China’s market for mass consumer goods has exploded over the past decade and will continue to grow with breathtaking speed, outpacing overall economic growth. By 2000, some 260 million people will be able to afford packaged consumer products (Exhibit 1), making China the world’s largest market in many categories such as beer and biscuits. Winning in China has therefore become a top priority for multinational corporations, many of which see the Chinese market as a once-in-a-lifetime opportunity to catapult themselves into position for global leadership.

But winning won’t be easy. China’s vast area and weak distribution infrastructure, as well as increasingly intense competition, will make market leadership an elusive prize. Many companies are already having to reconsider their approach to doing business in China, failing to translate their ambitious aspirations into clear growth trajectories; in all too many cases, early gains have turned into a serious drain on resources. It seems clear that approaches followed so far aren’t the formulas for success in the Chinese consumer market of the 21st century. Something quite different is needed.

What will market leaders look like?

One thing is certain: in coming years the market leaders of the next century will dramatically increase the breadth and depth of their China operations.

By 2000, leaders will need to have category market shares of at least 20 to 25 percent nationwide, probably more to be considered clear winners. For mass market categories such as food, beverages, or personal care, this implies achieving annual sales in excess of $1 billion. Yet in a survey of 13 leading multinationals, we found that most had China sales in 1995 of less than $100 million.

Leaders will also need far wider geographic coverage. Each of the surveyed companies typically had salespeople in only about 15 cities. But with millions more consumers set to cross the $800 annual income threshold—the level at which consumerism takes off—winning companies will need sales offices and established supply lines in well over 100 cities by the year 2000. Nor will it suffice to continue focusing on higher-end department stores and large chain supermarkets, as most multinationals currently do. Although specific coverage requirements will vary by category, winners will generally need much deeper outlet coverage than they have today. For real market impact, multinationals will have to supply the small local groceries and corner stores that command over three-quarters of the volume of mass products in large Chinese cities. That means penetrating more than 250,000 outlets, versus today’s 20,000. Leaders in China also will need to deal with an increasing number of joint venture partners, as JVs will remain the principal means of expansion. The average multinational in our survey had just four JVs; the winners in 2000 could easily have a dozen or more.

Finally, the organizations needed to support all these activities will be much larger and much more capable. The companies in our survey still are relatively small—with 200 or so employees working within sales in China, for example—and have only nascent organizational capabilities. Winners in 2000 will easily employ ten times as many people as they do today, and they will have world-class sales and marketing skills underpinning their success.

Obstacles to market leadership

A number of consumer goods companies are rapidly increasing their presence in China. Procter & Gamble, Coca-Cola, Unilever, and Nestlé look set to reach a popular goal: "one by two," that is, $1 billion in annual sales by the year 2000. Many others, however, are struggling to achieve the necessary growth and market coverage. They face five formidable obstacles.

1. Rapidly escalating competition

Early this decade the main challenge in China was to negotiate joint ventures and establish local manufacturing. Pent-up demand and the scarcity of high-quality foreign goods meant sales would take care of themselves.

But as competition has intensified, market share and volume growth are much more difficult to achieve. Practically all leading consumer multinationals have established operations in China. In skin care, food, and premium beer, for example, 50 world-class competitors now have manufacturing facilities in China, more than four times as many as there were in 1990. In addition, many mid-sized Asian manufacturers such as Lam Soon, Yeo Hiap Seng, and President Foods have used their superior understanding of China to make significant inroads. Not to be left behind, progressive local companies, such as Yanjing Beer and Lucky Film, are also pressing to improve quality and compete with joint venture brands.

There are several consequences of this assault on the Chinese consumer:

Market share is volatile. Bombarded with opportunities to buy a bewildering array of products, consumers are in experimental mode and significant market share gains can be won—and lost—with dismaying speed. In Shanghai, for example, the market share of a nutrition drink named Wahaha went from 33 percent to 80 percent to 8 percent in a matter of six years. Often the competition is a completely different product, as consumers with limited disposable income decide between trying a foreign shampoo or a new food (Exhibit 2).

