Special report | Business in Asia

How to keep roaring

Over the past two decades Asia’s companies have enjoyed huge success. But now they need to reform to become brainier, nimbler and more global, says Patrick Foulis

IN 2012 AMERICA’S intelligence agencies forecast that Asia would soon be carrying more weight in the world than at any time since 1750. By 2030 “Asia will have surpassed North America and Europe combined in terms of global power, based upon GDP, population size, military spending and technological investment,” the spooks predicted. They made it sound like a foregone conclusion.

On the ground, though, Asia seems a more nervous place than that forecast implies. Peace, a foundation stone of the region’s economic boom over the past 20 years, is under threat from border squabbles between China and its neighbours and from a regional arms race. Investment patterns are changing in response, with Japanese firms shifting away from China. Two of the main inputs that fuelled the boom—labour and capital—have become more expensive. Wages are rising and the workforces of Japan, China, South Korea and Taiwan will soon peak or are already in decline, part of a growing “Greysia”. Interest rates around the world may rise soon and state-run banks in India and China have lots of bad debts, pushing up the cost of capital.

The continent’s success to date has also created a new set of headaches. Growth has been rapid but lopsided: for example, Asia generates 45% of the world’s carbon emissions but owns only 10% of its biggest brands (see chart 1). Across emerging Asian countries, a vast new middle class wants a less dangerous, less corrupt and less polluting capitalism. Economists worry that China and the better-off places in South-East Asia will be caught in a “middle-income trap”, with weak institutions and a lack of innovation slowing down development.

Investors expect wrenching change. Over the past three years Asian shares have lagged American ones by 40%, dragged down by “old-economy” stocks. When Alibaba, a Chinese internet firm, floats in America soon it may have a greater market capitalisation than China’s entire steel industry. Fund managers are desperate to invest in “new-economy firms” in Asia but cannot find enough of them.

Close-knit diversity

For all its diplomatic discord, in economic terms Asia is more integrated than ever before. Some 54% of the continent’s trade is within the region, up from about 25% in 1990. Japan, Taiwan and South Korea are in a tight embrace with poorer China. Dense supply chains link multinational firms with China’s factories. Bits of Thailand, Malaysia and Vietnam, too, are becoming part of this giant industrial cluster known as “Factory Asia”. India and Indonesia hope to join in. The rise of the renminbi as a world currency will also help integrate the continent.

Yet Asia (which for the purposes of this report excludes Australasia) is not only huge but hugely diverse, ranging from rich and ageing Japan to still much less rich but also ageing China to much poorer and younger India and Indonesia to places like Myanmar, only just emerging after decades of political isolation.

All Asian leaders are keen on reform, but given their different starting points they face different challenges. President Xi Jinping wants markets, consumption, innovation and the rule of law to play a bigger role in China. Japan’s Shinzo Abe is looking for a way out of his country’s deflationary and demographic trap. Narendra Modi, the new prime minister just elected in India, and the new Indonesian president due to be elected later this year, must get their countries onto the first rung of industrialisation by improving infrastructure and attracting factory jobs. Their task is harder than it was for South Korea, Taiwan and China when they went through the same phase in the late 20th century. Manufacturing is becoming increasingly automated and many of the newly created jobs may be intended for robots, not nimble-fingered people.

Politicians and economists may think that they are the drivers and navigators of their countries’ economic destiny, but businesses are every bit as important. In 1960-80, Sony, Toyota and other Japanese firms instituted a culture of excellence that made their country rich. Since the 1970s South Korean business conglomerates, or chaebol, most notably Hyundai and Samsung, have made giant and successful bets on shipbuilding and more recently on cars and smartphones. From the 1990s onwards the earnings of India’s technology firms, which miraculously bloomed despite a rotten state, have repeatedly saved India from balance-of-payments crises. Since 2000 Western multinationals have been piling into Asia, increasing competition and fuelling a consumer boom.

This special report is about the companies that will help shape the new Asia. They, too, will need to reform to cope with five megatrends affecting the region. The first, already mentioned, is a deteriorating diplomatic climate. A second is demography across Asia and the rise in labour costs in China. This will alter both the kinds of things that are produced and the way they are made. Japanese and South Korean firms are terrified that China will move up the value chain, blighting their high-tech manufacturing industry. India and Indonesia, for their part, should be praying that China will do just that, making space for them in labour-intensive industries.

