The McKinsey Quarterly 2006 Number 1 84

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Making China your second home market 85
Like many other global companies, Danfoss had been taking a slow
boat to China. During the mid-1990s, the company moved some of the
manufacturing of its valves, compressors, and motion controls there to take
advantage of low wages. It was selling some of the output around the
world and the rest locally, at high prices, to business customers in the major
coastal Chinese cities.
This approach was successful: after some ten years in China, Danfoss
can boast prots, high growth rates, and excellent relations with the Chinese
authorities. Yet the companys CEO, Jrgen M. Clausen, who in 1996
took the helm of his familys business (which had 2.2 billion in net
sales in 2004), wondered if Danfoss was achieving its full potential in China.
Moreover, he doubted that the cautious approach would ensure a lasting
and meaningful role for the company in a market that over the next 40 years
will probably overtake the United States as the worlds largest.
A companys long-term goals in China and the timing of the moves required
to meet them are strategic issues that chief executives all over the world are,
or should be, pondering. For Danfoss, another dimension was involved as
well. Coming from a country with only 5.1 million inhabitants, the company
was acutely aware that it could achieve strong growth only through market
leadership beyond its own borders.
Making China your second
home market: An interview
with the CEO of Danfoss
The head of the Danish industrial-controls company wants to make China
one of its core markets.
William E. Hoover Jr.
The McKinsey Quarterly 2006 Number 1 86
Danfoss had used the opportunities
that emerged from the recon-
struction and integration of Europes
economies after World War II to
make much of the Continent its
wider home market. But the com-
pany shared the fate of most others
by moving too slowly to challenge
long-standing domestic incumbents
in the United States, Japan, and
South Korea. Now, Clausen believes,
there is a uniquebut quickly
closingwindow of opportunity to
contend for market leadership
in China, the next major market
to open.
In an interview with Bill Hoover, a
director in McKinseys Copenhagen
ofce, Clausen spoke about his
companys strategy to make China
its second home market, as well as the operational and organizational
challenges involved in that quest.
The Quarterly: What was Danfosss China strategy in the 1990s?
Jrgen Clausen: We didnt really have a long-term strategy. We sell in
more than 80 countries around the world and have factories in about 20,
and we thought of China as one of many markets, although its huge
potential naturally became clearer and clearer over time. Basically, we were
gradually expanding our manufacturing capacity in the country to
take advantage of the labor rate differential. Some of the output was sold
worldwide and some of it was sold to big Chinese and multinational
businesses in Chinas fast-growing coastal areas.
We had been fortunate in two ways. We were granted a business license
for a wholly owned subsidiary in 1993 and didnt have to cope with one
of those joint ventures that have proved cumbersome for many Western
companies. Also, one of our division presidents, who went to China to scout
for a suitable industrial-development park, found what turned out to be
an ideal choice. We bought a piece of land in the development zone in
Wuqing, in the Tianjin municipality, and initially rented some manufactur-
ing space there while we built our own factory. It was ready in 1996, and
Article at a glance
In an interview, Danfoss CEO Jrgen M. Clausen
discusses the challenges of making China this
industrial-control companys second home market.
After glimpsing Greater Chinas many business
opportunities on a journey through the old Silk Road,
Clausen launched a strategy to achieve market shares
similar to those Danfoss holds in Europe.
Establishing R&D centers in China and acquiring
local companies, Clausen says, is the way to address
the key challenge: widening the companys product
range to include products designed for the huge
mass market.
Clausen explains that Danfoss aggressively protects
its intellectual property, lobbies government
ofcials tirelessly, and trains Chinese managers to
speak their minds.
Making China your second home market 87
weve expanded it four times since. It now houses seven product lines and
650 employees.
The Quarterly: Why was Wuqing a wise choice?
Jrgen Clausen: Its about two hours outside of Beijing. There is plenty
of labor available at attractive rates, while at the same time Wuqing is still
close enough to Beijing for expatriates who want to live in the capital so
that their children can go to international schools. We are also a relatively
large company in a very small development park, which means we get a
lot of attention from the authorities. That wouldnt be the case today in the
big zones where the truly large multinationals are based. There, we would
just be a tiny mouse.
