ORGANIZATIONAL DYNAMICS, LEARNING FROM PRACTICE Strategic Action at Lenovo*

Jerry Biediger Tracy DeCicco Timothy Green Greg Hoffman David Lei Karthik Mahadevan Jane Ojeda John Slocum Kyle Ward

* This research was sponsored by a grant from the OxyChem Corporation made to the Management and Organizations Department, Cox School of Business, Southern Methodist University. Portions of this paper were discussed at the 21st Pan-Pacific Conference, Anchorage, Alaska, May, 2004. The authors would like to thank Anita Bhappu, Billie Boyd, Mel Fugate, Don Hellriegel, Peter Heslin, JoAnn Lan, and Ellen Jackofsky for their constructive comments on an early draft of this manuscript. Please address all correspondence to: Professor John Slocum Cox School of Business Southern Methodist University Dallas, TX 75275-0333 jslocum@mail.cox.smu.edu. 214-768-3157

Executive Summary Lenovo Group Limited is the largest information technology (IT) corporation in the Peoples Republic of China (PRC). It has long dominated its home market in the manufacture of personal computers (PCs), and now harbors ambitions to enter other related electronics businesses on a global basis. Using the diamond business strategy model proposed by Hambrick and Fredrickson, we highlight how Lenovo crafted its business strategy to build and sustain its competitive advantage in PCs in Asia. Furthermore, we highlight some of the critical success factors that have enabled Lenovo to attain its competitive advantage over the past two decades in the Chinese market. In addition, we consider some actions that Lenovo may undertake in the next few years to build more enduring sources of competitive advantage as it strives to become a global powerhouse. The lessons that apply to Lenovo may also be instrumental to other Chinese companies seeking to design and produce name-branded products for the global marketplace.

Introduction Business strategies must be based on some source of competitive advantage to ensure the firms success. Distinction is a key driver of any organizations effective strategy. A firm is only as profitable over the long term as it is distinctive. Recently, Hambrick and Fredrickson have provided us with an analytical model to examine the strategy of a firm. They propose that in order for a firm to have a viable business strategy, senior managers must be able address five key pillars of strategy by answering these questions: Arenas: In what markets will the firm compete? which product categories? which geographical areas? which core technologies? Vehicles: How will the firm get there? by internal development? joint ventures? acquisitions? licensing? Distinguishing features: How will the firm win in the marketplace? Is it through image? styling? customization? price? Staging: What is the sequence and speed of moves? Economic logic: How will the firm obtain its economic returns? Will these be achieved through lowest costs through scale advantages? premium prices due to service? premium prices due to proprietary product features? Hambrick and Fredrickson argue that a successful business strategy addresses all five questions. These questions must be addressed for the following reasons. First, senior managers need to make decisions. All five questions require investments that cannot be generated simultaneously. The focus is on using the firms core competencies in specific market segments. Second, the answers to all five questions must be aligned and coexist with each other. That is, there needs to be an internal consistency among the elements of a business strategy. Internal consistency provides coherence to an organizations initiatives. It also serves as the basis for enhancing and renewing the firms source of distinction vis-avis its rivals. As Lenovo seeks to enter new businesses and markets outside of China, we use this firm to illustrate the answers to these questions. Moreover, we also address the critical success factors that Lenovo must nurture to sustain its competitive advantage. Equally important, as Lenovo seeks to enter new markets outside of China, the firm must 3

be willing to implement new actions that will promote enduring sources of competitive advantage on a global basis. Early History Based in Beijing, Lenovo Group Limited is the largest manufacturer of personal computers (PCs) in China with annual sales of more than $24 billion in U.S. dollars (USD) in 2004, and a market share of 30 percent. Its sales for first quarter of fiscal year 20042005 have risen by more than twenty-one percent. It remains one of Chinas powerhouses in its bourgeoning and fast growing high-technology industries. Yet, Lenovo today is confronted with numerous strategic challenges as the firm considers its future not only in newer generations of PCs, but also in other electronic gadgets and information technology services. In some ways, how well Lenovo manages its own growth and strategic direction may be a bellwether for the transition and integration of the entire Chinese economy into the global economy. Lenovo (originally known as Legend Group) began as a spin-off of the Chinese Academy of Sciences (CAS) new technology unit in 1984. Initially, Lenovo was a reseller/distributor for AST computers in China and Hong Kong and then expanded to resell other foreign brands like Hewlett-Packard and IBM. Lenovo started making its own brand PC in 1990. Lenovo became the first Chinese brand to outsell any foreign brand (not just PCs) in China in 1996. By 1997, it had become the countrys best-selling PC. In 2003, it had a market share in China of approximately 30 percent, according to International Data Corporation. Lenovo is the number-one PC brand in the Asia Pacific market (excluding Japan) with a market share of 12.4 percent. Besides the manufacturing and sale of PCs, Lenovo has recently begun manufacturing motherboards in Hong Kong, mobile handsets, and hand-held devices. It provides IT (information technology) consulting services. Overall, Lenovo is the largest computer company and the second largest electronics manufacturer in China. The major shareholder of Lenovo is the Chinese Academy of Sciences, providing Lenovo with strong technological support and broad connections (guanxi) in the PRC. This is strategically important because Liu Chuanzhi, Lenovos founder and chairman, is able to maintain close working relationships with the Chinese Institute of Technology, where he has established strong relationships with the government.