Overcapacity is already apparent. For example, the world’s top 10 beer companies and many smaller ones have rushed to buy or build capacity. All have visions of achieving leading national market share, but most will be sorely disappointed. If all their capacity announcements materialize, production of premium beer could exceed demand by 80 percent by the end of the decade.

Sales and marketing costs are on the rise. To keep up with competitors in major cities, companies need to supplement distributors with a more expensive, direct sales presence. They also must spend more on promotional items and channel support in order to stand out. Meanwhile, advertising costs are soaring: the price of airtime in Guangdong, for example, is rising by over 25 percent a year.

2. Poor transportation infrastructure

By the year 2000, almost 250 Chinese cities will have sufficient average annual income levels to support consumerism. More than 160 of these cities will have populations exceeding one million. And 20 will have the absolute spending power that Guangzhou has today (Exhibit 3).

Delivering products reliably and cost-effectively to several dozen cities, will, however, be an enormous challenge given China’s poor transportation infrastructure. It generally takes four times longer to transport a container of snacks from Beijing to Guangzhou, 1,900 kilometers away, than it does to cover the similar distance from Baltimore to Houston. Moreover, the contents of the container are up to 20 times more likely to arrive damaged. Journeys to smaller, more distant cities are even more problematic.

The current situation can only get worse, as planned increases in transportation capacity are unlikely to cope with growing demand. And though private investors can invest in rail, shipping, and trucking, they are discouraged by the government’s reluctance to let them earn more than 15 percent on their investments, as well as by controls on pricing and routing.

Stockpiling products is no easy solution to unreliable transportation. Warehouses are scarce and so have to be built. Moreover, inventories are difficult to manage as market estimates are notoriously inaccurate, and there is practically no information about when product shipments will arrive.

3. Underdeveloped and fragmented distribution channels

Poor public transportation and limited ownership of motor vehicles account for the proliferation of small-scale groceries and corner stores in China. As a result, less than 10 percent of grocery sales go through large format stores, even in major cities. This fact, combined with lower customer spending power, means that an average retail outlet in China sells less than one-thirtieth of the average US or Japanese store. Restocking and merchandising therefore pose expensive logistical challenges for multinationals, particularly for smaller ones with limited product portfolios or weaker brands.

Using local distributors to reach all these stores might in theory offer a cost-effective answer; however, distribution channels are also highly fragmented. Most foreign companies find their joint venture partners have hundreds or even thousands of distributors that they deal with directly. The typical state-owned brewery in a large city will have over 2,000 primary distributors, many of whom resell to hundreds of secondary wholesalers and thousands of independent street hawkers. Compounding the problem, these distributors tend to be undercapitalized and have very poor coverage and sales and merchandising skills. Companies in our survey felt most of their distributors were inadequate with respect to delivery, sales, merchandising, promotion, and collection (Exhibit 4). Few had even the most basic customer tracking and credit systems.

Unfortunately, better distributors are unlikely to emerge soon, again because of government restrictions on foreign investment. Currently, with a few exceptions, joint ventures are limited to distributing only goods that they themselves manufacture.

Another formidable challenge is the lack of control multinationals have over their goods: counterfeiting and arbitrary pricing are commonplace. Some companies are trying to overcome these problems by using counterfeit-proof packaging, by printing retail prices on packages, and by marking production runs differently by channel so that counterfeits can be pinpointed more accurately. Nevertheless, the sheer scale of these problems increases the level of complexity for managers in China.

