China Rising

By Tim Gray

How Wharton alumni and faculty are influencing the surging economy that is reshaping global dynamics.

Robert Zou’s career trajectory would have been impossible in the China of a generation ago. In the span of three decades, he has gone from bricklayer to drug-company manager to entrepreneur.

Zou’s wide-ranging professional adventure personifies today’s China. As a teenager, Zou, WG’92, endured the Cultural Revolution, an ideological cleansing campaign initiated by Mao Zedong. Now, by starting and running Shanghai-based Arrail Dental Group, a chain of dental clinics, he enjoys income and travel opportunities his parents could never have imagined. “When I was a bricklayer, I didn’t even dream that I’d ever be able to go to college,” Zou says.

Today’s China is a country in the throes of cheerful tumult. Its huge, fast-growing economy is lifting millions of people out of poverty each year and creating a new class of entrepreneurs and executives. It is achieving, in a matter of decades, an economic feat that took hundreds of years in Western Europe and a century in the United States.

According to the World Bank, about 10% of the Chinese people live in poverty, compared with nearly two-thirds in the early 1980s. What’s more, the economy is growing at a rate of about 10% a year.

This summer, the Beijing Olympic Games were an extravagant coming-out party designed to show the world how far the country had come. China not only won the most gold medals but also staged an opening ceremony that could only have been produced by a place bursting with ambition, optimism, and 1.3 billion people.

Wharton’s China Strategy

Going forward, it’s essential for Wharton to be engaged in China,” says Franklin Allen, the school’s Nippon Life Professor of Finance. “China is where the future is, and it already has enormous influence on global finance through its sovereign wealth fund.” The fund, called the China Investment Corp., invests a portion the foreign currency reserves generated by China’s robust trade with the West.

“China was off on its own from about 1950 to 1980,” Allen adds. “Now it has re-emerged, and we need to know, as scholars, how they do things and to teach our students to do business in the ways that they do business.”

Wharton professors are taking up that challenge by educating entrepreneurs like Zou as well as providing insight into the forces behind China’s unprecedented boom.They travel to the country frequently to meet with government officials, corporate executives, and colleagues at Chinese universities. Allen, for example, has published a series of papers on the Chinese financial system as well as helping to organize an executive education program for China’s Securities Association, a nonprofit regulatory body.

Allen is only one of many. Raffi Amit, the Robert B. Goergen Professor of Entrepreneurship, has launched studies on how both entrepreneurial and family-owned companies operate in China. Marshall Meyer, the Richard A. Sapp Professor of Management, is examining the structure and geographic segmentation of Chinese firms.

“We can’t be global thought leaders unless we understand the phenomenon that is occurring in China,” Amit says.

Research is only part of Wharton’s multipronged engagement with China. Dean Thomas Robertson is leading an effort to ensure that the School and the country have a deep relationship that should only grow over the coming decades.

“I believe that the quality of the relationship between China and the United States will have a direct impact on global peace and prosperity in the 21st century. Mutual understanding will be a key factor in maintaining and strengthening this relationship,” he states. “The Wharton School must take the lead in learning about China, disseminating information broadly that will inform students and the interested public about China, and teaching the world’s future leaders about China.”

Since the 1970s, Wharton has worked cooperatively with Chinese business schools including the School of Management at Shanghai Jiao Tong University and Guanghua School of Management at Peking University. It has established alumni clubs in Beijing and Shanghai. And it has opened a representative office in Shanghai, which is run by China native Phillip Wu, WG’95. “We’re having an alumni forum in 2009 in Beijing,” Wu says. “I’m hoping we’ll have 1,000 people there.”

In addition to these initiatives, Wharton in 2005 launched China http://www.knowledgeatwharton.com.cn/index.cfm?languageid=4, both to generate new insight into the Chinese economy and to distribute broader research to the growing Chinese business readership. It’s published in traditional and simplified Chinese characters as well as in English.

Wharton’s ties to China stretch back to the early 20th century. In the 1920s, the School trained managers for the country’s national railroad system. Philadelphia, at the time, was one of America’s industrial and transportation hubs, and the School’s proximity to such major railroad operators as the Reading Co. drew the Chinese managers to Wharton.

“We played a prominent role in the creation of their railroad system,” says Jeffrey A. Sheehan, Wharton’s associate dean for international relations. These ties were broken in 1949 when Mao founded the People’s Republic of China, ushered in communist rule, and established a largely closed society. “There was a void until 1990,” Sheehan says. “It was a period when there were no Chinese students who came to Wharton.” These days, Sheehan says, Wharton receives about 600 admissions applications a year from China and currently has a network of 1,047 alumni in China.

