An emerging innovation power 2013 China Innovation Survey

An emerging innovation power 2013 China Innovation Survey

Contacts Strategy& Beijing Steven Veldhoen Partner +86-10-6563-8300 steven.veldhoen @strategyand.pwc.com Hong Kong Bill Peng Partner +86-10-6563-8300 bill.peng @strategyand.pwc.com Munich Anna Mansson Principal +49-89-54525-579 anna.mansson @strategyand.pwc.com Shanghai Sarah Butler Partner +86-21-2327-9800 sarah.butler @strategyand.pwc.com John Jullens Partner +86-21-2327-9800 john.jullens @strategyand.pwc.com Huchu Xu Partner +86-21-2327-9800 huchu.xu @strategyand.pwc.com China Europe International Business School George Yip Professor of Management gyip@ceibs.edu Bruce McKern Professor of International Business bmckern@ceibs.edu 2 Strategy&

About the authors Steven Veldhoen is a partner with Strategy& based in Beijing and head of its consumer and retail practice in China. He is the co-leader of the firm s global innovation practice and co-leads the firm s China innovation practice. Anna Mansson is a principal with Strategy& based in Munich. She is the leader of the firm s Greater China operations practice, principally working with companies in the engineered products, consumer, and retail sectors. She also co-leads the firm s China innovation practice. Bill Peng is a partner with Strategy& based in Hong Kong. He is the leader of its engineered products and services practice for Greater China, principally working with clients in the automotive, machinery, and manufacturing sectors. George Yip is a professor of management and co-director of the Centre on China Innovation at CEIBS. He is co executive editor of Chinese Management Insights. His current research concerns innovation, strategic transformation, and managing global customers. Bruce McKern is a professor of international business at China Europe International Business School (CEIBS) and co-director of the CEIBS Centre on China Innovation. His research interests are innovation and the globalization of firms from rapidly developing economies. This report was originally published by Booz & Company in 2013. The authors would like to thank Strategy& s John Jullens, Charles Wong, Olivier Pincon, and Michelle Wang, as well as Eric Chen, formerly of Booz & Company, for their contributions to this report. In addition, the authors would like to thank Mariska Kiewiet de Jonge, general manager, Shanghai, and Robbert Gorris, general manager, Beijing, of the Benelux Chamber of Commerce in China, along with Bofan Wu, publisher of 21st Century Business Review. Strategy& 3

Executive summary China is regaining its historical position as a global innovation power. The nation that brought the world such inventions as water-powered mills, paper money, and explosives is increasingly viewed as a center of 21st-century innovation excellence. That said, corporate and government leaders know that Chinese companies must move up the value chain for China to achieve developed nation status, and that the way to do this is by focusing on new technologies, product offerings, and services within the country. Local companies continue to spend massively on R&D, the government sector is actively supporting their efforts, and multinational companies (MNCs) are making large investments in China as a laboratory and workshop for global innovation. The China Innovation Survey, now in its second year, shows that innovators in mainland China are gaining rapidly in competitiveness compared with companies in Europe, United States, and other regions. This year, nearly two-thirds of respondents at MNCs operating in China said some Chinese competitors are at least as innovative as their own companies, a strong increase since last year. Chinese companies also said their innovation efforts are competitive with those of MNCs in China, although they still see significant room for improvement. And though they believe they are less innovative overseas than their multinational rivals, they plan to increase the amount of their innovation directed toward overseas markets. The survey also shows that China is well on its way to becoming a true global innovation hub for MNCs from developed markets: Some two-thirds of the respondents reported that they are conducting R&D in China for foreign markets and even more plan to do so in the future. In addition, the survey contradicts a piece of conventional wisdom: that innovation in China tends to focus on copying and making incremental improvements to existing products. In fact, the data shows that Chinese companies to a higher degree than most global competitors pursue the same kind of innovation strategies that are practiced by the world s most successful innovators, notably companies based in Silicon Valley. 4 Strategy&

