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Donald Sull of London Business School and Simon London, the FT’s Management Editor, answer your questions on Lenovo, the Chinese computer giant.

The most thought-provoking online contributions may be published in the Financial Times newspaper. Please supply your full name, company and location

Dell and HP practice a geographical approach to both customer order fulfilment and manufacturing, establishing a manufacturing presence in each of the major growth geographies (US, Asia, Europe). It would be interesting to hear what Lenovo has in mind as a supply chain strategy to both efficiently serve global markets, as well as compete on delivery and service times. Would Lenovo be considering a non-Asian contract manufacturing model for servicing markets such as the US or Europe? That would be interesting considering the previous decisions of IBM regarding these facilities.
Bob Ferrari, Manufacturing Insights, An IDC Company Supply Chain Services Program Director

Donald Sull: Lenovo’s supply chain strategy is still work in progress, so any thoughts at this point are provisional. Pursuing a customer-pull innovation strategy and providing innovations quicker than rivals requires both local marketing and design centres and sophisticated capability to rapidly produce and distribute new products. This pull to the local market may outweigh the labour cost advantages of Chinese assembly.

Chinese appliance maker Haier, for example, already has a factory in the United States to respond more quickly to the local market. (A multiple geography approach also hedges against currency shifts and changes in trade laws.) It will also be interesting to see how Lenovo works with and competes with Taiwan as its firms attempt to capture more value through design and marketing. I expect to see Lenovo try some interesting experiments in supply chain strategy going forward, which will require the company to work well with new partners.

Simon London: Lenovo executives were reluctant to discuss their manufacturing and logistics strategy in detail - in part, I think, because the strategy is still being worked out. I can tell you that Liu Jun, the 36-year-old Lenovo executive now running global supply chain for the enlarged company, is very, very smart. He told me that Lenovo’s cost advantage in China rests on its three assembly plants in different regions, so manufacturing takes place closer to the end customer. He conceded that Lenovo lost some economies of scale with this approach but emphasised that the ‘end to end’ cost of getting product to consumers was lower than in a more centralised model.

Another clue could be that Lenovo has, so far, preferred to own and run many parts of its business that IBM (and Dell and HP, come to that) chose to outsource. Call centres is one example. So Lenovo may be reluctant to rely too heavily on contract manufacturers as it expands into Europe and the US. On the other hand: (a) the influx of knowledge and expertise from IBM means that the ‘new’ Lenovo is very different to the old and (b) Yang Yuangqing, Jiu Jun and other Lenovo executives are pragmatists at heart. If there are strong arguments for using contract manufacturers to serve local markets, I’m sure they will do it.

Could you predict what disruptive effects accelerated Chinese investments in the US and Europe are likely to have for electronics companies in the west?
Pavlina Ivanova

Simon London: Don is probably better placed to answer this one. Looking across the tech sector, you can see one or two Chinese companies with potential to disrupt the competitive position of US, European (and other Asian) groups. Lenovo is one. Huawei, the networking equipment company, is another. Conventional wisdom says that SMIC, the semiconductor company, has further to go but could be a disruptive force on a 3-5 year view.

However, I doubt that many Chinese companies will follow Lenovo by making big acquisitions outside of China. The politics remains difficult. Lenovo was helped by the fact that PCs are a relatively mature technology. Networking and semiconductors, for example, are much more sensitive.

Donald Sull: If the Lenovo/IBM deal works, it may blaze a trail that other Chinese firms could follow. The great hope is that Lenovo gains the opportunity to grow its brand and gain access to new technologies and distribution channels and seize economies of scale.

In addition, Lenovo hopes to learn how to be a mature company from IBM and reinvigorate Big Blue’s PC business with entrepreneurial speed and agility along the way. If the combination works, it could show other technology companies a way to quickly achieve global scale, build a brand and get big right by avoiding the problems that have derailed many tech companies as they expanded in terms of complexity and size.

Chinese telecommunications equipment manufacturers such as Huawei and ZTE, for example, might consider a similar approach by acquiring a Western rival, if it got into financial trouble. We’ve already seen China’s appliance giant Haier try something similar with their proposed acquisition of Maytag. Of course, there is no guarantee that the Lenovo experiment will work, but if it does, it may provide an attractive approach for other Chinese companies that excel at cost discipline and product innovation to accelerate their ascent to a global leadership position.

What other investment routes are Chinese companies likely to undertake into technology companies in the west?
Emil Hovsepyan

Donald Sull: Chinese firms are already exploring a variety of ways of working with western firms. Consider Galanz, the world’s largest producer of microwave ovens. Galanz executives pioneered a novel partnership agreement in which European white goods companies moved their entire production lines to Shunde, where Galanz would make the microwaves for export back to their home markets for sale under the European companies’ brands.

The partnership has been compelling for European producers because they could fully utilise their state-of-the-art production equipment. Factories in France, for example, typically ran only one shift per day, four days a week, whereas Galanz ran three shifts daily seven days a week. The Europeans also take advantage of China’s low labour costs and Galanz’s established expertise at efficient manufacturing processes and supply chain management.

