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Getting Your China Strategy Right

The U.S.’s economic relationship with China is complicated. Here’s what some CEOs are doing to fine tune their strategy

Jim D’Addario is mad as hell, and he’s not going to take it anymore. Chinese manufacturers are counterfeiting about 70 percent of the high-end guitar strings sold under the D’Addario brand in China and passing them off as genuine. The CEO of Farmingdale, N.Y.-based D’Addario & Co. is getting absolutely no help from the Chinese government or from the White House in stopping this travesty, even though U.S. Sen. Charles Schumer has publicly allied himself with D’Addario’s cause.

And D’Addario is tired of hearing that he should forgive the targeting of his brand because America’s economic and geopolitical prosperity is inextricably tied to China’s fast evolution into a global superpower. “I’m not going to let them try to leapfrog me and become a competitor,” said the third-generation owner of the $150-million manufacturer of musical-instrument components. “I do want their economy to be strong and for the Chinese to buy our products, but not at the expense of American jobs and security. It’s almost becoming a national-security issue.”

American CEOs like D’Addario are facing a day of reckoning on China. Many U.S.-based companies are benefiting handsomely by tapping into China as a source of manufacturing, as a rapidly growing market, or both. But now, more CEOs are finding their American customers, shareholders and employees are souring on China because of growing negative dimensions of the entire U.S.-Chinese relationship.

No doubt China is an increasingly messy elephant in the American living room. Its economic burgeoning is a “growing source of concern,” Treasury Secretary Tim Geithner said this month, because of how the rising power of Chinese businesses and consumers threatens to eclipse American companies and the nation. China is the single biggest holder of U.S. debt. China’s military is increasingly advanced and assertive. China won’t cooperate on currency manipulation. China toys with depriving Western markets of strategic-mineral exports. And, as D’Addario has experienced, Chinese companies – with the apparent cooperation of their government – heedlessly spurn the intellectual-property protections that are a crucial cog in the Western capitalist system.

And so as Washington prepares for the visit of Chinese President Hu Jintao on January 19, it’s not just President Obama and other U.S.-government leaders who must figure out what to do about China. American business leaders must do the same thing.

The extent of the short- and long-term economic threat that China poses to the United States is clear: America remains far ahead overall, but by many measurements China will catch up within a few years. One example: Chinese investment in R&D spending averaged growth of more than 19 percent a year in inflation-adjusted dollars over the last decade, compared with just 3.3-percent growth in the United States.

But as U.S. CEOs plot their corporate strategies concerning China as a source and as a market, “soft” numbers are important as well. For example, nearly half of Americans already believe that China already has become the world’s leading economic power, according to a recent Pew Research Center survey, while fewer than one-third correctly ascertain that the United States still ranks No. 1. Americans also were equally split in the same poll about whether U.S. trade with China is a good thing or a bad thing.

So far, American CEOs are reacting to these intensifying concerns – and in the interests of their companies — in a number of different ways. Google CEO Eric Schmidt, of course, has famously tangled with the Chinese government about internet freedoms. CEOs in a few other American industries, including “clean-tech” energy and coated papers, are agitating for action against China.

“Chinese subsidies, starting with currency manipulation, must be addressed,” said Sandra Van Ert, president and CEO of Appleton Coated Paper, an Appleton, Wis.-based company that, along with American competitors, has been pushing for federal action.

Others are doing more. D’Addario, for example, already has repatriated manufacture of the few products his company makes in China, such as guitar straps. “We were at 89 percent U.S. manufacture, and now we’re back up to 93 or 94 percent,” he said. “And we just had a meeting the other day to figure out where it’s realistic to do even more.”

Yet, the more complicated picture emerging in the overall U.S.-Chinese relationship isn’t daunting other companies. McDonalds indicated that it will be upping its investment in new outlets in China by 40 percent in 2011 alone, for instance. And Facebook CEO Mark Zuckerberg recently trekked to China to meet with the heads of some of the nation’s biggest tech companies as the next step in his oft-expressed desire to penetrate the Chinese market.

In any event, U.S. CEOs will be continually faced with the necessity to affirm or shift their China strategies from now on. The U.S. relationship with China will be the “central American challenge going forward,” Larry Summers, the White House’s top economic advisor, told a gathering of CEOs in November. And in that context, he warned his listeners to “think very hard about their obligations as citizens of this country and to think very hard about how through their activities they can make it work for all of our citizens.”

So far, the mainstream approach by CEOs of U.S.-based companies is exemplified by Bob McDonald, CEO of Procter & Gamble, which is quickly developing China’s huge domestic market for its brands. The growing importance to McDonald of addressing China with his customers and employees was clear from the open letter that he placed in P&G’s hometown Cincinnati Enquirer last October.

McDonald regretted that “much of the political debate about China” has “fixated on the false assumption that China’s growth must come at America’s expense.” He argued instead that “China and the U.S, more than any other economies in the world, are mutually and positively interdependent. We should embrace our mutual interests and invest in opportunities for shared growth.”

Already, like P&G, nearly every sector of American business has lined up behind some sort of strategy or another that depends on China. From Wal-Mart to General Motors, hundreds of America’s biggest companies – and thousands of its smaller ones – already are firmly seated on China’s bandwagon, either as a source of inexpensive manufactured imports, or as a burgeoning domestic market for their goods, or both. U.S exports to China were up about 35 percent in 2010 over 2009.

Advocates of ever-expanding U.S.-Chinese business relationships cite the fact that disaster didn’t follow similar-sounding concerns that many Americans expressed about growing Japanese control of the U.S. economy in the Eighties, especially the consumer-electronics and auto industries.

