China's New Generation of Entrepreneurs
Matthews Asia
By Lydia So
July 21, 2011
Until China adopted its open door policy in 1978, the country’s economy remained closed and completely controlled by the state government. Needless to say, market competition, innovation and ownership of private businesses and personal properties were stifled. Fortunately, the economy’s eventual liberalization brought forth much needed changes and development such as a relaxation of foreign direct investments and housing reforms that have allowed private home ownership.
With the diminishing dominance of state-owned enterprises (SOEs), China’s private sector is increasingly becoming an important driving force for economic growth. Over the past few decades, these private businesses have been a large contributor to providing consumer-oriented goods and services, generating employment, and leading to innovation as well as increased productivity in China. These changes didn’t occur overnight. A favorable business environment is essential in fostering entrepreneurship in any country. While entrepreneurs in China got a relatively "late" start compared to their global counterparts, its achievements and contributions in driving the private economy have been impressive. To date, small and medium enterprises (SMEs) have become the dominant growth driver and a critical source of China’s expanding and evolving economy. In 2007, SMEs accounted for 55% of GDP, 60% of China’s industrial output, 65% of patent registrations and 70% of employment in urban areas.
Who are the people behind these small and medium enterprises? What struggles did they encounter as they sought to establish and expand their businesses? How are they delivering desired goods and services to consumers that are becoming ever more selective and sophisticated? As an investor in Asian markets, I have the opportunity to speak to many entrepreneurs in the region. My encounters with Chinese entrepreneurs are particularly fascinating from the perspective of their diverse backgrounds and industries. As many people know, China’s domestic consumption market has evolved and grown considerably, and local entrepreneurs are always at the forefront to witness these changes and stand ready to help meet consumer demands. In addition, the changing profile and education levels between older and newer generations of entrepreneurs also sheds light as to what to expect of emerging industries.
Generally, in the early days of the post-reform era, entrepreneurs were former employees of state-owned entities with engineering, manufacturing and industrial backgrounds. Not surprisingly, they tended to continue on in the industries in which they had technical expertise—either starting a business from scratch or buying out some assets from the state. As China transitioned to a more consumer-driven economy, many entrepreneurs subsequently found opportunities to create value by building consumer-oriented franchises. For example, retail entrepreneurs enhanced the experience of shopping in state-owned department stores by delivering services and products that had not been readily available in the past, such as international luxury brands. They also introduced new concepts such as customer loyalty programs. To date, there are several well-respected department store chains that customers associate with quality service and authentic merchandise as a result of the impact of the new generation of Chinese entrepreneurs.
However, delivering growth and profits can still be challenging. Starting a business requires capital, and access to venture capital and private equity was almost non-existent prior to 2005. Oftentimes, banks lack the expertise in underwriting loans to SMEs. Fortunately, with the development of the capital markets, more and more companies are managing to raise equity funds in the stock markets to fund the expansion of their business. With the deepening of the capital markets, an increasingly favorable environment for entrepreneurship can be expected. Ongoing challenges remain, however, in such operational areas as retaining skilled workers and fostering skilled, mid-level management.
Making the Grade
One encouraging observation I have made in meeting management teams, particularly among the younger generation of entrepreneurs, is the rising level of education and overseas work experience. In 1993, only an estimated 13% of private business owners had received higher education compared to 52% in 2004. In speaking with many of these entrepreneurs, I detect a higher level of business savvy and creativity than one might have witnessed in the past. This is particularly true and evident among executives in Internet-related industries; however, entrepreneurs involved in developing some segments of the health care sector have also been emerging with more advanced business acumen. Entrepreneurs that were previously employed by multinational corporations are also increasingly using their past work experience to grow their own businesses. The majority of them are acutely aware of the importance of creating a sustainable business model and understanding the competitive landscape as well as emerging global trends. This shift highlights the ability of China’s new generation of entrepreneurs to propel the country’s economic growth and innovation.
Local entrepreneurs have also played an important role in the rise of China’s services sector, which has grown substantially since the opening of the economy, from only 24% of GDP in 1978 and 43% in 2009. Looking ahead, the services sector is likely to continue to be a central driving force of China’s growth and entrepreneurs will surely be key to its ongoing development.
Assessing New Players
As investors, we are presented with an expanding universe of small- and medium-sized entrepreneurial firms with innovative business models in China. At the same time, competitive pressures are also increasing with the growing presence of both domestic and international companies in the market. It has become increasingly critical to identify and differentiate companies with sustainable business models and viable long-term strategies. It is not uncommon to see entrepreneurs who are overly ambitious in their expansion plans, take excessive risks and lose focus in building long-term value. Recent concerns over the quality of Chinese companies serve as another reminder of the challenges in investing in less-seasoned companies. However, we are also encouraged by the many compelling smaller Chinese firms that have successfully grown revenues and profits over the past decade, creating valuable brands and franchises along the way. In the end, we believe that these entrepreneurs with the desire to innovate and succeed will continue to propel China forward.