A third is a strong desire in Asian society for a shift from quantity to quality, with a new middle class keen to have a better living environment and products that are safe and fit for purpose. Fourth, the internet threatens to disrupt Asia more thoroughly than it has the rich world. Immature industries such as retail and logistics will leapfrog straight from the pre-industrial age to the internet one.

Fifth, and perhaps most important, many Asian firms face intense global competition. Some pockets of comfortable parochialism will remain: think of Hong Kong property, Chinese noodles or Japanese pachinko parlours. And the gold-rush stage of Western investment in Asia is over. But customers’ tastes these days are influenced by social media, not by neighbourhood billboards. Asian firms must compete in their home markets with multinationals that boast global supply chains, brands and research and development (R&D). For emerging Asian firms the barriers to entry in many industries have risen to formidable heights over the past decade.

These are immense challenges. Can corporate Asia rise to the task? Twenty years ago the answer might have been no. The most valuable firms then were Japanese banks and consumer-electronics firms inflated by the bubble, Asian property outfits and buccaneering Hong Kong conglomerates such as Hutchison Whampoa, Swire and Jardine Matheson. In the 1990s Japan’s stockmarket sank. The 1997-98 Asian financial crisis had a devastating effect, bankrupting many indebted conglomerates in South-East Asia and South Korea.

Since then Asia Inc has built up a lot more muscle. It now accounts for 27% of world market capitalisation, up from 20% a decade ago. The biggest Asian firms easily match their global counterparts for size. Big South Korean conglomerates such as LG, Samsung and Hyundai have global scale, and Samsung’s profits are not far off Apple’s. Toyota and Volkswagen have almost identical sales. PetroChina invests more than Exxon Mobil does. India has produced a clutch of world-class firms in technology and pharmaceuticals, and its crusty conglomerates have been revived. Asia’s technology firms make up about 12% of the listed sector, double the figure in 1994. Property firms have faded. Chinese state-backed, private and collectively owned firms have created a massive wave of listings. Since 2000 Asia has had 11,000 initial public offerings and now boasts 25,000 listed firms.

Many of the jobs are being created by smaller firms, even though they are often starved of credit. Of the world’s listed companies with market values of under $2 billion, about 40% are in Asia. A vast and only partially recorded number of firms exists outside the stockmarkets. China has 41m private businesses. Japan’s myriad small firms are essential suppliers to its corporate giants. India has 45m “medium, small and micro” enterprises that repair rickshaws, yank out rotten teeth and serve hot sweet milky tea on the street. But exports are dominated by big firms. In South Korea, Samsung Electronics generates 17% of the total; in India, Reliance, the country’s second-biggest firm, makes up 14%. In China, with its continent-sized economy, corporate power is more dispersed, but control is concentrated in the party’s hands.

Most Asian firms are financially disciplined. Asia Inc’s return on equity has slipped, from a peak of 17% in 2007 to 13% (excluding Japan, where profitability is rising from abysmal levels), but is on a par with the rest of the world. Its balance-sheet is mostly solid. Scarred by the 1997-98 financial crisis, South-East Asian and South Korean firms tend to be cautious and avoid borrowing in foreign currencies. Two decades of deflation have encouraged Japanese firms to build up a $750 billion gross cash pile, says Kathy Matsui at Goldman Sachs, a bank. But India’s industrial and infrastructure firms need recapitalising, and Chinese state-owned enterprises (SOEs) have accumulated massive debts, although the largest of them are still in good shape. Both countries’ banking systems are in trouble.

Governance has improved. Corruption remains a serious problem outside Japan, Hong Kong and Singapore, but most countries have moved their accounting rules towards global norms. In South Korea, Japan and South-East Asia the banking systems used to be too close to industrial firms, encouraging crony-lending. The 1997-98 crisis put an end to most of that, and banking supervision has got better. Greater use of capital markets has improved transparency. And many Asian companies could teach Western firms a thing or two about restraint on executive pay and longer investment horizons.