4. Scarcity of talent

The fourth obstacle, and one of the biggest brakes on growth, is the dearth of good managers. Typically, Chinese joint venture partners are responsible for manufacturing and sales and distribution, while foreign partners focus on marketing and broader strategic issues. But most multinationals soon discover that their local partners lack the product and market knowledge, distribution reach, and financial resources to match MNC aspirations. Skilled local managers and experienced expatriates capable of leading initiatives in China are woefully scarce. One executive had to spend the first nine months of his China posting on recruiting, just to satisfy current requirements. Most companies, meanwhile, are projecting growth rates that will necessitate a tenfold increase in staff levels over the next five years. All this in an environment where staff turnover of over 30 percent a year is common, as multinationals and leading Chinese enterprises poach people from one another with promises of ever-increasing salaries.

5. Unwieldy joint venture relationships

As the China business expands, manufacturing, logistics, sales, and marketing activities all need to be carefully coordinated, to realize synergies, maximize impact, and manage cost duplication. That’s no easy task in the best of worlds, and all the more difficult in China, where it usually means orchestrating a growing number of joint ventures. JV partners do not necessarily want to cooperate. Some might want to expand more rapidly, others won’t want to make further investments, still others will oppose staff reductions. Achieving a consensus is tough enough when dealing with three or four joint ventures; the problems only escalate as more partners are added.

Three approaches that fall short

In our work with multinationals in China, we’ve seen three common approaches. Companies following the first two routes—"Wait for payback" and "Bet on a few strong brands"—often get off to a fine start but then sputter and stall, simply because they are under-gunning it in China and don’t have the power to win long term, especially once strong competitors enter the race. The third approach—"Build volume fast"—rightly aims for aggressive growth, but often fails because market expansion gets too far ahead of the organization’s ability to support broad sales and distribution efforts. None of these approaches squarely addresses the challenges outlined above, and companies get trapped into vicious cycles from which it is difficult to escape.

Waiting for payback before investing further

This is a cautious approach that aims to generate clear returns before committing further investments. Multinationals following this course typically have made heavy investments in manufacturing and have enjoyed early success—in wealthier markets and high-end channels—without making significant investments in sales and distribution. They might be holding back because of concerns about the pace of market reform in China, or a belief that their local partners are better equipped to manage day-to-day problems. As a result, their strategy is based on the premise that further investments (e.g., in training, advertising, and promotion) should wait until it’s certain that success is sustainable. This might work in a world without competitors; but once other, more committed players come into the picture, the early movers’ share of existing markets rarely increases, and they face difficulties expanding into new markets.

Take, for example, the recent experience of a beverage company. Its product was initially popular, but it failed to respond adequately when aggressive newcomers entered the market. It didn’t invest in distributor support, limited its sales coverage to large stores in a few top cities, and didn’t maintain its share of voice in advertising. As shown in Exhibit 5, this approach had dire consequences. As demand for the product slackened, retailers and distributors lost interest, which hurt coverage and further reduced brand popularity. The resulting decline in market share put additional pressure on financial performance, making it even harder to keep up with competitors.

Another multinational, this one a snack-food manufacturer, suffered as a result of its reluctance to invest in its China organization. Seeking to minimize expatriate involvement until market demand could completely justify the cost, it limited most expats to short-term training assignments and relied almost exclusively on its ill-qualified partner to train new hires and build the right skills. This created high turnover among Chinese employees and deterred promising recruits—most of whom seek first-class training—from joining the company. With performance suffering, the joint venture was even less able to afford expensive expatriates.

Betting on a few strong brands

Other multinationals take a focused product approach to China. They concentrate on getting a small number of top brands right, recognizing the challenge of launching brands properly with limited resources. They tend to believe that the market has reached critical size, and so invest heavily to build the brand and a sales team. They assume that it’s futile to compete with cheap, poor-quality local goods in the low end of the market, and thus position their products at the top by maintaining premium prices and channeling goods to modern outlets.

What these narrowly focused companies often find, however, is that their volumes are not sufficient to compensate for their high overheads, and that their unit sales and distribution costs are higher than those of competitors with broader portfolios. Moreover, they often have difficulty getting coverage in the smaller outlets that prefer dealing with multinationals with higher-volume, broader portfolios.

