The dragon has gone on a diet, and half a globe away, some of the Chicago area’s most prominent companies are feeling the pinch.
While China remains a market with huge potential, its nearly insatiable appetite for such American products as Oreos and Big Macs appears to have eased, a reflection of a slightly slowing economy and a new emphasis on frugality, part of a government plan to combat corruption.
Deerfield-based Mondelez International Inc. revved up its marketing of Oreos and Chips Ahoy and introduced Golden Oreos to Chinese consumers in 2013, but its cookie and cracker revenue in China rose 2.1 percent in the third quarter, a far cry from 16.3 percent growth in the quarter last year. For some of the firm’s Chinese managers, “this is the first time these categories have slowed down on their watch,” Irene Rosenfeld, chairman and CEO, told stock analysts recently.
In June, McDonald’s Corp. added rice wraps and bowls to its offerings of Big Macs and fries in China, but it had a 4.2 percent decline in same-store sales during the first 10 months of the year. It slowed its pace of 2013 store openings in China.
Hyatt Hotels Corp. reports softening banquet sales, which it attributed to the government’s austerity plan.
“If you go to dinner and can order a $100 bottle of wine or a $20 bottle of wine, you will end up ordering the $20 bottle,” said Hyatt President and CEO Mark Hoplamazian.
Meanwhile, some of Illinois’ leading manufacturers, including bulldozer giant Caterpillar Inc. and Motorola Solutions Inc., maker of two-way radios, warn of potential risks as the world’s second-largest economy downshifts, steering away from massive infrastructure investment and toward a more consumer-driven system with opportunities for greater competition in the marketplace.
Others, like Chicago-based wallboard producer USG Corp., are exercising caution as they increase their footprint in China, aware of the housing bubble and concerns about the safety of intellectual property.
While long-range expectations remain high in light of economic and social reforms announced in November and the swift rise of an urban middle class estimated at 300 million and mushrooming, the increasingly sophisticated market no longer looks like such a clear sprint, at least in the near term.
“After 30 years of breakneck growth, China has reached a new stage,” Chinese economist Yu Yongding said in a recent lecture to the Chicago Council on Global Affairs. “Faced with choking smog, ubiquitous waste, lackluster foreign demand and fast decline in capital efficiency, China has no choice but to change its growth pattern.”
The ripple effects are felt across the world, of course, not just locally. But Chicago and the entire state gain much of their economic heft from the multinational companies headquartered here. In fact, Mayor Rahm Emanuel last week visited China, aiming to boost ties by meeting with the nation’s commerce minister and signing economic partnership agreements with eight cities.
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When shifts in China translate to reduced profits, that can be felt in myriad ways in the Chicago region, from headquarters staffing levels to corporate income tax payments.
“China is now a $300 billion market for U.S. companies. It matters,” John Frisbie, president of the U.S.-China Business Council, said at a recent panel discussion in Chicago.
A survey of the business council members — U.S. companies that sell goods and services in China — found that optimism levels tapered this year.
Increasing competition from other multinationals, as well as Chinese firms, together with rising costs for labor, land and currency exchange are “squeezing margins — companies are definitely feeling that,” Frisbie said.
Corporations also feel the effects of a slowdown in gross domestic product growth, from between 9 and 10 percent in recent years to a current range of 7 to 8 percent, and President Xi Jinping’s frugality push, launched last December, to combat outrage over corruption scandals and the lifestyles of so-called princelings.
Mondelez cited these factors when discussing this year’s slump in sales growth for its China business, largely “biscuits,” or cookies and crackers, including green tea-flavored Oreos.
The downturn came after the company had doubled net revenue in China in the previous three years, to $1.1 billion in 2012. The company expected the softness to continue in the fourth quarter and then to progressively improve in 2014.
“There is no question that some of the government policies are impacting gifting in particular, and biscuits is a big gifting item,” Rosenfeld said during the third-quarter earnings call with analysts. “We’ve taken a number of steps to improve our pricing and sizing.”
The company also changed its leadership in China and instituted daily tracking of sales.
Hoplamazian, of Chicago-based Hyatt, sees Xi’s austerity program as “the new normal for the foreseeable future.” The company, which entered the greater China market in 1969 and manages 23 luxury hotels there, expects to launch its first more budget-minded inns there in mid-2014 — a co-branded Hyatt Place and Hyatt House in Shanghai.