Because Galanz does not export branded products beyond China, it does not compete with its original equipment manufacturer partners on their home turf. This partnership has been a great deal for Galanz, which achieved economies of scale in manufacturing and purchasing. Galanz also secured permission to use its partners’ manufacturing equipment to produce its own branded products for sale in China. In contrast to Haier, Galanz avoided expensive investments in building a global brand and distribution network. Galanz rapidly extended its partnership model to over 200 multinational partners and expanded its microwave production from approximately one million units in 1996 to over 12 million five years later. The company subsequently extended its business model to other products, such as rice-cookers and electric magnetic ovens, and stated its ambition to move into the global air conditioner market.

It is interesting to understand these different models of investment and partnership. The more interesting question, in my opinion, is how these partnership models will evolve over time. If Lenovo builds a brand, and brings in IBM’s technology, will it expand aggressively beyond PCs? Based on its unique understanding of global microwave technology and consumer trends, will Galanz accept more R&D responsibility for its partners? The best Chinese companies exhibit a creativity in spotting innovation opportunities, the agility to make them work and the pragmatism to cut their losses when things aren’t working as planned. This applies as much to partnership and investment approaches as it does to products.

Simon London: People who know more than me about Chinese management have said that the ‘big acquisition’ route to international expansion taken by Lenovo is very un-Chinese. Yes, Chinese companies are ambitious. But they are also pragmatic and prepared to take a long view. This means that strategic alliances and joint ventures are more likely than big acquisitions. The wild card, as Don pointed out to me the other day, is politics: the Chinese government wants some big, non-oil companies to succeed in international markets. Perhaps this will push Chinese managers to move faster than they would like.

What do you think are the main benefits for Lenovo from this acquisition, given the high price (£1.75bn) and the compromises required, such as New York headquarters and a new CEO?
Max Clarkson

Donald Sull: There are several potential benefits. The obvious ones are the economies of scale in purchasing, and perhaps in supply chain and distribution. Most intriguingly, Lenovo has a chance to build its brand globally by sales through the IBM sales force. One of the great stumbling blocks for emerging market companies going global has been building a brand. Samsung Electronics did it successfully. They also spent nearly $3bn between 1993 and 1999 alone on advertising alone to build the brand (and another $7 billion in R&D). Samsung Electronics funded that massive expenditure, in part, by selling off businesses that the Group had built under decades of government protection.

Lenovo, like most emerging markets companies, lacks this family heirlooms to sell off to fund growth. Other companies, such as Acer, that have tried to build a global brand from scratch out of emerging markets have found it a rough path. Some Chinese producers, such as microwave oven leader Galanz, has decided to avoid building a global brand at all. Instead, Galanz sells under its own brand in China, but manufactures on a contract basis for appliance companies in other markets.

Selling Lenovo products to established IBM customers through IBM sales side by side with the IBM brand for a while represents a very interesting experiment in building a global brand. Will it work? That remains to be seen, but the approach is innovative, and will no doubt be closely watched by other Chinese firms struggling with the question of how to build a global brand to support low-cost, high-quality, innovative products.

Simon London: Well, the first benefit is additional scale. Narrow margins dictate that the PC industry is a scale business. This deal gets Lenovo to scale in one big step, giving it third place in the industry behind Dell and HP.

In addition, Lenovo has acquired (a) international management expertise and infrastructure (b) design and engineering expertise (c) the ThinkPad franchise and (d) a strategic relationship with IBM.

So, I can see the strategic logic from the Chinese point of view. As you say, the question is whether the acquired assets - especially the intangibles - are damaged during the integration process. To their credit, Yang Yuanqing and his team are well aware that they need to protect and nurture what they have acquired. That’s a start!

What will Lenovo’s channel strategies be in developed markets in comparison with HP and Dell? How far will IBM PC Division’s previous channel strategy be modified by Lenovo?
François Duhamel, France

Simon London: There are two answers to this. First, the IBM salesforce will continue to receive incentives for selling Lenovo PCs. Bear in mind that IBM has an equity stake in Lenovo and views this as a long-term strategic alliance. So the direct sales channel should remain open, especially for large enterprises.

Second (and this is where it gets interesting), Lenovo needs to develop channels for the small business and consumer markets. For the former, a mix of retail and value-added resellers is likely, I think. A deal has just been signed with Office Depot, the office supplies retailer, for example. The consumer market will be a tougher proposition. As we know, margins on PCs sold though consumer electronics retailers are very low. My impression is that Lenovo is still working out what its channel strategy will be for the consumer market. The small business segment (which they will start to address early in 2006) will be something of a testbed, I think.

Donald Sull: I agree with Simon’s analysis on this question. The only thing I would add is that Lenovo has a chance to add real value to IBM’s position at the low end of the market. Across a range of markets, including automobiles, appliances and electronics, new entrants from emerging markets have often started at the bottom and clawed their way up. Lenovo can protect IBM’s flank on the low end.