This was precisely the experience of a beverage manufacturer that entered the market early and enjoyed initial success with a single product. When its main rival launched a range of products that could generate significantly higher volumes, performance faltered (Exhibit 6). Because unit distribution costs were higher, distributors were less interested in pushing the product. This resulted in lower market share, which also reduced retailers’ interest in the brand. The multinational now finds itself a distant number two, increasingly at a cost disadvantage and unable to penetrate the important smaller channels.

Building volume fast

A focus on volume growth and expansion into new cities and smaller outlets marks the approach of a third group of multinationals. Most have invested heavily in capacity and are aggressively advertising, promoting, and building salesforces in the belief that the swiftest will be the victors.

Although this approach usually results in rapid volume gains, it can easily spin out of control. In their rush to build coverage, these multinationals need to rely on unreliable local distributors, and as a consequence frequently lose control of pricing and positioning. They find their sales achievements are actually quite fragile, and can easily disappear if rivals move into markets that are not strongly supported. Moreover, some underestimate the costs of doing business on multiple fronts in China and run into cash-flow problems.

One early entrant into the beer market quickly built up its volumes in a number of large cities through heavy advertising and concerted courting of local distributors. Its rapid success encouraged it to more than double its local manufacturing capacity. However, the new capacity came on line just as other international brands began entering the market and the economy slowed. Determined to keep up volumes, the company allowed speculative distributors to take the excess production, and ended up flooding the market (Exhibit 7). Regular distributors found themselves holding products they couldn’t sell, and began cutting prices and dumping beer in lower-end outlets inconsistent with its premium image. This had disastrous implications for the brand’s positioning and, in turn, its popularity. It also compounded distributor turnover problems, further damaging the beer’s reputation in the trade and weakening channel commitment. The train of events exacerbated the multinational’s capacity utilization problem, and put further pressure on it to sell its product in an undisciplined way. Today, the company can no longer afford to compete with aggressive international brands, and has been forced to move out to less competitive secondary cities.

Another snack-food multinational ran into problems when, driven by unrealistic corporate aspirations, it expanded too quickly into several hun-dred cities and thousands of outlets. Large overheads and higher-than-expected logistics and inventory costs led to disappointing results. An attempt to expand out of the problem only worsened financial performance, and the company is now reassessing its strategy in China.

A surer way to win: dominate, then replicate

As the above examples illustrate, some companies just haven’t gone far or fast enough and are now losing ground to more aggressive competitors. And others, though they’ve recognized the need for progressive expansion, are not building their China businesses on a consistent basis.

That otherwise-successful multinationals stumble and fall in China shouldn’t come as a surprise. As described earlier, the market is extraordinarily dynamic and complex, and managers are usually so busy solving today’s problems that they can easily lose sight of the larger picture.

Yet, despite the difficulties of competing in China, some companies are getting it right, and are clearly pulling ahead of their rivals (Exhibit 8). It’s instructive to examine what lies behind their success.

Winning companies in China’s consumer markets are bold. From the outset they play to dominate key markets, then replicate their strength elsewhere. They do so by building beachheads in cities they can win outright. By generating positive momentum with both consumers and the trade they pull ahead of competitors, then go on to secure their positions by controlling sales and distribution and quickly building deep organizational capabilities. Once in a position of dominance, they can weather onslaughts from aggressive new entrants. Profits from these early wins can be used to fund expansion into new markets and help maintain corporate commitment. The key to replicating success, however, is to balance speed with endurance. Too many multinationals, lured by early, easy volume gains, fail to consolidate their positions in their base markets, overextend themselves, then fall when competitors attack.

To dominate markets in this manner then replicate success elsewhere in China, companies should heed three principles.

1. Take charge of sales and distribution

Companies that enter the market early have a distinct advantage when it comes to establishing a dominant position. They have their choice of production assets and distributors, they have open access to shelf space, and they find it easier to build their brands in uncrowded markets. In the cola wars, for example, whichever company first established a bottling plant in a given city has since maintained leadership there (Exhibit 9).

