Volume 4 Issue 1

Conquering the Challenges of Chinese State-Owned Enterprises During Economic Slowdown

Due to China’s economic slowdown, the state-owned enterprises (SOEs), both centrally- and locallyadministered, are suffering from declining sales and profits, alongside increased liabilities. This adds to SOEs’ operating difficulties and highlights their chronic mismanagement issues. 

Since the 1990s, China’s SOEs have been in persistent pursuit of expansion, aiming to rank in the Fortune Global 500. Through their investments, mergers and acquisitions both domestically and overseas, a legion of China’s SOEs have realised this goal, thereby achieving the original purpose of scale expansion. 

However, because of their lack of core technologies and weak market competitiveness, when the global economic crisis struck in 2008, they suffered a slowdown in growth, a drop in economic efficiency, and huge losses. This was compelling proof that a strategy based solely on expansion was a futile pursuit. The SOEs’ current challenges can be attributed to the following causes:

  • Dominant presence in the domestic market. Private enterprises have expanded their competitive presence internationally and grown rapidly. SOEs, however, have not been motivated to globalise their operations and have been unwilling to take risks. By focusing on and dominating the domestic Chinese market, SOEs have deepened their presence and experience in the local market and thereby reaped huge profits. 

  • Emphasis on accumulating tangible assets to the neglect of intangible assets. Many SOEs focus on the management and integration of tangible assets of newly acquired companies, while they neglect the integration of intangible assets, such as human capital and corporate culture. Yet those intangible assets play an important role in boosting competitiveness, creating profits, and realising goals in an acquisition. 

SOEs have not incorporated innovation into their DNA. Instead, private enterprises are leading business innovation in the Internet Age. Baidu, Alibaba and Tencent have enjoyed rapid growth and are experiencing huge successes due to the large vacuum in market innovation in China. SOEs’ lackluster attempts at technological innovation and management-model innovation, along with weakening core capacity in the absence of technological strength, are inherent obstacles to the future expansion of SOEs.

Management concerns for SOEs

Areas in which SOEs are lacking are: 

  • Lack of innovative drive. While private enterprises innovate to retain vigor and remain competitive, SOEs are not as motivated due to limited competition. 

  • Lack of experience. Compared to those foreign enterprises that have lasted for hundreds of years, SOEs are still in an initial phase of technological development. Sometimes, SOEs find it more rewarding to introduce mature technologies from abroad than to develop these seemingly ‘risky’ technologies themselves. 

  • Lack of long-term R&D investment. Some SOEs increased their investment in innovation, but retreated soon after, when no immediate results were in sight. There seems to be a lack of understanding and acknowledgement that innovation is a long-term process, which requires sustained input and know-how accumulation to achieve breakthroughs. 

  • Lack of strong leadership has long been a prominent issue in SOEs. Institutional constraints and inadequate incentive systems impede the growth of entrepreneurs and the performance of SOEs during a downturn in the economic cycle. 

  • Decision-making process. The majority of SOE decision-makers are appointed directly by the government. Since a higher position-holder is likely to have greater power and resources, a wrong decision by the leader can plunge the whole enterprise into a predicament, and also put the leader personally at risk. As a consequence, SOE leaders are inclined to be overcautious and over-conservative.

  • Limitations of incentive mechanisms. While the current salary ceiling is of great significance in achieving equality, it often weakens  leaders’ initiative and motivation to pursue excellence and perfection. 

Human Resource Management concerns of SOEs

In addition to the management concerns, SOEs also face challenges in the following areas of human resources:

  • Structural workforce issues – redundancy. SOEs tend to shoulder more social responsibilities. Regular employees in SOEs are state-employed and retain their jobs as long as they are deemed faultless. Consequently, low-caliber talents have been hired into the SOEs, thus obstructing the recruitment of higher-caliber talent. 

  • Inadequate incentives and indistinct rewards mechanisms. Compared to private enterprises, SOEs lag far behind in compensation and other material incentives. SOEs lack a rational compensation structure that links payment with employees’ performance. Inadequate incentives and indistinct reward mechanisms weaken employees’ initiative, which in turn leads to inefficiency in the enterprise and brain drain. 

  • Lack of objectivity and a fully flexible talent selection mechanism. Leaders may select and promote employees on a whim, which results in the risk of incompetent managers holding key positions. Seniority- based promotions, made at the expense of brilliant performers, serve to reduce engagement levels.