The Quarterly: What about your manufacturing systems and product
ranges? Were you adapting them to Chinese conditions in the 90s?
Jrgen Clausen: No, we simply replicated our European production lines
and even used our old suppliers, to begin with. That meant we could hire
local people and teach them to operate the machines. As a next step, we
started switching to local subsuppliers. So we had a strategy of not trying
to do too many difcult things at the same time.

The McKinsey Quarterly 2006 Number 1 88
This approach has served us well by assuring the same quality and
productivity we achieve in Denmark or Germany but at a much lower cost,
because of the wage differential. So by the mid- to late-1990s, everything
was going well for us in China. We were growing and making a prot.
I was out there regularly, and we were very seriously and successfully lobby-
ing local and national government ofcials. Even so, it would be fair
to say that China was moving up on our agenda but was still only one of
many markets.
The Quarterly: In 2004 Danfoss dramatically shifted gears in China.
The company now aims for growth of 50 percent a year and for a
quadrupling of sales by 2008steps toward eventually achieving market
share similar to the average 15 to 20 percent that Danfoss holds in
Europe. How did this change come about?
Jrgen Clausen: There were two eye-opening events that made me start
thinking about a long-term strategy for China. First, I read an article in
a newspaper one day about a big European manufacturer that was happy
with its 40 percent growth in China until it discovered that the entire
market for its product category was growing by 80 percent, which meant
the company was actually losing market share. This made me wonder how
successful we really were in China and if we too were being fooled by growth
rates that were vastly superior to the ones we were getting in Europe.
The second event came when my wife and I indulged ourselves by making
an old dream come true: we traveled the ancient Silk Road from Almaty,
in Kazakhstan, to rmqi, in Chinas western province of Xinjiang. We
drove for two days in a Land Cruiser through what struck me as quite
backward areas until we reached the Chinese border, where the president
of our Chinese subsidiary waited for us in another Land Cruiser.
Once wed crossed into China, I was struck by the good roads and the
nice pavements lining them and, in general, by how relatively modern and
well organized things seemed to be in this very remote area, so far from
Beijing and Shanghai. In rmqi
I peered through the window of a
dressmaking factory and saw that
it was highly automated, which
I was surprised to see in a remote
area where labor must be very
cheap. In a department store, we mingled with ordinary Chinese shoppers
and were surprised to nd exclusive dresses and $100 ties on offer. Some-
thing that particularly caught my eye was a refrigerator with inverters that
I came away from our glimpse of
Greater China with the feeling that
there must be many opportunities
that we werent addressing
Making China your second home market 89
control the speed of the motor and thus save energya luxury category
one wouldnt nd even in a large Danish town.
Anecdotal as all this may be, I came away from our glimpse of Greater
China with the feeling that there must be many opportunities in the market
that we were not addressing. So I went to my chairman and said, Were
growing by around 35 percent in China and were making good money,
but are we doing enough? He didnt know the answer and neither did the
board of our Chinese company. So we decided to nd out by conducting an
exploratory review of all our product markets. This was more difcult than
it might sound as there is little ofcial market data available in China.
The Quarterly: What did you nd?
Jrgen Clausen: We found that we were just skimming the surface and
capturing only a few percentage points share in most of our product
markets. Our products addressed the high end of the market and some of
the middle, but not the low end, which in many cases we hadnt even
known existed. This shortcoming was actually not surprising, as we had
simply taken our existing European product line to China. What stunned
us was the size of the low-end market. We concluded that if we could
offer the right products, there was a potential to increase our coverage by
a factor of 10 and our prots by a factor of 30 in one segment of industrial-
control devicessomewhat less in other segments, but still by a very
substantial amount. Collectively, this could give us a market share of from
15 to 20 percent, roughly equal to our share in Europe.