Strategic Action Hambrick and Fredricksons innovative model of strategy can be used to guide managers in thinking through five key pillars that lay the foundation for a sustainable, distinctive business strategy. We will discuss and apply each of these pillars as they relate to Lenovo. Arenas Arenas indicate where the business will be active, and how much emphasis will be placed on each area. Lenovo is engaged in the manufacture and sale of Lenovo brand personal computers (PCs), hand-held devices and mobile handsets for the Chinese market, and has begun providing advanced IT services. Lenovo also contract manufactures motherboards, mobile handsets and hand-held devices for other original equipment manufacturers (OEMs). Lenovos geographic scope encompasses the Greater China and Asia Pacific markets. Lenovo manufactures its PCs in Beijing, Huiyang and Shanghai, with a total annual production capacity of about 4.5 million PCs (desktops & laptops). The company places major emphasis on delivering solutions to the corporate IT segment (56 percent of revenue), and consumer IT (30 percent of revenue). There is a relatively low revenue mix from hand-held devices (8 percent of revenue), contract manufacturing (4 percent) and IT services (3 percent of revenue) at this time. These revenue figures are from 2003 financial statements. It is clear that the combined corporate and consumer IT segment is centrally important to Lenovos strategy, whereas hand-held devices and IT services simply broaden the line of offerings for its customers. The growth of these newer, non-PC-related arenas is becoming important to Lenovo in several ways. First, the PC industry is beginning to feel the heat of growing foreign competition in China. U.S. companies such as Hewlett-Packard Co. and Dell Computer Corp. are beginning to make serious inroads into the Chinese market, with the latter company even capturing some important contracts from the Chinese government. More important, the PC industry is beginning to mature, particularly as newer technologies enable Chinese consumers to communicate with each other over the Internet through nonPC devices. Also, Lenovos ability to compete in the Greater China/Asia-Pacific market will begin to face the prospect of new, indigenous competitors in many of these markets, as upstart firms in these countries begin to climb the high-technology industry food chain.

Vehicles Beyond deciding on the arenas in which the business will be active, the executive also must decide on how to get there. Vehicles are the means (e.g. internal product development, joint ventures and licensing) for attaining the needed presence in a particular product category, market segment, geographic area, or value creation stage. They are the result of deliberate strategic choice. Initially, Lenovo achieved its competency in PC distribution through joint ventures (JVs) with PC original equipment manufacturers like AST, Hewlett-Packard, and IBM Corp. Lenovo began its existence primarily as a manufacturing/outsourcing platform to build keyboards and other simple devices for larger, well-heeled multinational firms. However, the company quickly learned how to build an entire personal computer system. Of course, Lenovo needed more than manufacturing alone to succeed. Through these joint ventures, Lenovo increased its competence in PC distribution, and gained an understanding of the needs of Chinas computer market. Lenovo learned the most from Hewlett-Packard. It was through Hewlett-Packards distribution system that the Lenovo executive team learned how to organize sales channels and how to market PCs. As Lenovo developed capabilities to assemble PCs, the company began to backward integrate to manufacture motherboards and other key subassemblies, to increase their value to their joint venture partners as low-cost producers with guanxi. This gave Lenovo a growing depth and breadth of competencies needed to assemble, manufacture and market PCs. Once those competencies were mastered, they developed their own Lenovo PC brand. Because of the first-hand experience gained in building PCs and the willingness to learn from JVs, Lenovo developed a strong domestic base of technological know-how that enabled the company to capture a growing share of the Chinese domestic PC business. This experience helped Lenovo reduce the normal uncertainty and risks caused by poor market planning and product development delays typical of upstart companies. Unlike other businesses where it entered into joint ventures, Lenovo started its IT services business through its own internal development. Its first service business was a PC customer support unit. Then Lenovo extended its service to provide some integrated software services, including basic networking of all PCs for small businesses in China. Lenovo is still working its way up the services value chain. They see it as a growth engine in the future because there are 10 million small (less than 200 employees) companies in