These companies pursue Need Seeker strategies, as we will show below: focusing their R&D efforts on consumer needs, developing products that meet those needs, and then quickly getting the products to market. The challenge for Chinese innovators going forward will be to preserve and build on this model as they grow domestically and internationally. For MNCs in China, the challenge will be to integrate innovation in China into their established global innovation models. Finally, this year, for the first time, we asked participants to cast votes for the most innovative Chinese companies (see Top 10 Innovative Companies in Mainland China, page 26). The China Innovation Survey is jointly conducted by the Benelux Chamber of Commerce in China, 21st Century Business Review, China Europe International Business School, and Strategy&. This year s survey reflects the views of 264 respondents, more than double the number who participated in 2012. More than 80 percent of the respondents are C-suite executives, corporate officers, directors, or managers. To further develop our understanding of the data, we also conducted individual interviews with key executives in a range of companies and industries (see Appendix, page 27). Strategy& 5

China s innovators on the rise China s investments in R&D are rapidly increasing. The number of China-based companies appearing on Strategy& s Global Innovation 1000 (which lists the publicly held companies that spend the most each year on research and development) has risen from 15 to nearly 50 over the past five years. In 2011, companies headquartered in China increased their R&D spending by 26.5 percent more than double the global average, five times as much as European firms, and 11 times as much as Japanese firms (see Exhibit 1, next page). The strong growth in R&D spending is evidently beginning to pay off. This year s China Innovation Survey shows that both the perceived quality and the effectiveness of innovation in China continue to advance. Some 64 percent of the respondents at non-chinese companies said some Chinese competitors are equal to or better than their own companies at innovation a strong increase from 48 percent in the 2012 survey (see Exhibit 2, page 8). Other data confirms this perception. A recent survey of more than 1,500 senior executives in Europe conducted by Strategy&, the European Executive Council, and INSEAD found that European companies now consider China a greater competitive threat in the field of innovation than the U.S., India, or Japan. China, the report stated, is being seen as an innovation heavyweight largely due to its massive catch-up investments in R&D and education. 1 Chinese companies are moving aggressively to make their innovation programs more global. More than two-thirds of respondents this year said they are now conducting product development for the rest of the world in China, up sharply from 41 percent in 2012. Even more expect to be doing so in the future: 88 percent of Chinese companies said they will be doing global R&D in China by 2023 (see Exhibit 3, page 9). Chinese executives, however, are striving for far more, and they believe there is considerable scope for further improvement in innovation, according to the survey. Just more than half the participants at Chinese companies said their companies are among the most innovative in their 6 Strategy&

Exhibit 1 Chinese companies are increasing their investments in R&D faster than competitors in any other market 30 25 26.5% 20 15 10 5 12.2% 9.7% 5.4% Average 9.6% 2.4% 0 China Rest of world North America Europe Japan Change in R&D spend by companies headquartered in each region, 2010 2011 Note: 2012 Global Innovation 1000 yearly R&D comparison for the 918 companies for which R&D spending is available for both 2011 and 2010. Source: Bloomberg data; Strategy& Global Innovation 1000 articles in strategy+business; Strategy& analysis home market, but only about a quarter count themselves among the most innovative companies in the world (see Exhibit 4, page 9). This is particularly true for companies in the automotive, finance/insurance, and computing and telecom industries. As Chinese companies become more competitive in innovation, they increasingly worry about potential obstacles to further innovation growth. The survey shows that access to talent, retention of talent, and rapid cost increases are all key concerns for innovation in the future. The areas of concern that have increased the most over the last year include difficulties in understanding market needs (particularly in the Strategy& 7

industrials sector), inadequate infrastructure and innovation ecosystems, and inadequate intellectual property protection (particularly in the health and life sciences industry). These worries are likely to increase pressure for stronger laws regarding intellectual property protection, and may well lead to more innovative ways to conduct R&D in cooperation with universities, institutes, and other entities. MNCs in China, however, did not report increasing concerns over the past year (see Exhibit 5, page 10). Exhibit 2 Nearly two-thirds of non-chinese respondents say Chinese competitors are better than or equal to their own company in innovation 30% 36% 40% 53% 18% 24% 2012 survey 2013 survey Chinese more innovative Chinese equally innovative Chinese less innovative Some Chinese competitors are better innovators than my company (% of non-chinese company respondents) Source: 2012 China Innovation Survey; 2013 China Innovation Survey 8 Strategy&