To build real depth in the market, however, multinationals must consistently meet the needs of trade channels and consumers, providing distributors and retailers with dependable turnover and margins, and customers with uniform product positioning and consistent availability. By doing so, they generate momentum with both customers and the trade. This is enormously difficult in China, where the basic distribution infrastructure and distribution skills are so inadequate. As a result, multinationals must play a much more active role in sales and distribution than they are accustomed. Concentrating on marketing and brand management will not suffice.

To improve distribution control, multinationals are trying a number of new approaches. Some have invested in "shadow-managing" major wholesalers, assigning their own staff to work directly with these wholesalers, train their salesforces, and install systems for monitoring inventories and performance. Other companies—typically those with large volumes, such as Coca-Cola, which can afford to bypass distributors—have substantially reduced their dependence on wholesalers in major markets by selling and trucking directly to tens of thousands of retailers. This gives them a distinct edge in controlling product positioning and promotions. Similarly, multi-category enterprises with strong brands, such as Procter & Gamble or Nestlé, have the scale to build significant cost advantages and to ensure that wholesalers toe the line on pricing and merchandising policies.

But you don’t need the clout of these giants to achieve the reliable distribution networks that are crucial to sustained growth. Taiwan’s President Foods has aggressively built teams to promote and merchandise its products in thousands of smaller outlets. While it’s too early to pass judgment on the results, the company has generated substantial volumes in a very short time. Similarly, San Miguel, the Philippine beer company, entered Guangzhou early and worked hard to generate consumer interest (in part through aggressive advertising) and to build loyal distributors. San Miguel found that getting the little things right went a long way toward earning loyalty; for example, it gave distributors specific order-pickup times so they didn’t need to line up at the brewery for hours. As a result, it is far and away the leading foreign beer brand in southern China.

2. Overinvest in building organizational capabilities

To dominate markets, companies also need the leadership resources and organizational structure that will allow them to build local capabilities. Again, conventional models for entering markets do not hold.

Don’t be too quick to localize. Most companies assume they should localize as soon as possible, quickly reducing the number of expensive expatriates in their Chinese ranks. Successful companies, however, do just the opposite: an informal sampling of 10 such companies revealed they had almost doubled the number of expatriates they employed in the space of six years.

These companies recognize that expatriate managers provide the critical experience and leadership required to build well-functioning business processes and manage unruly distributors. Hence, they treat expatriate costs as essential investments, not as operating expenses. They also spend considerable time finding and developing key local managers, such as sales supervisors. Some companies, Procter & Gamble and Pepsi for example, have set up training "universities" for pivotal functions like sales.

Recognize the value of centralizing key activities. JVs are typically set up as independent, profit-making entities. Often, the local partner has quite different objectives than the multinational, which is trying to build a consistent brand in multiple markets and optimize production and distribution. The practice of setting up separate joint ventures for different product categories—necessary because Chinese manufacturers tend to be fairly specialized—compounds the problem, often creating redundant sales and distribution activities in the same market.

Ambitious multinationals, intent on building integrated, cost-effective China operations, are therefore attempting to centralize all their sales, marketing, and distribution activities under umbrella holding companies, as illustrated in Exhibit 10. These relatively new legal entities give MNCs greater control over brand management and sales and distribution activities than they could achieve through their individual JVs (which, as mentioned earlier, may distribute only their own manufactured goods); they also give the company volume clout. Of course, making this structural change requires persuading JV partners to concentrate on what they do best—mass production—in exchange for guaranteed purchases and perhaps equity in the holding company.

