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an example of globalization of Chinese companies

AN EXECUTIVE’S NOTE

Lenovo:an example of globalization of Chinese enterprises

Chuan Zhi Liu

CEO and President,Legend Holdings Ltd Journal of International Business Studies (2007)38,573–577.doi:10.1057/palgrave. jibs.8400281

Online publication date:17May2007Introduction by Rosalie L Tung,Simon Fraser University Mr.Chuanzhi Liu is President,CEO and co-founder of Legend Holdings Ltd.Lenovo belongs to the Legend Holdings Group. Lenovo is the world’s third largest manufacturer of personal computers(PCs),after Dell and Hewlett-Packard(HP).

In2002the Chinese government announced its‘go global’policy by encouraging Chinese companies with the capabilities and know-how to expand abroad.Lenovo,as a leader in the IT sector,responded to this government initiative.In2003Legend adopted a new brand name,Lenovo.The first two characters,‘Le’,were taken from‘Legend’,to reflect its heritage,and‘novo’(‘new’in Latin)to signify the‘spirit of innovation’that is central to the company’s mission.1Mr.Liu is the principal architect behind his company’s2004acquisition of IBM’s PC Division(PCD), and hence is commonly referred to in the press as the‘Man who acquired IBM PC’(Shenzen Daily,2004).Even though the size of the acquisition was relatively small in the broader context of global mergers and acquisitions,the deal had‘tremendous symbolic’importance to China,because it signified that that country had finally arrived on the global economic scene (Ling,2006:361).

Mr.Liu graduated with an engineering degree from Xian Military Communication and Engineering College of China,and began his career as a research scientist at the Institute of Computing Technology,Chinese Academy of Science.

The13September2001issue of The Economist characterized Mr. Liu as a leader of a‘corporate cultural revolution’in China because of the role he played in charting his company’s development and growth under the unique circumstances of the Chinese political-economic environment,which was in transition from a planned to a market economy(Economist,2001).Mr.Liu recognized the importance of human resources,and devised an ownership and incentive system to motivate his employees to contribute to the sustained growth of his company.One of his favorite sayings was:‘A small company manages affairs,a large company manages people’(Ling,2006:309).

Mr.Liu’s vision and contributions have won him many accolades, including the title‘Star of Asia’by Business W eek(2000);‘Asian Business-man of the Year’by Forbes(see also http://www.referenceforbusiness. com/biography/F-L/Liu-Chuanzhi-1944.html);and the chief protagonist in the2001Harvard Business School Case,‘A technology Legend in China’(Rukstad et al.,2001).In

November Journal of International Business Studies(2007)38,573–577

&2007Academy of International Business All rights reserved0047-2506$30.00

https://www.wendangku.net/doc/0715279844.html,

2001he was selected as one of the‘25Business Leaders with Global Influence’by Times,the only executive from China to be thus honored(see also https://www.wendangku.net/doc/0715279844.html,/biography/ F-L/Liu-Chuanzhi-1944.html).

In2006Mr.Liu was selected as the recipient of the2006AIB Fellows’Distinguished Executive of the Year Award.I chaired the selection committee for this award.Other members of the committee,in alphabetical order,were:Paul Beamish,Phillip Grub,Marjorie Lyles,Oded Shenkar,Danny Van den Bulcke,and George Yip.

The following write-up is based on Mr.Liu’s actual presentation at the AIB plenary session,2 and incorporates select questions raised by the audience at the end of his presentation,followed by a one-to-one interview I conducted with him thereafter.

Presentation by Chuan Zhi Liu

In1984I started Legend Group,an IT company, with another10scientific researchers in a gate-keeper’s room.All eleven co-founders were researchers in the Institute of Computing Technol-ogy,the Chinese Academy of Sciences(CAS). The CAS invested200,000RMB(approximately US$25,000)in the company.We left the institute to start our own company because we were frustrated that the results of our work in the institute could not be commercialized.

Since its founding22years ago Legend has grown rapidly–so much so that our total annual revenue for2005exceeded US$13billion,and we currently employ around19,000employees world-wide.In China,Lenovo is recognized for three major accomplishments.

First,the company competed successfully with well-known multinational companies such as AST, Compaq,HP,IBM and Dell in the Chinese PC market. Since1996,we have been the largest PC manufac-turer in China,and control over30%of the country’s market share.In the early years,however,we suffered many disadvantages compared with our competitors. Our ability to overcome these odds and attain the dominant position has attracted the attention and interest of researchers,both domestic and abroad: many seek to understand how Legend was able to accomplish this feat.

