CFO Ma describes the unique challenges awaiting Chinese companies that seek growth through international acquisitions.
In the six years since China joined the World Trade Organization, Chinese acquisitions of businesses in other countries have increased sharply. Chinese officials estimate this “outbound foreign direct investment” at a mere $551 million in 2000 but at nearly $7 billion in 2005.1 That is only a fraction of the $60 billion2 or so of investment flowing annually into China, but it represents a growing number of Chinese companies scanning the horizon for opportunities to invest abroad.
One of the most prominent examples of that trend was the 2005 acquisition of IBM’s personal-computer division by Lenovo Group, based in Hong Kong, for $1.2 billion. The success of this deal, heralded as a signal moment in China’s transition from a developing to an industrial economy, was due in no small part to Lenovo’s energetic senior vice president and CFO, Mary Ma.
Before joining Lenovo, in 1990, Ma worked at the government-run Chinese Academy of Sciences, where she managed science and technology research projects jointly developed by Chinese and European organizations. She was also involved in the administration of World Bank loan projects to support research in China. Today Ma is widely recognized as one of her country’s most influential global executives.
McKinsey’s Gordon Orr and Jane Xing recently visited Ma at Lenovo’s Beijing offices to discuss Chinese acquisitions abroad, the challenges of integrating companies across cultures, and the role of private-equity firms in providing business experience.
The Quarterly: Chinese companies are still relatively new to acquiring businesses abroad. Are they ready for international markets?
Mary Ma: Chinese companies are better prepared to invest abroad than many people believe. People outside of China often think that China has protected its personal-computer industry for the past 10 or 20 years, which is not true.
Fifty years ago, however, the government did protect companies in the information technology industry. Under the planned-economy system at that time, companies couldn’t manufacture in China without a permit, and if they manufactured elsewhere, they had to pay a 45 percent to 50 percent tariff to import their products into China. As a result, companies that had permits were well protected from competition. When that system fell apart, Chinese companies suddenly had no protection at all, and they had to compete with international players in the China market.
The silver lining, especially for Chinese IT companies and high-tech companies, is that they quickly had to learn to grow in a fully competitive environment, so they could leverage their strengths in efficient operations. That made some Chinese companies very competitive when they decided to go international.
The Quarterly: Yet as we know, even two very skilled companies aren’t always a good fit when they merge. How much of a challenge is it to integrate a business outside of China?
Mary Ma: It’s true, and cultural integration is still one of the biggest challenges. By this I don’t mean merely that an acquirer might have a different corporate culture than a company it acquires—that’s a different issue. Instead, we face the combined effect of different corporate cultures and the difference between the cultures of the East and the West. These East-West cultural differences are built into our identities from a very early age and affect the very basic ways that people interact. In the East, for example, the education system and the family and society shape the minds and behavior of young people in a way that is totally different from the West. Even today, students from age 5 to 25 sit formally in classrooms, attentively listening to teachers. They don’t ask questions, even when prompted. But classes in the West today are quite informal—students eating in class, sitting on their desks, and even debating ideas with their teachers.
Those differences show up later in business meetings that include both Americans and Chinese, when our American friends are considerably more outspoken. But the Chinese will sit quietly and think, and then think some more. Only then will they prepare a presentation that spells out their thoughts. Many Chinese companies still don’t realize how much of a long-term effort is needed for cultural integration at this level.
The Quarterly: How should Chinese companies prepare for that challenge?
Mary Ma: The most important thing for a Chinese company is to grow big enough and strong enough in its home market—in China. Probably the biggest reason for the failure of international growth is that companies lack a certain critical mass at home. Without that, they will lack the level of strategic thinking needed to manage an international organization, and they will lack managers with the necessary breadth and depth of experience.
And this is purely about size; a smaller company’s management wouldn’t have the capability even to think about operating at a global scale, nor the capacity to absorb hundreds more people and managers. The depth of Lenovo’s management meant that we could sustain our success in China and still have managers available to go anywhere we needed them, as long as there wasn’t a language barrier.
China is the place to build that experience; this is where a company will have the biggest advantage. Even if competition is severe, managers know the market very well and they have everything in their favor.
The Quarterly: Should companies ever try to get an advantage in their home market by becoming global first?
Mary Ma: Under certain circumstances, yes. There are some start-up companies in industries where China is not the right place to start. Take solar panels, for example; one or two Chinese companies are very big on solar panels, but there really isn’t much of a market for them in China. Such companies should probably start out overseas instead.