China that Lenovo can service. However, this field also represents an important challenge for Lenovo, since building a service-based infrastructure in a vast country requires significant investment in new kinds of service centers, deeper understanding of networking technology, infrastructure, and training of customer service associates. If successful models are developed, it might be possible for service centers, whether for product, training or consulting, to be franchised. Franchising could speed up Lenovos growth and reduce the investment on building infrastructure. Meanwhile, it reduces liability and increases market reach. The Internet boom in late 1990s and early 2000s led to consumer demand for devices other than PCs to access the Internet and perform computing. As a result, Lenovo entered the growing hand-held device market. This would not have been possible without Lenovos conscious choice to spend research and development (R&D) monies as a means to fuel expansion. The decision to enter the hand-held and other consumer electronics markets represents an important turning point for Lenovo. The firm must now begin to think about designing an entirely new line of products for different market segments. Lenovo Chairman Liu Chuanzhi recognized the company needed to spend more to develop distinctive products. "If we do not achieve breakthroughs, there will be greater uniformity in PCs and other products, Mr. Liu said. Lenovo has been spending about one percent of its annual revenue on research and development. Mr. Liu indicated that would increase to two or three percent. "If necessary, it may grow further than that. This is still relatively low when compared with IBM, which spends six percent of its $84 billion revenue on R&D. R&D investment needs to be based on the strategic direction of the firm. Where is Lenovo going with its products and services? Distinguishing Features Distinguishing features refer to attributes that enable a company to distinguish itself from its rivals and gain market share. They require executives to make up-front, conscious choices about which strategic assets will be assembled, refined, and deployed to beat competitors in the fight for customers, revenues, and profits. Lenovo is focused on domestic competitive advantages to increase its market growth. The strongest distinguishing feature that Lenovo has is its ability to understand the Chinese market, its values, and preferences. By building their computers for domestic use only, Lenovo has

concentrated on integrating the Chinese ideographs and symbols into their input mechanisms (for instance, keyboards and icons designed for Chinese characters and culture). As a result, it has been difficult for U.S., Japanese, and European firms to compete effectively in the Chinese PC market. Many foreign firms in other sectors, such as Lehman Brothers, DaimlerChrysler and Foxboro Company, all experienced difficulties establishing their presence in China. The reasons for failure include trade barriers, not understanding the changing role of the Chinese government, lack of negotiating acumen, and disparate communication competencies. Distinguishing features create barriers to entry for foreign competitors, such as Dell, IBM, and Hewlett-Packard. In addition to a hardware advantage, Lenovo develops software with a firm understanding of the Chinese market. For example, accounting practices in China are different from those in the United States. Lenovo has designed their software to meet Chinese standards. Due to Lenovos leveraging of these competitive advantages, foreign firms must spend enormous amounts of resources to overcome these barriers to entry. Chinese consumers place value on these distinguishing features, as evidenced by Lenovos dominant market share in the face of foreign rivals. These core features that distinguish and insulate Lenovo from intense foreign competition may not last long. Indeed, to remain competitive requires strategic acumen. Lenovo will need a deep understanding of domestic markets as well as foreign ones, the current needs of customers in terms of product and service, and their future needs. For example, how will the iPod generation use products twenty years from now? Already, Dell Computer has begun to make inroads into China by replicating its direct customer sales model in some channels that has worked so effectively in the U.S. market. Even so, the company must take steps to further build its brand equity in the Chinese market. Although Lenovo excels in manufacturing computers and components, it has not yet created the kind of premium brand loyalty that deters customers from switching to other firms. In developed markets, people understand the importance of branding. If Lenovo has a line of high-end products, it must be able to find large-scale distributors in these markets. Lenovos sponsorship of the 2008 Olympic Games, to be held in Beijing, is designed to give the brand international household exposure, in much the same way that the use of Seikos time-keeping devices in the Olympic Games during the 1960s enabled it to become a

worldwide leader in watches. Perhaps this will convince businesses that Lenovo is a potent, low-cost, home-grown alternative to Dell, Hewlett-Packard and other competitors. Throughout its history, Lenovo has not been a technology leader. It has allowed international industry leaders to set trends, and has adopted a follower strategy. One of its core competencies is its ability to adapt technology to fit the needs of the Chinese consumer. Technology is in its infancy within China. Liu Chuanzhi realizes there is a benefit to the IT follower/learner strategy. For management, the long-term growth and sustainability calls for a balance between efficiency that may lead to cost savings, and creativity that may lead to trend-setting products. Following the trend is very much a part of the Chinese culture: docile and self-disciplined. It is not uncommon to see 15 managers supervise 5000 workers in China. On the other hand, a docile workforce lacks the sense of ownership and does not cultivate/reward independent thinking and creativity. Lenovos PC brand has surpassed Hewlett-Packards sales in China, and Lenovos printer is on its way to becoming the leading printer in China. Until recently, most multinational PC and electronics firms viewed China as a powerful outsourcing and manufacturing platform, rather than as a major consumer of high-technology products. Foreign company research and development has been focused towards the more developed international markets. This has allowed Lenovo to concentrate on R&D resources for the Chinese market. Liu Chuanzhi takes the stance that The biggest challenge is that the industry changes so much. We cant be like US companies that are in a position of leading the trends; the main thing for us is to keep up with the trends. People are a core driver of knowledge and innovation in technology-driven businesses like PCs and IT Services. Lenovo motivates people using a non-traditional Chinese reward system, including stock options to increase performance and reduce management turnover. This helps them attract highly talented professionals in the competitive technology environment in China. All white collar employees who have been in the company for more than two years receive stock options and, says Liu, [w]hen they reach upper management, they get a lot more. In addition, every employee gets extensive training through Lenovo University. A combination of opportunities for continuous learning and growth along with motivational tools helps Lenovo utilize their key assets (human) effectively. As a people-oriented enterprise, it has created a unique corporate

