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Digital China on the Rise
APRIL 2014 · 
Keywords: digital age,globalization,innovation,McKinsey,CIO
The rise of digital enterprises in China will increase productivity across industries, speed up Chinese enterprises’ globalization process and usher in chief information officers into the strategic decision roles, and also force shopping mall developers to go bankrupt and governments to counter new job losses, McKinsey Asia Chairman Gordon Orr predicts.
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Digital China on the Rise
McKinsey Director Gordon Orr's good guesses about how digital enterprises will transform business and social territories in China.
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It is not new for Mr. Gordon Orr, who is director and chairman of McKinsey Asia, to publish predictions about China, as he has been doing this annually for six consecutive years. Backed with the past 20 years of life and work experiences in China, especially his responsibility for creating McKinsey’s China practice – with the opening of offices in Shanghai and Beijing in 1993 and 1995, his predictions do make sense in terms of where China goes for next step. Recently in an interview with FBK about his good guesses made in January 2014, Mr. Gordon highlighted the rise of digital enterprises in China, as well as the social impact and governmental policies that respond to this trend.


Digital business: starting point for globalization

Digital business means tremendous opportunities for Chinese local enterprises. If you create your business online from the beginning, you can become nationwide and even become international, because all of these enabling systems – payment and logistics systems – would support you in doing that.

“But the real challenge is not about going nationwide but about creating a business that you can run professionally once you get a little bit larger, and having the skills and organizational processes in these systems to do that,” Mr. Gordon said in the interview on March 14.

Digital technology allows you to connect to people globally. “That is the most important thing, so it is an enabler to allow you to do that. But it is only the starting point. If you don’t understand the consumers in the United States, it doesn’t matter even if you are connected to him, because he is not going to buy your products. And you also have to understand the specific regulations in your market.”

He said he would counsel Chinese enterprises to not entirely focus on digital business, and create online and offline businesses in the targeted markets at the same time. For example, a lot of Chinese companies sell in Brazil. You need to have Brazilian people in your organization working in Brazil alongside your online presence, because the customer wants to talk to someone in his own language, someone who can explain to him about the products that had problems and have been fixed.


Digital disruptive power to re-structure businesses

In his annual China predictions for 2014, Mr. Gordon highlights two important phrases of “productivity growth” and “technological disruption”. “In China for the last few years, the costs of many things – like costs of factory workers, energy/water/land costs, and the cost of borrowing capital from banks – are going up, and you’ve seen across many industries profitability has been declining. So the way you address that is through improved productivity. In the past, when Chinese companies had a problem, they would say: ‘Ok, we would hire 10 more people to fix the problem.’ Now they would say: ‘Should we be using technology?’” he said during the interview.

Which kind of industry would get the most benefit out of the digitization trend, and which the least? “This is a tricky question. Because what can happen to industry is an enormously changing volatility, not being winners or losers in industries,” he said. Take banking industry for example. The banking industry is going to change tremendously, we’ve already started to see some of that, but the incumbent banks that have their real estate and tens of thousands of branches are going to have challenges because of their cost structure. So there could be winners and losers, but most importantly and most excitingly, there would be lots of volatility.

“The retailing is the same. There could be strong physical stores, but they have to have strong online presence. I mean, if you are a travel agent selling airline tickets, that is not a good business. If you are a real estate company building shopping malls, you have to certainly change your business model, because it won’t be easy to attract people like before,” he added.


More Chinese go for online banking?

Compared to other countries, Chinese consumers love doing things online. Would people be doing the banking online, through one of these new private banks or ICBC and China Merchants? “In many cases, yes. What we’ve seen is that it is incredibly easy to get the deposit. 80 million people do. Make it easy to gather the deposits, and that is what Internet does. But now that they’ve got the money, they have to find somewhere that is safe to lend their money to, and to have risk management process in place, so that you don’t lend the money to companies that are going to go bankrupt or unable to pay back or run away with the money. That is really hard.”

But it is up to Chinese regulators to decide on how fast the number of Chinese people who are to do the banking online will grow, and how much they choose to restrict this. “The point that was made about process management is incredibly important. Because the regulator says to the traditional banks: ‘You have to hold certain amount of capital against bad debts.’ You know Internet banks today are not holding any capital against their debts, and that has to change.

