China Begins to Fulfill Its Potential for Big Profits

BEIJING – Many foreign companies have long viewed China as a land of great potential but little immediate profit. As recently as the late 1990s, most Western marketers found this country more frustrating than fruitful.

A 1998 survey by consulting firm A.T. Kearney found more than one-third of multinationals were losing money in China, and an additional 25% were barely breaking even. In 1999, when the American Chamber of Commerce in China polled its members on how long it took their local operations to post a profit, many of them responded by writing humorous notes on their forms.

That situation has changed faster than many executives expected. Today, China represents not only a fast-growing source of revenue for many multinational companies, but also a rising source of profit. The change has given those companies and their shareholders a sometimes-overlooked stake in the continuation of China's rapid economic transformation.

Although better known as a prodigious exporter, China has become the world's biggest market for cellphones, with more than 500 million wireless subscribers; that makes it crucial to companies such as Nokia Corp. and Motorola Inc. It is second to the U.S. in number of Internet users – 162 million – a reason why Sun Microsystems Inc. expects its revenue in China to double within three years, surpassing Japan as Sun's biggest Asian market.

China is the second-biggest market, after the U.S., for personal computers and cars. It also accounts for a huge share of the global demand for commodities such as iron ore, driving growth for mining interests such as Rio Tinto.

An analysis by San Francisco-based Revere Data of filings by companies trading on U.S. stock exchanges shows that 44 reported that 5% or more of their 2001 revenue came from China. By last year, the number had leapt to 108. The true figure is all but certainly higher, because many companies don't disclose revenue by country.

"Everyone understood that China would be a big thing one day, but nobody knew quite when that one day would come," said Richard Lavin, chairman of the China operations of Caterpillar Inc., a Peoria, Ill., maker of heavy-construction equipment.

Caterpillar, which has been in China since 1978, said its sales really took off in the past five to eight years. In that period, overhauls brought by China's entry into the World Trade Organization in 2001 have opened markets and trimmed red tape. Per-capita income has tripled in the past decade, helping increase consumer spending, and a construction boom has boosted demand for commodities and heavy machinery. Caterpillar last year sold more than $1 billion of goods in China, roughly split between goods made locally and those exported from its U.S. home base.

While China sales account for 2.5% of Caterpillar's $41.5 billion in global revenue, the company is looking for sales to triple by 2010 and provide one-fifth of its additional global revenue during the period, Mr. Lavin said. In 2005, Caterpillar designated China one of its "critical success factors." The others are broad areas like distribution and quality. "If we don't lead in China, then our global leadership position is going to be challenged," Mr. Lavin said.

Caterpillar also has created a group of top executives, called the China Council, to ensure that senior management acts quickly on new investments and other important decisions.

This year, China for the first time will contribute more to global economic growth than any other country, including the U.S., according to estimates by the International Monetary Fund. With its economy expanding at a rate of more than 11% this year, China is on track to surpass Germany as the world's third-largest national economy by dollar value, although its annual output is still less than one-quarter of the U.S.'s at market exchange rates.

"People were not sure how fast this could happen," said Sam Su, China division president of Yum Brands Inc., which gets nearly 20% of its revenue from its Pizza Hut and KFC restaurants in China.

Although Yum Brands, of Louisville, Ky., has been in China for 20 years, longer than most Western companies, it is no longer exceptional in reaping significant revenue in China.

And that growing revenue is increasingly translating into profit. In surveys by the U.S.-China Business Council and the European Union Chamber of Commerce, more than 80% of respondents said their China operations were profitable last year.

As a result, China is becoming much more important to investors world-wide, even those who don't own shares in a single Chinese company. "China is too big to ignore, so you always have to have a view of what's happening there," said Brett Gallagher, deputy chief investment officer for Julius Baer Investment Management in New York.

The growth potential of the country's domestic market also shows why so many people in business and government are concerned about the rising friction between China and its major trading partners, the U.S. and European Union, over China's currency policy and, more recently, the safety of China's exports.

That potential is transforming the way companies do business. Pharmaceutical company AstraZeneca PLC, whose predecessor company, Astra AB, started off in China in 2000 with a manufacturing plant and a sales operation, has expanded its clinical-trials program here, added research staff and opened a purchasing operation. The China market last year generated $320 million of the British company's revenue, or less than 2% of its global total of $26.5 billion. AstraZeneca expects sales to increase 25% this year and for China to be its third-largest market within five years.

China "is an emerging market, but it's also a market of huge scale. It's a mixture of two worlds. So it gets a very high level of management attention," said David Smith, AstraZeneca's London-based executive vice president of operations.

Yum Brands also has changed how it runs its business to reflect China's clout. With the KFC and Pizza Hut restaurant chains having taken off in the current decade, China is now, by far, Yum's most important growth market. In the first half of this year, the China division, which includes small operations in Taiwan and Thailand, accounted for 70% of the company's profit growth over the same period last year. In the most recent period, Yum would have reported an operating loss if not for the $65 million in operating profit from China.

That is why Yum gives Mr. Su and his division a lot of autonomy to make investments, which has in turn allowed them to open more restaurants more quickly. "There's a lot of things we do a little different here than in the rest of the world," he said. China's importance also is reflected in pay: Mr. Su was Yum's second-highest-paid executive last year, after the chief executive, earning $3.8 million in total compensation.

Intel Corp. has made similar changes, as China's share of its total revenue rose to 14% last year from 6.4% in 2000, the first year it started reporting China sales separately. This year, it made China a separate business unit, one of five globally that reports directly to headquarters in Santa Clara, Calif. "China is the only country outside the U.S. with such an extensive and full operation" for Intel, said Wee Theng Tan, president of Intel China. "Every part of Intel's business is represented here in China."