culture. Chairmen Liu believes that providing staff with an excellent living and working environment helps their creativity. He believes that the perpetual motion that drives Lenovos success is its invaluable human resources. Staging Choices of arenas, vehicles, and differentiators constitute what might be called the substance of a strategy, or what we plan to do. This substance mandates decisions on the fourth element in Hambricks and Fredricksons model. Staging refers to the speed and sequence of strategic moves to be taken in order to heighten the likelihood of success. Lenovo created a leveraged IT consulting/services business from its core product business. However, the company is still finding it difficult to achieve competitive advantage in consulting. IT-related service may still be quite new in China. Consulting and training, although more profitable, may not yet be understood as value added to the business in China. Therefore, on one hand, there is great opportunity; on the other hand, Lenovo will have to convince its customers to initially accept a lower return on investment (ROI) to pay for these services. This will be a great challenge because it will require a paradigm shift in order for the Chinese to accept and understand such services. In developed markets, training and consulting are used extensively, but not in China. This is evident from Lenovos low market share (2 percent). The dominance of major consulting firms such as IBM Global Services, Accenture and the presence in China of services companies from India like Infosys and Wipro have made Lenovo a minor competitor in this market. With its current competencies on developing integrated software solutions for its hardware products (value additions to PCs) and support services, we believe that Lenovo will have to go through a steep learning curve to gain competencies that can turn into competitive advantage in the services business. Likewise, the infrastructure requirements to develop a sustainable IT consulting business are enormous. This particular industry segment demands state-of-the-art knowledge about a variety of software platforms, middleware, and applications that corporate customers demand in a one-stop-solution format. For Lenovo to become a serious contender in this arena, it must also learn and further refine its software and applications businesses to provide customers with the kind of intimate knowledge that is required for solving enterprise-wide challenges and issues.

10

When talking about software development, what is salient is the open-source movement or a partnership. This also might require a paradigm shift in the minds of Chinese business people. That is, there can be a win-win where all parties share profits, and competitors can be allies. The logic of traditional Chinese thinking is If Zang makes the money, then Li must be losing money. The final step in the sequence of evolution is Lenovos foray into hand-held devices. Lenovos dominance in this market (evidenced by its 20 percent share in a fragmented, growing Chinese market) can be explained by the company learning how to leverage its core capabilities in contract manufacturing and final assembly of PCs into hand-helds. It also had the existing infrastructure to deliver products in the marketplace. This move reflects an important strategic inflection point for Lenovo. The top leadership must now decide if they want to further refine Lenovos PC-based competencies (and thus become more like Dell or Hewlett-Packard), or further diversify into new types of electronics (and thus follow a similar path taken by Samsung and Toshiba). If Lenovo develops a broad range of hand-held gadgets and other consumer electronic devices, it must begin to develop a strategy to compete with the likes of Nokia AB oyj, Motorola Inc., and Siemens AG all of which have important market shares in China itself. Economic Logic Economic logic refers to how the firm will generate profits above its cost of capital. A business strategy must clearly state how profits will be generated. Unless there is a compelling basis for generating business, customers and competitors won't let that happen. The most successful business strategies have a central "economic logic" which serves as the fulcrum for profit creation. In some cases, the economic key may be to obtain premium prices by offering customers a difficult-to-match product, such as Toyotas Lexus brand. Currently Lenovo allocates about 80 percent of its resources to make corporate information technology (IT) and consumer PCs. This is supported by the fact that 85 percent of its 2003 revenues come from these two business segments, which provide a 17 percent combined margin (corporate being more profitable than consumer). Using profits from this base, Lenovo has expanded into arenas such as hand-helds and IT Services and has built a broad portfolio of businesses. As it faces more competition from other vendors, Lenovo will need to focus more resources on its fledgling IT services business, where there is potential for