“The hardest job in China today is public regulation of financial systems,” the McKinsey director said.


Remodeling shopping malls

As said in his predictions, shopping malls are losing ground to online marketplace. While overall retail sales are growing, e-retail sales jumped by 50 percent in 2013. Although the rate of growth may slow in 2014, it will be significant. Yet developers have already announced plans to increase China’s shopping mall capacity by 50 percent during the next three years. For an industry that generates a significant portion of its returns from a percentage of the sales of retailers in its malls, this looks rash indeed. If clothing and electronics stores are pulling back on the number of outlets, what will fill these malls?

“This is a very important challenge,” Mr. Gordon told FBK in the interview. “Of course, there would continue to be malls, but they are going to be different in the future in multiple ways. My prediction that many malls would run in financial difficulties is clearly happening. I mean state-owned companies in particular, but also some private ones as well.” They might be building new malls in second-or-third-tier cities like Shenyang and even first-tier cities like Beijing, and malls are getting difficulties in every bad location.

What’s going to be changed? “Traditionally when you open a mall, you focus on attracting retail stores like clothing and electronics ones. There would still be some of those in the future, and maybe more grocery-type stores, but there are going to be many more services businesses: doctor’s, optician’s, hairdresser’s, tutorial’s, cinemas, and restaurants. Things you can’t get online. It will become a service center rather than purely a retail center, and that is going to, for the mall owner in most cases, generate less revenue. So they are going to adjust their business models.”


CIOs are a hot commodity

McKinsey director predicts that the CIOs’ day is coming. The productivity imperative is making technology a top team priority for the first time in many enterprises. Strong CIOs (chief information officers) should expect large compensation increases – they are the key executives in everything from aligning IT and business strategies to building stronger internal IT teams and adopting new technologies, such as cloud computing or big data.

“Historically, particularly in Chinese state-owned enterprises, the CIO is deep down in your organization. It is not very popular or respected position, and there is no strategic role. And that is part of the problem now. You know CIO can put the wiring together and buy PCs and the like. But can they think strategically? Can they communicate with you about what my business model is? Very few can. And this is one of the most important roles in China today. Enormous opportunities for people who can talk about technology and business together to become really invaluable advisors to CEOs.”

He advised that Chinese enterprises have CIOs report directly to CEOs and allow them to hire new talented people who are working in the digital world. “They have to be at the table and at the management board meeting. It is more important for the new hirings to have digital experience than to have industry experience such as in financial or retail services. You have to understand what the changes should be.”


Balancing digital growth with job losses

Expect the Chinese government’s rhetoric and focus to shift from economic growth to job creation, Mr. Gordon predicts. The paradox of rising input costs (including wages), the productivity push and technological disruption is that they collectively undermine job grow, at the very time China needs more jobs.

He said he has been recently in a Beijing forum on China development with Chinese leaders and global CEOs, and was required to write a paper on this problem. “Technology is an inevitable force, and these industries are going to be re-structured. What businesses have to do, what the government has to do? Have they collaborated with each other?”

“This is a really tricky one for the government in hand,” he told FBK. In many industries in China today, market forces are driving behaviors. “Let’s take insurance industry. State-owned and private companies, start-ups and giants, they all have access to digital technology. So the people are going to offer insurance products online. And if they are cheaper, you will make your customers buy them. so these companies don’t need so many sales agents. That’s going to happen, and there is very little government can do at this point to stop that happening.

“What the government needs to do is recognize that is what the technology is making it happen, and intervene at two levels: one is helping people who come into the job market have the right kind of skills for the new jobs that are coming; the other is encouraging industries to re-organize to retrain people.”


What is digital enterprise?

“A digital enterprise is an enterprise that understands the technologies that are relevant in terms of impacting the way it does business today and re-invents how it does business tomorrow,” McKinsey director said to end the interview.

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PROFILE
Gordon Orr
Director & Chairman
Mr. Gordon was responsible for establishing McKinsey's China practice, with the opening of offices in Shanghai and Beijing in 1993 and 1995, respectively. Gordon has been on McKinsey's global board of directors since 2003. He has been based in China since 1993 and has been with McKinsey since 1986. He is chief editor of the Chinese editions of the McKinsey Quarterly and of McKinsey on Technology.
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