Sunday, May 6, 2007
Inside the Mind of the Chinese CEO: Profits
Just what is going on in Chinese enterprises? Are they making smart decisions? Are they making money? And, are their managers incentivized to continue to do this? The answers are fragmentary, but appear to all be in the affirmative. Chinese enterprises [maybe it's time to call them firms], appear to be rapidly maturing into organizations that we in the West can more easily recognize. Arthur Kroeber, who runs Dragonomics, and whose work I continually rely upon, put it pretty directly last September, in a China Insight, entitled "The Mystery of Profit," when he observed: • "Industrial profit growth in China is real and broad based • The "margin squeeze" story has been exaggerated • Economy-wide profit growth, however, tells us nothing about the rate of return at individual firms • Financial investors find it difficult to profit because in China’s high-growth environment, companies rationally target expansion, not rate of return" These conclusions were reinforced in Dragonomics 2nd Quarter, 2007, China Quarterly Economic Outlook, which reported that: "Margins are improving even in both upstream [logical because of the energy industry impact, and the more general monopoly-like character of such industries in China] and non-upstream sectors: • Upstream (oil/gas/coal/mining) profit margin (profit/revenue) is close to 30%. • In most other industries profit margin is between 5-8%. • Midstream processing industries (e.g. steel and some metals smelting; oil refining) faced margin pressure in 2005 but are now recovering; in most manufacturing sectors margin pressure is not very evident." Now, a research project out of a team from several Hong Kong universities, and reviewed in February 2007 issue of The Academy of Management Perspectives, entitled "What Drives Compensation for China's CEOs?" [which can be found on the IMD Online Databases, using TOC Premier, under "Business Source Complete"] uses late 1990s-early 2000 data [unfortunately] to consider evidence of incentivizing around profits. Reassuringly, they find that incentive links tied to profits do exist and tend to be most likely found in foreign invested enterprises [not surprisingly], but can also be found in those SOEs that report [not owned by] to the Central, as well as local, governments.