Q & Asia

OVER THE PAST decade innumerable PowerPoint presentations have condensed Asia into two bullet points. One is its rise as a vast consumer market. About 30% of the world’s middle-class spending is done by Asians, up from 20% in 2000, according to the Brookings Institution, a think-tank, which defines the middle class as those earning $10-100 a day at purchasing-power parity. The other is Asia as a production hub: 47% of world manufacturing is now in the region. But the world’s boardrooms have started to grapple with a much broader set of questions about Asia. The most immediate ones are higher labour costs and ageing populations, growing consumer expectations and the way the internet will affect business there. A rising risk of hostilities in the region is adding further complexity. And in the background looms the broader issue of whether, and if so how much, Asian companies need to globalise (which will be dealt with later in this special report).

Higher labour costs in China are already beginning to bite. In 2010 a Taiwanese firm, Foxconn Technology, suffered a spate of suicides at its factories in China where over a million workers assemble electronic products, including many for Apple. In response the company raised wages dramatically, “to protect the dignity of workers”, its chairman explained. Since then higher wages have become an accepted fact. According to China’s current five-year plan, the average official minimum wage across the country must rise by at least 13% every year.

An obvious consequence is that low-skilled, labour-intensive work will move elsewhere. The globe’s best barometer of this is Li & Fung, a Hong Kong-based firm that sources $16 billion-worth a year of clothing and other products, mainly for big American retailers. The suppliers in its network employ tens of millions of people. William Fung, its boss, says the shift from China has begun and will accelerate. Labour in Vietnam costs 40% less than in China and in Bangladesh 60% less. Indonesia, Myanmar and Africa will benefit too. A question mark remains over India. It has lots of young folk, but Asian bosses shun it because of red tape and dysfunctional politics.

According to China’s current five-year plan, the average official minimum wage across the country must rise by at least 13% every year

Higher-skilled work, such as assembling electronics, may be much slower to shift from China. Foxconn is considering building a factory in Indonesia, but other firms are staying put and trying to lower the share of labour in overall costs by automating production instead. Zhang Ruimin, the chairman of China’s Haier, one of the world’s biggest manufacturer of household appliances, says that his local workers now get 25% of the pay rates at his American plant, against just 5% in 2000. He has cut staff by 19% since the start of 2013 and plans a “lights out”, entirely automated factory in China. The number of industrial robots in China has doubled since 2010.

Manufacturers in Japan, Taiwan and South Korea are concerned that rising labour costs will encourage Chinese firms to graduate to more complex products, providing extra competition. South Korea’s Samsung, the world’s biggest smartphone-maker, is currently being subjected to an onslaught from Lenovo, Huawei and other Chinese firms. But the mood of sophisticated manufacturers outside China is relaxed. “It is true they will eventually be able to catch up with us, but by then we will be well ahead in other businesses,” insists Fujio Mitarai, the chairman of Japan’s Canon, which makes cameras and office equipment.

Companies and investors are also conscious of the opportunities created by ageing populations in large parts of Asia. China is getting older, as are Taiwan, South Korea and Thailand. Japan already has one of the world’s oldest populations, and this year sales of nappies for adults will exceed those for babies for the first time. But the most obvious growth area is in health care, says Yu-Ming Wang, the head of investment at Nikko Asset Management. At present the sector accounts for only 3.8% of Asia’s stockmarket, and only 1.3% without Japan, whereas the average for rich countries is 12%.

Rising consumer expectations are another thing Asia needs to work on. Hong Kong’s airport now limits the amount of white powder travellers can take out of the territory. The powder in question is not some mind-blowing drug but dried-milk formula for children. Chinese parents are so scared of contamination that they would rather buy supplies abroad.

At the heart of the milk issue is China Mengniu Dairy, China’s biggest dairy firm. In 2011 it admitted that a batch of its milk contained impurities and its share price collapsed. Under a new boss it has launched a reform drive. It has bought a stake in a big supplier to give it more control over quality, and strengthened production partnerships with a Danish firm and with Danone, a French company that now owns a 10% stake in Mengniu. The board has been rejigged and a $500m international bond issued. Sales, and the share price, have recovered.

Sloppy quality can prove costly. Over the past five years Ranbaxy, an Indian generic-drugs firm controlled by Daiichi Sankyo of Japan, has been found guilty of several production transgressions by America’s Food and Drug Administration. India’s authorities have done little in response, but Ranbaxy’s shares have been pummelled. In April Daiichi announced it was selling its stake in Ranbaxy to Sun Pharma, a well-run Indian drugs firm.

An increasing desire for safety and quality has often been a feature of economic development in the past. Disgust with unsavoury abattoirs in the early 20th century led to a wave of regulation in America. As the country’s middle class grew, food brands that commanded trust, such as Heinz and Birds Eye, did particularly well. In emerging Asia the push to quality is likely to come more quickly than in the past because the new middle class is aware of global norms, thanks to the web and social media, and has the choice of buying foreign products.

The quest for quality

For firms this shift to quality presents an opportunity as well as a threat. Business models based on selling Asians cheap products may not stand up. In 2009 Tata Motors, an Indian car firm, launched a low-cost car, the Nano, but saw it flop. Over the same period it has made profits of $10 billion selling luxury Range Rovers and Jaguars, often to emerging-market customers.

The best firms have already adapted their model. AIA, a big pan-Asian life-insurance company, has moved on from the industry’s wild era of seeking market share at almost any cost and is now concentrating on higher-margin products. It has also invested heavily in training its sales agents and keeping them happy in order to raise retention rates and improve customer service. The result has been good for shareholders, says Mark Tucker, AIA’s chief executive. Value of new business, an insurance-industry measure of the present value of profits from new policies written, tripled between 2009 and 2013.

