THE CHINA MARKET: Turned on, tuned in, on top

CHINA ECONOMIC QUARTERLY

(This article originally appeared in the November 10, 2003 issue of South China Morning Post in Hong Kong and is reproduced here with permission from the publisher)

The world's biggest television company is now Chinese-controlled. Does this portend an inevitable takeover of the world's consumer appliance markets by low-cost Chinese producers?

Not quite. The merger of the TV production operations of Huizhou-based TCL and France's Thomson, announced last week, created the world's top TV company by production volume (although almost certainly not by profits). With control assured via its 67 per cent stake in the new venture, TCL has effectively pulled off the biggest-ever cross-border acquisition by a Chinese company.

For both partners, the deal represents a cheap solution to vexing and costly problems. Thomson removes a major loss-making operation from its balance sheet and gets to focus on more profitable business lines. TCL, meanwhile, gains instant access to distribution channels in coveted US and European markets, as well as an established, if somewhat tattered, brand portfolio - all without spending any cash.

The potentially interesting thing is not the deal itself, but what TCL manages to make of it. And here the outlook is tantalising, but uncertain.

The premise of the merger is that Chinese companies can revitalise moribund foreign brands by slashing costs (achieved by closing foreign plants and moving production to China). This concept has been gaining currency in China's corporate circles for two or three years. For Chinese consumer-product companies, this approach seems an attractive way out of a strategic cul-de-sac.

At home, the prospects of top companies such as TCL are constrained by the local protectionism which prevents them from buying up or bankrupting their smaller or less efficient rivals. Most consumer-product markets thus suffer from overcapacity and razor-thin margins.

On the export side, companies like TCL make a fair bit of export money by producing goods on contract for foreign brand-name firms. But they have found it difficult to establish their own brands in foreign markets, and capture the much higher margins that own-brand sales would command.

Hence the ingenious notion of taking over existing foreign brands that have fallen on hard times and may, therefore, be bought cheaply. By cutting production costs, the new owners can, in theory, re-establish these brands as reliable, low-cost options for budget-conscious consumers. Thomson's chief American TV brand - RCA, a once-proud, but now badly faded name - will provide an excellent test case.

It is important to recognise that, at least at the outset, this approach represents not a leap forward in Chinese branding ability, but an extension of China's comparative advantage (cheap labour efficiently organised) into new territory.

The long-term viability of this model will depend on how successfully the Chinese partner uses their new vehicle to master the management of distribution channels in mature markets, and the even more complex and costly art of brand-building. If it succeeds, it may be able to creep up from the bottom end of the market to the more profitable mid-to-upper reaches.

This is by no means an easy task. But over the past two decades, Chinese firms have proved themselves good learners. It would be unwise to suppose they will stop learning.