A New Kind of Business Practice in China

In the 1980s, then-leader Deng Xiaoping began to relax the political and economic isolation of the Mao years. His government revived the country’s colleges and universities and encouraged Chinese students to study abroad. It was these changes that allowed Robert Zou to attend college first in China and later to attend Wharton.

When he was 15, the government assigned Zou to work as a bricklayer. At the same time, party officials branded his parents, both schoolteachers, as intellectuals who needed reeducation, sending them to the countryside to work as farm laborers while Zou remained in his hometown of Tianjin. He read schoolbooks at night to ease his loneliness and cobble together some semblance of a formal education. “I had to kill the time,” he recalls. “I had to do something. When I look back, nobody wants to have that kind of experience, but it gave me a kind of training. It was so difficult, so challenging.”

In the late 1970s, Deng’s reforms began to take hold. Zou took a college entrance exam and was admitted. (His parents also returned home.) He majored in English, and when he graduated, he landed a job with a pharmaceutical company that had a partnership with SmithKline Beacham, a predecessor of Glaxo Smithkline.That position led to one with SmithKline, which had its U.S. headquarters in Philadelphia. “I’d been to Philadelphia a number of times, and I talked with my colleagues about attending Wharton. They said, ‘Why not?’ So I applied.”

After graduating in 1992, Zou became a management consultant with AT Kearney, joining its Hong Kong office. While there, one of his former SmithKline bosses approached him about studying the dental-implants market in China. Zou obliged and found that while Chinese consumers weren’t ready for implants, they might patronize Western-style dental clinics for preventive care and cosmetic services. Previously, hospitals had provided most of China’s dental care, mainly on an emergency basis. Zou wrote a business plan for the company that would become Arrail. He then raised money, mostly in France.

“I came back [to China] in 1998 and started this business,” he says. “We opened the first clinic in April 1999. We’re a little different from clinics in the U.S. The average size of our clinics is 10 treatment rooms, with 10 to 15 dentists. Our largest has 20 treatment rooms and 25 dentists.”

Zou calls Arrail China’s first high-end private dental practice. It has 10 clinics with about 100 dentists. “Our motto is, ‘We’ll give you a confident smile,’” he says. Local companies and multinationals have begun to offer Arrail’s services as a fringe benefit to their executives.

As with any entrepreneurial venture, Arrail has faced obstacles, and sometimes still does. Despite a decade of operation, for example, it can’t persuade Chinese banks to lend it money. “We’re private and don’t have a lot of collateral, and they don’t care about cash flow,” Zou says. “We raised money privately at the beginning, and since then, we’ve grown from our own cash flow.”

Understanding the Growing Pains of a Financial System

The banking industry’s unwillingness to lend to entrepreneurs would seem to girdle China’s growth. But as recent numbers indicate, the economy is sizzling. Allen was intrigued by this paradox. As a finance professor, he couldn’t help but notice that China’s growth came despite an inefficient banking system and nascent capital markets. Until recently, the government owned the country’s banks, and loans were made based on policy goals, not creditworthiness. Banks, as a result, carried big slugs of non- performing loans on their books, which dragged down their earnings. At the same time, China’s stock and bond markets had barely reached adolescence, so they didn’t offer much of an alternative for companies seeking funding. “Up until just a few years ago, the banks were in terrible shape,” Allen notes. “And the markets still aren’t really very important in economic terms.”

A popular research topic among development economists is ferreting out the political characteristics and institutions that countries need to succeed economically. A common answer is good legal and financial systems. “Yet China has neither of those things,” Allen points out. “My co-authors and I document that using standard measures of the quality of institutions.”

What, then, has enabled China’s growth in the absence of these institutions? “We argue that there are alternatives that work well based on things like reputation and trust,” Allen says. “My co-author, Jun Qian, would argue that the Confucian culture also plays a role.” Qian is a finance professor at Boston College and a native of China. Confucius was an ancient philosopher and teacher who developed an ethical system that stresses devotion to family, love of humanity, and harmony in thought and conduct.

A recent follow-up study by Allen and Qian argues that, in some circumstances, China’s institutions enjoy advantages over their western counterparts. “The U.S. legal system, for example, can tend to get captured by interest groups,” Allen notes.