Second,we successfully completed the restructur-ing of the company’s ownership.The CAS invested 200,000RMB and was initially the sole shareholder of the company.Over time,with support from the leadership of the CAS,we accumulated our bonuses in a savings account for seven years.In2001we used those accumulated savings to buy a35%share of the company,and in the process successfully restructured the company’s ownership.Our efforts in this regard have set a good example for the restructuring of other state-owned enterprises. Third,when Lenovo announced its decision to acquire IBM PCD on8December2004,the IT industry and business community were shocked. Most people thought that this acquisition was destined to fail:not only because acquisitions in themselves are inherently difficult and fraught with challenges but,more importantly,because it was a smaller Chinese company from a less developed country(with then an annual revenue of US$3 billion)that was acquiring a larger American entity, a company from the most industrialized economy in the world(with revenue of US$13billion).From the Chinese perspective this would be the case of‘a snake swallowing an elephant’.Most people were skeptical,and did not think that we could accom-plish this feat.I once gave a speech to an EMBA class at the Guanghua Management School at Peking University.There were90students in attendance,and only three of them expressed optimism about the outcome of this acquisition: two of them were Lenovo’s employees!

Today I would like to share with you the story of Lenovo’s acquisition of IBM PCD.

At the end of2003the top management of Lenovo had engaged in a month-long strategy meeting,where we set globalization as our target. The reason to go global was straightforward:with a 30%share of the Chinese PC market,Lenovo realized that its opportunity for further domestic expansion was limited.Since the global PC market was estimated at around$200billion,it could pose huge potentials for us(Shenzen Daily,2004).To expand abroad,we realized that we were lacking several things,including a brand name that had worldwide recognition,a strong presence in the world market,and human talent to run and manage a global company.We recognized that there were two primary ways to globalize.One was to grow organically.We were aware,however,that this approach would involve a very long process. Another way was to expand through mergers and acquisition:this was,however,a very risky process. With the help of external advisers and consultants, we decided to adopt the second approach.

At the end of2003,coincidentally,IBM approached us about buying their PC business.At first,we could not believe this.When we

realized Journal of International Business Studies

that IBM was serious about the proposed sale,we conducted our own due diligence,and sought to answer the following three questions:

(1)Why does IBM want to sell its PC business?

(2)How can Lenovo turn PCD,which is losing

money,into a profit-making business?

(3)What are the risks associated with an acquisi-

tion of this nature,and how can we manage them?

Let us turn to the first question.Why did IBM want to sell its PCD?In the1980s IBM had expanded its business to include R&D and manu-facturing of all types of computer,including the hardware and software of all personal computers, servers and mainframes.In the1990s,under the leadership of Louis Gerstner,the company adjusted its strategy and chose to focus on two major lines of business:software,and service provision.Conse-quently,it sold its manufacturing plants,hard disk drive and printer businesses.While corporate revenues did not grow much due to such sales,the gross profit margin improved dramatically,and so did the net income.In addition,the businesses that IBM disposed of performed well under their new owners:that is,it led to win–win outcomes.Viewed in this context,IBM’s intention to sell its PCD business was really a continuation of this strategy initiated by Gerstner.

With regard to the second question–whether Lenovo could turn around IBM’s PCD from a money-losing venture into a profitable business–we discovered that IBM PC’s gross profit margin was around24%.This was,in fact,much higher than that of Lenovo’s,which was about14%.However,the latter has a5%net income whereas the former was not profitable.The reason was quite simple:costs and expenses were higher,some of which were unavoid-able as long as the business was still part of IBM. Let us take the example of the overhead costs of IBM’s headquarters,which are allocated to all business units based on their turnover contribu-tion.PCD had a turnover of over$10billion, accounting for one-ninth of the group’s overall revenues.Although it had a higher gross profit margin than other companies in the PC industry,it was still very low compared with the software and services business within IBM.Thus the heavy allocation of headquarters overhead eliminated the profitability of PCD.We felt that this situation could be greatly improved under Lenovo, however,because we were recognized in China for our cost control and operational efficiency in manufacturing:in Chinese,we refer to this as ‘wringing water out of a towel to get more income’. Thus Lenovo’s strategy contrasted with IBM’s philosophy of high investment with high return. We could find ways to reduce costs dramatically in R&D,all operational processes,manufacturing, service and IT management.There were also opportunities for synergies in procurement.Profits could also be greatly improved by merely control-ling overall costs and expenses.For example,the assembly cost per unit in the US was US$24 compared with US$4in China.In the final analysis, we concluded that it was not a question of whether we could turn the PCD around so that it become profitable,but rather a question of how profitable it could be.In other words,‘We y found that this was not a question of wringing a few more drops out of the towel,it was a question of getting bucket-loads more water’(Ling,2006:363).