11

attractive margins upwards of 40 percent. However, this move into new businesses will present a series of important economic decisions for Lenovo. Can Lenovo become even more distinctive than Nokia or Samsung (in hand-helds) and IBM or Accenture (in IT consulting) firms which have similar ambitions in the Chinese market? Even if Lenovo can successfully compete with these long-established rivals, will Lenovo earn a compelling high rate of return? Leveraging Critical Success Factors Unique to Lenovo Over the past two decades, Lenovo has grown tremendously in its domestic market. With a stated goal of becoming a Fortune 500 company by 2010, Lenovo has to look at expanding into the global marketplace. To identify opportunities and to neutralize threats from competitors in the Chinese market, Lenovo has found activities that have allowed it to perform in ways that competitors cannot do as well. Even though numerous rivals may compete in the same industry, Lenovo has been able to perform five activities better than its rivals. However, the transition from competing solely in the domestic Chinese market to the wider (and more intense) global market will be an important test of Lenovos capabilities and management. In the following section, we identify these factors that have been critical to Lenovos success in the Chinese market, which still accounts for 96 percent of its business. Some of the strengths they have developed may be leveraged into international success. Management Aggressive Learning of Cutting-Edge Practices When China began to ease its governmental stranglehold on business and Lenovo began as a distributor for foreign companies in the early 1980s, Liu discovered that management was something he and his team had to learn. So they learned from foreign companies with which they collaborated while gaining an understanding of Chinas computer market. Liu and his team learned the most from Hewlett-Packard, as this U.S. giant has been a paragon of how best to manage large distribution channels and networks of value-added resellers in the PC and printer industries. Lenovos management is also studying other corporate models to further build on its business model. For example, Liu says he learned corporate governance from General Electric Co. through reading books on GE while spending time at the companys management-training center at Crotonville, New York. Liu and his management team constantly read foreign management journals (although they do so with

12

a mindset to apply the theories to the realities of China) and best-selling management books to learn new ideas. This commitment to learn and copy successful techniques is a potential strength as they venture into other geographic and cultural settings. Participation in Capital Markets Greater Shareholder Awareness Lenovo was one of the first Chinese companies to be listed on the Hong Kong stock exchange. Liu believes that this has had two major effects on Lenovo. The first was the ability to obtain capital from financial markets. The other is dealing with shareholder pressure. Shareholders inherently put pressure on firms to be more transparent and manage more systematically. Liu regards this type of pressure as a form of motivation, since its most fundamental objective is to serve the interests of its shareholders. An example of Lenovos transparency is that, while the Hong Kong stock exchange requires only semiannual performance reporting according to Hong Kong generally accepted accounting practices (GAAP), Lenovo reports quarterly as is customary in the US. Lenovo also creates two kinds of reports; one according to Chinese standards and other according to Hong Kong GAAP standards, as required by the Hong Kong Stock exchange. Lenovo does not make or sell PCs in the U.S., and therefore, does not report financials using U.S. GAAP standards. It also does not conform to all of the provisions of the Sarbanes-Oxley Act. Lenovo has a head start on most other Chinese companies, but there still need to be major changes in its accounting practices to meet international standards. Should Lenovo decide to become a publicly traded company in the U.S., it will have to make significant adjustments to its financial reporting and accounting systems to bring about the kind of transparency that is demanded by U.S. and other foreign investors. Manufacturing Moving Towards Greater Agility Lenovos ability to manufacture PCs according to customer needs and orders is another critical success factor. This is important because in the future their next biggest challenger is Dell. The costs of build-to-order are higher for Lenovo than for Dell, but so are the perunit profits. Lenovo has built channel relationships in China with more than 200 home-PC specialty shops (consumer IT) and more than 3000 dealers. These dealers do not want to abandon Lenovo by shifting to Dells direct model manufacturing strategy because of guanxi that they have established with Lenovo. Because of their channels, Lenovo has to carry higher inventory levels, which add to its inventory carrying cost and operating

13

expenses. This is unlike Dells direct model, where there is no channel inventory and lower operating expenses. Currently, Lenovo takes direct orders only from businesses. It doesnt take orders directly from consumers, largely because of Chinas underdeveloped electronic bank payments system and transportation infrastructure, which make business-to-business e-commerce almost impossible. Lenovo is preparing to compete with Dell in the global market by copying their direct selling methods in developed countries where e-commerce is easy. At the same time, Lenovo may be able to successfully transplant its existing channel-dependent model in less developed countries with similar infrastructure limitations to China, particularly in the Greater China/Asia Pacific region where PC demand is beginning to take off. In 2004, Dell opened its first manufacturing plant in Xiamen, China, to serve both the Chinese and Japanese markets. Dells global supplier networks give them a 10 percent cost advantage over Lenovo. Dell now can offer its computers through distributors, who act as purchasing agents for government agencies. Dells legendary manufacturing competencies are challenging Lenovos core manufacturing competencies. When the Communist Party invited bids for replacing hundreds of its computers in 2004, Ren Jinhua, chief information officer (CIO) for the Party, chose Dells because Lenovos main circuit boards had constantly burned out, and Dells price was lower than Lenovos by $2.50 per unit. Organizational Design Attributes Inducing Professional Practices Lenovo has created two levels of management. On one level there are the nuts and bolts of management, such as logistics management, marketing and promotions, etc. On a second level there is what Lenovo calls culture, but what might also be described as motivation and ethics. Liu feels that this is more problematic than developing the nuts and bolts of management. He has attempted to instill a different culture at Lenovo, hoping that the highest managers at Lenovo will come to work with a desire to serve the company. A Lenovo manager must first think of Lenovo as a career. Many employees in China take two days off per week to rest. At Lenovo, most employees take only one day off so that they can study. If Lenovo aspires to be a major global company, it needs to carefully evaluate its governance structure, and communicate it clearly through names and titles for others to read.

