Geographies in Depth

The art of transformation: how to thrive in a changing China

A worker directs a crane lifting steel wires at a factory in Dalian, Liaoning province.

A worker directs a crane lifting steel wires at a factory in Dalian, Liaoning province. Image: REUTERS/Stringer

Lars Faeste
Managing partner, Boston Consulting Group, Greater China
Fang Ruan
Partner and managing director, Boston Consulting Group
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This article is part of: Annual Meeting of the New Champions

In China, it is time for business leaders to start fixing their companies to ensure resilience in a rapidly changing landscape. In other words, it’s time to start transforming pre-emptively.

Even if all is currently well, winners will anticipate the effects of new competitors, technological disruption, new business models, tariffs and even economic slowdown, ahead of time. Many Chinese businesses have expanded in the past few years, but will not be resilient enough to survive the changes of the next era. Winners will focus on how their business can grow stronger, rather than bigger.

Uncertainty as an opportunity to change

The uncertainties in China today present an important incentive for companies to transform pre-emptively, anticipating future scenarios and maximizing their operational excellence now. From there, they must continue striving to optimize the business to produce cash flow that allows them to invest aggressively in new growth areas.

When the economy begins to slow down, companies that think ahead and embark on a transformation strategy will have an advantage over slower-to-act competitors. Those competitors might even become inexpensive acquisition targets.

According to our research, companies that transform pre-emptively showed growth in value created, reflected in total shareholder return (TSR) that on average was 6% higher over a three-year period than the TSR of companies that had transformed reactively. Furthermore, preemptive transformations were accomplished in 15% less time, at 20% lower costs and with 20% fewer changes needed in the leadership.

What makes a transformation successful?

None of what we've said should minimize the formidable challenges and risks that come with transformation. We have found, however, that the transformations that increase a company's value tend to have at least five elements in common – the five primary drivers of success:

1. Efficiency drive to fund the journey. Typically, corporate leaders start looking at how they can retrench when the economy slows down. Our research has found that leaner spending is necessary to fund the transformation and make it viable in the short term – certainly during the first year:

  • Cut costs and optimize non-core areas to create a more efficient organization
  • Achieve excellence in operations by creating transparency and applying best practices in areas such as procurement, production processes and logistics to boost margins and cash generation
  • Allocate capital out of the non-core functions and into such areas as R&D, innovation, talent acquisition, M&A opportunities and precision marketing – the engines that will contribute to future revenue growth

2. Revenue growth. In an era when companies must adapt to a new environment, it’s particularly critical to view pre-emptive transformation as a strategy for continued growth – not just a temporary turnaround strategy. You cannot cost-cut your way to greatness.

Many industries would do well to recalibrate their business units with a focus on strength – i.e. growth engines – rather than size as they seek future growth. Mergers & acquisitions activity is an especially important component. We anticipate that there will be interesting opportunities ahead to acquire other businesses at lower prices. This is a particularly powerful strategy for companies with strong operational performance and the ability to lift performance in acquired units.

3. Long-term orientation and investment. We have found that the companies most likely to realize outsized gains in value creation following a transformation are those that make significant commitments to R&D. Investing in digital initiatives and new business models is also key to effective long-term success. These allocations tend to create more value than investment in capital expenditure.

Use digitization to enable further cost efficiencies and personalize client or customer services. Continue to gather data that can be analyzed and leveraged to constantly improve operations, products and services.

4. Leadership. The right leadership team, capabilities and performance management are critical. While transformation may be run under a consolidated agenda, pre-emptive change generally works best when it relies on a culture that encourages new ideas, employee participation and consensus-building, rather than a heavy-handed, top-down approach.

Transformations perform best if executed by new management teams. On average, this leads to higher value creation, though also with a higher variance in outcomes. What this means for incumbent management teams is that they need to be open, 'paranoid' and question themselves on what more they can do.

“Jazz leadership” describes the most effective style for leaders in the 20s. A winning organization should be structured like a collection of jazz ensembles – rather than an orchestra with a single powerful conductor. Today, in the fast-evolving and unpredictable business environment, leaders should be agile, welcome new diverse ideas and able to improvise to reach new heights.

5. Formalized transformation programs.

Our research shows that the most successful transformations take place under a formal, structured program that the company defines at the beginning of the process. We recommend one full umbrella program, often with a time horizon of two to three years or more, that factors in the entire company, as opposed to a collection of smaller programs for each business unit.

Larger programs, with restructuring costs of at least 2% of sales, led to an increase in value creation that was five percentage points higher, on average, than that of companies that enacted smaller-scale changes.

The process of transformation

We have organized the overall process into three distinct phases: rapid assessment, 100-day impact, and realization of full value.

In the rapid assessment phase, senior leaders take stock of what can be accomplished – and how to fund the journey. At this stage, they should set targets and acquire the tools needed for a successful new operating model. Short-term, no-regret initiatives, designed to provide flexibility in uncertain scenarios, are appropriate at this stage.

Somewhere between two and three months into the transformation, leaders should prepare to assess the 100-day impact. At this point, there should be some improvement in earnings and a positive market response. This is the time to plan longer-term moves for growth, build an agile culture and implement digital initiatives that will allow for quick wins and strengthen your performance management, as well as get down to business with cost reductions and organizational efficiency.

After one to two years, and into the future, leaders should be able to gauge success in the realization of the full-value phase. This is when leaders can ensure continued, disciplined execution of initiatives throughout the organization, building a culture of sustainable high performance and cost excellence.

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