Exhibit 3 Chinese companies are increasingly developing products for the rest of the world % of respondents 100 80 60 41 40 +66% 68 64 +38% 88 Average agreement 5 4 4.6 4.7 3 2 3.0 3.3 3.1 3.4 3.3 3.6 20 1 0 2012 2013 In 10 years (2022) In 10 years (2023) 0 Mainland China Western markets Developed Asian markets Developing markets 2012 survey 2013 survey 2013 10 years later Chinese respondents conducting product development for foreign markets in China Relevance of R&D from China for different markets My company s R&D efforts in China contribute to developing products/services in. (1=strongly disagree, 5=strongly agree) Source: 2012 China Innovation Survey; 2013 China Innovation Survey Exhibit 4 Despite recent progress, Chinese respondents do not consider themselves among the global elite in innovation Average agreement Average agreement 5 4 3 3.6 3.4 5 4 3 2.8 3.6 2 2 1 1 One of the most innovative in our industry in mainland China Chinese companies and MNCs views of their innovation competitiveness in China and in the world (1=strongly disagree, 3=neutral, 5=strongly agree) One of the most innovative in our industry in the world Chinese company Non-Chinese company Source: 2012 China Innovation Survey; 2013 China Innovation Survey Strategy& 9

Exhibit 5 Key concerns of Chinese innovators include understanding market needs, a lack of IP protection, and an insufficient innovation ecosystem Average agreement 5 4 3 2 1 +7% -1% +18% +18% +5% +12% 3.9 4.2 4.3 4.2 4.2 4.3 3.7 3.9 3.9 3.9 3.4 3.5 3.4 3.8 3.8 2.9 3.3 3.9 Talent access Chinese companies Talent retention Difficulties in understanding market needs Rapid cost increases Inadequate infrastructure and innovation ecosystem Inadequate intellectual property protection Average agreement 5 4 3 2 1 +7% -1% +11% +2% 3.7 4.0 4.0 3.9 4.1 0% +2% 4.0 3.3 3.2 3.2 3.6 3.7 3.5 3.6 2.9 3.2 3.2 3.0 Talent access Non-Chinese companies Talent retention Difficulties in understanding market needs Rapid cost increases Inadequate infrastructure and innovation ecosystem Inadequate intellectual property protection 3.3 Key obstacles today and in the future In the process of conducting innovation in China, my company faces and will face the following challenges (1=strongly disagree, 5=strongly agree) 2012 survey 2013 survey 2023 perspective in 2013 survey Source: Strategy& 10 Strategy&

China for the world The results of the China Innovation Survey also show an acceleration of China s development into a true global innovation hub for MNCs from developed markets. Two-thirds of the MNCs in China that took part in the survey reported that they are already conducting product development for foreign or global markets in China, a significant increase from last year s survey, when just more than half said they were doing global R&D there. Participants were even more aggressive in their projections for the future: 74 percent said they expect to be conducting global R&D in China for the rest of the world 10 years from now, up from 65 percent last year (see Exhibit 6, next page). Among MNCs in China, the greatest proportions of companies doing R&D for global markets are in automotive (77 percent) and computing and telecom (76 percent), followed by consumer goods (72 percent), health/life sciences (71 percent), and industrials (70 percent). As is the case with Chinese companies, chemicals and finance/insurance are below average in this category. In nearly every industry, the proportion of MNCs conducting global R&D in China is expected to rise over the next 10 years. Consumer goods, health, and industrial companies have the most aggressive plans for global innovation based in China. By 2023, for example, 94 percent of the survey respondents at consumer goods MNCs in China, as well as 88 percent of those in health/life sciences and industrials, expect to be doing global R&D in China (see Exhibit 7, page 13). One example of the kind of products generated by innovative MNCs based in China is the Chevrolet Sail car, manufactured by Shanghai General Motors (a joint venture of General Motors and SAIC Motor). The latest model was designed and engineered at Shanghai GM s Pan-Asia Technical Automotive Center, and is exported to India, Latin America, North Africa, and the Middle East. In other industries, such as healthcare, MNCs are using innovations pioneered for the Chinese market for export to other markets. GE Medical Systems subsidiary in Wuxi, for example, developed and launched a sophisticated, compact ultrasound diagnostic machine that has become a global success. Strategy& 11

