China Private Equity

From his perch at the Washington Post,  John Pomfret is one of the better-known American journalists writing about China. He is also, coincidentally, one of my oldest and closest friends. I quibble with him often about his take on China, particularly now that I’m living here and he isn’t. He moved back to the US five years ago, and wrote a well received book about China called “Chinese Lessons”.  Quite a lot of it was written in my dining room in LA. 

For a change, I actually agree with the main thrust of one of John’s articles on China. It’s an opinion piece, co-written with his colleague Steve Mufson, published recently in the Post. It’s title: “There’s a new Red Scare. But is China really so scary?” Read it here.

The key insight is that America, in the midst of a deep and long recession,  is undergoing one of its periodic bouts of self-laceration. The widespread anxiety that America is in decline is exacerbated by a sense that China is now better, smarter, faster in many important ways. A lot of this is plain silliness, as John’s article points out. 

America’s problems are home-grown. China’s rise over the last 30 years is overwhelmingly positive, for its own citizens first and foremost, but also for the rest of the world, US included. 

There’s a lot for an American to admire, even envy, about China. Two examples: even while remaking most aspects of its society, the family has retained its primacy in Chinese life, as a source of stability, happiness, and purpose. China also remains the most “kid friendly” country I know, measured by the care and affection lavished on the young Chinese, particularly infants and preschoolers. 

Americans, in the main,  have always had a special fondness for China, regardless of the state of the political relationship between the leaders of the two countries. But, that fondness doesn’t stop many of them from perpetuating simplistic notions about the place. Once, China was seem as hopelessly backward and poverty-stricken. Now, it’s seen as a novice superpower, outmuscling the US across the globe. 

John’s article cites a quote from Sun Tzu, “If ignorant both of your enemy and yourself, you are certain to be in peril.”

1837. That’s when the first and still grandest of all consumer brand companies got its start.  Procter & Gamble started off selling soap and candles, then in 1879, introduced its first major branded product, Ivory soap, which quickly became the leading soap brand in the US. P&G then gradually, over the next 130 years, added other brands that became market leaders, including Tide, Crest, Pampers, Gillette, Olay, Head & Shoulders. 

This same slow-and-steady pace characterizes most other well-known consumer brand companies, including: Unilever, Coca-Cola, McDonalds, Mercedes-Benz, Gucci, Tiffany, Nike, Hershey, Crayola (http://www.chinafirstcapital.com/blog/archives/927), etc. 

The lesson: building brands takes time. Lots and lots of time. 

Except, that is, in China. Here, brands go from drawing board to market dominance in a matter of a few years, or less. The reason? Like so much else in China, economic and social change occurs so rapidly that time seems compressed. Three years of economic growth in China is faster than a generation’s economic growth elsewhere. No major economy in modern times has grown as fast, for as long, as China has over the last 30 years.

 The other reason, peculiar to China, is that there were few brands of any kind before the 1980s. Back then, a stolid proletarian China had a depressingly small number of equally stolid proletarian brands. Many have since disappeared. Those that are still around have often been overwhelmed into irrelevance by newer Chinese brands, or ones imported from abroad.

Good examples of this are Flying Pigeon bicycles and Bee & Flower soap. They were once near-monopolies in China, during Mao’s time. Today, they are bare remnants of their former, dominant selves. Neither has more than a 1% market share, if that. It’s hard to find any other examples outside China during the last 25 years of once-dominant brands losing so much market share so quickly. 

In the US and Europe, older brands often have cache. In China, they are toxic, for the most part, because they are the products of an era of scarcity and little to no consumer choice. So, the tens of thousands of Chinese consumer brands created over the last 25 years entered a market with few, if any, well-established incumbents. A few foreign brands have also done well in China’s mass market over this time: P&G has a great business here with Crest, Tide, Olay, Pantene. Other winners include junk food giants McDonalds & KFC, along with Coca-Cola, Nokia, Apple, Nike, Marlboro, Loreal.

But, in many cases, new Chinese brands have fought and won against competition from well-known imports. Protectionist trade rules have played some part in this, of course. But, a lot of the credit really belongs to smart Chinese entrepreneurs. Thanks to them, China’s consumer market has gone from brand-less to branded in less than a generation.

P&G’s kingpins, like Crest, Pantene and Tide, face a proliferation of Chinese competitors, priced both lower and higher than the global brands. In many other product markets, Chinese brands stand alone, including tissues and toilet paper (sold here in bulky ten-roll packs), bed linen, men’s and women’s underwear, and most food products.

Overall, there are few dominant brands with market shares large enough to discourage new competitors. In fact, new brands arrive all the time. In evolutionary terms, China is in the middle of a kind of Cambrian Explosion, with the rapid appearance of all kinds of new brands. Inevitably, the huge number of brands will shrink, as winners emerge, and has-beens die out. This process took decades in the US and Europe. It will almost certainly happen far more quickly in China. 

