Creating Value for All Stakeholders: China's Executives Rethink Business Models

In many ways, 2010 was a tumultuous year for the movers and shakers of Corporate China. Consider the travails of Tencent. In October, the country's most popular instant messaging provider waged a high-profile battle with anti-virus company Qihoo 360 over user privacy. The tit-for-tat spat left neither company looking good and unleashed a wave of questions about how the companies are run.

But there is a bright side. Stung by criticism that it has been leveraging its market dominance to copy innovative products created by smaller rivals and worried about its future growth, Tencent is taking action. At the 9^th China Entrepreneur Summit 2010 held in early December in Beijing, Pony Ma, Tencent's founder and president, announced that the company will undergo a six month planning period for a major transformation as it moves to an open platform that accommodates more third-party applications. “I hope every individual and every company will become a 'value contributor' through this open platform and will benefit from it,” Ma said.

Tencent isn't the only company feeling pressure to change. At the summit in Beijing, Wang Shi, also announced a similar overhaul at Shenzhen-based Vanke, China's biggest real estate company with annual revenue of more than RMB 100 billion (US$15 billion) where he is president. “In the next decade, Vanke will go through two transformations,” he said. “One is to move from traditional sales and marketing to technology research and development, and the second is to move from building and selling houses to providing services. In both transformations, we have to be more consumer-oriented.”

Meanwhile, Haier Group, a RMB 125 billion (in annual revenue), Tsingdao-based white goods manufacturer -- the largest in the world by market share -- is another company undergoing an overhaul. Since its launch in 2008, it has eliminated a national distribution center and rolled out a supply-on-demand model that dramatically cuts down the inventory it needs to keep on hand. It also began outsourcing large parts of its manufacturing, while having its factories focus on marketing and developing products. “In the old era, manufacturing companies were centered on production and on how they sold their products to customers,” said Zhang Rui Min, president of Haier since 1984, in an interview published last year in CEIBS Business Review magazine. But the Internet and other new technologies have changed that, helping companies to accelerate how they respond to new market trends.

Indeed, one reason is that new technologies are rapidly eliminating a company’s competitive advantages, destroying old distribution channels and traditional barriers to entry, while simultaneously squeezing profit margins and zapping the market share of incumbent players. Another reason: The fast-evolving business environment within China, says Henry Han of Peking University’s Guang Hua Business School. “Ten years ago, the low cost of labor and the rich Western markets provided enough of an advantage for many manufacturers in China, while high-tech firms achieved success by imitating existing products and carving out domestic market share. But those methods might not work in the future.”

According to Han, “The better approach is to create value for the entire value chain -- for example, by addressing some untapped demand from customers or helping suppliers improve what they do. That is what good companies should be doing, rather than just squeezing the margins of their suppliers.”

As Zhang put it, a business model now “should be a win-win strategy for a company and its clients. If you stray from that path, your business model won’t work, no matter how sophisticated the model is.”

What's the upshot, according to experts?"Executives are encouraged to think holistically about the total value they can create for all stakeholders through business model innovation, which spans industry and firm boundaries, rather than simply thinking about the profitability of their own company,” says Raffi Amit, a Wharton management professor.

Pushing and Pulling

In the case of Tencent, the business model transformation is "radical yet timely,” Amit notes. The Nasdaq-listed, Shenzhen-based Internet company got its start by copying instant message tool ICQ, and now controls more than 80% of the instant messaging and about 25% of the online gaming in China. With a market capitalization of US$40 billion as of early January, it is the second largest Internet company globally, after Google. But Ma knows there's no resting on laurels.

Tencent has been moving upstream in the past few years by launching a range of online products and services, such as QZone (for blogging and social networking), QQLive (for videos), QQ show (for sharing photos) and paipai (for consumer-to-consumer e-commerce). But it has been criticized for not creating value for the whole industry chain, says Jin Cuo Dao, editor-in-chief of China Entrepreneurs Online and author of a new book titled, Micro Revolution."Now, it looks like Tencent will adopt an open strategy,” having been pushed as well as pulled into a new direction. “Tencent is being forced to be open because it has been challenged in various ways,” he says.