What we then did was to identify areas where we needed to create new
offerings. One was simple motor-speed controls for commercial refrigera-
tion units. While our products had all the bells and whistles and adhered
to European Union standards, they were too expensive and overengineered
for most Chinese companies. These companies in the low-end segment
were mainly interested in two things: getting the energy-saving function at
the lowest possible price and getting a specially designed dust cover to
protect the machinery.
The Quarterly: What was the thinking behind Danfosss very ambitious
strategic plan for China?
Jrgen Clausen: The plan was colored by our experiences in the US,
Japanese, and South Korean markets, where homegrown companies had
already established themselves as market leaders by the time we moved
in and so held all the best cards. We have never been able to become big
The McKinsey Quarterly 2006 Number 1 90
there, and we didnt want to miss the opportunity once again. China
may not be huge today, but in 15 years the Chinese market will be further
advanced and ripe for our products on a big scale.
So there was a sense of urgency that came into the strategic planning
a realization that we can move in forcefully now while the window is still
open or wait ve years while others take the top positions and resign
ourselves to being one of many small players here too. This shift toward
dening our aspirations in China by market share rather than by growth
rates, which are often from a very small base, also led us to the concept
of China as our second home market, after Europe, which currently
represents some 65 percent of our revenues but where economic growth
is slow.
By home market, we mean one where we want to be a market share leader,
an aspiration that helps us set a goal for ourselves. Maybe we cannot be
number 1 in China, but maybe we can be number 2 or 3. We certainly dont
want to be number 17, because then we will be in trouble later on when
the industry consolidates, and we wont have the volumes needed to compete
with local Chinese incumbents.
The Quarterly: What are the operational and organizational challenges
of such a strategy?
Jrgen Clausen: Its a big step. We were already manufacturing high-end
and middle-level products in China and selling to big businesses in its
top cities. We realized that now we have to develop some completely new
products at competitive pricesproducts with local components and
manufactured with less capital-intensive techniquesand to distribute them
in maybe 40 urban areas across the country. To make all this happen,
we need to expand our Chinese staff from around 700 to perhaps 4,000 by
2008 and to develop a cadre of Chinese managers.
The Quarterly: How are you addressing the low-end gap in your product
range? Is it possible to take a European product and strip it down into a
simpler, cheaper version?
Jrgen Clausen: No, I think a low-cost product must be designed from
scratch, something our European engineers cant easily do. They dont
have the right mentality and would set excessively high standards for even
the smallest details, ending up with an overengineered and too expensive
product. However, I think it is possible to go the other way, by start-
ing out with a simple version and improving its quality while still taking
advantage of Chinas low-cost base. Thats why we plan to address this
Making China your second home market 91
gap by acquiring Chinese companies, so that we can draw on their products,
distribution systems, and R&D.
For example, we just acquired a Chinese company that makes energy-saving
inverters for specialized machinery. This company is very successful in the
low end of the market, while we already have products for the high end and
the middle.
The Quarterly: What will doing all these things in China mean for your
companys product range and innovation on a global level?
Jrgen Clausen: Its very important to be in China. For one thing, we
can hire maybe ten engineers or researchers there for the price of one in
Europe. We have begun establishing R&D centers in China for refrigeration,
air-conditioning, and heating. These centers, in conjunction with local
acquisitions, will help us create a competitive range of products for the
Chinese market, and they will also give our company a broader portfolio
in the rest of Asia and elsewhere.
Its a fairly big decision to establish an R&D center, because it requires its
own little organization. But once a center is in place, we can use it for
many things with the help of modern communications technology. I was
visiting one of our R&D units in China recently and looked over the shoulder
of an engineer. On her screen I recognized a product I didnt think was
being designed in China. Oh, yes, she explained, she was running the project
together with one guy in Germany, one in Slovakia, and one in Iowa.
The Quarterly: What about protecting your intellectual property in China?
Have you found ways to do that?
Jrgen Clausen: A lot of companies copy our products, and we have now
adopted a policy of going after them systematically, especially the ones
that export the copies from China to other countries. There was one case in
particular where we got inquiries from customers about a product that
was supposedly ours and that was being sold at a very low price. We investi-
gated and found that it looked very much like ours, had a Danfoss label
that said it was made in Denmark, and came in a box that looked exactly
like ours. We managed to locate the Chinese company manufacturing the
copies, documented our case well, and then went to the police. The police
raided the company, conscated the goods, and the owner was sent to jail.