Exhibit 6 China is becoming a true innovation hub, even for non-chinese companies based in the country % of respondents 100 80 60 51 +29% 66 65 +14% 74 40 20 0 2012 2013 In 10 years (2022) In 10 years (2023) Non-Chinese companies in China that conduct product development for foreign/global markets 2012 survey 2013 survey Source: 2013 China Innovation Survey MNCs plan to increase innovation from China for Western markets now seen as equally important as the Chinese market for local companies and they increasingly feel that their R&D efforts contribute to developing better products and services for those markets. Asked for their 10-year projections, they rated the importance of innovation slightly higher for Western markets than for developing markets or developed Asia (see Exhibit 8, next page). MNCs also plan to further develop their innovation centers in China: The vast majority (83 percent) believe that China-based R&D is adding equivalent or higher value to their bottom lines in comparison with R&D conducted in other regions. By 2023, almost all respondents expect that China-based R&D will be adding equivalent or higher value (see Exhibit 9, page 14). 12 Strategy&

Exhibit 7 In most sectors, innovation among non-chinese companies based in the country is expected to increase % of respondents 100 80 60 40 77 80 54 69 76 82 72 94 42 67 71 88 70 88 Average 68 20 0 Automotive Chemicals & energy Computing & telecom Consumer goods Finance/ insurance Health/life sciences Industrials Non-Chinese companies that conduct product development in China for foreign/global markets Present 10 years later Source: 2013 China Innovation Survey Exhibit 8 MNCs in China now see innovation in China for Western markets equally important as for developing markets and the rest of Asia Average agreement 5.0 4.6 4.5 4.2 4.0 3.5 3.0 2.5 2.0 1.5 1.0 Mainland China 3.0 3.9 Developing markets 2.9 3.7 Developed Asian markets 2.2 3.1 Western markets Average agreement 5.0 4.3 4.5 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 Mainland China 3.0 3.4 Developing markets 3.1 3.6 Developed Asian markets 3.2 3.7 Western markets 2012 survey 2013 survey Relevance of R&D from China for different markets (responses from non-chinese companies) My company s R&D efforts in China contribute to developing products/services in. (1=strongly disagree, 5=strongly agree) Note: Developed Asian markets include Japan, South Korea, and Taiwan; developing markets include (but are not limited to) India and Southeast Asian countries. Present 10 years later Source: 2013 China Innovation Survey Strategy& 13

Exhibit 9 The value of R&D work done in China is equal to or greater than that done in other markets Lower value added 1 18% 4% 13% 2% 4% 10% 2 16% 27% 32% Equivalent 3 32% 33% Higher value added 4 5 28% 7% 23% 51% 2012 rating 2013 rating 2023 expectation In comparison with R&D work performed worldwide, my company s R&D work performed in China is. (1=lower value added, 3=equivalent, 5=higher value added) Note: Sums may not total 100 due to rounding. Source: 2012 China Innovation Survey; 2013 China Innovation Survey 14 Strategy&

Innovation case study: WeChat WeChat is a good example of Chinese innovation. The free program, developed internally by Tencent, builds on the instant-messaging functions of earlier platforms like WhatsApp and the social media components of Facebook by combining these features into a single app and adding new functions. Launched in January 2011, the program has grown extremely rapidly, with more than 450 million users today. That success stems from Tencent s capabilities in three specific areas: Internet user intelligence, microinnovation, and execution excellence. Internet user intelligence: Tencent, the largest Internet company in China (and among the largest in the world), has significant experience in Internet operations. The company s portfolio includes QQ.com, a major Web portal in China, along with QQ, an instantmessaging service; social networks; e-commerce technology; and game platforms. As a result, it has a deep understanding of Chinese Internet users, allowing it to rapidly identify the market potential of new applications and services. Microinnovation: In addition, WeChat does not merely mimic earlier programs. Tencent has strong capabilities in microinnovation, which allow it to develop new features to meet the needs of Chinese consumers. For example, WeChat allows voice chat and group chat, along with several innovative social media features. One of them, called Shake, allows users to connect with other WeChat participants, locally or worldwide, simply by shaking the phone. Drift Bottle lets users send a message out to float among the WeChat user base like a message in a bottle until someone decides to open it and respond. In addition, Tencent recently announced that it will add mobile gaming functions to the platform as well. Execution excellence: Tencent s large team and sufficient resources enable it to roll out programs extremely rapidly. The company launched tailored versions of WeChat for different mobile platforms (ios, Android, Symbian, Windows) within a week, and it released 44 updates in its first year. Strategy& 15