Allen’s travels in China have brought insights that have deepened his understanding of both the country, specifically, and economic development, in general. “I didn’t realize that development could happen that quickly. If you think about the U.S., it became the dominant country in the world over the space of maybe a century — from about 1850 to 1950. So people had a long time to adjust. Still, that came as a shock after the Second World War to Europeans.”

1,047 Wharton alumni live in China.

Nearly 50 Chinese students graduate from Wharton each year.

The Wharton Alumni Club has chapters in Shanghai (founded in 1987) and Beijing (founded in 1999).

China Knowledge@Wharton is published biweekly in English and simplified Chinese characters at www.knowledgeatwharton.com.cn.

The Wharton Global Alumni Forum will be held in Beijing, June 12-13, 2009. Visit www.wharton.upenn.edu/ alumni/forums/2009/beijing/ to register.

A Cultural Force Like No Other

Just as China surprised Allen, it has long fascinated other Westerners, inspiring awe — and affection — in those who study it. As writer Simon Winchester details in his recent book, The Man Who Loved China, the British biochemist Joseph Needham spent decades trying to unravel what’s come to be known as “the Needham question,” exploring how China, a country credited for inventing technologies such as printing, the compass and suspension bridges, ended up falling behind the West and missing much of the Scientific Revolution. Needham never managed to solve this puzzle, but in the process of trying he created an encyclopedic work, Science and Civilization in China.

Some scholars argue that no one has yet to sufficiently answer Needham’s question. Nonetheless, what might be called a “new Needham question” has emerged in its place, overshadowing the prior one. It goes something like this: How has China created one of the world’s largest industrial economies in the span of three decades, after starting from nearly nothing?

Marshall Meyer is, in some ways, an inheritor of Needham’s mantle. Today, he devotes much of his time to studying China and is both perplexed and intrigued by the place. And like Needham, much of his earlier career focused on other topics. He was, he says, a classic “quant,” someone who uses quantitative techniques like statistical analysis and mathematical modeling to unravel business problems. In his case, he studied organizational design and performance. But he became convinced a few years back that China’s economic emergence was likely the biggest business happening of his lifetime.

It started in 1999 when an opportunity arose for Wharton professors to teach at China’s Tsinghua University and Meyer grabbed it. He spoke no Chinese and knew little about the country but figured that business smarts and good manners — and capable translators — would compensate for his shortcomings. He couldn’t have predicted how geopolitics would nearly bollix his plans.

“The day that I flew to China was the day after the U.S. accidentally bombed China’s embassy in Belgrade [Yugoslavia],” he recalls. “United Airlines said, ‘We’re still flying, but we’re not sure you want to.’ One of my friends was supposed to be teaching there, too, and reneged, but I’m a damn-the-torpedoes type and went ahead.”

More trips and more teaching in China followed and Meyer soon began to research the efforts of China’s state- owned enterprises, or SOEs, to transition into for-profit firms. “I told one of my colleagues who knew China better than I did of my plans, and he said ‘You’ll spend the rest of your life just pounding on the door,’” Meyer recalls. SOE managers, his friend warned, had little to gain from cooperating with a western academic.

Yet over the last nine years, as Meyer has visited China four to six times a year, he has found the opposite to be true. Chinese executives welcome him and eagerly share information on their operations and challenges. Says Meyer, “Western academics are held in esteem in China, and you’re not viewed as political.”

Meyer has woven what he’s learned from these conversations into a series of case studies, articles and lectures, including one titled, “China’s Second Economic Transition: Building National Markets,” which he presented to the China Institute of Policy Studies, a government think tank reporting to Premier Wen Jiabao.

“My argument is that China can’t build global corporations until it tears down its internal barriers,” he explains. “The assumptions we make about western firms don’t hold in China. Even the large oil companies, like Sinopec and PetroChina, are deeply decentralized, and China as a country isn’t economically integrated. So I’m saying to them, ‘You have to build a domestic base before you can be effective globally.’ They hadn’t heard that before.”

Making a Western Brand Chinese

Sam Su, WG’83, would agree with Meyer that Western assumptions don’t work in China. In his case, that has meant that a firm can’t just take its systems from the United States and Europe and try to clone them in China. Su has learned that as a marketer and executive for Pepsico and Yum! Brands, which spun out of Pepsico. Today, he is China president for Yum, which owns the KFC, Pizza Hut, and Taco Bell fast-food chains.