One reason for the especially rapid pace: lots of capital is now available to create and support new brands. Why? There is so much to be gained for any company that establishes a dominant brand in China. China will soon have the largest domestic market in the world. Grabbing a few points of market share in China will often equate to billions of dollars in revenue over the next five to ten years. 

In many of the most promising consumer markets, no brand has even emerged yet, with national scope and distribution. Here, smart entrepreneurs can build a brand in fertile virgin turf, rather than trying to force their way into an already crowded patch. If done right, you can turn a new brand into a billion-dollar household name in a short-time. 

I see this process very clearly with one of our clients. It’s still quite a ways from being that billion-dollar colossus, but it has a real potential to become one. The entrepreneur spotted a huge market opportunity five years ago, to create a brand to sell designer accessories to Chinese women from 20 to 35 years-old.

His key insight: the process of urbanization in China is creating an enormous group of working women in this age bracket, with the spare income to spend on not-too-expensive, but well-designed earrings, bracelets, necklaces, sunglasses. 

His business is now growing very fast, with over 100 stores in most of China’s major cities. Sales should double in 2010 to about $50mn, and keep doubling every 18 months for a long time to come. The best part: he faces no real competition, and so every day, his brand grows more and more known, and so less and less vulnerable to whatever competitors may one day come along. My guess is that this brand will be one of the quickest new consumer product companies in Chinese history to reach Rmb 1 billion in sales. 

Like many of the best entrepreneurs, this one makes it look very easy. It isn’t. He takes hands-on responsibility for the four key disciplines needed to build and sustain the brand: marketing, design, management and manufacturing.

That’s the other part about brand-building in China: it not only happens fast, it often happens inside smaller founder-run companies without the input of “specialists” or ad agencies.  I don’t know how many people in China have studied product marketing in school, but my guess is not many.

Hangzhou’s main art museum, known as the Zhejiang Provincial Museum,  sits on a nicer plot of land than any museum I’ve ever been to, including the Louvre in Paris and National Gallery in London. It’s on a small bend in the road that circles the city’s famous Xi Hu, or West Lake. From the museum entrance, you look out across the lake at a particularly lovely spot, with a small steep island ahead and the steeper mountains beyond. The museum itself is modern, in a classically-Chinese format, with pavilions reached by gabled walkways, set among small streams teeming with koi. 

The setting is perfect, but sadly, the museum’s contents are anything but. One pavilion offers a bunch of world “art treasures” that looked like they were bought for ten bucks each at airport souvenir stores . A low point: a set of mounted bull horns from Indiana. Another beautiful pavilion had the paintings and personal effects of a Hangzhou-born 20^th century artist who had studied painting in France in the early part of the century, and then did some so-so pastiches of Chinese subject matter, incorporating elements of Cezanne, Picasso, Monet among others. 

A pavilion said to hold “historical relics” was locked and empty. Finally, you get to the two buildings with Chinese porcelains. My hopes remained high, since, after all, Hangzhou is the greatest of all China’s cultural cities, capital of the Southern Song dynasty, which produced (for my money) the finest porcelains the world has ever seen, including Jun, Ding, Guan, Yaozhou, Longguan, Qingbai, Cizhou, Ge styles. (The bowl above is an example of Song Dynasty Guan porcelain.) I’ve had the good fortune to see a lot of Song porcelains over the years, in museums in the West, and have handled a fair number at auctions in London and New York.  Many were produced close to Hangzhou. 

My not-unrealistic expectation, therefore,  was that the Hangzhou museum would have both more and better Song porcelains than I’d ever seen. So sure was I of this that I invited four CFC colleagues to come along with me, after we finished a client meeting. 

Bad choice. The museum, though in a gorgeous setting on a lake fabled for its beauty and historical meaning, is mainly a sad reminder that many of China’s most important art treasures are held outside the country, in museums and private collections. The porcelains in the Hangzhou museum look like (and most probably are) the leftovers after all the best pieces had been spirited away. The celadons have little sparkle or translucence, and have a gimpy shape.  There are no examples of the Jun and Guan styles most prized by connoisseurs. The one Yaozhou bowl is clumsily carved. Song burial urns are among the least ornate and less precisely-molded I’ve ever seen. 

The two pavilions with Song porcelains are a colossal disappointment, not just because the art works are generally of middling quality. Instead, a museum that should be a encapsulation of the greatness of Song culture is, instead, a subtle reminder of how much has been lost or pillaged.  Thousands of Song wares are in collections, public and private, around the world. At least six times a year, Sothebys and Christies hold auctions in London, New York and Hong Kong that include dozens of  works of Song porcelain far better than any on display in the Hangzhou museum. Museums from Tokyo to Paris to Washington D.C. are loaded with great works from the Song. 