Lenovo itself started with the international market, some 20 years ago, and then expanded into China in 1990. We wanted to manufacture PCs in China under the old permission-based system, but we couldn’t get a permit. So we started from Hong Kong. The goal was to show the government that we could be successful in international markets, so why couldn’t we also do that in China?
The Quarterly: If companies have the choice of smaller acquisitions or organic growth versus big acquisitions, how should they think about making the trade-off?
Mary Ma: It depends very much on the market of the industry in question and the company itself. In our first stage of international expansion at Lenovo, we were looking for some small acquisition. There were so many options that we finally just had to look back at ourselves—at what we really needed from an acquisition.
We identified three reasons for going international. First, PCs are really a volume game, and we needed the advantages that come with scale. China was no longer a closed market, and we were selling 4 million units a year before the acquisition and competing with companies selling 24 million.
Second, many PCs are nearly identical, no matter who manufactures them, so we had been thinking about how to differentiate ourselves more. In part, differentiation means product innovation, making sure you have special features tailored to customer needs. So we really needed a technology team, research and development, and product specialists. But the small companies we looked at couldn’t help us on these points.
Finally, we needed to leverage the skills of Lenovo’s management—which we also felt were better suited for a large acquisition than a small one.
The Quarterly: Had you considered organic growth as well?
Mary Ma: Yes, and that build-or-acquire question provoked an interesting debate for many months. Lenovo had been successful at organic growth since its establishment and achieved a leadership position in the PC industry in its home country. So in a purely self-developed organic company like Lenovo, people were asking why we should consider an inorganic approach. Again, it was a question of volume and differentiation and scale. We did a comparative valuation of whether we could use a similar amount of investment to achieve the same goals organically, but we decided we couldn’t. We didn’t have the experience at the international level.
We also didn’t have the brand globally. Brand is also an important factor in deciding between a large versus a small acquisition, because with a lot of the smaller possible acquisitions, and with some other Chinese companies, you may buy brands that are really struggling.
The Quarterly: The negotiations seem to have dragged out for some time. Why was that?
Mary Ma: The terms of the auction emphasized strict nondisclosure, and that was a big factor. IBM was rightly concerned about what would happen if news of a deal were to leak out and the deal then fell through.
But that wasn’t the only reason for the negotiations running so long. In large part, it was because several prospective buyers were bidding for the PC division. Also, negotiating so many items, even if only on price, can be quite difficult.
Finally, the PC division was not itself a listed company. All the numbers and data and due diligence depended on the data they provided us. So we definitely had to take the time to understand that thoroughly. That meant separating everything—IT and finance and customer support and marketing—because they were all integrated closely into their parent company. We negotiated numerous agreements or contracts and subcontracts, because everything was interrelated. That takes time.
The Quarterly: Right at the end, after you decided to do the deal, you chose to bring some private external investors into the process. What was the rationale for doing that, and how well do you feel it has gone?
Mary Ma: One of our private-equity investors—we have two of them who are still with us—was actually among the possible buyers in negotiations with IBM at that time. In the end, they invested in our merged business instead of acquiring the PC division, which turned out to be good for both of us.
Now, normally a private-equity firm would want a controlling share; without control, it wouldn’t do a deal. But the first thing they said to me when we talked was, “For this deal, we’re not interested in a controlling share. We don’t want to take control; we just want to be an investor working together with management, with other shareholders, to make it successful.” They also agreed to work with us both at the board level and at the management level, providing any support we needed.
The private-equity investors brought us more than funds. More importantly, they brought insight and experience. And during the negotiations for their investments—and in the 18 months since—we’ve found these private-equity investors play a very important role. First, they are very active at the board level, especially on the strategy committee. Their role isn’t to lead or guide, but instead they are very active participants in our conversations about strategy and how an international business should play at this level. They’re also involved at the operational level; at the request of managers, they provide experts to work on manufacturing, the supply chain, and even on human resources.
Probably few Chinese companies realize how important private-equity players can be. Some would likely worry about working so closely with so many foreigners, but that’s probably a misunderstanding, because private-equity partners can provide a lot of support and guidance.
The Quarterly: How did the involvement of private-equity firms play with other investors?
Mary Ma: The interest in Lenovo from two very prominent private equity investors really served as a vote of confidence in the company. Part of the challenge initially was that because Lenovo had been a Chinese- and Hong Kong-based company, our institutional investors and analysts had a hard time developing solid research reports on us with our expanded global presence. To address this, we worked to communicate with them about the global PC market picture. At the same time, we worked hard to introduce ourselves to New York analysts, many of whom hadn’t even known there was a Chinese company called Lenovo.
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