The China innovation strategy The 2013 survey results show that innovation strategies by MNCs in China and local Chinese companies differ significantly, more so than indicated last year. We posed a series of questions about the innovation strategies that companies are pursuing, using the taxonomy developed over the last eight years in Strategy& s Global Innovation 1000 study, 2 which slots innovators into three categories: Need Seekers, Market Readers, and Technology Drivers (as estimated by Strategy& from respondents answers). Need Seekers, such as Apple, Procter & Gamble, and Haier, focus on proactively engaging customers directly to generate ideas. They develop new products and services based on superior end-user understanding. Their goal is to seek out both articulated and unarticulated needs, and then to try to get new products that address these needs to market first. Market Readers, such as Hyundai and Caterpillar, generate ideas by closely monitoring their markets, customers, and competitors and creating value through incremental innovations. This implies a more cautious approach one that depends on being a fast follower in the marketplace. Technology Drivers, such as Google and Bosch, depend heavily on their internal technological capabilities to develop new products and services. They leverage their R&D investments to drive both breakthrough innovation and incremental change, in hopes of meeting the known and unknown needs of their customers via new technology. They tend to be the least proactive in directly contacting customers. Following a Need Seeker strategy, although difficult, offers the greatest potential for superior performance in the long term. Although each of the strategies can be highly successful, analysis from the Global Innovation 1000 study shows that following a Need Seeker strategy, although difficult, offers the greatest potential for superior performance in the long term. Fifty percent of the respondents who defined their companies as Need Seekers in the 2012 study, for example, said their companies were effective at both the ideation and conversion stages of innovation, compared with just 12 percent of 16 Strategy&

Market Readers and 20 percent of Technology Drivers. The study also found that these are the same companies, by and large, that consistently outperform their peers financially. This year s China Innovation Survey shows that a much higher share of Chinese companies are following the Need Seeker strategy. In 2013, fully 44 percent of the Chinese companies we surveyed see themselves as conducting activities that make up the Need Seeker strategy, compared to the Global Innovation 1000 average of 27 percent. Non- Chinese MNCs, on the other hand, were near the global average, at 29 percent, with the majority of respondents following a Technology Driver approach. This disproves the conventional wisdom that Chinese companies tend to be more in the fast follower camp, copying and improving other companies products (see Exhibit 10, next page). Interestingly, Chinese companies share their propensity to pursue the Need Seeker strategy with companies in one other distinct geography: Silicon Valley. The Global Innovation 1000 study found that 46 percent of Silicon Valley companies are Need Seekers, just a bit more than the share of Chinese companies. 3 MNCs in China, in contrast, continue to drive innovation in the country predominantly through their technology advantage, stemming from fundamental research and superior technology. As Chinese competitors gain experience and maturity, however, it is likely that they will catch up in these areas over time. We therefore expect that MNCs will find it increasingly important to adopt some components of the Need Seeker strategies and tools used by local companies, so they can identify customer needs more quickly and leverage the resulting insights to innovate along the entire value chain, including channel and service innovation. The fragmentation of customer needs across the vast country will also make it more and more important to understand these needs in order to tap into demand in lower-tier cities. Strategy& 17

Exhibit 10 Chinese companies are more likely to be Need Seekers than the global average 38% 44% 27% 30% 29% Need Seeker 28% 25% 26% 50% 34% Market Reader 33% 32% 47% 20% 37% Technology Driver 2012 2013 Chinese company in China World average of Global Innovation 1000 2012 2013 Non-Chinese MNC in China Innovation strategy (by company type) Note: State-owned enterprises are more oriented to a Need Seeker approach (47% Need Seeker, 22% Market Reader, and 31% Technology Driver) than private Chinese companies (41% Need Seeker, 27% Market Reader, and 32% Technology Driver). Sums may not total 100 due to rounding. Source: 2012 China Innovation Survey; 2013 China Innovation Survey 18 Strategy&

