Sleepy giant

CHINESE business leaders will gather on June 26th in Tianjin, a charmless industrial city near Beijing, for the annual “Summer Davos” conference. This talking shop for big shots, organised by the World Economic Forum, will feature endless discussions about the fourth industrial revolution, panels on the internet of things and briefings on other whizzy topics that occupy the minds of business leaders the world over. China’s bosses will lap it up. The country wants to shift from its position as the world’s sweatshop to become a powerhouse of creativity and invention. The priority for corporate chiefs, runs the fashionable refrain, must now be to embrace trailblazing innovation and technology. In fact, a better bet would be to concentrate on the nuts and bolts of management.

China does need to shift from brawn to brain, but Chinese companies are not going to turn into Google or Apple overnight. Most of them, especially those controlled by the state, will continue to plod on in unsexy industries, such as steel or cement, for some time yet. For this cohort of firms, the central problem is not a lack of futuristic thinking or transformative innovation but how to get better at what they do.

Many are struggling just to get by, according to a report released on June 23rd by the McKinsey Global Institute (MGI), a think-tank. It calculates that over four-fifths of all “economic profits” (which take into account the cost of capital) generated in China come from one industry: finance. And that is not the result of the brilliance of China’s bankers, but rather of state-run banks being guaranteed profits by the regulatory system. By the same measure, almost half of the 20 biggest industries make a loss.

That points to China Inc’s dirty secret. Outside the country, its firms are often portrayed as mighty enterprises poised to conquer the world. China’s best are indeed world-beaters (think of Huawei, a telecoms-equipment giant, or Haier, an innovative white-goods goliath). Export-oriented manufacturers (nearly all of them private) have sharpened up dramatically. Mainly thanks to their efforts, productivity in China rose sharply between 1990 and 2010, outpacing many countries.

But that growth rate should not distract from the absolute levels of productivity, which are still abysmal. Across a variety of industries, in services and manufacturing, Chinese labour productivity is still just 15-30% of the OECD average despite those two decades of improvement. This is not just because the economy is biased toward heavy industry and dominated by stodgy state-owned enterprises (SOEs) that overinvest and underperform. Productivity lags behind badly at firms across the economy.

The boffins at MGI scrutinised the financial performance of some 10,000 Chinese and American companies. They found that three-quarters of the gap in returns between the two groups is explained by the performance of individual companies, not merely the mix of businesses in the Chinese economy. If local firms could improve performance by enough to match the average return on equity of American firms, it would lift the economy-wide return on invested capital in China from 7.4% to 10.2%.

How might this happen? Some things only the government can do. Letting failing firms go bust would be the most powerful reform of all. At the moment, no big company, public or private, can go bankrupt in China. Official subsidies, cheap loans and the inevitable bail-outs from local officials, worried about jobs and social upheaval, ensure survival. Another way to boost productivity would be to open up to competition the many parts of the economy (energy, telecoms, banking, airlines) that are run by oligopolistic SOEs.

Rather than wait for liberal reforms that may never come, however, managers in China must crack on with their own productivity efforts. The country has some extraordinarily efficient factories run by contract manufacturers such as Taiwan’s Foxconn and America’s Flex (formerly Flextronics). But it has a far greater number of poor performers. Globally proven management techniques like Six Sigma, a data-driven approach to running a company, and “lean manufacturing” have been tried only in name. They must now be taken up in earnest.

Technology need not be right at the cutting edge to help corporate officers do the basics better. More automation would boost productivity. Although China is the world’s biggest buyer of industrial robots, it still has only 36 per 10,000 manufacturing workers—half the global level and less than a tenth of the proportion in South Korea. Digital technology is another path to productivity gains. China’s logistics industry, for example, is a fragmented, over-regulated and corruption-riddled mess. Digital platforms that co-ordinate scheduling, warehousing and deliveries could boost the efforts of the 700,000 firms in this business.

Boards have a role to play, too, in realigning incentives for managers so that long-term productivity gains are rewarded. Most firms pay executives a salary and bonus that is determined by short-term performance. A study of firms listed on Chinese stock exchanges by BCG, another consultancy, found no correlation between executive pay and company performance.

Be normal

In the end, the most important thing managers in China need to change is their outlook. After a long period of double-digit growth, many firms are still on an expansionist course. But with the economy now slowing, bosses must shift away from the strategy of growing at all costs to an approach that emphasises the boring stuff: cost cutting, restructuring and operational efficiencies. As MGI’s Jonathan Woetzel puts it, companies in China need to do more everyday “blocking and tackling”. This sort of talk may not impress the Davos set, but the resulting productivity gains are much more likely than all the guff in Tianjin to spark China’s next industrial revolution.