By Jonathan Woetzel, Joe Ngai, Jeongmin Seong, Kweilin Ellingrud, Nick Leung, Franck Le Deu, Sven Smit, and Peixi Wang
Over the past 30 years, multinational companies (MNCs) have enjoyed an increasingly open world. Taking advantage of a unipolar globe with relatively free flows of capital, trade, and ideas, MNCs tapped capital from wherever they chose, built businesses optimized for global supply and global demand, and served increasingly globalized customers. That may no longer be possible. In a world reshaped by the coronavirus pandemic, rising geopolitical tensions, renewed inflationary pressures, and war, MNCs must reassess, reevaluate, and reconfigure their businesses for a new era. And China is where some of the most dramatic reconfiguration may take place.
The reconfiguration will not be easy. The sheer size and complexity of the Chinese market may mean that notions of outright decoupling are simplistic; furthermore, we continue to live in a world connected by those global flows of capital, trade, and ideas. As we describe in a new paper from the McKinsey Global Institute, MNCs face a much more difficult imperative: maintaining access to China’s upsides while managing increasingly complex risks. It is a challenge that will define the next era for MNCs, and those that solve it will be tomorrow’s winners.
China and MNCs built a mutually beneficial relationship during the past few decades. Between 1990 and 2019, China’s real GDP grew at an average of almost 10 percent per year, contributing more than a quarter of global GDP growth, and average household income rose from about $750 to $13,000. That dynamism was a magnet for MNCs, which flocked to China to capture part of the growth. At one point, MNCs employed 16 million people and accounted for more than half of China’s exports. They also helped bring best practices to China, boosting the economy’s productivity in such industries as chemicals and cosmetics.
But MNCs have started reappraising their relationship with China. A recent survey indicated that the share of US MNCs perceiving China as one of their top three investment priorities dropped from 77 percent in 2010 to 45 percent in 2022. Though many MNCs are continuing to invest in China, some are curtailing their operations there or rebalancing their investments toward other countries, and a few are pulling out of China altogether.
The reappraisal may seem surprising, given that MNCs’ opportunities in China remain large. In an increasingly multipolar world, China has emerged as a major pole. Its GDP is now 18 percent of the global total—a share equal to the entire European Union’s and second only to that of the United States (with 24 percent). In advanced technology, such as artificial intelligence, advanced connectivity, and space technology, China is becoming a world leader. China’s climate transition will require investments worth many trillions of dollars, which are likely to represent sizable business opportunities. China is also one of the world’s largest producers of renewable-energy products, such as solar panels and battery components for electric vehicles.
But China also presents MNCs with unique risks. Rising tensions with the United States and Europe have the potential to disrupt global value chains, especially in critical sectors. China is aging at the fastest pace among the world’s emerging economies, putting downward pressure on its labor supply. China’s investment exposure to rising real estate prices is driving risk as well. The country’s ratio of debt to GDP is 274 percent, a historic high.
MNCs are now seriously asking themselves if they have the right strategies to succeed in China. In fact, many are losing ground as the gap widens between the highest- and lowest-performing (Exhibit 1). For the MNCs that grew the most quickly between 2010 and 2021, revenues rose by 20 percent per year during the last two years of the period—a pickup from their 16 percent annual rate during the first nine years. At the same time, opportunities for low-performing MNCs are shrinking: those whose revenues shrank the most quickly between 2010 and 2021 saw faster revenue loss after the pandemic started (5 percent per year) than before (3 percent).
Exhibit 1
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In addition, local companies in China are competing with the MNCs more fiercely for market share in many industries. For example, MNCs’ share of all revenues earned in China declined from 16 percent to 10 percent from 2006 to 2020. Local companies selling portable electronics, groceries, and fifth generation (5G) infrastructure have gained 20 to 40 percentage points of market share over the past decade. The R&D spending of China’s largest public companies grew three times as quickly as that of non-Chinese Fortune 500 companies between 2017 and 2021 (Exhibit 2).
Exhibit 2
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In this context, MNCs are rethinking their China strategies. Their most pressing question can be put bluntly: stay or leave?
The answer depends on at least two more questions. First, what is at stake? For example, China accounts for 25 to 40 percent of the global market in some sectors, such as cars, luxury consumer goods, and industrial equipment; can companies in those sectors afford to miss out on the China market? Similarly, can companies that depend on supply chains in China or derive important contributions from R&D facilities there afford to leave? Even if they choose to leave, how will they cope with Chinese competitors in markets elsewhere?
Second, how can MNCs derisk business in China? In the following six areas, they will face a spectrum of choices that define the China imperative:Capital and ownership. Can MNCs tap into Chinese and global capital and build self-funding business models? Should they go further and spin off China subsidiaries?
Supply chains. What should MNCs localize and what should they diversify? How much concentration in each step of the value chain is reasonable, not just in China but globally?
Innovation. How much innovation, both in process and products, should take place within China and how much elsewhere?
Branding. Can MNCs build brands appealing to local customers while taking advantage of the power of their global brand?
Talent. How should MNCs hire employees from China’s increasingly skilled talent pool while still benefiting from global talent flows?
Technology and data. How can MNCs localize their data and technology infrastructure in accordance with evolving Chinese law while conforming with global security protocols?
The MNCs that succeed in a rapidly changing China will be those that choose wisely in those six areas. The challenge is formidable, but the opportunity is significant.
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