Marketing Asia

China’s latest five year plan: insights for law and other professional service firms

According to the China Business Review (Jul/Aug 2010): 'As the drafting process for Chinas Twelfth Five- Year Plan (12th FYP) for Economic and Social Development (201 1-1 5) continues, a clearer picture of China's economic, industry, and social objectives - and the policy guidelines that will be used to achieve these goals - has emerged. The plan, which lays out national social and economic policies for the next five years, will focus on restructuring the country's economy to rely less on exports and fixed investment. Other policy objectives of the plan will include developing new energy sources, increasing energy efficiency in industry, and correcting imbalances in education, healthcare, housing, income distribution, and social security.'

Looking at the new 5 year plans as they develop can provide useful insights into understanding China's broad economic, investment and development objectives. When supplementing these with the changing investment and FDI within the country, intra-regionally and globally, they can be useful research inputs into law, accountancy and other professional service firms strategic thinking and planning processes (assuming they have formal or informal mechanisms in place to think about the longer term).

Internal Consumption and Changing Investment

One of the key facets of Chinas economy that has been discussed for some time is the over reliance on exports and the need for a consumption driven model of growth. The growth of consumer spending as a percentage of GDP is something the PRC government is supposedly actively developing and we are seeing greater investment developments (such as shopping malls) in regions within China not traditionally attracting significant investment.

2008                                            2000

Figure 1: Regional analysis of China FDI in 2000-2008

(Source: Dr. Liao Qun, China's FDI spread: sectoral and regional trends. Perspective, The Journal of ACCA Hong Kong, Autumn, 2009).

 

Figure 1 shows the movement of China FDI between 2000 and 2008. We can see that in percentage terms, central and western China FDI has doubled during the period. In fact, we now see many law firms taking an interest in so called second tier cities such as Chengdu, Tianjin, and Xiamen. The Pearl and Yangtze River Delta and the Pan Bohai Rim areas are also still hot beds of high end legal work as local organizations seek to realize their local and international growth aspirations. The increased investment between Chinese cities now means that domestic law firms have a significant advantage in location since foreign firms can only set up in a limited number of locations and must wait three years between opening offices, subject to passing this probationary period. Domestic firms are challenging international firms for large scale FDI work whilst boutique firms within the country are beginning to challenge the larger local firms in certain practices such as IP.

 

2008                                        2000

Figure 2: Sector analysis of China FDI in 2000-2008

(Source: Dr. Liao Qun, China's FDI spread: sectoral and regional trends. Perspective, The Journal of ACCA Hong Kong, Autumn, 2009).

 

Figure 2 shows how sectoral investment has changed during this period. We can see a substantial percentage drop in manufacturing and a significant increase in real estate as well as the finance and insurance sectors. Other service areas which are highlighted in Chinas new 5 year plan include outsourcing, e-commerce, logistics etc. Many businesses are looking for specialist advice in these industries and in house legal counsel are known to bemoan the fact that few firms have developed advisory capabilities in emerging industries. Law and accountancy firms would do well to look at these changing trends and think about building capabilities both in selected industries and reach. As MNCs continue to invest within China and Chinese firms also direct additional investment to their domestic markets it will be increasingly important for professional service firms to expand their reach within China, often through alliances. The recent merging of Baker Tilly and Chinese firm VICPA is a good example of this type of thinking. Since Hong Kong law firms, under CEPA, face no geographic restrictions in terms of the firms in China they can associate with, the attractiveness of CEPA and Hong Kong may grow as foreign firms increasingly look to the city to leverage the ability to win legal work involving the China market.

 

Infrastructure, Energy, and other Emerging Sectors

The Chinese government seems very concerned (at least openly) with alternative energy sources such as hydro, solar and wind power. Part of this is related to Chinas need to reduce its energy intensity and pollution levels. Rural areas in China are gaining importance as the government intends to reduce the income gaps between rural and urban areas, presumably contributing to not only a more stable environment but also spurring domestic consumption. China has recently said that it will spend up to US$1 trillion on infrastructure projects including road and rail. There will be considerable opportunities here for the AEC industry and there are already a number of well known architect firms from the west doing projects in the region. For example, KPF Architects (from the US) has signed roughly a dozen projects in China. Although not as heavily regulated as the legal industry, the AEC industry in China is still one where local knowledge and access to domestic experts who can sign engineering documents etc is an important process of getting work done.