14

Another aspect of Lenovos organization and its enabling strategic objectives is its ability to execute in a rule-based system. A rule-based system is characterized by a reliance on rules to govern people/system interests (and information is largely public) as compared with a clan-based system, which is characterized by a reliance on personal relations (and information is largely local and private). Lenovo is a rule-based organization. As a publicly held firm, it relies on public information vis--vis the market to help guide its transactions, determine demand for its PCs, and set firm direction. This is an important step in Lenovos evolution, since the use of a rule-based system enables the firm to quickly institute new types of management programs and initiatives across the entire firm. It also represents an important step in the direction of professional management an important reform that has been lacking in most Chinese enterprises that still have strong nepotistic traditions, as well as influences of state-run administrative constraints. To compete more effectively as a manufacturer and distributor, Liu decided to separate the branded products from third-party distribution. Lenovo Computer (about 60 percent of Lenovos total sales) is focused on branded products while Digital China (about 34 percent of Lenovo sales) was spun off as a company that focuses exclusively on the distribution of third-party products. This helped Lenovo maintain its JV relationships with Hewlett-Packard for distribution, and at the same time, compete with them in the branded products. The Role of the Government Transitioning to Private Ownership The Chinese economy was planned and controlled by the central government in the 1950s and 1960s, and therefore, corporate leadership was not critical. The reform that began in 1978 brought revolutionary changes to previous management practices. Managers in stateowned enterprises (SOEs) found themselves having to lead and be accountable for decisions they made. Privately-owned enterprises (POEs) were regarded as illegal in the pre-reform era, but the reform has provided unprecedented opportunities for Chinese people to start their own companies. POEs are not typically allowed to enjoy support from the central government, as the SOEs do. However, they are free from the extensive government regulations that often hinder SOEs from moving quickly. Chairman Liu structured Lenovo like a private company POE from the beginning. Liu had to raise capital from banks and outsiders to get the company going. In addition,

15

when he discussed terms and conditions for Lenovo with the government, he requested the authority to make decisions himself. He also had financial decision-making power, so he could determine the wages and bonuses of his employees and was not required to perform strictly according to the governments whims. Liu wanted Lenovo to make its own PCs because he and his staff were technology experts. At the time, Chinas government wouldnt permit Lenovo to produce computers, because Lenovo had to have a license from the government. The Chinese government felt that the country already had too many factories and had difficulty rationalizing their support of another one and the issuance of a license to Lenovo. Accordingly, Liu crafted a strategy to go to Hong Kong, which did not require a license. He began the company in Hong Kong to trade in the PC market, but quickly established a factory for production as well. Consequently, Chinas central planning unit realized that Lenovo indeed had the capability to operate a factory and gave the company a license to manufacture in the PRC. Lenovo ultimately relocated to Beijing. Lenovos experience also shows the difficulty that entrepreneurial firms face when dealing with a Chinese legal system that is still in its infancy when considering such issues as contracts and private property rights. For example, in 2004, Huawei Technologies, a leading Chinese networking firm, had to stop production and revise new products because of intellectual property right infringements of Cisco routers. Actions to Create an Enduring Global Competitive Advantage If Lenovo wants to be a global company, it will have to make a conscious choice on whether to expand sales to other regions, like Europe and North America, and sell branded products or leverage its lower cost structure and make products for other OEMs and grow through large volumes. This means that Lenovo must now take important actions to reconfigure itself to compete on a global basis. However, this transition is not easy for a number of key reasons, many of which are applicable to other Chinese companies with similar global ambitions. One of the problems that Liu is wrestling with is the lack of brand recognition outside of the Asia Pacific region. For firms in the worlds industrialized countries, a critical aspect of business strategy includes global expansion. Businesses in China are not exempt from this trend. As Sony Corp. of Japan and Samsung of Korea have achieved, and