Meanwhile, the PR agent on our team encouraged Chinese newspapers to
write articles in which we praised the police and the judge. So it became
a very positive story from the Chinese authorities point of view. They are
The McKinsey Quarterly 2006 Number 1 92
now very happy to work with us. Our policy also acts as a deterrent. The
copycats now realize that Danfoss will go after them.
There have been some other cases that we brought to the attention of the
Chinese government, which is taking the intellectual-property issue more
seriously now. Things will get better and better, I would say, but the issue
will always be around, just as it is in the West.
The Quarterly: Turning to organizational challenges, how do you develop
and retain Chinese managerial talent?
Jrgen Clausen: It is very important to overcome cultural barriers. In
Denmark, people are raised to speak frankly and to disagree in public. The
Chinese rarely disagree with a higher-ranking person and wont speak
until asked to do so. This is no good for us, because we need their help to
nd solutions to the challenges of growing quickly in the Chinese market.
So with the help of the Copenhagen School of Economics, we have
designed a three-month development program for Chinese and other Asian
leadership talent. Psychologists in these programs support the participants
in their personal development and teach ways to bridge cultural differences.
This approach is working very well.
We also focus on sharing our corporate values, and I think that has helped
our Chinese managers to adopt our corporate culture very fast and
to be loyal to us. We have very high retention, which is quite unusual in
China. I know of only three or four people in leading positions who
have left the company.
The Quarterly: What role does the second-home-market concept play in
the new China strategy?
Jrgen Clausen: Its only been a year since we launched this idea, and I
can see that its already made a huge and positive difference in the attitude
of our employees and customers in China. It adds to our credibility when
I tell Chinese government ofcials and customers that they shouldnt view
us as a foreign company. We are Chinese, just like you, I say. Only I
am Danish. The technology you buy from us is from China, and you create
employment in China when you buy from us. They hadnt thought about
it from that perspective before.
The Quarterly: What role do you as CEO play in this strategy?
Jrgen Clausen: I think the CEOs strong commitment to a high-speed
strategy is crucial. I am chairman of our Chinese company, and its
Making China your second home market 93
president reports directly to me. The CEO plays a key role in developing
good relationships with the government, something that is crucial in
China, and this role probably grows even more important with a second-
home-market strategy.
You simply have to invest a lot of time because you will only get results if you
lobby systematically over a long period. Just saying hello once or twice to
the Chinese ambassador wont help a bit. I go over to China ve times a year,
and some of these trips have as their prime purpose meetings with govern-
ment ofcials. We have pictures in our ofces of me together with Chinese
mayors and government ministers, and this kind of picture serves as a stamp
of approval in the eyes of our customers, who often cannot get that close to
government leaders.
The Quarterly: How big a bet is Danfoss making on China? Is it a
risky gamble?
Jrgen Clausen: Absolutely not. We are already making prots in China,
and the government there nanced much of the over $100 million in
investments that we plan to make. In fact, we have decided that we now want
to repatriate some protspartly to see how that process worksand to
nance further investments by borrowing the money in China. So we can
actually afford the bet we are making there, and not to have made it would
simply be another missed opportunity, like the United States, Japan, and
South Korea.
The Quarterly: How important is speed? In what kinds of businesses is it
still possible for multinationals to aspire to market leadership in China?
Jrgen Clausen: I would say that in some marketsfor example, PCs and
white goodsits already too late because Chinese domestic players are
very strong. Then there are markets, like the ones where Danfoss is operating,
that are maturing but where the game is far from over. But you cannot
make a decision on China when youre sitting behind a desk back home.
Youve got to get up from your chair, buy a ticket not just to Beijing and
Shanghai but to other parts of China as well, and see the opportunities
and risks with your own eyes.
Q
Bill Hoover is a director in McKinseys Copenhagen ofce. Copyright 2006
McKinsey & Company. All rights reserved.
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