In addition,the growth of PCD in IBM was constrained by IBM’s overall strategy of focusing on its software and services businesses.Thus there was little room for maneuver for PCD.For example,it sold products only to commercial clients,but not consumer clients.Under Lenovo,the situation would be very different.Consider the case of IBM’s Thinkpad and Lenovo’s PCs.The former would be targeted toward large clients,such as high-end small-and medium-sized businesses,whereas Leno-vo’s PCs would be directed at the consumer market and the majority of small-and medium-sized businesses.In this way,we could accomplish the dual positioning of our products.

The third question revolved around the types of risk associated with the acquisition,and how we could manage them.We recognized at least three types of risk:market,employee,and business and cultural integration.I will briefly explain each of these.

With regard to market risk,there was the question of whether people would want to buy a high-priced product made by a Chinese company. In other words,would the new company lose clients?We did several things to help reduce this risk:we kept the brand name intact by using the IBM logo on Think products for the next five years; we retained the sales team of the former PCD, and sent out over2,000people to our customers to reassure them that the new company would provide the same quality products and level of service;and we established our headquarters in New York–this will gradually be relocated to Raleigh,North Carolina.These measures have yielded good

results.

Journal of International Business Studies

In the area of employee risk,we were concerned that former PCD employees might not be willing to work for a company whose major shareholders were Chinese.This risk has also been controlled,thanks to our efforts in two important regards.

First,we publicized widely our vision to manage-ment that the new Lenovo would provide more career opportunities for progression to top manage-ment,which were more limited under the former IBM PCD.We emphasized that we were not a traditional Chinese company,with a rigid and closed mind;rather,the culture of the new Lenovo is fully open and global.The official language of the new Lenovo is English.This set the employees’minds at ease.In one of my visits to Raleigh I had conversations with the employees there.One of the research engineers told me that,in the past,he had felt he was working to survive,whereas now he was working to win for the future!As a result,we did not suffer any major loss in key personnel.In the new Lenovo,about one-half of top management positions are occupied by Chinese and the remain-ing one-half by former IBM PCD employees.The Chinese occupy the positions of chairman of the board,chief financial officer,chief technology officer and chief of global supply chains.Steve Ward,who was senior vice-president under IBM, served for a year as CEO.During this time,he managed the transition.When the transition stabilized,we replaced him with William Amelio, former senior vice-president for Dell’s Asia-Pacific and Japan region.While Steve Ward did a good job in managing the transition,the board of directors felt that we needed someone who would better lead the company in an increasingly competitive indus-try.3This change was well received by our clients and the stock market.

Second,we announced that there would be no changes to the compensation of former IBM employees.People were happy to hear that–and thus the risk of losing talents was well controlled. As far as the risk of business and cultural inte-gration was concerned,we feel that this process is proceeding smoothly,for the following reasons. Despite differences,we realized that both compa-nies had much in common.For example,both IBM PCD and Lenovo insisted on world-class standards of operations and management.Thus there were few difficulties in the business transition.Because we have complementary business scopes,this greatly reduced conflict and possible overlaps in business and operations.For example,Lenovo’s operation focuses on China,whereas IBM PC’s focus is overseas.Hence there was no problem of employee redundancy.4Our experience was differ-ent from HP’s acquisition of Compaq.In that case, both HP and Compaq had subsidiaries in countries around the world,and so there were many over-lapping businesses.For example,HP employed 1000people in China and so did Compaq.Thus 1000people might have to be laid off as a result of the acquisition.Furthermore,tremendous prepara-tions were made for the transition.For example, Yuanqing Yang,the present Chairman of Lenovo, and Steve Ward,then CEO of Lenovo,had reached an agreement on three guiding principles and,in the process,set a good example for the whole company to follow as far as cooperation was concerned.The three guiding principles designed to join the employees from two cultural back-grounds,both national and corporate,were candor, respect,and compromise.

Let me give two examples of compromise.One pertained to the location of the corporate head office.At first,Lenovo wanted dual head offices so as to avoid potential problems with the Chinese authorities,including such matters as taxation. Steve Ward insisted on retaining the head office in the US.Lenovo conceded by relocating its head office to New York.A second compromise pertained to compensation.IBM had the policy of fixed salaries,whereas Lenovo favored a lower fixed salary with bonuses tied to performance.Based on mutual understanding,we reached an agreement. In other words,in order to promote common interests,we divided issues into significant and inconsequential ones.For the latter,we felt that there was no point in wasting time and energy on them,so that we could focus our attention on the significant issues that need to be addressed.We realized that,if we did not compromise,there would be conflicts where no progress could be made.And it might even lead to destructive factions of two different nationalities within the company.We have yet more work to do in the area of cultural integration.I am happy to say,though,that thus far we are progressing satisfactorily along this front. Of course,price was an important issue in our negotiations.After one year of talk,an agreement was made.IBM sold its PC business to Lenovo for US$1.25billion,of which$650million would be paid in cash and$600million in shares.IBM now holds13.4%shares of Lenovo.In addition, three private institutional investors invested$350 million in Lenovo and together hold a10.2%share of the company:they are the Texas Pacific