But, here in Hangzhou, there are only cast-offs. Among the millions of Chinese who come to Hangzhou each year as tourists,  most will likely leave with no concrete appreciation of the paramount artistic achievements of the Song culture that sprang from here.  Instead, many must end up wondering, after visiting the museum, if there’s really anything much to be proud of from that period. One of the two pavilions for Song porcelain is almost entirely made up of shards of the most common sort of household pottery from the Song era, not the exquisite pieces crafted for emperors and scholars. 

The effect is a little like visiting Tiffany, expecting to ogle the diamonds, and finding it filled instead with broomsticks and knitting needles. 

The Chinese government, quite publicly, has been seeking to block the sale at auction of art objects looted from the Summer Palace in Beijing. It’s a small step toward the goal of one day recovering more of China’s lost artistic patrimony. I’d personally like to see the Chinese government more active, not just blocking the sale of items stolen long ago, but also buying some of the more important Chinese antiques that come on the market.

It’s easy to understand why the Chinese government has so far refused to do so, since they don’t want to let others profit from what it sees as wrongful expropriation. But, as a lesser of evils, I’d prefer them to bring back some of the more beautiful objects, and add them to the collections of important national museums like the one in Hangzhou. That way, at least, more Chinese would have opportunities to admire up close the crowning achievements of Chinese culture. 

It’s a good side project for CIC, China’s sovereign wealth fund, and China’s State Pension Fund. Along with trying to secure the country’s financial future, these two organizations could also invest, on a comparably small scale, to secure more of the country’s incomparable artistic heritage. 

The museum visit left me feeling sad, but also resolved to do my own small part. I’m fortunate to own a few Chinese porcelains and jade pieces from the Qing and Ming dynasties. The jade was left to me by my grandfather, who started collecting in the 1950s. I’d like to donate the art works to a Chinese museum when I die, if not sooner.  While nowhere near as important as the items regularly at auction at Sothebys and Christies, they are decent examples of the output of some of China’s finest artists and artisans. 

Art is a shared inheritance. But, more of China’s treasures should be seen where they were crafted. 

Christmas has passed, but the reindeer antlers are still out in force. At my local supermarket in Shenzhen, the checkout team began sporting plastic antlers in late November. We’re a long way from the North Pole, and even farther, culturally, from the parts of the world where Christmas is traditionally celebrated. But, if there’s a party going on anywhere,  the Chinese want to be part of it. 

It’s not just the reindeer horns. A good 30% of all other shops’ sales force, as well as restaurant wait staff, are wearing those droopy red Santa caps. Most lobbies of the larger office buildings have Christmas trees, lit and ornamented. Mine also has a small crèche, that looks like a gingerbread house big enough to sleep three adults.  

Incongruous? Sure. But, one grows inured very quickly in China to things that don’t seem to make a lot of sense culturally. Red wine is increasingly the drink of choice among urban, upwardly-striving Chinese. Never mind that most of the wine is domestically produced, and has a thin, sour watered-down flavor a bit like salad dressing, and doesn’t compliment well the salty and spicy foods favored in much of China. 

Other examples: pajamas are occasionally used as outdoor-wear in China. The slowest-moving trucks on China’s expressways tend to putter along at one-third the speed limit in the left passing lane. Many ads for infant formula feature fat blond-haired babies. 

Christmas in China does not involve gift-giving, carol-singing, church-going. It’s a reason to decorate buildings, wear odd outfits, and send tens of millions (by my guesstimate) of SMS messages wishing other Chinese “圣诞快乐” ，literally “Happy Holy Birth”.  Santa Claus? His plastic likeness is plastered everywhere. In China, though, he is known as “圣诞老人“，or “Holy Birth Old Guy”. 

Not only is Christmas part of China’s holiday calendar now, so is Halloween in some of the bigger cities. But, it’s a Halloween celebrated only by adults wearing scary costumes to restaurants and bars that night. There’s no candy, no trick-or-treating. 

Much as China’s government still describes the economy as “socialism with Chinese characteristics”, there’s a lot of my daily life here that can be understood as “Western civilization with Chinese characteristics”. Much is broadly familiar, but most things have a strikingly and singularly Chinese flavor. 

Thursday night is New Year’s Eve. It’ll be my first in China. Logic tells me it should mainly pass unnoticed. Chinese New Year, which falls this year on Valentine’s Day, is the most important holiday of the year, and is so deeply engrained in the consciousness that when Chinese say “next year”, they usually mean some time after Chinese new year, which has no fixed date on the Gregorian calendar. It begins either in January or February, depending on cycles of the moon. The New Year holiday lasts seven days in China. 

So while there’s no cultural imperative to celebrate New Year’s Eve, I do expect restaurants, bars and shopping areas to be unusually raucous on Thursday night, much as they were on Christmas and Halloween. Like a college fraternity, China seems determined to seize any excuse to throw a party. 