The emerging alternative energy sector is not only growing within China since a number of Chinese firms involved in producing alternative energy technologies are making significant investments outside of China. A few law and accountancy firms have recognized this growing trend and built dedicated practices to serving alternative energy investments. Education is another sector receiving attention and this has included foreign education institutions. It is only in the last ten years or so that even Hong Kong universities have aggressively expanded into China by setting up joint programs with local institutions in addition to further education centres which are run on a for profit basis (HKU SPACE a prime example).

Bio technology is another sector receiving growing interest, not only in China but regionally (in particular Singapore). Again, a few professional service firms have set up dedicated practices for this sector by developing specialized expertise and building regional capabilities to tap the cross border investments in this area.

Inward FDI and Potential

The government approved the establishment of 1,866 overseas-funded ventures in January 2010, a year-on-year increase of 24.73 percent. FDI in January mainly flowed into the manufacturing sector. The sector attracted 48.65 percent of total FDI. Since the country first opened to foreign investment, China has received over US$1 trillion in outside investment. According to the Economic Times, to attract more foreign direct investment (FDI), China recently revamped its regulations to improve conditions for foreign companies while restricting funding for environmentally-unsound projects.

Under the new rules, FDI in high-tech industries, services sector, energy-efficient and environmental protection projects is encouraged, especially in the central and western regions. Qualified foreign-funded companies will also be allowed to go public, issue corporate bonds or medium-term bills in China. These regulations come as FDI flow rose to $23.44 billion in the first quarter of 2010 bucking the downturn during the past eight months.

Overall, there seems to be a number of developing trends that professional services firms wishing to benefit from China can leverage through some time spent on analysis and basic strategic thinking.

 

Business Model Innovation for Professional Services: when and how?

Business model changes in the professional services sector are becoming increasingly important. The onset of the global financial crisis has seen many firms take a number of actions to cut costs and remain viable. Some of these approaches have included layoffs, pay freezes, reduced working hours etc. There is little doubt that some of these actions are warranted (except for across the board layoffs without systemic changes in work practice since such layoffs have been empirically shown to negatively affect future performance) since revenues sharply declined and future work projections were not looking pretty. However, there is still a belief among many firms that things will return to normal and that real changes in the way they do business is not needed. This view is surprising as a number of studies coming out of the professional services sector show that clients are now and truly in the driving seat and such attitudes are not going to reverse just because the economy picks up in certain areas.

The firms that are trying to change are doing a number of things:

• Moving to alternative billing such as fixed fees and value pricing
• Elimination of hourly billing and time sheets
• Moving away from lockstep compensation to merit based systems
• Formation of commercially oriented management structures with boards and professional managers
• Changing associate promotion paths, training, and on the job experience
• Focus on client teams and industry structures instead of practice groups
• Wide ranging performance indicators, not only financial but soft issues such as leadership and communication skills
• Focus on project management and efficiency
• Experimentation with cost cutting such as outsourcing
• Different set ups such as virtual offices, contingency staff, and placement services

The key questions any professional service firm leader wants to know is when, what and how to change their firm's business model? A recent research study published in Strategy & Leadership by Edward Gieson and colleagues (Vol 38, no 4, 2010) gives some useful guidelines on these very questions. The authors suggest that business model innovation can be guided by the three A's:

Aligned – leverage core capabilities and design consistency across all dimensions of the business model, both internally and externally, that build customer value

Analytical – use information strategically to create foresight and prioritize actions while measuring and tracking for rapid course correction

Adaptable – link innovative leadership to enhance the ability to effect change and institutionalize operational flexibility

The authors give a number of examples (not specific to the professional services sector) and advice on recognizing the right time and what to change. They also identify different elements to business model innovation which are explained more fully in the new IBM global leadership study; Capitalizing on Complexity-insights from the global CEO study (2010). These are elements are:

1. Enterprise model innovation - Specialising and reconfiguring the business to deliver greater value by rethinking what is done in-house and through collaboration.
2. Industry model innovation - Redefining an existing industry, moving into a new industry, or creating an entirely new one.
3. Revenue model innovation - Changing how revenue is generated through new value propositions and new pricing models.