3. Pace yourself for a marathon, not a sprint

Dominating a few beachheads will not deliver success in China’s enormous market. Winners will have to replicate success in other cities. This will require deep financial pockets and consistent commitment from corporate headquarters. Maintaining that high level of corporate commitment and confidence is difficult. Staff on the ground in China are working flat out and are frustrated by "unreasonable" performance expectations from distant head offices that don’t appreciate what it takes to get even basic programs running. Meanwhile, those at headquarters are tantalized by the promise of an enormous market, but are uncomfortable with risks they don’t understand and resent seemingly never-ending requests for resources. Unless there is better understanding, China expansion programs are likely to stall when headquarters balks at yet another call for cash.

Ultimately, playing to dominate will allow companies in China to demonstrate clear successes and justify a sustained commitment. In the meantime, the key is to ensure that expectations—from both sides—and requirements are communicated loudly and clearly, and that aspirations are realistic in light of the available resources.

Manage corporate commitment proactively. China management needs to be explicit about market development priorities, investment needs, and likely returns. Which markets must be secured at all costs, which are secondary, and which should be treated purely opportunistically as sources of easy but fragile volume? How much investment is required for specific markets—not just in hard capital assets but also in sales, distribution, and marketing? How will these investments enhance the company’s ability to dominate priority markets?

For its part, the parent company must clarify its appetite for investment and its willingness to endure negative cash flows because of development expenses. The better a company’s understanding of what it takes to succeed in China’s mass market, the easier it would be to set realistic targets. Exhibit 11 is a questionnaire designed to help CEOs calibrate their companies’ current efforts and commitment level.

Balance aspirations with resources. When prioritizing additional cities, companies need to consider not just structural market attractiveness—size, speed of development, and the ease of doing business there—but also how easily they will be able to achieve a dominant position and replicate their successes elsewhere. The difficult question is whether to go for the small, easy wins, or to wage protracted campaigns for the big markets. An important determinant here is how deep the multinational’s commitment and resources are compared with their competitors’. Many MNCs feel they have to be in the most competitive markets, but end up fighting battles they cannot afford. Inevitably, they lose. At the same time, they ignore dozens of less well-known, but equally populous markets where they could be building strength. Agfa Paper, for instance, has managed to obtain a 26 percent share of China’s color photographic paper market by focusing on cities that Kodak and Fuji do not dominate. While this may not be a sustainable strategy in the long run, it may be the only way to build sufficient strength to compete head-on in the future.

Stretch resources through alliances (and maybe acquisitions). Rapid expansion inevitably strains resources, but smaller companies have learned to stretch their often limited resources by forming creative alliances. Mars, for example, engaged the East Asiatic Company, one of a handful of independent professional distributors in China, to distribute and support its confectionery products in secondary markets. Several non-competing multinationals with narrower or lower-volume categories, such as Colgate-Palmolive and Johnson & Johnson, are banding together to share warehousing and distribution facilities. Still others use the production and distribution facilities of better-established manufacturers. For example, Kraft Foods avoided building new capacity by producing its Maxwell House ice coffee at a Pepsi plant.

Even high-volume industry leaders are using alliances to stretch their lead. Coca-Cola, for example, has split China three ways—among itself and two prominent Asian groups, Swire Pacific and Kerry. By giving these companies exclusive manufacturing and distribution rights in certain provinces, Coca-Cola is speeding its entry across China.

Another way to gain ground quickly is to look for inadequacies in the strategies being pursued by competitors, both foreign and domestic. There may well be opportunities for savvy MNCs to take advantage of their rivals’ missteps. With all the new entrants, consolidation is inevitable, perhaps leading to attractive acquisitions for the leaders.

The rewards in China’s mass consumer goods market will be immense. But winning requires playing for high stakes, and playing now. Given the escalating competition, companies can no longer expect to earn easy profits by just skimming the surface of new markets. To succeed in the 21st century, multinationals must take an integrated approach to China, one that enables them to dominate priority markets, then replicate their success elsewhere. Only those companies in dominant positions, with deep sales and distribution capabilities, are likely to emerge unscathed from the industry battles that lie ahead.