Too many inventive minds over too many years have focused on trying to solve environmental problems that may be insoluble: like a internal-combustion engine that gets +100mpg, or a new fuel that will burn cleaner and cost less than gasoline. Of course, a solution to either of these would earn its inventor a multi-billion fortune. That’s a very powerful motivator.

But, let’s face it. Some of these bigger problems may be beyond the wit of man and the realms of molecular science. There are so many smaller, more manageable problems to be solved that will both lower pollution and earn its inventor a very tidy sum. Case in point: a new water cooler for China. 

Here’s a problem crying out for a solution. Solve it and you could build one of the largest consumer products companies in the world, much like how Sony’s Akio Morita got his start inventing a small, portable transistor radio in the 1950s. 

Most offices, as well as a large percentage of urban households in China, have a water cooler. They look like the kind you see in the US, but with one addition: Chinese water coolers also have a hot water spigot. The machines keep hot water, as well as cold water, on tap. They do this by having a small in-built heating system to keep about one liter of water continuously heated to around 80-degrees centigrade (176-degrees Fahrenheit). The reason is obvious: many Chinese still like drinking tea. 

When I first came to China almost 30 years ago, cold potable water and bottled water were both all but nonexistent. Today, they are both pervasively common. Tea often seems like a dying brand in China, except as an accompaniment to a cooked meal. 

But, most Chinese water coolers still offer the hot water function, and will likely continue to do so for many long years to come. There are two problems with the current design in China. First, the hot water is produced continuously, even outside of working hours, at enormous cost in wasted electricity. Since in China most electricity is produced by burning coal, this equates to a lot more coal being mined and burned than is necessary. 

Problem number two: though heated, the water is kept at a temperature too low to make a decent cup of tea.  For that, you need water at or about boiling point. It’s not a difference discernible only by tea connoisseurs. You need the hotter water to get the flavor, as well as get the tea leaves to sink to the bottom of the cup. All tap water needs to be boiled, for health reasons in China. But, the water coolers use bottled water (in 18.9 liter jugs). Each jug weighs over forty pounds. The massive infrastructure to deliver these water bottles, mainly done by guys riding specially-configured bicycles that can hold four of the jugs over the back wheel, is another problem crying out for a solution. But, we’ll leave that one be, for the time being.   

China needs a better water cooler. The person who can invent one, and can protect it from copycats with patents,  is going to become very rich. Two relatively small changes would achieve the goal: (1) incorporate a timer so that the machine will waste less energy;  and (2) design a system that will bring water to a boil and then dispense it. Better air and better tea. Both marketing messages should resonate deeply with a large part of China’s urban population.   

I’m no engineer, but assume there will be a positive energy trade-off here. The new system will likely use more power to get water 25% hotter, to boiling point.  But, the timer would shut down the hot water production, in most cases, for at least 40% of the time, outside of office hours. 

How big is the potential market? My guess would be it’s quite big. In most of the larger hypermarkets in China like Wal-Mart or Carrefour, the section devoted to water coolers is quite large, with at least ten models on display – more space than is given to vacuum cleaners, for example. This gives some approximation of overall sales volume. The current models are all roughly equivalent. Top-of-the-line models not only have the hot water, but refrigerate the cold water before dispensing. These generally cost around $150-$200. An eco- and flavor-friendly model should be in the same price range. If so, it would likely become market leader. 

Inventors mostly like to tackle life’s biggest problems. But, there’s a lot of money to be made in “gradual innovation”, particularly when it delivers improvements on a product that is a ubiquitous in a country as large as China.

Launched amid much worldwide rejoicing when the financial crisis struck last year, China’s Rmb 4 trillion ($585 billion) stimulus package is given much of the credit for China’s continued strong economic performance this year. China’s GDP growth is likely to exceed 8%, and the domestic stock market is up by over 70% since the start of the year. 

A Keynesian miracle? To read a lot of the financial commentary on China, you might well conclude this is so, that government spending has single-handedly kept the economy jaunty, while both firms and consumers sank into a deep funk. It’s a great story, and provides a simple explanation for how China dodged the bullets that struck all other major economies. Other countries looked on enviously, and urged China to continue the fiscal pump-priming to help out the overall world economy. 

Problem is, the analysis is flawed. China’s stimulus plan is not all it’s cracked up to be. While the additional government spending has clearly played a part, it is not the only reason why China’s economy has remained so sound this year. The unsung heroes of China’s economic success this year are its ordinary consumers. It’s their continued confidence and increased spending that have really made the difference. 

Economic statistics are notoriously iffy in China. The further one gets from the economic lever-pullers in Beijing, the harder it becomes to track economic activity. That’s another reason why the stimulus plan was so often singled out as the main spur to China’s growth. It’s easier to calculate how much additional the Chinese government is spending building expressways than it is to see how many pairs of socks or bowls of noodles Chinese are buying. 

