June 6, 2013

Changing the Recipe for Chinese State-Owned Firms

The head of China’s largest food conglomerate predicts the fate of SOEs – and his firm’s place in the economic buffet.

Sharon Kahn

When Frank Gaoning Ning, chairman of COFCO Corp., scanned the packed house waiting to hear him speak at the China Business Initiative–sponsored talk in late May, he tossed away his notes (and the 46 slides he brought). Rather than his planned talk, “The Path to the Market: The Transformation and Reengineering of Chinese State-Owned Enterprises,” he pontificated on the business climate in the current and future China. “From the questions I've heard since beginning my visit to the United States,” Ning said, “I think you’d rather hear about three topics: how the Chinese economy is coping, how the SOEs are moving forward, and how COFCO is continuing to grow.”

Ning is well positioned to gaze into China's crystal ball as chairman since 2004 of COFCO, an acronym for China National Cereals, Oils and Foodstuffs Corp. The company is China’s largest food processor and is also one of the country’s largest state-owned enterprises. Ning, meanwhile, has been named to numerous leadership lists, both domestic and foreign, including Fortune Magazine’s 25 Most Influential Business Leaders in China.

On the Menu: Slow-Cooked Growth

Although growth will necessarily slow as the country’s middle class swells, Ning expects China’s economy to do just fine because the government has all the tools to engineer a soft landing — and the incentive to do so. For the past 30 years, the state has wielded a tightly controlled economy. If housing prices rise too fast, the government imposes a tax on real estate profits. If currency issues threaten Chinese competitiveness, the government increases or decreases the value of the RMB. If inflation heats up, the state imposes price controls.

“It's a very pragmatic approach,” said Ning, who added that the government’s motive is to achieve social stability. “Like it or not,” he said, “the approach has worked.”

Managed economics does have two significant problems, Ning allowed. First, state control is not conducive to innovation. Recognizing this, the current government has instituted reforms to entice creativity. “We're waiting to see if they will be effective,” said Ning

State-Owned Enterprises: Overdone

The second big problem is right in Ning’s wheelhouse. A managed economy meant to provide jobs “creates size, not productivity in the SOEs,” he said. The so-called Beijing Consensus acknowledged this issue some 20 ago and instituted often-extreme efficiency measures, including closing outmoded operations and laying off thousands of redundant employees.

That painful era paved the way for privatization of about 95 percent of SOEs. By listing in Hong Kong, New York, and London, and answering to shareholders, SOEs have the incentive and means to adopt market standards and strategies.

Of course, the government still owns major positions in most former SOEs, so China’s transformation to a market economy is hardly complete. And the state maintains 100 percent ownership of about 50 companies in strategic sectors, including power, transportation, telecom, banking, and, to a large degree, food.

Many of the remaining SOEs “have lost direction,” he said “Many are losing money, are not competitive, and have been slow to embrace environmental change.” Numerous industries, including his own, have too much capacity: “In the food sector, we have too many soybeans, too much corn processing, too many plants making aluminum cans for packaging.”

The answers, he said, may lie in another round of reforms, increased incentives to managers, and more privatizations, at least in sectors deemed less crucial to national security. Acknowledging that the state recognizes the problems, Ning anticipates continual change among SOEs.

COFCO: The Transformation Continues

Ning’s own company is one of the exceptions — a profitable SOE — reporting a $1.6 billion net last year on revenues of $35 billion. Since its founding in 1952, COFCO has transitioned from a small trading firm to a conglomerate controlling all aspects of the (literal) food chain from growing crops and raising animals to processing, transportation, distribution, and even operation of port facilities for export. COFCO has also expanded into real estate, developing residential properties, shopping centers, and hotels within China.

Along the way, the company has adopted efficiency and innovation measures as well as management carrots and sticks. Although COFCO isn’t publicly traded, seven of its subsidiaries are. It spent some $3 billion on R&D last year, hiring 400 PhDs. Recently COFCO began a Gross Profit Sharing (or GPS) bonus program for all employees. Managers get incentives but are also held accountable through its Replacement on Evaluation (ROE) plan. “Every year,” said Ning, “the lowest scoring 5 percent of our top 100 managers must be replaced.” The effect “is like 100 people running from a tiger. Nobody wants to be caught.”

In late May, a sister SOE, Shuanghui International, caught headlines with its $4.7 billion offer to buy US pork processor Smithfield Foods. COFCO is also scouring the globe to increase the food supply for a still-hungry China that’s increasingly interested in nutrition and taste as well as food safety issues. Ning expects to tap foreign sources through importing agreements, but M&A is another route COFCO will take. In early May, for example, the company acquired 51 percent of Chinese yogurt operations from Danone Group, the French food conglomerate.

“Our business model is a fully integrated value chain,” Ning said. “We’ve improved a great deal over the years, but we're not finished yet.”

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