I will attempt to explain these briefly and link them back to what is happening in the professional services industry and the changes that professional service firms (PSF) need to make.

Aligned: how the internal aspects of the firm relate to each other to in delivering customer value and how externally, collaborating with suppliers and customers can create an open business model. From the perspective of a PSF, the need to share and leverage intellectual capital both within and outside the firm is crucial. A number of PSFs are now using 'Enterprise 2.0' systems (such as intranets and extranets) where they can locate and share information inside the firm to enhance client value outside the firm. For example, Booz Allen's 'hello' intranet which helps people in the firm map out connections and knowledge, or the few law firms which have developed enhanced extranet systems to share information with clients on current projects and provide knowledge as part of a value added package that is much more than just cross selling.

Analytical: according to the authors, successful business model innovators are able to use business intelligence about customers and the environment to make better strategic forecasts and understand their economic impact. This includes financial modeling and effectiveness measurements. This is somewhere PSFs need substantial improvement. Understanding client needs and building databases that can be mined and used for decision making will become increasingly important in an era of globalization and alternative pricing structures. Additionally, the ability to manage and measure spend across a vast spread of international offices is crucial when firms want real time up to date information on their costs and relationships with external suppliers. The use of Rosslyn Analytics by Clifford Chance is a good example of a global PSF using cloud computing analytics to manage spend on a global basis. These capabilities will become more important as clients demand cost efficiencies from their providers and the use of business process outsourcing grows among PSFs.

Adaptable: the authors state that successful business model innovators are flexible and can mimic the speed and nimbleness of smaller firms and start ups. Leadership that is innovative and can create the right cultural context for the firm is a crucial facet of the business model innovation process. Adaptable firms will also have flexible operating models such as lean processes and scalable technology, as well as asset and cost flexibility. The authors also state that successful firms will be willing to experiment with new pilot models without putting the existing model in danger. The new associate training programmes (apprenticeships) being used by Howrey LLP and two other law firms is a good example of a pilot innovations being used in conjunction with the existing firm system. The growing number of PSFs using business process outsourcing is also a good example of asset flexibility as they decide what can be done in house and what should be done elsewhere.

There is little doubt that many PSFs are in need of some type of business model innovation. According to the authors, firms should look at enterprise model innovation during economic downturns and it seems that some PSFs have heeded that message. They are focusing on greater collaboration and re-assessing the value they deliver to their clients. Many of these firms are also looking at revenue model innovation and are creating longer term collaborative pricing arrangements with clients such as fixed fees and other value pricing approaches. In the legal industry the ACC value challenge stands as a leading example of how law firms need to respond to changing client demands and the recent move by Pfizer to create a panel of 19 law firms that work on a yearly fixed fee is realization that value is just as much about service quality as it is technical quality. In the AEC industry, BIM (building information modeling) is being touted as a disruptive technology that will require greater collaboration from differing sectors such as architects, engineers, and construction firms. Since most firms have problems sharing knowledge across different practices, sharing knowledge across firms will be an even greater challenge.

I could go on about the many business model innovations we have seen in other sectors (such as Amazon, Netflix, Dell) but that never seems to inspire those from the professional services. As with many of these changes, it will take effective leadership and continued demands by clients for the firms to deliver the value they require. The fact that E&Y has just taken on its first ever non executive directors gives hope to all PSFs that change is possible but it will require, as usual, a firm which is market driven and based on knowledge.