Another reason: a lot of the economic commentary comes from folks who believe that governments really are responsible for what happens, good and bad, in an economy. Again, it’s just so much simpler to view things this way, that powerful government men can pull out their checkbooks and spend their way to national prosperity. These are often the same people who will tell you, wrongly, that Roosevelt’s New Deal spending lifted the US out of Depression.

China’s supporters and detractors both give the government too much credit. There are those who are convinced China’s economic growth is all some kind of fraud, cooked up by the central government, and that once the extra government spending is dialed down, the economy is certain to crash. 

Again, pure hogwash. 

In China, the government rightly deserves credit for excellent economic management, for creating the circumstances, both marco and micro,  that allow the Chinese economy to continue to thrive. I’ve said it frequently, including in public forums: China is the best-managed major economy in the world. 

But, again, let’s also commend the country’s one-billion-plus consumers, too often seem as miserly skinflints, saving up all their money for their great-grandchildren’s rainy days. It just ain’t so. China’s consumers, with an ever-increasing choice of products, services and shops, are spending ever-increasing sums on improving the quality of their lives. Newer and better housing. New cars. Holidays. New wardrobes. You name it. 

I see it every day here, the untethered exuberance of the Chinese consumer. It’s true that in the early part of this year, there was a relative lull. Back then, shops were working harder to attract customers, by putting a lot of their goods on sale at steep discounts. About four months ago, the situation began to change markedly. No more major knockdowns. Prices now all seem to carry list price, and the prices for many common consumer products are as high, or higher, than in the US. 

Not much of this, it goes without saying, gets noticed by the world’s financial commentariat. Car sales in China are at an all-time high, and China is now the world’s largest car market. But, listen to the commentators, and they’ll tell you it’s the result of some small government tax breaks on new car purchases. Helpful, yes. The main spur? No. Car prices in China are still, in dollar terms, generally much higher than in the US. Based on a percentage of average disposable income, car prices in China are probably among the most expensive in the world. Same goes for property prices. Yet, Chinese keep buying. 

They will keep buying, at or near this record pace, long after any tax breaks phase out.  Chinese want the new cars to drive on the new expressways to carry them to the new shopping malls to buy the new furniture for their new apartments. 

Of all the economic statistics I’ve seen lately, the one that best captures what is going on now in China is this: revenues in China’s restaurant industry were up 18% during the first half of 2009, to over $120 billion. That’s not due to stimulus, or bank loans, or tax concessions, or a government mandate to entertain more. It’s largely because Chinese are out having a good time, more often, and spending a lot more doing so than they did a year ago. 

It’s one of the best barometers of a nation’s mood, restaurant spending. In China, the mood is buoyant, the outlook bright, and the woks are working overtime.

Shenzhen is such a relentless modern city that it’s often hard to discern the influence of 3,000 years of Chinese history and culture. The skyline is so futuristic that it often resembles the home planet of a higher civilization.(See photo above, of the City Center and buildings near CFC’s office). 

But, of course, this is still a part of China, with all its embedded messages and references to a history longer and richer than any other. It just takes a little wisdom to perceive it. I can’t lay claim to any such wisdom. Luckily, though, I have a friend here who has both the historical knowledge and scholar’s temperament to properly put modern Shenzhen into a more classically Chinese context. 

This friend, Zhen Qinan, has had a exemplary career in the financial industry, first as part of the working team formed in 1990 to establish the Shenzhen Stock Exchange, and then as head of a joint venture between four Chinese financial firms and Merrill Lynch, where he worked with leading Chinese companies like Huawei and Taitai Pharmaceutical. 

These days, Qinan is semi-retired. I try to spend time with him whenever I can. He’s warm and thoughtful, and I know now from experience that he’ll offer astoundingly wise insights to even my most mundane questions. How mundane? Over a meal at one of Shenzhen’s better Sichuan places, I commented on how lucky we were to be in a city with so many good restaurants, even by Chinese standards. 

If I had to come up with reasons why, I would settle for the fact Shenzhen is richer than other cities, and has a population drawn from all parts of China. Qinan, however, offered a much richer explanation, rooted in his learning and respect for Chinese history. 

Shenzhen is part of an unbroken tradition, reaching back at least 1,200 years, of commercial centers in China having the best food and also the most beautiful women. So, in their day, the great trading cities along the Grand Canal – Hangzhou, Suzhou, Yangzhou — were particularly renowned as places with the finest and most varied cuisine, and the most desirable women. This reputation has remained largely intact in those cities, even as the commercial locus of China shifted elsewhere. 

The reason then, and the reason now, is the same: in wealthier commercial cities, there’s a heightened appreciation, as well as larger audience, for the pleasures that money can buy. Qinan is from Xian, and to drive home the point, he drew the comparison for me between Shenzhen and his home city.