16

Haier of China is accomplishing, Lenovo Group of China keenly desires to be another success story for an Asian brand that began as a low cost product and developed into a premium global brand. For Chinas businesses in the worlds industrialized countries, the big hurdles are brand recognition, marketing skills, perceived quality problems, and innovation. The biggest obstacle for Chinese manufacturers is the lack of vital marketing acumen. For example, Lenovo has not invested in Chinas educational market, which enrolls millions of students. U.S. companies and educational institutions have signed multiyear contracts with Chinese institutions that guarantee low prices and services. In 2004, Lenovo launched two computer models in Italy, but the campaign failed for lack of an effective advertising strategy. Chinese businesses have mastered the feat of scale production and consequently manufacture goods at very low cost. But with this accomplishment comes the dubious perception that being Made in China also translates to made cheap to the rest of the world. China is very good at being a me-too producer, but must make efforts to innovate products through research and development as well. Regardless of R&D efforts, Chinese companies must begin to build their brands internationally, requiring both large capital expenditures and five to ten years before Chinese brands become truly global. Brand building is critical to global viability because it is a distinguishing feature attribute in Hambricks and Fredricksons model. The current distinguishing feature of low-cost can eventually be defeated by other low-cost wage countries, such as India and Malaysia. In late 2000, Wu Bangguo, chairman of the National Peoples Congress of the Peoples Republic of China, gave notice that the development of brands was essential for the nations continued growth. This sentiment is echoed at a panel discussion on branding where Fiona Gilmore of London consultancy Acanchi comments, They recognize that in the future they need to have brands, they dont just want to have to manufacture the products for everyone else. Branding is an important concern for many Chinese firms in other industries, such as Haier in refrigerators and appliances; Ningbo Bird in cell phones; TCL in consumer electronics and television sets. Lenovo initially existed as a government-influenced Chinese company doing business in China. It built its position on retail support to domestic customers and customized software to make computing easier in the Chinese language. Lenovo began to

17

move away from this insular business strategy by partnering with Hewlett-Packard as its Chinese distributor of Hewlett-Packard printers. Not satisfied with simply functioning as an OEM or a distributor to other global companies, Lenovo has embarked upon a quest for international importance. Since 2001, Lenovo has adopted a business strategy of focusing on high technology, service, global marketing, and diversification of products and services. With the expansion into the overseas markets in addition to its home base of China, Lenovo plans to gain 25 to 30 percent of its sales from overseas markets in three or five years. For Lenovo, global competition requires new strategies. Lenovo differs from Chinas prototypical top-down, price-cutting, grow-at-any-cost monolithic organization because it focuses on profits, and not simply volume. Unlike other SOEs, management at Lenovo understands that the companys success is not guaranteed by the Chinese government. Instead, the company rallies behind the philosophy of providing users with the best services. Foreign competitors, such as Dell, Hewlett-Packard, and IBM have made inroads into Lenovos territory. Dell, in particular, has been rapidly gaining market share in China (about seven percent), Japan and other countries by applying the same formula that made it so successful in the U.S.: managing lean supply and distribution chains to assemble reliable, competitively priced computers on order and delivering them quickly. Lenovos predicament highlights the growing pains facing other Chinese companies (e.g. Haier, China National Tobacco Corporation) as they strive to become global players while defending their market share from foreign rivals. Management has already taken some of these lessons to heart. In its effort to expand globally, Lenovo realized that it must re-brand itself. The companys original name, Legend, had many conflicts with products already established under the name Legend. In April 2003, Legend changed the name of its computers to Lenovo. In March 2004, Legend changed the name of the company to Lenovo Group Limited. The change has not been easy; the company invested 20 percent more on advertising to build a unique and popular English brand name. Hoping to mimic Samsungs overwhelming success in global brand recognition (Samsung saw a rise of 311 percent in sales in the U.S. after the Seoul games), Lenovo has signed an agreement to be the exclusive computing technology equipment and service provider for the 2006 Turin Winter Olympics and the Beijing Summer Olympics in 2008.

18

Lenovos president Yang Yuanqing predicts that the investment in brand and international image will have a reasonable return. The sponsorship will include supplying desktop computers, laptops, servers, desktop printers as well as funding and technical service. To illustrate the scale of this commitment, Lenovo will install 4,500 computers, 500 servers and 500 portable PCs for the 2006 Turin Olympics. To sponsor both Olympic Games will cost the company approximately USD $65 million to USD $ 80 million. In August 2004, Yang Yuanqing, Lenovos CEO, indicated that Lenovo was changing its strategy to actively pursue initiatives focusing on its core businesses and building a more customer focused sales organization. Lenovos corporate IT group and new PC products targeted for educational and government markets have penetrated their markets. The sales organization has been restructured to permit Lenovo to develop stronger ties with local townships across China. Conclusions The strategies and management initiatives that apply to Lenovo are clearly important models for other Chinese firms as well. Though most PRC firms strive to make a profit, they also are driven by longstanding government initiatives: providing jobs, producing at high volumes, and protecting the existing status quo. Using the Hambrick and Fredrickson model, we have been able to illustrate how Lenovos top management team must focus their business strategy to remain a competitor in the PC marketplace. More important, this strategic model points out some critical strengths and weaknesses of Chinese companies in general. Other Chinese companies aspiring to sell branded-products on a global basis face many of the same issues that confront Lenovo. Yet, they may have an even tougher time as foreign companies begin to produce and sell in China in earnest. Even Lenovo now faces the prospect of intensified competition on its home base. Dell, IBM, and Hewlett-Packard are aggressively marketing their products in China and establishing manufacturing facilities to achieve low cost. Lenovos guanxi initially generated business connections that foreign competitors could not match. Guanxi is grounded in trust, mutual obligations and shared experiences. The concept traces itself back to ancient Chinese social customs wherein reciprocity and mutual obligations were used to build and maintain interpersonal relationships throughout society. Other companies are increasingly adept at applying guanxi to build their own relationships, many with Chinese companies that are looking for

19

current OEM relationships to bridge into future global ambitions. While guanxi is still an important part of Chinas cultural heritage, Lenovo must focus on its manufacturing and marketing competencies if it is to remain competitive.

