Will China Change IT?

By Brian P. Watson  |  Posted 08-27-2008

Will China Change IT?

China is one of the world's oldest, most dominant civilizations. Yet, it remains shrouded in mystery, walled off from the rest of the world and a victim of ancient stereotypes.

The Beijing Olympics offered China a chance to reopen its doors. For American CIOs and business leaders, it's a chance to ponder China's future in the global business world.

Few experts can shed more light on China's business and IT potential than Harvard Business School professor F. Warren McFarlan, the dean of American IT academics. He's been studying China--both up-close and from afar--for decades, and has chronicled its development through the centuries. What he sees is a country that has built up formidable technological infrastructures and educational institutions. At the same time, pollution has muddied the waters (literally), and intellectual property violations have plagued its reputation.

But that's no reason to count China out, McFarlan posits. The question is, What will the next incarnation of China look like? Will it be the world's sweatshop, an outsourcing go-to that will take India's throne? Or will it grow into a dominant player in the world of business and technology?

McFarlan analyzed China's potential impact on American business and IT, as well as its massive challenges, in a wide-ranging conversation with CIO Insight Online Editor Brian P. Watson. What follows is an edited, condensed version of that conversation.

CIO Insight: What do American IT executives need to know about China right now?

F. Warren McFarlan: It's something they really have to keep their eyes on. We know that IBM has about 6,000 people there, Hewlett-Packard has a huge presence, and India's Tata and Infosys are spreading there very rapidly. The language is the challenge. There's a lot of outsourcing being done to Japan instead of China because they have a history of adapting to English. But China is a very technologically adept and friendly group. They're willing to work very hard for vastly different compensation numbers than we'd pay them if they were here.

China has many different markets. American co mpanies operating in them need support from their own IT staff or their outsourced staff. Almost all the technology and outsourcing vendors are dragged in there to support the Chinese subsidiaries of the American companies. Chinese companies like appliance manufacturer Haier and shipping firm Cosco are growing, and they need a level of control and systems integration. They're spending heavily to get the productivity and service levels up.

There are as many people coming out of Chinese universities technically trained as there are coming out of Indian universities. It's a combination of skill level and cost, and India has gone right up the value chain. But how long are American companies going to be able to do outsourcing business with just HP, Accenture, EDS, etc.? Where do the Indian companies Infosys, Wipro, etc., fit in as their brands come into the marketplace? And China has a deeper pool and much broader, deeper technology infrastructure than India does.

Educating Future Executives

You teach an MBA course called "Doing Business in China in the Early 21st Century." What are the key things you're teaching future executives?

McFarlan: First, there's the incredible emergence of China in the last 30 years. There's no other place that's had a sustained 11 percent growth rate per year that China has had for the last 30 years. This has led to glittering things like roads, automobile congestion, stadiums and buildings. On the surface, it looks very exciting.

But there are all kinds of gaps in the infrastructure. For example, you need only a bank account and a cell phone to get a credit card. The cell phone is used for the confirmation of a transaction passed through your house. The 50 years that we've had of developing credit authorizations simply is not there. So what you see is very exciting, but they're 50 to 75 years behind us.

Second, this is the land of centralized political control. It's been that way for the last 3,000 or 4,000 years. There's nothing in the slightest bit different between the current government and the dynasties, except that instead of today's leaders being hereditary, every five years they go through a process and pick a new leader.

Here's the third thing: People sometimes get confused confused thinking it's a communist country. In fact, it's the most entrepreneurial, deal-making operation that you know. As long as you don't try to overthrow the government, the notion of making money is glorious.

That leads to the next point: At every step along the way, there are institutions of government control that you may not be aware of. When you run across something that's against public policy, you can suddenly becut off. So there's an incredible pressure in trying to understand the environment.

In many ways, China is the last of the great empires. In 1900, the great empires were the British, the Russian, the Austro-Hungarian and the Chinese;the others have all gone the way of history, but China is actually physically bigger than it's been in almost  any point in its history.

Are China's environmental problems an obstacle to its business potential?

McFarlan: We're on the other side of the Pacific from China, but we're getting their soot in the Rocky Mountains. But the people being hurt worst by the pollution are the Chinese. We need to be careful: People who live in glass houses shouldn't throw stones.

In 1910, we had 130,000 miles of railway in the United States. In China, at that time, they had 233 miles. Basically, they have lagged us 50 to 75 years in the development of the economic infrastructure. Then, look at Pittsburgh in 1950: It was an absolute horror, in terms of a cesspool of pollution from the steel mills. The last killer smog took place in London in 1951, just before they eliminated coal-burning stoves. When coal burning stopped, the killer smog stopped.

For the last several hundred years, the signs of a rapidly emerging industrial society have included the problems of pollution, which had to be addressedbecause they became a huge detriment to quality of life. China is now working through that problem. 

Olympic Impact

So what has to happen for China to capitalize?

McFarlan: China needs overseas acquisitions to secure its raw materials base. There are also huge domestic markets growing inside. To put this in context, in the 1950s, Japan was synonymous with low quality; now, it's synonymous with high quality. China is scrambling to come up that curve.

Today, one of the biggest retailers in Japan is Gome.People don't know that some of the brands being sold there are Chinese, so Gome essentially protects the brands of these Chinese electronics companies. But you see a lot more Chinese companies beginning to come onto the market, just as the Japanese did. You see the branding activity, and that's all part of them getting extra value as they go up the chain.