“They are designed to appeal to and be accessible to a broader population base,” he said.
Oak Brook-based McDonald’s faces more than the usual macroeconomic pressures.
Competitor Yum Brands Inc., whose stable of restaurants includes KFC and Pizza Hut, is engaged in very aggressive pricing, said R.J. Hottovy, senior restaurant analyst for Morningstar Inc. Yum and McDonald’s were hurt earlier in the year by a China Central Television report in late 2012 that two former suppliers had sold them chicken with unhealthy levels of antibiotics.
Kenneth Chan, CEO of McDonald’s China, announced at a November investors meeting that the company would make “extra value” offerings available all day, rather than just at lunch and dinnertime. The company also rolled out bargain pricing on its Spicy Chicken Filet sandwich and introduced Spicy Pork McBites, hoping to capture a portion of China’s appetite for pork.
The company slowed its store-opening pace in China in 2013, projecting 275 by year-end. This falls short of earlier plans for 300, which would have put the company at the 2,000 mark — double the level in 2008.
The company expects to cross that threshold in the first quarter of 2014. Chan said the company plans to return to a 300-a-year pace in the coming year.
“China continues to be the major consumer growth story of our lifetime,” he said at the meeting. Though China’s growth rate has moderated, it is expected to remain two to three times greater than in the U.S.
Analysts agree that long-term prospects remain good for consumer product companies. “There should be enough untapped potential in a country like China to still get rapid growth,” said Thomas Graves, an equity analyst for S&P; Capital IQ, referring to the outlook for Mondelez.
Observers also see promise in the social and economic reforms that came out of November’s Communist Party plenum, which aim to accelerate urbanization and open doors to more private competition by 2020. But they remain cautious.
“In the longer term, they seem to be pulling the right levers. … But there are short-term concerns that would have me really think twice about making strong moves into the country,” said Northern Trust Co. senior analyst James Pressler, citing high debt levels, a real estate bubble and speculative investment activity.
A number of Illinois manufacturing companies remain uncertain about how the changes will affect their place within the Chinese market.
Schaumburg-based Motorola Solutions, which sells two-way police radios and other products in China, expects to end 2013 with high-single-digit to double-digit growth but has concerns about the emergence of Chinese competitors.
“In markets or technologies where China chooses to compete, they do so and will, I think, initially preference their local indigenous providers,” CEO and Chairman Greg Brown said in a recent meeting with the Tribune Editorial Board. “It’s a little too early to tell to what pace and what degree that happens for our business in 2014.”
China is looking to develop its own standards for two-way radios, for instance, and Motorola would like to have access to those standards so it can compete head to head. It is hoping for such clearance in the first half of 2014, Brown said.
Caterpillar also is facing increased local competition in a shifting landscape.
For many years, the Peoria, Ill.-based producer of earth-moving equipment enjoyed a sweet spot as China pushed ahead with infrastructure projects, particularly because there was a dearth of local competition. That appears to be changing at a time when demand for equipment in the mining sector is weak, analytics firm Seeking Alpha stated in a recent report titled “Caterpillar Has a China Problem.”
Also, China is expected to experience a pullback in government stimulus projects.
Though Caterpillar saw China sales and revenues increase by about 30 percent in the third quarter, to $800 million, the company also cited “significant risks” that could temper global growth, including China’s transition to a more consumer-driven economy.
Still, Edward Rapp, a group president, said he was confident the company would continue to thrive in China.
“There still will be urbanization, which will require build-out of roads, housing and water,” he said.
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Jim Metcalf, chairman, president and CEO of Chicago-based plasterboard-maker USG, opted to expand in China in spite of some short-term challenges.
This fall, the company, which had a ceiling tile factory in China with a local partner, agreed to form a joint venture with Sydney-based Boral Ltd. The deal will give it plasterboard manufacturing capabilities in China as well as a presence in 11 other Asian countries. USG agreed to pay $500 million in the transaction, which is expected to close in January.
Metcalf recognizes there is a housing glut in some cities and a highly competitive landscape.
He sees potential because of the relaxation of the one-child policy, an outcome of the plenum, as well as the increasing involvement of American architects on Chinese projects, fueling more Western practices in a region where concrete interior walls are still common.
And then, there’s the sheer size of the nation, which is approaching 1.4 billion people.
“You have to be in China,” he said. “It is a long-term play.”
Twitter @kathy_bergen