Needed capabilities not yet clear Participants were asked to identify the most critical capabilities (which we define as processes, tools, knowledge, skills, and organization) for each of the four stages of innovation: ideation, idea conversion, product development, and commercialization. The results show that Chinese innovators (both local and MNCs) have a less distinct view of the key capabilities needed. This points to several conclusions: 1. The innovation environment is still evolving. 2. Companies operating in China require a distinct set of capabilities that are different from those needed in other markets. 3. There is significant scope for Chinese companies to improve their effectiveness in deploying innovation capabilities. There is less agreement among companies about which key capabilities are needed to innovate successfully in China than in other geographies. We calculated this by asking participants to rank the importance of capabilities needed at each of the four stages of innovation. In the global average, there was a large spread between the capability that companies rank the highest at each stage, and the capability they rate the lowest, showing a consensus about which capabilities are required for success at each stage of innovation (a sign that the global innovation market is relatively mature). No similar consensus, however, was evident in the results for Chinese companies and MNCs operating in China. Instead of identifying a distinct, clear-cut winning capability for each innovation stage, respondents gave very similar rankings to both the most and least important innovation capabilities. For example, at the ideation stage, the global consensus is clear: The two most important capabilities are consumer and customer insights and analytics, and understanding of emerging technology trends; the least important is supplier and distributor engagement. For Chinese companies and MNCs operating in China, in contrast, the rankings for all the capabilities are clustered in the middle ranks. The results for the other three stages of innovation Strategy& 19

are similar. This suggests that the innovation market in China continues to evolve, and that both local companies and MNCs are having difficulty identifying and prioritizing the most important capabilities (see Exhibit 11, next page). Even though Chinese companies and MNCs operating in China do not cite many distinct innovation capabilities, the ones that are distinct are different from the ones we see globally. The survey results show that Chinese companies are still focusing on core innovation capabilities such as platform management and production ramp-up, and are also moving away from reverse engineering as the sole source of innovation. The MNCs in China are more formal and process-driven, and focus on capabilities related to government relationship management and understanding the market potential (see Exhibit 12, page 22). Chinese companies and MNCs also favor different innovation tools. For example, at the ideation stage, Chinese companies are making greater use of customer-focused tools such as direct customer observation and end-user/customer focus groups, while MNCs in China appear to make greater use of feedback from sales/customer support, and technology road mapping (see Exhibit 13, page 23). Both sets of favored tools are quite different from the global averages. One of the survey results shows the potential for Chinese companies to further improve their innovation efforts: Chinese companies consider themselves weakest on the very capabilities that they see as most important to contributing to the company s success. For example, Chinese companies ranked the capability to manage global, enterprisewide product launches as the most critical, but also gave themselves poor marks for their competence in executing this capability. The results are similar for product life-cycle management and open innovation/ capturing new ideas (see Exhibit 14, page 24). (For MNCs operating in China, there is no significant relationship between importance and competence.) 20 Strategy&

Exhibit 11 Companies in China are less clear on innovation priorities than firms in other markets Understanding of technology trends Consumer and customer insights Competitive insights 3.0 Supplier/distributor engagement 3.0 Resource forecasting and planning Market potential assessment 3.4 Portfolio trade-off decision making Technical risk assessment/management Strategic disruption decision making Product platform management 2.8 2.8 2.9 2.8 Specific goal design 2.9 Reverse engineering 3.3 Supplier/partner engagement 3.0 Customer engagement 2.6 3.1 3.2 Controlled rollouts 3.6 Product life-cycle management Diverse user group management Production ramp-up 3.2 Regulatory/government relationship management Non-Chinese MNCs in China Open innovation 3.4 2.8 3.4 3.5 3.9 Chinese companies in China 2.9 2.9 2.7 2.6 2.9 3.2 3.1 2.9 3.2 3.0 3.0 3.0 3.3 3.2 3.0 2.9 3.9 3.5 3.3 3.3 Global average 2.0 1.7 2.7 2.7 2.5 2.4 2.6 2.4 2.4 2.9 3.2 3.0 2.7 3.5 3.4 4.2 4.5 3.7 4.1 3.9 Ideation Idea conversion Product development Commercialization +1.3 +1.3 +2.8 Capability average importance (1=least important, 5=most important) Source: 2013 China Innovation Survey Strategy& 21

