Enter the Dragon
China will soon be the biggest PC market in the world, and everyone wants a piece of it.
One problem: A homegrown powerhouse called Legend.
"THERE'S ALWAYS CHINA." That's the motto of every American executive facing a saturated domestic market. For most, the promise has been a mirage: What looks like a billion consumers too often turns into a snarl of red tape. But for manufacturers of personal computers, who have seen sales go flat in the US, Europe, and Japan, the mantra is more than a desperate cry – it actually makes sense. Next year, after a decade of hypergrowth, China is expected to become the world's second-largest PC market, surpassing Japan. Chinese consumers will buy 10.1 million PCs in 2002, accounting for roughly one in thirteen Intel microprocessors made this year.
And demand is still growing like bamboo shoots after a spring rain: more than 15 percent annually, adding what amounts to the market of a good-size European country to the PC industry each year. Despite the huge sales figures, the PC remains unaffordable for most of China's citizens – only 11 percent of all homes have one. But as average family income goes up (it rose 14 percent last year), PC sales will accelerate, thanks to China's huge appetite for technology and self-improvement. China is already the world's largest market for everything from elevators to light bulbs to mobile phones. By 2006, China will have more Internet users than any other nation. That same year, forecasters say, it will pass the US to become the biggest market for PCs.
So China is the glorious future of the PC. And the big PC makers? They're all over it. Late last year, Dell added manufacturing capacity in its Xiamen plant, which opened in 2000 and now employs 1,000 people. In March, Sony broke ground for a new Vaio plant in Jiangsu. "China has become the hot spot for the international IT market," says Sun Zhenyao, president of HP China, which has two plants in Shanghai. "The mainland will be the key target in the coming years."
But outsiders may be in for a surprise. Just as past invaders were stopped by the Great Wall, PC manufacturers face their own immovable force: Legend Group. Most US consumers have never heard of Legend, but in China it owns the PC industry. More than one-third of the 20 million computers ever sold in China are Legends. Last year, Legend cleared 2.9 million units, claiming 30 percent market share – three times more than its nearest domestic rival and six times more than IBM, the closest international brand. A Legend spin-off, Digital China, is also the main Chinese distributor of HP printers, Cisco routers, Toshiba notebooks, and IBM minicomputers, as well as a leading player in handhelds, systems integration, and servers. With $3.5 billion in revenue, a 35 percent annual growth rate, and a $3 billion market cap, Legend is the fifth-largest publicly traded Chinese enterprise.
As a homegrown operation, Legend has certain advantages over foreign competitors. It's mastered China's vast distribution challenge by exploiting the arcana and inefficiencies of government bureaucracies. It intuitively understands the need for providing extensive customer service in a nation that is largely computer illiterate. It knows how to work the hidden Chinese game of guanxi, the intricate social network of having the right friends in the right places that has long frustrated foreign players.
None of this is surprising for a company that has deep roots in China. What is amazing, though, is that Legend has also managed to become a manufacturing powerhouse, acquiring American-style efficiencies in a decidedly un-American environment. Look no further than Legend City, an airport-sized campus in Beijing that's home to the gleaming steel-and-glass corporate headquarters as well as the company's newest factory. This year, as many as 2 million PCs will roll off the plant's production lines – a computer every 24 seconds. It's China's largest automated factory, housing six production lines and covering 3,000 square meters. (Another million or so PCs will be built this year by a supercheap labor force at a similar Legend factory in Huiyang.)
From the assembly line, Legend PCs are boxed and sent into a multilevel sorting maze that resembles the scream factory in Monsters, Inc. The average time from order to delivery, including assembly and testing, is 5.7 days. That's as quick as Dell in the US – though Dell offers online ordering and home delivery (a model that Legend is only now developing in a nation slow to embrace ecommerce and shipping). All this is enough to get the attention of Michael Dell himself, who says that he fears Legend more than any other company in the world.
STANDING at a whiteboard, Legend founder and chair Liu Chuanzhi is making a pitch to prospective partners from a Chinese Internet company. The well-rehearsed overview strikes grand themes. "Computers," says Liu, "are both the symbol of the New China and the means by which we will create it. The combination of the PC and Internet will change ordinary people's lives."
The son of a Shanghai banker, Liu graduated from a military engineering college in 1966, the year Mao launched the Cultural Revolution. Along with millions of students and other intellectuals, Liu was sent to a labor camp, where he worked as a rice farmer for four years. Returned to Beijing, he took an engineering job at the prestigious Chinese Academy of Sciences.
The academy was devoted to researching advanced computing technology; commercial activities were frowned upon. "The only scientists who would go into commercial ventures were inferior," says Liu. When Mao died in 1976, that began to change. Deng Xiaoping's reforms included initiatives that demanded a payoff from all the government-run tech research. In 1984, Liu's superiors told him to create a for-profit spin-off. It was, he says, a demand to xia hai – "jump into the sea."
With a paltry budget of $23,000, Liu and his handpicked group of 11 engineers moved into a one-room office. "We were confused about what we should do," says Zhou Xiaolan, a computer scientist who was part of the founding team. "We had no concept of management, marketing, or finance." Within a year, Liu had lost most of his startup funds to swindlers, so he opened a trading office in Beijing – a shop for color TVs, digital watches, and roller skates, as well as IBM and AST computers, HP printers, and Hayes modems.
When an IBM or AST 286 machine showed up at the shop, Liu's engineers would sometimes dismantle it, trying to figure out what it would take to easily display and process Chinese characters. In 1985, they designed a Chinese language input/output device that became a mainstay in China and led to the company's name, Lian Xiang, which means "linking thinking" and describes the way the PC card works, by linking related characters and phrases. Pronounced "li-an shang," it's a rough – and unintended – homonym for "Legend." The company's first computers, released in 1990, were rinky-dink clones, but they were cheap.