Xian was always a center of learning and political power, rather than a city with vibrant trade and a large, successful merchant class. As a result, the food, though still quite delicious, has always been a little more basic, less expensive, less intricate, less subtle than that of the trading centers to the east, along the Grand Canal. There’s just not enough money around to support a thriving community of top-quality chefs and restaurants. They migrate to where the money is. 

The same logic, of course, applies to why beautiful women are more prevalent in rich commercial cities in China. Traditionally, beautiful women went to Suzhou, Hangzhou or Yangzhou to find a rich patron to take them as a subsidiary wife. They then produced better-looking children, on average, so creating a virtuous cycle. Let the process run, uninterrupted, for several centuries and the results would be that the cities gained a reputation, probably grounded in fact, for having particularly good-looking ladies. 

To this day, Chinese will always aver that Suzhou has the most beautiful women in the country. I haven’t been to Suzhou in over 25 years, so I can’t say if the reputation is deserved or not. But, I do know that most Chinese believe this to be true of Suzhou, even though, of course, few will have ever been there to see for themselves. 

While concubinage is officially no more in China, there is still a similar process at work in today’s Shenzhen. Concubines are no more. Polygamy is outlawed. Today, the term is 二奶 “er nai”, or “second lady”. It’s analogous to a mistress. Shenzhen, I’m told, has more “er nai” than any other city in China. These tend to be pretty girls in their early 20s who come to Shenzhen from all over China, and often end up clothed, housed, fed and otherwise supported financially by an older, usually married man. Nowhere else in the world (not Paris, Milan, or other centers of mistress culture) have I ever seen so many dreary older men in the company of stunningly beautiful women. 

Shenzhen has more “er nai” both because it’s the richest city in China, and also because there are a lot of men from neighboring Hong Kong who either live or work here, during the week. Part of the standard “expat package” would seem to be taking a Chinese girl as a mistress. I’m told the going rate, in terms of monthly cash stipend, is at least $1,000 a month, with apartment, car and clothing budget extra. That’s about five times more than a woman of similar age can make working in one of Shenzhen’s factories.

One other difference from the China of yore: these women will usually return to their home village with quite a nice nest-egg, marry locally and start a family. This then creates a “job opening”. The man will now find a new “er nai” and so start again the process of clothing, feeding and housing an attractive woman new to Shenzhen.   

Food and sex. They are life’s two most basic drives, as well as the fuel that has kept China’s commercial centers buzzing for well over a thousand years.

“Chimerica”, “the world’s most important bilateral relationship”, “the G2”. These are phrases now in vogue to describe the relationship between China and America. The two countries tower over much of the rest of the world, accounting for over 25% of its population and 60% of global economic growth over the last five years. While China and the US continue to have their squabbles, economic and political relations are better than at any time in my lifetime.

My own life has been one long and fulfilling love affair with both countries, They represent twin poles of attraction. I grew up as a typical American kid, except in one respect. As far back as I can remember, I was completely fascinated by China. I believed that if I dug a deep enough hole in my backyard, I’d eventually come out in China. I kept starting the hole, especially when I was frustrated with my parents, but don’t recall ever getting very far. To me , the best thing about going off to university was that I could finally begin studying Mandarin. The most exciting day of my life (and I’ve had my fair share) was the day I walked across the Lowu Bridge in Hong Kong and into China for the first time in 1981.

My life’s goal became first to learn more about China, to study there and finally, after a lot of interesting career twists, to contribute whatever experience and talents I have to help China’s continuing economic transformation. That is why, two years ago, I started building China First Capital, a boutique investment bank that works with China’s private SME to arrange pre-IPO private equity finance.

I’m now lucky enough to call both countries home, dividing my time between Los Angeles and Shenzhen. Of course, there are more differences than similarities. For one thing, the food is better in China, and the summer weather is better in Los Angeles. But, all the same, I’m often struck by the deep affinities between China and the US – both are self-confident, continental-sized nations, with a shared sense of patriotism and optimism.

But, there is one important way in which the countries are moving in opposite directions. In this case, there is going to be a clear winner and a clear loser.

Americans are drifting further from their once unshakable belief in free markets. Chinese, meantime, are becoming ever more certain that the free enterprise system is the best way to organize society and fulfill the goals of its citizens. This is a very worrying development for the US, and a wholly positive one for China.

This remarkable shift is born out in the chart at the top of this post. It shows how Americans’ faith in free market system has been eroding, while Chinese are ever more certain of its superiority.

As someone working with some of China’s better entrepreneurial companies, I’m tremendously heartened by this change in China. The belief in free markets is affirmed by many daily interactions I have there, whether it’s with the boss of a successful private Chinese company, or the family that serves me steamed dumplings for breakfast. Chinese see opportunities everywhere for self-advancement, and want only the freedom to pursue it. Americans, by contrast, have grown more disillusioned, fearful. They are looking to the government, more than at any time I can recall, to solve their problems, to soothe what ails them.