China’s current macro-policy aims to shake off structural and cyclical economic problems by adopting pragmatic domestic economic policies in conformity with global economic development standards. Such economic reforms will influence the management and growth of SOEs.

  1. The objective of enterprise development will shift from the pursuit of ‘scale’ to that of ‘strength’, i.e., competitiveness. SOEs will shift their strategic management focus toward making profits. Consequently, many SOEs will restructure their operations to optimise the potential of their industrial capabilities. Many SOEs will emphasise business model and technological innovation in order to achieve breakthroughs in key technical equipment, enhance their enterprise’s strength, and reinforce their core capacity. Those enterprises following market trends and executing sensible practices will adapt and survive in the economic transition; those sticking to the old established rules and practices will be phased out by the market, despite their grand scale.

  2. SOEs’ globalisation strategy will become more challenging. In recent years, the failure of some SOEs in expanding into overseas markets has weakened their general confidence in overseas investment and expansion, mergers and acquisitions abroad. Consequently, these SOEs will be more conservative in exploring foreign markets. An upturn in America’s economy and the stabilization of Europe’s economy may further increase their wariness of investing abroad and so the internationalisation strategy of SOEs may enter a phase of slow growth. 

  3. The SOEs’ structure and SOEs’ internal management will not undergo rapid reform. Diversified ownership of formerly stateowned enterprises currently is under cautious experimentation. The performance of recent publicprivate partnerships has been mixed, and private investors have become more prudent based on their experience. The internal management reform will also proceed slowly without adequate motivation from the executive level. Changes in the incentive system to address this issue are unlikely to occur in the near future. 

In short, in the process of China’s economic cycle, the SOEs are plagued with both internal and external issues:

The external issue of ‘non-opening’

The sustained growth of the US economy and the stabilisation of Europe’s economy in recent years have increased the difficulty SOEs face in investing in foreign companies. SOEs are passive in global competition as they lack an understanding of global operations, culture and management style. 

The internal issue of ‘non-opening’

The inherent conservatism of SOEs over the years has curbed human resources development, stifled innovation, and weakened their competitiveness. SOEs need to:

  • Slow their outward expansion and focus more on their internal growth. An innovative culture and reform in human resources management could play a significant role in their development and strengthening their competitiveness, both at home and abroad. 
  • Wake up to the crisis that confronts them. Experiments in diversified ownership should continue in order to enhance SOEs’ market competitiveness. 
  • Undergo a transition from leader-led innovation to grassroots innovation. Private enterprises often take the pulse of the market through their front-line employees. In contrast, SOEs take an estimate of the market from their top-level leaders, which they then convey down the hierarchy of the enterprise, thus incurring inevitable delays and information errors. SOE leaders need to open direct communication channels with employees to ensure clear communication between leaders and grassroots employees. 
  • Reform their current evaluation mechanisms to encourage greater tolerance of error. Innovation is a long, continuing process that requires long-term investment and know-how accumulation; such efforts will inevitably result in some failures along the way. Therefore, tolerance of failures is a prerequisite of innovation in order to produce real output. 
  • Establish and improve a rational performance evaluation system. Only through a fair and just evaluation of staff efficiency can their contributions be confirmed, working procedures improved, and innovation inspired. Competition should be instituted within the enterprise to tap staff potential and achieve the overall objectives of the enterprise. 
  • Establish a comprehensive human resources system with a distinct reward and recognition mechanism. The aim is not only to ensure employees’ job security, but also to improve employees’ productivity and commitment to the organisation. 
  • Implement a fair, open and transparent recruitment process. SOEs should establish a full-range recruitment mechanism, where the recruiter is not just the immediate superior of the potential recruit. Managers from higher levels should also be included in this process to prevent the possibility of the recruiter hiring personnel with lesser capability. 
  • Establish a talent development system. The organisation should have effective talent management and retention programmes. Moreover, an assessment of how managers cultivate their subordinates should be taken into consideration when determining their performance. 
  • Consider market-related factors in the selection and management of enterprise operators. In the selection, cultivation and employment of talents, SOEs should integrate the Organisation Department’s examination of their political caliber and the board’s evaluation of their competence and performance. Hierarchy-oriented consciousness can be weakened by converting the current mechanism of superiors’ appointing leaders to a process whereby recruitment is public and selection is based on market supply and demand.

Written by:
Michele Lee  
Global Partner, Aon Hewitt                                                                                                  
Aon Strategic Advisors & Transaction Solutions  

Dr. Liu Guilin
Senior Economist of Baosteel and Adjunct Professor                                                                               East China University of Science and Technology

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