Su arrived in Hong Kong, Yum’s hub in the region, in 1989. Soon, he was heading the effort to expand in China. Early on, he studied his competitors and realized that the uniformity that had made the industry leader, McDonald’s, so successful in the United States might be a weakness in China.

“Their system is so developed that it can’t change very well,” he notes. “We didn’t believe that a system created for the U.S. could be the answer in China because the Chinese are a very proud people. So we developed a strategy to fundamentally change the business model. We decided to create more variety with more protein and vegetable choices and to add new products to make the menu more exciting. Fast food is a format, not a food. It doesn’t have to be the same 23 items on the menu forever.”

Su’s improvisations appear to be working. KFC is the leading foreign-owned fast-food chain in China, with more than 2,500 outlets, and it’s opening a new store almost daily. Pizza Hut, though not as large, is also thriving, with about 400 eat-in restaurants and about 70 separately operated delivery services. But perhaps most impressive is Yum’s creation of a new chain, called East Dawning, that’s attempting to bring KFC standards for value and service to traditional Chinese food. For now, East Dawning is small, with 15 outlets. But if all goes well, Su may soon be exporting his flexible Chinese model to the United States and elsewhere.

Localizing Exotic Securities in a Complex Environment

David Yi Li’s business, finance, couldn’t be more different from Su’s.

Yet Li, WG’92, had a similar experience to Su’s when he became the head of UBS’s China subsidiary. He set about rethinking the company’s local strategy and realized that it relied too heavily on importing foreign methods and staff. He decided that a way to localize UBS’s approach would be to acquire a Chinese firm. At that point, the government had not allowed a foreign firm to do that.

He therefore approached Chinese regulators with a proposal to, as he puts it, “restructure” a troubled local outfit. Out of respect for local sensibilities, “we don’t say ‘acquired,’” he says. His plan won approval at the end of 2006, and the restructured company began operations in May 2007. “We became the first foreign company to really get into the local markets in securities,” he says. “Very senior people in the government tell me that we made history. They wanted to use us as a test case. They wanted to see how a foreign company would run a local securities firm.”

Like Robert Zou of Arrail, Li grew up in China and is old enough to remember the Cultural Revolution. He managed to endure that period in slightly more pleasant surroundings than some of his peers because of his athletic abilities: He was a professional soccer player. Even so, he recalls wondering what the future held at a time when so many avenues seemed closed.

“People my age, we’re so lucky,” he says. “We saw the Cultural Revolution and knew what was going on when the universities were closed. Then suddenly, the schools re-opened, and Deng Xiaoping said, ‘You guys can go abroad.’” That reopening to the West and to new ideas, Li suggests, laid the groundwork for today’s prosperity.

“The country is moving up, up, up. But we still have problems. The hardware buildup” — such things as infrastructure, factories, and skyscrapers — “has been pretty quick. But we still have a lot of work to do in the soft areas, like the balance of growth between east and west parts of the country and between the city and the countryside.”

The Force of Growing Freedom

Like Li, Z. John Zhang, Wharton’s Murrel J. Ades Professor of Marketing, is a native of China who’s old enough to remember the country before people had the ability to study abroad or start a business. He was a member of the first generation of students who enrolled in universities in the United States. He ended up staying and building a career as a teacher and researcher. But he returns home often, both to teach and visit family, and has seen the revolution in thinking and lifestyles that Deng’s seemingly simple reforms launched.

“Freedom does enable people,” he says. “Once you give people freedom to do whatever their capability allows, then you’ll create the economic miracle. It used to be that nobody had an incentive to work hard in China. Now you’re rewarded for what you do. A lot of entrepreneurs have been born and are doing things they’ve never thought possible before. All the reforms you see coming out of China, whenever they are successful, are essentially to return freedom to people in an orderly fashion.”

Wharton already has contributed to the success of many entrepreneurs through its research and teaching, through the activities of its alumni, and through the Chinese-language version of Knowledge@Wharton, the School’s biweekly online business-news and analysis journal. Zhang says. “I taught a large number of executives in China, and they read it,” he notes.

Those kinds of links will only grow as China continues to expand its role in world commerce. That, in turn, will help both China and Wharton, Zhang says. “This is one of the best business schools in the world,” he adds. “We’re known for generating new ideas and doing new kinds of analysis and for our innovations in business education. People in China tend to be very receptive to what we have to say, as we are all business. And in the process of teaching them, we keep our fingers on the pulse of China and get to know China much better.”

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