Group, Journal of International Business Studies

General Atlantic LLC,and Newbridge Capital LLC. Beyond capital,the latter three brought their rich experience in M&A and networks as far as human talent was concerned.They have provided solid and invaluable assistance to the board and its manage-ment team.For example,we strengthened the leadership by the board to help Steve Ward lead the business in the transition period.We set up a strategy committee at the board level that consisted of shareholders and major investors.This commit-tee played a major role in setting strategies and operations in the new company’s first year:all major decisions were made at the board level. Through the extensive networks and connections of our board,and particularly the three private institutional investors,we were able to identify Amelio as the new CEO of Lenovo.

The new board is very strong,and espouses a common vision.One-third of the board members are from Hong Kong,as Lenovo is a Hong-Kong-registered company;another third of the board members come from the US and Europe;and the rest come from China.

One year has passed since the closing of the deal. From April2005to March2006Lenovo had a worldwide PC shipment of14.4million sets:this made up 6.4%of global market share,with an annual growth of over15%.The notebook business accounted for48.9%of the group’s revenues,and has become the new growth engine for the company.The group’s revenue reached HK$103.6 billion(approximately US$13.33billion).Our gross profit margin reached14%,1.1points higher than that of the previous year.The company was profit-able in its very first year of integration.

In the past year,the process after acquisition has proceeded smoothly,and we are on track.5 One of the most important lessons we have learned from this is to think clearly and systematically before we proceed.We gave a lot of thought to the purpose of the acquisition,strategies to be followed and measures to be adopted to counteract all possible risks and potential problems.Such systematic thinking should be done not only by the chairman and CEO,but also by people with expertise in these areas.Although unforeseen contingencies are inevitable,by and large things proceeded smoothly,because we have clearly thought about these issues in advance.6We recog-nize that we still have a long way to go to attain full integration.In the final analysis,regardless of whether we are successful or not,Lenovo’s acquisition of IBM’s PCD will make an interesting MBA case.

Thank you!

Notes

1See Lenovo’s home page:https://www.wendangku.net/doc/0715279844.html,/ lenovo/ca/en

2Mr.Liu’s presentation in Chinese was translated into English by his assistant,Mr.Jason Zhou.

3Yuanqing Yang was quoted as saying:‘We are now entering into a new phase,a profitable growth phase, and our board wants to see more aggressive growth in this period y Mr.Amelio has the perfect background to lead us on the path to profitable growth’(Zhang and Sellami,2006).

4In March2006,as part of its restructuring plans to reduce costs,Lenovo reduced its workforce by5%,that is,approximately1000jobs(New York Times,2006).

5In May2006,because of national security con-cerns,the US State Department announced that it would not use the16,000computers it bought from Lenovo for classified work.

6Lenovo’s net profits for the3months ending on30 June2006fell87%,including a$19million write-off for laying off1000workers in March(Lee,2006).

References

Business Week(2000)‘50leaders at the forefront of change’,Business Week,3May,[www document]https://www.wendangku.net/doc/0715279844.html,/ 2000/00_27/b3688009.htm(accessed3April2007). Economist(2001)‘Legend in the making’,13September,[www document]https://www.wendangku.net/doc/0715279844.html,/displayStory.cfm?story_ id?780748(accessed9May2007).

Lee,M.(2006)‘Lenovo net profit dives to US$5million’,The Standard,4August,[www document]http://www.thestandard. com.hk/news_detail.asp?pp_cat?1&art_id?24324&sid?916 1919&con_type?3.

Ling,Z.J.(2006)The Lenovo Affair(translated by M.Avery)John Wiley&Sons(Asia):Singapore.New York Times(2006)‘Lenovo cuts1,000jobs in bid to shave costs’,New York Times,17March,summary available at http:// https://www.wendangku.net/doc/0715279844.html,/articles/2006/03/16/business/techbrief.php. Rukstad,M.G.,Chen,H.,Qin,H.,Ye,G.and Yin,Z.(2001)‘A tech-nology legend in China’,Harvard Business School Case,5April. Shenzen Daily(2004)‘Liu Chuanzhi:the man who acquired IBM PC’,[www document]https://www.wendangku.net/doc/0715279844.html,/english/ NM-e/115844.htm#.(accessed3April2007).

Zhang,J.and Sellami,H.(2006)‘William J.Amelio:heading the New Lenovo’,City Weekend,1January1,[www document] https://www.wendangku.net/doc/0715279844.html,/en/beijing/cib/2006_01/william-j-amelio-heading-the-new-lenovo.html,subscription

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