In some ways, it is uncharted territory for the likes of Tencent, Jin notes. “Chinese Internet companies have no history of being open, but if Tencent can really be open, if the new business model can allow many companies to get involved in its platform, the company will have immeasurable business potential.”

“An open business model will allow Tencent to sustain its leadership position and leverage it to a greater extent with more partners,” predicts Amit. In a paper published last summer titled, “Business Model Innovation: Creating Value in Times of Change,” Amit and his co-author Christoph Zott at University of Navarra's IESE Business School in Spain, discuss why a business model now reflects all of a firm’s interactions with stakeholders. “What matters is the value a company creates for its stakeholders, including vendors, partners, customers and, of course, shareholders and employees,” says Amit. “In an interconnected world, especially a world in which financial resources are scarce, managers must look beyond products and processes to focus on ways to innovate their business models. This can help them create and exploit new revenue opportunities, and position themselves for the next economic upturn.”

Many companies in China are still running their businesses using a traditional model that largely revolves around lowering costs and grabbing more market share at the expense of other companies, says Han of Guang Hua Business School. “I’m not saying you can’t do that, but once you have grabbed market share, you have to cultivate and create value for the market…. Otherwise, we will see the growth of firms at the cost of destroying the business environment.”

Apple is a good example of how new models are being adopted, he says. “Its innovation and creativity provide the company with huge revenue stream, but Apple also benefits its rivals by exploring and creating new markets for them,” says Han. “This is what good competition should be: Expanding the boundaries for their own business and the entire value chain, so every player in the market benefits.”

“What Haier did by reforming its organizational structure was to understand and respond to customer demands more efficiently," while also streamlining how it worked with suppliers so that contracts were larger and more lucrative, says Han. “Therefore, it creates value for all parties, expands its business boundary, and improves the efficiency of its supply chain.”

In general, as Zhang of Haier Group said in the CEIBS interview, “developing a competitive business model is the foremost priority for today’s executives. Technology is important, but you won’t always be able to take the lead when technology changes so quickly and is easily copied by others. But business model innovation is hard for others to copy. It involves all employees and a 360-degree reform, which is very difficult to imitate.”

Calling All Consumers

For sure, all this places a company's customers in the spotlight. “Consumers will have a dominant position in a company’s innovation process,” says Jin. “In the traditional model, innovation is initiated by the company; in the future, innovation might be initiated by consumers,” he says. “In the past, when you had technology, you had a unique weapon; today, whoever knows consumers better will be more competitive.”

The process is already under way in some sectors in China, according to Jin. “China is a rare market for the Internet in which local companies have beat foreign players: Baidu is beating Google and Taobao is beating eBay,” he says. “This reveals the emergence of the new rules of the game: The core competitiveness of these firms is understanding their customers. That’s why local companies can win. They are not winning the battle through technological breakthroughs, but by applications tailored to consumer needs.”

As Zhang of Haier sees it, “The Internet should not just be a platform for sales, but an important media to communicate with and understand your consumers. I told my people that on the Internet you can attract consumers by listening to what they want, and recommend good products to them, rather than just selling products online…. The ultimate goal is to face customers directly and give them solutions to problems.”

That is, of course, no small feat. “It is not easy to address changes in demand from stakeholders in the supply chain,” says Han. “For example, most companies produce standardized products so it is hard to know exactly what their customers want.” The culture of the company also has to be open to change, and a company's executives must be willing to invest in the costs of organizational reform, he notes.

In their paper, Amit and Zott recommend that before managers begin transforming business models that embrace stakeholders, they should seek clear answers to seven questions: What is the objective of the new business model? What novel activities are needed to achieve the objective? How can the activities be linked to each other? (For example, a retailer might provide information about customers' garment preferences to manufacturers.) Which activities should the company perform and which activities should a partner perform? What governance will be required as a result? How will value be created for each participant? Finally, how will revenue models need to adapt with, say, new pricing strategies?

For Tencent's Ma, “‘open and sharing’ is not a slogan, and it is not a simple concept. Open is a capability; it’s about how you build up a system to execute opening and sharing.”

McKinsey Quarterly