Exhibit 12 Chinese and non-chinese companies emphasize different innovation capabilities Pilot user selection/controlled rollouts 3.9 Product life-cycle management 3.5 Regulatory/government relationship management Pilot user selection/controlled rollouts 3.6 3.9 Diverse user group management 3.3 Diverse user group management 3.5 Product platform management 3.3 Product life-cycle management 3.4 Production ramp-up 3.3 Open innovation/capturing ideas at any point in the process 3.4 Open innovation/capturing ideas at any point in the process 3.2 Ongoing assessment of market potential 3.4 Project resource requirements forecasting and planning 3.2 Reverse engineering 3.3 Chinese companies rating of most important capabilities Non-Chinese MNCs rating of most important capabilities Top seven capabilities for innovation in China (1=low importance, 5=high importance) Ideation Idea conversion Product development Commercialization Unique critical capabilities Source: 2013 China Innovation Survey 22 Strategy&

Exhibit 13 Chinese and non-chinese companies favor different key ideation tools Ideation processes, tools, and practices 0 20 40 % of respondents 60 80 100 Direct customer observation 63 78 15 Traditional market research 62 59 Idea workout sessions 57 57 Feedback from sales/ customer support 65 78 13 End-user/customer focus groups 48 58 10 Technology road mapping 37 52 15 Respondents use of key ideation tools Chinese company Non-Chinese company Note: Key tools are those used by more than 50% of respondents. Source: 2013 China Innovation Survey Strategy& 23

Exhibit 14 Chinese companies indicate weakness in the capabilities they perceive as most critical Competency 5.0 High 4.5 4.0 Product life-cycle management 3.5 3.0 2.5 Open innovation/capturing ideas Low Global product launches 0.0 0.0 2.5 3.0 3.5 4.0 4.5 5.0 Low Importance for success High Perceived capability importance vs. competency (all capabilities) Chinese companies Non-Chinese companies Source: 2013 China Innovation Survey 24 Strategy&

Market implications Companies in China have made great strides in building their innovation competitiveness, according to the 2013 China Innovation Survey. The sharp improvements from 2012 to 2013 also show that the innovation imperative in China has momentum, and that further advances are likely over the next several years. Chinese companies are more aggressively using their unique innovation strategies to pursue opportunities in global markets, particularly Western markets. Critically, however, the data also shows that Chinese companies have not become complacent, but instead are quite self-critical and aware of the potential for improvement. This suggests that they can make even greater gains in the future if they can extend the innovation results they have achieved domestically to markets in the developed and developing worlds. China has already established itself as a location for R&D that is competitive with most other regions of the world, according to the survey. MNCs are developing their innovation centers in China as global hubs, and they are accordingly adding value to their organizations there. Overall, R&D spending in China was nearly 2 percent of GDP in 2012, still less than the 4 to 5 percent typical in developed countries. China, however, is a large country, and spending in cities like Shanghai and Beijing is already in the 4 to 5 percent range, indicating that these cities are becoming global innovation hubs. Innovation in China is rapidly gaining strength, and the country may regain its place as a world center for innovation. Chinese companies will use their specific innovation strategies and advantages to compete with their rivals at first domestically, but later also globally. Multinational companies, for their part, will find themselves forced to adapt their innovation models in order to compete more effectively with Chinese companies. They also will have to face the challenges of figuring out how to integrate China-based R&D into their global research networks. Innovation in China is rapidly gaining strength, and the country may regain its place as a world center for innovation. For Chinese companies, the biggest challenge will be to preserve some of the advantages they have built up, particularly as MNCs begin to understand the abilities of their Chinese competitors and look for ways to emulate their strengths and incorporate them into their own proven ways of doing business. Strategy& 25