How advanced is Lenovo’s capability in terms of making and designing laptops and how will the IBM acquisition help improve their technology capabilities?
Yung-Kai Yang, Doctoral Programme Member, Manchester Business School, Manchester, UK

Simon London: Lenovo does design and build some nice laptops for the China market but I think they would agree that IBM’s design engineering with the ThinkPad was way out in front. You can see this, for example, in the ‘airbag’ technology used to protect ThinkPad hard drives in the event of an impact. (Not an airbag, in fact, but accelerometers that move the read/write head away from the disk drive when an impact is likely.)

The use of magnesium casing in ThinkPads is another example, as is research and development in thermodynamics and battery life. So, yes, one of the big assets Lenovo acquired with the IBM PC division was knowledge and expertise in notebooks and other small form factors. As they point out, notebooks are both the fastest-growing and most profitable segment in mature markets.

Donald Sull: IBM certainly brings a technical lead in laptops. The big question is how well Lenovo can integrate this technology into its own products. The key to fast customer-pull innovation is the ability to rapidly recombine existing technology components to meet emerging customer needs and preferences. Think of the technical components of a laptop (or any technology intensive product) as plastic block toys such as Legos. It is critical to know what the existing blocks are and be able to quickly reassemble them in new configurations to solve customers problems.

This depends critically on a how the technology components are structured within the system, as well as interfaces between the components (how they interlock). Many components of PCs are, of course, quite standardized and can plug and play with other components. More proprietary technical components, however, may be more difficult to quickly reconfigure into new products to quickly meet customers demands. This could slow down

Lenovo has the long-term challenge of growing substantially in a mature - and in many respects, saturated - industry. Against this background, it has probably not yet attained sufficient critical mass to protect it from being squeezed out by HP and Dell.

Is Lenovo’s acquisition of IBM’s Think brand the key to gaining this vital additional momentum, or is its intended parallel global pursuit of lower-end market growth with Lenovo-branded goods - which would first require it to become a household name synonymous with reliability and excellence - the key? How can Lenovo compete over the long term with Dell?
Nicholas Wolsey, Germany

Donald Sull: The PC industry as a whole is likely to grow at a modest rate in developed countries in the future. But industry is not destiny. Even in the most mature commodity markets, such as steel, brewing and cement, some companies have managed to grow faster than the market while earning profits in excess of their cost of capital. Moreover, many of the most interesting of these firms have, like Lenovo, come from emerging markets. Mittal Steel - the world’s largest steel maker - started from a single mini-mill in Indonesia; the Brazilian brewer AmBev along with merger partner Interbrew is the largest brewer by volume in the world; CEMEX rose from a peripheral player in Monterrey Mexico to the third largest (and most profitable) in the world.

Over the past few years, my colleagues and I have studied several of these emerging market champions. They have not won because of access to low cost capital. Indeed, in most cases they face a higher cost of capital (and spottier access) than their rivals in developed countries. This has clearly been the case for Lenovo. Nor has government protection been the answer. Again Lenovo follows the pattern. Its early success came largely because the main ministries overseeing information industries ignored them.

The key to emerging market companies growing profitably in mature markets has been threefold. First, they excelled at “customer-pull” innovation where they provided products responsive to customers’ latent needs consistently faster than rivals. Lenovo rose to leadership in the Chinese market by doing just this. The great advantage of customer pull innovation is that it does not require massive expenditures on R&D.

Second, they consistently innovated to keep costs low. In a commodity business, the lowest cost producer has the flexibility to use price as a weapon when necessary, and can outlast rivals in any price war. Third, these companies can rapidly transfer their customer pull and cost-saving innovation practices to acquired companies.

If emerging market champions can profitably outgrow rivals in cement and steel, the PC industry looks relatively easy.

Simon London: I think Lenovo would take issue with the premise that the global PC market is saturated. In the US, western Europe and Japan, the growth of the PC market will probably track GDP (or maybe a shade higher) from here on. But in emerging markets - including China, its home market - there is huge growth to come. Will it be profitable growth? In China, it has been. Lenovo’s gross margins in its home market are very good by international standards. Can the company replicate this in India, Brazil, Russia and elsewhere? It will be a tall order.

In mature markets, the enlarged Lenovo believes it can take on Dell by delivering more innovative products at competitive prices. It is not the first to try this strategy, of course. Sony’s PC division has been differentiating on innovation and design for some years but remains a niche player. HP has been ‘talking the talk’ since the Compaq deal in 2001 but has little to show for it. While HP spends more on PC research and development than Dell, it has had trouble persuading customers to pay premium prices. The net result? Low margins. The issue, I think, is whether Lenovo can deliver Sony-style PCs at Dell-style prices. Again, it is a tall order.

My understanding is that the Lenovo brand will be the masterbrand in consumer markets, positioned as leader in value, style and innovation. The ThinkPad brand will remain focused more on the business market, although broadened into the small and mid-sized business market. Interestingly, Lenovo’s research shows that the IBM brand was a mixed blessing when addressing small businesses. It stands for quality and services, but it is seen as primarily a brand for big business.

FT background briefing:

Simon London: A global power made in China

Simon London: Your rules and my processes

Simon London: Quick-fire lessons in globalisation

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