How did China get it so right, while America is getting it so wrong? Recent history plays a big part. China has experienced unprecedented economic growth over the last 30 years, largely through a rolling program of reform that liberalized ever larger parts of China’s once hidebound economy. China’s economy has grown ten-fold over that time. Each additional increment of market freedom has brought with it improvements in the wellbeing of most Chinese citizens.

In the US, people are still reeling from the economic shocks of the last year – the credit crisis, recession, unemployment at a 27-year high, bailouts and bankruptcy of some of the country’s largest and most well-known businesses. Americans are looking for something to blame. Unfortunately, too many are blaming the free market system. Mistakenly, they look to government to restore growth and prosperity.

In China, on the other hand, the economy is vibrant, and Chinese have more opportunities than ever before, If they are looking to government for anything it’s to continue to maintain a steady course by continuing to liberalize.

I’m no pollster. But, I do notice, as I move between two countries, that not only is the belief in free markets stronger in China these days, but the overall business climate is more favorable as well. Competition is increasing, delivering more choice, better service, lower prices.

The US, meanwhile, is experiencing the largest increase in the size and scope of the government in peacetime history. Most people are smart enough to know that this will eventually mean more intrusive regulation and higher taxes — the twin forces that most choke a laissez faire system.

My sense is that the pendulum will eventually swing back in the US. People will be reminded soon enough that government cures are often worse than the underlying disease.

In China, economic liberty is increasing steadily, and life continues to get better for the vast majority of China’s vast population. If anything, this process is accelerating. China is, of course, still far less economically developed than the US. There are economic challenges, and issues on the horizon like an aging population to deal with.

But, at this particular moment in China, the population is growing more confident that solutions will come with freer markets, not greater centralized control. That is great news for everyone, including the companies we work for in China. The sooner Americans start thinking the same, the better.

.

Back again in Shenzhen, with plenty of food for thought, as well as food for the belly. I go through the same “immersion program” whenever I arrive back here: it involves stopping for a plate of dumplings or bowl of noodles once every 30 paces. Or anyway, it certainly seems that way. 

The food for thought, as always, centers on ways to deliver enhanced value and service to clients and business partners. We have a set of core principles, that we build our business on, and that collectively represent our main differentiators. They are disarmingly simple – to work with integrity and honesty,  and always put the success of our clients’ first. We know that if we do this, our own success will follow. 

Simple, but not nearly as universal as they should be in our business. A lot of investment banking, IPO and advisory work in China has bordered on the criminal. Hundreds of SME companies were damaged, if not destroyed, by advisors, lawyers and others who neglected entirely to put their clients’ interests first. Instead, they pushed for companies to take various fast routes to IPO in the US, typically reverse mergers, OTCBB Listings, Form 10, SPAC deals. The reason: the advisors, lawyers, bankers all made a pile of money, quickly, through these kinds of deals. When things turned sour, as they often did, the advisers, bankers and lawyers were generally nowhere to be found, and the Chinese companies were left in dire straits.

Obviously, the bosses of the Chinese companies were complicit, since they agreed to these kinds of schemes to achieve a fast IPO. But, in my experience, the bosses main sin was that of ignorance. They simply didn’t understand all the workings of these kinds of deals, or even the fee-structure that would disproportionately reward the advisers, lawyers and bankers. In other words, the Chinese bosses didn’t do their DD, didn’t check the dismal track record of the many Chinese companies that already opted for OTCBB listings or reverse mergers.

I sometimes think the Chinese term for IPO, “上市” ( “shang shi”) has magical, intoxicating effect on some Chinese bosses. They hear it and suspend all their normal caution and suspicion. Soon, they end up agreeing to what are often truly disastrous transactions that don’t even deserve the name IPO.

There are, by some estimates, several hundred Chinese companies now listed on the OTCBB that are somewhere between “on life support” and “clinically dead”. Their share prices fell steeply immediately after listing (by which time the advisers, bankers and lawyers all pocketed their fees and lined up their next victims) and are below $1. There is little to no liquidity. They often trade at PE multiples of 1-2x. The costs of retaining the OTCBB listing are bleeding the companies of badly-needed money. They have no chance to raise additional capital, nor to do much of anything (except waste money on Investor Relations firms) to lift their share price.

I get angry just thinking about this. I’m offended that people in my field of work would be involved in such self-serving, greed-ridden transactions. Secondly, it’s also brought a lot of harm, and sometimes complete failure, to what were very good Chinese SME companies that once had bright futures, until they had the misfortune of putting their financial futures in the hands of these advisors.

Of course, the guiding principle behind all investment decisions must be “caveat emptor”. Chinese bosses clearly didn’t “caveat” enough. That’s regrettable. But, the gains made by the advisors, lawyers and bankers were so enormous, and so ill-gotten. That’s the heart of the matter: Chinese companies were ruined so that a bunch of ethically-challenged finance people could get rich.  For me, this is contemptible.  How these people sleep at night I don’t know.