Top 10 innovative companies in mainland china Respondents to the 2013 China Innovation Survey were asked to name the most innovative Chinese company (see Exhibit A). Alibaba Group was voted number one. According to vice president Junling Li, the nation s leading B2B company pursues innovation on two levels: at the strategic level, which requires top-down decision making from the core management team, and through frontline employees providing new ideas from the bottom up. What s essential to keep the innovation mechanism healthy, says Li, is the right culture: There should be a culture, rather than a process, to make information flow effectively within the organization. Process is the foe of innovation. Three other companies on the Top 10 list are Internet-based: Tencent Holdings (3), whose businesses include social networks such as the Tencent QQ instant-messaging service, Web portals, e-commerce, gaming, and the extremely popular WeChat application (see Innovation Case Study: WeChat, page 15); Baidu (7), the Web services company best known for its Chinese language search engine; and 360Buy Group (9), the nation s largest B2C retailer. Five of the top 10 are manufacturing companies: Huawei Investment & Holding (2), which operates in the telecommunications equipment, mobile devices, and consulting industries; Lenovo Group (4), computers and smartphones; Sany Heavy Industry Company (5), heavy machinery; Haier Electronics Group (8), consumer electronics and home appliances; and Wanxiang Group (10), auto parts. China Merchants Bank (6), the Shenzhen-based banking company with more than 500 branches in mainland China, Hong Kong, and New York, is the only company in the Top 10 from the financial sector. Exhibit A Most innovative Chinese companies Rank Company name Rank Company name 1 Alibaba Group 6 China Merchants Bank 2 Huawei Investment & Holding 7 Baidu 3 Tencent Holdings 8 Haier Electronics Group 4 Lenovo Group 9 360Buy Group 5 Sany Heavy Industry Company 10 Wanxiang Group Source: 2013 China Innovation Survey 26 Strategy&

Appendix Survey population 264 161 (61%) 7 (3%) Professional services 14% Other 3% 9% Automotive 9% Chemicals & energy Other 17% C-suite 28% 110 44 (40%) 66 (60%) 2012 96 (36%) 2013 Industrials 22% Health/life sciences 7% 9% 14% Finance/insurance Computing & telecom 13% Consumer goods Manager 27% 9% Director/general manager 18% Vice president (including SVP & EVP) Total respondents Breakdown of participants by industry Breakdown of participants by position Not disclosed Chinese companies Non-Chinese companies Note: Chinese companies include both private organizations and stateowned enterprises. Non-Chinese companies include MNCs and Sinoforeign joint ventures. Sums may not total 100 due to rounding. Source: 2013 China Innovation Survey Strategy& 27

Strategy& is a global team of practical strategists committed to helping you seize essential advantage. We do that by working alongside you to solve your toughest problems and helping you capture your greatest opportunities. These are complex and high-stakes undertakings often game-changing transformations. We bring 100 years of strategy consulting experience and the unrivaled industry and functional capabilities of the PwC network to the task. Whether you re charting your corporate strategy, transforming a function or business unit, or building critical capabilities, we ll help you create the value you re looking for with speed, confidence, and impact. We are a member of the PwC network of firms in 157 countries with more than 184,000 people committed to delivering quality in assurance, tax, and advisory services. Tell us what matters to you and find out more by visiting us at strategyand.pwc.com. Endnotes 1 Growing Europe: The Competitiveness Imperative, State of the European Union 2013, Strategy&, INSEAD, and European Executive Council, www.strategyand.pwc.com/media/file/strategyand_eec_ INSEAD_Revitalising-the-European-Dream-2013.pdf. 2 The 2012 Global Innovation 1000 Study: Making Ideas Work, Strategy&, www.strategyand.pwc.com/media/file/strategyand_the-2012- Global-Innovation-1000-Study.pdf. 3 Barry Jaruzelski, John Loehr, and Richard Holman, The Global Innovation 1000: Why Culture Is Key, strategy+business, Winter 2011, www.strategy-business.com/article/11404?gko=dfbfc. This report was originally published by Booz & Company in 2013. www.strategyand.pwc.com 2013 PwC. All rights reserved. PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity. Please see www.pwc.com/structure for further details. Disclaimer: This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.