Patent exaggeration

What lets Asia Inc down is a quartet of shortcomings: sector mix, branding, innovation and internationalisation. For emerging Asia the difficulty is best illustrated by the iPhone. Less than a 20th of its value is captured in China, where it is put together. The bulk of the value accrues to the owners of the brand in America and the makers of its high-tech components in South Korea and Japan. Meanwhile in rich Asian countries such as Japan and South Korea, firms worry that their hierarchical culture may be stifling innovation and creativity.

Despite a lot of hype about “new industries”, Asia does not have enough companies in them. India and Indonesia have yet to create any big internet companies. Asia’s health-care sector is small. Outside China and Japan the level of investment in green energy is far too puny to deal with a looming pollution problem.

Asia also has too few big global brands. Of the world’s 100 most valuable ones, ranked by Interbrand, a consultancy, only ten are Asian, all of them either South Korean or Japanese. In emerging Asia local marques are seen as inferior and untrustworthy, whereas foreign brands are considered safe and prestigious. Asian firms have not invested enough in creating brands, and without them they lack pricing power.

Innovation at first sight appears to be one of Asia’s strong points. Some 41% of the world’s patents filed in 2012 originated in the region, with a single telecoms and technology firm, ZTE, filing 3,906 of them. According to official figures, Asia accounted for 29% of global R&D spending in that year. And its share of high-technology exports has risen to over half the world total.

Not all of this is quite what it seems. Few high-end manufacturing firms as yet see emerging Asia as a major threat. It is good at copying and making incremental improvements, not breakthroughs. Xi Guohua, chairman of China Mobile, the world’s biggest mobile operator by subscribers, points out that mobile-phone operating systems are still largely in the hands of American companies. “What really matters is the core technology and innovation capability. America does not have to worry about that,” he says. Some 82% of China’s high-tech exports are made by foreign companies.

One test to apply to the number of patent applications is to see in how many countries they have been filed. Anyone who is serious about protecting his intellectual property would want to patent it in as many countries as possible, but in 2005-09 only 5% of Chinese patent applications were also registered abroad, against 27% in America and over 40% in Europe. Creative industries in Asia are small. China’s export revenues from its “core intellectual property” activities (which include creative industries and some software) were only 4% of America’s, according to China’s copyright agency.

Asia Inc has one further weakness: it remains too parochial. Asia’s 100 biggest firms make only 30% of their combined sales abroad, compared with 50% for the 100 biggest Western firms. This lack of global presence is partly a reflection of the relative youth of some Asian firms, but is also both a cause and a consequence of weak brands and innovation.

Try something new

Most Asian countries are trying to find new economic models. What worked in the past 20 years may not be right for the next 20. The region’s firms, too, need to tackle their shortcomings and adapt. One worry is that their ownership models make them inflexible. Their traditional, stodgy corporate structures contrast with those in America, where a system of creative destruction has proved good at sustaining nimble, global firms and at encouraging new startups.

Only 28% of Asia’s stockmarket is made up of firms controlled by institutional investors. The mix varies from country to country, but conglomerates—often family-run—and SOEs loom large. Japan is an exception, but although it has the trappings of shareholder capitalism, its conservative managers call the shots. Only a fifth of the world’s mergers and acquisitions by value involve an Asian target, and hostile deals are rare. Asia lacks the apparatus to nurture lots of new firms: since 2007 just a tenth of global venture-capital activity has taken place in the region, according to Preqin, a research firm.

Most Asian bosses publicly disdain American-style capitalism and have little intention of aping it. But as this special report will show, Asian firms are discarding some of their traditions as they limber up for a new era of growth. State-owned firms are opening up, particularly in China, where private entrepreneurs are also proliferating. Japanese firms will become pioneers in surviving in an ageing society. Asia’s grand old conglomerates are evolving into focused multinationals and investing in brands and technology. Internet entrepreneurs are working to upend the old corporate order. For Western firms all this heralds greatly increased competition as Asian firms become more sophisticated. For Asia, it means pain and disruption but also the promise of progress. It has become the greatest laboratory for companies since early-20th-century America.

This article appeared in the Special report section of the print edition under the headline "How to keep roaring"

A world to conquer

From the May 31st 2014 edition

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