I do know this: we try to do everything we can to make it less likely that a good Chinese SME goes the same route, and ends up in the same sad condition. One way is through information. We’re producing Chinese-language materials meant to explain the hazards of transactions like OTCBB listings and reverse mergers. Our plan is to distribute the materials as widely as possible, both online and off. It may not put the bad guys out of business, but at least it will make it easier for Chinese SME bosses to know which questions to ask, what kind of track record to look for or, more often,  run away from.

I’ll be sharing soon on this blog  the English version of some of this information.

.

“Go to a Chinese bookstore”. This is my advice to anyone who wants to get a quick, accurate and comprehensible sense of what’s happening, and what’s most remarkable about this almost unfathomably large and complex country. 

Why a bookstore? Well, first, all of us have been to these in our own cities and countries. So, we have a good enough idea of what to expect in a boostore. It’s usually a quiet, not overly well-trafficked location, with people milling around in silence. Even in the larger US chains like Borders and Barnes & Noble, there’s always a somnolent feeling about the place, like the paying customers are too few to support the cost of the lease. Sadly, that’s often been the case and Borders, for one, has run into huge financial problems. 

Now, let me take you – at least in words – to the bookstore closest to my home when I’m in Shenzhen. It’s called Shenzhen Book City, and even from the outside doesn’t look like any bookstore I’ve ever seen elsewhere. It’s a seven-story blue-glass tower the size of an office building. A typical big-box two-story Borders looks like some kind of cutesy toy compared to Shenzhen Book City. 

It’s on the city’s main thoroughfare, Shennan Road, and just above ground from a subway station. It’s open from 10am to 10pm daily. Just approaching it, you have the happy feeling of being pulled into a giant vortex of human activity, as big crowds of people quickly move into the store, or head out of it. 

Inside, it’s more crowded and generating a more palpable sense of buzz than the crowd at a baseball game. There are readers everywhere, moving from section to section, floor to floor, or stopped in an aisle deeply concentrating on some book they’ve taken from the shelves. This is a picture of China in the process of continued self-improvement. It’s very inspiring, and bears only the faintest resemblance to any other bookstore I’ve been to, in the 70 of more countries I’ve visited. 

The checkout lines are long, at any hour of the day. There’s a huge staff spread around the place, answering questions, guiding people to the section they’re looking for. Of course, this being China, there are also places to eat – quite a few of them – in the bookstore itself. It’s also more than just a retailer. There are classrooms on the upper floors where people come to take paid classes on all kinds of subjects aimed at self-improvement, like foreign languages, or accounting. 

The Shenzhen Book City, single-handedly, restores my faith that a love of books and the pursuit of intellectual inquiry has not been completely deadened by YouTube, video games and chat rooms. 

Shenzhen has other Book Cities, spread around the city. The others I’ve been to are no less crowded – and my guess, no less successfully financially than the one in my neighborhood, which must be making a small fortune every day. Books aren’t all that cheap in China. They used to be. But, the quality and choice have both improved enormously over the years. Some of the cover art is as good as anything I’ve ever seen. 

Anyone from outside China would have some immediate familiarity on entering the place. It looks like other bookstores, with lots of aisles and bookshelves, grouped in sections by topic,  stacked with books. But, what isn’t going to be familiar is the sheer exuberance of the place. It’s more like a jam-packed department store on Xmas eve than a staid bookstore.  It’s got that same air of  “I’m here to spend money, now”. 

It’s somehow raucous and purposeful at the same time. 

Standing by the entrance one day, a woman approached, seemingly intent on discovering why I was so obviously awestruck by the whole scene.  I couldn’t convince her there was anything worthy of note – as what seemed like thousands of people surged in and out of a book store. As it turned out, she also provided a nice small lesson on the state of Shenzhen’s economy at the moment. Until recently, she’d been working in 外贸, “waimao”, or foreign trade in English. It’s a catch-all term for a lot of the economic activity in Shenzhen until recently, embracing trading, sourcing, import-export. 

With the sudden downturn in the world economy last year, many of the easiest opportunities to make money from foreign trade more or less evaporated, as did many of the small companies that carried out this kind of work. The woman lost her job, and just a short time later, found a new one as a clerk in the bookstore. In other words, she made the transition, quite smoothly by all appearances, from earning a living off exports to earning a living from the domestic economy. 

I wandered some more and found my way to the section selling business, management and career-guidance books. It was particularly jammed with people, heads down, buried in their books, as if cramming for a big exam. In their urgency, their evident hunger to learn, to improve, you could catch a glimpse of just what lies deepest within the remarkable economic transformation of China over the last 30 years. 

It’s all there for the viewing, in an ordinary Shenzhen bookstore. 

.