By 1993, AST, Compaq, IBM, and HP had nearly two-thirds of what was becoming a fast-growing PC market in China. Early adopters were impressed by international brands and assumed (correctly) that Chinese technology was inferior. Foreign manufacturers were happy to have the business but paid much more attention to the booming US and European sectors. That gave Legend an opening. As the quality of its technology improved, Legend undercut the competition with low prices and better service. At the same time, Liu exploited the guanxi system to win government contracts, which at one point made up 50 percent of Legend's business (and now constitute 20 percent). Legend turned its first profit in 1993, went public in Hong Kong in 1994, and pushed ahead of Compaq to become the number-one PC seller in China in 1997. "It was astonishing, since no one – Chinese or foreign – thought a Chinese company could beat the respected international brands," says Edward Tian, CEO of China Netcom, a Legend customer. "Legend is heroic because it gave confidence to Chinese people that our technology could be as good as any in the world."
Liu, now 59, suddenly found himself running a big company. "I was in a panic to succeed," he recalls. And his management style reflected the authoritarian regime in which he grew up. For years, he confesses, he was a "tyrant who behaved like a dictator." Any employee who was late to a meeting was forced to stand "like a child" in the corner of the room. "For Chinese engineers, who wanted to blend in, this was particularly humiliating," Liu says.
As Legend grew, Liu began studying the management practices of his foreign partners, including Microsoft and Intel. He learned about delegating responsibility, encouraging risk, and rewarding individual employees for their contributions – concepts that long have been anathema to the Chinese system. "Americans have a sense of the market, business ethics, and a pride in the products they are making," he says. "We don't have that tradition in China." Liu responded by easing up on the discipline and embracing American-style incentives: merit-based pay raises, pension plans, profit sharing, stock options.
CHINA'S one-child policy has created a generation of so-called little emperors, lavished with the best that their parents can afford – especially when it comes to education. "We don't look at PCs as luxuries so much as a bridge to a better life," says Xu Bing, a Shanghai limousine driver. "A computer can lead our son to be a more refined human being and to a very good job in which he will contribute to the prosperity of our nation."
The little-emperor impulse has played to Legend's products – personal computers are the gateway through which Chinese citizens join the technology revolution sweeping the world. Legend has figured out how to help consumers buy their first PCs, then teach them how to use the boxes. Foreign manufacturers, long disdainful of customer service as a drag on the bottom line, never appreciated these market demands. "In China, you cannot be successful if you simply sell computers," says Liu, who has opened 580 tech-service centers to provide walk-in support. "You must gently hold the hands of people who are intimidated by technology and who, in many cases, have never spent this much money on a single purchase."
Legend offers free computer classes at its 520 retail outlets, as well as at shopping malls, schools, and community centers in dozens of cities. In the jam-packed Zhongguancun district of Beijing, dozens of people – ranging from 15 to 79 years old, dressed in everything from Brooks Brothers suits to Mao-era peasant jackets – enter a store and duck through a black curtain. In the back room, they sit in blue plastic chairs. An instructor greets them. "Welcome to the Introduction to PC course. And welcome" – he pauses, surveying the room – "to the modern world. The computer is your future, the computer is China's future."
On the main floor of the store, a salesman is explaining to a couple in their fifties how to get on the Web with a Legend Conet. He encourages them to take the computer home for a week before deciding whether to buy it. Next he demonstrates the Tian Le ("Happiness PC"), which operates by touchscreen, and explains the "idiot" button: "If you download anything unwanted or otherwise mess up the preset configurations, the button resets the system."
Legend's success has captured the attention of the biggest players in the industry. Last year, it cut a deal with AOL that gives AOL software and services to every customer who buys a Legend PC. A Legend-AOL site, to be merged with the computermaker's popular portal, FM365, is expected to go live next year. The leading Chinese portals, Sina.com and Sohu.com, have never faced such competition. "Legend without AOL may be stoppable. AOL without Legend would be inconsequential," says the CEO of one leading Chinese portal. "But the two together scare the shit out of me."
Rivals hope that Legend's edge will be undone by China's admission last year to the World Trade Organization. It's true that foreign manufacturers will have an easier time setting up operations, thanks to lower barriers. In particular, one of the key effects of the WTO is that it removes import tariffs. The problem is, most PC tariffs in China were abolished in 1992. So for the last decade, Legend has been beating its competitors on a more or less level playing field. The reality is that "Chinese companies still prefer to shop locally," says Duncan Clark, founder of BDA China, an Internet consulting firm in Beijing. "There's a nationalism that can't be negotiated away."
Perhaps, but Legend is hardly untouchable. Foreign manufacturers have money, experience, and a proven ability to create brand preference in emerging markets. "If anyone, Legend should be fearing Dell," says Richard Gao, manager of Matthew International Capital's China Fund. Last fall, Dell introduced the SmartPC, a machine specially designed for the Chinese market, which sells at roughly twice the price of a color TV. Orders soared, and Dell is expected to knock out IBM to become the market leader among foreign OEMs this year. Of course, it still has a long way to climb. For every PC that Dell sells in China, Legend sells seven.
Liu calls the foreign makers "aggressive, worthy competitors" – and he's girding for the fight. And not just in China. A recent government report singled out Legend as one of the country's brands with "global potential." Liu is coy: "We have much to do in China." When pressed, he confesses, "It may take two or three years, but the logical next step for us is to make Legend a global brand."