Roundtable with Matthews Investment Team
This month’s Asia Insight focuses on the topic of Asian entrepreneurs in a conversation with the following Matthews Investment Team members:
- Robert Horrocks, PhD, Chief Investment Officer and Portfolio Manager, Matthews Asian Growth and Income Strategy
- Lydia So, Portfolio Manager, Matthews Asia Small Companies Strategy
- Michael Han, CFA, Portfolio Manager, Matthews Korea and Matthews Asia Small Companies Strategies
- Tarik Jaleel, Research Analyst
Q: What differences do you see between Asian entrepreneurs over the past few decades?
Lydia So: As mentioned in the commentary, Asian entrepreneurs today are more educated and now have overseas work experience. They are also more aware of global trends and events because, especially in the case of China, they are not closed and isolated from the rest of the world and I think that’s definitely for the betterment of society.
Tarik Jaleel: Thirty years ago, entrepreneurship, especially in Singapore and Malaysia, was more state-directed. Businesses tended to be trading-related and there were a limited number of entrepreneurs who wanted to take capital risks. It was around this time that governments stepped in to provide capital and to encourage entrepreneurs and, in extreme cases, governments started up and ran these businesses. Another facet that has changed is the makeup of private entrepreneurs. The types of businesses launched shifted from those that were in contract manufacturing or trading-oriented to those providing high value-added services and technologies.
Michael Han: Over the past couple of decades, I think many Asian countries have become transparent which means for people who want to start up businesses, regulation and financing wise, it’s much more democratic and easier than 20 years ago. Back then, if you wanted to borrow from a Korean bank for example, you needed personal guarantees from friends or family members, or you needed to have a strong connection with politicians.
Q: Do you assess smaller or new firms differently than you do for larger, more established firms?
Michael Han: Looking at Korea specifically, new businesses may have a great product or great service, but beyond that, we also look at other functions like the CFO function or recruiting efforts by human resources, because traditionally, small businesses have had difficulty attracting talented employees. We also look at how actively these entrepreneurs are recruiting senior management to make up for the skill set that they may lack. We look at these areas to see if businesses can withstand a shock that they may not have seen in past five years. With larger, more established companies, they have a track record we can look to, but with small companies, we tend to spend more time conducting research and due diligence.
Tarik Jaleel: I think the issue is scalability. If you have a company that grows from US$20 million in revenue to US$100 million, the management skill set changes. As companies become larger, there are different challenges. And sometimes these entrepreneurs may not have the skills required to grow their businesses.
Lydia So: To add to these points, when we talk to the person with the vision behind the business, they may not necessarily have the right business management skill set to lead the company. So whenever we talk to a company and its founder or founding family, we examine how willing they are to let the more talented people take over management functions. This is crucial, because without being open to bringing in new talent, some entrepreneurs may not be able to take their business to the next level and some may simply be content to have a "cash cow" business. We are looking to differentiate those companies that are capable of taking their business to the next level.
Michael Han: That type of opportunity provides us very interesting investment ideas. There’s one internet portal company, similar to Google, which started with a great idea and had been very appealing. But as the firm grew, it struggled for several years because the CEO didn’t have the right mindset. But three years ago, he recruited and hired a new management that had more of a bottom line focus. The company has a strong franchise, and the CFO and new management team have been monetizing the existing business and as a result the company has experienced a fantastic turnaround.
Tarik Jaleel: Not everyone is like Steve Jobs. For example, the founder of one company was a visionary in the portable MP3 player industry—one of the early entrants in the market—but couldn’t scale the business beyond its start-up size to a sustainable model because the founder didn’t have the requisite business skill set.
Q: What are your thoughts on the culture of entrepreneurship in the region?
Robert Horrocks: In Asia, there’s never been a shortage of people who have visions, who want to create something. But a lot of times, in the past, people with creative vision weren’t necessarily profitable in building their empires. There’s now been a change in the culture of entrepreneurship—it’s now creating things to make money, not necessarily just creating large empires. I think the reason that’s happened is that capital markets have become more important and governments less important. That’s certainly the case in China.
Michael Han: In Korea, that’s certainly true especially after the Asian Financial Crisis in 1997. Before then, an automaker for example, didn’t have to care about the bottom line—just go overseas and export even if they didn’t make money because the government backed its business and banks were willing to lend. But after 1997, capital markets have become more powerful. And that’s important because as productivity levels continue to increase, at least to meet the cost of capital, it’s going to be more important to drive that through to create innovative, profitable inventions rather than importing core components from developed economies.
Robert Horrocks: Across the board, Asia has been much better in creating profitable innovations in the past 10 years than they were prior and I suspect this change is linked to democratic reforms from Taiwan, to Korea, to Indonesia.
The subject matter contained herein has been derived from several sources believed to be reliable and accurate at the time of compilation. Matthews International Capital Management, LLC does not accept any liability for losses either direct or consequential caused by the use of this information.
(c) Matthews Asia