20

SELECTED BIBLIOGRAPHY For a good explanation of the importance of Confucianism and the role of the Chinese government in business, see W. Mobley, Special Issue on Leadership Challenges in Asia, Organizational Dynamics (2004): 1-109, and M. Chen, Inside Chinese Business: A Guide for Managers Worldwide (Boston, MA: Harvard Business School Press, 2001); J. Walsh, E. Wang, and K. R. Xin, Same Bed, Different Dreams: Working Relationships in SinoAmerican Joint Ventures, Journal of World Business 34 (1999): 69-93; J. Child. Management in China during the Age of Reform (Cambridge: Cambridge University Press, 1996); and P.Williamson and M. Zeng, Strategies for Competing in a Changed China. MIT Sloan Management Review (summer 2004): 85-91. For work on business strategy, see D. Hambrick and J. Fredrickson, Are You Sure You Have a Strategy? Academy of Management Executive 15, no. 4 (2001): 48-59. Also see D. Lei and J. Slocum, Strategic and Organizational Requirements for Competitive Advantage, Academy of Management Executive, in press. To read about Lenovo, see A. R. Gold, G. Leibowitz, and A. Perkins, A Computer Legend in the Making, McKinsey Quarterly, no. 3 (2001): 73-83; P. Coombes and M. Watson, Corporate Reform in the Developing World, McKinsey Quarterly no. 4 (2001): 89-92; P. Gao, J. R. Woetzel, and Y. Wu, Can Chinese brands Make it Abroad? McKinsey Quarterly, Special Edition (2003): 3-13; T. Hout and J. Hemerling, Chinas Next Great Thing, Fast Company, March 2004, 15-24; C. Hutzler. Computer Makers Woes Reflect the Heat Felt by Chinese Manufacturers, Wall Street Journal, 28 June 2004, http://online.wsj.com/ar; and the SinoCast China Daily News, a newspaper that prints stories about Chinese manufacturers.

21

Biographies
Jerry Biediger is vice president of finance for Transport Industries, L.P., a provider of transportation and warehousing services. Biediger is a C.P.A. and holds a B.B.A. from the University of Texas, Austin and an Executive M.B.A. from the Cox School of Business, Southern Methodist University. Tracy De Cicco is a sales operations manager for IBM. She has been with IBM for more than seven years. She finished her Executive M.B.A. in the Cox School of Business at Southern Methodist University in 2004, majoring in management. Timothy Green is a consultant for Attentus Solutions and holds a B.A. from Wright State University and an Executive M.B.A. from the Cox School of Business at Southern Methodist University. Greg Hoffman holds a B.A. from the University of New Hampshire, a J.D. from the University of Louisville, and an Executive M.B.A. from the Cox School of Business at Southern Methodist University. He is a regional sales manager with Thomson West, a global integrator of legal information and technology solutions. David Lei is an associate professor of business policy in the Cox School of Business, Southern Methodist University. He is author of Strategic Management and more than 40 journal articles in the area of business strategy and technological change.

Karthik Mahadevan is a senior consultant in the supply chain operations practice at IBM. He has consulted with companies in the semiconductor, telecommunications, electronic and aerospace industries in the areas of business process improvements and strategic initiatives. He holds a B.S. in mechanical engineering from PSG College of Technology in India, an M.S. in industrial engineering from Arizona State University and an Executive M.B.A. from the Cox School of Business at Southern Methodist University.

22

Jane Ojeda is executive vice president and chief financial officer (CFO) of Fritz-Pak Corporation, a global manufacturer of concrete admixtures. She holds a B.S. from Oregon State University, a Ph.D. from Texas A&M University, and is completing her Executive M.B.A. from the Cox School of Business at Southern Methodist University.

John W. Slocum is the O. Paul Corley Professor of Organizational Behavior at the Cox School of Business, Southern Methodist University. He is the author of more than 25 books and more than 130 journal articles. He consults with organizations in the areas of human resource management. Kyle Ward is currently working through the Officer Development Program at Southwest Bank of Texas in Houston. He has worked at Trammell Crow Company, Grubb & Ellis, and CB Richard Ellis in corporate real estate before accepting his latest assignment. He has an Executive M.B.A. from the Cox School of Business, Southern Methodist University.

23

24