Seems like it's happening rather quietly, though.

McFarlan: It is. And then the brands grow. You may not notice it over six months, but if you look back over five- or 10-year periods, you see that the tide is running cleanly. The question I keep my students focusing on is: How are Chinese businesses going to be able to manage the limitations to growth?

It's not an accident that the words "harmonious society" is what China's president is hammering on, because the inequalities have grown up in visible kinds of ways. Different ships are being lifted at different rates in the tide. That's why the Olympics are important for them: It's a symbolic thing, where they can take pride in the fact that they can do all these things.

This is a project in full sway. We're up to six Mandarin-speaking professors on our faculty--up from zero five years ago. That's been a deliberate focused effort to bring those skills to our faculty to do the education and research we need to do. China is 20 percent of the world's population, and we think they're going to be a huge force, and very likely our dominant trading partner--and competitor--40 years from now. So whatever we can do to understand and find peaceful ways to collaborate is going to be very helpful.

This is also a land where relationships are very important. The Chinese remember more about you and how you behave than any other group I can think of. People will remember when I was there in 1979 and was entertained in the Great People's Hall, yet I can hardly remember who entertained me. During hard times, when you cut and run, they don't forget it. So the notion of trying to keep a steady course becomes increasingly important.

What do you expect the Olympics will do for China in the eyes of the rest of the world?

McFarlan: It's a huge psychological issue for them; it's their national coming-out party. It's a validation that after 30 years, China is back.

For most of the last 3,000 years, the most dominant civilization--until 1500--was China. In medicine, prosperity, health, trade--they dominated the west. As technology began to rear its head, they missed the ball. China had the largest navy, but they came to believe the rest of the world was uninteresting. The emperor proceeded to basically destroy the navy and the shipyards and put more money into building the Great Wall.

In terms of the actual size of the economy, the United States has been the largest economy since 1892. We knocked off China. The whole 20th century was basically consumed with the fall of the last dynasty.

This led to all kinds of carving out, with cities like Shanghai being [divided up into different regions controlled by other countries]. The country was paralyzed in the 1930s as the warlords went back and forth, and the Japanese took control of large parts of the north and Manchuria.

That led into World War II and the emergence of Mao Zedong in 1948. From 1948 to 1978, China went through a series of failed experiments, including the Great Leap Forward and the Cultural Revolution. In 1978, Deng Xiaoping emerged with his notion that if capitalism and entrepreneurialism generate wealth, then they'll do that and open it up.

After 30 years, China has run into a scenario where the limits of growth have begun to impinge on them. Depending on how you count it, 16 or 19 of the world's 20 most polluted cities are in China. They've got air pollution, which is the easiest thing to see. They have water pollution in the lakes and oceans. The desert is steadily moving in from the west. Dealing with those infrastructure problems is going to be an extraordinary challenge.

The Bill Gates Effect

What do you see happening in China's business community over the next 10 to 15 years?

McFarlan: The chief economist and personal financial advisor to the president of China was in one of our programs. His perspective was extremely interesting: He says, basically, it's more of the same.

China ends up losing because it winds up being the sweatshop of the world. That doesn't improve the quality of life for anyone. He pointed out very clearly that the key to their success lay in the combination of information technology services and the ability to climb up the value chain on the services side.

That's where the Chinese are really scrambling today. They've allowed their currency to roll up about 20 percent. Inflation is pretty high in southern China. The result is that a number of textile factories have had to shut down, and the work goes off to Cambodia, Laos and the cheapest parts of the world.

Are there any instructive case studies of American companies that have gone into China and found success?

McFarlan: Microsoft is a case study in how they turned their original strategy around. In China, something like 97 percent of all desktops are run on software from Microsoft, and almost all of it is pirated. The basic concerns the Chinese worried about was that there was spyware in there and that it was a tool for the CIA to infiltrate China. So Microsoft basically gave the Chinese government all their source code and said, "You look at it for yourself." They looked into it and couldn't find anything wrong.

When the president of China visited Bill Gates, the first thing he said was, "It's terrific to see you, because when I wake up in the morning, you're the first person I think of." When the president wakes up in the morning, he fires up his PC. So word went out from the Chinese government that people should start paying royalties, and the pirated software in the government and state-run enterprises has dropped dramatically.

China also has intellectual property it wants to protect. The problem in China isn't the laws--it's the enforcement of the laws that's the issue. Bill Alfred studied this at Harvard Law School and took our class through it. He said it was quite clear that there's nothing wrong with the laws; it's all how it's been enforced. Now that China has more intellectual property and continues to come up the value chain, everything changes in their direction. Patterns have begun to come together.

Do the Chinese have a secret weapon?

McFarlan: They have a huge population (1.3 billion). And they're an intellectually able population. Literacy rates are at 90 percent, contrasted with 60 percent in India. They've put a lot of resources into developing universities and are beginning to climb up the curve there.

They're also hard working and very comfortable with technology. They've made huge investments in infrastructure: Their highways, railroads and electricity operate at another level than they do in India, for example. India has had a much more difficult time dealing with democracy, unrest, protests, etc.

In China, though, they don't have the safety valves to let the pressure out, so you're always worrying that the political pressures will build. Traditionally, when the pressure built up, China solved the problem this way: Dynasties fell, either by war or by death, and leaders were replaced.

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