“Most CEOs rightly view China mainly as a growth engine,” said John Frisbie, president of the U.S.-China Business Council, of which P&G’s McDonald is chairman. “Therefore, U.S. companies need to be engaged to participate in that, and to access China.” He added that American business leaders “would like to see strategic and military national issues separated from trade issues, rather than see economics politicized in a way that wouldn’t be helpful.”

Joel Ewanick, for instance, is no stranger to how international tensions can affect corporate strategies: He was chief marketing officer of Hyundai in Americafor several years as U.S.-Korean trade tensions simmered. And now, as global CMO for GM, at this point he’s determined to keep the corporate head low on the question of America’s increasingly tense relationship with China – which has emerged as a hugely important source of engineering as well as a domestic market for General Motors.

“You can make yourself crazy trying to anticipate [developments] and how they would change consumer behavior in the United States and other countries,” Ewanick said. “Sure, we have contingency plans, but you’ve got to live for today, and hope that smart people keep [the two countries] out of trouble.

Some experts argue that continued economic engagement and geopolitical developments regarding China already are working hand in hand, for the greater good of America and every other economic and military rival to China. The nation is “growing not by writing its own rules, but instead by internalizing the rules of the advanced industrial West,” creating a co-dependence that will only benefit the global economy, argues Edward Steinfeld, acting director of the MIT-China program, in a new book, Playing Our Game: Why China’s Rise Doesn’t Threaten the West.

Indeed, this is nothing like the Seventies, when Occidental Petroleum CEO Armand Hammer went rogue in developing a deep corporate relationship with the Kremlin. The Chinese “are not like a Soviet Union that aspires to take over the whole world,” argued Henry Chesbrough, executive director of the Center for Open Innovation at the University of California. “The Chinese want prosperity. They’re investing in their military capabilities, and there will be frictions for sure, but this is not a global ideology vowing to overthrow the United States and the West and take over.”

In any event, said Gary Hirshberg, CEO of Stonyfield Farm, “The only way we make change is find a new way of relating to each other.” The co-founder of the Londonderry, N.H.-based world-leading brand of organic yogurt is considering setting up a beachhead in China. “This isn’t some liberal, peace-loving thing. Commerce is the oldest form of exchange that there is, and we’ve got to employ the tools of commerce for sustainability or there’s no hope.”

But other China watchers in the U.S. see ominous developments that could increasingly sour the backdrop for American CEOs and everyone else.

“The legitimacy of the Chinese government is becoming increasingly precarious” inside the country as belief in communism continues to fade, said Frank Gunter, a Lehigh University sinologist. A threatened Communist Party could “seek popular support by encouraging nationalism, possibly by inviting conflicts with its neighbors and its only peer competitor, the United States.

“If its economy stalls, China may be a greater challenge to the world community than the current worldwide recession and the war against terror combined.”

And even without sharing geopolitical concerns, more American CEOs are faced with some very immediate business worries about China, such as rising labor costs. “In China’s new five-year plan, the focus shifts from export-led sectors to raising Chinese laborers’ incomes so they can prosper in this new era,” said Savio Chan, president and CEO of U.S. China Partners, a consulting firm.

Labor “is the biggest problem I see for us in China,” said Abel Zalcberg, CEO of OFM Inc.,a Holly Springs, N.C., company that sources much of its product line in China.

Partly as a result, more CEOs of U.S.-based apparel companies, for instance, are adopting a “China plus one” sourcing strategy, now augmenting their previous reliance on Chinese manufacturers with production in at least one other low-cost country. “China is seen as more uncertain, so they make sure they have an extra source, not as a principled stand but as a good business decision,” said Philip Levy, resident economics scholar at the American Enterprise Institute, in Washington, D.C.

That sort of pragmatism is likely to rule American CEOs’ thinking in regard to China for a long time to come. Even General Electric CEO Jeffrey Immelt has backed off his previous China critique and recently announced that the company will invest more than $2 billion in China, mostly in expanding research and development there, over the next two years. GE has been thwarted by the regime’s “indigenous innovation” philosophy that protects Chinese high-tech sectors. But new policies and reassurances from Chinese authorities about “how welcome GE is” have proved encouraging, said Mark Norbom, president and CEO of GE Greater China.

As Hirshberg of Stonyfield Farm put it: “The bad news about China is also the good news. The bad news is that it’s a totalitarian regime that is very controlling of people and information. The good news is that they get a hell of a lot done, very quickly.”

Summary for CEOs

American companies have benefited from ambitious China strategies so far. But increasingly problematic relationships between the United States and China are making that more difficult.

Here are some things that CEOs are doing to make sure they’ve got the right China strategy in this new environment:

  • Ensuring that the company’s ties to China provide potential long-term benefits as well as short-term advantages.
  • Communicating the corporate position and strategy about China with increasing regularity and through more channels.
  • Repatriating functions such as manufacturing and engineering to the U. S. from China where possible.
  • Looking for the “next Chinas” that might provide manufacturing-cost advantages that are dwindling in China, such as southeast-Asian countries, and a similarly fast-growing market, such as India.
  • Keeping an ear to the ground about political and economic anxieties about China expressed by their American constituencies.
  • Staying in tune with Washington’s shifts in approach and temperament about various aspects of China policy.

About Dale Buss

Dale Buss
Dale Buss is a long-time contributor to Chief Executive, Forbes, The Wall Street Journal and other top-flight business publications. He lives in Michigan.