges in the world was opened last year to link Shanghai with its new deep-water port. China built 6,717km of highways last year, has 10.7 billion square metres of housing under construction and is spending more than $10 billion a year on new power stations.

Alexander Lohausen, at the Shanghai office of architect Albert Speer & Partner, says he has worked on more projects in 14 months in China than he did in nine years in Europe. The construction binge has been a huge shot-in-the-arm for large engineering multinationals. Siemens, which has 70 different businesses and 36,000 employees in the country, increased sales by 15% in China last year, with huge orders for power-generation equipment, telecoms infrastructure and high-speed trains. China is now its third largest market after the US and Germany.

But smaller companies have also benefited. German specialist engineering group Herrenknecht is building the world's largest tunnel excavator at a plant in Shanghai for a tunnel under the Yangtze river. Demag, which makes industrial cranes, has just opened its second factory in China, and its reputation for quality has allowed it to outrun cheaper domestic rivals.

High-profile engineering projects can be complicated, however, especially if it involves new technology. In order to persuade China to build a Maglev rail link to Shanghai's airport (using the technology of a joint venture between Siemens and ThyssenKrupp), the German government had to provide $1 billion. Now China is demanding more German funding and access to the technology for its planned Maglev line between Shanghai and Hangzhou. So far, Germany has resisted.

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