Green energy should boom as consumers demand a cleaner environment. But its capital intensity, reliance on government subsidies and vulnerability to bottlenecks make it risky. China’s solar-equipment-makers have already seen a boom and bust. CLP Group is one of the biggest foreign investors in renewable-energy plants in India and China. Its chief executive, Richard Lancaster, argues for a measured approach. The company invests about half a billion dollars a year in green energy in those two countries. More than that, he says, would compromise the quality of its projects. Governments need to ease bottlenecks, for example by making land available and improve the reach of their power grids, to allow the green industry safely to absorb much more investment.

Of all Asia’s “new” industries the most hype surrounds the internet, partly thanks to Alibaba’s proposed initial public offering. The frenzy has encouraged some weak Chinese firms to float. Yet in developing the internet Asia is going its own way, diverging from the Western model. Online retail sales in China should surpass America’s this year. Japan and South Korea are already the world’s third- and sixth-largest “e-tail” markets respectively, reckons McKinsey, a consultancy.

Asia has its own internet giants, with listed firms worth almost $300 billion, which could rise to over $400 billion once Alibaba floats. Japan has Rakuten, which operates a mall, and SoftBank, which owns stakes in Alibaba and Yahoo Japan. In South Korea search is dominated by Naver, not Google. Marketplaces, where merchants interact with customers, are more important in Asia than in other parts of the world, accounting for 90% of online retail sales in China, against 24% in America. And Asia’s big online firms manage without a bricks-and mortar presence. In America seven of the ten biggest online retailers are traditional firms such as Sears and Walmart. In Japan only one of the top ten is a traditional firm. Conversely, India’s bricks-and-mortar retailers have no credible web presence. Lastly, most new online business in emerging Asia will be conducted by mobile phone, leapfrogging the personal computer.

Starting from scratch

Broadly speaking, Asia’s big internet firms have less of a connection to traditional business models than their Western counterparts, even in mature Japan. That may mean the web poses more of a threat to traditional firms than it does in the West. “We are going to see massive innovation and advancement,” says Hiroshi Mikitani, the boss of Rakuten. For example, he thinks traditional money might cease to exist. One of the largest operators of malls in Asia says that sales in less favoured locations are already tailing off. The head of a big Chinese firm under no obvious threat from the internet confesses it still terrifies him. “If we make a mistake we could collapse, just like Kodak.”

Internet firms in emerging Asia are creating entire new parts of the economy, or replacing crusty bits that have not been reformed. One of India’s internet stars, Flipkart, is building a national logistics network from scratch—an epic task it has so far tackled effectively. Bao Fan, the head of China Renaissance, an investment bank that works with many mainland technology firms, says China’s crummy television is ignored by the young, who go to video sites instead. With few opportunities for traditional entertainments such as concerts or sports, China’s youth is obsessed with online games. And China’s big internet firms have launched investment products that have grabbed about 1% of the banking system’s deposits in short order.

It is safe to conclude that in the long run “pure” internet firms will control a bigger chunk of Asia’s economy than in the rich world, which has many hybrid firms that evolved from offline businesses. But there are still some question marks. One is whether India and Indonesia will eventually develop their own internet giants. There is little sign of this yet. Flipkart, which is India’s biggest internet firm, is valued at about $2 billion. That is small for the genre, but the opportunity is huge.

A bigger consideration is whether Asia’s web firms will one day challenge America’s giants. It is early days yet, but Rakuten has just bought Viber, a global messaging platform, and SoftBank has bought a mobile-phone business in America that it could turn into a digital platform for itself. Alibaba makes no secret of its global ambitions.

Colouring all these questions is concern about hostilities in the region. Maritime tussles between Japan and China should be worrying investors and companies. “There’s massive geopolitical risk that’s being completely ignored,” says the boss of one of the world’s biggest firms. A hot war between China and Japan, or China and India, would be an apocalyptic event all round. The effect of deep-freezing relations would be more differentiated. India imports lots of basic goods from China, but investment links are feeble. Conversely, Japan would be hard hit. Its manufacturers have strong supply chains in China and its consumer firms sell plenty there. A tenth of Japan’s global stock of direct investment is tied up in China.

After a row in 2012 over the Senkaku/Diaoyu islands, which are claimed by both countries, China imposed a boycott on Japanese goods. In December total Japanese exports to mainland China were down by a fifth on the previous year. Things are calmer now, but Japanese firms are quietly hedging their bets. In 2013 only 7% of Japan’s foreign direct investment went to China, compared with 13% in 2010. Instead, more Japanese money found a home in South-East Asia, mainly Thailand and Indonesia. All this is happening just as Japanese banks are back in action. Their market share of global cross-border loans outstanding has risen to 13%, against 8% in 2007.

China is a big trade partner for most Asian countries, but remains a banking and corporate pigmy in the region. What might change that is the rise of the renminbi as a regional and global currency. It is now used to settle 18% of China’s trade and is the world’s seventh most actively used currency for payments, though these figures probably overstate its role. Still, over time the influence of the renminbi will surely rise.

The process could be hastened by America’s increasingly restrictive rules on foreigners settling payments through America’s financial system, or even through foreign banks with American businesses. To avoid red tape, more Asian firms and banks may seek to avoid dollar transactions. “The renminbi will become constantly used for trade settlement in Asia, the Middle East, Africa and eastern Europe,” says Stuart Gulliver, chief executive of HSBC, a global bank. Yet if China wants its neighbours to use its currency, it will have to make an effort to get on better with them. Its tetchy relations with America are one reason why it is nervous about most of its own vast foreign-exchange reserves being tied up in American treasuries.